Does Bretton Woods 2 end with a bang or with a wimper — a dialogue
What follows is a bit of an experiment. I am posting — with permission — a lightly edited version of an email exchange that I had with a global equity portfolio manager a few days ago.
Like all good conversations, it evolved. What started out as a conversation about China's economic cycle — or more precisely, the absence of much recent macroeconomic volatility in China — developed into a broader discussion of US competitiveness, global capital flows and the conditions that might bring today's relatively stable equilibrium to an end. Enjoy.
Global equity portfolio manager:
The growth rate of China's exports and construction & mfg in general raises another question. US history suggests that high growth regions have greater economic volatility since so much of their economy represents growth industries. A slowdown in growth rate creates powerful "feedbacks" (not the right word), since getting to a steady-state economy requires substantial restructuring.
Might this be true of China, even as a short-term effect? If US export growth goes to zero, what about all their internal business devoted to generating increased growth? This is not clearly stated in most articles discussing global rebalancing.
Brad Setser:
Your point on China is a good one. In the 90s Chinese growth (overall and in exports) was high but very volatile. Some of that was external – Asian crisis/ tech bust (and impact on demand for computer assembly). Some was internal (inflation & over investment in early 90s restructuring of state-owned enterprises in late 90s). From 02 on though Chinese growth has been high and lacked volatility. The same is true of exports. You could argue this is just storing up future volatility in both…
Tend to agree with you re: lack of US investment in real economic capacity in the US. It is a problem. I tend to think the exchange rate is a solution (right now it makes sense to invest in tradables production in China than in the US). But I tend to always think the exchange rate is the solution, so I may be blind to other factors.
Continues below the fold.
Global equity portfolio manager:
Given today's global imbalances, I too suspect fx is the key variable. But USD deval is an awful solution. Rebuilding export capacity — skills, mfg, sales and then slowly gaining mkt penetration — is a slow process. The J-curve from Hades.
Consumption declines, inflation, foreign purchase of US assets — wouldn't there be a host of earlier macro impacts from USD deval before we entered the promised land of renewed export competitiveness?
Brad Setser:
Yes, both on taking time to rebuild skills & the need to deal with an ugly period of adjustment. That is why I long thought change now is better than change later, but well, I have been saying that since 04 and since then Chinese exports have doubled (at least).
Hopefully the adjustment in the US will be far less extreme than in Argentina in 02 (which had to deal with financial consequences of “liability dollarization” – i.e. the use of the dollar in domestic contracts – in the face of a necessary depreciation of the peso.
It is amazing though how investment in tradables (and tourism) in Argentina soared after the depreciation, though the rise in resource prices also clearly helped.
Global equity portfolio manager:
Agreed. Devaluation is usually great for growth assets, like equities. However I wonder about scale effects. Engineers say that every 10x change in scale radically changes the dynamics. We've never had a deval like the USD, including loss of reserve currency status. That is, not just a change in flows — but likely movement in "stocks" (holdings of US debt) that dwarfs the usual flows.
I'll bet the unexpected consequences would be far larger than the expected ones.
This could be much larger than the usual flows of US debt (e.g., debt creation of US issuers, c/a deficits, interest). As you know better than I, loss of reserve currency status suggests — at the very least — foreign private holders become less interested in holding USD debt.
I don't see how any global re-balancing involving USD deval avoids massive changes in who holds our debt — which might be difficult to arrange in an orderly manner (no global equivalent of NYSE specialists for these order imbalances).
Plus, of course, during this transitional period we'll still be running a large current account deficit. Not only will the transition to a low c/a take time, AND any currency flight (by foreign & domestic investors) be financed, BUT ALSO the c/a could rise during the j-curve period. Scenarios in which the US regains export competitiveness seems path-dependent, and many of these paths seem "difficult." As a fringe
observation, this transitional period seems to get little attention by those recommending solutions.
Who moves first to spark rebalancing? Central banks’ tend to be slow moving, incremental, reactive, usually counter-cyclical, decision-makers. Private actors are the opposite, in aggregate.
My guess is that at some point private holders (both foreign and domestic) will be motivated sellers of USD - whether increasing gradually or suddenly depends on events. Coordinated action by central banks' will be required to avoid chaos or worse.
I see no other likely scenario. That is, I can imagine scenarios in which one or more central banks' initiate or jump on a downward USD move - but consider these a low probability group.
Going one more step, I suspect (with no evidence) there has been informal discussion by central banks' about these scenarios. Things get interesting at that point. Are you familiar with the Stephen Jay Gould & Niles Eldredge theory of "punctuated equilibrium." I believe this applies well to geo-political affairs, which is what this becomes.
Brad Setser:
"of course, during this transitional period we'll still be running a large current account (c/a) deficit. Not only will the transition to a low c/a take time, AND any currency flight (by foreign & domestic investors) be financed, BUT ALSO the c/a could rise during the j-curve period."
Actually, that was more or less what I have been arguing. Suppose private markets lose confidence in $ before central banks. The net result — given US financing needs during an adjustment — is that central banks need to intervene more, and they will end up providing most of the financing to the US that in some sense allows the US to avoid a truly wrenching adjustment. They do this in part b/c of inertia (dollar pegs and the dollar share of their portfolio are often fixed in the short-run by policy decisions and cannot easily be changed), and in part b/c they aren't motivated solely by financial gain.
You can argue this is what happened in q4 and q1 — global reserve growth spiked to around $250b then, with dollar reserve growth probably rising to around $200b a quarter – enough to basically cover the US CAD at a time when private markets didn't want to finance this US deficit.
The interesting thing is this happened w/o outright overt coordination and it happened automatically as a byproduct of central bank inertia. Private flows to the emerging world picked up. Emerging market central banks intervened more, basically sending the money private investors were taking out of the US back to the US. The net result: the US deficit was still financed, despite less willingness by private us investors to keep their dollars in the US & smaller private flows from the rest of the world. At least that is my interpretation of the data.
The problem is that central banks right now seem to be as much in the business of blocking adjustment as they are in the business of financing adjustment.
Global equity portfolio manager:
So what happens if we get substantial capital flight, with flows 5x or 10x greater from today — the scenario I was considering? That might snap CB's out of their inertial state!
One item on the "one step more" speculation: will CB's intervene without the usual drill of setting conditions (e.g., fiscal, monetary) for the miscreant? I suspect not.
Brad Setser:
So far emerging market central banks have provided the US with unconditional liquidity support. The US Treasury was never as kind to emerging markets back in the 1990s.
The day this changes and emerging market central banks start acting like the US Treasury, the world changes.
Global equity portfolio manager:
Agree. The concept of punctuated equilibrium is non-consensus for reasons unclear to me. The historical record shows periods of stasis then rapid change. IMHO, Bretton Woods II is an attempt to project current stasis into the future — rather than consider that pressure might be merely accumulating unseen.
From Wikipedia:
Punctuated equilibrium (also called punctuated equilibria) is a theory in evolutionary biology, which states that most sexually reproducing species will show little change for most of their geological history. When phenotypic evolution occurs, it is localized in rare events of branching speciation (called cladogenesis), and occurs relatively quickly compared to the species' full and stable duration on earth.
Punctuated equilibrium is commonly contrasted against the theory of phyletic gradualism, which states that most evolution occurs uniformly and by the steady and gradual transformation of whole lineages (anagenesis). In this view evolution is seen as generally smooth and continuous.
In 1972 paleontologists Niles Eldredge and Stephen Jay Gould published a landmark paper developing this idea. Their paper was built upon Ernst Mayr's theory of geographic speciation, I. Michael Lerner's theories of developmental and genetic homeostasis, as well as their own empirical research. Eldredge and Gould proposed that the gradualism predicted by Charles Darwin was virtually nonexistent in the fossil record, and that stasis dominates the history of most fossil species.
Brad Setser – but after the end of the initial conversation.
The pressures on Bretton Woods II are actually rather visible. The recent acceleration in reserve growth isn't all that hidden — and from the point of view of the world's emerging economies, the scale of reserve growth is one measure of the costs that they are incurring to sustain the current system. Evidence of a backlash against "globalization" also isn't hard to find in the US. That backlash is driven by weak median real wage growth more than anything else, though the sense that China's allocation of its reserves is helping to decide who wins and who loses in the US economy presumably doesn't help.
What is far harder to determine is whether such pressures are building to the point where the system is close to a breaking point.
Very interesting exchange. My first reaction was to look for the Herb Stein quote via google: “things that can’t go on forever, won’t.” Unfortunately that doesn’t help one to identify where the “won’t” part of the expression will spring up. When I googled the phrase, one of the top items was an entry with that title in the Fist Full of Euros blog. It was remarking on some of the same phenomena. The key point is that the entry was from 2004. Three years later and we’re still waiting for “won’t” to kick in.
going back to an estimate made yesterday: “market capitalization of global equities and bonds is that it is more in the order of magnitude of $ 100 trillion” in a conversation about ways of slicing and dicing global markets. Assuming we can break out that which can be truly defined as ‘US assets’, which is likely not the same as all assets currently traded in USD, wouldn’t total US assets still be, by far, greater than all other categories combined? and if so, limiting a great deal of selling if only due to a lack of other assets to buy and the fact that no other currency yet seems to be up to, or want the job of replacing the USD as global reserve currency. That being said, the system is evolving very quickly and it could be that much is lost as the focus tends to center on overly generalized categories, rapidly outdated models and ‘breaking points’ rather than transitions.
Interesting. I am not an evolutionary biologist but a bit familiar with that stuff. Bottlenecks, genetic drift… For me, the most powerful selective pressure that can be felt rigth now in finantial markets, more than exchange rates, is in CDOs markets. If the assets that back those obligations turn to be overvalued by too much, the pressure will be felt by the owners (local), the lenders (local) and the bondholders (global). Depending on who is left holding the bag, that pressure will resolve differently. Genetic drift theory may apply for mortgage borrowers in trouble, and the bottleneck hypothesis to bondholders and traders in trouble.
Ironically enough, IMF president Rato announced a revamp to the currency surveillance program yesterday, including as a fourth principle that “A member should avoid exchange rate policies that result in external instability.” The US would argue that that means PBOC and assorted others should quit fiddling with exchange rates for mercantilist purposes.
China would probably argue that if they pulled the bid in USD/RMB, greater instability in the current trend of external imbalance widening would occur. And therein lies the problem. Bretton Woods I was about the creation of multilateral institutions to help manage financial and trade flows. Bretton Woods II is about single nations acting unilaterally and, in many cases, free rising on the global financial system. Much as the UN is becoming increasingly irrelevant in resolving military and security disputes, BWII is all about nation states using financial markets to aggressively promote their self-interest. And sadly, in a somewhat bitter irony, markets can remain irrational as long as they remain solvent.
http://www.stanfords.co.uk/info/store-one,9,GP.html
Link to Rato’s announcement above.
Scenario:
US interest rates have yet to bite, but will. The housing and mortgage markets were hypersensitive to rate increases within a zone of still historically low rates. The trade deficit will follow suit in due course. One more Fed tightening will probably begin to choke import demand. And the dollar won’t necessarily be the most important part of the adjustment. US interest rates will dominate across the board.
(Re $ 100 trillion estimate above - US GDP is roughly 1/3 of global GDP at dollar rates; market caps should be roughly proportionate, although US markets deeper still)
” markets can remain irrational as long as they remain solvent ”
Clever variation on Keynes - but liquid over solvent.
06-20 15:54:43 - thank you, but without more details do the market cap numbers tell us all that much about how a global ‘flight to quality’ might play out in a liquidity crisis?
Ancient banking maxim:
If the bank lends you a million, and you can’t repay, you’ve got a problem.
If the bank lends you a billion, and you can’t repay, the bank has a problem.
Your guess is as good as mine on the details of a global liquidity crisis.
If I were the Chinese central banker instead of a dumb ol’country boy, I think I would ask/demand the US Treasury and Agencies to issue Yuan demoninated bonds as a condition of China’s continued participation in the auctions. If you want Chinese savings, then the US must assume fx risk. Existing treasuries and agencies would be converted as well. To my limited understanding, China is assuming too much risk in the current BWII scheme. Perhaps China would agree to float the Yuan in return for access to Yuan bonds.
to me inflation (consumer/producer/asset or otherwise) is the key and/or protectionism; i wouldn’t think that a subprime (and derivatives thereof) levered hedge fund implosion (taking private equity — and ratings agencies — with it, via CLOs?) would do anything to topple BWII.
why? because inflation/protectionism denotes a loss of confidence in money and/or trade, which (national) CBs are in a poor position to address, given (transnational) flows. credit cycles, even massive ones, CBs are eminently prepared to deal with given a ‘reasonably’ flexible labour force (ask japan); just throw ‘em out of work and hope they find something else more ‘productive’ to do.
if anything, a crisis’ll cause CBs to come to the rescue and they’ll be more than welcome to organise a bailout; that’s what they (have been trained to) do — provide liquidity, moral hazard be damned* — it is, afterall, their raison d’être. sure they’ve been warning and shying away, playing coy, but when it comes down to it they always come around and act like little bitches, to start the cycle of jerking markets around anew.
—
* tho roach might suggest that this jeopardises price stability over the long run, i dunno how many asset bubbles have been ‘blown’ over the years around the world, but it seems to be they’re just as deflationary (after the climax)
” I think I would ask/demand the US Treasury and Agencies to issue Yuan demoninated bonds as a condition of China’s continued participation in the auctions ”
Interesting idea, but doesn’t China have the initial ‘problem’ of being stuck with US dollars from its trade surplus? The problem is what to do with those dollars otherwise (unless Chinese exports become invoiced in yuan as well).
Fix India first: “…How does one make the benefits of financial flows trickle down to… - or create opportunities for - the have-nots? Here’s a wacky plan: Turn Mumbai into a special administrative region like Hong Kong…” http://www.bloomberg.com/apps/news?pid=20601039&sid=amPprgUkOVmg&refer=home
My 2 cents: BW II will end either (1): when China implodes for purely domestic reasons (inflation, banking crisis, environmental “event”; one of the 66 daily large violent demonstrations gets out of hand);(2) if China makes it to the fall, the Americans will supply the crisis with a tariff; I would like to hear your speculations on the latter possibility.
Brad: Thanks for sharing this very interesting discussion. It seems to me that Macro Mans is very much on target with his view that “Much as the UN is becoming increasingly irrelevant in resolving military and security disputes, BWII is all about nation states using financial markets to aggressively promote their self-interest”.. Hence, what is a probable answer to the question “Does Bretton Woods 2 end with a bang or with a whimper?”. In my view probabilities favor that “it ends with a bang”. In its Regional Report on Asia (April 2007) the IMF has revised upwards its 2007 and 2008 projections for China Current account surplus; now put at 10.0% and 10.5% of GDP, respectively. Also, it views China exports as increasingly relying on domestic sources as contrasted to imports. This means that the rate of growth of imports will decline, even as the rate of growth of exports increases. http://www.imf.org/external/pubs/ft/reo/2007/APD/ENG/areo0407.pdf
Hi you all,
It’s very nice to see a headline by an economist from Kansas quoting a great british poet!
Brad is captain Kurtz, on the right side of the table (not in the midle of the jungle) talking economics, and macroman is a clever “potitician” talking about our surprising financial world.
A great post, endeed!
The end won’t be fine (after olimpic games, probably).
Anyway, as I know that you all are at your forties, fifties, or sixties.
Let’s read I nice article about new ideas to change the world. We don’t live only from economics (sorry, brad, for a long post, but… I needed it):
Levitate the Pentagon
By Pepe Escobar
“I read the news today oh boy.” - The Beatles, A Day in the Life, 1967.
“The only enemy of Iraq is the occupation.” - Muqtada al-Sadr, 2007.
Forty years ago down in sunny Monterey, California, an ultra-cool black cat from Seattle named James Marshall Hendrix set the world on fire. “Respect” by Aretha Franklin (written by Otis Redding) was the No 1 hit single in the US (to be replaced, a month later, by “Light My Fire” by The Doors). Hendrix and Otis in Monterey merged into the Summer of Love - the apotheosis of Make Love Not War, vinyl treasures and Indian mottoes dressed in caftans and granny dresses.
Already in the spring of 1967 a stirring wave of counterculture fusion between London and San Francisco was irresistible. Dismissed Harvard sage Tim Leary ordered everyone to “turn on, tune in, drop out” (The Beatles, already in 1966, were quoting from Leary’s version of The Tibetan Book of the Dead - “turn off your minds, relax and float downstream”).
While the radically politicized were yelling “Kill the pigs!” the Beatles were inventing whole new groovy sounds in the studio and beat poet Allen Ginsberg was singing the praise of Bob Dylan’s victims in “Chimes of Freedom” - and assisting LSD experiments unsupervised by the Central Intelligence Agency.
The irretrievably fragmented consciousness of the whole Western world was unifying, at least in the hearts and minds of young people everywhere, even for a fleeting moment in time. It was a river flowing out of the postwar consumer boom, from jazz to the beats to rebels without a cause to Dylan to The Beatles.
The Grateful Dead loved Allen Ginsberg’s “Howl” (from 1955) so much they set it to music. The doors of perception were being cleansed by what Ginsberg defined as “the divine herbs and greases” and by LSD - the crucial catalyst.
Yippie icon Abbie Hoffman, who defined The Beatles’ Sgt Pepper’s Lonely Hearts Club Band as “Beethoven coming to the supermarket”, later recalled that “at the height of the American Empire we had all the bombs, all the cops in the world - and it was all ours - the Cadillacs, the two-car garages, the split-level ranch houses”.
But then young people, spiritually unfulfilled, started to think there might be something else. Flower power met the East, met unbounded optimism - before, in 1968, reality came crashing down and despair set in.
From 1967 to 2007
Today Leary’s motto would be “turn off, tune out, drop dead”. At the decline of American Empire, young people have all the bombs, all the post-September 11, 2001, cops in the world - and it is not theirs. They have Hummers, holidays in Cambodia, neo-Byzantine condos. But then, spiritually unfulfilled even though they have been to all the five-star healing spas in the world, they still think there is nothing else - apart from a shot at TV celebrity.
Nobody gives a damn: the best lack all conviction (and take refugee in their iPods) while the worst simply lord over all, unchallenged. In overwhelmingly dumbed-down global medialand, airhead heiress Paris Hilton is the Queen of News, governments are no more than “political commissars of economic power”, in the formulation of Portuguese Nobel Prize winner Jose Saramago, and the Bush administration/industrial-military complex merrily fight proxy wars in Iraq, Palestine, Lebanon and Somalia.
History does repeat itself - as farce. By early 1967, the US had half a million troops in Vietnam. Massacres of civilians and torture - the precursors of Abu Ghraib - were routine. Half a million Vietnamese - the precursors of Iraqis - had already been killed. President Lyndon Johnson, another regular guy from Texas, was not going to “negotiate with terrorists”.
Vietnam was being destroyed with napalm and Agent Orange. Laos had been bombed for three years without the US Congress even knowing about it (during the administration of Richard Nixon, the victim would be Cambodia). By the Summer of Love, young people everywhere in the affluent West - and all around universities in the satellite global South - already knew the Vietnam War was no less than undiluted state-sponsored terror.
Muhammad Ali refused the draft - joining the throngs of “hell, no, we won’t go”. No one could possibly come up with a sound reason for shooting unknown Asians in far-off jungles (as if there is a good reason for shooting unknown Arabs in far-off deserts). The Vietcong were regarded as true freedom fighters (as are Sunni or Shi’ite Iraqi nationalists today).
Hippies and blacks were uniting against the Man (the white, conservative system) - but unfortunately there was not a lot of communal action, as blacks increasingly started feeling themselves members of a separate nation led by Eldridge Cleaver, Huey Newton, Bobby Seale and Stokely Carmichael. The year 1967 in San Francisco, London and Amsterdam was not exactly multi-racial: it was in essence a white phenomenon.
But politics did cross culture. Jean-Paul Sartre and Bertrand Russell became the executive and honorary presidents of a war-crimes tribunal set up in Sweden to try the US government for its crimes in Vietnam, including dropping more bombs than in the entire World War II, unleashing chemical poisoning and herding more than 8 million peasants into barbed-wire gulags. The tribunal had two sessions - in May and then in November 1967. In his speech, read by his American secretary, Bertrand Russell, in pure beat/countercultural mode, said:
We have no armies and no gallows. We lack power, even
the power of mass communication. It is overdue that those
without power sit in judgement over those who have it …
We are responsible before history.
Never in Western civilization had a war been stopped by public pressure - in fact, the pressure of a whole generation - like the Vietnam War. Then there was a book - The City in History by Lewis Mumford, in which the Pentagon is described as an ancient malignant structure that has to be destroyed to ensure a peaceful world. Magic realism met political theater. Why not try to exorcise and levitate the Pentagon?
Abbie Hoffman dropped in to visit the malignant structure, measured it, got arrested - but also got a lot of free publicity. The happening took place on October 21, 1967. Norman Mailer, who immortalized 1967 in Armies of the Night, reflected on how totalitarianism breeds apathy: there was no confrontation at the gates of the Pentagon because the Man had channeled the protesters - a mix of new yippies and ex-hippies, dressed from native American to all shades Eastern - toward an empty parking lot. But the ceremony proceeded. Ed Sanders of The Fugs chanted a magical sort of mantra - to the sound of bells, cymbals, drums and brass.
In the name of the generative power of Priapus, in the name of totality, we call upon the demons of the Pentagon to rid themselves of the cancerous rumors of the war generals, all the secretaries and soldiers who don’t know what they’re doing, all the intrigue, bureaucracy and hatred, all the spewing coupled with a prostate cancer in the deathbed. Every Pentagon general lying alone at night with a tortured psyche and an image of death in his brain, every general lying alone, every general lying alone. Out Demons, out, Out Demons, out.
The times they-are-a-changin’ … not.
So where are the Bertrand Russell-style tribunals now? Where are the civic consciousness and the responsibility toward history of bloated pop stars, financial-system moguls and celebrities hawking their own line of clothing? Now more than ever, a triumph of the imagination is needed. The only way to stop the insanity of the Iraq - and soon Iran - war is through total, visceral mobilization of US public opinion.
Only mega-successful levitation would force the Pentagon to get rid of its must-list of four “enduring bases” (whatever the costs) in Iraq: al-Asad Air Base in Anbar province; sprawling Balad Air Base, with attached Camp Anaconda in the Sunni belt; Tallil Air Base in the south; and Camp Qayyaragh near Irbil, Kurdistan. And we’re not even talking of the three Baghdad bases - Camp Victory (adjacent to Baghdad, formerly Saddam Hussein International Airport); Camp Taji (25 kilometers north); and of course the 10-square-kilometer, hit-every-day-by-mortars Green Zone, which is a base in itself containing the Vatican-sized, 40-hectare, biggest embassy in the world.
Both the White House and the Pentagon have just confirmed on the record what every distressed observer of the Iraq tragedy already knew: this is naked Empire on steroids, aiming at securing control over Iraq’s oil wealth and establishing permanent bases to control the Pentagon-denominated “arc of instability” from the Middle East to Central Asia.
Two weeks ago, Pentagon supremo Robert Gates stressed the “Korea model” and the US bent on securing a “long and enduring presence” in Iraq. And then White House spokesman Tony Snow reconfirmed that this is what President George W Bush wants and needs to fight “the larger war on terror”.
Blowback is a given: more and more Shi’ites will actively support the Sunni Arab, Iraqi nationalist guerrillas, and they may be supported in their cause by Iranian Shi’ites as well. Pentagon desperation - or cunning - is evident in the fact there are no more holds barred now to divide Sunni and Shi’ite to project an appearance of ruling.
The Bush administration and its neo-con advisers’ latest not-so-covert plan is to convince US public opinion of a nebulous Iranian government-Iraqi guerrilla connection - in plain English, another pre-packaged lie (echoes of Vietnam, echoes of Iraq). This carefully manufactured lie establishes the precious casus belli to bomb Iran. Call it Bombing Iran as an Extension of Destroying Iraq.
Any ludicrous disinformation trick in the book goes - such as Dick Cheney and National Security Council supremo Stephen Hadley accusing Iran of developing a new Shahab-3 missile capable of reaching more than 2,500km and striking Rome. In a sane world, the proposition of US anti-missile shields in Eastern Europe to “protect” the North Atlantic Treaty Organization from Iranian missiles would be dismissed as a (mediocre) exercise in black humor. What is actually a fact is Russia’s new multi-warhead intercontinental ballistic missiles, capable of smashing any missile defense known to man, plus new cruise missiles that President Vladimir Putin will have to point toward Western Europe if the Pentagon keeps on treating Russia as a delinquent kid.
Power to the people
Forty years after the levitation of the Pentagon, there’s no “democracy” to speak of anywhere. This is a plutocratic world. There’s no formidable push to change the world for the better anywhere - but there are already rumblings of repressed anger from all corners of the global South, capable of exploding like a thousand volcanoes.
Slovenian philosopher Slavoj Zizek evaluates how hard it is today to think of a credible alternative to the current system: “Thanks to all these Hollywood movies and the catastrophic scenarios depicted by ecologists, it is easier today to imagine a total catastrophe destroying all life on Earth than a radical change in social life. In sum, an asteroid touches the Earth, but capitalism survives.”
In 1967, the Pentagon did not engage in liftoff. It did not turn pink. But the 1967 levitation ceremony at least gave the world the indelible poetic metaphor of a rose down the barrel of a M16 - and the flowers dropping from the helmets of trembling 21-year-old soldiers. The Pentagon was humbled, anyway. It was - at least metaphorically - levitated. And the US - losing any intellectual support from its elites - started losing the war on Southeast Asians for good. It was a triumph of the human imagination over heavy-metal greed.
Can US public opinion - or at least the iPod generation - muster the will, the commitment and the courage to do it all over again?
NC Jim — your proposal is clever. I have long wondered why China doesn’t insist on lending in its own currency … though that would imply accepting some internationalization of the yuan. it would also imply that the us start issuing in yuan — which would be a huge change. and so long as china is willing to buy $ debt there isn’t much incentive for the us to start issuing in yuan. why take the fx risk if you don’t half too?
Incidentally, there are lots of countries — as NC Jim no doubt knows — that finance current account deficits by issuing debt that is not denominated in their own currency (most ems, historically). the US doesn’t need to finance its deficit by selling $ denominated debt — the $ that foreigners accumulate thru the trade surplus could be exchanged for say yuan denominated debt issued by a us resident rather than for $ denominated debt. in both cases, a $ is being traded for a financial claim.
NC Jim: I , too, suggested that the Treasury issue RMB bonds a couple of weeks ago, but for different reasons. China refuses to allow speculation on the RMB by making the currency convertible and granting speculators access to onshore rates. By issuing RMB bonds (or, more to the point, bonds that settle in dollars but pay a coupon based on Chinese onshore yields and whose principal value varies with the level of USD/RMB.)
If China’s going to maintain an artificially weak exchange rate, why shouldn’t the US and other countries borrow in RMB? And if the RMB is going to appreciate more quickly, why not grant Western investors more access to RMB currency exposure?
koteli — shorter comments please. thanks.
Brad, I tend to think the readjustment path is a little easier than is imagined.
The strain in the US monetary system is really caused by military spending. If military spending had been 30% of world total, rather than 50%, the US budget would probably be in surplus today. It’s hard to know exactly, but a reasonable SWAG is that the c/a deficit would be half as large– and the proportion of debt held by foreigners would be radically smaller. In short, we might not be in the chips, but no one would be comparing us to Argentina.
Italy, maybe.
Our reliance on military power has cost us in other ways, as well. It’s blinded us to the need to develop renewable energy. It’s led us to encourage allies to keep inadequate, poorly-interoperable militaries. It has meant we have neglected soft power, of which the industrial base is an indispensable element.
If we reach a national consensus that we need to scale back and get other countries to do much more, we cna weather this crisis. But not without major changes in the contours of world power.
Re: exchange rates. The yuan has appreciated rougly 5% against the USD in the past 1-year period. If they keep this rate of appreciation, then it will take 7 years to get a 40% appreciation. I think this 40% is what the US wants. So, maybe we should just wait this out.
re: 7 years
meanwhile “China implodes for purely domestic reasons (inflation, banking crisis, environmental “event…”
“China’s smoking habits and pollution are triggering heart disease, cancer and respiratory ailments in the country’s 1.3 billion inhabitants. The government is spending more on everything from syringes to ultrasound machines to prepare for an impending health-care crisis. That’s driving up shares of Chinese medical-equipment makers, putting them among the best performers in the industry. The needs of China’s hospitals and doctors’ offices mean stocks of domestic medical suppliers are worth buying even as Chinese securities appear headed for a correction… Demand for medical devices in China outstrips supply by a third… “Health care is particularly exciting…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aS2pzUrCHUjg&refer=home
Brad a.k.a. ‘captain kurtz’ - do you identify with ‘koteli’s posts?
re: “['Americans'] will supply the crisis”
is this the “bloodbath” that R**b*** and, should we presume his clients, so desperately need and want? “…decline in U.S. home sales will last at least another 12 months, reducing the median house price by 5 percent this year and next. That would take home prices back to 2004…”
” Incidentally, there are lots of countries — as NC Jim no doubt knows — that finance current account deficits by issuing debt that is not denominated in their own currency (most ems, historically). the US doesn’t need to finance its deficit by selling $ denominated debt — the $ that foreigners accumulate thru the trade surplus could be exchanged for say yuan denominated debt issued by a us resident rather than for $ denominated debt. in both cases, a $ is being traded for a financial claim.”
I’m having a slight problem with this. The FX market would open up in the sense that Chinese exporters would be able to exchange dollars for an expanded source of Yuan through the US Treasury. But this won’t change the US current account or negative NFA situation.
At some point, China may still prefer to put a limit on US sovereign exposure, notwithstanding the currency advantage of Yuan denominated assets. They still have the problem of ‘diversifying’. And the PBOC et al, instead of intermediating the currency risk presently unwanted by the private sector, may be forced to intermediate unwanted sovereign risk in the same way, becoming an investor in Yuan denominated US assets as private sector demand falls off.
They’d end up sterilizing US Yuan debt with Chinese Yuan debt. I guess you can argue the situation is marginally better than that with the present currency risk, but there’s still an underlying problem of imbalances.
BWii will end only with a bang. it will happen if
a) either a resource scarcity(oil)
b) wage inflation wiping out labour arbitrage
i think there is still some way to go before we are there
Brad - off-topic, but an interesting article on the history and forecast of Canada’s NFA position. Text provided in case site not accessable.
http://www.canada.com/nationalpost/financialpost/story.html?id=66dd82fc-5ec1-487f-803f-701573675d20
Canada could be become a creditor nation for the first time in its history by the end of the decade. Economists said the country could soon join classic creditors like Japan and Germany and the burgeoning list of emerging-market creditors like China that have more foreign assets than liabilities — which would give it more control over its financial destiny. “For the first time in its history, Canada would be a net creditor,” said Stefane Marion, assistant chief economist at National Bank in Montreal. “Historically we have always depended more on foreign investment than we could afford to pay out overseas.” Douglas Porter, deputy chief economist at BMO Capital Markets, agreed. “We’re running current account surpluses on the order of about $25-billion a year so roughly in three years time, that sounds about right.” The forecasts were made yesterday after Statistics Canada reported Canada’s foreign assets continued to swell in the first quarter while its foreign debt plummeted. Net external liabilities, the difference between the two, dropped $6.8-billion to $92.2-billion in the first quarter of 2007 from the end of 2006. As a percentage of GDP, net liabilities fell to a record low of 6.2%, down from 6.8% in the previous quarter, 17.6% in 2003 and 44% in the high-debt days of the early 1990s. A spokesman at Statistics Canada said Canada has not been a net creditor at any time in its data going back to 1926. Before that, foreign investment, mostly from the U.K. was probably all that kept the young country going. The value of international assets abroad, which include foreign bonds and stocks, foreign direct investment and other holding such as official reserves, totalled $1.23-trillion, up 3.4% from the end of 2006. Gains on foreign bonds drove 40% of the increase, along with appreciable gains in Canadian direct investment and reserve assets. International liabilities did creep higher by 2.6% to $1.32-trillion, largely due to an increase in foreign direct investment here. But for the large part, the data utterly contradict arguments that Canada is being “hollowed out” or being overrun by foreign investors. BMO Capital pointed out that Canadian direct investment abroad totaled $71-billion more than foreign direct investment in Canada. Statistics Canada said the rise came mostly from injections of working capital into existing foreign affiliates. (Perhaps this is where Canadian companies are deciding to spend their bulked-up loonies, rather than at home? Recent data have shown spending on machinery and equipment has been lackluster in Canada despite the surge in the currency.) The turnaround in Canada’s net external liabilities has come through a combination of bulging trade surpluses, thanks to the commodities boom and a determination to slash government indebtedness starting in the mid-1990s. Federal net debt has slid from about 70% of GDP to around 25%. There has been less debt issued, and fewer foreigners holding them. While the total federal debt of about $480-billion has seemed painfully slow to recede, our assets have been swelling while corporate debt has also dropped dramatically. Having less debt held by foreigners means Canada is not nearly as exposed to foreign whims and reduces the country’s exposure to foreign market shocks. Less debt, of course, also means less interest payments and more money to spend on other things.
“…ABC’s accumulated bad loans in 2006 were Rmb729bn, or 23.4 per cent of all loans. To reduce them to 5 per cent, the unofficial benchmark used in the makeover of other large state lenders, would cost about $76bn. In addition, a further $40bn would be needed to get ABC’s capital adequacy ratio to 8 per cent, in line with international standards which China has signed on to, according to Victor Shih, an expert on Chinese finance at Northwestern University. Even with China’s bulging foreign exchange reserves, the potential bill of more than $100bn to fund the restructuring has already sparked alarm in sections of the bureaucracy…” http://www.ft.com/cms/s/548d4604-1f54-11dc-ac86-000b5df10621.html
re:”Canada is not nearly as exposed to foreign whims”
“…At a time when the mining industry is booming thanks to record metal prices and soaring demand for materials from China and other emerging economies throughout the world, Canada’s place on the world mining stage has shrivelled… In 2003, Canada was the leader among mining nations, home to 12 of the industry’s top 40 companies as measured by market value. Since then, seven of those Canadian mining firms have been taken over, including high-profile nickel stalwarts Inco Ltd. and Falconbridge Ltd., which were snapped up last year by aggressive mining firms from Brazil and Switzerland for a combined $40-billion…” http://www.globeinvestor.com/servlet/story/GAM.20070621.RHOLLOWMINING21/GIStory/
” …At a time when the mining industry is booming thanks to record metal prices and soaring demand for materials from China and other emerging economies throughout the world, Canada’s place on the world mining stage has shrivelled… ”
That’s certainly the big issue right now … and seemingly very disproportionate given the size of the country and the size of the companies that are being swallowed up … much more predicted to come re the oil sands … compare it to the US reaction to the same type of foreign interest.
jkh — i think the US offers more currency risk than sovereign risk, so if i were the Chinese, i would be more concerned about the currency risk — though there is a more general point about the risks of concentrated positions of any kind.
re: 5% a year for 7 yrs –
a) it depends a bit on what the $ does v. the world. the RMB hasn’t appreciated in real terms by 5% a year — in fact, the rmb has been basically flat in real terms
b) the pace of RMB appreciation varies — sometimes it looks like 6-7, sometimes 2-3 …
c) inflation differentials have until recently favored China (i.e inflation in China has been lower than inflation in the US), so the real appreciation is less than the nominal appreciation.
d) Chinese productivity growth is very strong, so over time, the needed appreciation also keeps growing. 40% now may be 50-60% in 5-10 years …
e) a predictable 5% appreciation = invitation to speculation — tons of money wants to go into China.
f) you never quite know when China will decide enough is enough —
all this is a long way of saying 5% a year sustained would certainly be positive compared to say 0% appreciation, but i don’t think it works perfectly as a policy.
Punishing China for America’s woes won’t work
by Frank Ching
http://www.nst.com.my/Current_News/NST/Thursday/Columns/20070621083435/Article/index_html
The congressmen are silent on an important element of the US trade deficit, something that is within the power of the United States to address: The fact that Americans consume too much and save too little (and China does the opposite). If Americans don’t spend and borrow so much, there will not be such a big deficit.
Even if, in the unlikely event, Beijing dramatically revalued its currency, it would not do anything for America’s trade deficit. If Chinese products become more expensive, the US will simply turn to another low-wage country, such as Vietnam or Malaysia, for its imports. The US trade deficit will not be affected. Not a single new job will be created. And inflation will rise since the new imports into the US will cost somewhat more.
To have any impact, the US would have to get every low-wage country to substantially revalue, and even then it is very doubtful if labour-intensive jobs will reappear in the United States.
After all, the currency differential is by no means as important as the wage differential. The US federal minimum wage will rise to US$5.85 an hour next month, while the average wage in China is estimated at 64 cents an hour. That means a Chinese putting in an eight-hour day will make less than what the lowest-paid American worker makes in one hour. Given those differentials, what difference will a rise in the currency make?
What is impacting the American economy is not so much China as globalisation.
DC, well, if china thought the US over-consumed, they are in a position to do something about it!
incidentally, the US congress has reduced the fiscal deficit over the past few years, so the savings deficit has shifted from the public sector to the private sector. first housing finance and now private equity/ corp leverage ..
Brad,
How about reducing the US trade deficit by eliminating the absurd mortgage tax deduction that encourages overconsumption and imposing a huge levy on gas guzzler SUV’s. What is the economic rational for the US goverment subsidy for building McMansion houses? Why are home equity ATM loans tax deductible for the purchase of military ruggedized, gas guzzler Hummer SUV’s? Why is it so politically incorrect to address federal government tax and regulatory distortions of the US economy, but politically correct to scapegoat the Chinese government for every capital misallocation in the US economy?
Regards,
Dave Chiang - Here here, I seconded motion!
Before China revalues its Yuan, US should first reduce its wages in the highest bracket trickling down, thereby reducing prices and inflation across the board (no more hoarding and pumping “artificiailly higher” asset values by private equity and collecting “artificially higher” tax revenues by the government’s misdeeds to over- and mis-spend taxpayers hard earned money), and at the same time promote its legal residents and citizens to fill jobs that illegal immigrants are crossing borders and willing to take.
“Senator Jim Webb asked federal authorities on Wednesday to look into “national security implications” he said are posed by Chinese government involvement with Blackstone Group as it moves toward a stock offering expected to raise more than $4 billion.”
If $3 billion in one private equity group is a problem, what about a couple hundred billion with a Chinese SWF in the near future?
Link
It seems to me that if you don’t want to sell your assets, you should not spend more than you earn.
DC — eliminating the mortgage tax deduction would have helped a few years ago, but right now, the US doesn’t have a surplus of residential investment. and Asian man, a lot of those private equity salaries have their origins in cheap credit, which China presumably has something to do with.
as a macro level, if one sector (government, housing) reduces its demand for credit, the price of credit will fall to the point where folks supply less credit (clearly not happening with china, see its huge external surplus) or others start using more credit (right now: private equity firms, us companies gearing up to avoid being taken over). in equilibrium, so long as China is running a huge surplus someone has to run a huge deficit.
Much as it pains me to say this (I like bashing the bush administration as much as the next guy), it does seem that China has done less to help reduce imbalances (see its surplus, absence of real appreciation) than the US (falling fiscal deficit) over the past couple of years. So i no longer believe — unlike in say 04 — that symmetric criticism is fully justified. the US slowed. Europe is growing. the US reduced its fiscal deficit — there should be a lot more adjustment happening now.
instead both China and Japan’s current account surplus just keeps on rising …
Brad,
The US economy is geared towards overconsumption. US Economic growth over the past decade has primarily been a function of multiple, successive credit bubbles in the stock market and housing that have massively misallocated capital in the US economy. Easy credit was even provided to millions of individuals with less than stellar financial records (ie. think subprime mortgage fiasco with Federal Reserve regulators sleeping on the job ). Asset bubbles are equally dangerous as inflation in the misallocation of capital for any economy. Except for the US Federal Reserve which disavows that asset bubbles can even exist, most of the other world central banks specifically target dangerous asset bubble. For instance, the PBoC concerned about a developing housing bubble in Shanghai and Beijing, has raised interest rates, increased bank reserve requirements, increased housing down payment requirements, increased real estate transaction taxes, etc.
Regards,
Hi you all, and sorry Brad for the long post,
Greetings to D. Chiang. Nice to see you here, again! It’s always good to have someone walking on the other side of the wild or the wall.
I agree a lot with Anonymous ibid.
I’ve posted several references about US Army’s energy consuption, US Army’s share of USA budget and so on, but…
Here goes an interestin link about it. The latest article by Michael T. Klare:
http://www.tomdispatch.com/post/174810/michael_klare_the_pentagon_as_global_gas_guzzler
And a last link to the CIA facts book:
https://www.cia.gov/library/publications/the-world-factbook/rankorder/2187rank.html
What country is the last? And the one before?
Spain. Considering that housing is much more inflated here than in USA…
I don’t know if it will be a bang or wimper…
But it smells to a big bang.
Good night.
Minor technical point - private equity probably uses credit mostly to recapitalize and leverage existing assets, rather than deploy economic saving in new capital expenditures. In that sense, its more a conduit than an end point for economic saving. China may be investing in Blackstone, but is Blackstone going to use that money for capex, or to pay out the shareholders of the companies it takes over? To the degree the latter is true, its not really the true economic source of demand for either foreign saving, or domestic saving that might be freed up by a slowing new housing market, or an improvement in the government deficit.
Brad - I say let China & Japan run its course of providing “cheap credit” since during the “industrial revolution” Britain and US had its share of the run cycle. It’s only befitting for China to run its course and most likely next runnerup would be India. The questions is both Britain and US could restart their industrial base and be cheap creditors, but why don’t they?
My view is that they’ve been there, done it and don’t want to do the labor intensive “dirty” jobs again, especially not seeing their next generations working in blue collar work but rather in Entertainment, News Media, Politic, Sales & Marketing, etc (If they did, both governments would have less tax revenues to play with (like the Iraq War), and less for increasing their pensions and salaries (very unfortunate for victims of Hurricane Katrina still with lack of government aid).
Dave Chiang: what happens when things get expensive, we reduce consumption………its very easy to do…so we will consume as long as it is cheap.
i am buying into the fact that japan, china, india etc are causing a problem by manipulating their currencies….maybe they need the growth ….but they are getting it at the cost of others.
arguments aside, i was pondering over what may happen if;
1. BOJ keeps the interest rates low like current, and keeps supplying money for the carry trade
2. India and china dont let their currency appreciate and keep supplying cheap exports for-ever.
how long can it go??
can some one explain..how it will play out…step by step (sorry i am not a economy major, just a IT guy, so pardon my ignorence)
The global equity portfolio manager, quoting Wikipedia, should have kept reading. Further in the entry in reads:
Punctuated equilibrium is … mistakenly thought to oppose the concept of gradualism, when it is actually a form of gradualism, in the ecological sense of biological continuity. This is because even though evolutionary change appears instantaneous between geological sediments, change is still occurring incrementally, with no great change from one generation to the next.
Dear Dr. Setser,
First of all, I congratulate you for this blog, specially, regarding this particular topic. Now, about the US current account adjustment, I believe you leave out some important considerations.
A huge USD devaluation (or protectionism -even as an imminent threat-) do changes economic agents’ minds all over the emerging world; because it implies THE CRASH OF THE UNIQUE BUSINESS PERCIVED AS SUSTAINABLE: net exports. Facing such a situation, demand of local currency would collapse while these countries outflow or “eat” their fx reserves (this is the final “decoupling” that you’ll see). So, speculators, traders, grocers, firemen, teachers and beggars shall press for CB’s exchange. As always, the herd reaction will include the hoarding of money out of the financial system. They will demand US dollar, euros or yens… ¡but never local currency!.
Or do you believe that a huge real US devaluation or protectionism will occur “ceteris paribus”? or “all the things equal”?…
When it happens, everybody wants money. Then, the inflows that US will need during the adjustment effort must be added to the dashing against CB reserves by emerging market’s people. So, US adjustment will face us with a liquidity restrain, which always ends in higher interest rates or an inflationary liquation of indebtedness -if central bank provide money-. And if both, US and emerging market economies want money at the same time, crisis becomes fatal or adjustment impossible. On the contrary, if demand of money grows so then interest rate becomes a key word. And if you want to rebalance, you’ll need similar level of real interest rates. Do you imagine the financial impact?…
Nobody must throw out neither an inflationary nor a deflationary stage. If a inflationary liquation of indebtedness take place, it might be directly proportional to bizarre excess of it. If so, US people shall look bad. Uncle Sam’s debt will impose much higher prices (¡prices, not wages!) or a longer and painful exposition to a more tolerable inflation -while the J curve works- to hold back real consumption. Politically harmless?…
Now, as regards US issuing of securities in yuan or any other currency which don’t work as value store, demand would be tiny (specially as counterpart of a real appreciation) because such revaluation destroys the income sources of whichever emerging country; AND NOBODY PURCHASE A SIZEABLE AMOUNT OF THE DEBT OF A COUNTRY WHOSE MOST PROFITABLE BUSINESS IS MELTING DOWN. Please, don’t forget it.
I’m an argentine. ¡One minute of silence for my immolated country, please!…
Argentina had no problem with contracts because my country didn’t respect any law (¡my fellows leave civilization and I ran away!). Besides, as you know, Argentina defaulted 75% of its liabilities. This default played as your expected huge real USD devaluation, except for a difference: our size is globally irrelevant but yours would bring awful global repercussions. Despite solve legal and financial questions so, Argentina’s poverty indexes skyrocketed till African levels… ¡along one of the best external stages in the history of this impoverished country!. Nowadays, the political system is destroying the official statistical bureau to lie freely about inflation, growth and poverty. So, try to imagine our “incredible miracle” when wind blows out.
Argentina isn’t a good example of external adjustment, but a good example of secular national suicide. Never doubt it…
Finishing, if a successful US external adjustment is hard (relative expansion of tradable sector WITHIN A WORLD ABLE TO BUY YOUR PRODUCTION), emerging world’s one is worst. This, for the following reasons:
1. Credit restraining imposes a delay in developing of a complementary greater non tradable sector (if we get it). ¡Of course, both, FX “eating” and real contraction excluded!…
2. According to my assumption, this need would face raising expectations -at least- of a future exchange crisis (what about incentives? do you believe we don’t need?).
3. In long term, emerging world isn’t able to increase domestic demand because it can’t issue debt in local currency (once again, the original sin); specially, when a huge real appreciation destroys current income.
I do apologize for my English. I talked enough…
Good luck and thanks!
BARUCH
some one please answer in layman’s language (as much as possible)
what happens if:
1. BOJ keeps the interest rates low like current, and keeps supplying money for the carry trade?
2. India and china dont let their currency appreciate and keep supplying cheap exports for-ever?
3. US currency keeps losing value with other currency except for india and china (or any other manipulator)
how long can it go??
i just read that New Zealnd(NZ) is having a tough time because of this carry trade since they are not able to control inflation and rising interest rate is not helping, any comments on this?