Are sovereign wealth funds an inevitable consequence of globalization?
Stephen Jen — Morgan Stanley’s sovereign fund guru — say so.
I am not convinced.
Sovereign wealth funds are arguably an inevitable consequence of very rapid reserve growth. Thus, they could be an inevitable consequence of targeting an undervalued exchange rate — or a government decision to save a large share of the surge in government revenue from a surge in commodity prices .
But not of globalization.
Globalization need not imply current account surpluses in the emerging world, and a flow of capital from poor to rich. Eastern Europe is globalizing, or at least Europeanizing. Yet inside Europe capital flows, generally speaking, from rich to poor. The same was true globally in the mid-1990s — and, I think, the 1870s - as well.
For that matter, today’s flow of capital from poor to rich isn’t a by product of private capital flows either. Private funds are available to support a current account deficit in most of emerging Asia — and in more than a few big Latin economies as well.
A sudden sharp rise in commodity prices certainly would be expected to produce current account surpluses in commodity exporting economies, as domestic spending and investment adjusts with a lag. But it is hard to see how rising commodity prices explain, for example, the roughly $300b increase in China’s current account surplus over the past three years. Today’s global economy looks very different than the global economy of the 1970s: then, large surpluses in the oil-exporting economies financed deficits in oil-importing emerging economies, not just deficits in the US and Europe. Asia in particular ran a deficit then.
I also would argue that there is nothing intrinsic about globalization that requires an "official" capital outflow from the emerging world to the advanced conomies.
Some reserve build-up, sure — no one should want a repeat of the financial turbulence and sharp falls in output the emerging world experienced in the 1990s. But not reserve build-up on its currrent scale. Almost everyone would agree that the more reserves you have, the less need to have to add to your stockpile. The $1.2 trillion or so - the final data isn’t yet available — emerging markets added to their reserves in 2007 certainly looks excessive.
But nothing about globalization required that China and the Gulf maintain (more or less) dollar pegs as the dollar tumbled against the euro. That was a policy choice. And that policy choice large explains why private capital — on net — is flowing into much of the emerging world.
Back in 1998 and 1999, lots of people in China were convinced that China would have to allow the RMB to depreciate against the dollar. They — not surprisingly — found ways to move money out of China. Now they think that the RMB will appreciate against the dollar. Not surprisingly, ways have been found to move money into China. Hong Liang’s charts showing the fall in domestic dollar deposits as a share of total dollar deposits are indicative of a broader shift. If emerging market currencies were allowed to appreciate toward an equilibrium level, (net) private outflows would materialize. That would create a world — still a globalized world - that would not be marked by the build up of central bank reserves and SWFs.
I suspect the recent growth of sovereign wealth funds is not an inevitable consequence of globalization so much as an inevitable consequence of a set of specific policy choices. If those policy choices changed, there is no reason why the growth of sovereign wealth funds wouldn’t slow. That no doubt shapes my view of SWFs generally: to me, they stem from policy decisions that have blocked the natural emergence of a more balanced global economy, one that would bring deficits and surpluses globally better in line with private capital flows.
I certainly would argue that the need of many US and European financial institutions to seek capital from SWFS is not an inevitable product of globalization, but rather a product of a set of policy decisions by those firms that left them without enough capital to support the risks they were taking. I think many of the firms that recently have raised capital from SWFs were buying back their stock not all that long ago — and paying out significant dividends. That was their choice, not an inevitable dictak of a more globalized world economy.
Incidentally, Gillian Tett reports that sovereign funds are no longer quite as eager to invest in troubled financial institutions as they were in December and January. Apparently, they are starting to worry that Dr. Roubini might be half-right and that they put money into troubled banks before the banks had recognized all their losses.
"But having stepped into the breach so visibly late last year, some funds are now getting jitters. In China, for example, there are rising complaints that funds are foolish to shovel cash directly into risk-laden US banks when they could be using it in better ways, such as purchasing western commodity or manufacturing groups.
“The Chinese are worried they are turning into [the source of] dumb money,” says one well-placed Asian financier, who partly blames the trend on the Blackstone saga, which produced significant paper losses for the Chinese investors.
Meanwhile, in the Middle East, the latest round of Federal Reserve interest rate cuts has created unease. …. the dramatic scale of Fed cuts has prompted concern that Wall Street is still sitting on a putrid mess - contrary to what the US banks told the sovereign wealth funds late last year. Unsurprisingly, this leaves Gulf investors cynical about promises from Wall Street banks.
Fair enough. Banks lauding sovereign funds for their sophistication and long-term view were (literally) talking their own book, at least in some cases.
That said, China doesn’t appetite for high risk/ high return investment in the financial sector doesn’t seem to be exhausted.
I am a bit surprised that China seems so gung ho to shift from a very safe portfolio — one dominated by Treasuries and Agencies — to a quite risky portfolio, one dominated by potentially risky investments in financial institutions. Adding a few commodities to mix would effectively double down on China’s own investment in its own banks — and both are indirectly bets on continued strong Chinese growth. It probably wouldn’t dramatically reduce the risk profile of China’s fund.
Starting out with a few more old fashioned index finds that provide general equity market exposure would have struck me as a more sensible first step. Call me (financially) conservative.
Hey, Brad — a chain of events for you to parse.
U.S. economy, with low real long interest rates for a period of many years due to intervention by foreign banks, gains massive overinvestment in non-tradeable sectors and a very low savings rate due to the low real rates and the foreign competition/investment causing them.
Next, economic activity slows down due to some butterfly flapping its wings and causing some credit combustion. This piles up into the “subprime” mess, and risk aversion develops big-time. The economic growth in the states sours, and so do many of the investments made by our same foreign friends. The Fed leaps into the fray with a heroic 1.25% drop in a week and a half. Interest rates begin to drop on less-risky debt as real rates of return and inflation expectations are reigned in.
Long bonds popped today though. Really nasty bid to cover and indirect bidding numbers. TIPS didn’t diverge. At the same time, the dollar has gone up significantly against most currencies, even the JPY. Just not the RMB or the Gulf pegs, but hey. Gold doesn’t do much either. This isn’t inflation being priced in.
It’s got to be an increase in real rates of interest. Why? Well, the source of the low rates to begin with was the reinvestment of money by foreign institutions and central banks, greased with all the brilliance of wall street and its acronyms to glow shiny white hot. We’ve seen our imports slow down dramatically during this recessionary phase. You’ve seen the retail sales and ISM numbers. A general drop in economic activity and trade would not be too surprising. Inflation is going up rapidly in China too.
The combination of lower economic activity here buying things made there, along with realigning real yields and inflation expectations, might mean a lot fewer FX reserves from intervention they need to reinvest. That’s why the foreign bankers didn’t bid much today, and neither did crippled domestic banks for their own reason. There’s just not as much cash to invest, even in the safe things, despite Fed efforts to date.
Regardless of why, an increase in real interest rates at this point indicates one of two things: a severe capital crunch and increase in the present value of capital, or a significant increase in expectations of economic growth. Most of the news has been kinda really ugly. Also, if we expected greater economic growth, why would the price of risk be expanding at the same time?
I’m concluding that the real value of money is increasing. Investors are demanding a higher real return on their cash. This encourages savings at a time when economic growth is awful and credit is being destroyed all over. In my opinion, deflation looms. Bernanke better cut a lot further, and quick.
SWF’s are certainly not an inevitable result of globalization, but they are the result of two major factors of the late 1990’s and early 2000’s
1) The Washington consensus which convinced emerging markets that they should peg their currency to the dollar
2) The Asian crisis which convinced emerging markets that they need large dollar reserves
3) The War in Iraq and the Bush tax cuts which created a massive need for US financing.
I think that things would have been quite different economically had Gore gotten elected in 2000.
bsetser: I suspect the recent growth of sovereign wealth funds is not an inevitable consequence of a set of specific policy choices. If those policy choices changed, there is no reason why the growth of sovereign wealth funds wouldn’t slow.
True, but changing those policy choices is going to be quite hard at this point. In particular, now that the US is in Iraq, it’s likely to be bleeding money there for the next several years, and reversing tax cuts is much, much harder than implementing them in the first place.
Also, I really don’t see a major motivation *why* the US would want to change those policies. Putting the world economy into some abstract “balance” is a poor reason for someone to support policies that results in a drop in standard of living.
Finally, even everything goes into balance, you still have China and the Gulf states with several trillion dollars ready to invest and that is going to change things even if no money comes in.
Latest excuse from Washington Consensus to prohibit SWF from developing nations, “SWF are Insider-trading risk”. Where is the hard evidence? While the SEC did absolutely nothing to protect small minority investors from systemic Enron-Citicorp criminal corruption, any excuse will do to bash the Chinese government which hasn’t broken any US securities laws. - Dave C.
SEC Says Sovereign Funds Pose Insider-Trading Risk
http://www.bloomberg.com/apps/news?pid=20601089&sid=atdhFIRDTK_U&refer=china
Feb. 7 (Bloomberg) — Investment funds owned by foreign countries, which are buying more stakes in U.S. companies, may try to use government information to commit insider trading, a Securities and Exchange Commission official said.
The Washington-based SEC is also concerned foreign governments may resist U.S. attempts to examine suspicious trades by sovereign wealth funds, potentially letting illegal activity go unchecked, Linda Thomsen, the agency’s enforcement chief, told the U.S.-China Economic and Security Review Commission today.
I am also skeptical of investment banks’ bullishness about sovereign wealth funds (SWFs), as they stand to make more money from the higher margin, riskier, less liquid investments that a SWF might buy compared with the kind of assets held in a more staid central bank reserves portfolio. I am especially critical of Stephen Jen’s call last July for Japan to create a SWF:
http://reservedplace.blogspot.com/2008/01/one-country-that-does-not-need.html
“…Mr. Buffett… sees no problem with… “sovereign wealth funds” buying up big stakes in U.S. financial stocks. “…The United States is fueling the sovereign wealth funds. We’re making deposits in their wealth funds, in effect.”…” http://www.nationalpost.com/news/story.html?id=291469
SWFs are a bad idea. Governments should create and enforce laws that enable businesses to succeed, not invest directly into businesses. The success/failure criteria should be set by a free market, not by who the government chooses to invest in.
How would a company like UPS feel if it paid taxes and those taxes were invested in FedEx?
My hunch is SWFs look like easy pickings for wall street. Get them to invest $10 billion in say Citigroup when $100 billion is really needed. After the initial $10bil, the rest is easy. Otherwise, they’ll lose the initial $10bil investment. Better for them to invest in government bonds. Something they understand much better.
If SWFs proceed to invest hundred of billions of dollars in equity markets, it will end very badly. Governments need to operate like governments, not businesses.
“China Investment Corporation, the Chinese sovereign wealth fund, is close to an agreement with JC Flowers… The tie-up under discussion would differ from those deals because CIC would be investing indirectly, reflecting the growing worry among sovereign wealth funds of a political backlash as they put more money into well-known foreign companies…” http://www.ft.com/cms/s/0/aeaf55dc-d5b1-11dc-8b56-0000779fd2ac.html
In this discussion, I find the term “globalization” a bit slippery.
“Globalization need not imply current account surpluses in the emerging world, and a flow of capital from poor to rich. Eastern Europe is globalizing, or at least Europeanizing. Yet inside Europe capital flows, generally speaking, from rich to poor.”
Europe may be a special case that proves the rule. European countries were decimated after WWII; many were victims of brutal oppression. Even though they were impoverished, they were not exactly third world countries in terms of cultural or political heritage. They did not and do not have the huge mass of uneducated labor so indicative of many third world countries.
My point is: Globalization works under some conditions; under other conditions, rapid globalization is a recipe for disaster. Economic dislocations are inevitable.
In terms of SWF’s, I would argue that the political composition of some countries (China, for example), combined with rapid globalization enables the growth of SWF’s.
I would argue that the growth of SWF’s in the Middle East is, in some ways, a result of the political composition combined with rapid globalization: Rising demand for a key resource combined with power focused in the hands of a few.
“SWFs are a bad idea. The success/failure criteria should be set by a free market, not by who the government chooses to invest in.”
Tell that to state-owned California CalPHERS pension fund that invests money. California CalPHERS is the largest US pension fund with assets of $146 billion. In fact the CalPHERS pension fund acts more like an activist Private Equity fund than the passive, long-term investments made by the China CIC. In recent years, state-owned CalPHERS filed class action lawsuits versus board of directors of numerous companies, directs state-owned capital into California-based corporations for regional industrial development, and even invest in Chinese state-owned companies including China Mobile, and Bank of China. Please stop making the BS argument that a Chinese SWF conducts business is fundamentally different compared with a state-owned US government fund in California or New Jersey.
http://www.calpers.ca.gov/
Interesting article that, by Tett, and I dare say he’s uncomfortably near the truth.
The way I see it, this subprime mess is basically a US problem. At least the bulk of it, but how it spreads around the rest of the banking world is a bit out of proportion. What’s happening here in Iceland, for example, is typical of many other places, I think. There is no default crisis going on here, but there is a bank crisis. By now it is practically impossible go get a housing loan in any bank here.
The reason this is the bank/bank credit crunch, which is just like a traffic jam. The kind that builds up for miles but is only caused by an accident on the other side of the freeway. You’re standing still or creeping along for hours, because morbidly drivers slow down to get a look at the accident -on the other side, and the ripple effect has caused the huge congestion.
I’m sure these banks that have sold stock to the various SWFs are in need of fresh capital, absolutely. But the rest of the banking system just needs to be able to borrow with similar ease as they could, before the US default epidemic hit.
So, why don’t these SWFs start to behave like banks, more than like “silent partner” investors? Why don’t they start making capital available at reasonable rates of interest to banks that had good business going, but are struggling because of this money traffic jam? Wouldn’t that be a more responsible approach towards the global economy, compared with planting 10 billion here and 10 billion there, then wait and see?
I bet the next step is asking : is globalisation inevitable ?
And the answer is of course not. As inevitably rising protectionism will show.
It s funny to see that whenever a country pushes its currency down, lowering the external purchasing power of its consumers, it boosts profits at home (through high profits exports), boosts foreign investment at home, is so doing boosts its asset markets, hence the external purchaing power of its home investors.
How is it that a chinese worker can not buy the US ketchup at a decent price, but the chinese investor can easily buy a US company share (simply trading it agaist his-her overvalued Chinese company share) ?
Same thing happened in japan 1990.
US 1930.
France 1620.
as written in another thread and as an answer to gillies. (hi Gillies) :
Lowering rates is great. But not enough.
The printing press needs to be reactivated to the max. The central banks need to “lend” to the government and the government needs to pass the cash to borrowers and lenders alike.
Disappearing credit based endogeneous money must be replaced by publicly exogeneously emitted money.
If that is not done, deflation will follow.
Nothing would be worse than restarting another credit boom. Real interest rates must fall while the debt creation remains below the growth rate, and since growth is turning negative, that means debt must be destroyed.
If deflation is to be avoided it is not by lowering rates so that new debt is emitted. It is by printing money so that old debts get erased by public emissions of money.
Dave,
I don’t think it’s a good idea for CalPHERS to be buying equities either.
I’m not sure comparing a pension fund to a central bank is a valid comparison. Pension funds exist to make profits without taking on too much risk. Central Banks exist to stabilise economies. They don’t exist to make profits.
It would be more valid to compare the US Federal Reserve to the PBoC. It would be a very bad idea if the FED were buying equities with their money instead of loaning it to banks.
China’s SWF is used as a political scapegoat in Washington for the bursting of the US Housing asset bubble. It has no financial impact or bearing to the US Economy performance. -DC
http://globaleconomicanalysis.blogspot.com/
Is Citigroup lending to US consumers after two bailouts from Arab SWFs?
Would Citicorp be lending if China CIC Bought the bank? (The deal would never be approved so we have to talk in theory).
The answers to the above questions are
1) no
2) no
This notion that sovereign wealth funds can bail out the US Economy is BS. Sovereign wealth funds do not change this picture. One reason is rampant overcapacity and the second reason is jobs. US consumers are cash strapped. Unemployment is raising dramatically and is poised to go way higher. The recession has just begun. Consumers out of money cannot spend. More houses will be turned over to banks. I am looking for $500 billion worth of capital impairments on residential and commercial real estate. I could be way off on the low side.
The party is over for the US even though hope lingers on.
dave the problem is not SWF, it is undervalued asian and oil exporting currencies and related, excessive foreign reserves and overvalued stock markets in those countries.
If currencies rates were close to the power of purchase parity, there s just no way those countries would have such external surplus with the western world, no way they d have so much reserves, no way they d be able to buy so big companies just by trading massively overvalued shares for a bit less overvalued ones…
THe thing is that US Europe, asia and the oil exporting countries choose the short term growth fix, just add more debt to the pile.
Now the sheme is unwinding. Things are going to be bad for the US and europe. they will of coruse go much worse for CHina, oil exporting countries and all those who rely on western countries demand.
WHo s gonna get screwed ? asian and oil exporting lenders ?
Who s gonna lose most jobs ? Asian exporting industry workers.
The party is over for the world now. And it s time we see how to manage to live without adding to the debt pile…
First step for that needs be stop to antagonize china and USA, as if both countries had not been equally guilty of choosing debt led easy growth path.
DF,
The “real” problem is with irresponsible “loose credit” Federal Reserve monetary policy that has massively misallocated capital in the US Economy into a non-productive asset Bubble in Housing over the past two decades. There is no reason for US banks to lend anymore and there would still be no reason for banks to regardless of what SWF capital infusion pours in. We do not need any more “service economy” strip malls, grocery stores, nail salons, pizza huts, houses or anything else.
The debt-fueled credit bubble in mortgage finance was an absurd monetary policy of the Bernanke-Greenspan Federal Reserve to stimulate the US Economy. One of the most ludicrous economic speeches ever given by a Federal Reserve Chairman, Bernanke’s stated plan to “drop money from helicopters” directly to US consumers might temporarily stimulate the US Economy, but at a longer term cost of more economic imbalances.
When i write “the problem is not SWF, it is undervalued asian and oil exporting currencies and related, excessive foreign reserves and overvalued stock markets in those countries. ”
I m not disagreeing with brad. I just mean, who cares in what form exporting Asia and oil exporting coutnries are lending to the USA and EUrope (sovereign funds or central banks), who cares if that lending goes to secure loans (govt bonds) or more risky ones (banks, commodities). The main problem is : how come they have so much money to lend in the first place ?
this can be developped in :
Why is equilibrium not allowed to happen ? Currencies should float or be fixed so that equilibrium in exchange happens.
Why are those lending countries stupid enough to lend to a country that will never repay, and the borrowing country stupid enough to accept loans that it will never be able to repay. Why are all countries engaging in a lending-borrowing relation that is inherently suicidal, when it would so much more secure to let adjustment happen now rather than later …
The national debt bubbles are exploding one after another. USA, Spain, UK, Iceland, soon France, europe as a whole, japan will get back to its deflation era, and China and oil exporting countries will ultimately see their own bubbles explode (starting with their asset markets).
When all countries see their national debt bubble explode, then of course the international debt bubble will explode too.
THere s just no way asia and oil exporting countries will go on lending to the USA and europe once the asset markets will be falling all over the world, along with house price bubble, commodity bubble, and this in just all god damn country on this planet.
THis is just what every body s been expecting for so long now. Happening now. REbalancing is on the way. It s just that it is now forced by scared to death markets, rather than skillfully planned by clever administrators. And we all know that markets allways fail in forecasting the future, while administrators are the only able to take the common good in charge and enforce some discipline on the market lemmings.
“Who s gonna get screwed ? asian and oil exporting lenders ?
Who s gonna lose most jobs ? Asian exporting industry workers. ”
We shall see. But even under the worst case scenario, if exports from China to the US completely collapse, those exports represent only 2-3 percent of China’s GDP. Ok, China’s GDP growth falls from 10-11% to 8-9%. It’s not a good thing condidering that China needs to find upwards of 12 million more new jobs every year, but not a economic disaster either.
The US is in recession, but the oil price never significantly falls below $90 per barrel. Demand must be coming from somewhere. The somewhere is China where oil consumption import demand soared 21 percent in 2007. China still has difficulty meeting energy demand with even with a new coal-fired power plant built every week in China, 60 new Nuclear power plants in development, dozens of hydropower plants under construction, new oil fields in development from Africa to Latin America, and thousands of wind turbines installed last year.
dave you have it all wrong and it s not the first time.
The bernanke speech was the best in all history. Action is needed when deflation looms. The speech is a bit too optimistic on what the fed can do, and clearly underestimating what the congress needs to do : regulate the finance industry, ban all derivative business, put administrative limits on credit growth, etc : Back to the basics of post 1929 crisis.
THe fed has huge responsabilities in the current mess for not taking action against the stock market bubble post 1995 and the housing market bubble. But most of the blames needs to be put on congress (and other legislative bodies around the world) who deregulated the finance industry and allowed free international movement of capital.
But the fed is not the only central bank in this world, and I have yet to see just one central bank that can come up and say : in my country monetary growth has not exceeded the GDP growth.
THis has happened every where, Be it europe, US, canada, asia … Every where we ve seen central banks happy to let credit bubble happen.
You blame greenspan. Great. He deserves some blame. How about you blame the chinese central bamk too ? After all, they helped to keep the US rates low, they help to finance the US federal deficit. ANd what about the chinese government then ? WHy did they chose the chili export led growth policies instead of the brazil internal demand growth policies ?
Following stupid washington consensus policies, most of the countries have simultaneously adopted export led growth policies. ALl this has led to the world debt bubble whose explosion we are now watching.
Loose credit is stupid ? You bet. Then why did china open loose credit to the USA ? ANd Europe ? ANd why did all asian countries do the same ? ANd why did all oil exporting countries do the same ?
The debt fueled overinvestment in export industries in asia is about to explode now. Who you re gonna blame ? Greenspan again ?
And when the debt fueled overinvestment in housing happens in oil exporting countries (think dubai), who are you going to blame ? Greenspan again ?
ANd when the debt fueled overinvestment in commodities (copper, platinum) fo feed the debt fueled overinvestment in Asia explodes. Who are you going to blame ? Greenspan again ?
You can’t just put all the blame in the USA. The debt led easy growth path has been more or less chosen by all countries over the last few years. And it more or less is the end result of deregulating the finance industry in the early 80′S.
Want to blame someone ? Blame Thatcher and Reagan. But then you’ll have to forget how strong were unions back then, how wage led inflation was a problem back then etc.
My own feeling is action should have been taken in 1990 after the first big housing bubble and the collapse of the japan economy. At the latest action should have been taken post the asian crisis in 1997.
But nothing was done. And debt piled up, while more exotic loans kept appearing …
And so here we are.
those exports represent only 2-3 percent of China’s GDP.
Nah. The surplus is 2-3% of china’s GDP. THe exports are about 35% if my memory is right.
COmpared to Europe and USA taken as a whole, china is 3 times more open.
You think China has enough internal demand ? I say we shall see. Easy bet.
Besides CHina has it s own housing bubble like all other countries, and will suffer from its explosion like all other.
On top of this China has the biggest asset bubble in the world, with PER probably topping those japan in the 1990s. (I got news that the chinese oil company is now the biggest company in the world according to its market value, even though its yearly business and profit is cheap change compared to exxon and other western companies).
So you have : housing bubble like everywhere, asset bubble biggest than everywhere and export dependancy worse than everywhere …
Just tell me how china can keep its economy going once the world debt bubble has topped. I wanna hear.
It s not like it s stupid US policies creating some trouble only in the USA, it s stupid pro debt policies all around the world creating havoc all around the world.
from china wikipedia page
GDP by components, % (2006)
Private consumption (36.4)
Government consumption (13.7)
Gross fixed investment (40.9)
Exports of goods/services (39.7)
Imports of goods/services (-31.9)
So let me see those exports falling say 10% (with world trade starting to fall in 2009, faster than world the world economy), fixed investment falling too (40.9 signals a HUGE overinvestment) … And yeah China is going to thrive, because suddenly by a move of some magic wand, private consumption is going to jump to 70% of GDP, as in europe.
Come on, we all know that china is the heater of the world economy, and this is just thermodynamics you know, the heater cools always faster than the room it has been warming (by its foolish loose lending policies).
SWF are not products of globalization rather
the undervalued currency of big economies like china is the problem. Small nations can peg their currencies. Once the economy gets really big with cheap labour, capital all investments are going to take place there. There is an investment bubble in east asian economies and thus lack of investments in factories elsewhere. Even Brazil or Russia can build a reasonable mobile factory or textiles or other consumer durables. These investments are skewed towards asia.
It really couldn’t be said better Brad, great post.
It is impossible to untangle the rise of the new SWF’s and the pegged FX regimes of the countries that have surpluses with the US.
Unfortunately, yours is a lonely voice.
For reasons, many self serving, the debate about the new SWF’s and the capital they’ve allocated to US financial institutions has been a narrow one consisting almost exclusively on the political repercussions, which obfuscates the issues that you raise here. I have to say that I think that is intentional, though some seem to not have a firm grasp on the issue.
This, in my most humble opinion, is about BWII, and the believers and participants of it are just upping the ante. Instead of just subsidizing the US with low interest rates and supporting USD, they’re now gambling on also supporting inefficient and poorly run companies (read; asset prices) that to need to be made over.
R
SWF’s are the product of some political systems plus rapid globalization. It goes without saying that national SWF’s will not be allowed in some economies precisely because their political structures or their beliefs.
If by globalization we include all countries with any political system or structure, then yes, SWF are inevitable. Globalization among just democracies will not necessarily produce SWF’s, certainly not SWF’s of extraordinary power and influence.
Globalization in the abstract is just an idea. As an idea it is noble. It works best when it is done among equals. When there are huge disparities in wealth, population size, education, etc., real dislocations can occur. The have’s want more; the have-nots are left figuring out how they can get a piece of the pie.
Globalization has been underway for a number of decades. In the past, the poorer nations have gotten the shaft.
Now, no more IMF’s or loans or costly bail-outs.
This time, I think the have-nots have figured it out. China leveraged its weakness and strength–its huge impoverished population–and led the way.
DF,
Export-Imports to the US constitutes only 20% of China’s trade, that is less than 2-3% of China’s GDP or the US GDP. If trade between the two nations were to crash to zero, the decline would be very marginal to the Chinese economy. Frankly, the typical businessman or worker deep in Central China couldn’t care less if the US dropped off the face of the earth. Outside of the Shenzhen or Shanghai export zones, there is really very little business interaction with Western nations. For instance, there are a few McDonalds and Walmarts in Changsha China, capital of Hunan province, but the Western-owned businesses are entirely staffed by local Chinese with all of the mechandise made in China. McDonald’s even has their own potato farms for french fries in Western Xinjiang province. And if the McDonalds and Walmarts were to go out of business in Changsha, it wouldn’t constitute a economic crisis, but would probably be a blessing for health reasons. The economic importance of the US to the Chinese is really overstated today by the US Business media. Except for the Boeing 737 aircraft flying overhead, it is very difficult to find anything made in the USA exported to China. The Chinese economy is tremendously better diversified donestically and globally today than a decade ago.
What the US Treasury and IMF are really complaining about is that the world is alot more competitive and fairer for developing world nations. The fact that the Chinese and other Asian nations can no longer be bullied into austerity plans formulated by the IMF like during the 1990’s Asian economic crisis is a development that should be celebrated by anyone concerned about global economic justice. The growth of sovereign wealth funds will further redistribute income around the world to emerging world nations. For instance, the African continent is today receiving more investment capital than ever before in history. Latin American economies are booming from Asian commodity demand. It is certainly much better today than during the Clinton Administration years of predatory capitalism by the Washington Consensus elites.
df
1) Trade won’t go down by 10%, since there are plenty of other trade partners.
2) Fixed investment can go up further, since there are lots of railway and highway and urbanization projects. China today is just like the U.S. before. People are building the whole country.
3) Gov can increase spending, since the deficit is tiny. Healthcare and education are two areas that badly need more money.
4) Private consumption won’t go to 70%. It is not healthy. Look at what the debt-driven-comsuming economy has done to U.S. I doubt that anyone still believe that 70% consumption is a right path.
Delining export of course has some negative impact. But people are prepared and there are enough ways to counter that.
ndk — I was tied up earlier, so didn’t have time to respond. I am still trying to understand $ strength in the face of weak data from the US; presume it reflects a growing sense that weakness will spread to europe plus recognition that at 1.45 to 1.50, the euro is very strong. the low level of indirect bids on the thirty year bond shouldn’t be a surprise. Central banks generally don’t like tons of duration, and many cannot go beyond ten years. Back in 2006, when i looked closely at this with Elisa Parisi, we found that central banks were bigger buyers of notes in the 1-10 year range (pretty much anything there) than either of bills or the long bond/ TIPs. That might have changed, but if you are a buy and hold type, I can see not wanting to lock in 4% on long-term bonds to a country with a big deficit …
anonymous — thanks for the support, i do feel a bit lonely right now. there are lots of folks who are quite keen to see the sovereign bid have the effect on the equity market that it already has had on the bond market, and in effect, to substitute the sale over over-priced equities for over-priced bonds in the context of BW2. that is my take, at least.
Quote of the Week:
“there are several measures that the Fed, or any central bank, can take to reduce the risk of falling into deflation. … the U.S. government has a technology, called a printing press … that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
A deficit-financed tax cut is essentially equivalent to Ben Bernanke’s famous “helicopter drop” of money.
- Fed Chairman Ben Bernanke, National Economists Club
Thanks a lot for the response, and I’m glad you freed yourself for a moment.
It’s really interesting to hear that central banks don’t hold securities that long. I guess the only ones who buy the 30 year would be pension funds, life insurers, etc. that have really long-dated liabilities. That restricts the conclusions we can draw. Oh well.
Still, the more I think about it, the more I like the concept that recycling of income by the current account surplus countries into the USD actually depressed the dollar. By definition, there could be no adjustment against these pegged currencies. It also led to an abnormally low real rate of return on U.S. investments. This meant that currencies that could adjust did so in an expected way: private investors left USD-denominated assets for those offering a higher real rate of return denominated in other currencies. As the U.S. is forced to offer a better real rate of return, the USD would strengthen in response.
We’re at the point where we have to offer a higher real rate of return to get any savings here. That smells like ugly, and like the USD is likely to actually appreciate in real terms until we do so. That probably also means appreciation in nominal terms, barring a sudden outburst of inflation overseas — not unlikely, given what we see happening now in China. Price controls, yuck…
It’s totally contrary to a lot of common sense, but it’d sure explain a lot. I love this blog.
http://www.atimes.com/atimes/China_Business/JB09Cb01.html
Despite all the hype about increased spending, on average Chinese consumers still save about half of their income - after deducting basic living expenses, there’s little left to splash out on a Louis Vuitton handbag or French Connection sweater. According to government data reported by Forbes, the per capita disposable income of China’s urban residents jumped 19.5% in the first-quarter of 2007, but is still only 3,935 yuan (US$550). A recent report by Morgan Stanley found that consumption in China is still only 35% of gross domestic product, about half the rate in the US.
df. i do not understand the concept of the ‘printing press.’ it has to be a metaphor, because cash (printed money) is so small a percentage of all money. in fact i do not understand bernanke’s helicopter, or the whole concept of borrowing to get out of debt. i never understood the mortgage debt slicing to create AAA assets, but then perhaps nor did the people who thought they did. i understood the bubble. it began about the time greenspan used the words ‘irrational exuberance.’ i understand ‘globalisation.’ i saw it on a television channel (eurochannel ?) in a bar, but too far away to read the captions or hear the commentary. the business report showed the week’s graph from various international stockmarkets. the graphs all did the same thing. long fall, short recovery, short fall - is the best way i can describe it. not identical, but all dancing to the same tune. you did not even need the detail to spot it.
as i have pointed out before, i am not against s w fs (nor californian pension funds.) the nature of a player in the markets is far less important than their size, relative to the market. there are rules against price fixing among supermarkets, because this subverts competition. so does any player who controls too many of the chips in a particular investment game. it’s a rule of nature, it’s why bicycle oil lubricates bicycle wheels, but sand or rocks do not. stock markets are a casino, they will not work smoothly if there are a couple of tree trunks instead of half a million chips.
. . . . and the dollar. whatever happens, we are all roped together. if the dollar jumps off the cliff - the dollar will fall. but that does not mean that the dollar gets to the bottom first. the helicopter policy is no more than an expression of the zeitgeist, the spirit of the age. if staying out of debt comes back into fashion - no amount of helicoptereing will change that. compulsory irrational exuberance ? tell me another one.
.
Sovereign wealth funds are likely to be the latest proof that governments are pretty bad at picking winners in terms of investments. History is rife with examples of government officials doing a bad job at guessing which sector or company will yield the highest return. And SWF’s seem to be right in line with this as they picked the tanking US Dollar as a major destination for their funds. Even though the dollar may be near the bottom (or at least nearer) the US economy looks to be rather sickly at the moment so they are STILL making the same mistake.
Is it a product of globalization? No. It is a product of some countries having governments which want to accumulate large reserves and then do portfolio management themselves. They will wish they had followed the advice that any sane economist would have given them - Diversify. If not directly then diversify the management of your pile of paper.
But we here in the US ought to be glad SOMEBODY is funding our excesses. Otherwise we would have hit a wall long ago. Hey, now that I think of it maybe that would have been better than that wall I see right in front of us ……….
“so does any player who controls too many of the chips in a particular investment game”
Which is precisely why some people are against SWF: the US can no longer control the chips (i.e. the supply of USD). The chips will now be spread across the globe.
Unclear why this is a bad thing to the world economy- will force some discipline on the printing presses.
I think China’s investments are a bit too large to be investing in index funds. But they do want to diversify from pure cash to an asset mix, I would imagine.
The Australian government recently set up a SWF, they called it the Future Fund and said it was to pay for the pensions of our policemen and servicemen.
They used the proceeds of the privatization of our telco and it is going to be a sink to soak up any “excess” receipts from our mainly mineral exports.
The idea is to have a sort of economic shock absorber.
This confronts us with some issues,
- Is it legitimate to use such a fund as an economic tool.
They say that is is quarantined but the act of adding to it and taking from it is never quarantined and this is all we need to do to have it functioning as an economic lever
- What are the effects of taking funding of pensions, etc out of current expenditure by setting everyone up with an endowment.
Lately we see that funds from these schemes can build up quickly and it all needs a good safe home. The bigger the better as far as risk reduction is concerned.
We seem to be reaching a wealth storage ceiling.
It seems to be a version of the “consider the lilies of the field and the birds of the air” problem, i.e. how much can we insure our future and what is the price we pay for doing that?
Steven Kyle made a point. Why are SWF’s picking US-dominated investments? The long term trend of the dollar seems to be down. Are they merely buying US-based equities because they are cheaper realtive to the SWF’s currency? Many smaller countries, generally speaking, have fewer assets that they “own”. I wonder if SWFs are merely a mechanism of diversifying outside their own country’s resources as part of some overall strategy. Forgive me, I’m still a newbie at this.
artichoke — i would put it differently: because China’s fund is potentially so large, it may in practice have few alternatives to index funds. Indexes are the obvious way to place large sums without gaining control or influence.
binary options - the dollar’s long-term trend v the emerging world is likely to be down. it isn’t clear that the dollar will continue to fall v the euro. after all it already has fallen by a lot.
i would argue that investment in the US seem larger than they are –
a) a lot of SWFs did a fair amount in Europe in various ways from 05 through 07. their financial investments have included European firms - Barclays, Fortis (tho that was from a Chinese insurer not a SWF/ state bank owned by the SWF), UBS. Given the United States size, one would expect a fair amount of investment … and the woes of the us financial sector created a buying opportunity.
b) The biggest Chinese investment was in an anglo-australian mining company — rio tinto. (by Chinalso — a state firm, with financing from the CDB, itself owned by the CIC …. it all gets confusing.
there though is a second reason for investing in the US — the US needs the financing (generally speaking) to cover its deficit, and US financial institutions also needed the money. that creates a natural match. SWFs also need to hold a fairly large dollar portfolio is they do not want to put additional pressure on the $ — remember, if the GCC/ China sell enough dollars for other currencies that they drive the $ down, they would in effect be driving their own currencies down and adding to their economies inflationary pressures. to help out their respective central banks, they may need to hold a dollar heavy portfolio.
the last point tho is subject to much debate.
c)
Charlie: Governments should create and enforce laws that enable businesses to succeed, not invest directly into businesses. The success/failure criteria should be set by a free market, not by who the government chooses to invest in.
It’s not either/or. China has managed to come up with a system in which the state is the major investor in companies, but that the success of those companies are largely determined by the market.
There are some very well known problems that result when governments own businesses, but China has worked out ways around them. In particular, really, really bad things happen when governments try to manage companies.
Charlie: How would a company like UPS feel if it paid taxes and those taxes were invested in FedEx?
Not good, but since 1983, the Chinese government hasn’t directly funded state owned enterprises with tax money precisely to avoid this problem. There is some indirect funding, but those are aimed the state taking over the social welfare services provided by SOE’s. Also, the regulatory functions of the state are kept separate from the ownership aspects, so what happens is that you don’t have the same person or group of people acting as referee and player.
Chinese state companies end up being profit centers rather cost centers. Personally, I don’t see why having the state as a passive shareholder is necessarily worse than having private families or public shareholders.
Charlie: My hunch is SWFs look like easy pickings for wall street. Get them to invest $10 billion in say Citigroup when $100 billion is really needed. After the initial $10bil, the rest is easy. Otherwise, they’ll lose the initial $10bil investment. Better for them to invest in government bonds. Something they understand much better.
You do have to realize that the people running CIC’s have business school MBA’s and have worked on Wall Street for many years. I don’t think “not understanding business” is going to be a problem.
Charlie: If SWFs proceed to invest hundred of billions of dollars in equity markets, it will end very badly. Governments need to operate like governments, not businesses.
Going back to Deng Xiaoping. Seek truth from facts, and don’t seek truth from theory. Have SWF’s invest $10 billion, see how it goes, and if it works, then invest more. If it doesn’t figure out why, and do something else.
The great genius of Deng was that he wasn’t for capitalism, he wasn’t for socialism, he wasn’t for state ownership, and he wasn’t for private ownership. He was for whatever works. This was great because it freed China from a lot of Marxist non-sense, but the same sort of thinking also applies to anti-Marxist theories. This is always why I find Wall Street a fun environment to work in. No one cares about ideology. The only ideology here is making money, and that gets rid of an awful lot of non-sense.
DC: If trade between the two nations were to crash to zero, the decline would be very marginal to the Chinese economy.
Just as devils advocate, when people mention the numbers that support that, they always mention GDP and output. I do wonder what the impact of a drop of exports would have on employment.
2fish –
there isn’t much ideology left on the street when it comes to privatization. if you can make money selling us companies to SWFs, do it. if you can make money selling SOEs in EMs to private investors, do it. tho from the rhetoric around privatization in the 90s, you would think there was a bit of ideology involved.
when it comes to personal income taxes (or the taxation of carried interest) tho, my own experience is that there is still a bit of ideology left. even if socialized medicine delivers better care at a lower costs, it isn’t accepted — at least not if it means higher income taxes.
Q: So, why don’t these SWFs start to behave like banks, more than like “silent partner” investors? Why don’t they start making capital available at reasonable rates of interest to banks that had good business going, but are struggling because of this money traffic jam?
Because loaning money to a bank doesn’t help its balance sheet. If you loan money to a bank, then the asset increases but so does the liabilities, so the loan itself doesn’t help the bank. If the lender is willing to make capital available at very, very low rates of interest then bank could lend the money out at a higher rate of interest, and make money that way, but then the question becomes why would a lender want to do this?
df: You think China has enough internal demand ? I say we shall see. Easy bet.
It’s trivially easy for a government to create internal demand. Hire half the people in the country to dig a hole in the ground, bury some money, and hire the other half to dig it out.
bsetser: when it comes to personal income taxes (or the taxation of carried interest) tho, my own experience is that there is still a bit of ideology left. even if socialized medicine delivers better care at a lower costs, it isn’t accepted — at least not if it means higher income taxes.
That’s not ideology talking. Lower costs to whom? If you make $500,000/year, socialized medicine is not going to save you any money. ***Your*** taxes will go up, and ***your*** quality of care will go down. Any ideological arguments people present are just a smoke-screen. Change the situation so that makes $500,000/year will actually benefit or at least won’t get hurt from state-supported medicine, and it’s amazing how much their views will change.
My experience is that everyone is self-interested, whether they make $5000, $50000, or $500000/year. The thing about New York is that people are a bit less shy about admitting what they really want then people in Washington and things happen a bit quicker.
Twofish,
I think you are right about the Chinese authorities preferring the employment effect of a strong export industry, as opposed to increasing the buying power of the average citizen. The stubborn pegging supports that theory.
The credit crunch, which is hurting the average bank by paralysis as the inter-bank rates have shot up, is not being helped in any obvious way by the SWFs. They are buying into the big names, and I am sure that reflects the kind of trouble these banks are in, but it is not yet having any effect to lower inter-bank rates. That is a great problem for most economies.
The music has stopped and everyone is diving for a chair to sit on, until the music starts again. I just think the *wealth* part of the SWFs needs to be part of the music, rather than being part of the chairs, if you see what I mean?
In comparison to the recent Chinese government investment in Africa today, the minority stake investment by the China CIC in a few US Investment banks is really just pocket change. In Africa’s Congo alone, China SOEs will invest $12 billion in hard cash for mining and infrastructure development. - DC
from http://www.allAfrica.com
The Chinese companies will, for one thing, start work on infrastructural projects in 2008 more or less along the lines of the five priorities Kabila has set: water, electricity, education, health, and transport.
These works will cost more than 9 billion dollars. That is a lot of money, considering that the 2007 government budget was a mere 1.3 billion dollars, most of which was needed just to pay the salaries of government staff.
The basic idea is that Congolese and Chinese state owned enterprises (SOEs) set up a joint venture, Socomin. This mining company will invest another 3 billion dollars in mainly new mining areas.
One well-informed European diplomat admitted that “if carried out well, this can be positive for Congo.”
2fish — my experience would be that few are willing to baldly state “I just don’t want to pay more taxes” and instead defend low levels of taxes (And low levels of public services, including medical care for working age americans) on efficiency grounds. the carried interest tax break is defended on “financial competitiveness” grounds.
Off-Topic:
AP Poll: Stimulus Checks Welcome, but to Really Help the Economy US Should Leave Iraq
http://wiredispatch.com/news/?id=39179
The heck with Congress’ big stimulus bill. The way to get the country out of recession — and most people think we’re in one — is to get the country out of Iraq, according to an Associated Press-Ipsos poll.
Pulling out of the war ranked first among proposed remedies in the survey.
I find it a bit disturbing that there is no mention of how to remedy the situation here. It’s all about what happened and who’s to blame. Not a word about what needs to be done.
http://www.guardian.co.uk/business/2008/feb/10/creditcrunch.alistairdarling
“The world economy faces a ‘turbulent time’, the Chancellor, Alistair Darling, warned this weekend after meeting finance ministers from the world’s main industrialised nations in Tokyo to discuss ways of tackling the credit crunch.”
Yeah, we already know that, but what to do about it? How do we uncrunch the crunch?
bsetser: my experience would be that few are willing to baldly state “I just don’t want to pay more taxes” and instead defend low levels of taxes
People would be unwilling to state this, but that’s what they are really thinking. One way of seeing this is to create a situation in which socialized medicine obviously benefits them, and see how quickly they change their minds.
My experience is that ideology in economic issues is almost always a cover for self-interest, and when self-interest changes ideology changes quite quickly.
Another good post. I agree that the build-up of foreign reserves in China and Japan are the result of deliberate policies. I think they were done to promote export-led growth (or, in the case of Japan recently, to make up for deficient local demand). I’m afraid of what will happen if the policies become viewed by others as ‘exporting unemployment.’ For a while, the system seemed to work fine - the loans to the U.S. contributed to appreciating asset prices, which encouraged local consumption and provided demand enough for all. Now, the question is where the demand will come from if U.S. net borrowing ceases, or at least falls to sustainable levels. So far, the only policy options under consideration seem to have been ways to keep up U.S. borrowing, both by the private sector (lower interest rates) and by government (bigger deficits).
“…”It’s heroin-dealer economics… Your first shot is for free, and after that it becomes more expensive…” http://www.washingtonpost.com/wp-dyn/content/article/2008/02/07/AR2008020701336.html
Guest,
HELLO! Americans love of the credit card was caused by the Bank of America, not China. My daughter who is 10 years old and my 3 year old dog get offers for free credit cards in the mail from Chase Manhattan and Citicorp. Just sign or stamp your paw on the bottom line. Actually the state-owned Bank of China does issue Visa credit cards in the US from bank branches located in New York City and San Francisco Chinatowns, but how many Americans do you know carry around a credit card issued by a Chinese bank.
http://www.prudentbear.com/index.php/GuestCommentaryHome
The Economist pundits believe current liquidity problems can be corrected with a little fiscal stimulus and cheap money to jumpstart the ailing economy. It is not liquidity that is preventing the money from flowing; it’s insolvency! The banks won’t lend to deadbeats anymore! Sure, cheaper money helps high credit score borrowers refinance and pay less in interest charges, but cheaper money does nothing for the existing bad loans backed by No Income, No Collateral, and No Character.
Pallj ,
I do not think China “as opposed to increasing the buying power of the average citizen”. Low end manufacturing is the natural choice for a poor country to develop economy. While low-end jobs provide a lots of employments, they just cannot pay people well. To increase buying power of average people, we need high-end manufactruing, then there will be internal demand for servcie sector. There is no second path.
Brad,
Check out our World Net Daily Commentary about Soverein Wealth Funds, “The tax break China gets but you don’t.” I think that we are the first to break the story that SWF investments in the US pay no U.S. taxes. By the way, we quote you on page 77 of our book that is due out on March 1. Here’s the link to our commentary: http://www.worldnetdaily.com/index.php?fa=PAGE.view&pageId=55899
Howard Richman
http://www.idealtaxes.com
The US has long had a Sovereign Wealth Fund.
We call it Social Security.
the soc. sec trust fund is invested:
a) domestically
and
b) exclusively in treasuries
its domestic portfolio looks safer than the external portfolio of most central banks — and nothing like the portfolios of most SWFs.
in effect, the US opted not to create a sov. wealth fund or a sov. pension fund with the soc sec trust fund.
two fish… If it s that easy to create internal demand, how come Japan did not succeed ? How come the US did not succeed in the 30’s.
Historically the only way to create internal demand that has worked is preparing for and then waging war.
one of my post got lost.
Gillies. Let us suppose all central banks are 100% public banks owned by the government. THat s the case about anywhere except in the USA.
In that case when the central bank lends money to the government, it basically is giving it to the government. The debt owned by the government to the central bank can reach the infinite, it is not a problem because the central bank does not care if that debt is repaid or not.
Since the fed is a private bank things are a bit different, but not that much. And if they are, well just nationalize the Fed, and problem will be solved.
So basically there s two ways to create money :
1 Print it, or have the central bank increase the amount of government bonds it owns.
This is pure exogeneous money creation, money that is not backed by debt. This money creation is decided by the government and does not rely on expectancies of future profit.
2 lend it into existance. That s what banks (mostly) and some other market agents do. There is money creation only when the total debt rises. Private debt can not rise ad infinitum. Thats because private agents who borrow do it only if they think borrowing is profitable for them. SO for instance households will borrow less and less in the case of falling housing prices. ANd also private agents will lend only if they expect it to be profitable for them. SO banks will lend one to another only if they expect other banks will not go bankrupt in some near future.
Basically during the last 20 years, the second path for money creation has been used to the max. Worldwide.
Now this path is blocked. Creidt based money is about to be destroyed faster and faster through a circle of bankrupcies, and disappearing profit opportunities. Noone will find it profitable to borrow, even with very low nominal interest rates. Capital good prices are beginning to fall worldwide, especially housing prices, then stock market prices, commodities will follow and then general prices.
The only way to counter this worldwide fall in the monetary base and worlwide fall in prices,is through strong injections of debt free money by the central banks around the world.
df: two fish… If it s that easy to create internal demand, how come Japan did not succeed ? How come the US did not succeed in the 30’s.
1) US and Japan were developed economies
2) US and Japan both had monetary policies that were wrong headed. Just because it is easy doesn’t mean that people will do it.
I don t think you got my answer. It s ok to state that the US monetary policy in the 30’s was not sufficiently expansionist. Agreed.
But Japan central bank did EVERYTHING it could to boost inflation, it lowered interest rates to 0% for years, and meanwhile the japanese government spent TRILLIONS.
BUt this was not enough. It just take times to absorb excesses and misallocations of capital and workers. The oversized cars and homes have been build in the USA, they will not disappear overnight. People will have to live in them, heat them. And the debts related to those houses and cars will not disappear overnight. It ll take a lot of cash priting to erase them. ANd even electronic presses can not erase thrillions of debt in one single year.
so the global debt deflation we re entering in will not be dealt with in 2 seconds.
df: But Japan central bank did EVERYTHING it could to boost inflation, it lowered interest rates to 0% for years, and meanwhile the japanese government spent TRILLIONS.
Obviously, it didn’t do enough. One problem with the Japanese system is that the banks were so tied into the real estate and stock markets, that there were limits to what the Japanese government could do without causes the whole system to collapse. So one thing that the Japanese government couldn’t do is to write down the debts and take the losses (the sort of thing that is happening now in the financial markets).
df: BUt this was not enough. It just take times to absorb excesses and misallocations of capital and workers.
It doesn’t take that much time. The savings and loan crisis of the early 1980’s got fixed rather quickly without too much pain.
df: The oversized cars and homes have been build in the USA, they will not disappear overnight.
But they can be remarked to their actual values and ownership can change very, very quickly. The problem with prices is that they tend to overshoot. Real estate values go down suddenly, but the shock of that ripples through the markets and affects the prices of things whose value really hasn’t changed.
df: And the debts related to those houses and cars will not disappear overnight.
It takes a few months to clean up the debt. Bankruptcy judge hits a gavel. Boom. Your debt is gone, and the creditors take the loss. Bank looks at a debt, figures it never is going to get any money, forecloses. Boom. The debt is gone, and the bank writes down the loss.
We are in the process of making about $250-$500 billion dollars of bad debt disappear. When a major bank says that they are writing down $10 billion in bad debt, it means that that debt is being taken out of the system.
df: It ll take a lot of cash priting to erase them. ANd even electronic presses can not erase thrillions of debt in one single year.
You can erase debt either by having the lender give up, and admit that the debt is never going to be collected and write it down, or else having a bankruptcy judge force that process through. It should take about a year or so for that process to happen.
DC: My daughter who is 10 years old and my 3 year old dog get offers for free credit cards in the mail from Chase Manhattan and Citicorp.
You have computers go through credit records and automatically spit out these letters. They sometimes get names wrong, but it doesn’t matter because……
DC: Just sign or stamp your paw on the bottom line.
And provide a social security number. Once you have an SSN, the computer will access the credit record, and if it turns out to belong to a dog or a 10 year old, it will deny the application. The bank just wasted the cost of postage.
Also, most people don’t use credit cards for anything other than revolving credit and payment processing. Credit cards are very lucrative because they bank makes gobs of money *even if* you don’t carry a balance. There’s something like a 3% transaction fee for all purchases.
DC: The banks won’t lend to deadbeats anymore! Sure, cheaper money helps high credit score borrowers refinance and pay less in interest charges, but cheaper money does nothing for the existing bad loans backed by No Income, No Collateral, and No Character.
That’s what bankruptcy and credit default swaps are for. The existing pool of bad loans are getting written down, which is where all of the dramatic stuff is happening.
Also there is collateral in the form of real estate. When you have a writedown, you take whatever you can get.
twofish :
1 not all creditors agree to simply erase debt. Especially when its HUGE amounts we re talking. Credit loans crisis was a small thing. We re talking about the US household holding 120% of the US GDP in debt. back in the 80’s this was below 60%. Tell me how you can quick and fast erase half of the debts now running…
2 Even if you erase all the debts and reprise all the houses and cars… THEY STILL WILL NEED AS MUCH GOD DAMN OIL to be heated and warmed. You can t erase that with a pencil. Those thing exist in the real world and have real world needs. May be homes will be shared between several families, cars will be turned into collective taxies …
The biggest probability however is still : lots of house will turn into ruins because noone will be able to afford living in them. And same with cars.