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Is the US trade deficit declining?

by Brad Setser
September 27, 2007

Michael Pettis

In an article in yesterday's Financial Times, Jim O'Neill, who heads global economic research at Goldman Sachs, asks if the US trade deficit is about to disappear.  According to him the latest monthly data show that the US trade deficit, at $59 billion, has declined from 7% of GDP to 5%.  Exports have been growing nearly 15% year-on-year whereas imports have been growing at just over 5%.  If a subprime-crisis-related economic slowdown keeps import growth at this level, and a weak dollar also keeps export growth at this level, the trade deficit would drop to 3% of GDP within one or two years. 

 

I am not smart enough to say whether O'Neill's speculations are loony or sound, and I am not sure what is driving this shift, but O'Neill points out that retail sales are growing in all the BRIC countries at double-digit levels (China recorded over 17% growth in July).  They only account for half the global share of GDP that the US does, but their spending growth is double the US rate.  

This satisfies the savings-glut model by suggesting that a slowing down of the growth rate of developing-country savings is having the expected effect on the US balance of payments.  The weaker dollar and the consumer fears arising from the sub-prime crisis, I guess, satisfy the excess-US-consumption model.  Either way, if things continue at this rate and the US trade deficit declines sharply – a big if, I know, I know – we could see a major shift in the world economy, and it might not necessarily be a very pleasant one. 

I say this not because I am one of those apparent crazies who are not terribly worried about the US trade deficit, and even believe it is a necessary pre-condition for the very difficult demographic adjustment needed by Europe, Japan, Russia and especially China in the coming decades.  I am, but my concern is different. 

As I said in an earlier post I believe that the recycling of the US trade deficit has been the main factor underpinning the recent globalization cycle.  If so, and when the current cycle ends, if history is any indication the adjustment from the insanely happy days of too much liquidity (with its attendant surge in risk appetite) to a more “normal” level of liquidity will be a very difficult one and can result in significantly reduced global growth lasting many years – especially for those countries that begin the slowdown with the weakest and most rigid financial systems.   

In previous cycles, financial systems, which during the good times had evolved into greater risk-taking activity and more-tightly-stretched asset-liability structures, were suddenly caught short by the secular change in risk appetite.  In many cases their ability to intermediate the flow of capital slowed considerably, and what followed often involved considerable economic slowdown.

 

 

My evidence is largely anecdotal, but it seems to me that those countries with the highest levels of financial risk-taking and the least flexible financial systems were the ones that did most poorly – the United States in the 1930s, with its reliance on thousands of small banks with rigid deposit bases, a weak and inexperienced central bank, and an investment banking industry in shock, of course did among the worst, although there were plenty of other non-financial factors that exacerbated the problem (by the way, it is worth remembering that in 1929 the US had, after several years of very high trade and capital account surpluses, very high levels of reserves, which in the end didn't help).   

I am curious to know what readers of this blog think are the major economies with the most susceptible financial systems.  IF the US trade deficit really is declining sharply, and IF the recycling of the US trade deficit really was the industrial-strength punch that kept this party going for so long, who is most likely to be hurt when the punchbowl is taken away? 

76 Comments

  • Posted by Anonymous

    A wild guess would put the current US trade deficit at about 2 per cent of global but non-US GDP. The rest of the world has been growing more quickly that the US. Couldn’t a recalibration of ROW growth rates to more sustainable levels accommodate an orderly but steady unwinding of that 2 per cent?

  • Posted by Guest

    I think Brad would say the point really isn’t about recycling the US trade deficit per se, it *is* the (rather large) US trade deficit. If the US’ (vendor) financiers are balking and unwilling to “recycle” goods into paper IOUs or, equivalently, the US is unable to “manufacture” debt and/or sell off assets that the ROW wants, then it’s the US’ living standards that will decline, not those who have been providing the US with goods (and oil) in return for depreciating US dollars.

  • Posted by Guest

    Michael. Excellent points! Weak & rigid financial systems tend to occur in countries with weak & unstable property rights. That means, in turn, a lack of free press, no independent judiciary, no checks & balances. I suspect that countries such as Russia, Argentina, Venezuela and (to a lesser extent) Brazil and Mexico would be very vulnerable in a scenario of decreasing global liquidity. China, I would think, is at least taking steps towards the rule of law. By the way, every Friday at the Global Liquidity Blog we publish the Global Dollar Liquidity Measure, which captures some of your ideas about the savings glut, etc. Cheers, Agustin. (www.liquidityblog.blogspot.com)

  • Posted by Dave Chiang

    Americans need to cut their Spending to reduce the Trade Deficit
    http://www.atimes.com/atimes/Global_Economy/II28Dj01.html

    Lowering interest rates is wrong because it will do few any good, but cause harm to many. Lower interest rates are unlikely to boost economic growth. The reason? The markets are facing a valuation problem, not a liquidity problem.

    To heal the excesses of the housing bubble, we need lower home prices; subprime borrowers are best helped by downsizing, not by receiving subsidies. The Fed’s grave mistake was to lose control of money supply during the credit-driven expansion. As volatility, risk and fear are returning to and are priced back into markets, we are facing a market-induced credit contraction.

    Pushing liquidity at any cost when the markets demand a contraction is what gold bugs have been waiting for; that’s a positive way of saying Bernanke may live up to his “Helicopter Ben” reputation, flood the market with fiat money and risk further decreasing the purchasing power of the US dollar. The problem gets more severe as many US policymakers believe a weak dollar may actually be good for Americans.

    Bernanke seems to subscribe to the view that borrowing costs will be contained because it is in no one’s interest for the dollar to plunge and for foreigners to refrain from purchasing US debt. But that does not mean one can turn good policy upside down and force foreigners to invest in the US. This is where academically trained central bankers looking at econometric models of past behavior are playing with fire.

    The Fed’s policies are thus aimed at restoring profitability at US banks. The challenge for the Fed is, of course, that it is difficult to help both mortgage holders (along with consumer spending) and banks at the same time, as the policies required to assist each group are diametrically opposed. The Fed may be better off getting out of subsidizing pockets of the economy and instead focus on what ought to be its mandate, to preserve price stability.

    A weak US dollar may boost the earnings of a couple of multinationals based in the United States, but it will weaken the competitive position of the US, planting seeds for more protectionist policies in the future. And a country dependent on the mercy of foreign creditors can ill-afford protectionism. Rather than protectionism, the solution is to cut spending, for the government to live within its means.

  • Posted by Anonymous

    In related news, eurozone exports growth to the USA is negative year on year (-1.2%). Having said that, imports from the USA are also rather sluggish with around +1% y-o-y.

  • Posted by Anonymous

    The broken system has perpetuating the offshoring of US standard of living. The only saving grace has been the gains from productivity via technology. The flip side is it allows competitors to leapfrog up the industrialization curve. The question is when does the Chinese gov have sufficient confidence in the domestic market to stop subsidizing the US disproportionately high standard of living. Perhaps the entanglement slash stability thesis works? Who is really exploiting who? Is it the Chinese who are susbdizing the US consumer with reserves decaying in value or is it the Untied States who continues selling into a bull market for junk..

  • Posted by Dave Chiang

    Weak dollar central to oil price boom
    http://www.reuters.com/article/reutersEdge/idUSL2576484820070926

    LONDON (Reuters) – The weak dollar’s leading role in oil’s ascent to record highs is partly due to a tide of financial flows into commodity investments but also reflects a shift in the greenback’s relationship with crude.

    So the steep fall in the dollar to record lows against the euro, for example, has helped drive oil to a record of $83.90 a barrel, reached on September 20.

    “I’m certainly in the camp of dollar weakness driving crude strength,” said Anatol Feygin, head of global commodity strategy at Bank of America.

    The proceeds from the current oil boom — petrodollars — have not gone to support the U.S. currency.

    “The petrodollars which historically got invested back in the U.S. in dollar-denominated investments now have more options back home or in emerging markets or the euro,” said Badung Tariono, who manages an energy fund for ABN AMRO.

  • Posted by Guest

    “…A perpetuation of existing exchange rate policies, then, based on flawed economic analysis, is creating broadly similar conditions to those that prevailed before the Great Depression. History suggests great economic hardship will follow and that it will be proportionately borne greatest by the debtor nations. But the creditor nations will be afflicted as well as they suffer the loss of their largest export market, and the risk of an economically aggrieved America increasingly prone to resolve its difficulties through the embrace of military unilateralism…” http://www.pimco.com/LeftNav/Viewpoints/2007/Renegade+Economics+-+Executive+Summary.htm

  • Posted by Guest

    Fears that keep the renminbi undervalued
    http://www.ft.com/cms/s/0/1808c9dc-6c3f-11dc-a0cf-0000779fd2ac.html

    Beyond the weakness of the top political leadership, the reason for exchange rate timidity may lie in the fabulations of Currency Wars and an abiding suspicion of foreigners who demand that China change. On finance, Chinese policymakers see two regional examples of “opening up” under foreign pressure, the revaluation of the Japanese yen in the mid-1980s and the open capital accounts of south-east Asia, which came home to roost in the Asian crisis in the late 1990s. To the Chinese, both policies had disastrous consequences they are determined to avoid. In China, there is no sense of change on the horizon on the currency. The political calendar – the Communist party congress in October, followed by the swearing-in of a new government next March – will delay any meaningful debate until mid-2008.

    With a huge current account surplus and multiple daunting challenges on the environment and energy, it is often said China’s economic development cannot keep going the way it is. But all the signs are that, for the time being, it will. Foreign advice to the contrary, however correct, may perversely ensure less change than more.

  • Posted by HZ

    most susceptible financial systems

    Among the major economies, Japan and Germany? But they are also the least risk taking ones at this time? Japan still shell-shocked by the deflation and Germany escaped the housing bubble.

    Interestingly the most flexible systems are in the English speaking countries of US, Canada, UK, Australia, NZ, Ireland … with the possible exception of Canada and NZ, also have the most risk appetite and all had major asset inflations.

    Does this mean the whole thing is pretty balanced? :-)

  • Posted by Dave Chiang

    Here’s a great reading book for Robert Rubin, Larry Summers, Bill Clinton, and Alan Greenspan. Thanks to the late 1990′s Indonesian Economic fiasco that impoverished 100 million people and contributed to the massacre riot deaths of over 15,000 ethnic Chinese, the Asian financial community has gained invaluable knowledge on Wall Street’s manipulation of global finance. – Dave Chiang

    China’s best-selling book Currency Wars on Asia Crisis
    By Richard McGregor in Beijing
    http://www.ft.com

    In a new Chinese best-seller, Currency Wars , these disparate events spanning two centuries have a single root cause: the control of money issuance. Even today, claims author Song Hongbing, the US Federal Reserve remains a puppet of private banks. Mr Song ignores the government’s role and argues that the Fed’s key functions are ultimately controlled by five private banks, such as Citibank.

    In China, which is in the midst of a lengthy debate about opening
    its financial system under US pressure, the book has become a surprise hit and is being read at senior levels of government and business.

    “Some senior heads of companies have been asking me if this is all
    true,” says Ha Jiming, the chief economist of China International
    Capital Corp, the largest local investment bank.

    The book also gives ammunition to many in China who
    argue that Beijing should resist pressure from the US and other
    countries to allow its currency, the renminbi, to appreciate.

    The book’s publisher, a unit of the state-owned CITIC group, said
    Currency Wars had sold nearly 200,000 copies, with an estimated 400,000 extra pirated copies in circulation as well.

  • Posted by Shrek

    Asia does not understand finance at all. They keep thinking that the US is somehow out to get them with the our evil financial system when that simply is not true. The communist government wants economic growth while keeping power and those two things are not compatible in the long run. Notice that US leadership generally comes from whatever area is doing the best. Right now its the debt producing industry.

  • Posted by Twofish

    Shrek: Asia does not understand finance at all.

    Asia is a continent with about three billion people. Some of them don’t understand finance. Some of them understand finance quite well.

    Shrek: They keep thinking that the US is somehow out to get them with the our evil financial system when that simply is not true.

    It’s actually quite complex. There are people in the US political establishment who are out to get the Chinese government, for various reasons. Some see a rising China as a threat to US interests and values. Some see a rising China is an evil dictatorial regime that must be destroyed at all costs. Munich gets mentioned a lot. See Bill Gertz, Bill Kristol, the Washington Times, and some people in the Fox News Channel for this view of things.

    At this point all you have to do to shut these people up is to ask “So how are things going in Iraq these days?”

    The US economic establishment is overwhelming pro-China. The people in the US economy that have issues with China, have specific concerns which can be bought off by trade concessions or deals.

    Shrek: The communist government wants economic growth while keeping power and those two things are not compatible in the long run.

    I think that they’ll do a better job than most people think, even if there is a massive political upheaval. You look at who ends up in charge in post-Communist societies, and they generally are more or less the same people that were in charge in pre-Communist societies. Take down the red flags, hire some media consultants, learn to look good on TV, and the Communist appratchiks in China will become democratic politicians.

    If you look at what happens during those transitions. The bureaucracy is still there. The corporations are still there. Some people will move into power. Some people will move out of power. But the people that ran things before the revolution, will be more or less be the same people running things after the revolution.

    So what is the point of having a revolution? Yes, what is the point indeed?

  • Posted by Twofish

    Guest: . In China, there is no sense of change on the horizon on the currency. The political calendar – the Communist party congress in October, followed by the swearing-in of a new government next March – will delay any meaningful debate until mid-2008.

    No that’s incorrect. The major debates happened during the summer, and a consensus was reached. What that consensus was, we’ll find out in a few weeks. Personally, I think that the RMB is going to appreciate rather sharply in the next several months.

    The big event is the Party Congress in October. All of the big decisions happen *before* the Congress. The state positions follow the Party, and so March 2008 date is pretty irrelevant.

  • Posted by Estragon

    In the short to medium term I’d expect Canada, and to a lesser extent Mexico, to take the brunt of the adjustment.

    Although Canada has a reasonably flexible and well developed financial system, it’s probably most exposed to declining US imports. Trade intensity is on the order of double that of the US, and the US is by far Canada’s largest export market. The USD/CAD XR has already moved down by ~50% since 2002 and some industries (timber, for example) are already essentially shutting down. Outside energy, I expect this to accelerate. If oil prices weaken much below around $55, and the XR stays around parity the economics of oil sands projects will start looking shaky.

    It’s worth noting though that Canada is also the largest export market for the US. If Canada gets hit by a US slowdown, it’s reasonable to expect a lagged decline in US exports to Canada, which may limit the scope for improvement in the US trade balance.

  • Posted by Twofish

    The other thing that annoys me is that when people use the term “state-owned media” to imply that Hu Jintao agrees with something. With some very few exceptions, most state-owned publishers are not state-subsidized, so their main interest is to publish whatever will make them money. There is a censorship system, but it mainly exists to remove forbidden topics and viewpoints, rather than actively control what gets published.

    If I were to try to publish a book in China saying that the Dalai Lama was a great guy, that would be on the list of things not to say, and it wouldn’t get anywhere. If I were to try to publish a book in China saying that the Dalai Lama is actually a space alien from the planet Kuzbain and has a secret affair with Paris Hinton, the censor looks on the list of forbidden topics/viewpoint and this isn’t on it, so that book would make it past the censors. Doesn’t mean the Party agrees with it.

    One other thing, the Chinese government has set up the censorship system so that the type of things that most people are likely to do won’t get them in serious trouble. Most people in China shrug off the great firewall as an annoyance.

  • Posted by SotT

    Twofish: But the people that ran things before the revolution, will be more or less be the same people running things after the revolution. So what is the point of having a revolution? Yes, what is the point indeed?

    China’s a bad example of this point. The 1949 Revolution and its aftermaths in the following decades definitely changed “who” was in power (which isn’t to say a lot of them didn’t end up doing quite well in Taiwan) and the business structure of the country. What it didn’t change (at least in the long run) was that local officials still end up with way too much power leading to massive corruption and abuse.

    I do think it’s an open question whether the Chinese financial system is well equipped to handle a floating currency.

  • Posted by Twofish

    I don’t think that the party is going to end that quickly. The US deficit appears to be disappearing not because imports are collapse but because exports are increasing.

  • Posted by Dave Chiang

    Twofish,

    The US economic establishment is NOT overwhelming pro-China. Read Economist Stephen Roach’s editorial today. It should be noted that Stephen Roach is considered a Wall Street iconoclast who has demonstrated a pro-China and anti-Greenspan bias in his past Morgan Stanley commentaries. New fall session legislation in Congress that imposes a 20-40% across the board tariff on Chinese imports is likely to pass with a veto proof margin.
    http://www.nytimes.com/2007/09/25/opinion/25roach.html?_r=1&pagewanted=print&oref=slogin

    In Washington, China-bashing is the bipartisan sport du jour. New legislation is likely that would impose trade sanctions on China unless it makes a major adjustment in its currency. Not only would this be an egregious policy blunder — attempting to fix a multilateral deficit with more than 40 nations by forcing an exchange rate adjustment with one country — but it would also amount to Washington taxing one of America’s major foreign lenders.

    That would undoubtedly reduce China’s desire for United States assets, and unless another foreign buyer stepped up, the dollar would come under even more pressure. Moreover, the more the Fed under Ben Bernanke follows the easy-money Alan Greenspan script, the greater the risk to the dollar.

    So far, the dollar’s weakness has not been a big deal. That may now be about to change. Relative to the rest of the world, the United States looks painfully subprime. So does its currency.

  • Posted by HZ

    Estragon,
    “If oil prices weaken much below around $55″
    That is not really compatible with a strong CAD. So I’d say Canada will do fine precisely because CAD is not fixed and its financial system can adapt, though US investors may want to take profit some time down the road. Now some Eurozone countries are quite different, esp. the smaller ones. They are tied to Euros which don’t necessarily adjust to these individual economies, being dominated by Germany and France.

  • Posted by Estragon

    HZ – “That is not really compatible with a strong CAD”

    Quite true, but it does depend somewhat on how much further things go. It’s possible that we see $100+ oil and a much hihger CAD before demand drops off meaningfully, in which case CAD at par might be “weak”.

    I also understand your point about the smaller Eurozone countries, though I don’t think they’re nearly as exposed to a US slowdown as Canada.

  • Posted by Macro Man

    Frankly, I’m not sure if it’s even useful to think of who would be impactyed by declining liquidity in terms of nation-states. It’s probabl;y safe to assume that there are some people in EVERY country that would be hurt by a liquidity withdrawal.

    One legacy of the Asian crisis is that countries have learned the utility of changing the rules under times of stress, in terms of pegging exchange rates, closing capital accounts, etc.

    To me, the more intersting question is which participants in global financial markets would be most hurt by a liquidty withdrawl? To a degree, we already have an answer: those who use short-term borrowing to fund the purchase of long-term assets.

    More generally, however, if money is no longer cheap, and moreover if some of the FX reserve money that has heretofore gone into sovereign or semi-soveriegn bonds goes instead into equities, then we’ll be left with a situation where it’s more expensive to borrow and corporate assets are also more expensive.

    That would appear to put quite a dent in the private equity business model.

  • Posted by Stuart Joynson

    Speaking directly to the benefits of a strong trade position (see below). Loonie is going higher.

    Federal budget surplus balloons to $14B
    Last Updated: Thursday, September 27, 2007 | 3:50 PM ET
    CBC News

    A booming Canadian economy generated such big tax revenues this past year that the federal budget surplus approached $14 billion, Prime Minister Stephen Harper said Thursday.

    The final surplus for the 2006-07 fiscal year came in at $13.8 billion, Harper said at a Toronto news conference. That was far more than the $9.2 billion forecast in the Conservatives’ March budget.

    The surplus will be used to pay down the federal government’s accumulated debt, which stood at $467.3 billion as of March 31, 2007. Since 1996, the debt has been paid down by $95.6 billion.”

    Glad to see they’re moving in the right direction.

  • Posted by Guest

    http://www.financialsense.com/editorials/engdahl/2007/0925.html

    Why then the high-risk war to control Iraq? For a century US and allied Western oil giants have controlled world oil via control of Saudi Arabia or Kuwait or Nigeria. Today, as many giant fields are declining, the companies see the state-controlled oilfields of Iraq and Iran as the largest remaining base of cheap, easy oil. With the huge demand for oil from China and now India, it becomes a geopolitical imperative for the United States to take direct, military control of those Middle East reserves as fast as possible. Vice President Dick Cheney, came to the job from Halliburton Corp., the world’s largest oil geophysical services company.

  • Posted by Twofish

    Twofish: The US economic establishment is NOT overwhelming pro-China. Read Economist Stephen Roach’s editorial today.

    I don’t have to read about the US economic establishment. I’m part of the US economic establishment. If I need to find out what the US economic establishment thinks, I ask the people sitting next to me (a huge number of which happen to be Chinese). Lots and lots of Chinese people on Wall Street.

    I haven’t been to any “let’s enslave the world” meetings or any “let’s help Washington stay in power” meetings. I’ve been to a lot of “how do we promote Chinese economic growth and make lots of money for the company doing so” meetings.

    There are a number of bills going through Congress right now. The big ones are Fair Currency Act of 2007 (HR 782),the Currency Reform for Fair Trade Act of 2007 (HR 2942), and the Currency Reform and Financial Markets Act of 2007 (S 1677). None of them would impose tariffs on Chinese goods, and they all have rather different administrative procedures to go through to impose dumping penalties.

    HR 1002 imposes sanctions, but looking at the names of the sponsors, it doesn’t have much chance of going through. I seriously doubt it will make out out of Committee.

    You have to go through the details of the bills on http://thomas.loc.gov/

    In the case of protectionist Congressmen, they generally want jobs for their districts, so they stay elected. This is something that is not anti-”rise of China” in any sense, and deals can be worked out. Use CIC to create jobs in their districts, they’ll turn wildly pro-China.

    One problem I have with your view of the world is that you aren’t looking accurately at who your friends are and who your enemies are, and more importantly who your potential friends are and who your potential enemies are. This risks turning a potential friend into a potential enemy. There are only a very small number of people in the United States that are fundamentally opposed to the rise of China, and part of what I try to do is work with people who more or less share my view of the world to keep these people isolated and divided.

  • Posted by Dave Chiang

    Twofish,

    There maybe lots and lots of Chinese people on Wall Street, but most of them work in the back offices in accounting, quantative analysis, or network support positions. The invisible glass ceiling prevents ethnic Chinese from entry into the front executive or senior investment banking offices. How many ethnic Chinese occupy CEO or even Executive VP positions on Wall Street can you name? Even the Chinese government MOF recently introduced new regulations that require at least some executive positions of Western banks operating in China to be held by ethnic Chinese.

    The real US power structure isn’t visible if you aren’t either a male WASP or Jewish insider. A family friend of mine who worked in investment banking at JP Morgan-Chase recently quit due to the institutational bias and discrimination toward Asians at the upper management levels. He bitterly left to start his own investment banking firm for wealthly Asians. And by the way, for the record, the Clinton Administration never appointed one ethnic Asian, to any senior management position at any US government agency. Out of the millions of Asians in America, couldn’t they find at least one that was qualified. Wake up and smell the coffee.

  • Posted by Emmanuel

    Michael Pettis–again, let’s look at some numbers:

    (1) Total Chinese savings have gone up for six consecutive years from 2001 to 2006 according to chart 4 here. Chinese academics predict that those in 2007 will be higher still. It’s a bit premature to say that the global savings glut is winding down because China is not glutting the world as much as it used to (if you believe in the global savings glut).

    (2) You keep mentioning the demographic challenges of Europe, Japan, China, etc. but not those of the US in predicting this future when the US will again lend to the ROW. Instead of looking that far out into the future, are there no worries from your POV that there’s a baby boomer generation of 80 million people about to retire with so little saved? When the biggest bean counter of them all, GAO Comptroller General David Walker, expresses worry that the imminent retirement of the baby boomer generation is a demographic time bomb, shouldn’t we pay attention? As different as they are, the Brookings Institution and the AEI have joined Walker, so maybe deficits do matter after all.

    Sg+Sp=I+CA, and Sg is about to go ballistically negative as entitlements kick in bigtime. Do the math and the “don’t worry, be happy story” looks far less viable.

  • Posted by Keypoints

    Where are the bills going through Congress for:

    1) No Fair Trade Act
    2) No Federal Earmarks Act
    3) No Federal Over-Spending Act
    4) No U.S. Bailout Act
    5) No U.S. Current Account Deficit Consumption Act

  • Posted by PeterRabid

    “In previous cycles, financial systems, which during the good times had evolved into greater risk-taking activity and more-tightly-stretched asset-liability structures, were suddenly caught short by the secular change in risk appetite. In many cases their ability to intermediate the flow of capital slowed considerably, and what followed often involved considerable economic slowdown.”

    If this is any guide to the future, it looks to me like China is the most at risk. (I know Dave will jump all over me for this, but I will plow stubbornly – or blindly – ahead)ahead.

    The Chinese have the reputation for being big risk takers, and they seem to be living up to this reputation, with narrow stock markets rocketing skyward, along with empty skyscrapers.

    And the financial system seems rigid and primitive. It may be a command economy, but they certainly have problems getting their commands executed. At least there is big resistance to any slow down, as export indutries won’t stop blossoming

    So as the RMB and inflation rise, and their western customers purchasing power drops sharply, Chinese exporters may go broke in droves. Of course they will convert to supply the internal market eventually, but given their rigid financial system, that may take time.

    Meanwhile, extreme unrest.

    And their massive reserves may not help, as was the case in the US in ’29.

    Of course, things may be no better in the West, where financial structures may have their vaunted flexibility knocked out of them by the current meltdown.

  • Posted by black swan

    The winners are Canada, Australia and Denmark. All three have good demographics, Canada and Australia have great natural resources, and Denmark has a well educated, civilized population.

    The losers are the US wage earners (middle class), Japan and China, who, outside Italy, have the worst demographics and lack of natural resources. Add pollution and lung deseases to the China column.

  • Posted by touche

    The US is by far the most vulnerable economy.

    We have been conveniently willing to mortgage our future for big TVs, SUVs and McMansions, but when we’re broke, the rest of the world will prosper in spite of us.

  • Posted by Anonymous ibid.

    Most major US trading partners have reserves. China could afford to send everyone on vacation for six months.

    The worst hit countries will be those without reserves.

    Like the US.

  • Posted by qingdao

    The Economist: Sept 27: “But the popular notion that China is dependent on export-led growth is a myth; domestic demand is much more important.” I am one of the apparently deluded; would like to hear you views, Michael, and of course blog guests.

  • Posted by Michael Pettis

    Agustin, unfortunately, every major global liquidity contraction since 1825 has hurt Latin American countries badly and has resulted in sovereign defaults. With an increasing reliance on commodity production over the past decade (after over two decades of trying to cut that reliance) and substantial levels of debt (domestic, rather than external, which too may people mistakenly believe makes it alright), I agree that the adjustment is likely to be difficult for the region especially if the contraction is accompanied, as it usually is, by declining commodity prices. By the way, your blog is apparently off-limits in China – I am not able to get it.

    David Chiang, I agree that the US would be better off were it to improve its fiscal position, but I am not sure the rest of the world would benefit so obviously. I think to call the US a country dependent on the mercy of foreign creditors is not very revealing. From where I sit in China, it seems to me that creditor countries are far more addicted to the US trade deficit than the US is to vendor financing, and I worry that if a fall in US consumer demand or an increase in US protectionism cause a slowdown in Chinese export growth (I don’t think even a rapidly falling dollar could force the US trade deficit to shift to a wholly unprepared Europe) the consequences here would be horrible. Fortunately behind their brave words financial authorities here are terrified at the prospect, and are unlikely to do anything that threatens the export sector.

    That leads to PeterRabid’s comment. Yes, I agree that China is one of the countries most vulnerable to a secular liquidity contraction because it has much more government debt than is apparent, the debt is very poorly structured, the financial system is in very poor shape (I would say completely bankrupt but I know Twofish would disagree), and the banking system is too rigid to accommodate a massive adjustment. I know some might consider my nervousness about China to be strange, but as an ex-Latin American banker I have no problem accepting that today’s darling of the markets can be tomorrow’s disaster. In fact it almost seems that one must follow the other.

  • Posted by Guest

    Guest, after being interviewed last week on a local tv show I was approached by my co-guest (is that a word?), a senior government figure and friend of mine, who was planning to speak at a conference organized to discuss the best-selling book, Currency Wars. He asked me for my opinion on it and, as he was describing the book, I suddenly realized that he had gotten hold of one of those conspiracies in which somehow or the other the ills of the world are a result of the machinations of a cabal run by the Jews (mainly the Rothschilds, as if I needed to specify), the Queen of England and the Knights Templar. When I was younger Lenin always seemed to be part of the cabal too, but it seems he’s been expelled for some reason. After speaking with my friend and trying to convince him that this book was as credible as The Da Vinci Code (which by the way is hugely popular in China – many of my Peking University students have asked me to comment on it), it occurred to me to wonder again how in China it seems that trust in the government and the media is a little surreal and very brittle. My students, for example, are totally credulous in believing almost any written claim made with confidence, and yet are so quick to jettison that belief at any counterargument, which may partly explain the popularity at the best universities of some frankly bizarre religious groups. I guess that the Chinese are less used to snake-oil salesmen than we are (although they are proliferating in China nowadays) and so haven’t developed much immunity to books like the Currency Wars, which always seem so persuasive and jam-packed with incontrovertible fact. (Already I am sure that the more astute of Brad’s readers will have realized I am a member, albeit a very junior one, of the cabal, and so it is no surprise that I am so eager to discredit the book.)

    HZ, I agree that Japan has many of the characteristics of a country that is susceptible to a secular liquidity contraction, but it has already gone through its own great contraction, and I suspect that – with the exception of government debt levels, which seem very high to me but easy to erode via inflation – its balance sheet is in relatively good shape.

    Twofish, I think one of the most hotly debated topics in China is the currency regime, pitting on one side officials, usually at the PBoC and related institutions, who see a monetary disaster as the biggest threat, against officials, often in the provincial and municipal governments, who see rising unemployment as scarier. I agree that we are unlikely to see any action before the end of the 17th NPC, but I am even more worried that the Party has become so nervous about rising discontent in the cities and the impact that the Olympics might have in empowering the troublemakers that they put off any decisions until after next August. If that is the case, I think a serious and very difficult “adjustment” is almost a foregone conclusion, but I think you might not be as pessimistic as I am.

    I would also add, Twofish, that I may be excessively “monetary” and may focus to much on balance sheet and liquidity conditions and not enough on the real economy (it’s the bond trader in me), but I think that even if the US trade deficit disappears because of rising foreign demand, a rapid reduction will still cause a very tough financial adjustment. As the old bankers always say, bad loans are made in good times, and if the great recycling machine is suddenly turned off I am afraid we will be given a very good opportunity to see exactly where and how many the bad loans are.

  • Posted by Michael Pettis

    Macroman, yes, I take your point. In a globalized system not everything needs to clear at the national level. It may very well be that certain industries take the brunt of the adjustment, although in the past the end of these liquidity cycles were also accompanied by a reduction of cross border activity. One consequence of a major contraction might very well be that national systems increase their importance at the expense of globalized systems – perhaps rising protectionism has been one typical cause for this.

    Emmanuel, you are right, total savings in China has gone up until now, and may very well continue increasing. It is a little complicated for me to figure out, but if the US trade deficit declines, and if it’s decline is not matched by an equivalent rising deficit in Europe or Japan, then the developing world surplus must also decline and somewhere along the line savings in the developing world must decline. It could occur because of rising consumer spending or because of falling income. I need to figure it out, but I think that somehow it is a necessary consequence of a falling US trade deficit, whether you believe in the savings-glut thesis or the excess-consumption thesis, right?

    And I agree that the US also has a demographic problem, the pension problem, but it seems to me that there are some plausible things that can be done to address it – extend the retirement age, monetize pensions benefits (which basically means: erode them), increase immigration, etc. They may not be easy to pull off, but in the end something will be done, good or bad. The US, however does not have as serious an aging problem – I seem to remember that median age will rise from 34 today to 39 by the middle of the century – as the four countries I mentioned – Europe, Japan, China and Russia – which also have the pension problem that is compounded by a much more rapidly aging population and a sharp deterioration in the dependency ratio. China, in particular, has the problem in spades – it is aging much more rapidly than Japan or Europe (Chinese are younger than Europeans today but will be older in a few decades) and it is extremely poor. To say that the US is in a relatively good position vis a vis the other four is not to deny that it is any problem. The impact on the trade balance will be the same, however. With a better ratio of producers to consumers than those other counties, and with what I suspect will be serious productivity enhancing technologies, the balance of trade will most likely lead to a US surplus relative to those four counties. Maybe the real lesson here is that everyone should be running surpluses against younger powerhouses like India and Vietnam.

  • Posted by Michael Pettis

    Anonymous: In 1929 the US, like China today, had accumulated massive reserves thanks to a decade of world-record trade and capital surpluses. It was nonetheless pretty badly hit. I think a common mistake is to confuse reserves with national wealth. They are not. Perhaps the confusion exists because reserves can help protect a country form an external debt crisis.

  • Posted by Michael Pettis

    Qingdao, i think that is just the Economist in one of their myth-busting frenzies. Nowadays it is impossible not say anything without first declaring oneself a contrarian totally at odds with the prevailing wisdom, even though the math of contrarian majorities doesn’t work too well. I think what they mean is that exports, still a vitally important part of the economy (a major generator of GDP and with much higher returns on labor and capital than the economy as a whole) is not as important as it used to be. Maybe. But if you include the direct impact of exports, the impact of the export industry on domestic demand, and the importance of the export industry to the financial sector, you would agree that you wouldn’t be eager to see a significant problem in China’s export sector.

  • Posted by Anonymous

    The US ran both trade and capital account surpluses in the 20′s?

  • Posted by Twofish

    DC: The invisible glass ceiling prevents ethnic Chinese from entry into the front executive or senior investment banking offices. How many ethnic Chinese occupy CEO or even Executive VP positions on Wall Street can you name?

    Ethnic Chinese started entering Wall Street in the early -1990′s, and at this point they just haven’t had enough time to get to CEO or senior vice-president positions. I do know quite a few that are hedge fund managers, and lots of Chinese at the managing director level and a few at the senior managing director level. There is no glass ceiling. It’s actually the reverse. Having experience with multiple cultures is a *HUGE* benefit on Wall Street.

    DC: The real US power structure isn’t visible if you aren’t either a male WASP or Jewish insider.

    The WASP’s lost their dominace decades ago. If you look at who runs American companies, a lot of them are children of southern European immigrants that were consider “unassimilable” early in the 20th century. Overseas Chinese and eastern European Jews have a lot in common.

    Quick question: Why do you think you know more about the American power structure than I do? If it is so invisible then how come you see it and I don’t.

    DC: And by the way, for the record, the Clinton Administration never appointed one ethnic Asian, to any senior management position at any US government agency. Out of the millions of Asians in America, couldn’t they find at least one that was qualified.

    Immigration into the US by Asians was basically non-existent until 1952. If you have a situation where you have to be about 45-50 in order to get a cabinet position, then that means that there aren’t going to be too many applicants until the late 1990′s.

  • Posted by Twofish

    Certainly municipal officials are scared of rising unemployment, but it’s hard for me to see how a rise in the RMB is going to generate more unemployment since most of the drivers of growth are internal. In any event, the municipal officials that are most concerned about unemployment from exports, aren’t the municpal officials the Hu and Wen are most concerned about.

    I haven’t detected any real paralysis in Chinese decision making. Part of the issue is that Chinese decision making is very consensus oriented and always looks slow and indecisive to Americans who have a “do it now” culture. Also, a decision to do nothing is different from no decision. I’m reasonably certain that key decisions about RMB appreciation have been made already, however that decision could quite possibly be to do nothing about it. One reason I think that this is the case, is that it’s obvious that the China Investment Corporation was put together with a lot of thought, and it is impossible to think about CIC without thinking about wider issues of currency policy.

    It is, however, parallels with Latin America that have me worried. There isn’t a shortage of things that could be used to justify the case that “China is just different from Latin America.” The trouble is that there also isn’t a shortage of people saying “This country is different” right before everything fell apart.

    Personally, I think that the Chinese financial system is not too fragile. However the hole in my knowledge worries me a bit, because it is easy to say that China has X, Latin American didn’t have X, and that is a key difference, but I’ve learned to be careful saying that because I’ve often found on deeper investigation that Latin America *did* have X.

    I don’t think that the US is going to have a demographic problem. Just open the immigration gates, and presto, no demographic problem.

    One final thing about “nutty books.” The thing that worries me most is that you have an entire generation of people that believe that China *ought* to be economically prosperous. If anything disturbs that economic prosperity seriously, then there will be a huge market for “nutty ideas.” People will want answers, and they’ll take them from any nut that provides them. This would not be good for the planet.

    We are now in Globalization 2.0. The last era of globalization was in the late-19th century, and it abruptly stopped because of an assissnation in Sarjevo.

  • Posted by Twofish

    Here’s the worst case scenario that keeps me up at nights….

    If the Chinese economy falls apart, that most Chinese will end up blaming the US for it. If that happens, the framework of international relations that has been carefully built up over the last ten years falls apart. The US and China end up at war, cold, maybe even hot. This destroys both nations. The third world is now adrift, and ready to follow any ideologue.

    So the guy that sent two towers in NYC crashing down, wins…..

  • Posted by RebelEconomist

    Michael:

    You mention that China has more public sector debt than is readily apparent. I wonder whether the Chinese government is missing a trick by not selling off state shareholdings faster. Besides raising cash at good prices to pay down debt, this would lean against the equity bubble and could serve as an alternative to selling sterilisation bonds.

    I understand that the Chinese government has declared some self-imposed limits on their sales of state assets, but governments do not always keep their word!

  • Posted by Anonymous

    RebelEconomist on 2007-09-28 04:53:17

    Good idea.

    Although won’t affect sterilization unless shares held directly by PBOC?

  • Posted by Qingdao

    RebelEconomist: ref “selling off state shareholdings faster;” I’m reminded of L. Summers quip about being in government and his academic colleagues would always be giving him very good economic advise which was politically worthless. A lot of things in China just ain’t gonna happen, no matter how reasonable.

  • Posted by Anonymous

    Turkey is probably the weakest link in the chain. Turkish Lira is breaking records againts US dollar and Turkey has one of the largest trade deficits in the history. Too good to be true, this buble is going to burst soon.

  • Posted by Vikram Rout

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  • Posted by Twofish

    RebelEconomist: I wonder whether the Chinese government is missing a trick by not selling off state shareholdings faster. Besides raising cash at good prices to pay down debt, this would lean against the equity bubble and could serve as an alternative to selling sterilisation bonds.

    I do disagree about the level of public debt that the Chinese government has. Selling state assets have tended be a bad idea because what happens in China has in Russia is that the government has a hard time selling good assets because factory managers and local officials get a hold of the assets and sell it to themselves at ridiculously low prices.

    The worst thing about asset sales is that most of the hidden government debt exists in the state owned enterprises, so what has happened when assets sales have been tried is that someone runs off with the assets and just leave the state with debt.

    RebelEconomist: I understand that the Chinese government has declared some self-imposed limits on their sales of state assets, but governments do not always keep their word!

    There are two types of state assets in China. Things are worth something. Things that aren’t. The things that are worth something, there’s no particular reason that the state should sell. The things that aren’t worth something, the government is really willing to sell.

    Also there is hidden debt, but there are lots of assets that are in the SOE’s. If the government needs money, one option is to have the state-owned enterprises to issue a dividend to the state. That hasn’t been done yet for a number of reasons.

  • Posted by RebelEconomist

    Anonymous on 2007-09-28 06:00:09:

    As long as the government does not spend the proceeds – ie keeps them on deposit at the central bank – money is withdrawn from circulation. Sometimes the distinctions between government departments or agencies and the central bank are more confusing than they are worth. I tend to think in terms of a consolidated public sector.

    Qingdao on 2007-09-28 07:07:02:

    It would be interesting to hear what you think the political problems are with this idea.

  • Posted by Guest

    The 50 bps cut by the Bernanke Fed is “cowboy Keynesianism”. US public and private debt is hugely out of equilibrium. There are four ways equilibrium can be restored. US consumers and the US government can cut their expenditure to repay the debt. They can default on some of the debt. They can renegotiate some of the debt. Or the Fed can inflate away the real value of the debt.

    Bernanke recognises that inflation is the easiest course. Realistically, it may be the only option open to a country that finds it difficult to live within its means. The US will have traded toxic debt to China for lead-painted toys.

    Jeff Frank
    Professor of Economics,
    Royal Holloway,
    University of London

  • Posted by Twofish

    RebelEconomist: Sometimes the distinctions between government departments or agencies and the central bank are more confusing than they are worth. I tend to think in terms of a consolidated public sector.

    That’s very unwise in the case of China. The distinctions between government departments and agencies and the central bank are hugely important. Both politically and legally, the Chinese government doesn’t have complete discretion to move money between different entities, which makes which entity controls which account an extremely important thing to keep track of.

    The fact that you have such a complex system of interacting entities is how China resolves the socialist calculation problem that von Mises and Hayek provides. Basically, you can think of the market as a giant calculating machine, and the Chinese government has set up a legal and political framework by which various entities “owned” by the state act as market entities.

  • Posted by Anonymous

    RebelEconomist on 2007-09-28 08:39:03

    Does the government keep deposits with PBOC or the state banks or both?

    Depending on which, it would make a difference to your point.

  • Posted by Twofish

    There is a school of thought that attributes the American trade deficit to essentially a moral failing on the part of Americans.

    I don’t really find these arguments convincing since it seems strange that people’s moral character is so responsive to macroeconomic effects, and also because it takes two sides to make a financial transaction and there needs to be an explanation about why the world is so willing to fund the United States and not Zambia. The other problem is that every time these arguments have been used before (most recently Japan-1990), the “immoral” US ends up in good shape and the “moral” savers end up in trouble.

  • Posted by Twofish

    One big reason for the glut in Chinese savings is that the government spent about a decade trying to transform Chinese state-owned industry into profitable market driven companies, and they succeeded. The huge losses in the SOE sector in the 1990′s are now profits, and this creates a huge cash reserve that the government doesn’t quite know what to do with. Because state-owned enterprises have so much cash, they reinvest it directly into construction without going through the banks.

  • Posted by Anonymous

    Twofish on 2007-09-28 09:07:52

    Is the moral failing theory one of succumbing to the temptations of the savings glut, or something else?

  • Posted by Guest

    So therefore in the national accounts “spending splurge” = “savings glut”.

    Try…. there is a global spending splurge… and it all becomes clear.

  • Posted by RebelEconomist

    Anonymous on 2007-09-28 09:03:33:

    Good point, I was forgetting that big Chinese banks tend to be public sector institutions too! The key is whether the bank that takes the government’s deposits behaves commercially by lending them out, in which case the money is returned into circulation. Central bank lending is not determined by the amount of money deposited by the government, meaning that it effectively ceases to exist. It is conceivable, but unlikely, that the government could achieve the same outcome if it deposited the proceeds of its asset sales with the state banks and accepted zero interest on condition that that money would not be lent out.

  • Posted by vorpal

    The power goes to those with the oil. Nowadays, the oil goes to those who can pay for it. Zimbabwe and Myanmar are 2 countries that can’t pay for it because their financial systems are terrible. The US cannot afford the amount of oil it purchases because we are in a huge trade deficit. As the price goes up, we will be the first major industrial country to feel the bite. Germany and Japan, both wholly dependent on imported oil, are still in better shape because they have trade surpluses. The same goes for China.
    The US has racked up a huge bill, and is dependent on more credit to get by. Moreover, the cost of living is set to increase more rapidly as the price of scarce resources increases (Jeffrey Sachs has a recent article on this.)
    The US is most vulnerable. Because it depends on imports while it’s ability to pay for them has eroded. The true cost of the imports has been depressed, but it is impossible for this to continue forever.

  • Posted by Twofish

    RebelEconomist: Good point, I was forgetting that big Chinese banks tend to be public sector institutions too!

    Yes and no. The big Chinese banks are majority owned by the state, but they are set up both politically and legally so that the Communist Party can’t order them to behave non-commercially.

    One curious part of Chinese economic reform is dealing with the “curse of omnipotence.” If the Communist Party is omnipotent, then people will behave in ways that are not in the Communist Party’s interest. If you think that the Communist Party can and will seize your money at any given moment, then you will not save your money in state institutions.

    In the case of the commercial banks, the solution has been to have foreign banks act as guarantors. If the Party started to force the commercial banks to behave non-commercially, then Bank of America, Goldman-Sachs, the Royal Bank of Scotland, and Temasek Holdings would start screaming. All of the foreign banks also have seats on the board of directors so they can also monitor the banks behavior.

    The other part of the equation is to get up institutions so that when the Party has to act non-commercially, it can do bypass the commercial banks. If it needs macroeconomic adjustments, it operates through the PBC. If it needs to make policy loans, it operates through the three policy banks.

    This is why I don’t think that it useful to aggregate different institutions into one big whole.

    This is also why I’m more optimistic than Michael Pettis is that the PRC government has enough reserves to deal with debt in a business downturn. Basically, I think we agree on the total amount of likely debt in the system. The thing that I think we disagree on is the degree to which debts are defaultable.

    My argument is that the Chinese financial system is set up so that a large amount of hidden debt can be defaulted on without causing a major crisis, and that the amount of debt that can’t be defaulted on, is manageable, and for the most part, non-hidden.

  • Posted by HZ

    Michael,
    I do think your self-assessment of being too focused on monetary system and de-focused on the real economy. Fundamentally China has the capacity to supply its populace with almost anything other than food and oil, which its massive reserve could help importing. Any issue would come from distribution so I don’t see a case of real economic disaster because of the “CCP put” — for survival its government will be willing to underwrite any balance sheet problem that could potentially lead to crisis. In this sense it is the political flexibility rather than financial flexibility that ultimate counts.
    1929 came up a lot. Here we see how the political inflexibility led to disaster. It’s the mis-begotten notion of gold standards, sound money, crime and punishment in the economic sense and the myopia of the moneyed class. It took depression to shake these off, which China does not have to start with (coming from a command economy).
    I am not saying the Chinese system is good. The price paid is massive mis-allocation of resources. It also practically pushes people to take risk. If anything I would look at the physical limit (environmental degradation comes to mind) rather than financial ones for the downside risk.

  • Posted by Dave Chiang

    From Fortune magazine, Irresponsible Federal Reserve policy under Ben Bernanke
    http://money.cnn.com/2007/09/28/news/economy/sloan_bernanke.fortune/index.htm?postversion=2007092814

    It’s too bad that the governors of the Federal Reserve Board don’t have to take such a pledge when they assume office, because their recent interest rate cut has done a lot of harm to those of us who’ve managed our finances prudently.

    The Wall Street players in the biggest trouble, of course, were the ones who’d taken the biggest fliers in junk mortgages, ultra-risky leveraged buyouts, and other financial esoterica that proved to be malignant.

    If you look at the financial markets’ overall reaction to the Fed move – not at just the stock market’s reaction – you realize that as a result of the cut, those of us who keep score in dollars and didn’t need to be bailed out are less wealthy than we were in terms of anything other than our home currency.

    Why? Because the rate cut contributed heavily to the dollar’s recent sharp drop in the currency markets – parity with the Canadian dollar, and to the price spike in hard assets like gold, silver, copper, and oil. So our real economic wealth, relative to these other things, has diminished.

    And wait, there’s more. Even though the Fed has cut short-term rates, long-term rates, which it doesn’t control, have risen in reaction to the cut. So whatever economic benefits may flow from lower shortterm rates will be partly offset by the rise in long rates, which are at least as important to the economy as short rates.

    Finally, consider this. Even though Bernanke’s cut may mean that some junk mortgages will reset at lower rates, the cost of large, high-quality fixed-rate mortgages, which are tied to long rates, will be higher than they’d otherwise be. (Yeah, penalize the people who are prudent – way to go!)

  • Posted by black swan

    DC, no one’s forcing you to invest your money in this country. Think of the buying power you would have had here in the US, if you had converted your savings to euro bonds a year ago. If you really believe the USD will continue to fall, then get your investment capital out of the country. Here’s a great luxury condo deal in Miami that you could have bought for $.50 on the dollar. Now imagine far lower price you would have paid for one of these, if you had put your money into Euros last year. As you can see from the video the Canadians are doing fine here. Enjoy the video and thank the Fed for this high-end affordable housing.
    http://cbs4.com/topstories/local_story_264095336.html

  • Posted by Keypoints

    Dave Chiang,

    What do you say about today’s AP article: “Bush, Clinton, Bush … Clinton?”

    http://news.yahoo.com/s/ap/20070928/ap_po/bush_clinton_fatigue;_ylt=AlZykXZEQyxwRGuRJE8chyyyFz4D

  • Posted by qingdao

    RebEconomist: thank you for the gracious invitation, but in a world of hammers, I choose not to volunteer to be the next nail.There is a world of political scientists in usa who write about these things; most of it unintelligable. The short answer is: it’s a contact (contract?) sport. The head of the party in Shanghai was arrested for “corruption” and a few days later shot. Another provincial leader was arrested for having a mistress.

  • Posted by JG
  • Posted by Dave Chiang

    Blackswan,

    I would have invested my large pension 401K fund in foreign bonds or stocks if I were given the option by my employer.

  • Posted by HZ

    JG,
    Yes on Apr 27. Looks like FT hasn’t updated their site for a while.

    Now what is interesting is that Libor US$ hasn’t budged since the Fed cut: http://www.cbonds.info/index/index_detail/group_id/8/
    So cost of money for banks has not really come down at the wholesale level.

  • Posted by JG

    HZ oh ok

    The libor is hard to move it’s not very helpful for the ARMs resets too.

  • Posted by Twofish

    To qingdao: Correction the head of the Shanghai Party has not been shot. He has been demoted from all posts and expelled from the party. The head of the Chinese food and drug administration was shot, but he was charged with the crime of homicide in that prosecutors argued that his corrupt approval of a drug directly led to the deaths of eight people.

    One of the reason that China has developed “rule of law” is that it protects leaders if they get in trouble. I don’t think that Chen Liangyu will be shot because he hasn’t done anything that would allow for a capital crime.

    To DC: Anyone that losing unacceptably large amounts of money because of an interest rate or currency shift simply is not managing their finances prudently. In fixed income investing, interest rate risk is *the* biggest thing that you have to worry about, since interest rates have a far bigger impact on returns than credit risk. In forex, currency risk is also something you constantly have to think about. If someone is making bets about the direction of interest rates or currencies a year from now, they are making a bet, which is fine, but they don’t really have much room to portray themselves as “prudent” if the bet doesn’t work out. They are speculating……..

  • Posted by Nicole

    We can learn that both US and China are getting richer for years of the trade.That means the trade is right.
    Trade is so important to the globally-integrated economy. The U.S. is the number one trading country in the world, and China is our third largest trading partner.
    The need to achieve a “balance” that they look at their economy as a whole and accommodate the interests of import-sensitive industries as well as those U.S. manufacturers that rely on imports to stay competitive worldwide.
    As the number one trading nation in the world, America needs to keep balance foremost in mind.
    Boosting U.S. exports to China is the right step to narrow the trade gap.If the U.S. government allows more high-tech products to be exported to China, the trade imbalance could easily be improved. Demand for many US products in China are very strong.Welcome to AmeriChinaB2B( http://www.acb2b.com/ ) to begin your business trip of China.

  • Posted by Twofish

    vorpal: The US cannot afford the amount of oil it purchases because we are in a huge trade deficit. As the price goes up, we will be the first major industrial country to feel the bite. Germany and Japan, both wholly dependent on imported oil, are still in better shape because they have trade surpluses.

    The US trade deficit is still a few percentage of GDP. Also if it is one thing that people should have learned from the 1980′s, is that deficit=bad, surplus=good is wrong. There are cases in which surpluses reflect defects in the underlying economy, which was the case in Japan-1980 and it is the case in China today. China is generating massive amounts of wealth which its financial system cannot invest well internally, and this is why there is such pressure to export money from China.

    vorpal: The US has racked up a huge bill, and is dependent on more credit to get by.

    And the reason people are willing to extend the US so much credit is that people still believe (I think correctly) that their money is better put in the US than anywhere else.

    vorpal: Moreover, the cost of living is set to increase more rapidly as the price of scarce resources increases (Jeffrey Sachs has a recent article on this.)

    Jeffrey Sachs has been wrong before (disastrously wrong in the case of his plans Russia). Personally, I think that technology will cause standards of living to go up faster than resources cause standards of living to go down. If this is correct, then the nations that will do well are those which have a track record of being able to develop technology rapidly, and the United States leads the world in this.

    But it is not this country versus that country. The US is very good at coming up with new ideas. It’s much less good at implementing those ideas on industrial scales. Japan is better at that. It’s also much less good at actually producing the final widget using cheap labor. China is better at that. But asking what country is “better” is the wrong question. You set up your systems so that you put different functions in different countries, all playing to that countries strengths.

    A lot of that involves finance and social organization. It’s not that US engineers are smarter or more creative than Japanese or Chinese ones, it’s that there are linkages between private equity, venture capital, and the research universities that exist in the United States that don’t quite exist elsewhere. (And even in the US, they exist only in a few cities.) China is trying to replicate Silicon Valley, but that will take about two or three decades.

    vorpal: The US is most vulnerable. Because it depends on imports while it’s ability to pay for them has eroded. The true cost of the imports has been depressed, but it is impossible for this to continue forever.

    But the US has some core strengths, which become more obvious if you look in the past and try to figure out why all of the previous the “US is doomed” predictions failed.

    One is the structure of US university admissions. In the US, you are more likely to get admitted to a high ranking university if you are captain of the football team or president of the debating society whereas in Japan and China, it’s all about how well you score on tests. People who are football team captains tend to have the social and management skills necessary to start and run small/mid sized companies more so than someone that spends 100% of the time on tests.

    The other is the way that the US sees itself. Part of the strength of the US university system is that it takes the brightest people from around the world and turns them into Americans. So China and India are producing upteen million engineers. The US can go through those upteen million engineers, and set things up so that the brightest, most motivated end up in the US.

    This actually contributes to the American character. If you are quiet, obedient, and do what you are told, you are just not going to make it past the US immigration system. The people who get into the US, whether legally or illegally, are motivated passionate people who want to get rich. These are people who tend to start small businesses.

    People say that the US is doomed because Americans are lazy and people are borrowing lots of money to buy useless stuff like McMansions and HDTV’s, but they are not looking at the big picture. This is how the US works.

    You find an empty spot of land. Build a huge giant house with a pool and SUV. You fill it with HDTV’s, credit cards, citizenship papers, and a job that pays a huge amount of money for little work. You surround it with some immigration checkpoints, you broadcast it to the rest of the world and say “come and get this!!!!!” So what happens is that among the millions of scientists, engineers, shopkeepers, farmers etc., etc., all start running through loops to get the prize. They learn English, they figure out all of immigration tricks, etc. etc. Some of them make it. They enjoy the big house and the SUV, and you end up with some of the most motivated people in the world, ending up in the US, who then start the companies and come up with the ideas that pay for the house and SUV.

    Of course, their grandkids and great grandkids are going to end up fat and lazy because they grew up in the nice house rather than having to fight their way in. No problem. Lots of empty space….. Build another house……

    America, the world’s biggest reality game show…..

  • Posted by Twofish

    One more thing. It’s important to look at how America gets its wealth because it could end. One of the fascinating case studies is Argentina in the 20th century, and how things fell apart. If you went back to 1900, there Argentina was this destination for lots of European immigrants, and it has the same sort of advantages that the United States. Lots of open land, open immigration (if you were European), stable government, booming economy.

    What happens is that you have this bad cycle. The economy goes bad. People are more willing to shut the gates. This makes it impossible for new people to get in. This makes the economy worse. The gates shut tighter. Eventually this thing spirals completely down hill, and if anything kills the United States, it will be this.

  • Posted by RebelEconomist

    Twofish:

    Yes, Argentina shows the risk. The problem for the US, and I think the UK, is when the majority of people expect an easy ride. Then, in a democracy it becomes politically impossible to align incentives and expenditure to productivity. I see the latest Fed cut as part of this pattern. It becomes numerically, if not politically, difficult to take enough immigrants to maintain properity.

    But all is not lost yet. My response to this threat would be to make public childcare and education the clear priority for expenditure, to help the existing population to become as productive as possible and to break the link between poverty and opportunity, and in the longer run, create a more informed electorate. To raise the money, I would tax oil consumption in the US, and property in the UK.

  • Posted by bsetser

    2fish — i don’t think the current edifice of globalization was something that was built up over the past ten years. the striking thing about its dominant feature (EM financing of the US) is that it isn’t at all institutionalized. It sort of just happened — as ASia decided to follow the $ down and the oil exporters began to build up surpluses. There isn’t any institution that plays a formal role supporting the system, tho i would argue that China’s central bank effectively acts as the key wheel in the system (in part by holding the rmb down and punishing those who let their currencies appreciate by more).

    and the current edifice hasn’t generated large benefits for a majority of the US and European participants in the system — real median wages are flat, and i don’t really think you are better off in real terms if the market value of your home goes up. you are still living in the same space and realizing the gains requires downsizing and living in a smaller space. the gains have been captured by a relatively narrow segment of the population. so the current edifice doesn’t really command strong democratic support in the US and Europe.

    Chinese real wages are certainly rising — tho labor’s share of total national income is falling, as wage growth has lagged GDP growth. But i am not sure that a system based on investing a decent chunk of china’s savings in money losing assets (domestically, through the misallocation of capital and NPLs and extenrally by buying depreciating $) really would command majority support in China.

    This all suggests to me that the current edifice is has been built on very shaky ground. that is what worries me.

  • Posted by Twofish

    bsetser: and the current edifice hasn’t generated large benefits for a majority of the US and European participants in the system — real median wages are flat

    I do wonder if there is an “escalator effect” going on here, in that real median wages are flat whereas people are moving up. Something that is a bit surprising is the question of why people haven’t been complaining more than they are if things are so stagnant, and thinking in terms of wages as an escalator might explain things.

    bsetser: the gains have been captured by a relatively narrow segment of the population. so the current edifice doesn’t really command strong democratic support in the US and Europe.

    Walking on the street and looking around, I really don’t think that the gains have been captured by a relatively narrow segment of the population. I’m sure that this is because I spend my time in Texas and New York rather than Ohio and Michigan, but there are areas were globalization has lifted the standard of living of just about everyone in those areas.

    Again, the fact that none of the major candidates have have made globalization an issue is pretty significant. It may be that the power elite has got everyone brainwashed, but that doesn’t explain why that brainwashing was more effective in 1992 than in 2008. I think it is more likely that people are looking at their own lives and their own wages, and aren’t seeing things badly impacted by globalization.

    bsetser: But i am not sure that a system based on investing a decent chunk of china’s savings in money losing assets (domestically, through the misallocation of capital and NPLs and extenrally by buying depreciating $) really would command majority support in China.

    Most people don’t care about the details. They just care that they get their stuff. If you see a 10% drop in wages or if their bank account disappears, people notice that really quick. If people are seeing a 10% rise in wages, the fact that another 10% is going elsewhere is irrelevant. Same with bank accounts. Very few people care about whether the PBC loses $300 billion in currency reserves. However misplace $1 in someone’s bank account and they notice.

  • Posted by Ames Tiedeman

    The U.S. Trade Deficit is a huge problem. We will either end up being owned by foreigners or we will simply fade away. Both prospects are quite un-
    American. Some basic facts: The U.S. has not had a trade surplus with the world since 1974. We have not had a trade surplus with Japan since April of 1976. We stopped having trade surpluses with Eurpoe in 1983. Fifteen years ago we did not have a trade deficit with China. Now we have a 250 Billion a year deficit with the People’s Republic. A nation that does not make anything is a worthless nation. Worse, the longer we go without making the needed investments in our manufacturing infrastructure, the more knowledge we lose. We will either forget how to manufacture or we will simply not be good at it. Our creative energy fades away if we do not use it. Also, it is innate to want to make things. Kids play in sand boxes, youg men build tree forts. This is human nature. All of this is being taken away from the American people by idiots in Washington who do not know how to make trade deals. I may write a book on this topic.