The financial market is afloat on a sea of borrowed credit .when the owners come back for their money it is bad time.The recent volatality in the US is due to selling of bonds and shares by foreign managers to buy New zealand and Australian stocks and bonds.
untill recently USD/JPY was the trade that everyone wanted to be in. While the Federal Reserve, struggling to control inflation, increased the price of money sixteen consecutive times, the Bank of Japan was fighting deflation by holding interest rates near zero. Consequently during 2006, the interest rate differential between US and Japan made long USD/JPY a one way bet. Even though the US dollar still has a positive interest rate differential against the Japanese yen, interest rate expectations are visibly favoring the Japanese yen, what makes the USD/JPY a bad carry trade for 2007. Many traders are currently hunting high yielding currencies like the Aussie and the kiwi at the cost of the US dollar. Since the beginning of March, both the Australian and New Zealand dollars have surged over against the US dollar, .
Australia’s two year government bonds yield 5.48 percentage points more than similar Japanese bonds and have a 1.77 percent premium over U.S. As a result of this large differential, in just 12 months the Aussie climbed 15 percent against the Japanese yen, trading from a low of 82.07 on March 2006 to as high as 99.90 in April 2007, as Japanese investors bought Australia’s and newzealands higher yielding assets.
http://www.manojsai.wordpress.com

such as?

along with the unique characteristics of each (relevant) nation’s currency, might we assume that asset mix, pricing and price stability is also more or less affected by any of the following:

-rating agencies
-accounting standards and capacities for enforcement
-property rights and enforcement
-tax base and policies
-insurance
-organizational and political/legal infrastructure
-’brand’ valuations (sentiment) as affected by media and data influenced perceptions of (evolving) political and economic strengths and risks
-capacity to use force (military and other)

if consideration of the above may serve in any way to better differentiate between nations and determine relative risks and probable outcomes.

It is interesting to think about the meaning of ‘foreign’ as applied to a nation like the U.S., which may be the, or at least one of the most integrated political economies in the world, as compared to others.

or the notion of ‘generous’ foreigners which include self-interested nations with the largest wealth gaps in the world.

fwiw, i think their choice is fundamentally whether they want to continue in nominal assets or (as they have expressly desired) move to ‘real’ assets — those assets that (more or less) maintain ‘value’ independent of the general price level.

re: “the Greenspan put will never die. In fact it is part of their job. Moreover, the put would likely be transferred to the broader financial system”

i thought this was kinda interesting http://www.portfolio.com/views/blogs/market-movers/2007/06/26/will-china-prevent-the-cdo-meltdown
- “Stability and growth remain China’s objectives, and a financial crisis beginning in New York is every bit as threatening as a stock market crash in Shanghai. China could not have acted fast, as the US Fed did during the LTCM crisis. But, so long as only a few funds are in crisis and the unwindings are ‘orderly’, I think China will find it in its interest to be a ‘bagholder of last resort’, purchasing a few assets at prices high enough to prevent cascading markdowns or defaults against margin lenders. Fund investors will still lose money, but that rarely has systemic implications.”

self preservation as uncoordinated intervention, esp in light of http://www.nakedcapitalism.com/2007/06/carry-trade-threatens-deflationary.html
- “Central banks are likely to attempt to ratify current inflated asset values by inflating prices and incomes to avoid a deflationary economic collapse. Unfortunately, sharp reductions in interest rates in the US, UK and the euro area will lead to a rapid unwinding of the global carry trade, perversely threatening to worsen problems in the credit markets.”

I think you are right to emphasise the fact that the banking system means that the US current account deficit is automatically financed (ie a dollar bank deposit is a liability of a US bank), but wrong to worry about a slump if the Chinese do not spend their deposits.

If the Chinese wanted to keep holding dollars, but wanted to stop buying treasuries, say because they were concerned about the willingness of the US government to pay them back they could simply move the dollars to a time-deposit. The bank would then have to find an outlet for these funds. Normally they would lend the dollars, buy a security, which could be a US treasury, or ultimately, leave it in a settlement account at the Fed, earning no interest. The bank might pay them a poor return for this deposit, but that is what the Chinese would have to pay for the bank’s intermediation service, and for the Chinese, superior credit quality. The government may also have to pay more to get the bank to buy treasuries, but that would be a reflection of their deteriorating credit quality. The resulting rise in broad money supply and fall in velocity would hardly be meaningful.

Many economists that read this blog, and the host especially, are far more qualified than myself to begin to answer that comparison question specifically.

But its an important question I think, because there seems to be a general tendency to recognize the nature of the risk in some sense, but without necessarily visualizing the way in which ‘the event’ would actually transpire. It’s hard to visualize a risk that implicitly is assumed to be abrupt, when the system seems to grind on through inertia. And the mammoth market size of the US financial system must be important in judging how the risk would play out.

The scenario I outlined was the closest thing I could conceive of to an effective ‘drying up’ of capital flows, which I think is technically impossible in fact, due to the inevitable ‘round trip’ of payments made on current account back into the US banking system through nostro accounts. Even the baton passing of dollar balances through the FX market in a major FX crisis could not cause capital inflows technically to ‘dry up’. The fact is that vast reservoirs of US dollars can’t really disappear from the system, except by repayment of bank lending, or by credit defaults and equity losses.

The urgency of the issue of the deficit is more a liquidity issue, at least initially, than a solvency issue (although solvency, including that of the US government, is obviously a longer term consideration). What would a ‘liquidity crisis’ look like in terms of the flows or the absence of flows and the corresponding stock of foreign held assets? Perhaps it could become a hoarding of bank balances as described, with a total retreat from risk assets. (If there is a retreat, there must be an offsetting ‘charge’ into something in order to balance flows on a net basis).

The adjustment described seems bizarre, but perhaps less bizarre than others. The bottom line for me is that foreign investors en masse must make a choice on their existing asset allocation and their allocation of new monies earned through current account surpluses.

They have no choice - i.e. they have no choice but to make a choice in terms of asset allocation.

‘Fleeing’ US assets for the entire foreign population of investors is simply not a technical option. So how do they come to terms with the inevitability of having funds to deploy somewhere in the middle of an asset price collapse from which they are retreating?

My view is that Fed Reserve involvement would be rather heavy, both directly, and in terms of moral suasion and liquidity commitment to the domestic financial system. Perhaps the Greenspan put will never die. In fact it is part of their job. Moreover, the put would likely be transferred to the broader financial system through some form of ‘moral suasion’. The Fed would dominate relative to the normal involvement of the IMF.

I don’t know. Does that sound like Argentina?