Brad Setser

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What did I miss?

by Brad Setser
March 22, 2005

Let’s see.

Paul Wolfowitz looks set to take over the World Bank.

Oil is a bit over $56. That is not low, by any measure. I remember how much concern there was last summer when oil broke $40.

The current account deficit came in at around 6.3% of GDP in q4.

Unless something changes, my $800 billion forecast for the 2005 current account deficit looks rather conservative.

This deficit certainly is not being financed by FDI. The big story in the q4 current account data was the resumption of large net outflows of foreign direct investment. Outward FDI exceeded inward FDI by $65 billion in q4, and by $133 billion in 2004. Bad news, at least to me.

Hedge funds bought a lot of Treasuries in January (see the data on the Carribbean). Foreign interest in US equities also picked up in January, and Americans lost interest in foreign bonds and equities — leading to large net inflows.

Alas, the relatively strong private flows of January presumably did not last. That is the message that UBS keeps sending out. And, as I noted earlier, central bank reserve accumulation (and no doubt central bank financing of the US) picked up in February.

China is looking for someone to manage their $610 billion in reserves, as Guo Shuqing, head of China’s State Administration of Foreign Exchange, got a promotion (he was named the new Chairman of China Construction Bank).

And I suspect it is not a coincidence that China is once again complaining about “excessive speculation” I have a hunch that Guo is managing a bit more than $610 billion right now. China’s March reserve accumulation probably will exceed $20 billion. If China’s reserves increased by $20 billion in January and February, and $30 billion in March, Guo’s successor will inherit a stash of nearly $700 billion.

US Treasury Under Secretary John Taylor announced his resignation; his successor (presumably Tim Adams, the policy director of the Bush 2004 campaign as well as Paul O’Neill’s Chief of Staff) will have plenty on his plate.

I should have plenty to chew over during the course of this week.


  • Posted by Movie Guy


    Glad you are back.

    Trip report? Photos? Tall tales? Gifts?


    “Unless something changes, my $800 billion forecast for the 2005 current account deficit looks rather conservative.” – Yes, your estimate is looking safe.

    “Hedge funds bought a lot of Treasuries in January (see the data on the Carribbean).” – Is this worthy of a separate post and discussion?

    BTW, since your departure my per gallon costs on gasoline have increased 28 cents. Any connection between the two events?

    Hope you do a post on oil.

    Returning from a four week trip today, I was stunned at some of the posted gasoline prices. One Exxon station wanted an extra 11 cents per gallon for 89 octane over what I was paying across the highway at a BP station.

    Good luck on settling in…

  • Posted by DF

    Welcome back ! your blog missed me.

    You ought to add, the dow jones lost 4% down below 10600.

    This may sound nothing. But it’s been 5 years now since the dow topped at 11500.
    With each month passing the “long term” returns of stock market fall.
    That reform of social security better be passed fast ! By the end of this year if the dow stand at 7500 it will be hard to justify privatisation.

    May be you should post something on relative asset prices and currency value.

    As you well know, economists tend to think that the relative price of currencies should fluctuate around the power of purchase parity.
    If everything is artificially cheap in a country (say China) because of the low value of its currency (RMB), then tourists will flow there, exports from this country will skyrocket, until inflation shows up and there is no power of purchase difference.

    Now, as usual, I d like to rant about asset prices.
    Imagine that in some mad world, speculation is high, and capital can move faster than goods and people across borders. The power of purchase parity that counts is not anymore about goods, but about assets.

    So you have a country where the asset prices look cheap on a comparative basis because of its low currency (USA), and another where they stand higher (europe).

    When asset (stock) prices fall in the USA, this is an asset deflation and justifies an increase in the value of the dollar. And vice versa.

    this in order to explain how come that dow jones and euro/dollar ratio move in perfect sync.

    (of course because these crashes would lead to a debt deflation depression, there would be no surprise in this move, I’m just highlighting this because on this blog everybody seems to think that the deficits argue for a devaluation of the dollar. Well, not necessarily, if asset prices plundge and credit crunch follows, savings will skyrocket add deflation and this will solve the commercial deficit in a context of a rising dollar.

    Any comment on the link eurodollar parity and stock prices ?

  • Posted by Elaine Supkis

    Condi leaves China and China announces it is time to let the dollar drop by itself. Once again, insults bring results.

    I have said before: China’s rulers HATE US. They want the USA derailed and defanged. They WANT Taiwan. They also want to control their own capitalists and don’t mind hurting them more than just a little if this is what it takes to keep power.

    Condi basically declared war on China. Nearly everything she said and did screamed “we are at war” and so they will now crank up the Doomsday Machine: they are the world’s lenders, we are the world’s borrowers.

    Inflation up this month in America. You can bet, it will skyrocket from now on as we create “money” by printin press, as per usual with all freckless regimes.

  • Posted by Elaine Supkis

    Worse case scenario: the dollar rises against the euro and collapses against the renimi.

    Indeed, thinking monetarism will fix trade imbalances when the subject nation imports because they must, ie, we already sold nearly all of our nonmilitary factories and we desperately need to import raw materials especially OIL…a classic set up for inflation/stagflation.

    The car factories in America churn out nearly only gas guzzlers which will be wildly unpopular in coming years. This is probably the last of our “industries” and the Asians beat us on the fuel efficency issue…a dark tunnel we are entering, no?

  • Posted by RMoen

    When writing in hyperbole, what can I learn? Should I be fearful? Possibly. But, what am I to do? I really do not understand.

  • Posted by RMoen

    The problem with deficit worries, and I agree we should be worrying, is that there has no evident problem with all the worrying. Republican economists laugh that Democrats simply marginalize themselves by worrying about deficits. Look at who is a wildly popular and successful Governor in California, for it is not Governor Davis.

  • Posted by RMoen

    No, we are not entering a dark tunnel unless we choose to believe this.

  • Posted by Yusef Asabinah

    For me, the big news of the last ten days was the announcement of the second largest monthly trade deficit of all time, followed by the announcement that foreign investors had increased holdings of US financial assets by the largest amount since May of 2003. The latter announcement seemed to buoy the US dollar and cause a large decline in the price of gold. When Brad says that the UBS is already saying that the strong private flows of January did not continue, does this information mean that , with strong deficits continuing, we might expect a future decline in the dollar ?

  • Posted by DF

    “we are not entering a dark tunnel unless we choose to believe this.”

    Yeah right.
    After all ostriches survived Darwinian selection…

    Action is easy. If you were taken away by a powerful river right into a 100 m cascado… What would you do ?
    I’ll tell you what, the only option is move out of the water, but in order to do that, you have to push some water molecules downward, accelerate their fall. Hasten the crash by speculating and move out of monetary exchange, these are the best advices you can get.

  • Posted by Yusef Asabinah

    Getting out of a powerful river is easy? Moving out of monetary exchange is possible? How would one get out of monetary exchange? By moving into a barter system? Is that what you have in mind?

  • Posted by anne

    Though I am rather optimistic, I do not think we need to worry about difficult a market period if we follow principles that began to be set in place from the days of Ben Graham and are supplemented by Buffett and Malkiel and Bogle and Siegel. We look to buy diverse companies at values that are fair or better given earnings prospects, and we wait as long we we must till we find such companies or funds of such companies. The need is value value value. Though even if we can not determine value, we can happily index and own most of our market and other markets for extended times.

    We balance stock market risk if we feel the need to with bond funds or bonds. When we can own hundreds of investment grade bonds, with limited duration periods, and have a secure income flow, there is significant security for us beyond stocks. We can worry, but intelligently.

  • Posted by malabar


    Would you please further expand on your line of thinking regarding asset pricing and currency values? And what happens to the yield curve and GDP growth rates in different regions of the world.

    Not a lot of folks are discussing that view point but I believe that it is important in the current context.

    What if asset values decline???

  • Posted by GAB

    The most important thing you missed is that the WSJ y’day warned on inflation and (you’re obviously around for this) the Fed warned on inflation today. What’s most interesting about these two items is that gold and silver and the CRB broke down huge y’day, oil down pretty big today. Sounds like the magazine cover indicator on inflation is working.

  • Posted by spencer

    Since the Wolfowitz appointment is old news I take this opportunity to suggest another line of analysis that did not get discussed at the time.

    Foreign aid, the UN and other such international institution were created after WW II to be instruments of US policy of incouraging world economic growth as part of the cold war. But the real domestic political reason for supporting these institutions was the cold war.

    Until around 1980 there was a good domestic consensus on this and despite some minor problems the UN, the IMF,IBRD, ect. did function largely as an arm of US cold war policy.

    In the 1980s the extreme right wing came to power and said we should ignore international institutions because we can go it alone and do not need the potential constrainst on US freedom to act. As a consequence the US allowed these institutions to languish and they were taken over by some weird characters and the institutions became much weaker.

    Now we have the WoT and it is much like the Cold War. Consequently we need the UN, IMF, IBRD, etc. to be effective once more as part of out new international war. Consequently, the appointment of people like Wolfowitz may actually be good thing from a liberal perspective. It means that such institutions will no longer be ineffective. Rather, the US will expand foreign aid and use these institutions the way they were used during the cold war as an instrument of foreign policy.

    I know this is a different approach, but I would love to see others reactions. Somebody tell me why it is stupid.

  • Posted by DF

    about moving out of market exchange i mean :
    1 have a lot of friends. If social security goes broke, if your company goes bankrupt, better have lots of friends.
    become a “social entrepreneur” be involved in association, non profit organisations …
    2 increase your self production (cook your food, do your laundry, make your clothers, grow your vegetables, have solar warming system, good isolation and so on).
    3 be involved in the new economy of gift (copy left, linux and the like).

    About asset prices, just look at todays numbers. THe dow falls. When will it reach the 1999 peak ? In 2020 ? It’s been 5 years, 5 years of negative returns, think of it, dividends barely cover inflation …

    When asset prices fall, the dollar appreciates.

    That’s the biggest hit.
    In a “sane” economy, if inflation is high, then the dollar should fall, gold should increase.
    In an insane asset economy, inflation means low asset prices, low asset prices means low monetary creation, credit crunch, the dollar increases.

  • Posted by a different chris

    >Somebody tell me why it is stupid.

    Because Wolfowitz is not only no Kissinger, he is a demonstrable idiot. And Feith is going along for the ride. We go to the UN with the conservatives we have, not the conservatives we wish we had!

    But that doesn’t mean your thought experiment is not valid. Maybe their plane will go down and Bush Sr. will con Junior into sending some sensible people.

  • Posted by gillies

    D F

    yes, there’s a smell off the greenback. is it the scent of stale bears?

    hold on to your line of thinking on deflation. (mar 22). if the ceiling upon oil production is genuine, and not a contrived situation, global growth has plateaued if not actually entered a post growth contraction. in the long term the money flows will reflect the energy flows and gradually contract. no amount of military adventures or geopolitical chess moves can alter this – in fact they would inhibit trust and trade and make it worse.

    you have only seen what o p e c has known for a long time – oil rising from 50 dollars to 60 dollars over a year or two is inflation. but oil rising from 50 dollars to 100 dollars in a month or two is a sharp check on everything that moves and brings recession, asset price falls, and at the end of the phase, lower oil prices than before the shock.

    in a full blown crisis there would be a flight to perceived safety in different directions. who is to say whether the inflationary or deflationary forces would prevail? the potential of the loose or hot money to cause ‘ spikes’ must be considerable. the loose money is a larger and looser percentage than ever before. information now spreads instantly. the potential for panic ( panic = instant prudence ) is multiplied by the instant information technology.

    any attempt to print money in a crisis might only result in ‘spikes’ in land or gold or commodities that, like a spike in oil prices, would carry the seeds of its own rapiid undoing.

    your contrarian view ( contrary to most contributors) is valuable for that reason alone – for being contrarian.

    as an irish farmer, i accept that i carry little or no weight in these elevated circles – but while retaining an open mind and hoping to learn more from the site, i support your thinking.

    let me stick my neck out and say that the dollar will now rise for a while. does anyone else detect a note of desperation creeping into warren buffet’s repeated assertions that it must fall?

  • Posted by Stormy

    I would not be suprised to see Bolton storm out of the General Assembly when the U.S. does not get its way. Remains to be seen if this is an honest attempt to work within the UN or to attempt to demolish it from the inside.

  • Posted by Stormy

    Joseph Stigliz savages Wolfowitz’s nomination to the World Bank:;sessionid=TJC05Y3WIGGVPQFIQMFCM5OAVCBQYJVC?xml=/money/2005/03/20/cnwbank20.xml&menuId=242&sSheet=/portal/2005/03/20/ixportal.html&secureRefresh=true&_requestid=9721

    It’s “either an act of provocation or an act so insensitive as to look like provocation.”

    Wolfowitz, he goes on to say, “has no training or experience in economic development or financial markets.”

    Not sure how long the world will eat humble pie. England is quite used to it. But, if those trial balloons from China and others concerning diversifing their holdings stay aloft, I would say “before the end of 2005,” especially if the interest rates hikes accomplish nothing. Hard to keep an economy going on expensive fumes.

  • Posted by John

     I would like to introduce a basic economic concept into the political conversation going on in this country.

     The seed for this insight first came to me in 1996, when Bob Dole offered up his campaign slogan, “We want you to keep more of your money in your pocket.”

     My first thought was; Thank God, it’s not my money, or it would be worthless!

     In exploring the intuitive insight behind that reaction, it has occurred to me that the monetary system, as an economic circulatory process, is a form of public commons and what we have today is a tragedy of the commons.

     Our understanding of Capitalism is based on Adam Smith’s “Enlightened Self-interest,” but this linear assumption doesn’t account for the fact that humanity is as much both individual and group as matter is both particle and wave. Our problem over the last few millennia has been that it is increasingly difficult to define any standard for what is the group.

     Having outgrown the clear parameters of tribes and city-states and gone through quite a number of other permutations, based on geography, spirituality, ideology, etc., the current winner appears to be variations on top down corporate neo-feudalism with bottom up democratic nationalism as its foundation. It would seem this construct has few apparent vulnerabilities, other then  compounding economic  inequality.

     The economy is a form of convective cycle, with energy in the form of materials, labor, ideas rising up and wealth, civil order and social security precipitating down. When far more such energy is rising then is needed for the further growth of the economic, social and civil structure and is not precipitating down, large storm clouds of surplus wealth build up at the top.

     Money is a tool, not a God and turning the economy into a pedestal on which to pile ever larger mountains of wealth for the high priests to lord over can only go so far, before it all falls down.

     Much is made of government deficits, but no one asks where this money would be going if the government were not borrowing it. Only as much money can be saved as can be effectively invested, beyond that and it just inflates asset values. Government borrowing amounts to a nationalization of surplus wealth, but rather than taken, the government is being slowly transferred to the investors.

     In fact this has been going on for some time; Was Roosevelt just putting the poor to work, or was he also putting the money of the wealthy back to work, as well. How did Volcker cure an oversupply of cash in the economy by reducing demand? Reverse engineering loose money doesn’t necessarily put the genie back in the bottle. I suspect the government deficits were far more effective in both soaking up this wealth and getting the private sector going to the point of needing more as well. Supply side economics help to squeeze it to the top, where it could be skimmed off. As for the growth in the actual economy, having the baby boomers going through their most productive years certainly had the biggest effect.

     As it it is, the purpose of capitalism is to produce capital and to this it has been enormously successful. It would seem though, that the economic motor is nearly flooded out on all this cash.

     The highway system is another form of public commons and economic circulatory system, so to use it as an apt comparison; It would be as if every time the state built a road, everyone ran out and laid claim to as much as possible. Eventually everything would be paved/monetized and still few people would be able to get around.

     Money has no value other then that given it by the larger community and it passes through your hands like the highway passes under your car. Of course, no two people can use the same piece of road at the same time and the greater the velocity of traffic, the more road everyone needs. The situation we have today is where the great majority of people are being squeezed on to ever smaller sections of road, so that a few can drive very fast on the open pieces they claim. Is it any wonder that the economy seems to be going ever slower for most people?

     The irony is that it is the rich who are working hardest to destroy a system they benefit the most from. Just goes to show you that they really are not that much smarter than the rest of us.

  • Posted by Elaine Supkis

    When walking in weeds, one can imagine, everything is coming up roses…..

    Excuse me, but do I detect currencies and necessities heaving and falling and rising violently and hideously? Is this STABILITY? Or is this one farking earthquake after another? And when will the big 9.0 blowout earthquake happen?

    All the elements for one are here especially the super danger signal: stupid leaders.

    WWI–the British empire, grossly overextended, losing industrial ground to Germany and the USA, clinging to a mercenary/military/royal navy control of the world, guarantee of peace, lead suddenly at the death of Edward, by an idiot just in time for Austria and Germany and Russia to be headed by near twin idiots, all related closely to each other, equally dumb.

    What a nightmare.

    I don’t feel good about this at all. Bush is really stupid. And ingrown.

  • Posted by Michael Carroll

    $56 a barrell is low by one measure: Inflation adjustment of oil prices from the late 1980’s.

    Question of the day:

    Is there a “reverse” Balassa-samuelson effect?

  • Posted by Movie Guy


    “Though I am rather optimistic, I do not think we need to worry about difficult a market period if we follow principles that began to be set in place from the days of Ben Graham and are supplemented by Buffett and Malkiel and Bogle and Siegel. We look to buy diverse companies at values that are fair or better given earnings prospects, and we wait as long we we must till we find such companies or funds of such companies. The need is value value value. Though even if we can not determine value, we can happily index and own most of our market and other markets for extended times.

    We balance stock market risk if we feel the need to with bond funds or bonds. When we can own hundreds of investment grade bonds, with limited duration periods, and have a secure income flow, there is significant security for us beyond stocks. We can worry, but intelligently.”

    How do we apply these same fine principles during an unfolding fiscal crisis?

    Without listing all of the problems, I see little good news out there.

    I believe we’re just a few steps from walking off of the cliff. And the ground we’re standing on is beginning to shift.

    At this moment, I don’t believe that I will increase my holdings in bonds or stocks.

    Am I missing part of the picture that you see?

  • Posted by p

    Any material policy recommendations? Are we just venting?

    The economy is growing. This is good news. More over, this is a net measure which makes it a more important variable than the ones that are looking bad (and I agree that some of the other measures look bad).

    The long term picture for the US is not bad in my assessment when compared to the rest of the world.

    Much of europe is not growing, they are running budget deficits greater than ours, unemployement is very high, their population is aging quickly, and they are dependent upon the US for exports. Net currecy is not a long time buy.

    China is gambling with the savings of its citizens, the externalities of growth are rising rapidly (polution and social strife), they are increasingly dependent upon the US for survival. Without reciprical trade with the US, they will face the same problem Japan chose (stagnation).

    I would be interested in hearing more on policy recommendations or theory that explains the evolution of the global economy versus a fixation on looking at every data point as one more nail in the coffin …

  • Posted by Stormy

    For a while, I used to think that if everyone pursued their own interests, then the interests of all would evolve from that pursuit. Unfettered capitalism, we were led to believe, would raise all boats. I am beginning to wonder. The disparity between the rich and the poor continues to grow; we all know that the difference between the average CEO pay and the pay of the average worker continues to grow, if not exponentially, then certainly in a straight line. Reminds me of an image from “Pincher Martin” by William Golding—the same guy that wrote “Lord of the Flies.” Martin is the ultimate devourer—manipulative and selfish. As he drowns, he remembers that the Chinese used to bury a handful of maggots in a tin container. Big maggots ate the little ones…until finally there was one maggot left. At which point, the Chinese—a kind of final reality—dug up the tin and ate the last great maggot.

  • Posted by tre

    Wow, what a set of posts. Everything and the kitchen sink. But I’ve got a specific question:

    DF said: “In an insane asset economy, inflation means low asset prices, low asset prices means low monetary creation, credit crunch, the dollar increases.”

    I’m confused by this statement. I would say that monetary tightening in response to inflation (in CPI and PPI) leads to asset deflation, credit crunch, and then the dollar increases as debt holders scramble for cash. We have about $40 trillion in dollar denominated debt and $10 trillion in M3 (if I remember correctly). Therefore, at worst, one can imagine people trying to jump out of long-term debt into cash or cash equivalents. This will drive up long-term rates, which should be good for the dollar.

    Deflation should be good for the dollar. And bad for just about everything else.

    The fed is still on an inflationary path, but a deflationary collapse of asset prices could be in the offing.

    Or am I missing something?

  • Posted by brad

    I’ll try to think of something clever to say on oil, but am not sure i can top the basic points calculated risk has made (accessible via the link on angry bear) … i sort of thought there was a risk oil might lead US consumers to pull back last summer, but, well, it did not happen. We just started borrowing more.

    p — I laid out my basic policy recommendations in the paper I did with Roubini last september (updated in november) on rising US external debt. Of course, those recommendations assume that there is a problem with current account deficit of 6% of GDP, that such deficits cannot be financed indefinitely on the back of a “surplus” of global savings, and that the US (and the world) would be better off acting preemptively now to try to scale back the obvious external imbalances (not just the US deficit, but also surpluses elsewhere) before the market turns and forces the US to adjust. obviously, if you don’t agree with the diagnosis, you won’t agree with the prescriptions — which, i have to say, are pretty standard for those concerned with “imbalances.” I put a bit more emphasis on emerging Asia and a bit less on Europe, and a bit more emphasis on steps that would encourage demand in Europe rather than structural reform (whose impact on demand is ambiguous — see Germany), but the policy recommendations are not exactly earth-shakingly innovative. they are the obvious steps fs you think domestic demand growth in the US needs to slow, and domestic demand growth elsewhere needs to rise.

    Michael — reverse Balassa-Samuelson? Slow productivity growth in the tradables sector leads to a real depreciation? I guess that has to be true in a relative sense if rapid productivity growth leads to a real appreciation — rapid and slow are relative concepts. Explain a bit more, if you don’t mind. Am feeling a bit dense.

  • Posted by DF

    You have it right too.

    What I’m implying is that when inflation in CPI PPI rises, then the real returns on asset falls. Therefore their price falls.
    As credit demand falls, then whatever the federal bank may want to do, it can not increase monetary supply. (the credit multiplier goes down).

    But it’s true also that in inflation times, the fed is expected to tighten, and this reduces real returns on asset too.

  • Posted by anne

    Movie Guy

    There has of course seemed a considerable and growing need for caution, and I am being increasingly cautious, especially so since the Federal Reserve is being increasingly cautious. But, rejecting what NPR just reported, I am not thinking in dour terms such as when Social Security will go “broke.” When NPR simply reports as news that we will find out today when Social Security will go broke, I understand Social Security will not go broke and turn to classical music. There is reason for caution, but caution should not mean dire concerns.

  • Posted by Elaine Supkis

    This is a time of dire concerns. When you spot a hurricane or tornado coming, you don’t wait until the winds are screaming to go to the cellar or leave the area.

  • Posted by Keith

    IMHO there is a range of possible outcomes from our current situation. While the probability of financial crisis is certainly real, I don’t think its the most likely outcome because the Fed appears to finally be acting rationally.

    The biggest imbalance that we have is the trade deficit, which has a significant root cause in low real rates. But the Fed is correcting this problem in its very measured way. So, I think that the most likely scenario looks like this:
    -The Fed continues to raise rates .25% for the next four FOMC meeting or so.
    -The rate increases take the froth out of the hottest parts of the housing market and stock markets.
    -The higher rates plus stagnating or falling asset prices forces a consumer-led slowdown (the one we should have had four years ago.)
    -The retrenchment by consumers increases the savings rate and cuts into demand for foreign consumer goods.
    -Higher real rates and lower demand for foreign goods support the dollar.

    There is no reason that any of this must turn into a route of asset prices or the dollar. It could happen if some foreign central bank decides to do something silly, but bankers are a conservative lot so I don’t worry too much. Most of our current issues have roots in politics, not economics, and they can be fixed with solid policy by the Fed and government. The Fed is doing better and hopefully the federal gov’t can do better too.

  • Posted by anne


    Though I expected the Fed cycle to be more clearly defined, and though it has become so, I do not think the Fed acted too slowly. Joseph Stiglitz appears to be faulting the Fed from 2001 and on, but I am not sure why and have written a friend to ask. I have not the least hope for better fiscal policy for this session of Congress however, so the Fed had best be right in policy. Time to ask more questions, and consider your interesting thoughts. Hmmm.

  • Posted by brad

    Keith — combine your scenario with a UBS scenario (embedded in a critique of roubini/ setser) for gradual appreciation (and continued reserve accumulation) in emerging asia and you have a plausible scenario for a (sort of) soft landing.

    I would feel a bit more comfortable if some fiscal adjsutment in the US was part of the equation — the scenario you laid out would tend to widen the fiscal deficit, absent any offsetting policy changes, along with a bit of domestic stimilus to go along with higher real exchange rates in emerging asia.

    I know what you meant when you said central banks are a conservative lot. But I still find it a bit ironic to call the current behavior of Asian central banks “conservative.” Continuing to build up a massive long dollar position (financed in part with local currency debt) against a country with a 6.5% or so current account deficit strikes me as risky, not conservative, even if the US is paying 4.5-5.0% nominal rather than 4% nominal. It is the kind of huge macro currency bet more typical of a hedge fund than a central bank, and any hedge fund betting that a 6.5% of GDP (and rising) current account deficit could be sustained would be taking a huge risk … that still worries me. as does the risk that the asset market adjustment you mentioned might trigger some form of financial instability somewhere, somehow.

  • Posted by Keith

    When Greenspan decided to go down to 1%, he should have also had a plan on how to come back up. While I appreciate his desire to be “measured”, it takes a long time to go from 1% to neutral when you are moving at a “measured” pace. And that doesn’t even take into account the time required to go beyond neutral to restrictive. Policy application is a judgement thing, and we will see what happens. My own guess is that the Fed held rates too low for too long, and that inflation is back. We will see over the next few quarters if the cure was no better than the disease.

    I have been very disappointed in the ability of Congress to get any measure of discipline. I did not expect much, but they have delivered nothing. The GOP’s ability to act decisivly on the Florida right-to-die case, while showing an inability to tackle the budget, is especially distressing.

    But maybe the ship is turning. Every couple of months I talk politics with my father. He is a good touchstone for what the Rush Limbaugh-type Republicans are feeling. (He last voted for a Democrat in 1960). Two weeks ago he asked my opinion on Social Security, and I told him that the trade deficit, federal deficit and medicare were all bigger problems. I was very surprised when he didn’t argue with me, and this may mean that some voters are starting to shift viewpoints. 2006 might be an interesting election if we can make it that far.

    Yes, I take your points on the “conservative” nature of the Asian central bankers. These days the policies of conservatives everywhere seem to be a betrayal of the term.

  • Posted by anne


    Joseph Stiglitz seems to be saying the same, and I will add on the thread above. I think the Fed can move more quickly now. We could easily see 50 basis point moves, alas.

  • Posted by DF

    I d like to believe the soft landing scenario. But some points are still lacking.

    Keith said
    The biggest imbalance that we have is the trade deficit,

    I disagree with that one. I believe the biggest imbalance we have worldwide is the growth of the debt/GDP ratio. THe economy is with each day passing ever more in debt. This path is in itself not sustainable. Would you keep on lending forever bigger amounts, say 8% more each year, to some one increasing its revenues 4% each year ?

    It’s easy to blame the foreign central banks, but I believe they’re only a small part of the picture. Inside the USA debt is piling up at an incredible pace. Same within europe.

    More over in order to qualify for the “soft landing” label, your scenario needs a balancing force, some mechanism that would bring back growth after the long awaited “consumer led slowdown”.

    What will that one be ?
    My concern is that even in high growth period, the real wage has been falling (-0,4% this month).
    Wage lag even farther behing productivity.

    Do you believe that a slowdown will increase labor power ? I doubt it. Only when labor will gain again some pricing power will growth restart on a sufficient level.

    One last line on this post. Corporate scandals are directly related to falling asset prices. When prices rises, errors get erased, fraud remains unseen. Bring a fall of asset prices and I’m sure we’ll have those scandals again.

  • Posted by Keith

    Thanks for your comments as they force me to think about my position.

    I said that I thought that the trade deficit was the biggest problem. As I am sure you know, trade flows are complex, and I should have been more specific. Currently we have large merchandise deficit being offset by sending Treasury debt overseas. It’s the build-up of Treasury debt overseas which I find disturbing more so than the merchandise side (not that I like the merchandise side). Measuring the extent of this problem in terms of GDP for both flows and stocks is fine with me, so I’m OK with saying we have a debt to GDP problem.

    You, however, are saying that total debt is the problem, whereas I am specificly concerned with external debt. I have seen the charts which show the rise of total debt but this doesn’t seem as alarming. I have no reason for this complacency, but it may be because I don’t understand what is causing the rise of internal debt. Brad and others have done a great job of showing the problems with the external debt, but I haven’t seem similar work with the internal side.

  • Posted by DF

    The cause for the rise of internal debt seems plain simple to me : too low wages. Wages lag behind productivity, spending is boosted by debt.
    Add to that speculation on asset markets.

    The problem of internal debt are exactly the same that with external debt. It can not grow forever.

  • Posted by Michael Carroll

    Brad – Regarding the question of the day, I stupidly failed to recognize the condition I was considering was built into the description of the Balassa-Samuelson Effect. Namely, that a rise in foreign productivity will reduce relative domestic wage levels in non-tradeables. However this may be a case where your answer is more intriguing than my poorly though out question.

  • Posted by xanax

    The nice thing about being a celebrity is that if you bore people they think it’s their fault.