Off to the beach
I will be away from the office for a few days.
I will be talking about the design of the IMF’s proposed reserve augmentation line – a proposal intended to help emerging economies with solid but not perfect policies manage volatile markets without necessarily holding huge stockpiles of reserves. Or perhaps to help those countries that have yet to accumulate their huge stockpile of reserves manage market volatility.
I also intended to discuss the huge wave of capital that flooded most emerging economies in the first part of February – and the craziness of a world where emerging economies (at least some) borrow funds at 12 to 13% only to lend the money back to the US at 5%.
One of my points (RGE subscription required for the link; sorry) was going to be that emerging economies should not base their policies on the expectation that if they just resist appreciation for long enough, investors will suddenly lose interest in the emerging world. China has tried that policy for some time now – even holding Chinese rates well below US and European rates to discourage inflows — without much success.
But I rather suspect that recent turmoil will give emerging economies new hope that private investors won’t be quite so willing to send money their way – and make them even more reluctant to count on steady inflows of private capital from abroad to finance higher levels of investment than can be supported from their own savings. One of the ironies of today's world is that two of the biggest current account deficits – those of the US and the UK – are financed in large part by the (net) flow of official capital.
Finally, please take note of RGE's new comments policy. I want to thank all those who have commented here in the past — the tone on this blog has consistently been civil even in the absence of these kinds of controls. That is a tribute to all of the participants. I sincerely hope that this policy doesn't impede future discussion.
partying on spring break, ic
cheers!
Goldman, Merrill, Morgan Stanley Are Almost `Junk,’ Their Own Traders Say
Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.
Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. For Goldman, Morgan Stanley and Merrill Lynch & Co., that’s five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.
You write: “the tone on this blog has consistently been civil even in the absence of these kinds of controls. That is a tribute to all of the participants”.
Yes, a tribute to you too. I believe that rude and unacceptable tones in NR’s blog have been stimulated by NR’s tones too, who are not always fully respectful of different views. For ex., he often calls those who have a different vision “irrational” and much more. If he is ready to take a friendly advice, he should moderate his tones without calling “stupid” etc. anyone who disagrees. I know some characters are difficult to moderate, I also have problems with my own, but telling oneself the full truth is better than only laying the blame on others.
With BS I have had a constant argument over 2 -3 years, on issues such as: the level of the US dollar; the flexibility of Chinese internal adjustment in case of quicker currency appreciation; the relative role of CBs’ direct intervention in forex mkts in delaying global adjustment (as opposed to K-flows regulations, monetary policy, and the choices of private mkt participants). It turns out that I have been right and BS wrong (see PS below for details), I think not because I am more clever than BS but because some predictions are driven by a unique root, a unique intuition, that one may be just lucky to grasp at a given moment, and that uses to derive a number of apparently but not truly “independent” correct forecasts. This has led me to post some polite but sometimes a bit “impatient” and “frustrated” comments on this “unique root” of BS’s errors.
BS always replied politely and in a non aggressive way (even when reading between the lines one could feel a little tension). I give credit where credit is due. BS, you have helped all of us to remain correct and polite while debating everything.
Gheorghius
PS. Issues - The dollar was not massively overvalued in 2005-06 (I called for a halt of its slide in Dec.2004 subsequently argued with BS for 2 years on this), and began to fall in Nov. 2006 (as I forecasted in a number of comments in Oct.2006 and early Nov.2006), because of a progressive decline in the US relative rate of growth and its likely impact on interest rates (differentials). China’s peg did not collapse within a month, as BS forecasts in Nov.2006/early Dec., and reiterated in a reply to my comment (I suggested that it would take a bit more). On the impact of a Yuan appreciation in China, BS agreed independently in a later post that it need not reduce Chinese rate of growth below 8%, after rejecting earlier suggestions of this kind. On the relative role and importance of CBs direct intervention in forex mkts in delaying currency and global adjustment, as opposed to: K-flow rules and monetary policy; and the role of the private sector (which I all consider much more relevant), I managed to take BS on my side (after a final complex, hot debate in Nov.2006): not for a long time, though: for BS cannot help but see things through the lens of his preferred issue…
The underlying “unique root” of the mistakes made consistently by BS, in my view, was underestimating the depth and the (bounded) rationality of financial markets. One does not need to underestimate the rationality of mkt participants to be “progressive”, to believe in mkt inefficiencies and bubbles, and in the need for gov policy intervention, correction, and guidance.
All the best, BS.
Have a nice time Brad.
Regards
Claus
back in the days of the cold war there was a much used expression ‘the free world.’ your blog remains an oasis in a world where so many other freedoms are in decline or under threat. i am sorry that someone seems to have taken advantage of the open nature of your site, but toleration of dissent is an essential part of a meaningful discussion.
enjoy your break.
gillies
While Brad is off to the beach, the Chinese Central Bank moves to restrict capital inflows with China’s banks banned from borrowing foreign currencies.
http://www.bloomberg.com/apps/news?pid=20601087&sid=apBCV1YRsflY&refer=worldwide
” March 2 (Bloomberg) — China cut the amount that banks can borrow overseas to curb risks and stem foreign-currency inflows that have put pressure on the yuan to appreciate.
Chinese banks’ quotas for foreign debt will be reduced to 45 percent of the 2006 level by June 30 and then to 30 percent by March next year, the State Administration of Foreign Exchange said on its Web site today. For foreign banks, the reduction is to 85 percent and then 60 percent.
“Hot money has been flooding into the country because investors are betting on a yuan appreciation,” said Ha Jimin, the chief economist at China International Capital Corp. in Beijing. “The new policies are aiming at supervising and better managing the short-term foreign debt inflows.”
China has the world’s biggest foreign-currency reserves at $1 trillion and is trying to stop the flood of cash from record trade surpluses from overheating the economy. The Asian nation’s short-term foreign debt was $169 billion as of September last year. That’s equivalent to about 4 percent of the 35.3 trillion yuan ($4.6 trillion) deposits held by the nation’s financial institutions at the end of January. “
1 I d like to thank also M. Setser for his civility
2 I agree that M. Roubini is a bit more tough tongued, however I think most of the agressivity comes from his stance on the economy and the asset market. Many people seem to read here looking not for a better understanding of economics but for a way to make increased profits while speculating.
Btad about history. Even though the vietnam war is no equivalent to the first world war ( and yet for UK the first WW was never the drain it was for France and Germany) it is clear that historically there are many parallels.
THe US becomes a debtor with the vietnam war, bretton woods collapse with the vietnam war.
THis is why I say that right now we are in a situation very near to 1929, the apparent ruler is very fragile, it needs inflows of fresh foreign money to support its unsustainaible spending regime …
Take asia as a whole and it must be the size of the US economy (China, japan, korea and all those in the RMB-Yen underevaluated block).
DF
1929????
Gold standard back then!!! How do you equate that with now. Are you being serious?
of course I m serious guest.
The gold standard is irrelevant to 1929.
A huge underconsumption crisis is always based on the following :
A credit boom
Profits too high as a share of the VA
Investment too high
And usually this follows a huge technological revolution.
We have all this in place. The gold standard back in the 20th century never prevented credit booms and bust. It just made them shorter.
Real austrians will tell you that they favor the suppression of banking as we know it and that their model is not 19th century gold standard but 18th century holland and a short period of that century, back then when a bank could not lend the money that someone had put in them for storign purposes …
Look closely everything is in place for 1929.
WE have the highest debt to GDP ratio ever in the world economy
We have a productive investment boon in CHina, a housing investment boom in all the world and a human capital investment boom in the western world
We have capital earning too much profits and workers being forced to take debts in order to absorb production.
Everything is there.
As soon as the bubble of credit pops, the all thing unravels in a now standard manner. (closing of borders etc. )
And this makes me think there s another characteristic to these major macro changes : the size of the economic unit changes.
we had the cities to the nation states
(may be before that we had the feudal unit to the bourgeois City)
We are into the nation state to a regional power, at least it works in europe.
I must admit the change in the size of the political unit is less clear cut than the other aspects (tech change, power to K, credit boom, investment boom)
Beaches are wonderful places - try Eleuthera sometime. Have fun.
DC, Most of the dollars flowing into China seem to be from foreign earnings from exports, or direct investment. Bank borrowing was what percent of total recently?
The real world economy is mostly healthy but for the US, where consumption exceeds production by a wide margin. And China, where the reverse is true. BS’s point that less reliance on exports and more reliance on domestic market consumption is a good one, for reasons of stability, as we may find out very soon.
The financial economy is mostly inflated and believes itself riskless, till this week. Hopefully the deflation won’t harm the real economy too much in the next year or two.
The real world economy is mostly healthy but for the US, where consumption exceeds production by a wide margin. And China, where the reverse is true.
Oh yeah ?
Never read Setser’s posts about France’s economy like the USA ? Same for Ireland UK and Spain ?
The housing bubble is global, not noticed that ?
BS’s point that less reliance on exports and more reliance on domestic market consumption is a good one, for reasons of stability, as we may find out very soon.
BS points this as an advice to the chinese leaders. So far those leaders have not seem very keen to listen.
Hey Brad, suddenly a thought occured to me.
BWII this does not ring a bell ?
Come on, Bretton woods two, that means Bretton woods has died and something else less stable has been put in place, a poor comparison to the old system, supported by those members with interest in it.
Still does not ring a bell ?
What if Bretton woods 2 was the equivalent of post WW I gold standard ?
After all the gold standard before WWII was essentially a sterling era. After WWI UK had not the means to support the system. But the USA and other countries came to the rescue .. Until the final collapse.
There are some similarities also with the present situation.
BS you wrote on those strange chinese who don t want to make their people richer by reevaluating, you could have written about the strange US leaders who don t want to admit that they are indeed much poorer than they pretend to be.
Ths US dollar is overvalued like the sterling was and there s a price to pay for that.
afghan poppy production for 2006 was up 25%. so how much of the world’s economic activity is ‘off the books’ ? and who collected that statistic ? and who collects next ? - kabul grocery shops, pakistani arms smugglers, los angeles drug dealers ?
just curious. taking advantage of brad’s absence to ask slightly off topic questions. is something which boosts economic activity but wrecks lives still an economic good thing ? and are we all in the same boat - the respectable and the shady ? someone told me that when a recession is coming the prostitutes know it before anybody . . .
That s because they work before any body.
df, I was referring to the “real economy” which is production and consumption, R&D, employment, and so forth. Not the financial world of asset prices, FX rates, interest rates, credit and lending, and other monetary based activities. I’ve noticed the worldwide real estate bubble, equity market bubbles, and the economy in France. My kid lives there!
To BS’s main point, don’t you think it’s ironic that emerging economies don’t want so much foreign investment? If EM leaderships had their heads on straight, and the welfare of their people foremost, they’d be doing everything possible to absorb as much foreign investment as possible - expanding absorption capacity rather than erecting barriers. And using their growing trade surpluses for infrastructure development, education, health improvements rather than investing in paper assets of the US. Every “hot money” dollar in the bond and stock markets replaces a local dollar, which private entrepreneurs can use for some other economic activity, expanding the economies.
My last comment got lost.
HI oldvet. My point is that you can t have financial disorder without some disorder in the real sphere.
And indeed that disorder is clear : Profits are high, way too high, wages are low, way too low, that is relative to the productivity.
One of the reason of all this use of credit by consumers is that in the real sphere their wages are fixed too low.
Besides this is true globally. Globally we ve seen unions decline, work is more demanding now with more people confronted to strong constraints of pace and or directly in contact with clients.
ON top of that on the american continent working hours have increased.
All this is happening in the real sphere and is clearly not a sign of a healthy economy. Normaly when the economy is good, wages increase and people can take more time off. When wages are stagnant, when people must work longer to keep their standard of spending even though their work is more and more demanding then you know something is wrong in the real economy : capital has too much power and labor is too weak.
The crisis of under consumption is building both in the real and the financial sphere.
It isn’t only the economy, stupid
http://www.economist.com/daily/columns/marketview/displaystory.cfm?story_id=8796484
For a start, the market is supposed to be a forecasting mechanism, so it may be warning of economic problems ahead. There were few signs of economic problems in March 2000 when the dotcom bubble popped, but a mild recession duly followed.
Second―a point made by Bill Gross, a bond guru at Pimco, a fund management firm―these days it is often the financial markets that are driving the economy, rather than the other way round.
Think about the rise in profits as a percentage of GDP in America and elsewhere. That has enriched companies and their shareholders at the expense of workers. But if workers are being squeezed, why hasn’t consumer demand been hit? Because consumers still feel wealthy thanks to the rise in share and (until recently) house prices.
Furthermore, look at the extraordinary success of the financial sector. Profits have been rising relentlessly and bonuses have been exceptional. In the UK, the financial sector is a vital driver of the economy, which is why the current government would be mad to drive it away by, for example, capping bonuses or attacking private equity.
But the financial sector’s success is driven by 20 years of rising asset prices and falling interest rates. Remember how the Federal Reserve rushed to cut rates when the financial sector was hit in 1998 and 2001. Think, also, how the Japanese economy struggled through the 1990s, thanks to its ailing banking system.
So it is the mechanics of the financial system itself that will determine the prospects for the markets. Here there are dangers. Banks have been disintermediated. They can no longer rely on taking deposits from retail customers and lending the proceeds at higher rates to business.
The corporate sector borrows from pension funds, insurance companies and the like. The banks merely arrange the deals. This transaction activity, covering everything from stockmarket flotations to complex derivatives, is a vital source of income, as is the trading of those instruments when issued.
Any shock that dries up liquidity is a threat to the financial sector, and the markets. Reduced liquidity means less issuance. A reluctance to hold illiquid assets means lower prices, a blow to the trading arms of the banks.
Hedge funds also provide liquidity to the markets, because they trade much more often than traditional investors. Dresdner recently estimated hedge funds delivered 15-20% of investment banking revenues. Hedge funds are natural buyers of illiquid assets (where prices are most likely to be incorrectly set) and also sellers of volatility.
Those who sell volatility (the equivalent of writing insurance on financial markets) receive a steady stream of premium income that looks impressively smooth to investors. Liquid and less volatile markets look safer and appear to justify higher prices.
We thus create a virtuous circle in which investment banks and hedge fund together drive volatility down and liquidity and prices up. But at some stage, this process cannot be pushed any further.
The risk is what happens when the process unwinds. Prices fall, causing hedge fund and investment banks to retreat from the markets; this reduces liquidity, implying lower prices and so on.
Perhaps the shock of February 27 was insufficiently drastic to send the process into reverse. But that is the risk that investors should be most concerned about. In the next few weeks, they should be looking for signs of distress in some of the less liquid areas of the markets, such as high-yield bonds and credit derivatives.
I am hardly a currency specialist, but I am doing my best to become more savvy. While I fully respect that short yen may be a crowded trade due to carry dynamics, I’m still trying to figure out why the currency from a fundamental standpoint isn’t justified in trading at a lower price.
I keep reading about how Japan as a nation has a HUGE debt load and a population skewed in age much more severly than ours. If that is the case, and being a socialist gov’t there is a culture in place that defeats “creative destruction”, isn’t it possbile that the yen is a great short… and if you’re going to sell yen, you might as well buy something else with some real yield, fundamentals, technicals, etc. in place…?
There is so much expectation for an unwinding of the carry trade, but what if the yen collapsed vs. other currencies instead of rallying? This could be it’s own problem in itself due to the size of its economy in the world marketplace. Lastly, I believe they are running a fiscal deficit and a trade surplus? Doesn’t the trade balance ususally follow the fiscal balance? If the trade surplus turned negative, could that be a catalyst for such a collapse?
So many questions… my apologies if they are terrible. Everyone’s insight is appreciated.
Thoughts?
BOJ, Fukui Must Go Radical to End Debt Crunch
…the yen is a massive 40% undervalued against the euro…