Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Chastened prophets of doom

by Brad Setser
May 25, 2007

In a recent talk at the Council on Foreign Relations, former US Treasury Secretary Larry Summers described himself as a “chastened prophet”– a description that former Chairman of the Fed Paul Volcker also embraced.  Both warned about the risks associated with large US current account deficits several years ago.


I lack the stature of Summers and Volcker, but I too often feel like a “chastened prophet of doom.”   Along with Dr. Roubini, I publicly worried in 2004 that a $600b US current account deficit financed in large part by demand for US debt from the world’s central bank carried grave risks.     It is hard to be less worried by a $800-900b current account deficit if anything now financed in even larger measure by demand for US debt from the world’s central banks.    


Especially a deficit that doesn’t seem to be falling when global conditions are about as good – setting aside the dollar’s inability to fall v. many in Asia and high oil prices – for a benign adjustment as is likely to be case for some time.   


Yet, as Summers noted in his talk, the “balance of terror” generated a relatively stable state system during the cold war, as – at least– so far, has the “balance of financial terror”.


Dooley, Garber and Folkerts-Landau’s core argument back in 2003 – that reserve accumulation in the emerging world finance large current account deficits in the center at low cost – has stood the test of time. 


The best their critics can claim is that some of the contradictions in the Bretton Woods system are still playing themselves out, just at a slower pace than their critics – myself included – initially expected.  Protectionism in the center and inflation in the periphery are more visible now than they have been previously. 

Still, I never imagined that China would add over $40b to its reserves a month in a quarter – and might sustain that pace (close to $500b annualized) for an entire year.    That is an extraordinary number.   I never imagined that the Gulf countries – given all that has happened in the Middle East – would be as willing as they seem to have been to lend a large share of the oil windfall to the US (60%?).  If the most Kuwait is willing to do is to reduce the dollar’s share in its basket to 80%, I am not sure that changes much.    

I never imagined that Russia might be on track to add $30b (if not more) to its reserves in a single month.   I certainly never imagined that Brazil would stop releasing high-frequency data about its reserves because of worries that its reserves are growing too quickly, not because of worries that it was close to running out of foreign exchange.    Behind the wall of secrecy, Brazil probably is on track to add $20b to its reserves this month – though some of the accumulation may be “off balance sheet.”

Those are phenomenal numbers.   In the first quarter, Christian Menegatti and I estimate that central bank reserve accumulation reached $100b a month.    That is more than enough to finance the US current account deficit.    And if anything, the global pace of reserve growth looks to have picked up in April and May.  While India's central bank stepped back and let the rupee appreciate, other central banks did not.

It is hard to argue that Bretton Woods 2 (the financial coalition of the willing?) isn't still going strong.  Maybe a bit too strong.


  • Posted by Anonymous

    There is a strike by administrative workers in Brazil that is delaying data updating, not a conspiracy to hide reserve accumulation. The daily CB interventions are relatively transparent in terms of size.

  • Posted by Dave Chiang

    Will the US consumer “Joe6pack” soon crack under $80 per barrel oil coming this summer? The US consumer is already carrying record high levels of credit card debt with little relief coming from the broken housing ATM machine. While underestimated in the past, I seriously doubt the overleveraged US consumer can carry the burden of financing that McMansion and gas-guzzler SUV for too much longer, especially not at $4 per gallon gasoline coming soon. The American suburbia way of life is economically and environmentally unsustainable; typical of my town neighbors live in 4000-5000 square feet McMansions, drive monster SUV’s, even own speed boats. So just when everyone thinks that Bretton Woods 2 will last forever, it won’t. It is only just a matter of time until the US consumer collapses from exhaustion.

    Stage set for $80 oil prices this summer

  • Posted by Stormy

    At some point, “chastened doomers” have to stand back and look at how the system is actually functioning–apart from central bank financing and apart from the peg.

    By “system,” I mean everything: the sturdy stock market, export-oriented developing countries, trade imbalances, the growing disparity of wealth, technological efficiencies, FDI flows…to name only a few. Macroeconomic cash flows among countries, while important, do not bring the details into focus. Trade deficits, reserve growth…are not enough. Grasping for a metaphor here: It’s like looking at a patient that is slowly becoming disfigured. You know that something dangerous is happening…his eyes begin to bulge, stomach is swelling…but you do not have access to any of the finer tools—microscope, MRI—with which to make a good prognosis as to life span. Is the patient indeed terminal? Globalization is an interesting disease.

    In short, what is going on here?

  • Posted by carmelus

    It seems now that latinamerican countries are financing in higher proportions the usa deficit since asia is using its reserves so the financial terror equilibrium has new participants and maybe looks stronger and hard to break it. I do not know how long the story goes, we are in unchartered waters, but I do not forsee a good final. It is amazing how central banks allowed this situation during the last 5 years accumulating worthless treasuries as usa inflation is disguised and focusing in core inflation.

  • Posted by bsetser

    re: the strike by administrative workers —

    Brazil was still able to produce reserves data (though a bit more slowly) in the first week of the strike. They got their end April data up. Getting subsequent data up doesn’t seem to be a priority. Call me suspicious.

    I agree that it isn’t that hard for those close to the markets to have some idea of brazil’s interevention — but at the same time it isn’t quite as transparent as when the actual data was posted.

  • Posted by Guest


    “Back in 1980, the debt of slightly less than a third of U.S. industrial corporations tracked by Standard & Poor’s was rated junk. By the late 1980s, more than half were, and now 71% of the pie fits into that category, a record according to a new S&P report. ”

    – Wall Street Journal, 1/4/07

  • Posted by Guest


    Dare I say that this will end badly? What gives anybody an assurance that this entire system based on unsustainable US consumption, and asset price inflation will not unravel with most dire of the consequences?

  • Posted by bsetser

    fundamental source of assurance it will not end badly = assumption that foreign central banks will buy all the $ it takes to keep the system going, even if that means financing uS capital flight.

    if someone has another answer, do talk!

  • Posted by Cyrus

    With the notable exception of Brazil, most of those countries frequently mentioned as accumulating reserves beyond any reasonable need for reserves are countries intolerant of internal political opposition. Now social spending has often been demonstrated as a potent palliative of unrest. Could it be that these regimes, lacking any good way of estimating their future need for bread and circuses, and choosing in any case to err on the side of caution, have a indefinitely extensible demand for reserves? If the world will be reluctant to fund you if you should ever actually need the funds, best to accumulate the funds to meet any conceivable future need beforehand.

  • Posted by John Hofer

    When mutual self destruction is assured, all parties have a self interest in assuring that no one gets close to the button. Consequences of the cost of US imports rising 40-50% would be devastating. Consequences of a dramatic decline in exports to US markets coupled with huge loss in value of US assets is to painful for the rest of the world to contemplate.

    At some point, however, someone must mismanage a seemingly unrelated situation. For my money, that miscalculation is most likely to come in the Middle East, perhaps with an attack on Iran doubling oil prices.

  • Posted by Guest

    “…In a speech he gave last year… he discussed the long-term prospects for U.S. real estate and for world financial markets. Provided the U.S. continues to recognize human capital as collateral for investment loans, he says, it will continue to thrive… “Recent U.S. financial innovations – including new markets for securitized mortgages, collateralized loans and high-yield bond obligations – have helped spread risk and have created tens of millions of jobs by freeing up investment capital. As these financial technologies are deployed throughout the world, they will increase prosperity by multiplying the value of human capital. These technologies have the potential to create as much as $50-trillion to $100-trillion in worldwide liquidity.”… The combined value of residential mortgages in the U.S., Mr. Milken says, equals 95 per cent of GDP. The ratio is much less in other countries – 69 per cent in Germany, 36 per cent in Japan, less than 1 per cent in Russia. “A worldwide securitized mortgage market alone could free up $20-trillion for productive investment,” he says, “by unlocking the unused capital in residential real estate.”

  • Posted by df

    Balance of financial terror; How does that square with attacks on Iran ?

  • Posted by Guest

    5/25/2007 2:37:37 – TEHRAN – “Iran’s moderate press and economists yesterday slammed a decision by President Mahmoud Ahmadinejad to slash interest rates, describing the move as “incomprehensible” and risking “economic suicide”….”

  • Posted by Guest

    “…Their US dollar reserves already have swollen by $136 billion in the first quarter of 2007 and are projected to eventually reach $2 trillion in 2008 if they continue at this pace.

    But that’s not what’s really scary… In May, China’s former top drug regulator went on trial and is accused of taking bribes to approve untested medicine… Already, the US Food and Drug administration announced it was stopping all imports of Chinese…

    This week, former US Federal Reserve chairman Alan Greenspan stated that he feared a “dramatic contraction” in the Chinese stock market. Should the world event scenario I’ve painted above come to pass, his concerns on China could be quickly realized and the entire region negatively impacted. At that point, there won’t be much discussion about an over-valued currency…”

    – Andrew Busch Update May 25/07

  • Posted by RebelEconomist

    The risk of the imbalances ending badly that I see is protectionism from Congress. Reports of the SED suggest that the Chinese conceded little and that Congress now feel entitled to have a go themselves. A significant tariff on Chinese imports would raise US prices, which could be expected to lead to tighter monetary policy than otherwise. To the extent that the tariff succeeded in cutting the trade deficit with China, it would reduce their purchases of USTs, raising US long-term and mortgage interest rates. China might react to US protectionism and capital losses on bonds with trade restrictions of its own. Other, smaller trading nations might then feel entitled to take some protectionist measures of their own, and free trade would be curtailed.

  • Posted by Emmanuel

    Nossir, there is no need to be apologetic at all. Roubini and Setser said that rising protectionism would eventually threaten BWII. That’s exactly what’s happening now. Did you catch the House Ways and Means Committee’s blunt warning to the Chinese? Rest assured that Congress is serious about slapping tariffs on China should it refuse to revalue faster.

    The prophets of doom won’t be held down for much longer, myself included.

  • Posted by bsetser

    protectionism is the logical political response in the us to a political economy that hasn’t found a way to share the very large gains some are now enjoying broadly — or to compensate the direct lowers from the china trade. blackstone wins from china twice — cheap financing for its private equity deals courtesy of the impact of reserve growth on global “liquidity” (lots of global demand for debt) and from china’s participation in its IPO. Ohio workers in small towns lose twice — from the direct impact of competition with China on their wages/ jobs and from the indirect effect of factory closings on local real estate prices …

    it is perfectly rational (I suspect) for ohio workers to vote against the status quo if it doesn’t start doing more for them, even if the status quo helps ‘ the street big time.

  • Posted by Dave Chiang

    Despite threats from Congress, the Chinese are unlikely to budge from their stated economic policy of a slow but steady revaluation of the yuan. From my sources in the Chinese banking industry, Chinese Vice-premier Wu Yi presented to Hank Paulson the Japanese financial bubble experience resulting from the Plaza Accord that sharply revalued the yen versus the dollar. The resulting bubble collapse left the Japanese economy mired in a deep recession for 15 years, only today has their economy recovered from the resulting capital misallocation. The devaluation of the US dollars has not resolved long term US competitiveness issues with the entire world. The Chinese economy is not robust enough to withstand an equilvalent financial collapse without serious social repercussions. Given the rabid US political hostility toward China, the Chinese government seriously doesn’t care if the United States decides to impose protectionist tariffs on imports. Certainly the Chinese economy will take a significant hit under a trade war, but longer term the Chinese would build a more stable economy based more on domestic demand and less on exports. Unlike the US Federal Reserve, the Chinese PBoC has ample room for easing monetary policy to cushion the economic impact. Asian economic bloc centered on the Chinese economy would overtly exclude US economic and military interests.

  • Posted by bsetser

    DC — if China can survive a trade war/ protectionism by easing monetary policy (i would personally argue fiscal policy is the right tool), offsetting a 20% tariff, why can it not offer the same response to a bit more appreciation?

    the plaza led to japan’s lost decade argument has seized Chinese policy makers, no doubt. but there are plenty of other examples of currency appreciations that haven’t had disastrous results. japan in 60s and 70s, korea in 70s/ 80s, europe very recently …

    and if the goal is to avoid a bubble economy but not letting the currency appreciate, china has failed. it has the bubble even without any appreciation; indeed, i think it got the bubble in part b/c its efforts to resist appreciation have led to a huge monetary expansion.

  • Posted by Guest

    US concerns as China builds nuclear subs

    [China has surprised the Pentagon with the pace of development of a new class of submarine that threatens the nuclear balance by providing Beijing with a more robust nuclear deterrent.]

    It threatens the balance, or it threatens to ‘modify’ the balance?

    [According to the 2007 Pentagon China military power report – details of which were obtained by the FT – the Chinese navy is developing a fleet of five nuclear ballistic missile submarines [SSBNs]. The Jin class submarines would provide a much stronger nuclear deterrent because they would be armed with the new long-range JL-2 missile.
    “When they develop five vessels like this, they are making a statement,” said the US official. “China’s first effort at developing a SSBN force was not serious, but the next generation presumably will be serious . . . China is diversifying its ballistic missile capability [to have] more sophisticated regional capability and a more survivable force.”
    “What was grey before now is becoming clear. China now can effectively fight a nuclear war.”]

    Haha. So “balance” was: China cannot fight back. Hmmm… Where have I seen this before?

    Cue in the concern troll:

    [Mike Pillsbury, a Pentagon consultant on the Chinese military, argues that the Chinese are miscalculating by deploying the Jin.
    “President Hu Jintao probably does not appreciate the effect on the US that his military leaders’ new deployments will have,” he said. “These Chinese steps only play into the hands of our hardliners and push the US towards worst case scenarios. The Chinese have an apt proverb: ‘Don’t pick up a rock and drop it on your own feet’. President Hu needs to cut back this development and head off a cold-war style arms race.”]

    Ooh, scary. The hardliners are NOT in power already? They(re not waging an arms race already?

    [China’s defense ministry yesterday declined to comment on its nuclear strategy, but local analysts say the increase in US capability have made expansion and improvement of Beijing’s deterrent inevitable. While the increased range of the new nautical missiles is likely to have a psychological impact on Washington, Chinese analysts say the overwhelming superiority of US nuclear forces means fears Beijing might abandon its official “no first strike policy” are groundless.]

    Aah, but it might force the USA to re-think its own first strike policy fantasies. And THAT cannot be tolerated.

  • Posted by Guest

    “..The bigger worry, but much harder to calculate, lies in whether the country’s banks have unintentionally or secretly lent heavily to stock market speculators who would not be able to repay their loans if the market collapsed. Chinese banking regulations bar banks from issuing margin loans directly to stock market investors. But banks are allowed to lend to securities firms, which in turn provide margin financing. State-controlled media have also reported this year that regulators are looking into whether stock speculators are misrepresenting their intentions to banks, claiming that they need loans for real estate or other purposes. For lack of data, credit analysts have been unable to assess the scale of bank exposure to the stock market…”

  • Posted by Guest

    Don’t worry too much about being wrong, you just misunderestimated (to quote someone famous) the size of the financial el nino that’s currently underway.

  • Posted by Guest

    We all know what balance means:

    [Though the West, with 12 percent of the world’s population, is still responsible for 60 percent of global economic output, the balance is shifting. Two decades from now, Europeans and Americans will produce less than half of the world economic product — and with only 10 percent of world population by then.]

    Economic, military, political. It’s only ‘balance’ if the ‘west’ far outweights everyone else… So much to be concerned about to keep our spot on the top of the shit pile.

  • Posted by Anonymous

    brad – do we have any idea why job creation in China has been so weak -the use/import of labor substituting technology, a weak services sector etc etc? employment consderations are doubtless a key constraint on China’s willingness to move on other fronts.

  • Posted by bsetser

    i would put a lot of emphasis on the substitution of capital for labor … the absence of dividend payments/ huge internal funds generated by various businesses plays a role here, as do relatively low interest rates.

    i suspect stronger growth in labor income would tend to spur the development of a services sector as well.

    but this is based on what i have read, not based on work i have done — i specialize in the balance of payments. other views are always helpful.

  • Posted by HZ

    “Back in 1980, the debt of slightly less than a third of U.S. industrial corporations tracked by Standard & Poor’s was rated junk. By the late 1980s, more than half were, and now 71% of the pie fits into that category, a record according to a new S&P report. ”

    Another financial balance of terror? It could explain how profits can stay high. When everyone in the same sector needs cash flow to finance debt, that stops players from competing irrationally (for market share a.k.a. bragging rights e.g.).

  • Posted by HZ

    “why job creation in China has been so weak”

    A lot would have to do with what the jobs entail? In the state-owned “big iron bowl” days, that could mean doing relatively little. These jobs are harder to find now, outside of governments and monopolies. Those old jobs had to be shed (counting against net job growth) therefore job growth lags economic growth.

  • Posted by HZ

    I think one problem with the original “doom” thesis is to only look at financial flows and ignore the physical economy. If you look at the latter, one would say yes Chinese could have benefited from having a more efficient market based resource allocation scheme but because it has been in a catch-up phase for so long it wasn’t really hurting for the lack or inadequacy of it (of course depending on the point of view, an environmentalist may totally disagree — I take an imaginary average Chinese consumer, others may argue that is not the case). Similarly U.S. (more generally the West but U.S. is the one running large C/A deficits) has so far retained its leadership in creativity (at least on Wall Street, the technology front or in Hollywood). If these are to change one day the system will truly become unstable.

  • Posted by qingdao

    Ref. prefering fiscal policy in China, see Annalisa Fedelino and Teresa Ter-Minassian, “Intergovernmental Fiscal Relations in China,” December 2006 [abstract] [paper in pdf] ; working paper no. 305; Stanford Center for International Development; in a nutshell: fiscal policy not an option in China.

  • Posted by Anonymous

    Brad, the ‘balance of terror’ worked during the Cold War probably because only two parties existed, and the terror’s cost was unquantifiably high (how can anyone value the entire future of humanity, and most life on the planet?)

    In 2003-2004 the ‘players’ were China and Japan. South Korea maybe, Taiwan maybe, oil prices still werent where they are today so GCC wasnt as big a player.

    We now have many more players as you point out. It geometrically increases the fragility of the system.

    Everyone’s on the same page now, so it is stable; but any marginal player can now be the crack in the system.

  • Posted by gheorghius


    Brad, what I find “phenomenal” is your mix of kindness and resistance to truly acknowledged the arguments of those who correctly forecasted in the past the stability of current trends.

    Even today, you keep writing that “US current account deficit [is] financed in large part by demand for US debt from the world’s central bank” as if it were an objective truth (actually, you’re arbitrarily matching some particular US Balance of Payments flows in a convenient way as to make the desired point: that BWII is artificial, and must be unsustainable. But then, it is not…).

    You keep pointing at the “enormous” (and a sequel of other adjectives) US disequilibria (enormous compared to what?) but – given the low and almost stable US debt ratio – you resort to another rather unusual argument. You don’t claim that the US are close to insolvency (obviously they are not). So what arguments are left? Ah, the US is a large country so – in your view – the world cannot (doesn’t want to) absorb so much US paper! But where’s the analysis? You tend to make this point with adjectives rather than meaningful numbers: if you used numbers I suspect the argument would loose much of its strength and appeal.

    But then, in other situations, CBs are totally absent: for ex.: Japan. So how to argue that JP’s exrate is artificial (and unsustainable) here? No problem: you resort to ad hoc arguments, such as “the past memory of CB intervention” at 102 Y/$ three years ago, to justify the current yen/$ fall from 115 to 121! (I understand your argument, but I think you phenomenally over-boost your point).

    Coming to oil exporters, the argument you have long refused to consider is that – in the aftermath of past oil booms – they have saved too little not too much. So maybe you could consider, debate, if not accept, the view that oil exporters are rightly trying to build up foreign assets before rebalancing?! No. First, you argue with me in summer 2006 that I overestimate oil producers’ 2007 imports (so you boost projected 2007 global imbalances); then these imports come up stronger than [you] expected, and your conclusion is still: they should save less (to reduce global imbalances, of course!). The bottom line is: here again you ignore arguments about (1) the instability of oil prices and (2) the exhaustible resource incentive to save (so one should welcome, if anything, their prudence).

    So I’m sorry to say it’s no surprise that facts keep proving you wrong year after year. It’s the underlying “model” of the world economy that is wrong! The disagreement here is that you believe you’re taking note of contrarian arguments, while I think only marginally.

    But now, enough chastening. Did we learn anything from past mistakes? What about the future? NOW: May 2007, you think we are witnessing “phenomenal numbers”. What do they tell and anticipate? And why are they “phenomenal”? The US CuA deficit is again not an issue (see the Yen, the Euro, the pound, against the US$, see how forex participants vote every day freely on the US$!). The real burning issue now is the internal balance of fast-growing-official-reserves countries, such as China and Brazil. If we could agree that these 2007 numbers – and only these – are, for the first time, truly phenomenal (domestic!!) trends, then we could agree that (1) they could last for a while, but (2) they cannot last much. The logic behind is not about flows, but about stocks. These third world countries want to build up some foreign assets before stabilising, and they are rapidly reaching both their goals (Brazil, Russia) and their absorption capacity (China etc.). Then, we could agree – as I forecasted long ago – that in summer 2007 (if not June, some time in 2007) one country after the other (not all together!) – China included – will follow India and will let their currency appreciate.

    It will not be a global tragedy: just a price realignment, and some shake-out in some peripheral countries. Doomers will be chastened twice: once by the longer / wider than expected US CuA deficit (and associated long lasting third world pegs); and once by the smoothness how BWII will melt away.

  • Posted by gheorghius

    Brazil’s Foreign Debt Still US$ 203.5 Bi Saturday, 26 May 2007

  • Posted by bsetser


    re: Japan. Even i wouldn’t attribute all of the yen’s weakness to memories of past intervention. What I do think has had an impact is the MoF’s decision to reinvest interest payments on its $ debt rather than sell them in the market, and the expectation that at some point, the MoF/ BoJ would enter into the market. Does this prevent a 5, 10 even a 15% loss — almost certainly not at the 5% level, maybe not at the 15% level. but does the possibility that MoF $ buying would let a market player unload a position in a true drawdown make some more comfortable holding $ (and other high yielding assets) — i would argue yes, since there is a potential floor under truely extreme losses. but hey, that is just my view, and others have a different view. this is truely an untestable proposition.

    we have different views on what matters — i tend to think the turnover data matters less than the fact that CBs are holding on to a very large number of $, and in the process financing the uS. We can agree to disagree on this one.

    There is another issue, which is real: what matters, central banks share of gross inflows to the uS or their share of net. I agree that so long as one expects that FDI inflows will be matched by FDI outflows and that the int. bank system won’t be building up a net long $ position lending to the US unhedged (so bank flows can be expected to offset), what matters is role of central banks in generating net debt inflows or not.

    You can agree or disagree with my methods for estimating central bank purchases. Though in my defense, the survey data for june 06 supports my side of the argument; CB purchases were revised way up, private purchases way down. but there is a debate.

    what i don’t think is debatable is that there isn’t enough private demand for us paper to finance the uS CAD. the FRBNY custodial accounts ($500b plus annualized increase in q1, a bit less now) sort of settle that. as does the strong pace of global reserve growth — my numbers here are very, very good (lots of legwork –i tally up various central bank releases). monthly global reserve growth is $100b now. Pick your share going into $. it finances a large share of the US CAD.

    Russia’s reserves are set to rise by $100b in five months ($300 to nearly $400b). sure, a relatively low fraction goes into $, but that is still a huge increase. the mechanics of it all point to large net inflows of private capital to the emerging world, and insufficient private demand for US debt to finance a deficit of the size of the current US current account deficit at current XRs and int. rates.

    as for the oil folks, well, you can certainly debate whether spending or savings makes sense. i literally wrote a paper on the topic (for the IIE). if the shock is permanent, a fair amount should be spent. if you needed a bigger buffer to manage oil related volatility, you should start spending once you have the needed buffer. and you may have noticed that i have changed my tune on the oil folks — i don’t call on them to spend more. not now. they clearly are already doing that. i do want more XR appreciation, but that is a seperate issue. right now the oil exporters are spending a ton, and contributing to global demand growth. even if oil stays where it is now, their surplus won’t grow/ should shrink. my concern now is primarily with the way they are going about the adjusment and the very negative real rates …

    in sum, the only point that I think has held — and this is a point where I have always agreed with PEter Garber, Mike Dooley and co — is that continued CB intervention is central to the stabilty of the system. I think the recent data supports that part of the argument. official flows to the us picked up when private flows dropped. I thought that this system wouldn’t prove stable. so far it has. I have tried to concede that point.

    I do still think that the odds that it will prove unstable going forward are higher than the consensus (see the point made by anonymous on the stability of balances of terror with multiple players), but that is just my view. the consensus now puts the risks at a very, very low level. So far, my concerns about the ongoing stability of a system based on strong reserve growth haven’t been borne out. they may not be in the future either. that is what makes this interesting. we don’t know the outcome.

  • Posted by jo6pac

    To answer Dave C. I’m as close to the ground as I can get, but yes it was a suprise for me to understand why (not) SUV sales were up. OH that right it Madison Ave saying you have to have it. I’m hoping that I get out alive at my advance age, and wondering why some of you that have the educations that you do, are not speaking out(not just at this blog) I hope that you mention in passing what your true feeling are to your classes at the great think tanks of the world.
    Thanks Brad & Dr.

  • Posted by gheorghius

    “we have different views on what matters — i tend to think the turnover data matters less than the fact that CBs are holding on to a very large number of $, and in the process financing the uS. We can agree to disagree on this one”

    but I didn’t mention turnover this time. I mentioned US Balance of Payment flows: Why not say that CBs are financing US K outflows? Or whatever else is in the US BoP?

    “as for the oil folks, well,… i don’t call on them to spend more. … i do want more XR appreciation, but that is a seperate issue”

    I am not sure it is a separate issue.

    “What I do think has had an impact is the MoF’s decision to reinvest interest payments on its $ debt rather than sell them in the market”

    Hey, fine, everone has his own opinion… but how much influence? I would say less than minimal…

    “You can agree or disagree with my methods for estimating central bank purchases…”

    On this matter I agree my eyes closed. I recognize your outstanding knowledge. But dont you see the argument in itself is limited? It goes: “since CBs buy lots of US paper, it is a proof that the private sector does not want US paper, the world cannot normally absorb a 7% (even 4%) US CuA deficit”. Arbitrary deductions!! I would expect youto prove your point directly, for ex. study the % of global savings that is absorbed by US (and others) CuA deficit and compare with a 200 years trend of deficit countries, then draw your conclusions about how much more the world can absorb (weighted by interest rates differentials and whatever complication you might want to consider). But you are too easily satisfied with your simple argument “CBs buy US$, thus private don’t want US$ unless US$ crash”.

    “continued CB intervention is central to the stabilty of the system… I thought that this system wouldn’t prove stable. so far it has. I have tried to concede that point.

    Yes you did. But is it enough?

    “I do still think that the odds that it will prove unstable going forward are higher than the consensus (see the point made by anonymous on the stability of balances of terror with multiple players), but that is just my view”.

    Your view? It’s anyone’s view! No one believes that, for ex., the US CuA/Gdp deficit can keep growing over time indefinitely. And no one think BW2 will last for decades at current exrates! I, for one, even think it will melt down in a few months, country by country!

    “the consensus now puts the risks at a very, very low level”.

    What risks? Sometimes I feel a confusion between systemic stability and BW2 stability. If BW2 collapses we don’t care an inch! It will. But what has this to do with global stability?

    “So far, my concerns about the ongoing stability of a system based on strong reserve growth haven’t been borne out. they may not be in the future either. that is what makes this interesting. we don’t know the outcome”.

    It would be interesting to read your view about “how” BW2 could go on at current trends and exrates for more than 5 years… You questioned BW2 stability in 2004-2006, while I was on the other side; and now I find myself more pessimist than you on BW2?! What we are discussing is timing: “when” BW2 will collapse; and “how” it will collapse (a global crash or a wmooth adjustment): not “if”.

    Thannks 4 the argument.

  • Posted by RebelEconomist

    Brad said:

    ” protectionism is the logical political response in the us to a political economy that hasn’t found a way to share the very large gains some are now enjoying broadly — or to compensate the direct lowers from the china trade. blackstone wins from china twice — cheap financing for its private equity deals courtesy of the impact of reserve growth on global “liquidity” (lots of global demand for debt) and from china’s participation in its IPO. Ohio workers in small towns lose twice — from the direct impact of competition with China on their wages/ jobs and from the indirect effect of factory closings on local real estate prices … ”

    It seems to me that socialism would be at least as appropriate a political response!

    You appear to be supporting protectionism. A respected commentator on balances of payment should think very carefully before saying such things. The damage caused by protectionism builds up slowly, as the countries directly involved respond and work around it, and as it spreads to other countries. That makes protectionism attractive to politicians anyway, and they do not need further encouragement.

    The real problem for America is how to adjust to a world in which inevitably it ceases to be the dominant global power, economically now, and consequentially in just a few decades, militarily. What is unsustainable is that a country of three hundred million people can stay ahead of a country of 1.3 billion people, let alone dominate a world of seven billion.

  • Posted by Guest

    re: “any marginal player can now be the crack in the system”

    Yes, but we might assume that the ‘nail that sticks out’ would immediately galvanize all other seemingly disparate players to hammer it back down again, at least long enough to protect or limit the damage to their own interests.

    I still think a big part of the problem is in the difficulty of defining, in economic terms, ‘greater’ U.S., China, Russia, Brazil… along with any number of other parallel economies, along with the tendency to brand entire populations as an economic and politically homogenous bunch! Three hundred million Americans are not ‘staying ahead’ of or ‘dominating’ the wealthy Chinese, East Indians, Russians, Brazilians, Mexicans in and outside of those countries any better than the majority of those nation’s own populations.

    I also doubt that the numbers are even close to adequately describing output and trade in an increasingly ‘knowledge based’ economy.

    As for protectionism, nothing is more powerful than rumours and consumer boycotts, especially in the internet age!

    “A rumour spread by text message has badly hit the price of bananas from China’s Hainan island, state media say. The messages claim the fruit contains viruses similar to Sars, the severe respiratory illness which has killed hundreds of people worldwide. Producers in Hainan say the resulting price slump is costing them up to 20 million yuan ($US2.6m) a day…”

  • Posted by Shashank

    I don’t think Brad was advocating protectionism as such, merely saying it would be a ‘rational’ response with respect to that individual. I think it’s important to distinguish sharply between the technical details over economic causality (what possibilities are open in strictly technical terms i.e. the precise nature of the global imbalances, the make-up of the flows and the precise inflationary costs of reserve accumulation) and the political realities, themselves mediated by individual judgments about the economic situation and division of income that results from gains from trade. The latter will often bear little correspondence to reality, the former category. But the political realities, as independent causal factors, matter as much, if not more, than the technical questions about flows.

    As a technical point, it is clear that we can envisage in broad terms a BWII scenario *given* a certain degree of cooperation between the major states involved. But the political realities point heavily away from that scenario. As the Ways and Means later shows clearly, no amount of faith in the feasibility of BWII is going to prevent, in the LT, from some form of protectionism. The political question is what form such protection might take. Namely, whether it will be substantial or effective enough to shape China’s incentives in such a way that the trading benefits gleaned by holding down the yuan are valued less than the possibility that the reserve accumulation and its opportunity costs (inc. less sterilization) so that the Dooley et al. dynamic no longer holds. And what will feed into this includes Chinese Plaza analogies, however historically garbled these may be.

  • Posted by Guest

    “…High tariffs, governmental corruption, and other governmental and institutional roadblocks to legitimate businesses can squelch a market’s formal sector and drive activity into the informal sector. All of these issues are probably factors in the growth of music black markets in places like Latin America and China. See this great TCS interview with William Lewis for more on the topic of the role of protectionism and corruption in fostering black markets…”

  • Posted by Guest

    might we assume the development of foreign exchange as an asset class, along with the ‘walls of money’ that are expected to flood into products in that market, may be intended at least in part to serve as corrective mechanisms for necessary BWII adjustments, as well as a ramps to the next platform of sorts. Somehow, I can’t see BWII ‘crashing’, depending on your definition of ‘crash’ – at least not without the help of something that could cause a massive, extended power blackout.

  • Posted by Guest

    oops, sorry BWII ‘collapses’ and the markets ‘crash’ – or is it the other way around?

  • Posted by Color Me Still Worried

    Do not rush to judgment: A fellow drops off the fiftieth floor. It is a long fall and the guy fears the worst. But, as he passes the third floor, he thinks: “Hmm, so far so good.”

  • Posted by bsetser

    not sure fx really is an asset — but when you but other assets, like s-term or l-term debt, you certainly buy xr exposure, and that can be good or bad. some folks can make their living trading the stuff at high frequencies, but that isn’t viable for many —

    and if by fx as an asset, people mean trading $ for higher yielding emerging currencies (or aussia and kiwi $), that doesn’t help support BW2.

    Gheorghius — the “gross” flows argument is stronger in my view than the “trading volume” argument. but i don’t think it makes any more sense to match central bank flows to FDI outflows than to match FDI inflows to FDI outflows. As I argued above, recently FDI inflows and FDI outflows have tended to offset, and unless you think that is about to change, there won’t be net financing from that source — for more structural reasons, i don’t think the int. banking system will be a net source of financing for the us (global banks don’t want an open fx position), so bank flows will tend to offset, as they have. that leaves portfolio flows, and there CBs are a very large part of the gross and the net flow. as for global savings, unless you assume that there will be a big fall in home bias, it won’t all flow to the US — and unless you think home bias outside the us falls more than home bias inside the US, you need to look at the potential stock outflows as well as the flow (stock outflows from us are potentially big). right now, the savings in the emerging world that is flowing to the us is either gov. svaings (petro$) or savings the government borrows from private savers who want local currency assets (China most notably), so without the government taking the fx risk, the flows wouldn’t happen. ergo i don’t find looking at “global” savings a productive way to go — not when the net flow of private savings is into the emerging world. I think we will have to agree to disagree on this.

  • Posted by Guest

    meant ‘facilitate a transition’ rather than ‘support’

    it’s my impression that FX as an asset class is in its very early stages

  • Posted by some fat guy

    Hmmm, interesting. China will not revalue. I thought they would have caved by now, but it makes sense. They will hope that Congress is selective in it’s import tax. Why tax themselves (by appreciating the Yuan) when they can probably get a better deal by having some (not all?) of their imports tax. Then, Congress can be blamed for the inflation that is created instead of China.

    On the topic of real estate. This party is ov-va. Real estate will be a drag on the U.S. economy just as it was in Japan for the past 15 years. I know, I know. Japan is “different” than the U.S. (high savings rates, etc. etc.). This will only make things worse in the U.S.

    and oh year, the dollar is toast.

  • Posted by Guest

    “…Elad Properties, owned by Yitzhak Tshuva has sold an 855-sq.m. triplex penthouse in Manhattan’s Plaza Hotel for $56 million, possibly making it the most expensive condominium in New York…”

  • Posted by gheorghius

    All right.

  • Posted by gheorghius

    But then, one year from now, how will we know who was right?

  • Posted by Twofish

    I’m in the process of writing a paper that argues for the “Candide model of global imbalance” that we are actually living in the best of all possible worlds.

    About protectionism. I don’t think that there will be much push for protectionism. Workers whose jobs are in the process of being moved overseas will complain loudly about free trade. Workers whose jobs have already been moved overseas don’t exist at all to complain. I think we are fast reaching the point that the industries that would have complained about the loss of jobs are already disappeared completely.

    Also, there have been huge numbers of jobs created in China, those are balanced by the huge numbers of jobs lost in the closing of state owned enterprises. Averaging across twenty years also misses some important trends. The job losses due to closing of SOE stopped around 2001 or so.

  • Posted by Anonymous


    to the extent that tariff forced higher prices could be realized, don’t you think that would also rep an (added) subsidy to the transnats

  • Posted by Rick45

    “About protectionism. I don’t think that there will be much push for protectionism. Workers whose jobs are in the process of being moved overseas will complain loudly about free trade. Workers whose jobs have already been moved overseas don’t exist at all to complain. I think we are fast reaching the point that the industries that would have complained about the loss of jobs are already disappeared completely.”

    TwoFish are you not forgeting the innocent victims of lost jobs/industry? Example, the single mother of 5 in any one of a medium-sized urban-center in the Midwest. She “pushes” paper for the state or other entity and works hard to stay above water. The house she bought 6 years ago has in real-terms appreciated little in value if at all. When the scapegoat of illegal immigration runs it’s course who is next, crooks in silk suits that continue to support the Ponzi Scheme of B.W.II? Or need I remind you that we have a general election coming-soon. Desperate people will produce atleast one black swan, for example a “populist-spiritual leader” thrusted into the White House!

  • Posted by RebelEconomist


    I am not exactly sure what you are asking, but I will endeavour to address the issue I think you raise.

    I presume that the proceeds of a tariff on Chinese imports would go to the US government and hence Americans in general. The cost of the tariff to China-based producers will depend on the extent to which they are able to maintain their pre-tariff price in the face of the price of their product in the US market, but the producer cost of the tariff will certainly be non-negative. American-owned Chinese producers may, however, benefit if the tariff revenue was used to, for example, lower corporate taxes, and it is conceivable that this could more than offset the cost of the tariff, in which case it would effectively subsidise them. American-based, American-owned producers would have the advantage of both a relative price change (in the American market) in their favour and any tax cuts.

    Of course, all of this only considers the immediate impact of the tariff and how the US government uses it. Assuming that Chinese exchange rate policy does indeed mean an undervalued yuan, the policy subsidises American consumer borrowers as well as Chinese producers, so they would lose out if the tariff reduced Chinese intervention. And then there are the effects of Chinese retaliation and any spreading of trade barriers to consider.

  • Posted by Guest

    “…Sotheby’s set a record total for a contemporary art auction this month, raising $254.9m in one night… But within 24 hours that figure was smashed by Christie’s, its rival, with a $384.7m buying binge… One way of looking at high art prices is as part of a global wave of liquidity that is pushing up asset prices everywhere… A variant of the same argument is that high art prices reflect the increasing number of rich people from all parts of the world. Russian and Chinese millionaires, along with hedge-fund and private-equity managers… But the founders of the Art Trading Fund reckon art prices are well below their peak in the late 1980s, when adjusted for inflation…”

  • Posted by Guest

    “…he believes that the art of running a company can be distilled down to precise and measurable rules… I manage to ask Koch whether you really can transfer macro-economic theories to a real-life company…”

  • Posted by Guest

    “…Morgan Stanley estimated in March that the total funds at the disposal of SWFs may be as high as $2,500bn (£1,157bn, €1,710bn), already around half the gross official reserves of all countries. By comparison, the global hedge fund industry is thought to manage about $1,500bn to $2,000bn of assets, some of which may include existing SWF money… “China Inc’s investment decisions are going to have the capacity to move markets for a long time,” says Brad Setser of Roubini Global Economics. But the SWF story is more than just China…

    Analysts say the evolution from official reserves to SWFs should be positive for emerging market assets and positive for risky assets in general. A wholesale move from bonds to equities by the world’s central banks should also boost the yen. Only 3.2 per cent of the world’s total official reserves are held in yen. However, global equity managers typically hold a greater percentage of their portfolios in the currency… If SWFs invest funds in equities in line with Japan’s global weighting, they will have proportionally more money in yen assets than they would have if they kept funds in traditional reserves…

    Some of the newer SWFs appear to be following a similar path to the Abu Dhabi Investment Authority… But there are few public details on its operations, with no official figures released for Adia’s investments. Morgan Stanley estimates it is the world’s largest SWF, managing as much as $875bn. But where this money is deployed is a matter of conjecture…”

  • Posted by Anonymous


    while initial studies re. Germany date back nearly a century, more recent seem to indicate that a protectionist tariff hike can lead not only to tariff jumping but also relatively higher profit rates for those firms already on both sides of the politically erected ‘barrier’. Which is also to say that rather than enhancing domestic firms, the contrary can take place. Certainly though degrees of sectoral concentration need also be taken into account.

  • Posted by Guest

    “…The effect of cheaper manufactured goods in the west has started to wane just as rapid growth in India and China has pushed up the cost of commodities, feeding into the cost of living…”,,2089382,00.html

  • Posted by Guest

    “…Authorities blame IPOs and enormous borrowings in the West by state and private firms for higher than expected capital inflows, which put additional pressure on the government’s inflation targets… the Central Bank, which has only weak monetary policy instruments, is forced to allow the value of the ruble to appreciate. That in turn erodes the competitiveness of Russia’s key export-oriented industries… The country’s booming economy is giving Kudrin another headache: how to spend it. The government has amassed more than $113 billion of windfall oil revenues in the stabilization fund… President Vladimir Putin last Monday suggested some of the money could go to support Russian stock markets, but backtracked three days later, saying there were no plans to do so.”

  • Posted by josh bivens


    i haven’t been able to check this site as often as i like recently, so, i’m sure you’ve written on this before, but, what *are* the GCC countries trying to do with all their dollar purchases?

    a pointer to something you’ve written on this would be excellent.

  • Posted by ExposingIslam