Brad Setser

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The US dollar fails the Chinese test

by Brad Setser
January 26, 2005

So China wants to adopt a basket peg because it no longer thinks the dollar is a stable store of value.

To quote Mr. Fan, Director of China’s National Institute for Economic Research:

The U.S. dollar is no longer — in our opinion is no longer — (seen) as a stable currency, and is devaluating all the time, and that’s putting troubles all the time,” Fan said, speaking in English.

(thanks to glory for the link)

Maybe the United States’ bankers did not think it was particularly polite for the US President to call them tyrants. Maybe they did not particularly like the new estimate for the FY 2005 budget deficit. Maybe a currency tied to a sinking dollar does not suit their image of a rising China.

Or maybe China’s leadership is not totally immune to international pressure.

It is hard for me to argue with the core point Mr. Fan makes. In the long-run, the dollar pretty clearly will go down further than it already has. A 6% of GDP (and growing) current account deficit and an export base of 10% of GDP usually do not auger good things. The long-run shift in the dollar may need to be larger if David Hale is right, and the United States capacity to produce goods for sale on the world market is already very limited. The real adjustment process won’t start until the dollar falls to the point where investment in the US to produce goods (or services) for the world market makes sense.

If China doesn’t want to keep adding to its dollar reserves, no one else will either. China is the big player in this coordination game, the anchor of the central bank dollar cartel. Thailand will be able to cut the percentage of its reserves in dollars without moving the market far more easily if other central banks are adding to their dollar reserves (Perhaps this should read Thailand was able to … I am not sure if Thailand announced a done deal, or its intent to reduce its dollar holdings)

It sure sounds like China would rather not continue to add dollars to its reserves at its current pace. On the other hand, so far China’s talk of greater currency flexibility has been a bit like the Bush Administration’s talk of reducing the budget deficit. Sounds nice in the abstract, but darn hard to do.

Mr. Fan put it nicely:

Fan said last year China lost a good opportunity to do revalue its currency, in July and October.

“High pressure, we don’t do it. When the pressure’s gone, we forgot,” Fan said, to laughter from the audience. “But this time, I think Chinese authorities will not forget it. Now people understand the U.S. dollar will not stop devaluating.”

To be honest, the time for China to have moved to a basket peg was in 2002, before the dollar fell against the euro. I suspect China will find it difficult to reconcile its aversion to a free float, its desire to avoid any large and disruptive changes to the renminbi-dollar, its desire to only move when the market does expect it to move, and its desire to reduce the pace of its dollar reserve accumulation. Moving to basket peg alone won’t do much to slow China’s overall reserve accumulation: the renminbi will still be undervalued, and there will be a strong incentive to bet that renminbi will have to be repegged at a higher level (v. the basket) at a later date.

p.s. I have another post forthcoming that takes on the Economist’s argument that the renminbi is not really undervalued.


  • Posted by Keith

    This is a fascinating statement by the Chinese, but I think it is unfortunate in its timing. I would have liked to have seen more political pressure build within the US for reducing the gov’t deficit before the Chinese start talking about revaluation. I would hate if a revaluation provided political cover for the Administration to do nothing about the US’s internal problems.

  • Posted by anne

    This is indeed interesting. If I understand properly the implication is that China could gradually peg to a basket of currencies from the Euro to the Yen to the Australian and Canadian dollars. A less and less American dollar accumulation? We will find out how markets respond soon. Is this a feint? The Chinese have often used feints. Hmmm…

  • Posted by anne

    China passes US as Japan’s largest trading partner
    By FT.COM

    China surpassed the US to become Japan’s biggest trading partner last year, underlining the importance of the Chinese economy to Japan’s faltering recovery.

    Total trade with China, including Hong Kong, reached Y22,200bn, against Y20,479bn for the US, according to preliminary figures from the finance ministry released on Wednesday.

    Imports and exports were fairly evenly matched, producing a trade surplus with China of Y1,455bn in 2004. That compares with Japan’s far larger surplus with the US of Y6,962bn.

    Economists say that the US continues to play a bigger role than raw figures suggest, since perhaps a third of Japan’s exports to China are eventually re-exported to the US in finished form.

    China now accounts for 20.1 per cent of total Japanese trade, up from 19.2 per cent in 2003. The US last year accounted for 18.6 per cent of trade against 20.5 per cent in 2003.

  • Posted by s

    ok. let me get this straight. the chinese want a window of opportunity in order to revalue, and they define that window of opportunity as a period when there is no pressure on the exchange rate. that is, when speculative inflows stop or moderate considerably. and then this top economist comes out and says that the chinese leadership is terrified of the instability of the dollar, and can’t wait to drop the peg? do they think this kind of rhetoric is going to ease pressure on the renminbi? this doesn’t sound like the best strategy for revaluation. either this top economist isn’t so smart, or otherwise he isn’t in the loop with other chinese policymakers. either way, he doesn’t look good.

  • Posted by Jesse

    I’d count this as a credible threat. Talk softly and carry a big (chop)stick.

    Jan 27, 2005
    Asia Times

    “…Because central banks have been accumulating dollars over a long period, the current decline may not look that steep. “It doesn’t particularly surprise me that at least some central banks are unloading their dollar holdings,” said Steve H Hanke, a professor of applied economics at Johns Hopkins University and senior fellow at the Cato Institute in Washington. “The expectation was that as soon as the euro currency came out, there would be some diversification in central banks’ portfolios, independent of the trends in the euro value versus the dollar and things like that.”

    But the fall could quickly turn into a major plunge if panic spreads among private investors and moves on to infect central banks, some economists say. If China and Japan, two countries with the biggest dollar reserves, decide even to dump some of their dollar assets, the dollar is likely to collapse completely and go down far more than just the anticipated maximum of an extra 20%. “The timing of any drastic move by big players is very hard to predict,” Weisbrot said. “China and Japan for example, either one of those, can cause a complete crash, a total collapse of the dollar just by selling a small portion of their reserves. In fact, probably they won’t have to sell their reserves, all they have to do is stop accumulating or slow down their rate of accumulation and it will be a dollar crash.”

  • Posted by rick

    Surely pressure to revalue to aid US current account (juicing the yet to appear J curve-alleged) is counterproductive for the US as higher import prices lead to lower bond prices and lower profits for us corps. A potential vicious circle develops. Maybe Europe believes it will help them, then again when the Euro was sub 1.000 there was no great kick to growth.
    So guess it all comes down to politics, and on this I know little!

  • Posted by Tom DC/VA

    Keith – good point.

  • Posted by Jesse

    We might get a chance to test Weisbrot’s theory in the next few months, tippingpoint-wise.

    Do you really want to hurt me…? by Good Old Boy George

  • Posted by General Glut

    “If China and Japan, two countries with the biggest dollar reserves, decide even to dump some of their dollar assets, the dollar is likely to collapse completely and go down far more than just the anticipated maximum of an extra 20%.”

    But since both China and Japan know this, why in the world would they provoke a crash by selling off “some” of their reserves? Japan in particular is heavily invested in US Treasuries which are earning far less than agency bonds or corporate bonds, and the Japanese are used to taking a bath on the yen-dollar exchange rate in exchange for access to the US market.

    China and Japan will have to get pretty cozy to agree to sink the US. Someday, but not today.

  • Posted by Jesse

    It may not take both. The dollar is a heavy burden to bear, and getting heavier with time.

    Why would they do it indeed? Because, sometimes they do.

    Why would two countries ever go to war? Because they think they can win. Or they want to effect the outcome.

    Our arrogance has become almost…palpable.

  • Posted by Michael

    For cryin’ out loud, is this ever going to happen? If it’s not one threat to the dollar it’s another, year after year after year after year after year after year after …

    I know the gist of sentiment here is focused on the doom-and-gloom of a failure of China or Japan to uphold the dollar, but I can’t help but be irritated to read the Chinese of all people – people for whom language is a sensitive thing – making a comment like this given the amount of their GDP accounted for by Americans and their faith-challenged currency – the currency China has been riding to their great benefit like a rented mule.

  • Posted by Michael

    It’s not exactly like we’ve cornered the market on arrogance.

    I would like, too, to hear why Japan and China would want to “win” against us in a manner that would sink both of their economies in the process.

  • Posted by kaleidescope

    This is not a feint. There is tension between China and the EU, the renminbi having fallen precipitously against the Euro and the principal cause being the weak dollar. A possible EU response would be a tarrif or quotas on Chinese imports. To head this off it’s reasonable and just that China link its currency to the Euro and other currencies besides the dollar.

    Does this mean the PBOC will lay off accumulating dollar reserves? Will linking to a basket of currencies make it easier for China to stop supporting the dollar? The U.S. is still an indispensable market. How can China give that up?

  • Posted by brad

    Keith. I am sure the Chinese (and the europeans) will raise the US deficit at the G7 + China meeting. I am equally sure the US response will be unsatisfactory — i.e. we are serious about controlling spending, but we are not very worried, people still want to invest in America. The Administration does not recognize that about 1/2 the “investment in America” is coming from may 15 major central banks. I also suspect that a revaluation — if it reduced Chinese reserve accumulation and thus Chinese inflows into the treasury/ agency market, would put pressure on the US to cut the deficit. So long as US long rates are low, there is not much domestic pressure to change …

  • Posted by brad

    Glut — care to estimate the impact on the dollar is central bank $ reserve accumulation fell from $400 billion plus a year to say $200 billion, or even the $100 b typical of the 90s? No sales. Just less accumulation.

    Rick — in the short-run, a renminbi revaluation won’t help much. J curve on imports. Limited and lagged impact on exports (it will come, but it will take time). I still think you get adjustment in the event a large revaluation reduces Chinese reserve accumulation through the capital markets channel. China’s dollar reserve growth slows, they buy fewer US assets, that leads to higher interest rates (one can debate how much) and the adjustment starts. What is not clear to me from your post is what form you think the adjustment should take. If Asian revaluation won’t help, what set of policies would work?

  • Posted by Andrew Boucher

    “care to estimate the impact on the dollar is central bank $ reserve accumulation fell from $400 billion plus a year to say $200 billion, or even the $100 b typical of the 90s? No sales. Just less accumulation.”

    Well there are two choices. Either there is less accumulation because the Chinese are buying dollar goods or individuals dollar assets – in which case no effect – or they are buying other currencies – presumably yen or euro – in which case those currencies would have a tendency to appreciate. At around 1.5 vs the dollar the eurozone becomes very uncompetitive, so you can expect a recession in Europe.

  • Posted by Lorenzo

    Wow. Great post. I thought I was the *only* one paying attention to the WEF meeting.

  • Posted by Alex

    The Economist Richard Duncan had a wonderful theory about this in his book the “Dollar Crisis”.

    He believe that after the fall of Bretton woods the world became flooded with dollars; this would do much to explain the stagflation of the 70’s. His theory is that the dollar acts has “high powered” money in countries with large trade surpluses with the US spurring increased lending and reckless investment. The banking situation become untenable as too many bad loans build up and boom we have a crash; Japanese real estate and the Asian financial crisis of 1997.
    Currently many of the Asian economies are experiencing insane growth on the order 7%; with China registering a whopping 9.54%. This will inevitably lead to inflation and higher prices. Under these circumstances I think the fastest and easiest way to kill inflation would be to revalue the currency against the dollar; since most commodities and oil are priced in dollars a significant upward revaluation of the Remimbi would result in a both lower growth and lower input costs for the all of Asia.

    Of course continued devaluation of the dollar could cause OPEC to reprice oil in either a currency basket or euros and result in an accelerated decline. I think other commodities would probably be repriced as well; creating additional downward pressure on the dollar.

    By not addressing America’s structural trade imbalances and low savings rates I think Bush is playing with fire in a room covered with gasoline. There are too many forces in this world that could cause a noticable devaluation of the dollar to turn into a run on the currency.

  • Posted by dsquared

    Two points:

    1) Reserve accumulation is a problem, but it isn’t a problem *for the Chinese*. There is probably a limit to the amount of capital that could realistically be invested in the domestic economy, so the fact that it’s piling up as overseas claims is unlikely to be starving worthwhile projects back at home.

    2) Similarly, the argument that there is any “balance of terror” or that “if you owe the bank $50,000,000 the bank has a problem” is a red herring. Even if the dollar absolutely collapses in its external value, a dollar will still buy roughly the same amount of US assets. And it’s ownership of underlying productive assets that needs to be looked at here; the question is whether there is such a massive difference between Chinese and US productive potential that the Chinese central bank is leaving a load of money on the table by having its surplus production build up as overseas claims rather than being reinvested in domestic projects. I don’t think that there is; if anything, the gap is likely to be the other way.

    So the Chinese, if they are sensible, will be thinking about their US investments in terms of whether the dollar is a hard currency with respect to inflation[1], not external value. Remember that the Chinese government is not marked to market or operating with borrowed funds; they can reconvert their holdings at any time in the next few hundred years (they are the ultimate “strong hands” for fans of technical analysis).

    I suspect that we will end up finding out that much more of Keynes’ work on the gold standard than we had thought turns out to be of fairly general relevance to a variety of international monetary regimes. In particular, I still believe in the fundamental asymmetry; that the burden of adjustment will end up falling mainly on the deficit country. The Chinese don’t have to revalue the renminbi[2] unless they want to, but they can if they want to.

    [1]I have been urging at least since the launch of the euro in 19999 that we should always make the distinction between a “hard currency” in terms of domestic inflation and a “hard currency” as one which maintains its external value. Nobody cares, apparently …
    [2]Another quixotic battle of mine, lost ages ago, is that the currency of China is called the renminbi yuan, meaning something like “people’s coin”. Calling it the renminbi is like calling the old German Deutschmark “the Deutsch”.

  • Posted by anne

    When I am puzzled about a stance by China, I turn back to Jonathan Spence and other historians. The guess is Fan Gang’s comments have little importance. There is no reason to believe China’s leadership feels a near term change in currency policy is necessary. There may be a need for a hint now and again that there may in time be a change, but little more. The Chinese leadership will not be pressured, and they do not intimate a change in economic policy in such a manner or in Switzerland. Mr. Fan is not part of leadership. The performance of the Chinese economy is excellent, and there has to be a reluctance for more than minor policy adjustments.

  • Posted by anne

    Thinking that Japan and China and other trade surplus nations are in dire difficulty because their central banks hold dollars, still has not been convincing. China grew at 9% again last year. Imagine the gains for 1.3 billion people. China’s leadership has much to be pleased about, but worries about development stability that are of more immediate concern. Currency worries seem to me a way off for China. But, my friends all disagree with me :)

  • Posted by Billmon

    “If China doesn’t want to keep adding to its dollar reserves, no one else will either.”

    This from Reuters:

    Meanwhile, a relatively sluggish U.S. Treasury auction also helped keep the dollar under selling pressure, analysts said.

    Demand for the $24 billion of two-year notes was fairly meager, especially so from indirect bidders, which include foreign central banks. They took up only 28.6 percent of the sale, down by more than half from the end of last year and the lowest since August 2003.

    But, hope spring enternal:

    “I don’t think you can read too much into that: I don’t think Asian central banks are done accumulating dollars,” said ABN Amro’s Anderson.

    In other words: “There is too a Santa Claus!”

  • Posted by anne

    Still, the Vanguard Long Term Bond Index has not declined. Central banks can buy other than short term Treasury debt. What we are not seeing is a rise in intermediate and long term interest rates, and corporate interest rates which lagged Treasuries in the decline in rates from 2000 to 2003 are catching up.

  • Posted by hbj

    As soon as I saw Bush’s demented inaugural, my first thought was “ok, this is all foreign central banks need to hear”. Not only is Bush not even recognizing the immense problem of American fiscal rectitude, he’s out there saying his only priority is to muck around in everyone else’s business, presumably with bombs, which is all he knows how to do.

    Time for this psychopath to be stopped, and if the American voter is too stupid or Christian to do it, the world will crush us economically and take away the means.

    That’s why China’s biding its time I suspect. The trendlines are in its favor. As yesterdays budget numbers show, we keep tightening the suicide rope instead of looking for a way to loosen it.

    I imagine there is quiet but giddy glee in the backrooms of many foreign powers who finally see a viable endgame coming for an America that is dangerous and horribly misguided.

  • Posted by steve kyle

    What nobody has remarked on explicitly in this thread is where the final step in the adjustment is likely to come from – Never mind J curve effects, because by the time they play out the adjustment will already be long under way. As every country who has undergone a major stabilization program knows (or at least almost all of them) you get a large chunk of your adjustment not from price induced changes in exports and imports but from a sharp drop in spending – i.e. a recession or depression.

    This channel is by far the most likely if we fail to act to promote a gradual adjustment by reducing the government deficit that is at the root of the problem. If we wont reduce spending or raise taxes sufficiently then the market will act for us and reduce our spending for us with drastically higher interest rates and lower values for our assets.

    A big difference between the “preferred” adjustment and the “imposed” adjustment is just whose spending (taxes) get squashed (raised). If the government acts now they get to choose who gets the hit. If they dont act then it will be all of us and the first on the chopping block will be interest sensitive activities – Anybody out there have a home equity loan? Anybody out there linked to the construction industry? etc. etc.

  • Posted by brad

    Steve Kyle: 100% agreement from me! We need to take steps now, before we face an imposed adjustment — though i suspect we need a bit of both expenditure reduction (best achieved via smaller fiscal deficits) and expenditure switching (some further shift in the $/Asia).

    Anna. I would argue — w/o being a China hand at all — that Fan’s comments reflect at least one strand of thinking inside the Chinese leadership, but perhaps only one strand. Others in positions of authority have leaked to reuters a “not yet ready to change” message. You are right to highlight how China gains from the current arrangement. At the same time, from the point of view of China, the current arrangement also imposes some significant costs.

  • Posted by brad

    Dsquared: so the RY then (//s the DM?). I am agnostic on the whole question, though renminbi yuan doesn’t really work, at least in english. Some say renminbi is better (the people’s money, I thought, but may it is just “the people”), others seem to use yuan … but then others say that is like “coin” and saying the “yuan” fell is like saying the “coin” fell. Authoritative views welcome!

    You are right that a “hard” currency or a “strong” currency has two potential, and different, meanings — as an internal store of value (i.e. modest inflation) and as an external store of value (i.e. its value in the fx market). I suspect though, that the buy and hold/ can wait forever Chinese care a bit more than the dollar’s external value than they care about the dollar’s internal value: afterall, the are issuing renminbi yuan debt to sterilize their growing reserves, and are left with renminbi on one side of the balance sheet and dollars on the other. If you borrow in renminbi yuan and buy dollars, you have to care about the renminbi yuan-dollar exchange rate.

  • Posted by Silent E

    China can read the CBO report as well as anyone. Even aside from the $2 trn in borrowing for his SS schemes, Bush’s stated goals of extending the tax cuts, coupled with fixing the AMT and ongoing “unbudgeted” Global War on Terror expenses will push the deficit close to $500 bn next year, and keep it there until 2015 at least.

    The General Fund (the total budget, less transfers to Trust Funds) ran an annual deficit of $800 bn last year. That will top $1 trn per year by 2010 and $1.3 trn by 2015 – all money that must be made up with higher future taxes or more borrowing.

    Chart at my blog. Numbers from CBO 2005 rpt (esp. p42). Trust Funds include SS, Medicare, Civil and Military Retirement, and others – not the kid of obligations we can default on easily.

  • Posted by anne

    Sinking Dollar Dominates Davos Debate

    DAVOS, Switzerland – Two things were as clear as the Alpine air on the opening day of the World Economic Forum on Wednesday: The relentlessly sinking dollar is Topic A, and anyone hoping for an answer to when it will stop dropping is likely to come away disappointed.

    Economists, politicians and business executives voiced deep unease about the imbalances in the global financial system, which are reflected in the dollar’s steep fall against the euro and other currencies.

    But most expressed skepticism that the Bush administration would reduce the trade and budget deficits, which have fed those imbalances. The White House has said that it does not view these issues as a major problem because foreigners still view the American economy as an attractive investment.

    Some at the forum said they doubted that China, which is financing much of the American debt, would bow to pressure to allow its currency to rise against the dollar this year.

    “The U.S. current-account deficit is a problem for the whole world,” said Jacob A. Frenkel, a former governor of the Bank of Israel. But, he said, “I don’t see the budget deficit being taken seriously.”

  • Posted by Steve McQueen

    Main Entry: ren·min·bi
    Pronunciation: ‘ren-‘min-‘bE
    Function: noun plural
    Etymology: Chinese (Beijing) rénmínbì, from rénmín people + bì currency
    : the currency of the People’s Republic of China consisting of yuan


  • Posted by Jesse

    Quote from Seymour Hersh in an interview with Amy Goodman last week. His primary thesis is that the Bush administration is going to keep pushing its several political and economic agendas until something stops it. Debatable, but we overlook that one may choose one undesirable outcome over another more undesirable to them, based on their values. I thought Noriel did a nice job of outlining that in his latest piece. I think the Declaration of Independence provides an anecdote.

    “It’s going to go very bad, folks. You know, if you have not sold your stocks and bought property in Italy, you better do it quick. And the third thing is Europe — Europe is not going to tolerate us much longer. The rage there is enormous. I’m talking about our old-fashioned allies. We could see something there, collective action against us. Certainly, nobody — it’s going to be an awful lot of dancing on our graves as the dollar goes bad and everybody stops buying our bonds, our credit — our — we’re spending $2 billion a day to float the debt, and one of these days, the Japanese and the Russians, everybody is going to start buying oil in Euros instead of dollars. We’re going to see enormous panic here. But he could get through that. That will be another year, and the damage he’s going to do between then and now is enormous. We’re going to have some very bad months ahead.”

  • Posted by brad

    silent e – nice work. gonna have to look at p. 42 of the CBO. have long wondered how to do all the adjustments needed to match total increase in US government debt (i.e. all the trust funds, not just the social security trust fund) with the budget numbers.

    Steve — thx.

  • Posted by Silent E

    brad, CBO likes to argue that Trust Funds aren’t real money – just accounting gimmicks for government programs with specific “earmarked” funding sources. They’ve been putting that language in for almost 10 years, at least – I’ve seen it as far back as 1996.

    Because the TFs are just more Gov’t money, it’s all fungible for the CBO (never mind that Cognress’d never default on the Military Retirement Trust Fund, for example) – what CBO thinks is really important is “Debt held by the public”, as if that were the only thing that markets or the public cares about. That’s all over the place in the report. “Politically inviolable obligations made to the public”, regardless of how real or important, is not a category that OMB recognizes.

  • Posted by dsquared

    OK, consider the last “yuan” diehard to have left the fort :-)

    Now that we’re thinking outside the box, the domestic/external hard currency point has set me off on one – couldn’t a lot of problems be solved if the USA were to have a nice solid bout of inflation?

    After all, that’s what you do if you want to restore external balance without having a crunch on domestic spending. And what’s the point of being the global hegemon if you don’t inflate your debts away from time to time? That way, the US govt can help to sort out its debts by imposing an inflation tax, which tax which have a significant part of its incidence on foreigners.

    Heresy, I know, but I’m beginning to think that it might end up being the least worst alternative. Credibility, in my book, is overrated. Target high single digit inflation for the rest of the Bush Presidency, and I say no lasting damage will be done.

  • Posted by steve kyle

    On the difference between debt held by the public and total debt, there are some questions where the former is the important variable and others where the latter is the important one to look at. When we want to (eg) know about current portfolio composition and choice, then the current debt outstanding to the public is the variable to look at. When we want to look at government funding obligations in 30 years, then we need to look at ALL 30 year bonds that are outstanding, regardless of who has them.

    So, the extent to which we “care” about one or the other aggregate depends entirely on what question we are asking.

  • Posted by anne

    Chile’s Retirees Find Shortfall in Private Plan

    SANTIAGO, Chile – Nearly 25 years ago, Chile embarked on a sweeping experiment that has since been emulated, in one way or another, in a score of other countries. Rather than finance pensions through a system to which workers, employers and the government all contributed, millions of people began to pay 10 percent of their salaries to private investment accounts that they controlled.

    Under the Chilean program – which President Bush has cited as a model for his plans to overhaul Social Security – the promise was that such investments, by helping to spur economic growth and generating higher returns, would deliver monthly pension benefits larger than what the traditional system could offer.

    But now that the first generation of workers to depend on the new system is beginning to retire, Chileans are finding that it is falling far short of what was originally advertised under the authoritarian government of Gen. Augusto Pinochet….

  • Posted by anne

    Four years ago, Alan Greenspan was worried about the federal budget surplus. So big that if it didn’t gobble up Chicago, we would have retired all Treasury debt this decade. However would we run monetary policy with no Treasury debt?

    Now there is discussion of defaulting on American debt or inflating away the debt as though the consequences would be minor. Suddenly we wonder whether we can afford to care for our parents who have worked so faithfully for us. Suddenly we wonder about teaching all the fools who have bought American debt, that America really has no obligation to honor the debt.

    Oh well.

  • Posted by Tom DC/VA

    Dsquared – targeting somewhat higher inflation might be good to include as a component of “turnaround” plan, as would raising taxes, ending the land war in Asia, separating the operational and capital portions of the federal budget, and dozens of others things. But sensible ideas have no traction in the current administration. The question to me is how does this mess resolve itself given the frameworks of America’s domestic culture, political and otherwise, and current geopolitics. I would love to see both of those frameworks altered, but America’s chance to do so ended on November 3. Other countries may force America to change its policies for the better, but they would be doing so primarily for their own benefit, not out of love for America. Whether they do so or let America hang remains to be seen.

    Also, I’m not enthused about rewarding the jerks who have put up McMansions in my previously nice neighborhood over the past few years, and inflating away their mortgages would do just that.

  • Posted by Andrew Boucher

    d^2: “Now that we’re thinking outside the box, the domestic/external hard currency point has set me off on one – couldn’t a lot of problems be solved if the USA were to have a nice solid bout of inflation?”

    Hey no fair, you cribbed my comments from the previous post.

    d^2: “Similarly, the argument that there is any “balance of terror” or that “if you owe the bank $50,000,000 the bank has a problem” is a red herring.”

    Is it? The Chinese are stuck for the foreseeable future with their dollars. That means if the US does inflate (intentionally or not), then they lose money. Secondly, investors being investors, the Chinese haven’t just bought Treasuries but MBSs and so they have taken on risk. They could lose their principal on a fair-sized number should the US housing market tank.

    Basically the Chinese and Japanese are too big for the market – and since the US can basically set the rules it wants for the market, they really do have a problem.

  • Posted by brad

    Re: the talk of inflating away the debt. Keep in mind the term structure of the debt. It is easy to inflate away a 30 year bond, but rather hard to inflate away a 30 day t-bill. My sense is that central banks are still somewhat overweight the short-end of the Treasury note curve: i.e. more 2 yrs than ten years. That makes it harder to inflate away the debt — unless you engineer a sharp two burst of inflation. And the end of the day, central banks will just charge much higher rates on the next rollover to compensate for the greater risk of inflation.

    if you want to be real wonky, look at the Turkish t-bill market. it used to oscillates between negative real returns (the banks believed the government’s plan to bring inflation down and charged 30% nominal, and inflation turned out to be 40%), and very positive real returns (banks charged 50% nominal and inflation turned out to be 30%). Because the banks and the government were looked in a repeated game, big losses at any point were made up by big gains at another point (de facto bank recapitalization). An inflate away the game debt between the uS and central banks holding two year bonds would not play out quite the same way … but it certainly has lots of features of a repeated game.

    on the other hand, China supposedly is buying lots of long-term agencies — and those would be real easy to inflate away.

    (unless DF is right, and we end up in a deflationary liquidity trap … )

  • Posted by peBird

    I wonder if Mr. Fan’s comments are in some way a response to the U.S. questions re: the sale of IBM PC business to Lenovo.

    You have these dollars lying around and the U.S. won’t let you buy a PC business for national security reasons?!?

  • Posted by Jesse

    Here is a thoughtful piece on China’s currency dilemma from Sean Corrigan’s Weblog. He and I talk about these things quite frequently, and what I appreciate is the notion that China is not ‘stuck’ but rather has some real motivation to consider its options as a ‘first mover.’

    BTW, I do not think it is at all necessary for China and Japan to move together. China can do as it wishes independent of Japan, as it has been doing now for almost ten years. THAT constraints sounds more like wishful US thinking than a real problem for them.

    Sean Corrigan’s Weblog

    27 January 2005
    Year of the Rooster

    At the yearly hoopla for the International Elite, the WEF in Davos, Fan Gang, director of the National Economic Research Institute at the China Reform Foundation, added a frisson of excitement to proceedings when he baldly told his audience of tax payer- and shareholder-funded junketeers:

    “The U.S. dollar is no longer — in our opinion — is no longer a stable currency, and is devaluating all the time, and that’s putting [sic] troubles all the time.”

    “So the real issue is how to change the regime from a U.S. dollar pegging … to a more manageable … reference … say Euros, yen, dollars — those kind of more diversified systems.”

    “If you do this, in the beginning you have some kind of initial shock,” Fan went on. “You have to deal with some devaluation pressures.”

    Coming hard on the heels of news that central bank governor Zhou Xiaochuan and Minister of Finance Jin Renqing would be open to “in-depth discussions” about the Yuan at the early February G7 meeting, this has intensified market speculation that China is about to undertake one of its sporadic but sudden policy shifts.

    In thinking about the ramifications of this speech, first we must recognise that Fan is not an official spokesman, but rather an adviser – more of a German-style “wise man”. Thus, his words reveal what the internal discussion is about, but not necessarily what the form or the timing of the policy response will be.

    Careful readers of Fan’s words will wonder if it was his broken English which led him to talk of China having to face an initial “devaluation” shock – rather than undergoing a re-valuation – when severing the link to the ailing Greenback.

    However, this does make sense if you read it as expressing Beijing’s concern that once a revaluation – or a move to a basket – is announced, some of the $100 billion or so of hot money which flooded into the country last year (taking the difference between the increase in FX reserves and the identifiable trade and FDI surpluses) will immediately wash back out in the form of widespread profit-taking.

    If this were to happen, it would mean an initial liquidity shock as Yuan was offered domestically for the dollars to be repatriated and the People’s Bank of China would have to stand ready to buy back some of the billions of treasury notes it has lately been issuing in an attempt to mop up – or “sterilise”, in the parlance – the current influx.

    This might be seen as risking a potentially damaging upheaval in the midst of ongoing attempts to engineer the fabled “soft-landing” – an especial risk given China’s less than advanced financial infrastructure – and thus, for them, it is not a prospect to be dealt with lightly.

    In truth, whether any money really would flow out is another matter, since a moment’s thought will reveal that a move to a Euro- and Yen-weighted basket would allow not just the Yuan, but all other Asian currencies to rise vis-à-vis the USD and hence give the Euro renewed headroom, too.

    In any case, one suspects that a mere 5% or so in immediate forex gains should not be enough to tempt too many Yuan “investors” to quit the fastest growing region of the planet, but this – the more rosy view – is not the official prognosis and – right or wrong – that is clearly the decisive factor in the argument.

    One other issue is the oft-expressed idea that the PBOC will delay any moves until after the weary speculators quit of their own accord (presumably, the Bank hopes, not en masse). Alas, this is likely to prove something of a forlorn hope and so, at some point, the Bank will have to bite the bullet.

    That said, politics and Confucian dignity seem to demand that the Chinese also receive a quid pro quo so they are not seen to have lost face and to demonstrate that they are not a people who knuckle under – in typically Japanese style – whenever the American bully flexes his biceps.

    Clearly, given the macroeconomic and political stresses involved, the temperature is rising, but the US payback would surely have to take the form of some meaningful fiscal restraint. Although Dubya-Dubya III is currently talking a good game on this matter, the betting man would have to wager that this will turn out to be little more than smoke and mirrors, more of the “Big Lie” at which this administration is so singularly adept.

    All is not lost, though, for perhaps the Chinese can wrest some non-economic reciprocation for their actions – a removal of the EU’s military sales embargo, recognition of China’s “market economy” status (a step to the lowering of a good many trade barriers), or resistance to American calls that they not be allowed to participate in Europe’s Galileo GPS project, among others…

    In the end, China itself is likely to derive substantial net benefits in monetary management from the currency regime change (as will a Hong Kong where USD-occasioned excess liquidity is also beginning to introduce dangerous distortions in its notoriously boom-bust property markets).

    Longer-term detriments may be harder to envisage. The import content of China’s exports are high, so a stronger currency is something of a wash, while Chinese labour is still so damned cheap that a few per cent here and there on the wage bill is hardly likely to price its firms out of Western markets – especially the ones where local competition is so evidently lacking.

    Moreover, given China’s growing internal needs, both for resources to fuel its growth and to satisfy the hunger of its burgeoning consumer class for goods, a currency not being dragged to the bottom by its anchor to the sinking dollar is hardly an aid to be despised.

    So, we do expect the Chinese to move, but we also expect them to move at a moment of their own choosing. Furthermore, we expect them to maximise both the tangible rewards and the harvest of kudos when they make such an enormous altruistic sacrifice (!) in order to aid their sovereign neighbours and esteemed business partners.

    Then, with the Europeans no longer bearing the full brunt of the dollar’s readjustment and with the Asian central banks not feeling such an overriding imperative to hoover up surplus Greenbacks – which they have been doing lest their own exporters lose even more ground to the Chinese – the second leg of the USD bear market can begin in earnest.

    If so, soon thereafter, the Fed will be faced with the unenviable dilemma of continuing to pretend to fight inflation or of abandoning the charade in favour of offering direct support to a rapidly ailing US bond market.

    For those who follow such things, the Chinese Lunar New Year falls less than a week after the upcoming G7 summit. It is neatly apposite that it may well usher in the year when US chickens finally come home to roost.

    Kung hei fat choy!

  • Posted by Nathan

    There may be a domestic politics point operating in what the Bush administration will and will not do. It’s become clear, to me at least, that the Bush administration is committed to redistributing the nation’s wealth to the wealthy—greatly lowering their taxes, essentially sacrificing Social Security to that goal.

    Given that goal, no matter how good an idea inflation might be, the wealthy constituency that Bush considers his own would never allow that to happen, since they’re the investor class—they’re the owed, not the owers, and they don’t want to see the value of the debts they claim reduced by inflation. In fact, Bush might rather have a recession that will gut the lower and middle classes than have higher inflation that will hurt the American wealthy.

  • Posted by Mike

    There IS one reason that the Chinese (and others) may be willing to dump their dollars even if they have to take a heavy hit and even if it does serious damage to their economy. And that is if they come to believe that by continuing to invest in dollars they are financing the buildup of a military machine that is intended to be used against them. No nation would do that. Slowly but surely it’s sinking in around the world that by buying American products and propping up the dollar they are cutting their own throats. They may be interested in long-term economic growth, but that will be trumped by short-term military threats. And that, IMHO, is why they are dumping the dollar, not really the deficits. And that is also why they may just do it sooner rather than later, regardless of the consequences.

  • Posted by Silent E

    Re: Inflating away the debt

    What about the TIPS? They can’t be inflated away.

  • Posted by glory

    re: targeting high single digit inflation

    greg ip was out today on upcoming fed talks to consider an explicit inflation rate; seems like people are a long way away from high single digits…,,SB110678773162837484,00.html

    “At 1.5% by the Fed’s preferred measure, inflation is now ‘roughly consistent with a working definition of price stability’, Federal Reserve Bank of Cleveland President Sandra Pianalto said last week, expressing a view shared by most of her colleagues on the 19-member Federal Open Market Committee, the central bank’s policy panel…”

    “An informal survey by The Wall Street Journal found some uncertainty over the Fed’s tolerance for inflation. Six of eight firms that closely watch the Fed believe it has an implicit inflation target range. Four — Goldman Sachs, Bank of America, Macroeconomic Advisers and Morgan Stanley — say it is 1% to 2%, as measured by the price index of personal consumption excluding food and energy. (The Fed believes that index measures the cost of living more accurately than the better-known consumer-price index.) A fifth, ISI group, says it is 1.5% to 2.5%. Merrill Lynch says 1.5% to 2%, and J.P. Morgan Chase and Lehman Brothers say there isn’t any implicit target…”

    “Governor Ben Bernanke has said 1% to 2%. Governor Edward Gramlich has suggested 1% to 2.5%. Philadelphia Fed President Anthony Santomero last October proposed 1% to 3%, and St. Louis Fed President William Poole advocates a target of zero, with some allowance for errors in measurement.”

    cf. mcculley…

    “the time has come for the Fed to communicate both its definition of price stability and its estimate of the size of the firebreak needed above that definition”

    anyway, ferugson has been against it tho, so i kind of doubt it’ll ever happen, esp if he gets the chairmanship 😀

    oh and dangerous thoughts by andy xie today! (anne won’t like ’em :)

    The Motorcycle Diary

    “The global economy has stumbled into a growth model based on the United States’ consumption and China’s investment… Inflation is not a problem, as the demand in OECD countries automatically creates supply in emerging economies. It is, however, very prone to asset bubbles, because excess money creation does not lead to inflation, and the surplus liquidity finds a home in asset markets… The global economy is now suspended inside a liquidity bubble, I believe. A significant adjustment is inevitable… The world needs a US recession, in my view.”

    also an interesting discussion on productivity, btw…


  • Posted by brad

    Glory — What do you know that we don’t. Ferguson for chair? Sort of surprising. I thought he was a Democrat (or at least a Clinton appointee). Vice-Chair is usually not “Chairman in waiting.” Maybe Alan Greenspan thinks so highly of him that he will push his name with Cheney, but i have trouble seeing it happen …

  • Posted by glory

    yeah, TIPS are a great ‘automatic stabiliser’ to keep inflation under control, in large enough numbers…

    but iirc, TIPS outstanding are only around $200bn? so as a percentage of total gov’t debt, they must be pretty tiny, like oh wait, lessee..* oh about 4.5%?
    *Debt Held by the Public
    01/26/2005 – 4,423,606,734,065.61

  • Posted by anne

    The Motorcycle Diary
    Andy Xie (Hong Kong)

    …I believe the Fed should raise interest rates quickly until oil prices decline sufficiently and the US trade deficit halves. Inflation in the US may decline to 1% or lower when this happens, but it should not be the excuse to cut interest rates again. The Fed should accept low inflation or even a little deflation. In terms of employment creation, the Fed should lean more on labor market flexibility rather than macro stimulus. Targeting full employment with monetary policy is suicidal, in my view.

    I believe that the US needs a recession, which is a necessary phase in cleansing an economy of excesses during a boom. Refusing to have a recession is destabilizing. The instability in the global economy is primarily due to the fact that the US stimulated massively and fast after the tech burst, which prevented the necessary cleansing.

    Many US officials think that a major revaluation by China would solve the US’s need to have a recession. This is naive, in my view. If China were to revalue enough to have a meaningful impact on the US economy, it would prompt the hot money to leave China and, hence, trigger a hard landing, which would add more pressure on the US economy. A small move by China would not do anything and might incite more speculation, which would overheat the motorcycle further and leave behind a bigger bill to pay afterwards.

  • Posted by Andrew Boucher

    “on the other hand, China supposedly is buying lots of long-term agencies — and those would be real easy to inflate away”

    Inflate away? I say make them go up in smoke – default!

    Good point about the term structure of the Treasuries. Still, a good 15-20% inflation, means you can almost cut a debt of two years in half.

  • Posted by anne

    Well, I can make no sense of Andy Xie. Happily Alan Greenspan has ruled out sacrificing the domestic economy for the sake of the dollar.

  • Posted by glory

    i know nothing! ‘cept that his speeches are even more sleep-inducing than greenspan’s 😀 he’s more greenspan than greenspan! he’s very greenspan-like 😀

    BUT, i’m a fan, so i’m rooting for his nomination…

    my first choice would’ve been mcculley if kerry had won it, but mcculley is even more of a democrat, so i like to think there’s an outside chance… like ferguson’s the kind of low-key, but competent and respected — battle-tested even! — guy that markets and both sides of the aisle would like… maybe?

    i dunno 😀

  • Posted by Ian

    TIPS also have other flaws. The liquidity available is much less then in the regular treasuries. So they don’t behave exactly like run of the mill govts. Also, while TIPS can not be inflated away, they can certainly be “hedonically adjusted” away. Various estimates of the understatement of inflation are out there, from people like Bill Gross, and the view seems to be that CPI is at least a percentage point under in measuring inflation. Of course that opens up the whole can of worms about what is inflation? House prices? Bond prices? Maybe inflation isn’t just what’s measured by the CPI ex-everything.

    I agree with others on this board and elsewhere that remnimbi revaulation will not the panacea for all that ails the global economy. It is ludicrous for me to think that China is ready for a true floating exchange rate, given the state of their financial system (Does anyone really think that the big banks are going be cleaned up in time for an IPO late this year or early next?). My best guess is some sort of crawling band a la Brazil ’98.

  • Posted by Ian or someone should give odds on the next fed chairman. I agree with Krugman that the fact that Bernanke is going to be moving into the Bush Administration to chair the CEA (whatever its called) is sort of a trial for possible fed chairmanship. I think that Bernanke is now the major intellectual weight in the FOMC and he would enhance the institutional credibility of the Fed after Greenspan. So he’s the horse I’m backing….

  • Posted by glory

    re: make them go up in smoke – default!

    great point! like if china or anyone were to say (maliciously? /paranoid :) dump treasuries, what’s to keep the US from (selectively) not honoring its debts?

    like wouldn’t that just be the modern-day BWII equivalent of nixon telling france to shove it in 1971?*

    exorbitant privilege 😀

    *”This is a great day for France!” -President Richard Nixon, while attending Charles De Gaulle’s funeral, from The 776 Stupidest Things Ever Said

  • Posted by brad

    Ian: and Brazil’s crawling peg in 1998 worked out so well …

    I have never quite understood the “China’s financial system is not ready for a true float” argument, in part b/c I never really thought China would go for the fully monty (a free float and an open capital account). I don’t think they really expect local banks to do things like help firms hedge fx risk in a free float, or even in ASian style managed float in the near future.

    A simple revaluation always seemed more likely, with or without capital account liberalization, or maybe a revaluation, a basket peg and a band. The PBOC would heavily manage the exchange rate in any band or similar structure — there might be some small scale private hedging, but the PBOC’s presence in the market would likely cap the potential risk in a lot of ways.

    p.s. if China recaps the big four banks and sells them, who would it let buy them? I cannot see the nationalistic Chinese letting one of the big four go into foreign hands, and if it gets sold off to someone domestically, that one person becomes a Chinese oligarch … they would intermediate an enormous share of China’s domestic savings … am thinking out loud here.

    glory — love the nixon quote.

  • Posted by Ian

    Ahh Owners equivalent rent….makes up 22% of the CPI, and yet is a completely (IMHO) BS statistic. A measure of what you could get if you did rent out your house, sliced and diced by statistical wizardry. If you get a chance, graph the OFHEO house price index next to the OER component of the CPI. There has been a wide divergence between the two since about 1998. So while house prices shoot up at something like 10% a year, the OER increases at only 2.3%. And it makes up nearly 1/4 of the CPI, more when energy and food are stripped out.

  • Posted by Ian

    brad- Isn’t the current thinking that the Chinese will list those banks in Hong Kong or NY? At least a portion of the shares? Considering that the banking system is the primary tool of economic policy in China these days, I can’t believe they would want to give shareholders much control. Of course, I’m not sure shareholders would approve of all the dodgy loans (state subsidies in a different guise)that these banks have been making. So if they do clean up these banks and float them, does that mean that the Chinese intend to actually use monetary policy as a tool to manage the economy? Instead of the situation now which is basically these banks as giant off budget slush funds for party hacks favored projects…

  • Posted by Jesse

    Default would be fine if one could selectively default by owner of the bonds, and not classification of bonds themselves.

    At last calculation I had done, about a year ago, domestic US money market funds had about an 8 percent exposure to Fan and Fred’s Debt. This is not including the domino factor.

    Default by inflation is much easier and more practical. It also does not need to harm the wealthy inordinately. They have better means to hedge it than the middle class, and of course the working poor.

    Think longer term. Think of an endgame approximating Victorian England wherein 2/3’s of the populace were ‘in service.’ Oh yeah, Guv.

  • Posted by brad

    Ian — who will want to buy a portion of the earnings (but no real control) of “off budget slush funds for party hacks”? listing and selling shares does solve the problem of “who controls” the banks by more of less saying “the same people who do now” … though i guess the theory is that the managers will have a new set of incentives. nominaly Communist bankers with stock options, anyone?

    Anne. Long-term creditors always prefer deflation to inflation — it increases their real return. Xie sounds like he wants the US to crucify itself on the cross of the renminbi … the US would solve the PBOC’s balance sheet problem by lowering domestic dollar prices/ wages and bringing about the real adjustment via US deflation (and chinese inflation) not nominal exchange rate adjustment. I.e. US workers earn less in dollar terms, and thereby can afford fewer renminbi goods since the $-renminbi stays constant.

    Fortunately, it is not going to happen, or so I hope. Xie is right that the US needs to adjust, but so does China. Time to go back to Keynes’ notion of adjustment by both the debtor (BOP deficit country) and the creditor (BOP surplus country) …

  • Posted by anne

    Thank you so much, Brad.

  • Posted by p

    Agree that the current account deficit is a problem

    Disagree over who to point the finger at

    The US is not the only guily party here … the world’s export dominate countries are EQUALLY guilty … Trade is a REAL issue in this discussion. Let’s not forget that the US economy is growing faster than most of the devloped world.

    GUILT can also assigned by the fact that Central Banks are doing all the buying of US dollars

    Now what to do
    1) Don’t think taxes … it solves the problem mathmatically but creates HUGE social costs …
    2) Quit blaming Bush … we Americans buy imports … we can blame Bush for exporting 500 pound bombs to Iraq … In addition, this problem is structural and has been coming for a couple of decades now.
    3) Address exports and imports … this is the real currency of the problem … playing with the math is academic at best

    Creative thought … treat and count large exporting nations as states thus eliminating the imbalance (China and Japan should suffice for now … we can add Korea latter)

  • Posted by DF

    Have a look at the latest post from andrew Xie at morgan stanley …
    He’s clearly advocating a US recession. See also a point I’ve been made several times. INflation is way too low presently given : commodity prices, growth level and money creation level.
    The result is asset bubbles

    THe main reason is to be looked in wages lagging productivity (by around 10% in the 90’s up to 2005) thus boosting profits and directing the flow of liquidity into assets.

    As recession hits, do doubt deflation will follow.

  • Posted by jm

    The trade deficit can’t fall unless the savings rate increases. At present, there is little incentive to save, as real interest rates (especially after-tax) are negative. Should it be surprising that there’s no saving?

    Some might opine that bidding up the price of stocks is investment and therefore saving, but actual inflow into the stock market is probably being exceeded by insider sales ($40-50 billion last year), so that what’s really happening is the rubes cashing out the smart money, with net dis-saving. Some also seem to consider the building of excess housing stock as investment and therefore saving, but there’s such a glut of housing that it can’t be rented at a profit. I think this is speculation, not investment (and therefore not saving).

    I can’t see how there can be any increase in saving unless interest rates rise to a level that is positive after taxes and inflation (real inflation, not the government’s phony hedonically-fudged indices).

    There is good reason to believe that a rise of interest rates to such a level would puncture the stock and real estate bubbles (thereby revealing that current stock and real estate prices reflect speculation rather than investment).

    If (when?) these bubbles are punctured, there is likely to be a very severe recession.

    Looking at it from another viewpoint, the trade deficit means that millions of Americans who in a balanced-trade world would be working in factories making things are instead working in warehouses and stores at the distribution and sale of goods imported with borrowed money. Fixing the trade deficit means closing down the warehouses and stores and moving those people back to factory work. We face in this the small problem that we have shipped a lot of the factories to China, so a lot of factory-building is also going to be required. There are going to be many, many empty stores and warehouses, and people who bought into the REITs that own these are going to lose. The investment in factory-building can’t happen without increased saving.

    I don’t see any way our trade deficit can be balanced without a severe recession.

    The flood of liquidity over the last decade has induced massive malinvestment. How can we think that there can be some painless resolution???

    I’m with DF. Overcapacity in the world is so great that no amount of liquidity-pumping the Fed will be ideologically capable of bringing itself to commit will be adequate to prevent deflation.

  • Posted by anne

    Watching America: Will It Listen to Foreigners, or Do as It Pleases?

    DAVOS, Switzerland

    W HAT stresses me most,” the chief executive of Novartis, Daniel L. Vasella, said, “is that we are getting new regulations from abroad without any consultation.”

    This has been the World Economic Forum that the United States government largely passed by. In a world that both respects and fears American power, there is worry that the United States does not care what others think.

    Or, as Tony Blair, the prime minister of Britain, put it in a speech to the forum, “If America wants the rest of the world to be part of the agenda it has set, it must be part of their agenda, too.” He added, “What people want is not for America to concede, but for America to engage.”

  • Posted by anne

    Notice that the report showing a slowing of our economic last quarter has sent the long term Treasury note to 4.15%. Make no mistake about it, long term interest rates have been most sensitive to domestic economic reports. Davos did not move long term interest rates.

  • Posted by jm

    In my post above I should have stressed that what is needed is for _real_ after-tax interest rates to rise, and that in a deflationary environment that can come to pass even at a nominal rate of zero. The current low long term Treasury rates may be a harbinger of deflation.

  • Posted by anne


    Interesting supposition. Asset prices have been rising, commodity prices as well, but the price of labor has lagged inflation for some time and labor costs are the decider of production costs. Hmmm.

  • Posted by jm


    Asset and commodity markets are destabilized by having a rate-dependent positive feedback loop which is able to overwhelm the stabilizing influence of negative feedback: the faster prices are rising, the more some people will expect them to rise. This can continue until some other constraining factor halts the rise; prices then start down, and the rate-dependent positive feedback starts working in the opposite direction.

    In electronics, one way to build an oscillator is to construct a feedback-controlled circuit with such a rate-dependent positive feedback loop. The power supply voltages will provide the constraints, resulting in an output that oscllates back and forth between the positive and negative supply voltages with a period related to the time constant of the positive feedback loop. Real estate markets are a nearly direct analog.

  • Posted by anne

    Clever, and sensible in psychological terms.

  • Posted by glory

    re: giant off budget slush funds for party hacks

    speaking of which, saw this on the FT editorial page the other day 😀

    Koizumi’s challenge

    “The 130-year-old postal service, now a fiefdom of the conservative factions of the LDP, has gradually been transformed into a kind of giant off-budget piggy bank to fund poorly monitored government expenditure. Japan Post has contributed to the sharp rise in government debt, and has thus distorted not only the market for financial services but the country’s whole financial system.”

    “Mr Koizumi has admitted that after privatisation the savings and insurance divisions of Japan Post would no longer have to invest in Japanese government bonds. This goes to the heart of Japan’s post office problem…”

    interesting to me are the parallels with the bush admin:

    “If there is one achievement with which Junichiro Koizumi, the Japanese prime minister, hopes to make his mark on his country’s history, it is the privatisation of the post office.”

    “Outsiders might regard this as a curious choice for a man who has moulded a more assertive Japanese foreign policy and overseen a recovery, albeit fragile, of the world’s second largest economy…”

    like in the economist yesterday:

    Dealing with reality

    “MOST presidents get more defensive and hesitant as they go on. George Bush is getting bolder. Since his re-election, the president has committed himself to transforming, among other things, Iraq, the Middle East, the tax system, pensions and the legal system. Phew. If he were allowed to win a third term, what would he do for an encore?”

    “Yet the gap between Mr Bush’s rhetoric and what is actually happening, or is likely to happen, is embarrassingly wide. The day after his ‘freedom speech’ his officials fanned out to explain that he didn’t really mean anything specific. In Iraq things are not going according to plan—if indeed the administration actually has a plan. Tax reform has been sidelined to a commission, with action this year, next year, sometime. His attempt to privatise part of the Social Security system is in trouble even before it starts…”

    john berry, btw, is really going after bush hard on SS…

    like first he accuses him of making “false claims” last week and today he’s saying he also “ignores reality” …rather strident! (i guess berry is a member of the AARP :)


  • Posted by D

    I’ve long said those low nominal rates are precursors of deflation.
    Nominal wages have lagged inflation only these last 2 years.
    The main problem is that real wages have lagged productivity.

  • Posted by anne

    Yes; Nominal wages are lagging inflation, but real wages have lagged productivity increases. If my memory is correct earnings as a sahre of GDP are at historic highs in America. Also, I thought I read this was true for western Europe as well. Please tell me if I am correct about Europe.

  • Posted by anne


    The articles you alert us to are a wonderful help. The ties between the LDP and construction industry in Japan strike me as critical in understanding Japanese budget making.

  • Posted by df

    this is true of europe. I posted a simple analyse of numbers available on the OECD website.
    Wages are lagging productivity everywhere.
    When wages lag productivity there’s only 2 solutions :
    prices decline (deflation)
    Profits (including investment) increases

    the investment boom is behind us, now is the time for profit, and since profits does not generate enough demand… Prices declines are about to follow.

    Unless of course some general strike puts us back on line.

  • Posted by jm

    Wages are lagging productivity and profits increasing as a fraction of revenues in Japan, too.

  • Posted by DF

    wages have lagged productivity by 25 % in the last 15 years in Japan.
    Deflation is deeper in wages than in prices !
    That is a sure sign it won’t end any soon.