Brad Setser

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Cross border flows, with a bit of macroeconomics

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Their savings, our problem?

by Brad Setser
November 30, 2004

It seems like American households are now saving about a penny of every dollar they earn, and recently even less. Foreigners exporting to the US, in contrast, save roughly 35 cents of every dollar they earn.

That is why the US depends so heavily on foreign central banks — and other generous souls abroad — to finance our budget deficit, and, more generally, to let Americans spend more than Americans earn. In aggregate, foreign savings will finance somewhere between a quarter and a third of all US investment this year.

Bond king Bill Gross clearly does not think this game can be sustained for long. But he also notes that if foreign central banks snap up every extra dollar that their exporters are earning in the US and then lend these dollars back to the US by buying US Treasuries, a larger current account deficit could well be consistent with stable Treasury prices/ relatively low interest rates — at least for a while.

If Gross did not learn that lesson from personal experience, others certainly did. Shorting the 10 year Treasury bond was painful at times over the summer. If a falling dollar generates more pain than the rest of the world can bear, and some big time players start intervening again and they park the dollars they are buying in the Treasury market, that would have an impact on the Treasury market. To quote Crane and MacKenzie in today’s WSJ: “Asian central banks have been called the no. 1 distorting factor in the Treasury market for much of this year. Their stepped-up buying of Treasurys, particularly in the first quarter, helped keep yields artificially low, according to many domestic investors and analysts.”

Crane and MacKenzie, though, go on to note: “investors now believe Asia’s support can no longer be taken for granted.” The Bush Administration, unfortunately, does not seem to be in the same place as the bond market. The United States’ current creditors have reason to be scared when an economist at a think tank close to the Bush administration on economic policy, if not on foreign policy, suggests that the US can increase its fiscal deficit by $212 billion a year without any impact on interest rates. The evidence: US debt went up by a trillion in Bush’s first four years without much impact on long rates. Of course, Asian central bank buying had something to do with that — as Steve Roach has noted, Asian reserves went up by about a trillion over the same time frame too.

Gross’ commentary on the Treasury market suggests one way our creditors could make their (dis)pleasure at US policy known: shift from Treasuries to short-term bank deposits. That would put pressure on long-term interest rates. It might remind US policy makers that long-term interest rates stayed low despite a surge in supply in no small part because of an offsetting surge in demand from foreign central banks. Sell Treasuries but not dollars. Clever. The tactic would work anytime a major holder of Treasuries wanted to signal, relatively subtly, that US economic policy — or for that matter US foreign policy — is failing the global test.

To be sure, a big holder could not shift out of the Treasury market, particularly the long-end of the market, without moving the market and cutting the value of its remaining holdings. The US should not take too much comfort from this though. If Gross is right, those in Asia holding long-dated, fixed coupon Treasuries are gonna see their value fall, the only real question is when … if they start to think the US is ignoring their concerns as creditors, they might decide the time has come to send the US a signal.


  • Posted by Navin

    I think the biggest headache for US officials is they dont know how China and Japan are going to play their cards.

    Economic Question : Is dollar decline a panacea for all economic problems in united states ?

  • Posted by DF

    Question :

    Let us imagine there is something as a maximum to the ratio debt/revenue.

    That maximum can be within a country (inner debt), to other countries (external debt) or globaly (world debt/world GDP).

    That would mean, that once this maximum is reached, it has to go down.
    In that case, there is no way a central bank can fight deflation.
    japan has been able to fight deflation through increased debt levels, increased money creation, it has been helped in this by the USA deficits, its need for imports and for savings (if you can’t force your own countrymen to spend, lend the savings abroad to consumers)…
    Now that the USA need to lower its debt level.
    What happens now ?

    please have a look at the reasonning below and tell me your opinion

    The problem is excess debt. Debt flows from savers – producers to consumers.
    It flows within countries : companies are eager for profit, instead of lowering prices or raising wages, they have increased their lending to consumers. (no increase in real wages, increase in consumer debt)
    It flows from exporting countries (Asia) to importing countries (USA).

    These flows of debt have increased at a higher pace than the pace of the global economy and each national economy. (increasing debt/revenue ratio)

    This flow of debt brings a flow of newly available money. (Money creation is the other side of debt expansion)

    There are increasing risks of bankrupcy, therefore these flows have to slow, they need to stop increasing or to increase at a slower pace than the economy …

    Because of reduced flows of debt there will be reduced demand, excess capacities, pressure on prices deflation.
    Because of reduced flows of debt, there will be reduced money creation, less cash available, again deflation.
    You can count on a depression. And reducing the ratio debt/revenue in a period of decreasing revenue (depression) … is even harder.
    You can count of falling asset prices, and therefore increased ratios debt/assets. Increased risks of bankrupcy.

    There is very little central banks can do about this. If there is too much debt around, no money creation is possible.
    Ex. The usual way to create money for the US central bank is to buy US bonds.
    Now imagine, that there is a reduced confidence in the US hability to repay its debt. Imagine this reduced confidence is so great that the US government pass policies leading to a budget surplus (or for the matter to reduced deficits) … How will the central bank create money ?

  • Posted by Jeff Fisher

    Alan Greenspan touched on this in his essay:
    Gold and Economic Freedom
    [written in 1966]

    “There is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
    This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.”

    My comment: It all boils down to property rights.
    The fractional reserve system protected by a central bank from collapse is a sham. It is fraud, and the cause of the effects we lament. Banks are free from honoring their commitments, and Government is free to deficit spend. War is financed, welfare programs expanded, and savings consumed. However, as Greenspan said “The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.”

  • Posted by General Glut

    Brad, I had thought that central banks concentrated their treasury note holdings in shorter term bills and didn’t hold the 10-year. Is this so?

    Gen’l Glut

  • Posted by Ian

    Recent steepening of the yield curve suggests that Asian central banks may be following Bill Gross’s (and Andy Xie of Morgan Stanley) suggestion to shorten up the duration of their US Treasury holdings.

  • Posted by hemant bhai

    ref the comment from Alan Greenspan that there is no way to escape inflation tax except gold.

    This is false. Buying land is the best and easy methof of inflation protection. It fails only when social order collapses under hyperinflation.

    Rent-seeking is the driving force behind American money creation. you folks probably know better than me, but Henry George warned about this a century ago.

    Eventually landlords will confiscate all production. This has happened in Japan with serious social consequences. Land in Japan has become so unaffordable (due to landlord-banker combine) that people refuse to get married and have children. Have children for what – when you have almost nothing left over after paying for the roof?

  • Posted by Marcel

    It would appear that the analysis of central bank purchases of US Treasury paper and the impact on yields is often incomplete. Of course, had central banks not been buying US paper someone else would have, only at a different price. The most obvious price that would have changed is the exchange rate. For central banks to have had a material impact on the level of US bond yields, the argument must be made that their price sensitivity for the Treasury paper is materially different from the private sector. That seems like a reasonable argument, though the order of magnitude is probably overstated.

    One way of trying to tackle this, I suppose, is to examine the residual from a bond model and provide a judgment on the extent to which yields are “too low” based on broad macro factors. Qualitatively, we can assign some of this residual to Asia central banks – probably around 40bp or so. We should also remember that the FED has kept rates lower than would be implied by basic reaction functions, which may have also contributed to this residual.

    Asia central banks are also clearly trying to do their best to avoid large distortions in the US bond market. Japan, for instance, accumulated a large stockpile of USD deposits while intervening, and have gradually invested those deposits into Treasury paper. As a result, even though intervention ended in March, official buying of Treasury securities has continued.

    Does this seem reasonable or too naive?!

    In terms of the duration of the securities purchased, the Treasury provides a bit of guidance with the split between bills and bonds ( Of the 1.1 trillion in official holdings as of Sep, 885.2bn is < 1 year, the remainder is in bills. My first comment on this blog, though a regular reader of the discussion...very helpful.

  • Posted by Jeff Fisher

    Mr. Bhai:
    You take Greenspan’s comments out of context.
    Essentially he was extolling the virtues of commodity money and commodity credit. If money is a market chosen commodity, and credit is only commodity credit then the boom and bust Business Cycle goes away and property is secure from inflation. The other anti capitalist stuff you mentioned makes no sense to me.
    Japan suffers from the credit boom of the 1980s and early 1990s coupled with goverments policies to raise prices and restrict imports.

  • Posted by glory

    just off of briefing: “Freddie Sees Record Asian Demand: The GSE’s $3B in 5-yrs saw Asian investors score a record 40% of the 4% reference notes”

    jeff, greenspan has since repudiated his views on the gold standard, altho you might say he’s now in a position where his views on such matters might reflect a conflict of interest 😀

    “The record of the past twenty years appears to underscore the observation that, although pressures for excess issuance of fiat money are chronic, a prudent monetary policy maintained over a protracted period can contain the forces of inflation.”

    also worth reading is mcculley’s views on implementing a new “gold standard:”

    “The modern day equivalent of the gold standard is, I submit, a nominal rate of interest on money that makes the holder whole for the two taxes that our government imposes on money: the explicit tax on nominal interest and the implicit tax of inflation. Put differently, money is ‘neutral’ if the after-tax real rate of interest is zero! That implies, of course, a positive before-tax real rate of interest, so as to generate sufficient nominal income for the holder to pay the explicit tax on nominal interest. And the higher the inflation rate, the higher the ‘necessary’ real rate.”

    imo, mcculley would make a fine fed chairman and i hope (altho unlikely) he’s nominated. afterall, muhammed el-erian almost got the IMF spot! roger ferguson, btw, would be my next choice and i think he has a pretty good chance 😀


  • Posted by Jeff Fisher

    Thanks for the feedback.
    Demand for dollar debt is flip side of C/A deficit. They have to do something with the dollars. That data just tells me trade gap for last month is new record!

  • Posted by anne

    Dollar’s Fall Drains Profit of European Small Business

    FRANKFURT – To get a sense of how fast the falling dollar can ruin a European businessman’s day, talk to Udo Pfeiffer, the chief executive of a small German machinery maker in the industrial Ruhr Valley.

    Mr. Pfeiffer’s company, SMS Elotherm, builds machines that forge crankshafts for cars. He exports many to the United States and Mexico, selling them for dollars to manufacturers like DaimlerChrysler.

    In recent weeks, the euro has been rising so rapidly against the dollar that Mr. Pfeiffer lost $10,000 in profit in the three days between shaking hands on a $1.5 million deal for a machine and signing the contract. The profit on these machines, he said, will be no more than $30,000.

    As the euro and other currencies climb into rarefied territory – the euro reached another record on Wednesday, settling in New York at $1.3319, and the British pound rose to $1.9327, a 12-year high – exporters are expressing more and more fear about how it will affect their businesses.

    For every familiar name like Mercedes-Benz or Louis Vuitton, there are scores of much smaller enterprises, making everything from crankshafts to concert pianos, that are being buffeted as shifting currency values make their products more expensive in the American market.

    Some are even more dependent on the United States and other dollar-dominated markets than Daimler or LVMH of France. And they do not have the financial resources of these big companies to engage in complex currency hedging.

    The distress in European industry is increasing pressure on the European Central Bank to respond, either by intervening in the currency market to curb the rise of the euro or by lowering interest rates. The bank’s governing board meets here Thursday, but it is expected to do neither.

    “The dramatic fall of the last couple of months has really set off alarm bells,” said Karl Kadar, a vice president at the Standard Federal Bank in Troy, Mich., who advises German automotive suppliers in the American market. “A lot of these are smaller, family-owned private companies.”

    Auto parts suppliers already had it rough. The price of steel, their basic raw material, has soared, largely as a result of demand from China. And their primary customers, the carmakers, have been squeezing them hard for price cuts as they struggle with their own weak sales.

  • Posted by Chris

    Good Day to all:

    Saw this interesting article in FT:

    Japan and ECB mull joint currency move
    By Alan Beattie in Tokyo
    Published: December 1 2004 22:01 | Last updated: December 1 2004 22:01

    Japan and the eurozone authorities have discussed the prospect of joint currency market intervention if the yen and euro continue to strengthen against the dollar, a senior Japanese finance ministry official said on Wednesday.

    Although he declined to comment on his European counterparts’ response, he said a common eurozone view had emerged that the euro had reached levels that were harming Europe’s economy. The European Central Bank refused to comment.

    The official, speaking to reporters on condition of anonymity, added that recent comments about the US current account deficit by Alan Greenspan, chairman of the US Federal Reserve, were a “misjudgment” that had increased market volatility.

    The official’s comments mark rising stridency in Japanese rhetoric about currencies, and a determination not to let US disapproval prevent Japan from resuming its intervention campaign to slow the yen’s rise. Separately, Hiroshi Watanabe, vice-finance minister for international affairs, told Reuters on Wednesday: “Conditions are in place for Japan and Europe to be able to take harmonised action. It is natural for Japan and Europe to act when the dollar alone is falling.”

    The ministry official said the dollar should not be weakening given the superior US growth performance. “If there is a general depreciation in the dollar, we should have harmonised action,” he said. “If the [dollar’s] movement affects the European economy and the Japanese economy, we should defend ourselves.”

    After rising sharply, the yen has stabilised around Y103 against the dollar, where it finished Asian trading on Wednesday. But the euro hit a new high against the dollar just above $1.33 and sterling reached a 12-year record of $1.93.

    The last joint currency intervention was in 2000, to support the euro. The Japanese ministry of finance, which sets currency policy, has not ordered unilateral intervention to prevent the yen appreciating since March.

    Previous Japanese intervention campaigns have drawn criticism from the US. But the Japanese official was defiant. “We don’t care what America says. We will defend ourselves,” he said. He also criticised US pressure for China to float its currency, now pegged to the dollar, saying that it made “no sense” to blame China for the US current account deficit and that growth in many Asian countries remained dependent on exports to the US.

    His remarks follow a blunt warning from Li Ruogu, the deputy governor of the People’s Bank of China, that the US should not blame other countries for its economic difficulties.

    Official Japanese irritation with US policymakers extends to the Federal Reserve. Mr Greenspan’s comments on November 19 about the “untenable” US current account deficit, which caused speculation about Asian and other central banks shifting reserves out of dollar-denominated assets, were a “misjudgment”, the Japanese finance ministry official said.

    “I don’t think November 19 was an appropriate time [to comment],” he said. “Already there was turmoil in the market. Such comments are not welcome.”

  • Posted by anne

    Announcing a possible intervention is a curious way to try to stem speculation.

  • Posted by Ian

    Recent economic research has suggested that “verbal” intervention can be as succesful as actual intervention. The whole point of either verbal or actual intervention is to change the phsycology of the market and make speculators realize that they are not placing a one way bet. The problem now with Japan and the Europe is that there are too many policymakers not in a position to affect currency policy making hawkish statements. Because this verbal barrage is coming from people not in positions of real power, it is being disregarded by the market.

  • Posted by Silent E

    The dollar is falling. Are we getting poorer or is the rest of the world getting richer?

    Just something to think about if you’re doing any comparative research with exchange-rate-adjusted GDP figures…

  • Posted by Silent E

    Are households really changing their spending habits so much from 30 years ago? They are certainly using different financial vehicles and methods of payment: more credit cards, more financed purchases, more automatic paycheck deductions and more tax-free investment accounts. But those financial tools have just cut out the middleman: the banks, where savings would occur.

    Households are still buying goods on credit (installment plans and layaway have been around a LONG time, to say nothing of home mortgages), and they are still saving for retirement and college. Its just that their 401k and 529 Saving Plans hold assets, not cash, while their credit cards and monthly utility paycheck deductions happen much faster, leaving less time for banks to carry a balance (and thus earn profits by investing those saving).

    Maybe I’m wrong, and households in the bottom 90% used to have net savings rates that exceeded all these recent factors – perhaps connected an explosion in sub-prime credit card lending. But it seems virtually all the REAL shift in savings is from the Fed Gov.

  • Posted by hemant bhai

    Mr Marcel,
    the problem of land (and more generally, collateral for credit creation) is at the centre of current political and economic distortion. State and local political representatives have been (always were?) deeply corrupted by landed interests.

    I am not anti-capitalist as you suggest but do object to what is called “rent-seeking”. Rent-seeking works to the detriment (reduction in compensation) of other factors of production.


  • Posted by anne

    “The dollar is falling. Are we getting poorer or is the rest of the world getting richer?”

    From the complaints in Europe and Japan, you would think that they are the poorer for strengthening currencies. But from the worries here about a weakening currency, you would think we are the poorer. When Robert Rubin was repeating “a strong dollar is in America’s interest,” many American exporters were claiming the reverse.

  • Posted by anne

    Who is the poorer? From the complaints in Europe and Japan, you would think that they are the poorer for strengthening currencies. But from the worries here about a weakening currency, you would think we are the poorer. When Robert Rubin was repeating “a strong dollar is in America’s interest,” many American exporters were claiming the reverse.

  • Posted by anne

    There is a sad irony to a Japanese minister telling us that Japan can not be bullied. Japan will support the dollar as long as she wishes. Why are Australia and Canada not complaining about strengthening currencies? Is the difference the resource base of Australian and Canadian exports, as opposed to the manufacturing base of Japanese or European exports?

  • Posted by anne

    There were 2 important items to consider today in addition to currency policy or lack of: 1. The firing of the President of the California state pension fund; 2. The use of a new hedge fund tactic that allows voting power in corporate affairs with no financial risk.

  • Posted by anne

    Calpers Ouster Puts Focus on How Funds Wield Power

    The ouster of the president of California’s public pension fund has raised questions about whether pension funds, endowments and other big activist investors will be able to keep wielding influence in corporate governance campaigns.


    Nothing Ventured, Everything Gained

    A new trading tactic that could tip proxy fights and takeover battles has emerged from the shadows of the hedge fund industry, igniting outrage among some investors and corporate governance experts.

  • Posted by brad

    glut — I think it is pretty clear that not all of the roughly $1 trillion in dollar reserve accumulation (very ballpart estimate) from 02-04 has gone into the short-end of the treasury market. most of it has, but presumably not all. China’s dollar reserve accumulation this year almost certainly exceeds its recorded purchases of short-term treasuries, for example, even if not all their reserves at the margin are going into dollars. Hence “Asian” demand for five year agencies, etc. CBs usually hold short-term treasuries for two reasons: one, they need a very liquid asset in case something bad happens (see mexico 94, etc), and two, they are conservative and don’t like losses, and long-term bonds have more interest rate risk. My guess is that neither concern is so dominant when you have as many reserves as some countries now have — you have more liquidity than you need even if you hold only a fraction of reserves in short-term treasuries, and if you cannot get out of your position in any case, you may want to hold a five year bond to maturity and pick up a bit of yield rather than hold a succession of shorter term instruments. Plus, given the costs of sterlization and the risks of capital losses from $ depreciation, some long-term holders (i.e. central banks) may be tempted to reach for a bit of yield.

    Marcel — keep commenting. useful info. Remember that the TIC data probably only captures a portion of CB holdings of treasuries — see the Higgins and Klitgaard NY Fed paper that looks into the gap between recorded CB inflows in the US “debtor” data and BIS “creditor” side data on dollar reserve accumulation. Suspect more long-term treasuries are held indirectly. My gut tells me the impact is bigger than 40 bp — closer to 100 bp or so roach estimates; but i don’t trade on my gut, so it ain’t worth much.

    Silent E — look at steve roach’s online commentary among others. the shift from budget surpluses to budget deficits clearly has been the driver of the fall in national savings recently, but there is little doubt that personal “savings” has fallen over time — hence a current account deficit that is larger than the budget deficit. savings in this context is a flow concept — the difference between current income and current consumption, i.e. the amount of your current income you are setting aside. As roach emphasizes, higher asset prices have generated a sense of wealth, and thus led people to both set aside less, and to borrow against their existing wealth (notably home equity) to spend more today. the widening of the current account deficit in 04 v. 03 stems from a fall in personal savings and a pickup in investment, not from a bigger budget deficit (as a % of GDP), as the pace of decline kind of slowed in 04 (thankfully).

  • Posted by DF

    Hey Brad, you did not comment on the global deflation issue I raised.

    I wonder how there can still be people like you Jeff… Gold can not prevent booms and busts. During gold standards there were more booms and bust of a lesser size. The basic impact of gold is reducing the size of imbalances between banks within a country or if gold stocks are centralized between countries. However even with gold standards there are vast amounts of paper money, and that amount fluctuates with booms and bust.

    What is ahead is DEFLATION and not inflation.
    Inflation has been shifted in the last years from an inflation in good prices (monitored and seen as bad) to an inflation in asset prices (un monitored and seen as good).
    This process has gone along a vast accumulation of debt. (higher debt/revenue ratio).
    This process has been if you care to talk about “confiscation of wealth” a process by which owners of huge stock of wealth have confiscated an ever bigger proportion of the wealth creation by workers. Asset inflation has been a confiscation of wealth creation by asset holders. Asset deflation and bankrupcies will be the price to pay for this.
    Government and even Greenspan are not to blame for that. There has been a general push of asset holders for higher asset prices. They have all pushed for this asset economy.
    Now it is collapsing.
    And we’ll get to see what comes out of this.

  • Posted by brad

    DF — Agree that there is a risk of asset price deflation ahead, as think there is a risk of reduced foreign demand for US debt, leading to higher rate and asset values.

    Worry a bit that China’s impact on the US economy will at some point shift from being disinflationary (lowering the rate of inflation) to being deflationary (lowering the price level), particularly if China insists on keeping its currency undervalued. peg means real exchange rate adjustment comes slowly and painfully, via inflation in china and deflation here.

    The fed kept us out of a “deflationary” liquidity trap (the formal term for Japan’s problems) after the stock bubble burst, and I think the odds are that the Fed will keep us out of one now. In Japan, people saved yen evne at zero nominal interest rates b/c of expectations of falling prices. We in the US are not so good at savings, so the risk seems smaller here …

    And I am not with you on the argument that the fed will lose its ability to create money. Even if the government stops running a deficit (unlikely), there will be lots of existing treasury bills out there to monetize. Look at some of the links I have made to data on the stock of treasuries, either at the bond market association or the bureau of public debt. There are plenty of them! In extremis, the Fed could buy agencies + some form of default protection or even corporates and some form of default protection to create a synthetic risk free asset. Back in the late 90s when the government was in surplus, some thought was given to this.

    Finally, if other countries do let their currencies rise v. the dollar, the basic impact should be inflationary, not deflationary — more expensive imports = higher prices.

  • Posted by DF

    And after these new numbers on employement ?
    And the low 0,1% wage increases ?
    And falling oil ?

    Come on … Once deficits multiply, once interests are forced way up …
    Is there a single chance to avoid depression by deflation by debt ?
    Just one single.

    Give me one.

  • Posted by General Glut


    I hope you post over at my web site: General Glut’s Globblog. The name of the game over there is “deflation”.

    Gen’l Glut

  • Posted by Jeff Fisher

    There are only two alternatives.

    One, the expanding banks may stubbornly cling to their expansionist policies and never stop providing the money business needs in order to go on in spite of the inflationary rise in production costs. They are intent upon satisfying the ever increasing demand for credit. The more credit business de mands, the more it gets. Prices and wage rates sky-rocket. The quantity of banknotes and deposits increases beyond all measure. Finally, the public becomes aware of what is happening. People realize that there will be no end to the issue of more [p. 222] and more money substitutes—that prices will consequently rise at an accelerated pace. They comprehend that under such a state of affairs it is detrimental to keep cash. In order to prevent being victimized by the progressing drop in money’s purchasing power, they rush to buy commodities, no matter what their prices may be and whether or not they need them. They prefer everything else to money. They arrange what in 1923 in Germany, when the Reich set the classical example for the policy of endless credit expansion, was called die Flucht in die Sachwerte, the flight into real values. The whole currency system breaks down. Its unit’s purchasing power dwindles to zero. People resort to barter or to the use of another type of foreign or domestic money. The crisis emerges.

    The other alternative is that the banks or the monetary authorities become aware of the dangers involved in endless credit expansion before the common man does. They stop, of’ their own accord, any further addition to the quantity of banknotes and deposits. They no longer satisfy the business applications for additional credits. Then the panic breaks out. Interest rates jump to an excessive level, because many firms badly need money in order to avoid bankruptcy. Prices drop suddenly, as distressed firms try to obtain cash by throwing inventories on the market dirt cheap. Production activities shrink, workers are discharged.

    Thus, credit expansion unavoidably results in the economic crisis. In either of the two alternatives, the artificial boom is doomed. In the long run, it must collapse. The short-run effect, the period of prosperity, may last sometimes several years. While it lasts, the authorities, the expanding banks and their public relations agencies arrogantly defy the warnings of the economists and pride themselves on the manifest success of their policies. But when the bitter end comes, they wash their hands of it.

    from Ludwig von Mises Essay: The Trade Cycle and Credit Expansion.

  • Posted by anne

    Sadly, back to the norm. The economy is growing nicely, but so is productivity and there is simply not enough growth in consumer demand to generate steady job creation above 200,000 a month. Again, we did not create enough jobs to keep up with what should be natural labor force expansion. Say what you will about the dollar falling and about foreign central banks wishing to sell American debt and currency and so drive up interest rates, but interest rates are being kept low because there is sadly no labor cost pressure. The heck with the dollar, we have a growth problem.

  • Posted by anne

    National Index Returns
    12/31/03 – 12/02/04

    Australia 26.7
    Canada 20.9
    Denmark 28.1
    France 15.9
    Germany 12.9
    Hong Kong 23.4
    Ireland 36.8
    Japan 10.6
    Norway 49.1
    Sweden 35.8
    Switzerland 11.6
    UK 17.8

  • Posted by Silent E

    Brad, thanks for the Roach pointer.

    Different take on it, then:
    1. Massive losses (and mis-investment) in the bubble and recession, slow employment and wage growth and nearly-maxed-out personal spending, and skyrocketing government borrowing mean the US is in terrible financial shape.
    2. The dollar should have fallen by much more already. Estimates put the “real” value of the dollar at 20-30% below the current market value.
    3. A weak recovery and lots of cheap capital are keeping interest rates (artificially) low.
    4. Foreign central banks are propping up the dollar, but cannot do so indefinitely.

    4. Conclusion: dollars offer a great opportunity for value! Buy foreign assets, goods and services, or borrow from foreigners (in dollar denominated terms). If they are willing to make you such a silly offer, you should take it!
    5. Low interest rates also offer great value! Finance anything you can at fixed rates because it’s not going to last.

    Isn’t that exactly what American consumers, homeowners, and the Fed Gov are doing right now? If we’re just price takers in this market, complaining about our behavior misses the target: its the foreign banks that are the problem (that and the cursed tax cuts).

  • Posted by Jeff Fisher

    Silent E:

    Why are tax cuts the problem?
    Could the real problem be government spending?
    Cutting taxes and increasing spending is ridiculous policy. Ridiculous policy is the problem.

  • Posted by anne

    Bubble Day
    Stephen Roach (New York)

    December 1, 2004 could well go down in history as yet another important milestone for America’s bubble-prone economy. No, I am not referring to the 162-point surge in the Dow Jones Industrial average that occurred on that day. Instead, my focus is on two widely overlooked statistical reports put out by US government statisticians — the latest tallies on home prices and personal income. Collectively, these reports paint a worrisome picture of an asset economy that has now truly gone to excess. As was the case in early 2000 when Nasdaq was lurching toward 5000, denial is deep over the potential downside of yet another post-bubble shakeout. That’s what worries me the most.

    The just-released report on US house prices for the third quarter of 2004 was a shocker — an 18.5% annualized surge from the second quarter and a 13.0% increase from year-earlier levels, according to the tabulation of the Office of Federal Housing Enterprise Oversight (OFHEO). That represents a stunning acceleration from the 9.8% Y-o-Y increase of the second quarter and pushes nationwide house price appreciation to a 25-year high. It’s an even larger rise in real, or inflation-adjusted, terms. The surge over the past year is now running nearly five times the 2.7% annualized increase of the non-housing components of the CPI.

    Housing analysts and central bankers often chide those of us who draw macro conclusions from a highly fragmented US real estate market. In the housing business, where “location” matters, concerns over nationwide trends are often dismissed out of hand. In a recent speech, Federal Reserve Chairman Alan Greenspan noted while discussing housing prices, “Overall while local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely in the United States, given its size and diversity” (see his October 19, 2004 speech, The Mortgage Market and Consumer Debt, at America’s Community Bankers Annual Convention, Washington DC). It’s a nice theory, but the risk is that it may now be wrong. According to the latest OFHEO tally, house-price inflation over the past year has run at double-digit rates in 25 out of 50 states plus the District of Columbia. In six states — Nevada, Hawaii, California, Rhode Island, Maryland, and Florida — home prices increased by 20%, or more, over the past year. Housing is an asset class that is just as prone to excess as are stocks, bonds, currencies, or commodities. If it feels like a bubble, acts like a bubble, and looks like a bubble, it probably is one.

    Meanwhile, also on December 1, the Bureau of Economic Analysis of the US Department of Commerce released its regular monthly update on personal income. The stock market loved the October numbers — stronger-than expected gains in both income (+0.6%) and consumption (+0.7%) that were perceived as signs of ongoing resilience of the indefatigable American consumer. I found the report appalling. What caught my eye was a further reduction in the already sharply depressed personal saving rate — down to 0.2% in October from 0.3% in September. The September numbers were widely thought to have been distorted by temporary hurricane-related losses to personal income. Most expected personal saving would rebound from this artificially-depressed reading. There was no such bounce in October. The consumer saving rate has now basically gone to zero.

  • Posted by anne

    Stephen Roach –

    While it has only been four and a half years since the bursting of the equity bubble, memories have already dimmed of that extraordinary speculative excess. Yet in retrospect, that may have only been the warm-up for the main event. Bubbles have a way of feeding on each other — ultimately compounding the problem and leading to an even more treacherous shakeout. That’s certainly the lesson from Japan and could well be the case in the United States. America’s housing bubble is now in the danger zone. So is its saving rate, current account deficit, and overhang of consumer indebtedness. It’s been a US-centric world for so long, that everyone takes it for granted. Yet global rebalancing poses challenges for all major countries in the world. Saving-short America will not be spared — especially if it must now come to grips with the biggest asset bubble of them all.

  • Posted by anne

    So, the government is running structural deficits, households do not and can not save, corporate saving is as high as its been in decades. But, corporate saving could be more useful were it turned to domestic investment to drive employment. Good grief.

  • Posted by brad

    silent e —

    you have got a point. when one a $1 bought $1.15 or so euros (.825 euro/ dollar), it made sense to go to Paris for a vacation. Now, it makes sense for Parisians to come to New York …

    If China is lending us $ to buy their products at firesale prices, why not?

    And if you think interest rates will go up, then borrow away now, and make sure you lock in a fixed rate.

    That is a core part of the current economic structure: the china price keeps US prices low, and even is perhaps generating pressure on US wages — Walmart prices imply walmart wages. Lower prices and lower wages = constrant real wages. If China’s currency stays pegged, the way the competitive imbalance is addressed is through falling US wages/ prices (deflation) and rising Chinese wages/ prices (inflation) — making the US more competitive over time.

    At the same time, chinese financing keeps interest rates low, driving up all asset prices. That helps some, but not others.

    The big question is how does this all end — if real adjustment comes through US deflation, anyone buying $10 year fixed rate bonds will do quite well. If real adjustment comes through a fall in the dollar, foreigners buying 10 year bonds at 4% won’t do so well. If the fall in the dollar contributes to higher US inflation, US purchasers of the ten year treasuries won’t do so well (unless they sell the bond before the market comes to expect higher inflation).

    I tend to think the bigger risk is inflation, but, hey, i could be wrong.

  • Posted by anne

    Why am I not surprised?

    From Bush Aide, Warning on Social Security

    WASHINGTON – Calling the current system of Social Security benefits unsustainable, a top economic adviser to President Bush on Thursday strongly implied that any overhaul of the system would have to include major cuts in guaranteed benefits for future retirees.

    “Let me state clearly that there are no free lunches here,” said N. Gregory Mankiw, chairman of the Council of Economic Advisers, at a conference on tax policy here.

    “The benefits now scheduled for future generations under current law are not sustainable given the projected path of payroll tax revenue,” he added. “They are empty promises.”

    Mr. Mankiw’s remarks suggested that President Bush’s plan to let people put some of their Social Security taxes into “personal savings accounts” would have to be accompanied by changes in the current system of benefits.

  • Posted by Marcel

    Anne: Thanks. Your point on who is richer / poorer from the exchange rate move is often lost in the rhetoric of exchange rate policy. Exchange rates are the channel for the redistribution of world demand, with a lower dollar reducing the purchasing power of the US relative to its trading partners.

    Of course, the US is a special case to some degree, with a favorable balance sheet effect. A weaker dollar adds to the value of US external assets more than it does US external liabilities. One of the benefits of being a reserve currency – you get to off-load exchange rate risk to foreigners.

    I think it will be very interesting to see whether the US is increasingly required to issue external liabilities in foreign currencies. Would start with corporate debt and then work up the credit spectrum presumably.

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