Looking back at the top macroeconomic and financial stories of 2007, and looking forward to 2008
Here is my list of the top five stories of 2007 - and some things that I’ll be watching in 2008. What did I miss?
1. The “subprime” crisis. The credibility of Wall Street’s financial engineering — and a business model based on transactions so that clever originators could avoid holding any exposure to the products they created — took almost as much of a battering as Citi’s balance sheet. The United States comparative advantage at churning out complex financial products (something the IMF argued would assure the financing of the US deficit — see p. 14) turned out not to be much of advantage after all. And it turns out the US hadn’t actually sold all the toxic stuff to foreigners seduced by a triple AAA rating - an awful lot seems to have been held by US banks (and their offshore SIVs and conduits), broker-dealers and other financial institutions. Anything that turns t-bills into .coms (if only for a few days), makes banks afraid to lend to each other, leads an entire market (ABCP) to come close to disappearing and turns Morgan Stanley’s Bernstein almost as bearish as Merrill’s Rosenberg is big news.
With the benefit of hindsight, the notion that the worst tranches of residential mortgage-backed securities, themselves assembled from the loans to the riskiest borrowers, could be combined and repackaged into triple AAA securities does seem rather far-fetched. Take a look at Portfolio’s cascade.
That is just a simple mortgage backed security. Then imagine taking the bottom tier of the cascade - combining it with the bottom tier of other cascades - and feeding it into a new cascade. Then imagine selling insurance (no doubt ultimately to Goldman) against the risk that a bond based on the cash flow from the next to bottom tier of cascade will default ("For Norma, N.I.R. assembled $1.5 billion in investments. Most were not actual securities, but derivatives linked to triple-B-rated mortgage securities … Norma, acting as the insurer, would receive a regular premium payment, which it would pass on to its investors). Then imagine repackaging the cash flow from the insurance premiums into a CDO with its own cascade of payments. Then imagine convincing the world that the top tier of that new cascade are as good as Treasuries, but yield a bit more (see the Journal’s graphics).
The result, according to Gillian Tett:
… faith in 21st century financial innovation has … evaporated. The events of last year showed with brutal clarity that risk dispersal does not always prevent financial shocks, but may fuel contagion instead. "Not since the high-quality batch of railroad and utility bonds of the late 1920s faltered during the Great Depression have so many high-quality ratings been unable to stand the test of time," says Jack Malvey, senior analyst at Lehman Brothers.
2. Oil’s rise from $50 (at least briefly) to above $90. If sustained for a full year, the difference between $100 a barrel oil and $50 a barrel oil puts something like $800 billion into the hands of a fairly small number of big oil-exporting economies. It also puts over $250 billion into the hands of four or five politically powerful Gulf families (and their investment managers.) No wonder all of London and a good part of New York decamped to Dubai in December …
3. Europe, the new engine of demand for Asian manufactured goods. In real terms, US exports have been growing faster than US imports since early 2006. The US deficit - excluding oil - is heading down. US imports from Asia are basically flat this year. Chinese exports to the US are still up - but they are growing at a much slower pace than before. But Asia, rather remarkably, hasn’t been forced to wean itself from exports. It just replaced exports to the US with exports to Europe. The IMF expects Europe - whose population is basically flat and thus should grow about 1% a year more slowly than the US - to grow faster than the US in 2007. Europe certainly grew faster than the US in 2006. The EU’s trade deficit with China was euro 128b in 2006 — and, on current trends, looks set to top euro 160b in 07. European demand for Asian goods in turn helped sustain China’s resource intensive boom, and the resulting boom in most commodity exporters …
4. The new trillionaires. Emerging market central banks are on track to add over $1 trillion to their reserves in 2007. China will add - counting reserves shifted to the state banks and the China Investment Corporation (CIC) - about $500b to its coffers. China’s total assets are now closer to $2 trillion than $1 trillion. Russia will add about $150b (after adjusting for valuation gains). Brazil, India and the GCC central banks (counting the non-reserve assets of the Saudi monetary agency) will all add about $100b. Talk of how the market had overpowered the state now seems remarkably premature ….
The intensification of Bretton Woods 2 in turn has generated an intensification of the pressures on Bretton Woods 2 - whether economic (difficulties sterilizing rapid reserve growth and a surge in inflation) or political (Europe isn’t terribly fond of China’s weak RMB policy).
5. Wall Street embraces state capitalism. Privatization: Over. The really big money is now to be made from cross-border nationalization. Transparency, at least from governments with rapidly growing assets: over-rated. Funds that don’t have to disclose their total assets, let alone report to pesky, risk-adverse parliaments are far more fun — and certainly far more willing to snap up big stakes in distressed banks.
The story of 2007 though isn’t the scale of the increase in the size of sovereign wealth funds.
As of now, the $1 trillion annual increase in the assets of sovereign wealth funds is just a forecast, unlike the $1 trillion plus annual increase in central bank reserves.
Sovereign wealth funds did probably add about $250b to their assets in 2007, but that total is somewhat deceptive. It seems likely that China shifted a bit over $100b from the PBoC’s account at SAFE to the CIC’s account at SAFE in late December. Without that influx, sovereign wealth funds wouldn’t be growing all that much faster in 2007 than in 2006 or 2005. Moreover, about $100b of the overall increase comes from funds that are still managed fairly conservatively: Norway is the most obvious example, but Kuwait has also stayed out of the headlines — at least so far. Some recent press reports suggest that the KIA now has deal-envy. Almost all the excitement came from the roughly the more aggressive management of the roughly $50b going into the funds of Qatar, Abu Dhabi and Dubai (money that is often leveraged), the redeployment of some of the accumulated profits of Singapore’s GIC and Temasek and a couple of small deals from the CIC and two Chinese state banks …
Rather the story is how quickly the Street and the City jumped on the sovereign wealth fund bandwagon — without the agonizing of say Tyler Cowen, let alone Larry Summers. The world’s biggest deal-makers are now convinced that the governments of emerging market economies - along with cash-rich state-owned enterprises — are the natural owners of a host of US and European financial assets, whether US banks, global securities firms, European toll roads or Australian mining companies.
Remember, Morgan Stanley, Blackstone, Barclays and Standard Bank together account for only about 3% of the total increase in the foreign assets of China’s government. The redeployment of China’s financial firepower outside the bond market has hardly started.
So what is next?
The data from the first few days of 2008 certainly seem to suggest that the probability of a US recession has gone up significantly. Nouriel argues that the real question now is what kind of recession — short and quick or long and protracted. Stephen Jen’s theory that a US slowdown is worse for the dollar than an outright recession may get put to the test. But I don’t claim any particular expertise in the US economy.
My personal watch list is a bit more esoteric:
1. Will the Gulf revalue?
$100 oil. A growing desire to spend the oil revenue at home rather than just stash it all away in Switzerland, London and New York. A weakening dollar. Rising inflation. The UAE central bank governor’s denial of the link between the dollar’s weakness and the rise in inflation lacks credibility. The Gulf isn’t willing to run the kind of restrictive fiscal policies needed to damp down inflation in the face of ongoing dollar weakness. The economics are clear. The Saudis seem to have ruled out a shift away from the dollar, but not a repeg.
I would bet, though, that the revaluation, if it comes, will not be large enough to make much of an impact on inflation — or large enough to end speculation about the next revaluation.
2. Will Europe’s own — and hopefully more modest — version of the subprime crisis begin to unfold in Eastern Europe?
European banks have, in some global sense, transformed the huge capital inflows associated with the global surge in demand for euro reserves into a surge in lending to Eastern Europe. That lending has financed large current account deficits and rapid growth in Eastern Europe. This is a good thing: inside Europe’s institutional structure, capital flows downhill, from the rich to the poor. But I am starting too worry that there has been a bit too much of this good thing. External deficits are now quite large in many Eastern European countries. An excellent recent IMF paper on Southeastern Europe illustrates that there deficits have been accompanied by growing balance sheet vulnerabilities — notably the buildup of foreign exchange risk in the private sector.
3. Will losses on foreign currency reserves emerge as a major political issue?
A number of countries with substantial dollar holdings let their currencies appreciate against the dollar (at least by more than in the past), some countries with substantial holdings of euros as well as dollars saw their currency rise against both the dollar and the euro. These central banks’ annual reports for 2007 will likely show significant (paper) losses. Some countries now intervening heavily — India and Brazil come to mind — also have domestic interest rates well above US and European rates as well.
4. Will global central bank reserve growth "peak" in 2007?
Private capital may be a bit less willing to flow toward those emerging economies with large deficits. That would slow aggregate emerging market reserve growth in 2008 even if the rising oil surplus and China’s still growing surplus keep the emerging world’s current account surplus quite large.
But that isn’t the real basis for my forecast.
Rather it seems likely at a few countries that until now have largely kept their surplus petrodollars and petroeuros on deposit at the central bank — Libya and Saudi Arabia most notably — will set up investment funds. Russia is also setting up an investment fund, but its contribution may be more modest.
Another set of countries, countries where the central bank has until now been doing all the country’s intervention, seem set to let the Finance Ministry intervene a bit more in the foreign exchange market. Brazil is one example. China is another — though the PBoC cannot be pleased that it has been the one that has had to buy the Finance Ministry’s bonds, which implies that it still is doing all the sterilization but not longer managing all the money. Still, the CIC likely got a ton of cash late in 2007 — and could easily get round 2 sometime in 2008.
And then a number of countries are simply disguising the extent of their intervention. China is forcing its banks to hold dollars to meet the recent rise in their reserve requirement, a policy change that could have led to the purchase of $70-80b of dollars by the banks in q4. Bank regulators used to worry about mismatched balance sheets, not they are forcing the banks to run mismatches. Other central banks — Thailand most obviously, but also Malaysia, the Philippines and no doubt others — are building up (and rolling over) large forward positions.
Government intervention in the foreign exchange market may not go down. But the intervention that takes place likely will be substantially less visible.
5. Will more Americans conclude that globalization is not the same as Americanization?
And what impact would such a realization have on public support for the current form of globalization?
I would not, though, rule out the possibility that Europe has its version of CNOOC or Dubai Ports World and rejects a major cross-border deal involving a state firm or investment fund before the US does.
Would it be useful to consider the meta-theme of “coupled” vs. “de-coupled”? Are you implicitly addressing that debate by saying that economies are less coupled, which provides financial actors (e.g., SWFs) in areas less affected by turmoil in the US financial economy (and possible turmoil in the real economy) opportunities to intensify coupling in the financial economy?
I generally have steered clear of the decoupling debate, in large part because I am not sure I have much new to say. The world economy clearly has decoupled from a residential-investment led uS slowdown. China’s growth accelerated in 07 even as US growth slowed, and US demand for Chinese imports slowed.
But as point 2) illustrates, china decoupled from the US by coupling with Europe. Chinese exports to Europe are now growing far faster than china’s exports to the US. And it isn’t clear to me how long Europe can sustain its current expansion. If Europe slows and the US slips into recession, Asia’s resilience will really get put to the test.
the rise in oil even in the face of a slump in us demand is also evidence of decoupling of a kind, and it does mean that there is a lot of money out there (mostly from sovereigns) to invest somewhere. I hesitate tho with the notion that sovereigns are always stabilizing. the big oil funds preferred safe bonds, equities and real estate to risky bonds — so they generally do not seem to have much direct subprime exposure. plus they had new inflows from high oil prices. other state investors — i have something in the works on china’s state banks foreign investment — look to have been caught, at least in part, by subprime, and have pulled back. And that isn’t b/c of a lack of $ liquidity in the Chinese banking system.
Globalization is not complete without free movement of labour( both high skilled and low skilled). Financial globalization will benefit only the corporates. Although
politically not feasible it does not make macroeconomic sense.FDI must be based on resource based cost optimizationnot on wage differentials as labour can be mobile. Globalization must include free labour movement, absense of PPP differentials(created via macroeconomic policies), single currency around the world to achieve optimum and balanced economic growth with only exogenous process being growth in technology.
1. Will the Gulf revalue? Good question. I think also important is whether or not it will somehow coordinate with China. Gulf and China seem to be taking a lot of domestic inflation to maintain their pegs.
2. If 2007 was subprime, then I think 2008 may very well be time when it dawns on folks that it’s also an Alt-A and Prime issue. Just be patient…
3. Gold breaks $1000. Even if (and that’s a big if) the dollar stabilizes, that does not mean that gold goes down. Remember end of 2005-2006 when the dollar stabilized, gold still shot up. I also think silver breaks above $25 in 2008.
4. Oil trades north of $125 as Cantarell depletion gets worse. Maybe Saudi opens up Khusaniyah but it does not help much because their internal energy usage is ramping up and total exports might still decline even with the new field. Chinese imports, especially for things like diesel, draw product from other regions and cause shortages in places outside of China… And no, the coming recession still does not help alleviate the problem of Peak Oil.
5. Drum roll, #1 with a bullet, the big phrase for 2008, knocking “subprime” from the top spot… will be COUNTERPARTY RISK.
Failure of decoupling may be the story in 2008. More broadly, failure of risk correlation analysis, first in CDOs, then in the macro economy.
Hi Brad,
Good stuff. Especially, the point about Eastern Europe. This needs watching indeed. The balance sheet exposure is very large; I can say this for sure since I have had my nose into a lot of the data here. The problem is in particular how this will transmit into Europe in general since Germany is very dependant on the margin on Eastern Europe.
As for the Gulf states. Well, steady as she goes seem s to be the thing here. This will probably go for the RMB too although the pace of appreciation against the Dollar is a bit more rapid. However, I concur with what you said over at Macro Man in the sense that both appreciation and rapid accumulation may be possible at the same time.
As for the decoupling/re-balancing à la traditionelle I think that Europe will succumb and thus that China won’t be able to rely on exports to EU to the extent that we have seen. At least, the boundaries for this process are moving closer. Spain and France will be important here as the Eurozone’s biggest deficit nations as well as of course the UK if we take EU27 in which case also the general Eastern European situation will be important.
Claus
I posted this link in response to the discussion a couple of topics ago, probably too late to get read, but as it covers a perennial topic, here it is again, in response to Brad’s watchlist item 3.
http://reservedplace.blogspot.com/2008/01/it-is-often-asserted-eg-in-brad-setsers.html
If the UK’s experience is indicative, the dollar may depreciate in the short term, but in the (not too) long term, provided that the private sector remains the marginal influence on interest rates and exchange rates, the central banks will not lose on their reserves, and the US will not be able to cast off its debt burden.
Re engineering - any risk can be subdivided into tiers of greater and lesser risk through an option structure, which is essentially what a cascade is. The problem is not with the concept but with the useless statistics assumed in the probability distribution for that risk. It`s easy to generate a AAA risk tier in theory from any such structure - the only question is how the probability distribution determines the depth or shallowness of the AAA tier. Bottom line is that the probabilities that determine“ such structures are themselves fraught with risk. Those who rely on quants will never learn this lesson.
Brad,
What else did you miss? Well how about absurdly low interest rates set by the Federal Reserve. The current 4.25 discount rate doesn’t adequately compensate savers considering the rising “real” rate of inflation, not the doctored “core rate” of inflation used by the Fed (ie. the real inflation rate is posted at every gasoline station pump).
In the mail over the weekend, I received a personal loan offer from Chase Manhattan for a “Zero” interest loan till December 2008. How can CNBC’s Jim Cramer complain that interest rates are too high? While I generally dislike carrying any debt load, how can money for “free” be turned down. Is this what Bernanke means by “dropping money from helicopters to stimulate the economy”. With a carry cost of “zero” interest, I intend to invest the proceeds into the Merk Hard Currency Fund that invests in countries with “sound” monetary policies. I think it’s almost a sure profitable bet considering Bernanke’s policy of cheap and even cheaper dollars.
On a footnote, Federal Reserve monetary policy is such a farce nowadays, CNBC’s Jim Cramer even jokes that every time he spouts expletives and pounds the table for interest rate cuts, Bernanke jumps into action. That oil is a $100 per barrel and gold is a record $860 per ounce should be a warning sign to US monetary policy officials. I think Bernanke should stop pandering to the narrow economic interests of leveraged Hedge Funds and Investment banks. The average US middle class saver deserves a fair compensation on his hard earned savings rather than find his “real” wealth eroded by the stealth tax otherwise known as inflation.
The reason the US Economy is in this terrible mess of multiple inflating bubbles is due to the lax monetary policies and loose regulation by the Fed. Once again, making money even cheaper doesn’t resolve the economic problem. A reinflation of the Housing bubble to build even more McMansions would represent a total abdication of “sound” money and a further massive misallocation of capital.
Rebel - the problem is that there`s no sign this is happening yet and time is moving along. Quite the contrary. Long treasury yields if anything seem to be perversely discounting dollar appreciation more than depreciation, which I doubt is what China is counting on at this stage.
DC — Ray Dalio (Bridgeport) seems to agree with you. See today’s FT! I think we may need a somewhat more symmetric monetary policy, one that responds to bubbles on the upside as well as on the downside, and a more active regulatory regime, one what isn’t loosened on the upside and then loosened on the downside (by for example waiving certain capital requirements to avoid inducing a credit crunch).
DC,
You know, when you steer clear of dubious arguments about M3 growth, dollar hegemony via dollar pricing of oil and aspersions on Rubin etc, I think you actually make sense!
Also watching: As the trade deficit declines, does consumption collapse, or investment? (Or both, like Doktor Roubini says.) To the extent that investment holds up (c.f. Hussman), the big beneficiaries will be firms with lots of operating leverage — like for instance, our high value-added, capital-intensive export champions. Course operating leverage heightens risk just like the financial kind; red ink builds up fast as you drop below breakeven. And more investment means less consumption, top line pressure on those hypersensitive margins. So as the wheels fall off the ABS graftwagon, that big volatility smile may not be so extravagant in certain sectors. One should perhaps not get too carried away with those back spreads, Mr. Skew-Strategy-genius-bending-spoons-with-the-sheer-power-of-your-awesome-mind, not to mention any names.
RebelEconomist,
Check out Shadowstats on broad M-3 money supply growth, currently rising at a 16% annualized rate.
http://www.shadowstats.com/alternate_data
In 1996 — the middle of the supposed Clinton economic miracle — the Kaiser Foundation conducted a survey of the American public that purported to show how out of touch the electorate was with economic reality. Most Americans thought inflation and unemployment were much higher, and economic growth was much weaker, than reported by the government. The Washington Post bemoaned the economic ignorance of the public. The same results would be found today.
Neither the Kaiser Foundation nor the Post understood that there was and still is good reason for the gap between common perceptions and government reporting: government data are biased in politically correct directions and increasingly have diverged from common experience and reality since the mid-1980s. Inflation and unemployment reports are understated, while employment and other economic data are overstated, deliberately.
Latest from Stephen Roach,
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_pesek&sid=aok4uGrh6E7g
Jan. 7 (Bloomberg) — In early 2001, economist Stephen Roach raised a warning flag that enraged many peers: The U.S. risks repeating Japan’s mistakes of the 1990s.
It was during the darkest days of the Nasdaq crash that Roach, then Morgan Stanley’s chief economist, began worrying Japan’s malaise could be repeated in the No. 1 economy. The concern was less about the loss of wealth than policy makers papering over economic cracks with easy money.
Roach called it the “bubble fix,” a policy then-Federal Reserve Chairman Alan Greenspan is now at great pains to justify. Ben Bernanke hasn’t deviated from that strategy since succeeding Greenspan in February 2006.
At its core is a Bank of Japan-like belief that low short- term rates and liquidity are the cure for sliding stocks, plunging real estate prices and lost investor confidence. As 2008 begins, U.S. policy makers need to look long and hard at whether they’re repeating Japan’s mistakes.
“The only lesson the U.S. has learned from Japan is how to clean up the post-bubble mess,” says Roach, now chairman of Morgan Stanley in Asia.
“America has failed to learn the much more important lesson — how to avoid dangerously destabilizing bubbles in the first place. The Greenspan/Bernanke ideology still places disproportionate emphasis on the former while ignoring the latter at great peril.”
$200 per Oil barrel in 2008 anyone?
Oil $200 Options Rise 10-Fold in Bet on Higher Crude
http://www.bloomberg.com/apps/news?pid=20601087&sid=aERkSvnAUV_U&refer=worldwide
Jan. 7 (Bloomberg) — The fastest-growing bet in the oil market these days is that the price of crude will double to $200 a barrel by the end of the year.
Options to buy oil for $200 on the New York Mercantile Exchange rose 10-fold in the past two months to 5,533 contracts, a record increase for any similar period. The contracts, the cheapest way to speculate in energy markets, appreciated 36 percent since early December as crude futures reached a record $100.09 on Jan. 3.
“One hundred dollars a barrel is actually 14.9 cents a cup, so we’re still talking about oil being remarkably cheap,” said Matthew R. Simmons, chairman of Simmons & Co. International, a Houston-based investment bank that focuses on energy. Inventories “are tight as a drum and I don’t see how we get out of this box,” he said in a Bloomberg television interview last week. “Demand clearly isn’t starting to slow down.”
Global Consumption
World consumption will rise to 87.8 million barrels a day this year, 2.1 million more than in 2007, or about the same amount that Nigeria supplies, according to the Paris-based IEA, an adviser to oil-consuming nations. Demand from China alone will increase 5.7 percent to 8 million barrels a day as imports expand to support an economy that’s likely to grow 11 percent, the IEA said.
RebelEconomist wrote: “You know, when you steer clear of dubious arguments about M3 growth, dollar hegemony via dollar pricing of oil and aspersions on Rubin etc, I think you actually make sense”
(a) Do you think M3 is actually decreasing ? And why isn’t it being published anymore, for that matter ?
(b) Do you think having your own currency as the world’s reserve currency, the currency in which you need to buy in order to buy oil from the Saudis, the currency in which you may/can/do denominate all your debts, a disadvantage to that country ?
Re: (b) I surmise Brad is concerned about PBOC reserve “transparency” because holding that many dollars destroys the “house” or “market maker” status of the US. In other words, the Fed’s ability to manipulate world currency markets via Fed Funds is threatened when a non-client state accumulates a trillion pieces of green paper.
point 5 of 2008: yep. Don’t foget all the South-South action going on down here.
Guest-
Oil has been rising abnormally in past two and half years. Given historical terms this is a small period of time. Dollar hegemony is a new concept that has surfaced in past few years. Dollar provided stability for so long that it cannot be discounted in a short period of time.
Its like biting the hands that fed them for so long. Another 3 years things may change. Dollar hegemony is a
another new phrase who dont like US and pull US down for any sort of rubbish reason. Nobody spoke of dollar hegemony in 1998 when oil and commodity price hit a low . Everybody was concerned about post soviet collapse at that time.
I am trying to justify all american actions are right
but people should not change mind in short frame of period. 10 to 15 years must be considered optimum for long haul macroeconomic decisions.
US Dollar Hegemony
by Republian Congressman Ron Paul
http://www.house.gov/paul/congrec/congrec2006/cr021506.htm
The US’s ability to undertake imperial conquests like that of Iraq depends on its obvious military supremacy, this in turn is ultimately based on the use of the US dollar as the world’s reserve currency. It is the dominance of the dollar that underpins US financial dominance as a whole as well as the apparently limitless spending power that allows it to keep hundreds of thousands of troops stationed all over the world.
The core advantage of the US economy, the source of its financial dominance, is the peculiar role of the US currency. It is because the dollar is the world’s reserve currency that the US is able to maintain its twin deficits (fiscal and trade) and depend on the world’s generosity. It needs a subsidy of at least 1.2 billion dollars per day to keep up its level of spending. Its military superiority is one reason why it it is unlikely ever to face an embargo, but more importantly, it can continue to live beyond its means because of US dollar hegemony. But for long?
US Dollar Hegemony
by Republian Congressman Ron Paul
http://www.house.gov/paul/congrec/congrec2006/cr021506.htm
The US’s ability to undertake imperial conquests like that of Iraq depends on its obvious military supremacy, this in turn is ultimately based on the use of the US dollar as the world’s reserve currency. It is the dominance of the dollar that underpins US financial dominance as a whole as well as the apparently limitless spending power that allows it to keep hundreds of thousands of troops stationed all over the world.
The core advantage of the US economy, the source of its financial dominance, is the peculiar role of the US currency. It is because the dollar is the world’s reserve currency that the US is able to maintain its twin deficits (fiscal and trade) and depend on the world’s generosity. It needs a subsidy of at least 1.2 billion dollars per day to keep up its level of spending. Its military superiority is one reason why it it is unlikely ever to face an embargo, but more importantly, it can continue to live beyond its means because of US dollar hegemony. But for long?
One more comment, if this oil backed US Dollar hegemony theory is a delusion, the US administration can easily discredit it - by declaring that the USA has no objection if oil exports to the Euro Zone and China are denominated in euros.
Satish - Really nobody spoke about Dollar Hegemony?
“By Lawrence Kudlow
Sometime in the latter half of the 1990s I coined the phrase “King Dollar.” This was back in the post-Soviet collapse period, when the U.S. greenback ruled the world currency roost.”
are the first two sentences of
http://intellibriefs.blogspot.com/2007/10/restoration-of-king-dollar.html
published in 10/2007.
The dollar hegemony is not bad on its own. Its just combined with the dollar’s speedy devaluation, which makes troubles for others. And this devaluation is the fault of too low interest rates.
You say one should wait longer to draw conclusions, but since GWB took office US problems have grown rapidly and it does not seem to me, that even a better president can change that soon. The reason why the high trade deficit already under Clinton was seen as not such a big problem, was that some people thought, the US would grow much faster than e.g. Europe for a long time. As well the federal budget was reported to have a surplus, which some believe was making sure, that US investment would be profitable, somehow. Now it seems US and Europe may well have very similar growth rates and the budget will not have a surplus any time soon.
Beside political reasons - Russia (bankrupt) and China still too weak, Japan in economic problems, Europe grateful for the US fight against the communism - these illusions have made it easy for everybody to accept “King Dollar”.
Guest on 2008-01-07 11:27:13:
I don’t dispute that M3 is increasing, but I do question what that means at a time when the activities of SIVs are being brought back onto bank balance sheets. I did look at DC’s shadowstats link (and, incidentally, I agree with him, and them, that inflation, and therefore real growth is being fiddled), and I noted that the narrow measures of money are growing comparatively slowly. In fact, I believe that base money, which is what the Fed directly controls, is hardly growing at all.
Having oil priced and traded in dollars is worth having, because it does mean that more dollars are held as precautionary balances, but since the oil buyer can obtain the dollars shortly before the transaction, and the oil seller can sell the dollars shortly afterwards, this is not a cause to hold many dollars. As Ron Paul says, the fact that the dollar is the world’s reserve currency makes funding the war in Iraq easier; it is not why the US invaded Iraq.
“As Ron Paul says, the fact that the dollar is the world’s reserve currency makes funding the war in Iraq easier; it is not why the US invaded Iraq.”
Ron Paul says that oil backed US Dollar hegemony was a contributing economic factor in the US invasion of Iraq, but not the only political factor. Remember that Paul Wolfowitz was on official record as stating, “oil revenues from Iraq will entirely cover the cost of the war”. When the oil factor in the Iraqi invasion was openly acknowledged by a senior Bush Administration official, why are people still debating whether Iraqi energy reserves played a significant factor. Why doesn’t the US also invade non-democratic North Korea and Cuba which are building “real” nuclear reactors?
DC,
I agree that the US (or perhaps I should say “we” since I am British and was not implacably opposed to the invasion) invaded Iraq primarily because of its oil, which I think the US wanted freely supplied to the world market. But that is not the same as saying that Iraq was invaded to defend US currency hegemony.
RebelEconomist,
if you think the US invaded the Iraq for oil, but wanted freely supply the world with it, then
a) why don’t they do it? The Iraqi gov. was forced to sign a contract giving special conditions for US companies in Iraq. This obviously switchs off competition and makes the oil therefore more expensive then it would be in case of no such contract. So the US is not selling it for “free”, but for a little fee. Only that US companies and not Gov gets the fee.
b) Why they have done the war then at all? In 1998 France urged the UN security counsil to stop some of the sanctions, which would have effectively allowed Iraq to export as much oil as it wants and foreign companies to invest in Iraq. French Total had plans finished on the desk. US and UK vetoed the French resolution, which would have passed otherwise by majority vote.
I personally think that the main reasons to invade Iraq were geostrategic and maybe even ideological - free the world and that stuff.
WASHINGTON (MarketWatch) — The biggest danger to the U.S. economy right now is that financial markets could remain unsettled, said Atlanta Fed President Dennis Lockhart on Monday
YOU SEE HOW IMPORTANT STOCKS ARE TO THE FED! of all the mortgage trouble, defaults, fraud, foreclosures, spike in unemployment, $3 gas, $100 oil and this is the Fed Presidents “biggest danger”.
the discussion here got a bit off track — i wasn’t really looking for a discussion of dollar hegemony so much as a discussion of what to look for in 08, and whether my top 5 list for 07 made sense.
Guest: Bottom line is that the probabilities that determine such structures are themselves fraught with risk. Those who rely on quants will never learn this lesson.
I really don’t think that it is fair to blame the quants for this one. Given any decent set of probablilities the CDO models all pretty clearly show that you will have a mess on your hands, and there is this thing called *common sense* that most people have (including quants) have.
The trouble is that in some places bringing up inconvenient facts will cause you to get slapped down, and there is always the “Dilbert factor” by which the intelligence of groups of people seems to be lower than those of the individuals within it.
The wonder of capitalism is that those places in the long run do much, much more poorly than places where warnings are taken seriously.
In my day, I’ve written my share of memos, saying to management, look… you have this big, big problem which will kill the company in two years or so. At this point one of two things happens. In somewhat rare situations, people listen and the problem gets fixed. In most situations, no one who can change things wants to listen to bad news, and in two years, there is this big, big problem that kills the company, but in the meantime I’ve gotten my parachute prepared and I leave with a clear conscience……
DC: In the mail over the weekend, I received a personal loan offer from Chase Manhattan for a “Zero” interest loan till December 2008.
Read the fine print. There’s often a 3% balance transfer fee, and if you miss one payment your interest rate jumps to 25%. There’s also the 3% transaction fee from the that the bank gets when you use a credit card. Also, if you use the credit card for anything while you have a promotion interest rate, then that charge usually gets charged at the high 20% interest rate.
Also the purpose of these promotions is to get people who use credit cards with revolving credit care balances in which case the bank really, really makes money.
Yes you can take advantage of the free money if you are careful, but there are a large amount of traps, that you can trap on, and if you trip any of them, then the bank makes money off you.
When dealing with financial institutions, always look the gift horse in the mouth. If you can’t figure out how the bank is trying to make money from you, then look harder.
that’s a good post, great clarity and focus - but the first time
and younger voters in iowa and new hampshire are not
reading setser / roubini on china, they are watching stuff on
u tube instead :
google for -
‘information clearing house’. 7 january 2008.
item : “how u s businesses shaft u s taxpayers.”
(true or false, you decide - but definitely effective ?)
.
One thing that colors my view of the world is knowledge that if the oil companies had their way, then there wouldn’t have been a war in Iraq.
Oil companies manage to do business with just about everyone. Every major US oil company is doing business with Iran through foreign subsidiaries and the lawyers make sure that all of the i’s are dotted and the t’s are crossed, and the money keeps flowing.
You can blame big oil for a lot of nastiness in the world (the fact that finding oil is probably the worst thing that can happen to a third world nation, the fact that the US has horrible urban planning, etc.) However, Iraq is something that big oil has clean hands on.
i am quite glad that young voters aren’t paying attention to either me or dr. roubini — though i suspect his style favors a younger demographic than my style!
mark — the big barrier to more south-south flows (on the financial side) is that almost all of the south (defined economically not geographically — australia doesn’t count) now runs a current account surplus. And even say india, which has a deficit, is intervening massively. I am not sure it would welcome a lot of chinese money, or be willing to run a bigger deficit if the deficit is financed by china than would otherwise be the case.
and there are a few countries in the south — brazil, india — with a major cost of sterilization problem.
DC: Its military superiority is one reason why it it is unlikely ever to face an embargo, but more importantly, it can continue to live beyond its means because of US dollar hegemony. But for long?
For as long as the American public is willing to put up with the cost in blood and treasure of empire which could probably be several decades at least.
Economic power -> Military power -> Economic power -> Military power -> etc….
I don’t have any illusions that this isn’t what is going on. I just think that it is a lot more stable than a lot of people think. As long as the Taiwan issue doesn’t blow up, there is neither the will or desire for China to challenge US power. Russia, India, and the EU also don’t have the will or the means to challenge the US. Japan’s very limited interest in foreign policy assertiveness under Abe has also ended.
sorry
“2. Will Europe’s own — and hopefully more modest — version of the subprime crisis begin to unfold in Eastern Europe?”
Why in east Europe, what about UK, Ireland, Spain with roughly 20% of GDP in the construction buisiness?
“3. Will losses on foreign currency reserves emerge as a major political issue?”
Do you really think authoritarian regimes will start a discussion as long as they can not change it? Wouldn’t start such a discussion mean to stop the dollar peg? If they complain, the western govs will just say, well, why have you bought so much of it?
“5. Will more Americans conclude that globalization is not the same as Americanization?”
Isin’t the polling of Obama and Huckabee already a sign, that most already have realised that? Will there be more protectionism, is a political question. May best guess is yes. In recent times one could read, that as well higher skilled and service jobs are threatend to be outsourced. At some point the political pressure to do just something will grow.
Europe had already several of “CNOOC” cases. E.g. Siemens (Germany) wasn’t allowed to buy Alstom (France). Germany is little China and France is little US, just that Germany gets the peg for free.
Despite some talk about protecting key enterprises and so on I would bet, that no “CNOOC” case will be in Germany. Russia was allowed to buy shares of EADS, what shall be more threatening then selling the biggest defense enterprise to the enemy? When the Sachsen LB was in trouble the federal minister of finance was strictly against federal gov money for the bank. Germany is just THE ultra free-trade country, since a long time. And continental Europeans just do not fear terrorism much. Most fear the govs more reducing civil freedoms for protecting from a fake threat.
To 2007:
“2. Oil’s rise from $50 (at least briefly) to above $90.”
I don’t think that was an big issue. There was a lot of talk about it, but oil was simply undervalued. A fair price is, when oil grows with the nominal GDP growth, not only infaltion. Go back to the 80s or so and extrapolate. You will probably see that it is not that much more expensive now. With growing GDP outcome per energy unit this should still not cause any problems. The more serious issue may be the slow dry up of US oil fields - meaning a higher share of the oil supply has to be imported.
“3. Europe, the new engine of demand for Asian manufactured goods”
This certainly should be watched 2008 as well. Up to know there is not much reporting about it in Europe - OK in Germany and there in 2007 was the biggest trade surplus of all time.
mheck — good comment, most appreciated.
some of the fx losses will show up in democratic countries. and even in china, i am not sure the pboc can hide its losses/ wants to — it may have a stronger interest in making it clear that it isn’t responsible for the current losses and should not be held accountable for future losses. i.e. bureaucratic politics may emerge as a force …
agree tho that any losses in kuwait would never need to be revealed. just give the central bank a bit more oil cash and its balance sheet will be better than new.
Brad,
As I said in a previous thread, the big 2007 story missing is that about food, where the 2007 milestone is best described by the FAO in their November 2007 Food Outlook at http://www.fao.org/docrep/010/ah876e/ah876e00.htm
And the key dynamics in play here is the diversion of agricultural production into biofuels, driven by relentlessly higher oil prices.
An outstanding, academic-level analysis of the issue has just been posted at
http://www.theoildrum.com/node/2431
Big Oil has clean hands on the Iraqi war, but Iraqi oil reserves were definitely a major consideration for the Neo-con foreign policy advisors in the Bush Administration. The fact is that Iraq has the world’s second largest conventional reserves. Paul Wolfowitz all but admitted that the Bush Administration’s strategic goal was to secure Iraqi energy reserves. The Neo-cons believed their own propaganda that an Iraq under US hegemony would be a land of milk and honey. It hasn’t exactly turned out that way, but US Dollar hegemony remains intact as long as oil is priced only in US petrodollars.
Latest from Stephen Roach,
America’s inflated asset prices must fall
http://news.yahoo.com/s/ft/20080107/bs_ft/fto010720081324550910;_ylt=Aowq_522SCo0vjzHOs.Lr5b2ULEF
The US has been the main culprit behind the destabilising global imbalances of recent years. America’s massive current account deficit absorbs about 75 per cent of the world’s surplus saving. Most believe that a weaker US dollar is the best cure for these imbalances. Yet a broad measure of the US dollar has dropped 23 per cent since February 2002 in real terms, with only minimal impact on America’s gaping external imbalance. Dollar bears argue that more currency depreciation is needed. Protectionists insist that China - which has the largest bilateral trade imbalance with the US - should bear a disproportionate share of the next downleg in the US dollar.
There is good reason to doubt this view. America’s current account deficit is due more to bubbles in asset prices than to a misaligned dollar. A resolution will require more of a correction in asset prices than a further depreciation of the dollar. At the core of the problem is one of the most insidious characteristics of an asset-dependent economy - a chronic shortfall in domestic saving.
With one bubble begetting another, America’s imbalances rose to epic proportions. Despite generally subpar income generation, private consumption soared to a record 72 per cent of real gross domestic product in 2007. Household debt hit a record 133 per cent of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007.
None of these trends is sustainable. It is only a question of when they give way and what it takes to spark a long overdue rebalancing. A sharp decline in asset prices is necessary to rebalance the US economy. It is the only realistic hope to shift the mix of saving away from asset appreciation back to that supported by income generation. That could entail as much as a 20-30 per cent decline in overall US housing prices and a related deflating of the bubble of cheap and easy credit.
China-bashers in the US Congress also need to stand down. America does not have a China problem - it has a multilateral trade deficit with over 40 countries. The China bilateral imbalance may be the biggest contributor to the overall US trade imbalance but, in large part, this is a result of supply-chain decisions by US multinationals.
By focusing incorrectly on the dollar and putting pressure on the Chinese currency, Congress would only shift China’s portion of the US trade deficit elsewhere - most likely to a higher-cost producer. That would be the same as a tax hike on American workers. If the US returns to income-based saving in the aftermath of the bursting of housing and credit bubbles, its multilateral trade deficit will narrow and the Chinese bilateral imbalance will shrink.
“…What “operating commercially” means to me is that the government central bank sets limits on the total rate of loans (either administratively or by open market transactions), but does not direct the banks to lend to individual sectors…” Written by Twofish on 2008-01-04 15:37:57
“…China’s monetary policy is opaque because it operates “under the guidance of the State Council” - that is, it is heavily politicised. The PBoC’s most powerful levers are what it calls “other policy instruments”. These include ordering banks to increase or decrease lending volumes - regardless of the prevailing interest rate - as well as suggesting where loans should go…” http://www.ft.com/cms/s/0/b86702ba-bd5a-11dc-b7e6-0000779fd2ac.html
For the moldbugs,
Gold is the new global currency
http://www.ft.com/cms/s/0/301c112e-bd51-11dc-b7e6-0000779fd2ac.html
It is seen as a store of value when everything else seems risky. But the bigger drivers behind the rising spot price are a depreciating dollar and the prospect of negative US real interest rates…
Prices have a long way to go before they approach the inflation-adjusted record touched in 1980 when Soviet tanks invaded Afghanistan. At Monday’s $859, gold was trading at less than half that level. It could top $1,000 and still be at the lower end of what some analysts argue is a safe haven range…
The world’s major economies have experienced rapid money supply growth of 10 per cent plus per annum in recent years…
Gold’s rise shows investors are nervous. That is an important message for central banks contemplating interest rate cuts. The Fed must show it is not prepared to allow inflation to take off. Keynes called gold a barbarous relic. It has life left in it.
http://www.forbes.com/2007/12/28/china-innovation-patents-tech-enterprise-cx_ct_1231chinadiary.html
The Chinese government’s goals are sweeping: to develop, influence or downright own the core intellectual property of the next generation of technologies that will power the global economy. To do this, the government has committed to doubling its spending on research and development so that it reaches 2.5% of China’s gross domestic product by 2010, approaching $100 billion annually. China is also on track to have more research scientists and engineers than any other country by 2015.
China’s efforts are sharply focused on 16 fundamental sectors. Among them are high-end chips, semiconductor manufacturing, next generational wireless communications, software, pharmaceuticals, large aircrafts and space systems including high-resolution Earth-observation systems. The government also intends to use China’s very large domestic market as a carrot to encourage the international community to embrace and support inventions from Chinese companies.
The current determination in China echoes what Americans experienced in the 1960s during the space race. Back then, we had a national focus. Programs touched everyone, even school children. We were thrilled to see an American take that first small step on the moon. The investments made to propel the U.S. through the space race and its military twin, the cold war defense buildup, became cornerstones of American economic prosperity. They supported the education of cadres of science and engineering students who subsequently invented personal computers, software, wireless communications and the Internet. Thanks to such investments, America became exceptionally good at thinking things up.
How will the world change if the next great technology breakthrough happens in China? We haven’t yet seen a Chinese breakthrough on the scale of an ipod or Web browser. But this will happen sooner than many pundits expect.
China transforms itself quickly. Everyone knows about the skyscrapers of Beijing or Shanghai. But I have also walked the streets of many “Tier 2″ and “Tier 3″ cities from Lanzhou in the northwest to Guilin in the southeast. These once decrepit towns now pulse with energy as crane after crane builds skylines that would rival any U.S. or Asian metropolis. In cities like these across China, a PC mall with at least 100 storefronts opens every other day.
Everyone has a stake in China’s innovation economy: the research institutions, American-trained Chinese Ph.D.’s flocking back to China, Silicon-Valley funded start-ups in Suzhou, the Chinese multinationals looking to join the ranks of the global greats. International companies, too.
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> some of the fx losses will show up in democratic countries. and even in china, > i am not sure the pboc can hide its losses/ wants to — it may have a stronger > interest in making it clear that it isn’t responsible for the current losses
> and should not be held accountable for future losses. i.e. bureaucratic
> politics may emerge as a force …
Anyone have any links to debates (in Chinese) about de-pegging (and not from stooge Chinese chief economists at the citibank shanghai…..). So far, I haven’t seen any (but I haven’t looked that hard). Clearly the peg is inflationary- wondering how many Chinese at CASS realize this, or whether its a political no-no to talk about depegging, because, for example, some Americans say they want it. Haven’t seen a lot of complaints here about the peg or currency losses, have seen headline stories on complaints about inflation. Want to see some debates about their linkages, in Chinese.
Satish: Having the dollar as a world currency isn’t intrinsically bad, if it leads to world economic stability. But the US has abused its “numeraire” privilege by fooling with rates for the sake of its own economy (actually, the sake of the US financial community), creating destablizing asset bubbles within itself and around the world. 1998, around the time of the Asian Financial Crises, was one such destablizing asset bubble. Being able to write IOU’s for all manner of your debts, and then getting everyone to use those IOU’s as world currency, is certainly a privilege anyone would like to have, but once you start abusing the the privilege by randomly printing IOU’s (say, for the sake of your own stock market), then ultimately, its detablizing to the world.
inflation is clearly the bigger domestic issue in china. it has far wider resonance. the difficulty for the pboc is letting the currency appreciate helps with inflation, but it means eventually showing losses. in some sense that is inevitable — the losses are how china subsidizes its exports sector through the central bank. holding your exchange rate down means over paying for foreign assets.
nonetheless, i am not sure that the Chinese public recognizes that fx losses at the pboc will dwarf the CIC’s losses on blackstone. and at some point, the intrinsic loss will have to be realized.
if you see anything in chinese that is is interesting (and translate it), do let us know.
To Guest:
The State Council stopped directly setting interest rates circa 1995, and the PBC stopped issuing credit targets to banks around 1999. From 2000-2005, administrative macroeconomic control has been done on the demand side by the State Council giving orders to SOE’s not to borrow or spend rather than on the PBC directly giving credit orders the banks. The China Banking Regulatory Commission *has* issued regulations on targeting lending. PBC hasn’t targeted sectors because it doesn’t have the legal authority to do this.
Also I wouldn’t call the PBC’s monetary policy “opaque”, Whether it is a good monetary policy or not is another issue, but the PBC has been pretty transparent about what it has been doing, and why it has been doing it.
bsetser: nonetheless, i am not sure that the Chinese public recognizes that fx losses at the pboc will dwarf the CIC’s losses on blackstone. and at some point, the intrinsic loss will have to be realized.
And then we play the great political game called “hide the losses” which is second only in popularity to the other great game called “it’s not my fault.”
Guest: Anyone have any links to debates (in Chinese) about de-pegging (and not from stooge Chinese chief economists at the citibank shanghai…..). So far, I haven’t seen any (but I haven’t looked that hard). Clearly the peg is inflationary- wondering how many Chinese at CASS realize this, or whether its a political no-no to talk about depegging, because, for example, some Americans say they want it.
I haven’t read any formal papers on it, but I have heard snippets of conversations at conferences. The reason that I think there hasn’t been a loud public debate is that there is a semi-cordial private debate about what is going on and what to do about it.
Also, I do wonder about the comment about “Chinese stooge economists at Citibank Shanghai.” Mid-level Chinese economic decision makers and Chinese wall street investment bankers basically come from the same group of people (i.e. went to school at Beijing or Qinghua, MBA from Harvard, worked on Wall Street for a few years before moving into the Chinese economic bureaucracy) so there are tons of personal links between Wall Street and the Chinese government.
Also, my sense is that there is no longer a debate over whether China should appreciate the yuan, the debate is on the operational details on how, and most of that involves dry technical details mixed with everyday bureaucratic decision making. I haven’t heard any Chinese voice in the last two or three months argue strongly that China shouldn’t appreciate the RMB.
Hi All,
I think the big thing to watch out for in 2008 is the reacceleration and reinflation in the US.
Call me contrarian, but I think we are going to see the lagged massive expansionary monetary effects in 2008. All thanks to the low interest rates and loose monetary policies.
The last push before the cliffs. Have you seen what happens when u overpour your beer into a glass? It spills.
2008 will see the beginning of Chinese firms pushing the US out of various areas of the world economy. The market cap, for example, of China Petroleum and Chemical is more than that of the three largest US chemical companies.
http://www.chinadaily.com.cn/bizchina/2008-01/07/content_6376074.htm
And Boeing will be squeezed too in the coming years. If aircraft exports from the US decline, our balance of payments will take a big hit.
“As much as Roach’s prescription makes sense, I guarantee that American politicians will do everything in their power to prevent consumers from taking their medicine. It’s much easier to blame China than admit to our own profligacy and live leaner.”
“China-bashers in the US Congress also need to stand down. America does not have a China problem - it has a multilateral trade deficit with over 40 countries. The China bilateral imbalance may be the biggest contributor to the overall US trade imbalance but, in large part, this is a result of supply-chain decisions by US multinationals.
By focusing incorrectly on the dollar and putting pressure on the Chinese currency, Congress would only shift China’s portion of the US trade deficit elsewhere - most likely to a higher-cost producer. That would be the same as a tax hike on American workers. If the US returns to income-based saving in the aftermath of the bursting of housing and credit bubbles, its multilateral trade deficit will narrow and the Chinese bilateral imbalance will shrink.”
Brad,
You say at 2008-01-08 00:00:48: “nonetheless, i am not sure that the Chinese public recognizes that fx losses at the pboc will dwarf the CIC’s losses on blackstone. and at some point, the intrinsic loss will have to be realized”
Read the link on my comment above on 2008-01-07 07:30:46, where I present evidence that casts doubt on the view that China will realise a loss on its dollar reserves. If you don’t agree, then say why you think the sterling experience is not representative. I like to think that I am open to learning from the discussions on your blog. I hope you are too.
As would be predicted, rising yuan seriously damaging China’s textile industry competitiveness. - DC
China’s Textile Industry Becoming Less Competitive
http://www.bloomberg.com/apps/news?pid=20601089&sid=aNeWGfYr6H_Q&refer=china
Jan. 8 (Bloomberg) — China’s dominance of the global garments trade may be eroded as rising labor and raw material costs are making it tougher to compete with rival Asian producers, a textile industry executive said.
“China is gradually losing its traditional competitiveness in production costs, while other Asian countries are speeding up development,” Sun Ruizhe, vice president of the China National Textile & Apparel Council, said at a conference in Beijing today.
Other Asian nations, such as Bangladesh, Pakistan and India, will take some of China’s business, while Vietnam and Cambodia may become apparel “tigers,” Antoshak said in an interview.
China’s average wages have risen more than 50 percent in the past five years, while the yuan currency has gained about 14 percent against the dollar since the end of a peg in 2005. The government has also cut export tax rebates and tightened lending.
“…the PBC has been pretty transparent about what it has been doing, and why it has been doing it…” Written by Twofish on 2008-01-08 01:07:17
“Yet policy in China - supposedly the world’s economic future - is largely unfathomable… Instead of untangling the Central Bank’s process, the key to understanding China’s monetary policy may be its bias towards expansion in order to mitigate social tensions.” http://www.ft.com/cms/s/0/b86702ba-bd5a-11dc-b7e6-0000779fd2ac.html
RebelEconomist on 2008-01-08 05:02:08
What you say should happen may well happen with respect to dollar depreciation plus dollar equity returns.
It may not happen with dollar depreciation plus treasury returns because the financial world is different now than it was in your case study.
Which is why China should be buying US equities now.
Stephen Roach as quoted by DC said:
“America’s inflated asset prices must fall”
From the viewpoint of “physical inputs role and limits-aware” economics, the crux of the matter is that future purchasing power must fall in terms of tangible things because there will be less tangible things to be purchased in the future. Period.
There are two ways future purchasing power aka wealth can fall:
A. Falling asset prices and steady commodity prices. This would happen if the Fed adopts a new monetary policy focused on the preservation of the dollar value for international transactions through checking its global supply growth.
B. Stable asset prices and rising commodity prices. This is the current path. It can be expected to lead to the abandonment of the dollar as international reserve currency and a further plunge in its value, at least against the currencies of critical commodities-exporting countries, if they wise up. But if the issuers of potentially competing currencies show as keen as the Fed in debasing them, the market may accelerate its ongoing process of adopting, first as store of value and eventually as medium of exchange, a currency that cannot be debased.
As Benn Steil said in
http://www.foreignaffairs.org/20070501faessay86308/benn-steil/the-end-of-national-currency.html
“It is widely assumed that the natural alternative to the dollar as a global currency is the euro. Faith in the euro’s endurance, however, is still fragile — undermined by the same fiscal concerns that afflict the dollar but with the added angst stemming from concerns about the temptations faced by Italy and others to return to monetary nationalism. But there is another alternative, the world’s most enduring form of money: gold.
…
It is the market that made the dollar into global money — and what the market giveth, the market can taketh away. If the tailors balk and the dollar fails, the market may privatize money on its own.”
Furthermore, from the viewpoint of Hubbert’s Peak, path B has the added significant drawback of accelerating - by causing relentlessly higher oil prices out of fostering aggregate demand in its current profile - the diversion of agricultural production into biofuels, thus hastening the arrival of the third horseman.
RebelEconomist
I don’t understand at all, what the text you linked wants to say. I expect the world reserve currency to have lower interest rate than other currencies. So I would have expected higher returns for the sterling debt than for the dollar debt, not vice versa.
As well some time of the showed time in the graph there was gold standard, BW, …
Part of the safe haven status of the dollar was due to political danger of higher probability in Europe to get a hot war than US.
Today situation in China, Japan and the gulf is completely different. They have massively intervened, so their currencies are undervalued right now.
Their currency will not become world reserve currency, which means they will not get the low interest advantage the dollar got over the last century as compensation for the appreciation.
The difference in PPP and nominal value, which should narrow with time, will bring higher inflation at least to China without depreciation of the RMB, but will force China to have relatively high interest rates. The other markets, especially the gulf markets are relatively small compared with US, which brings interest up, once they have to have an economy not based mainly on oil.
There will be losses in the short and the middle term. In the long term no predictions can be made seriously, but historic experience will help only limited, as we have a completely new situation.
Guest on 2008-01-08 07:13:30:
I agree that China should buy equities, which I would argue are more appropriate investments for a sovereign wealth fund than bonds anyway…..if the US will let them of course. Buying equities would protect the Chinese against inflationary debt repudiation by the US, which, when you read what Bernanke has said, must be a strong possibility in the near future.
mheck82 on 2008-01-08 07:29:34
Thanks for raising some differences. You make a good point about the US being a safe haven during the Second World War and Cold War. However, the UK was on the gold standard for very little of the 1914-2006 period. Convertibility was suspended during the First World War, resumed in 1925, and abandoned permanently in 1931. You could argue that sterling was tied to gold as part of Bretton Woods, but as the occasional devalations showed, the UK reneged whenever the going got tough. I certainly disagree when you say that the renminbi will not become the world’s reserve currency. China’s economy will soon be much larger than the US, if only because there are a lot of Chinese. I think it would be unprecedented for the currency of the largest economy not to be widely used as at least one of the reserve currencies - as even sterling remains to this day.
Guest: “Yet policy in China - supposedly the world’s economic future - is largely unfathomable… Instead of untangling the Central Bank’s process, the key to understanding China’s monetary policy may be its bias towards expansion in order to mitigate social tensions.”
I don’t think that policy in China is unfathomable or opaque. Once you know who the players are, how they see the world, and what they want, it’s pretty obvious what is happening and why.
Start out by learning what the major agencies are and how things got to be the way that they are. Also do a “day in the life of a Chinese bureaucrat.” Take some random people, look at their educational background and formation experiences, and try to figure out what a day in their life looks like.
Also the same goes true for the United States. American politicians have more experience dealing with the media so are actually a bit better than Chinese politicians about spinning their motives. Whenever some politician says something, you can do a google to find what they actually said and to whom, what their social/education background is, what their district produces, what they care about. For bills in both the National People’s Congress and the US Congress, its usually a very simple matter of track down legislative history and learning some basic parliamentary procedure.
Also wikipedia is a really good source of information since you have people posting there with lots of deep expertise in some areas.
Guest: 2008 will see the beginning of Chinese firms pushing the US out of various areas of the world economy.
Really, really doubtful. No one serious in China thinks that this is going to happen. Besides, why should Chinese companies “push out” American ones.
Guest: The market cap, for example, of China Petroleum and Chemical is more than that of the three largest US chemical companies
Which shows you how big the Shanghai stock market bubble really is. The *exact same thing* happened with Japanese banks in the late-1980’s, with Taiwanese companies in the early-1990’s, and with US dot-coms in the early 2000’s. When you have a stock market bubble, it massively inflates the price of the companies.
One thing that China has learned from Japan late-1980 is not to believe the propaganda. One reason Japan had problems in the 1990’s is that the Japanese policy makers then actually believed a lot of the “Japan will rule the world/the US is in decline” nonsense of the 1980’s. Chinese policy makers have a very clear eyed view about how powerful the US really is and how weak China is. One reason for this is that you have huge numbers of Chinese policy makers who have spend extensive time in the United States, which isn’t true with Japan-1980 or Soviet Union-1960.
“the renminbi will not become the world’s reserve currency”
The yuan will form the basis of regional bloc that will include Southeast Asia, but it won’t become the world’s reserve currency. The economic costs of becoming a global superpower is far too great for China, and would be resented around the world. Cultural and Ethnic ties bind China to Southeast Asia with a large Chinese disporia population. For instance, my father in-law born in Malaysia now lives in Guangzhou. Twenty percent of Malaysia’s population is ethnic Chinese. Seventy percent of Singapore’s population is Chinese. Already the Chinese yuan is almost as accepted as the US Dollar in Thailand, Malaysia, or Cambodia. Gradually the Chinese yuan is moving to more convertability in trade transactions across Asia.
With the recent Singapore-China defense agreement, Southeast Asia is rapidly integrating into the Chinese sphere of influence while the US will remain distracted by Middle East events for decades to come. With the notable exception of Aircraft carriers, the China PLA Navy is now larger in Western Pacific than the US Navy with 60 Destroyers and Frigates, 50 Attack Submarines, 45 Corvette patrol ships, 40 Amphibious Assault transports. A new unsinkable Naval Airbase has been constructed in the Spratly Islands in Southeast Asia.
“…and try to figure out what a day in their life looks like…” Written by Twofish on 2008-01-08 08:14:42
“…Chinese companies routinely shortchange their employees on wages, withhold health benefits and expose their workers to dangerous machinery and harmful chemicals…”
http://www.nytimes.com/2008/01/05/business/worldbusiness/05sweatshop.html
Twofish: Re: the stooges, sorry I take that back. Andy Xie was good (of course, he got fired).
http://liushan.blog.sohu.com/71608650.html
I don’t have time to translate the above word for word, and more importantly, don’t know if this is representative or not. But this blogger (vice editor of the China Business Times newspaper, Econ PhD) names the academics in the camps for slow reval and fast reval [as twofish pointed out, the debate may circle around this], points out the the slow reval camp tends to be more well known in domestic circles and the fast reval camp tend to be associated with international econ circles (e.g. the head of CASS Econ Institute Xu Yong), and that the slow reval camp has thus far won in policy. But he notes that the slow reval camp is changing direction, as seen in 2007 Q4 Monetary Policy Execution Report: “本å¸å‡å€¼æœ‰åˆ©äºŽæŠ‘制国内通货膨胀” = “local currency appreciation will help suppress domestic inflation”
Blogger, who is in the fast reval camp, also notes:
“在美元æŒç»è´¬å€¼bianzhi而人民å¸å¯¹ç¾Žå…ƒæ±‡çŽ‡ç›¸å¯¹ç¨³å®šçš„æ¡ä»¶ä¸‹ï¼Œè¿›å£äº§å“ä»·æ ¼çš„æŒç»ä¸Šæ¶¨ï¼Œå¿…ç„¶å¯¼è‡´å›½é™…ä¸Šçš„é€šè´§è†¨èƒ€ä¼ å¯¼åˆ°å›½å†…ï¼Œä»Žè€Œæ高生产æˆæœ¬ï¼Œåˆºæ¿€å›½å†…物价的上涨。”
“In the case of dollar depreciation and a relatively stable USDCNY rate, prices for imported products continually appreciate, necessarily leading to importation of international inflation. This leads to increasing production costs and stimulates prices of domestic goods.”
Also, just watched diyi caijing [China Business News] on TV. The two economists interviewed are looking for faster (”>10%, maybe even 15%”) RMB appreciation this year. They mentioned inflation will be the force that drives (the gov’t ?) to do that (”makes imported prices cheaper”) and discussed how this would help with the domestic price of oil.
So maybe people here are slowly realizing what this peg is doing to them (its not something you typically read about in the “China Daily”)
DC: Cultural and Ethnic ties bind China to Southeast Asia with a large Chinese disporia population.
That’s also precisely why the PRC *won’t* try to turn southeast Asia into a regional bloc, and why SE Asia won’t let it. Any effort by the PRC to assert power over southeast Asia will meet with a very nasty backlash from non-Chinese in SE Asia, and that won’t be good for the PRC, and it won’t be good for ethnic Chinese in SE Asia.
There was a SE Asian foreign minister (I think from Indonesia), who said that it would be awful if *either* China or the United States dominated SE Asia or if there were a huge conflict between the two over Taiwan. The best scenario for them would be if the US and China balanced either other in a friendly way, allowing SE Asia to play each against the other.
The friendliness between Singapore and China can been seen in this light. Singapore is also strengthening military cooperation with the United States at the same time it is strengthening military cooperation with China.
DC: Twenty percent of Malaysia’s population is ethnic Chinese. Seventy percent of Singapore’s population is Chinese.
And 80% of Malaysia isn’t ethnic Chinese, and 30% of Singapore isn’t ethnic Chinese. One thing that China has to be very careful about doing is to behave in a way that doesn’t destabilize ethnic relations within SE Asia. Traditionally, the PRC has been very good about this.
Trying to juggle national identities is something I have to worry about in a daily basis, and this is one reason I find working in multi-national corporations to be relaxing, because that’s one place where I don’t have to worry too much about the “loyalty” issue.
The curious thing is that I’ve tended to find more Chinese ultra-nationalists on the internet among Malaysian Chinese than Chinese Chinese, but reading Malaysian history makes this understandable. What I don’t think that there is an appreciation of is the difficulties (along with the benefits) that China as a rising superpower puts on overseas Chinese.
The one reason I’m interested in finance is that if the US economy collapses as China rises, this will get really bad for me. Really, really, really bad.
Guest: But he notes that the slow reval camp is changing direction, as seen in 2007 Q4 Monetary Policy Execution Report: “本å¸å‡å€¼æœ‰åˆ©äºŽæŠ‘制国内通货膨胀” = “local currency appreciation will help suppress domestic inflation”
Yup. That’s my sense of the direction of the debate too. Also there is a lot of good stuff on the web, and I’d wish some major newspaper would learn the value of “hypertext” and post links to original primary documents like the PBC monetary reports.
DC: A new unsinkable Naval Airbase has been constructed in the Spratly Islands in Southeast Asia.
It would be a total disaster for ethnic Chinese in SE Asia if the PRC pushed the Spratlies issue, which fortunately, it really isn’t doing.
China’s best course of action is to “agree to disagree” about the Spratlies and talk about joint exploration of oil.
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