Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


A hard landing in 2006 – just not in the US?

by Brad Setser
June 18, 2006

Nouriel and I postulated back in early 2005 that there was a meaningful risk that the next “emerging market” crisis might come from the US – and it might come sooner than most expected.   The basic quite simple: Ferguson’s debtlodocus might find that it no longer could place its debt with the world’s central banks, the dollar would fall, market interest rates would rise, US debt servicing costs would go up, the economy would slow and the value of a host of financial assets would tumble.    

Why the emphasis on central banks?  Simple: they have been the lender of last resort for the US, financing the US when private markets don’t want to.  See April 2006.  Consequently, a truly bad scenario for the US seemed to require a change in central banks’ policies.   Real emerging markets aren’t so lucky.  When private markets don’t want to finance them, they typically aren’t bailed by someone else’s central bank.  

It sure doesn't look like sudden stops in financial flows and sharp markets moves have been banished from the international financial system.   Certainly not this year.  They just didn't strike the US, but other countries with large and rising current account deficits. 

Iceland’s currency is way down (its stock market too) even though interest rates on Icelandic krona are up.   The private market’s appetite for krona disappeared.     

Inflation is up too, driven by the weak krona.

The Turkish lira is way down.  Lira interest rates are way up – as is Turkish inflation

Turkey's central bank sold dollars this week — for the first time in quite some time.  It was buying dollars in a big way in the first quarter.  Times change.

Currency collapses do not necessarily translate into economic slumps.   That was a key point that the Federal Reserve has made in response to fears about a US hard landing.  A fall in the currency doesn’t always translate into higher interest rates, at least in post-industrial countries.     And in part because lots of the damage from a fall in the currency comes when firms, banks and the government have borrowed in foreign currency, turning a currency crisis into a debt crisis.  

The US, thankfully, has financed itself by selling dollar-denominated debt, pushing currency risks onto its creditors.   But so did Iceland.   And even Turkey increasingly financed itself in Turkish lira.   Particularly in 2005, there were big inflows into Turkey’s local debt and equity markets.   Turkey obviously still has a fair amount of dollar debt.   It is an emerging market after all.  But things were changing. 

I still think the financial slump in both Iceland and Turkey could easily turn into a sharp economic slump.  In both countries, both policy and market interest rates are up significantly – in part because a weaker currency (and still strong oil) translates into higher prices for imported goods.   And I suspect higher interest will, over time, slow the pace of both economies’ expansion.

One big reason why Turkey was growing fast was that because its banks were lending tons of money to Turkey’s households, whether to buy a car or buy a house.    But it only makes sense to lend long-term at 13% (say for a mortgage) if inflation and nominal interest rates are expected to fall over time.  This year, both inflation and nominal rates rose.  Ouch (if you are a bank).  

I suspect that the result will be a significant slowdown in credit growth – and in the Turkish economy. 

Charles Gottlieb of the European Capital Markets Institute notes that Iceland too was growing in part on the back of a strong expansion of credit (see his figure 1) – though in Iceland’s case, demand for Icelandic Krona was for a while so long strong that Icelandic issuance alone couldn’t meet it.  Consequently, European banks started issuing so called Glacier bonds in krona (a note: I am sure the banks hedged their krona exposure, I just don’t know how). 

And Gottlieb nicely shows what a sudden stop looks like.   See his Figure 4.  It shows a huge surge foreign purchases of Icelandic securities issued by Icelandic residents (I think that means it excludes Glacier bonds) up until January of this year.  And then a huge – and I mean huge – fall.  Inflows became outflows.   Foreigners sold; Icelanders bought. 

I am not convinced Iceland is the next Thailand – but there are lots of unpleasant outcomes that aren’t quite that severe.

Turkey and Iceland are not the only markets who went through a rather nasty sell-off.   Emerging market equities just has their worst run since 1998.  Of course, it comes after a huge run-up.    And as no shortage of credible observers – like Ragu Rajan of the IMF — have noted, the markets that are selling off the most are the markets that rose the most.  That suggests that the causes of the sell-off are global, a change in the markets willingness to invest in emerging economies, not local – that is what the generally bearish BIS thinks and in this case they have support from some (former?) bulls, like MSDW’s Turkey analyst Serhan Cevik.

Despite this indiscriminate sell-off, there is still no agreement among investors as to what the sudden burst of global volatility actually reflects. …. Risk reduction always brings indiscriminate selling of all ‘risky’ assets at the early stages, regardless of underlying economic structures and policy frameworks.

The team at Danske bank hasn't been as consistently bullish at Cevik, but they seems to agree that it is hard to pin down any fundamental cause of the recent sell-off.

I certainly didn’t see this kind of global sell off of emerging economies coming, though I worried about a few specific markets.  And not just ex post.   But then again I am usually good for a cautionary quote … 

And in some sense, the fact that the current global sell-off focused on emerging economies is a bit strange.   I see the logic: what went up too fast has to come down.  

But the defining characteristic of the recent boom in private capital flows to emerging economies is that, at least in aggregate, capital was flowing into emerging economies didn’t need the money.   The US was attracting more financing that it needed to run very large deficits, and using some of the money to invest in emerging economies.   And emerging economies were taking financial flows from say Europe and using them to lend to the US.  It was a rather complex equilibrium. 

Look at the statistical data in the latest issue of the World Bank’s (very useful) Global Development Finance.  Developing economies collectively ran a current account surplus of $245 billion in 2005.    Private inflows of $490 billion were used to pay back the IMF and to build up reserves — these countries reserves were up by $395b or so in dollar terms, more than their current account surplus.

(One note for true balance of payments geeks: the GDF’s reserve increase isn’t adjusted for valuation changes.  If you make that adjustment, total reserve growth would be bigger, and the errors and other flows term would fall) 

Of course, what happens in aggregate can mask big differences in the specifics.   China, Saudi Arabia and Russia all had big current account surpluses.   Brazil a more modest surplus.  India had a small and growing deficit. Turkey – and Hungary — had big deficits.  

Despite these differences the equity markets of Russia, Brazil and Turkey have all tumbled this year.  Foreign funds that poured into these economies earlier this year poured out in May.  When the data comes in, the change will look a bit like Gottlieb’s graph showing flows in and out of Iceland.

My hypothesis therefore is twofold: 

The recent correction has been driven as much by developments inside the financial markets of the post-industrial economies as by a change in the emerging economies themselves.  Hence the general sell-off.

And the impact of the correction will vary dramatically.   Some countries didn’t need inflows.  Russia.   Others did.  Turkey.   But even in turkey, the inflows that were coming in far exceeded what Turkey needed.    In the first quarter, annualized inflows were something like $60b relative to a current account deficit of $30b.  If flows go to $30 or $25 Turkey is fine.  If they go to zero, not so much. 

Actually, my hypothesis is threefold.

In April, the G-7 communique triggered a fall in the market’s willingness to finance US deficits.    We saw that in the TIC data.  There also was a bit of a surge in capital inflows to Asia that prompted a bout of intervention.   Central banks financed the US when markets didn't want to.

In May and early June, folks who borrowed dollars and yen to buy emerging market equities (and debt, to a lesser degree) sold their emerging market equities and repaid their loans.  Call it deleveraging.  

The net effect has been to help finance the US.   Less money was flowing out of the US – US purchases of foreign equities averaged about $10b a month for the first four months of the year.   And if Americans may have actually reduced their exposure to emerging economies in May and June.   That too would help to finance the US deficit.   Deficits can be financed by selling (external) assets as well as issuing (external) debt. 

My question:  What happens once this process is over?

Do higher US rates continue to draw the financing the US needs to run big current account deficits – a deficit that I still think will be over $900b?  

In part because China and the oil exporters continue to use their central banks and oil investment funds to finance the US?

Or does the US join the list of high-carry (at least relative to Japan and Europe) countries that have experienced trouble in 2006? 

And what happens if an incipient US slowdown start to generate expectations that US rates have peaked and won’t provide as much support for the dollar?

If I had to guess, I would say Bill Gross (quoted in Business Week) is right.   

It's like Peter Pan who shouts, "'Do you believe?' And the crowd shouts back, in unison, 'We believe.'" You can believe in fairy tales and Peter Pan as long as the crowd shouts back, "we believe." That's what the dollar represents, a store of value that people believe in. They can keep on believing, but there comes a point that they don't.

Greenspan was here two months ago and talked with us for two hours. The most interesting point was his comment that there will come a time when foreign central banks and foreign investors reach saturation levels with their dollar holdings, and so he sort of drew his hand across his neck as if they've had it. Why can't they keep on swallowing dollars? Logic would suggest that these things start to fray at the fringes. Once the snowball starts it can really get going. …

The dollar is really well supported by its yield. We've got 5% overnight rates and Japan has zero. You get over 2% relative to the euro, so obviously 5% or 5.25% is dollar-supportive, and the more that Bernanke sounds off that he's going even higher, the more that supports the dollar. The real question is what starts it on the way down? At the moment people believe that's O.K. and yes, housing is starting down, but the rest of the economy is looking good, 2% to 3% GDP growth isn't so bad. I would say that if that's the case we've got a pretty good little fairy tale going here. But if it doesn't, if 5% leads to a crack in the housing market and the unwind of various global markets and the U.S. stock market … If the stock market keeps going down then that's a sign that 5.25% is too onerous a rate. So what the question becomes then is can the U.S. economy be supported at that level? That's when the question of whether there's the possibility of an avalanche begins. If we get rates then down to 4.5% and then all of a sudden the [other central bankers] are moving up, the money flows out. It's not because of the [lack of a] yield advantage; they've had it up to their necks in terms of dollars. The unwind of the dollar can come from saturation or geopolitical issues or simply that the U.S. economy isn't as strong as people think and they stop believing in Tinkerbelle.

A big fall in the dollar isn’t bad for the US.  A big fall in financial inflows that led to a rise in US interest rates though is another story.  A 200 bp move is not so big for emerging economies, but it is big for the US.  And because the US financial system is much more leveraged, it would also have much bigger consequences.


  • Posted by Gcs

    brad writes

    ” truly bad scenario for the US seemed to require a change in central banks’ policies. Real emerging markets aren’t so lucky. When private markets don’t want to finance them, they typically aren’t bailed by someone else’s central bank. ”

    and from that difference
    hangs the tale of
    the north south
    currency tilt

    my point

    what mad science backed by special interests makes
    this a reproduced system

    why are we not all screaming no mas

    as once agin

    the south dive looms on the horizon
    okay so its still
    yet a “bounded rational expectation ”

    but heavens good people must we keep going thri these bottle necks
    can’t we engineer a better channel for global development ???

  • Posted by psh

    Picking a country pair from the GDF appendix, A18&19 — take Hungary, where bond issuance almost appears to be supplanting bank debt, vs. Turkey, where bank debt has done more to drive financing growth — Turkey ought to be more vulnerable to carry trades unwinding, but maybe less vulnerable to big crimps in securitization. It’s the latter that scares me most; loan brokers assessing risk, faceless bond-fund saps bearing it (along with the custodians of China’s reserves). If the moral hazard of that comes home to roost and spreads get spooked, it’s curtains. Which suggests a hypothesis: ignoring comparative ratings, under the assumption that a rising tsunami floods all boats, if contagion hits Turkey but Hungary skates, we might get out alive. If Hungary gets nuked too, it’s time to man the apple stand. So far the forint’s hanging in, only partway to March lows.

  • Posted by Paul

    Great post.

    I have a hard time being gloomy about it though, at least if my take on it is correct.

    As someone who works in Engineering and IT (which I guess would be what you and others, such as Delong, call the export/import competing sector), a falling dollar would probably do wonders to the job market I am in. It may very well make that pesky offshoring thing not only go away, but go into reverse. That would be great.

    Further, I have no debt, save over 50% of my pretax income, and direct all those savings into international mutual funds that don’t invest in the US. So, if those markets hold more or less constant, or at least don’t fall much, in their currency, then I should make a decent amount of money on that in dollar terms as the dollar falls. That would also be great.

    Further, I rent and don’t own property, but would like to buy a house sometime in the next few years. Sharply rising interest rates would probably tank housing, especially those with ARMs. Sweet, cheaper homes. Further, with the money left over, I could invest it in the now high yielding US treasury bonds.

    I really hope you are right.

  • Posted by psht

    Long live Paul. Paul will doubtless succeed to suzerainty over blighted enclaves of inbred snakehandlers and nativist losers still in thrall to Clear Channel and the ruined stewbum Bush. Debt peonage should keep the lower orders compliant despite their sectarian hysteria. Let us hope he rules the masses with a firm yet kindly hand. Perhaps he will be so eminent as to shepherd his benighted charges into the cultural milieu of the Enlightenment.

  • Posted by Guest

    “… perhaps a telling economic indicator — that Goldman Sachs recently hired one of the nation’s most prominent bankruptcy lawyers, James H. M. Sprayregen… Mr. Sprayregen’s hiring by Goldman may pose a new threat to Wall Street’s restructuring boutique firms, like Lazard Ltd., the Blackstone Group, and Miller Buckfire & Company.
    They have historically dominated the small but lucrative restructuring netherworld… Last October, when Congress established the new bankruptcy code, lawmakers added a line to the bill at the last minute allowing major Wall Street firms to advise companies seeking bankruptcy protection even if they had done underwriting work for those companies in the past…”

  • Posted by Charles

    Brad, I agree that a dollar crash plus a spike in US interest rates necessitated by dollar saturation is a likely outcome. And then there’s world recession.

    But it makes the recent market moves all the more puzzling. For holders of US equities, this eventuality is really bad. It means that you are left holding equities headed down even as they are worth less and less in world financial terms. For holders of foreign equities, the situation isn’t quite that bad. They are left holding equities somewhat depressed by world recession, but whose value is not depressed by currency concerns.

    So, why is gold hit so hard? I dislike gold as an investment for reasons of conscience, but precious metals, raw land, and other investments less susceptible to currency fluctuations would seem to be the only safe investments.

    Anyway, interesting analysis.

    Charles of MercuryRising

  • Posted by Movie Guy

    Brad – You have fleshed out the situation pretty good, so I hope you go to the next step. Bill Gross summed it well, as did Naill Ferguson.

    Perhaps you will broaden your closing remarks: “A big fall in the dollar isn’t bad for the US. A big fall in financial inflows that led to a rise in US interest rates though is another story. A 200 bp move is not so big for emerging economies, but it is big for the US. And because the US financial system is much more leveraged, it would also have much bigger consequences.”

    The idea that a big fall in the U.S. Dollar isn’t bad for the U.S. might very well depend on whom we’re talking about: government (Fed and Treasury or USTR/Commerce), banks, consumers, U.S. domestic importers and exporters of finished goods, commodities, or services, U.S.-based TNCs (transnational corporations), wholesalers, retailers, farmers, and so forth.

    The presence of a globally weaker U.S. Dollar doesn’t necessarily reduce the overall dollar volume of imported goods (as we have discussed at length previously and with which Greenspan finally acknowledged), nor does it offer any guarantee that TNCs will land their corporate helicopters and jets anywhere in the U.S. to negotiate plant locations (another Greenspan acknowledgment). Bill Gross only brushed up against the trade issue, but I believe that he should rethink his limited remarks on U.S. manufacturing to some extent.

    Sure, a few TNCs might drift back, but it’s very evident that the ‘Go Forward’ visions of TNC leaders is to shift production primarily overseas where developing markets are generally co-located with cost effective, new production facilities. The TNC FDI has been programmed, or fully committed and costed, so make it work.

    The Administration’s apparent decision to ‘Go Forward’ with significantly broadening high tech sales of goods and services to China would, in theory, benefit from a weaker U.S. Dollar, but those procurement actions will happen anyway in order to satisfy China’s collective thirst for the high technology (in production, operations, and goods).

    How does a weaker U.S. Dollar affect housing mortgage financing? U.S. stock markets? And when?

    I share the desire for a weaker U.S. Dollar, but I wouldn’t say that a big decline in the global value of the U.S. Dollar is good for the U.S. without offering some qualifying details to support the argument. I’m not fully confident that it what the U.S. should be seeking within the next two years, though it may happen.

    Good luck in presenting the next stage of this presentation if you elect to do so. Hopefully you will. It’s needed.

  • Posted by HZ


    PBC April reserve data is out. FX increased Y66B RMB or about $8B US + change. I think you were looking for $20B plus. Any idea on why the shortfall?

  • Posted by Alex

    “I am not convinced Iceland is the next Thailand – but there are lots of unpleasant outcomes that aren’t quite that severe.”

    Although I’m not intimately familiar with Iceland’s economy or Thailand’s intuitively speaking I would think that Iceland is probably going to be in a world of hurt versus Thailand.

    From an intuitive standpoint liquidity can probably dry up far more quickly for a small economy like Iceland than economy like Thailand. Also whats the market for Icelandic Krone based debt like, I bet there certainly isn’t a huge demand by Chinese or the Saudis to recycle all there Krone. I just don’t see it.

    Personally I think Iceland could have some major liquidity, I’ve been told this is what happened to Sweden in the mid 90’s when Soros attacked the Swedish Krone and essentially drained the country’s foreign currency reserves.

    What I’m really trying to say is this. Small markets like Iceland can be affected drastically by foreign capital inflows and outflows and liquidity could dry up ALOT faster than anyone can imagine if the foreign creditors get spooked.

    “A big fall in the dollar isn’t bad for the US. A big fall in financial inflows that led to a rise in US interest rates though is another story. A 200 bp move is not so big for emerging economies, but it is big for the US. And because the US financial system is much more leveraged, it would also have much bigger consequences. ”

    Brad I think even you would probably be suprised by how leveraged the US economy is. The Treasury Department alone has to refinance 50% of the US debt over the next few years at escalating rates. I read that in a paper somewhere.

    In my part of the world we have homeowners pulling out equity just to pay bills. I have a friend who pulled equity out of his and parked it into a CD, craziness.

    I have another one is up to his eyeballs in an interest only loan.

    Just curious Brad why hasn’t anyone done any work on debt and moral hazard, especially with regards to home ownership? Of course we don’t need to mention how the marginal proposenity to consumer is far higher for increases in housing wealth versus other forms.

    Schiller just made a speech a few days ago at S&P regarding the current housing bubble and how its the biggest one since 1890. These are crazy times.

  • Posted by DF

    The dollar is supported by the yeld.
    Conversely, the Fed is not completely setting the rate in relation to inflation risks and US growth, it may be indeed setting the rate necessary to attract the needed capital inflows for the continuous expansion of it’s credit boom.

    It’s not hard to see a future with lot’s of CB’s trying to sell their dollars. Question if numerous countries suffer from a financial crisis and sell dollars to defend their curencies during a capital flight out of their country… What’s the impact on the dollar ?

  • Posted by Guest

    “…Japan may be about to end ZIRP, but is it about to let its currency appreciate rapidly overnight after a decade in the economic wilderness? … The carry trade is a global phenomenon, not an isolated incident like the that of Russian debt… The global financial system is in better shape tan it was in 1998… the economies of the U.S. Europe and Japan are growing in synch… The US can slow, China can slow, other can slow but there is a long way to slow… We are currently experiencing a period of great volatility in financial markets. Is it unprecedented? Absolutely nowhere near it… Clearly derivatives traders are not panicked… The diversification of assets supports the diversification of risk. It also supports leverage, and that is very much part of the carry trade fear. It is leverage that provides for the roller coaster ride, but leverage too is quelled by risk management techniques…”

  • Posted by Guest

    “…The derivatives market is the fastest-growing financial sector in Russia. While in 2005 derivatives trading volume was just $13 billion for the year, now there are about $1 billion worth of contracts concluded daily…” – Derivative Deals to Be Legally Protected

  • Posted by Guest

    Might it be possible to (credibly) estimate how America’s largely cash based (yes?) shadow economy may affect the data or the impact of a correction? Recent ‘illegal immigrant’ stories shed some light on one parallel system, but it’s just part of a bigger story.

    And thinking about how different regions in the US may affect, or be affected by a correction:

    “…Delaware, the second smallest state… is perhaps the single most important state in the business world… half of the large companies listed on the New York Stock Exchange are incorporated there… “With incorporation costs in Delaware among the lowest in the country and with no corporate income tax for companies that are formed there but do business elsewhere, there is much to attract foreign investors,” …. “Single member Delaware LLCs can provide tax avoidance benefits to international investors who are neither citizens nor residents of the US because they combine anonymity with the tax-free status of non-US source income,”… “The major benefit is that Delaware law does not require that information on the beneficial owners be kept or disclosed so the anonymity of the client can be preserved,”…”

  • Posted by kz

    Sorry, DF didn’t write “Dollar is supported by the yield”

  • Posted by DF

    No pb Kz, I agree that dollar is supported by Yeld, and I agree with your point too.
    I think the Fed has played a game it knew it would lose ultimately thinking may be that there were no better option at any given time.

    To me the Fed has raised rates to keep foreign money pouring in, in order to keep the debt bubble going, the imbalances rising, and the economic growth they bring, even though it knew that by raising interest rates, it ultimately would make the bubble burst.

    There’s an asymetry in economics regarding production and consumption goods. WHen production goods rise in prices without any “fundamental” reason (because of a growth in debt based money supply) we call this : A bubble. When consumption goods rise in prices without any “fundamental” reason (because of a growth in debt based money supply) we call this inflation.
    The fed and all CB’s have decides that bubble booms are great, and inflation is bad. However both are bubbles in prices having their origin ultimately in excessive credit expansion. It’s just that rich people, creditors and in general those holding assets love to see booming production good prices, while poor and indebted people prefer inflation in consumption good prices, especially if that inflation goes goes along wages rising even faster.
    For the last 30 years the monetary policies have been favoring those people who hold assets, lend and do not work over those who have no assets, borrow and work.
    May be it just happens to be so, may be there’s some political reasons for that …

    Anyway the game is now over. You can’t forever expand production and profits by not raising wages and instead increasing lending to your consumer. You can’t if you are China lending to the USA, you can’t if you’re an american house or car builder lending to your consumers.
    Rich people have had their time, now comes the time for poor people, and I’m sure the transition will prove to be somewhat conflictual.

    Of course rich and poor are oversimplification, since at stake is not only the ownership of the means of production (housing or stocks) but also the lending-borrowing behaviour (for instance the situation of production relative to finance, entrepreneurs relative to stock holders etc.).

    THe point was, it’s suicidal to raise rates to attract the capital necessary for your imbalanced growth knowing that rates rise will wreck the ship. But can the Fed to otherwise ? Who’s ruling indeed ? The Fed or the “markets” (the herd behaviour).

    I think until very very recently no one has been trying to act against the cycle.

  • Posted by bsetser

    Nice comments. GCS — if you have some ideas for a more rational int. financial system, do tell. We had large private flows to the emerging world in the mid 90s, but those proved too volatile. EMs shifted to a current account surplus and financed the US — and intermediated between foreign demand for their assets and the US need for financing. With a few exceptions, the recent wave of private cap. flows to the emerging world wasn’t trusted to finance current account deficits. That too has some problems. The question is what would work better?

    Paul — there are some advantages to diversification. Given my track record, I wouldn’t advise betting the farm on the prospect that I will be right …

    HZ — $8b for China in April makes zero sense. Tis smaller than the trade surplus. and there were big valuation gains. and money was flowing into everywhere else in Asia. something must have happened — i.e. a swap or transfer to a bank. I need to look at it this pm.

  • Posted by bsetser

    Alex — Iceland’s liquidity is a key variable, and i suspect the key there is liquidity in the banking system. They may be in slightly better shape there than Thailand though. Tis one of many things I wish I had time to really explore in depth.

    PSH — Turkey v. Hungary is interesting on many, many levels. But i wouldn’t discount external demand for lira debt/ equity in 05 — it was higher than much data suggests since some came thru the swaps market. at least in 05, you can make a decent case that Turkey financed its current account deficit with FDI and lira flows, with all the $ bank loans going to reserves/ used to pay back the imf.

  • Posted by kz

    I continue my argument with Charles in the previous blog that the volatility we are seeing this year is due to the fact that the market expected the Fed to pause at 4.5, 4.75 or at most 5% (I just don’t see BoJ that effective, still at 0%). If the Fed did pause, the USD would have fallen some more, the global liquidity would’ve stayed alive and the emerging markets would’ve stayed happy and robust. But the Fed acted otherwise. They raised hawkish voices as if they want more authority over other central banks and now caused chaos throughout the world.

    In my opinion, the Fed is simply postponing the restrucutuing of its CA by preventing the USD from collapsing too fast. This seems imprudent to me. The CA deficit is an issue not because it’s $805 billion a year but because it’s 6.5%GDP. Even if our CA deficit growth stops increasing as fast as it has, if our GDP growth slows down even more, to say 2.5% due to the Fed rate hike, then the situation is even worse as CA deficit per GDP will reach even higher level.

    The turning point is when the Fed finally give up in the face of the obvious economic slowdown, say real estate industry fallen, trade deficit risen or quarter GDP growth fallen. When the Fed pauses, I believe, with a lag of a month or two months, the USD may fall fast and the ficitional strength of the USD may finally be exposed. Great post, Brad.

  • Posted by Guest

    The range of opinions about India’s prospects are interesting. Isn’t a great deal of the money that drives consumption in India dependent on offshore jobs provided by US firms the flow of remittances from the nationals employed in the US?

    “…The stock market in India “is dancing to a different tune than in other developing countries,” Naissance Capital Chief Executive Officer James Breiding said in an e-mailed statement today. “Foreign investors have failed to grasp that India, unlike other emerging markets, has little dependence on U.S. consumption.” Breiding said he favors “infrastructure, regional banking and automobile stocks.”…”

  • Posted by Charles

    As I commented offline, kz, I don’t think we’re saying anything very different. There’s no doubt that both the Fed and BoJ are acting in ways that will reduce liquidity and slow growth, both of which tend to cause markets to decline. If the BoJ was tightening while the Fed was loosening, or if both were tightening while Europe was loosening, it would play very differently.

    As for the dollar, I don’t understand why it didn’t correct long ago. We’re witnessing a realignment of power of the kind that occurs once in a hundred years. All of the assumptions need to be re-thought, and chief among those is the view of the dollar as a safe haven.

    But in investing, forecasting pathway is as important as forecasting direction. Nuance matters. The largest market drops as of now have been commodities, Asia, and Latin America. This suggests to me that the driving force has been centered outside of the US. But there’s an alternate explanation, namely that US investors may have taken profits. Somewhere in the statistics lies the answer as to what triggered the market decline beginning ca. May 8.

    As for the Fed, I’d be very surprised if their objective is to assert dominance over other countries. They are looking at the same problems that all of us are: enormous twin deficits, endless war, rising oil prices, unsustainable housing prices, rising personal debt and so on.

    But worst of all is political gridlock. There is no political will, from either party, to fix the problems. The American army must leave Iraq and it cannot leave Iraq. The nation must end its dependence on oil and it cannot end its dependence on oil. Taxes must be raised and taxes cannot be raised.

    Just so, the Fed must raise rates and cannot raise rates. And so they talk.

  • Posted by Dave Chiang

    The first step towards resolving the numerous US Economic Imbalances is a fundamental change in U.S. foreign policy, a complete turnaround, in which the goal of global hegemony is replaced with the defense of the continental United States – the only proper policy for any constitutional republic. Defense, not global domination, is the hallmark of a rational foreign and economic policy. In the economic sphere, Neo-liberal Clinton-Rubin promoters of U.S. Dollar hegemony need to re-examine trade policies that have impoverished millions of families across Southeast Asia, especially Indonesia and created blowback conditions by Muslims against the United States.


  • Posted by Guest“>Mark Kiesel: Global Credit Perspectives – The U.S. housing market is turning for the worse and housing price gains are set to moderate. What does housing have to do with corporate bonds? Plenty. Rising home prices have been a key driver of U.S. economic growth, which in turn has played a major role in the tightening of corporate bond spreads. In other words, housing will foreshadow not only the direction of the economy, but also the direction of credit spreads. As the housing market turns, consumers will pull back their spending and the U.S. economy should slow. With a softening housing market, we should expect tighter lending standards, a moderation in the willingness to take risk, a slowdown in the pace of asset price appreciation, less liquid markets, and rising volatility in financial markets. And at that point, “for sale” will not just be a sign you see in front of your neighbor’s yard – investors may also put a “for sale” sign on risk assets as well. Investors in the credit market should therefore remain cautious given the tight overall level of corporate bond spreads and focus on developments in the housing market.

  • Posted by RN

    “The American army must leave Iraq and it cannot leave Iraq. The nation must end its dependence on oil and it cannot end its dependence on oil. Taxes must be raised and taxes cannot be raised.

    Incredibly well stated, Charles. Points right at the level of complexity and difficulty in the situation we currently face.

    Too bad we have a chimpanzee and Satan as a president and vice-president.

    I’m getting as short dollars as I possibly can.

  • Posted by Charles

    I can’t claim originality, RN. It’s drawn from a comment by an Iraqi, quoted by UK journalist Robert Fisk. But it struck me because it described a situation of maximum danger, when a nation must make a decision but is paralyzed.

    It’s very hard to time markets or currencies. And in the interregnum, in between the US as hegemon and … whatever emerges, it’s going to be very messy, very difficult to make money and easy to lose it.

    My guess is that Europe and Japan will finally stand up and start taking a leadership position. China… someday, maybe. Brazil, too and possibly other developing nations that are near First World technical competence, like India.

    Neither Bush nor Cheney are Satan nor chimpanzees. Both are, however, deeply irresponsible, incompetent, and corrupt. They got where they are because so many Americans accept dishonesty and hypocrisy, as long as they think they will get a bit more money. So, Bush’s departure from office will change nothing unless the American people understand that we must leave the politics of hate and division behind and return to rewarding wisdom, diligence, and competence. I don’t see any leaders of either party who are capable of leading that change. That is the major reason for my pessimism about the dollar and the domestic market.

  • Posted by Guest

    Charles — nice quote, or riff off a quote from Robert Fisk. You might add “The dollar must fall but it cannot fall”

    I wouldn’t say we are yet in the interregnum in between the us as hegemon and the post dollar hegemony financial order. rather we are in the stage where the US exploits its hegemony to the max (helped out by countries that willingly add to the $ reserves), leading some to wonder how long it can all go on.

  • Posted by bsetser

    “Guest” in the previous comment = bsetser

  • Posted by psh

    interesting on many, many levels, yuh, I wanna think the Euro is what’s crucial for the future there, so it’s nice to see that Turkey’s not been singled out for punishment: a 56 (fifty-six) bps jump on 1-year HUF debt, ow, HUF-EU weakest ever, ow. Though I can’t concur with Mobius, who would make an excellent Bond villain, when he says Turkey’s EU membership is immaterial. Turkey ∈ EU is the one thing that could do most to repair the devastation of the past six years.

  • Posted by Guest

    Foreclosures May Jump As ARMs Reset: This year, more than $300 billion worth of hybrid ARMs will readjust for the first time. That number will jump to approximately $1 trillion in 2007, according to the MBA. Monthly payments will leap too, many beyond what homeowners can afford.

    “ARMs are a ticking time bomb,” said Brad Geisen, president and chief executive of property tracker “Through 2006 and 2007, I’m pretty sure we’ll see a high volume of foreclosures.”

    Last year, foreclosures hit a historical low nationwide at about 50,000. But that number has more than doubled since then, according to

    And delinquency rates appear to be rising, as well. While delinquency rates fell for most types of loans from the fourth quarter of 2005 because of a stronger economy, delinquencies for both prime and subprime ARM loans increased year-over-year in the first quarter, according to the MBA.

    The hardest hit states so far are those that have experienced the roughest times economically. Michigan, Texas and Georgia lead the pack, specifically around Detroit, Dallas and Atlanta, whose major employers have run into strikes, bankruptcies and industry downturns.

    But as the housing market slows, experts expect foreclosures to skyrocket in those areas that have experienced the highest appreciation rate like California, Florida, Virginia and Washington, D.C.

  • Posted by OldVet

    for Guest, India’s my pet economy and you can see some interesting trends/countertrends playing out in the short run using Stock Exchange of India data:
    “”. You’ll see Foreign Institutional Investment starting to sneak back into equity markets, even as Indian mutual funds are switching from equity to Indian debt. The data is very timely, too. Guess what I’m doing? Sneaking back in on the heels of the Big Boys.

    Paul’s scenario and one-way bet on trends has been my dream scenario for a while now, alas. The twists and turns may wear me out before I get “rich.” I’m as short dollars as possible except for some temporary cash in flexible-rate loans in US dollars, which are rising for now. The PIMCO article on credit market spreads and risks is a little light in the loafers, because what currency is the greatest risk in the future? The dollar – overbought, overinvested, overpriced.

    We’re lining up for a real tussle over what constitutes “risk.” I’m with Soros and Company on currencies, and I’m with Goldman Sachs and Brad and many other economists on where the greatest rates of GDP growth lie in future. KZ (above) is quite plausible on how the dollar will act – very quickly, once some thread is pulled and the support for the Dollar unravels. I’m making some serious new bets on all this, and let’s hope you don’t have to buy pencils from disappointed OldVet’s on a windy corner in Nashville in the snow!

    Unnerving as all this panoply of potential futures is, I’d rather be living now than in some more boring time. Except for being marked in a negative sense as an American when travelling – that too shall pass, David Chiang, and the policies of aggression will drift away. Not fast enough for most of us.

  • Posted by kz


    Thanks for your feedback, although I didn’t mean to imply to you directly. I was just leading from previous comment to the current.

    You wrote:
    “Somewhere in the statistics lies the answer as to what triggered the market decline beginning ca. May 8.”

    I’m pretty sure it was around early May, like May 5th, when FOMC governors started raising hawkish tones. I still think my argument has perfect timing. And I must confess, most of the market seems to agree with me that the hawkish tones of the FOMC governors turned the world upside down.

    You wrote:
    “Just so, the Fed must raise rates and cannot raise rates.”
    The US political parties are divided, I agree. But last time I checked, which is very recent, there is only one FOMC governor who disputes with the hike, so “the Fed” is pretty agreeing completely.

    I agree with you. I used to argue the same thing before, that the Fed is raising the rate to attract capital inflow. But today, I believe that’s just one of the many reasons. They raise the rate due to the inflation concern, over-consumption concern, real estate bubble concern, and many other things. They talk as if their only concern is inflation. But as economists, they must know the magnitute of the consequcne their decisions bring.
    One funny thing, as I noted before, is that the Fed raised the rate, at least partially, to shrink the real estate bubble. They somewhat succeeded. But as a byproduct of that success, rent is rising, and ultimately core CPI is rising as well. Hence, they continue to raise rate. All eyez on the Fed right now, at leas until August 8th.

  • Posted by Charles

    Brad/Guest says, “You might add “The dollar must fall but it cannot fall”

    Yes. As in any addictive relationship, those central banks holding lots of dollars and those export industries that rely on a strong dollar are holding the dollar up. No one knows what will bring on the denouement. If other countries have enough bad luck, maybe nothing. Wile E. Coyote may make it across the canyon and onto the next mesa.

    And I agree we’re not yet in the interregnum. That will be a time of market anarchy, as investors try to figure out what’s the safer haven.

    kz, I refuse to disagree with you. I don’t think the facts are sufficient to have that level of certainty.

    However, in complex systems, it’s unusual for one factor to be causative in abrupt changes. Generally, there are unanticipated interactions between two or more factors. The Fed has been raising rates for quite some time, and if people believed that it would stop raising them, given the economic statistics, they were fooling themselves. So, something happened in early May. Maybe people just woke up. I just don’t know.

    If I may, please don’t confuse what the financial press says for market sentiment. Many financial journalists are amazingly ignorant, and the press is heavily manipulated by the interests that own it. Most participants are aware of this, but it’s harder to get at the real story than to figure out that the official story doesn’t add up.

    So, let’s revisit the question in three months, when the facts are clearer.

    Charles of MercuryRising

  • Posted by HZ

    One may ask the question of who are buying the blockbuster IPOs on the HK exchange. Might have people and businesses sent cash to HK to get ready for the IPOs? Not only were the IPOs big, they were also way over-subscribed. These movements should be big enough to make a dent on the reserve accumulation number. The interesting question is what will the banks do with their IPO capital? Could PBC have told them privately to not bother send those home?

  • Posted by Gcs

    “”The dollar must fall but it cannot fall”

    now thats the rub !!!!

    btw the days of dollar hegemony are in my estimation far from over

    until a global mechanism with powers an abilities
    far beyond those of venal institutions
    like the imf-ed
    and world bankette
    not munch of a response to your question of what better could happen brad

    but what could happen …like a currency club…
    what would be better …like even some crude but automatic
    ( both up and down) dynamic rev val forex formula
    is politically impossible

    till this setup we got now
    staggers into a real wing dinger
    it’ll be patch as patch can
    the hoped for
    new beginning

    like 1946
    takes n generations
    to come round again
    and as yogi sez
    that won’t happen before it happens

  • Posted by RN

    “They got where they are because so many Americans accept dishonesty and hypocrisy, as long as they think they will get a bit more money. So, Bush’s departure from office will change nothing unless the American people understand that we must leave the politics of hate and division behind and return to rewarding wisdom, diligence, and competence. I don’t see any leaders of either party who are capable of leading that change. That is the major reason for my pessimism about the dollar and the domestic market. ”

    I agree, little will change with whomever is next in office. 1) The choices are just too hard; 2) The American people are demonstrating what you get when you have a democracy of the uneducated. A democracy can only work when the voters are capable of voting for what’s in their true best interest. Too many Americans would rather vote, for example, against gay marriage than for fiscal sanity which would help their kids and grand kids. Well, say what you want about gay marriage, I have yet to hear an argument that it’s going to do much about the trade deficit or the debt (though I’m sure Greg Mankiw is working hard on it as we speak).

    Sadly, I believe a change in behavior will only come when real pain forces people to change it. Foresight and planning seem to have disappeared in the US, both in a macro and micro sense. This is the biggest ill effect I believe of the Chinese peg: it’s led to a sense of stability that is artificial. America has forgotten what it’s like to suffer the consequences of economic missteps. We think it’s a big disaster when the Dow goes down 200 points. It’s a lot like the wild animal you keep feeding off your back porch. Since the food is always there, it forgets how to compete. With an artifically supported currency, interest rates are eternally low and money is eternally available. We forget that in many parts of the world, people barely have enough to eat and shelter themselves. And many of these people are increasingly competing at par for jobs with the fat SUV-driving American. This American may get a wakeup call unlike anything since the Depression once his currency is allowed to float and settle based on the global value of the goods and services his country creates, a world where gasoline costs $8 a gallon and interest rates are 15%.

    I think in 50 years after things settle out, what will most be remembered will not be an economic crisis, but rather the failure of democracy that occurs when the populace is as uneducated as the typical American is. The fact that so many Americans vote not with thinking minds but with their bibles, has allowed slick “religious”-talking con artists like Bushco to funnel away the nation’s wealth to the superrich and keep the pain away from the average voter by runing things on debt in the meantime. And the fact that China et al. were happy accomplices who had no problem seeing the economic strength of the US be hollowed out and away.

    I also believe the same democracy will never vote to suffer to the extent required to pay for these misdeeds. I think it will vote to export pain back onto our creditors by allowing the currency in which the debt is denominated to become ever more worthless. What other choice does it have?

  • Posted by DF

    education is not the problem. Education is higher than ever, much higher that in the 50’s, policies have clearly not improved however.
    The problem is, among others, herd behaviour, free rider attitude, some mix of lack of morality and lack of courage, on top on gross disinformation on how the economy works, the importance of balancing wages and profit for the stability of the growth path etc.
    It is a human fact that some time we don’t have the courage to be up to our desires and even to our true wants. We say ‘I’ll do it tomorrow”. If as a single human we all do it at the individual level, it’s no surprise it happens at the collective level too.
    The global economy is a kind of messy house where no one dares start to clean up. Instead all wait for something to happen, some wake up call.
    On top of that we all have a tendency to be overly optimist and then pessimist, for instance we do not look out in the street, we get attacked by people we did not pay attention too, and then we’re scared to walk out in the streets. We have foolish expectations, then get deceived and depressed (we suffer, this cycle is clearly put forward by buddhists).
    Well, if we individually all do it, no surprise that collectively we all do it.

  • Posted by SteelCurtain67

    I am a doom and gloomer myself as I believe the RE market will collapse with many many bankruptcies and bank failures, due to bad loans, which will lead to a general recession in the US. However, the US is a big country with lots of natural resources and millions of capable people, I don’t think its going to be the end of the world as we know it. I think what is needed is a change to the international trading system that acknowledges the need for a general balance in trade. I think there should be some sort of sliding tariffs that would get activated when the trade imbalance between two countries was too large. The tariffs could be implemented in small steps over a reasonable period of time to allow for the balance to right itself and there could be ‘trading rights’ similar to pollution rights that countries could trade to accommodate the situation where some countries could never balance their trade, for example, the US with the oil exporting countries.