The Boston Globe: Perils of a weak dollar
On Saturday, the Boston Globe published an oped that I wrote. It is the first oped that I have ever had published.
The headline on the oped though is a little bit misleading.
I focus more on the perils of pegging to a weak dollar rather than the perils of a weak dollar per se.
One of the strange features of today’s global economy is that many countries with strong economies have weak currencies by virtue of their link to the dollar. That discrepancy distorts the global economy in a number of ways:
– It keeps the US trade and current account deficits larger than it otherwise would be.
– It means the adjustment against the dollar is unbalanced. There is a difference between a world where the Euro rises against the US and Asia and a world where the Euro and most Asian currencies rise against the dollar.
– It requires a ton of government intervention in the foreign exchange market, a fact that necessarily will lead to rising government ownership of a host of financial assets.
– And it has led a number of countries that peg to the dollar/ manage their currencies against the dollar to adopt wildly pro-cyclical macroeconomic policies.
As a result, the weak dollar is much more of a problem in the countries that tie their currencies to the dollar than in the US. I agree with Dr. Krugman: right now, the US benefits from a weak dollar. Exports are helping to support the US economy and reduce the trade deficit. In the oped, I argued:
The alternative to a weak dollar is a US monetary policy aimed at supporting the dollar rather than stabilizing economic activity in the United States - an even less attractive option.
The Gulf and China though have many alternatives other than continuing to manage their currencies against the dollar and as a result import US monetary policy — a policy that will be directed at stabilizing the US economy, not stabilizing their economies.
The problems dollar weakness is creating in the Gulf are now quite visible.
The Saudis are cutting interest rates like mad at a time when inflation is rising. Negative real interest rates are pro-cyclical. They are already fueling a real estate boom in Qatar and the UAE.
Curbing inflation - in the absence of currency appreciation or monetary autonomy - requires cutting back government spending and investment. Gene Leon of the IMF:
In recent statements, the IMF said Gulf states also need to trim spending and tighten money supply within stricter fiscal policy to curb inflation. “Fiscal policy is the only effective instrument to control inflation in Gulf Co-operation Council states,” said Gene Leon, deputy chief of the GCC division.
But it is kind of hard to explain why government spending, including government wages, should be cut in the face of rising domestic prices when oil is high and the government has plenty of cash. As a result, most countries are increasing spending to offset rising prices …
Michael Pettis has busy documenting the macroeconomic difficulties China is now facing as a result of RMB weakness - especially in the face of rising commodity prices and associated inflationary pressures. Keeping lending growth from exploding is an ongoing battle. The tightening of the fall seems to have given away to concerns about growth. Lending certainly increased significantly in January.
And - at least if the January data is indicative - China may not have shifted away from export led growth. Not yet. The pace of export growth picked up in January - rising back to the 25-30% y/y range (26.7% to be precise). Given that China exported $1220b in 2007, that implies a huge rise in China’s exports. Think of a $300 to $360b increase in China’s exports over the course of the year.
I doubt that kind of growth can be sustained.
But the fact that China’s overall trade surplus is up from last January even though oil is now around $90 and oil was a lot closer to $50 than $60 last January is really quite impressive. Especially in a global context where the US non-oil deficit is down. China has taken market share from other suppliers to the US, and increased its surplus with the world ex-oil ex-US dramatically.
Doing so has required enormous intervention in the foreign exchange market: some visible, some hidden. Buying depreciating foreign assets likely will result in significant financial losses - though the precise meaning of exchange rate losses at a central bank is still debated.
The weakest part of the oped, in my view, is the conclusion - which hints at the need for coordination to help manage a transition off dollar pegs and central bank financing of the US but doesn’t really spell out what that might entail.
That reflects space limitations. But it also reflects two deeper analytical issues.
The first - highlighted by Martin Wolf - is that adjustment requires a reduction in US aggregate demand (i.e. less US consumption) and an increase in global aggregate demand. Yet right now US policy is directed at trying to avoid a too-sharp and too-sudden a fall in US demand.
I think that is appropriate: Too fast a fall in US demand would just lead to less global growth, not a shift in the basis of global growth. But as Martin Wolf notes, applying stimulus in the deficit country but not the surplus economies risks sustaining imbalances. The key will be to shift away from stimulus as soon as the US economy stabilizes. It would be a mistake for the US to shift from a real estate fueled consumption boom to an equity fueled consumption boom, one reinforced by a surge in SWF demand for US equities.
The US - and the world - need to find a new basis for growth. US consumption cannot continue to rise relative to US GDP, helping to absorb the rest of the world’s high level of savings.
That though requires a bit more willingness on the part of other countries to adopt policies to support aggregate demand rather than maintaining policies that support export growth. Basically, there will be a need to shift from policies designed to avoid too sharp a fall in activity in the US to policies designed to support demand outside the US.
Europe’s reaction to Strauss-Kahn’s proposals wasn’t all that encouraging.
The second is that I have lost confidence in the “consensus’ policy recommendations made to address imbalances back in 2004 - policy recommendations enshrined in the disappointing end-result of the IMF’s multilateral consultations. The basic approach was threefold -
Fiscal consolidation in the US
More growth in Europe, whether from structural reforms (consensus view) or policies to support demand (my view)
Exchange rate adjustment in Asia, along with domestic policies to support an internal rebalancing.
From 2005 to 2007 two of the three actually happened. European growth picked up smartly. And the US fiscal deficit fell.
However two of three wasn’t enough. I think the 2005 to 2007 period will be remembered as a period when an opportunity for much deeper adjustment was missed, in part because China opted for a pace of RMB appreciation that was way too slow. Especially in a global context where the dollar was sliding against a host of currencies.
I also suspect that a couple of key policies were left out of the old three pronged approach -
Energy policy for one. The role of the oil-exporters in the world’s imbalances is now hard to ignore. If oil stays around $90, the US “petroleum” deficit will be close to $400b. That deficit in turn has created a glut of savings in the oil exporting economies — the Gulf is throwing one nice party for itself (and its real estate companies) and still has plenty of money left over. Here US and Chinese interests are aligned -
Some broader changes in the institutions for global economic coordination that recognize the growing importance of the emerging world for another. The G-7 doesn’t cut it. This though would require change not just in the G-7 countries but in China as well. From what I gather, China isn’t sure it wants the responsibilities that might come with membership in a group like the G-7.
And perhaps reserve management. It strikes me as likely that orderly adjustment will require that some key central banks refrain from aggressively diversifying their reserves as they move off the dollar. The delicate issue though is that the US needs enough central bank financing to sustain a gradual adjustment but not so much that the US avoids all pressure to adjust. A massive SWF bid for US equities that pushes equity prices up in the say that central banks pushed bond (and housing) prices up and creates a new wealth effect wouldn’t help.
I am not sure I quite see the potential bargain. Not yet.
When I was last in Dubai at the end of 2007 there was a distinct change in the attitudes of expats living there. Instead of the sunny optimism and “anything is possible” drive of earlier visits, I found them fretting about inflation. Most expats in Dubai continue to pay mortgages on homes back in London or Sydney or Auckland or wherever else they came from. With their dollar-linked salaries shrinking, and the cost of living in Dubai soaring, they are having a very hard time making ends meet between Dubai and their non-dollar debts back home. Since most are on fixed term contracts, they have little power to renegotiate their wages in the face of dollar decline and rising inflation.
For the first time I heard expats talking about giving up on Dubai and heading back home. If that happens, the miracle of Dubai will fade fast. Its rapid growth to a high standard of quality has been driven by attracting talent from four continents.
The IMF will move too slow to staunch the bleeding, impeded by (1) Bush administration determination to weaken and disempower all international institutions to butress neo-unilateralism, (2) commitment to avoidance mechanisms like selling gold to help disguise dollar devaluation rather than confront the policies driving dollar weakness, and (3) neither the USA nor European states are keen to lose power to the emerging market economies which are viewed as unaligned with their interests, if not actually hostile.
I also can’t see a bargain. But I can see huge risks for everyone in failing to work toward a bargain in good faith.
Brad, do you think global re balancing is likely without pain in the US? I agree with you on China but what does that get us? Is debt-is-good sustainable? If not, why is it in the interests of the US to say we have a strong economy and a soft landing is best? Why is it in the interests of the US to avoid a recession? Why are we lowering interest rates when we have a negative rate of return on savings? Isn’t fear necessary for markets? Does the answer to our problems really lie in China? Our answer to our problems seems to be more borrow and spend. Where does that lead us?
I think China will eventually figure out that they are better off working towards a joint goal with the big nations, but that would cost a significant quieting of criticism they have endured from key heads of state amongst G7 (democracy this and human rights that).
I worked in Shanghai for two years, and I can assure you there´s no need to assume the Chinese powers that be are strategically simple or naive. Far from it. They´ll let loose the RMB yuan only when they see it as the best move for China.
The Gulf states, on the other hand, might throw a spanner in the works. If you consider that the price of oil might treble over the next five years, how would that affect the global economy adjustment effort? It was only five years ago that the oil was at $25, so it’s not that far fetched an assumption.
To be honest, I can´t see how anyone can sustain a trade balance with the big oil exporting nations, even if oil stays around $100.
From your op-ed:
“the United States is trying to sell a mix of financial “lemons” and minivans - dolled-up subprime debt and reliable, but boring, Treasury bonds.”
I was somewhat confused reading this. Isn’t the lemons component more of a past tense issue? Unless you mean SWF equity investments, in which case I would alter the description.
“The key will be to shift away from stimulus as soon as the US economy stabilizes.”
You could, and should, make the same argument for Fed easing as for fiscal stimulus.
There are no shortage of potential sellers of (off-the-run) subprime bonds, just a shortage of buyers. There certainly aren’t many transactions happening. But I take your point — the tense is a bit off, and it might be better to have said dolled banks stuffed the subprime debt …
the lemon risk comes from their other exposure tho. SWFs bought in after the subprime hit but before any real blowups elsewhere.
Steven — we have been borrowing and spending for some time now. it is a question of what is the biggest risk, and for the moment, i think the biggest risk is that the collapse of a lot of credit markets will make it very difficult for a lot of folks to borrow and spend. A sudden collapse in spending thus strikes me as a real risk. The government is still able to borrow tho, hence the logic of a fiscal stimulus.
But a not-too hot and not-too cold approach has risks. Over time, the uS needs to borrow less and spend less. But it would be better if exports caught up to imports rather than if imports just collapsed. and in the short-run there are real constraints on how much the US can export. Boeing cannot produce more/ export more until it sorts out the 787 line/ invests more — no matter how much the dollar and US demand falls. So I am not in the camp that wants brutal adjustment now.
Anonymous — good point on fed easing. The fed kept rates too low for too long last time.
Is it fair to say:
a) The US and Europe are making a required adjustment
b) The US and China (et al) are not making a required adjustment (due to pegs)
c) Europe and China (et al) are making a counterproductive adjustment (due to pegs)
” Intervention Burden
The downside to intervention is that it increases the supply of the local currency, which tends to fuel inflation. To prevent that from happening, Asian central banks typically sell bonds to remove those funds from the economy.
That option has become more costly because interest on the debt is paid with income from its reserves, which are invested in dollar-denominated securities. The People’s Bank of China pays 1.31 percentage points more on its six-month bills than it earns on similar-maturity Treasuries following the U.S. Federal Reserve’s five rate cuts since September. Six months ago, the spread was 2.2 percentage points in favor of U.S. debt.
After four years of profits, the bank is now losing $4 billion a month by intervening, according to BNP Paribas SA, France’s largest bank. Nine central banks in Asia lost a combined $160 billion in the year started July 2006, said Richard Yetsenga, chief currency strategist in Hong Kong with HSBC Holdings Plc, Europe’s biggest bank.
“The losses are definitely a burden,” Yetsenga said. “The ultimate endgame is to intervene less.”
Brad, does this sound about right?
Feb. 18 (Bloomberg) — China will shift focus to managing the yuan’s exchange-rate against currencies of its biggest trading partners and not just the dollar, allowing for a broader appreciation, former central bank adviser Li Yang said.
China’s currency has fallen 6 percent against the euro since a link to the dollar was scrapped in 2005, prompting calls from European officials including French President Nicholas Sarkozy to allow faster gains. Some U.S. lawmakers also claim China’s currency is kept undervalued to make exports competitive, and have threatened sanctions unless the yuan extends a 15 percent gain versus the dollar since the peg ended.
There’s a “shift in how the central bank will be watching the rate and the focus of its policy target,” Li, head of financial research at the Chinese Academy of Social Sciences in Beijing, said in a Feb. 14 interview. The central bank will focus on a trade-weighted “effective” exchange rate, said Li.
Anonymous — I think your description is basically fair.
Wimpie — that sounds about right. Two qualifications though. Folks like me would argue that the losses are just (Starting) to be booked now, but at least some were actually incurred back when the country was intervening to hold its currency constant. So long as the currency didn’t move (and the interest rate differential wasn’t that unfavorable), there was no need to book the loss. But buying ever-more-dollars to keep the exchange rate constant assured future losses. There also is a debate, which I have mentioned in the past, about the meaning of central bank losses.
Finally, I hope Li Yang is right, and China will begin to allow appreciation against a trade weighted effective exchange rate (Even if that means faster appreciation and more losses). Preferably one that recognizes that a lot of China’s exports to HK are then shipped on to Europe and thus doesn’t overweight the dollar.
Can the world afford a middle class?
More countries are pulling themselves out of poverty, placing greater demand on food supplies and natural resources.
Gloomy picture of world’s oceans
A new global map compiled by analysing 17 different factors including fishing, global warming and pollution has revealed that 40 per cent of the world’s oceans are heavily affected by human activities.
Brad:
I think you focus too much on the perils of weak dollar for non-US actors rather than on US. If the dollar continues it’s decline to ease adjustment, how many Americans’ retirment account will be impacted and how will they be able to retire?
I think part of the solution (hardly mentioned) is the overhaul of tax code. Americans currently are being punished for saving (the IRA and 401K limitations are too low) and being encouraged to spend-just look at rebate checks coming in the spring!
Conversely, I think part of the solution in China is to adapt more of the American tax code, i.e. encourage spending and tax excessive savings.
Finally, for both countries, more social safety net, in the form of subsidized health care and increased pensions, will help the adjustment. I believe these steps need to be taken before exchange rate induced adjustment can begin. Otherwise it will be too much pain for the voters in America and too little incentive for the workers of China.
Re:Dubai
Dubai is bubble land. Outside the US there is no bubble like Dubai. It is being pumped by the oil wealth amassing in the Gulf and enabled by professionals from all walks of life and nationalities who actually tend to sell themselves rather cheaply for the “dream life in the sun”.
But, a bubble nonetheless and a big one. A huge “build it and they will come” scheme. Pick up a weekend paper or real estate mag there and you have literally hundreds of thousands of purchase and letting option- akin to reading a telephone book.
It is noteworthy that many nationals from developing/emerging economies in Asia are leaving Dubai as the inflation there destroys send home savings. It therefore comes as no surprise that Europeans also are preparing to pack their bags.
Dubai is being sold as a real estate play in a playground cum holiday theme park deal. Having lived in the Gulf, for the life of me I cannot imagine why. The climate for at least 7 months of the year is absolutely unbearable with humidity reaching the 90’s. The other 5 months vary from OK to very uncomfortable. To each his own though I guess.
But, like all bubbles it relies on new air, fresh blood in ever larger quantities. That seems to be hitting against the law of diminishing returns now. When the music stops in Dubai, I wouldn’t like to be left holding a chunk of vastly over inflated concrete, no matter what the view.
Since the successful imposition of the EURO € neatly created by the bankers for the bankers there is a new horizon to look forward to. It is called the AMERO of the potential North American Union.
It is quite possible that the FED wants to become a sort of new Bruxelles which is why they don’t care about the U. S. currency. In any case, they can print as much as they want.
Jim Rogers makes sense when saying get out of the dollar.
brad, could you briefly touch upon the “debate about the meaning of central bank losses”
‘Speculators’ are forcing revals through food & energy
While it’s relatively easy to get a central bank to devalue it’s much harder to force them to revalue, especially through indirect methods when the capital account is closed. It looks like markets may have figured out a way by paying attention to what the Federal Reserve does not (and what the rest of the world does): food & energy — ex-core inflation…
Well either the peggers could stop pegging or we could stop doing things to make the dollar weak. Since obviously we are not about to strengthen the dollar it is up to the peggers to stop pegging. But we have no control over that. So in effect we’re in a situation in which we are powerless and helpless. And that shows how our world economic power has weakened. Right?
Credit Suisse rose 3.1 percent to 56.7 francs. Qatar is accumulating shares in Credit Suisse and plans to spend as much as $15 billion on European and U.S. bank stocks over the next year, the Gulf state’s prime minister said in an interview.
“We have a relation with Credit Suisse and we bought some of the stock from the market, actually, but I cannot say what percentage because still we are in the process,” Sheikh Hamad bin Jasim bin Jaber al-Thani, who is also chief executive officer of the Qatar Investment Authority, said in an interview late yesterday in Doha.
Pretty soon Swiss banks won’t be Swiss anymore, but just fronts for Middle East banks.
@ Guest on 2008-02-18 04:36:09
Pretty soon Swiss banks won’t be Swiss anymore, but just fronts for Middle East banks.
Yup. BCCI with a Swiss accent.
From the op-ed: “China’s already large trade surplus increased by close to $85 billion this year, more than the US deficit fell.”
Germany’s trade surplus increased by almost $80 billion in 2007 to $290 billion (though in euro terms the increase was ‘only’ 40 billion). Many politicians and quite a few economic commentators here in Germany extol the dynamic of exports. I wish they realized that rising exports mean that you can afford more imports as well.
Otherwise you’re just lending others money and as can be seen in the last few months that’s not always such a good idea as an investment.
The imbalances inside the euro area continue to grow.
I have a bag full of French francs, German marks, Italian lira, etc.
The future of the U.S. dollar seems clear. It will no longer exist and will be replaced.
“…Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines… “They’re distorting their economies, and these policies can’t last forever,”…” http://www.bloomberg.com/apps/news?pid=20601087&sid=aMyJBjuJhn.o&refer=home
“Peter Peterson, a former US commerce secretary… is devoting $1bn of his estimated $2.5bn fortune to the new foundation, which paints a gloomy picture of the country’s financial future. The fund will be run by the US comptroller general David Walker, who is resigning from the Bush administration to take up the job… The approach has been criticised by the American Association of Retired Persons, which fears that it could be a thinly veiled argument for the privatisation of welfare…” http://www.guardian.co.uk/business/2008/feb/18/privateequity.useconomy
We seem to be mesmerized by the prospect of re-arranging the monetary deck-chairs on the ship, hoping somehow to change its direction and velocity.
That is a fool’s errand.
From the U.S. perspective, the problem is long-standing and obvious: we consume more value than we produce. Conversely, China produces more value than it consumes. Hence the current trade relationship between China and the U.S., and hence the looming iceberg. The relationship will soon end badly.
When a turn-around specialist gets installed as CEO of a failing company (costs > revenue), what do they do?
a. Cut consumption. All non-productive consumption goes overboard, pronto
b. All non-life-support resources are immediately channeled into profitable product lines, or new ones if the old ones aren’t profitable
In the context of the U.S., that means:
a. Entitlement and defense spending on a crash diet
b. Oil import bill slashed via conservation:
1. Telework. Move the work, not the worker.
2. Rails not trucks. Restructure the “last mile” loop between rail depot and loading dock
3. Retrofit homes to waste less (50% less in 3 years) energy. It’s do-able.
c. Massive R & D investment (not just some tax policy diddling on the edges) in robotics, nanotech, solar energy, accelerated education
Some will say “that prescription isn’t politically palatable”, hence we shouldn’t try it. The choice is rapidly narrowing to “ignore palatability and survive”, or “have a tasty last meal before an extended swim”.
You decide.
re: The imbalances inside the euro area continue to grow
“…Prosecutors are investigating hundreds of people, including several who are household names in Germany, on suspicion that they evaded taxes… Evidence that Germany’s rich tucked away their cash in… tax havens is creating a new narrative in German politics: the betrayal of the elites, who have spent the last decade calling for a painful reform of the welfare state, even as they apparently avoided paying their fair share. “The political implications of this are going to be great… In the U.S., we send people off to prison and say ‘good riddance,’ but it doesn’t actually shake people’s belief in the system.[???]…” http://www.nytimes.com/2008/02/18/business/worldbusiness/18tax.html?ref=business
Guest — the US has tools that would give it leverage (schumer-graham) though the US has wisely refrained from using them (and they would likely be found WTO illegal). There are also additional steps the IMF could take, though the IMF cannot compel change — only increase the heat.
re: Central bank losses.
If a central bank’s assets (fx reserves) fall in value relative to its liabilities (cash, sterilization bills), the central bank’s capital is depleted. But central banks can operate without any capital, as they have a theoretically unlimited call on the broader government if there is a real need. Good practice is to recapitalize the central bank with a government bond (the cost), but the interest on the bond is just handed back to the government — so there isn’t an obvious fiscal cost to doing this (tho the treasury’s debt and the government’s consolidated debt go up).
Everyone would agree that a central bank is in trouble if it cannot generate enough income from its assets to pay interest in its liabilities, and thus has to get a fiscal appropriation from the government to pay its bills. but since the pboc has a ton of zero interest liabilities (renminbi cash) that isn’t a short-term risk.
ergo fx losses (the fall in the value of the pboc’s assets v its liabiltiies) cut into the pboc’s capital and the interest rate shift (higher rmb rates on interest-paying liabilities v $ interest rates) cut into its income and its profits.
Personally, i would view the recapitalization bonds issued to cover the capital loss as a real loss — as those bonds could have been issued to finance infrastructure and the like (I think). But i would also recognize that central banks can and have operated with negative capital (even if that is not best practice) and the only binding constrain comes if the income on central bank assets is less than what the central bank needs to cover its liabilities, and the presence of zero interest rate liabilities (Cash) on the balance sheet tends to reduce that risk.
so the in short-run, the main visible cost is a fall in central bank profits (from the lower interest rate differential); the growing gap between assets and liabilities isn’t per se an immediate problem, even though it does to my view represent a future problem/ something that should be avoided.
I just want to note tho that there is real debate about this — my old boss, Ted Truman, knows a lot about central banking, and he strongly believes that a central bank can operate with a capital loss and it is a mistake to equate the fx losses of a central bank to the fx losses of a commercial bank.
“China produces more value” - stuff perhaps, but value?
Listen to Peter Bernstein on FT.COM.
Listen to the words stating the future is a mystery.
Major restructuring is on the horizon.
The NEW WORLD ORDER is forthcoming.
bsetser: So I am not in the camp that wants brutal adjustment now.
What is “brutal adjustment now”? Saving 5% of our income?
What is brutal adjustment then? When it hits you, “whoa, I’m not in Kansas any more”?
Revaluation is not something that should happen; it is something that will happen when the costs overwhelm the benefits. (Surely not far from where we are now). But America’s problems will keep growing. We can be players and make the tough choices, or we can be spectators and blame others.
Three possibilities:
a) A central bank without an FX loss
b) A central bank with an FX loss that is recapitalized
c) A central bank with an FX loss that is not recapitalized
The difference between the balance sheets of a) and b) is that b) has government debt as an asset (a receivable) - but a) and b) have the same liability structure.
The difference between the income statements of a) and b) is that b) generates less interest revenue in domestic terms due to the lower FX rate (assuming FX interest rates unchanged).
The recapitalization has no effect on the income statement, because while the government must pay interest on its debt to the bank, it recovers this cost through additional earnings on capital.
In c), the FX loss is fudged in the balance sheet in some other way (e.g. as a notional asset, but not in the form of a government bond). The FX loss is not marked to market in the capital account.
The net income statement in c) remains the same as in b).
So as in the comparison of a) and b), the recapitalization in b) has no effect on the income statement when compared to c). The government budget is affected to the decline in CB earnings in the case of both b) and c), but not by the recapitalization aspect.
The treatment in c) can go on in perpetuity, as FX assets mature and are replaced. The eventual economics really only depend on the interest revenue being generated by those assets. The domestic equivalent will decline proportionately as FX rates decline (ex changes in FX interest rates).
Essentially, FX reserves in c) are treated economically as a perpetual bond. The entire present value of a perpetual bond comes from its interest payments. So provided that the interest rate effect is accounted for each year into the future, the accounting is essentially whole without asset value and capital value adjustments.
This is essentially cash flow accounting as opposed to fair value accounting. In this framework, FX asset values provide insight into future FX cash flow behaviour, but don’t need to be combined with it.
There is no real limit to the treatment under c), even if the income statement turns negative due to decreasing FX interest revenue or higher cost interest paying liabilities, since the result of the income statement result is just factored into the government budget (deficit).
Fair value accounting is an interesting universal issue. It’s actually a huge factor right now in the case of credit default swaps, CDOs, and the monoline insurers. Monoline insurance replaces default cash flows - not default asset values. But CDS defaults require the replacement of asset values. So there is a mismatch between the asset value defaults of CDS and the cash flow default treatment of the monolines that are ‘insuring’ them. It’s on this basis that the monolines argue they are in fact adequately capitalized right now. This is going to be big in the resolution of that issue over the coming weeks.
Anonymous, you’re saying there is such a phenomenal difference in the interpretation between the monolines and their clients?!
It’s like if you insure your car and then total it, and the insurance company hands you a book of bus tickets…?
Brad, regardless of its title, anyone familiar with your work would expect the article to be more about “the perils of pegging to a weak dollar rather than the perils of a weak dollar per se”. As usual, you say more about how you think the rest of the world should change than considering what the US could do unilaterally.
I wonder whether, if the US just took what it had coming, and stopped trying to hold its consumption up with monetary and fiscal stimulus, the current account surplus countries might respond to a slowdown in their exports by a bit of fiscal stimulus in their own countries. I am sure that they appreciate the perils of pegging to a weak dollar enough not to try to resist a fall in US export demand by pegging even lower.
But that is a chance that the US is not willing to take. They prefer the “audacity of hope” to the toil of rehabilitation.
pallj on 2008-02-18 11:10:12
No. Its like if you insure against your disability, the insurance company replaces your income over the actual period of the actual disability, rather than the upfront present value of your expected lost income.
“toil of rehabilitation” is not a winning compaign slogan.
Rebel — the most important thing the US could do unilaterally is reduce its energy consumption/ reduce energy demand. that reduces both the us oil import bill and the oil exporters savings.
Other actions have a more ambiguous impact. To my mind, the reduction in the fiscal deficit from 04 to 07 had a smaller effect than should have been the case, as other countries didn’t adjust that much and a rise in household borrowing offset the fall in government borrowing. The conclusion that i drew from that episode is US action alone won’t work as effectively as action on both sides of the ledger; their also needs to be policies in place that reduce the surplus.
p.s. fiscal consolidation (lower rates) and a fall in us demand would likely be dollar negative, and if XR rates matter, that would increase the surplus of the dollar peggers — hence the increase in dollar inflows.
If someone else has additional ideas, let me know.
going from zero savings to five percent savings would be a brutal adjustment in the macroeconomic sense. bye-bye great moderation. it would be associated with a sharp rise in the volatility of output.
anonymous — i need to think about the overall balance sheet of the government (consolidated to include the central bank) in your various scenarios, but the story is basically right.
the scenario that you leave out is one where receivables (interest income) don’t cover expenses, effectively forcing either a recapitalization (increasing the central banks interest income) or a budget appropriation to provide the central bank funds to pay its liabilities.
in all cases, the loss effectively comes in the form of a dramatic reduction in central bank profitability, and thus a reduction in the value of a government asset.
There is a group of us out here in the real world who have enjoyed watching your journey through life. We’ve laid down our private bets and have hope that your voice, later on, will help drive major changes in the U.S. Government, Fed, and national economy. So, reading your op-ed the other day was a pleasure. Your selection over at CFR wasn’t a surprise, by the way. Good for you.
Now, let’s roll the clock back ten years or so. As the U.S. embarked on its advanced global trade path, it was already known that global currency relationships were less than desirable if not broken among many nations, including those in Asia. That nothing was actually accomplished toward fixing those problems prior to moving to the next stage of global trade set the stage for the next round of errors. And there was no mystery that this would occur.
Transferring considerable value-added production (whether existing, planned, or projected) to other nations - mostly developing countries - compounded the currency valuation problem and all the government/private financials that are tied to such valuations. That trade production move created more problems as it created pockets of shell economies around the world that were left concentrating primarily on the export of a given group of food products, raw materials, and some goods as well as a limited range of services (in some cases). Again, no surprise…at least to those who understood trade patterns subject to such levels of adjustment. Meanwhile, the financial markets created a host of phony backroom products that will ultimately serve as potential crash products not dissimilar to the dot.coms of the mid-to-late ’90s. Added to that garbage pile all the phony mortgage games including some support from the Fed, publicly and privately. Here’s a worthy layman explanation of that nonsense made available by Big Picture:
The Subprime Primer
http://docs.google.com/TeamPresent?docid=ddp4zq7n_0cdjsr4fn&skipauth=true
So, here we are…buried up to our necks in my Economic Hydrology Theory (as explained on your blog and elsewhere) on the global trade front, and buried up to the axles on multiple other fronts (you can fill in the subject names). A lot of stuff is broken right now or otherwise on the edge of domino collapse.
I caution you and others, though, not to hope for further corrections on the global front in the near term. Doing so might bring down the house of cards in ways that economists, analysts, and government leaders might not have a clue as to how to fix in short order.
The range of mistakes involved has created a mess of untold proportions. So large that the likes of Volcker and other bright minds may not be able to fix without destabilizing major economies later this year.
I recommend that Ben fix the major banks first and work out slowly from there. That’s his only viable option in my judgment. Much of that effort should clear the tables by May or June, and then we should be able to start digging through the rubble in search of other survivors. But, I caution again that this is not the time to be pushing for major changes. First things first, Brad. We’re in a helluva mess at the moment. And it is no mystery as to how we arrived here.
Kick your feet up on the desk and watch this unfold. It should make for a good chapter in your book.
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bsetser: going from zero savings to five percent savings would be a brutal adjustment in the macroeconomic sense. bye-bye great moderation.
Yes indeed! But “bye-bye great moderation”??? Is zero down no interest for two years great moderation? Is sending everyone a check with a message “show your patriotism and go out and spend” great moderation? Is lowering rates and taxes great moderation?
Reduce energy consumption? Great! How about a 50% Fed tax with a credit for low income? As a product of the 30s I see America becoming soft and spoiled.
“toil of rehabilitation” is not a winning campaign slogan.
true mr. anonymous -
but “yes we can” is not an economic policy.
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Brad,
You say: “US consumption cannot continue to rise relative to US GDP.” What about, for example, increasing taxes on energy to reduce the consumption of foreign oil, keeping the money in the USA, while supporting the economy by spending on mass transportation and energy savings in the USA.
There are many other unproductive, polluting excesses that will have to be reduced. Addressing them NOW would seem to be a middle ground- maintain consumption by offsetting economic changes while helping the US$.
Stephen H
Steven H — raising taxes on energy should reduce the consumption of all oil, not just foreign oil — but foreign oil is about 3/4 of all consumption so it will have an impact. and taxing energy use to make other investments (and bring spending and revenues into balance over the cycle would be a very positive step). It does involve a bit of toil, but I think an good candidate should be able to sell a set of investments that reduce the energy intensity of the us economy.
Congratulations on your first oped. The first of many no doubt. You are considerably more talented than most of the folks writing about economics. You and Mr. Roubini are writing some of the best economic commentary of our times.
“I focus more on the perils of pegging to a weak dollar rather than the perils of a weak dollar per se.”
For better or worse, attacking dollar devaluation as a means of rectifying global imbalances is PC. Any suggestion that the US should deliberately devalue or worse force the RMB to revalue gets a near hysterical response. Hence the distorted title of your article.
gillies -
very true
“China is expected to record a January inflation rate above 7 per cent - setting an 11-year high and providing evidence of entrenched inflationary pressures” http://www.ft.com/cms/s/8135416a-de45-11dc-9de3-0000779fd2ac.html
“Global steelmakers face a sharp increase in iron ore prices after Japanese and South Korean producers agreed with Vale, the Brazilian group that is the world’s biggest ore supplier, to a 65 per cent rise in term-contract rates beginning on April 1″ http://www.ft.com/cms/s/0ff842a2-ddde-11dc-9de3-0000779fd2ac.html
And gillies, speaking of ‘yes we can’ -
“Has positive thinking gone too far in corporate America? That may sound like a bizarre question: Optimism is widely seen as a virtue of American culture and key to success in business. Cultural norms and beliefs about good business practice increasingly stress looking at the sunny side and de-emphasizing the problematic.
But such overly positive thinking is difficult to reconcile with the need to make realistic, objective assessments. Finding the right balance between healthy optimism and delusion is harder than one might imagine, for both individuals and institutions.
And despite years — decades — of sobering examples, we don’t seem to be any closer to that balance. The recent recklessness of residential and commercial real-estate lending was in plain view, and a vocal minority wrote about it. But the financial and business communities dismissed all the warnings, insisting that any damage — should it ever arrive — would be contained to the subprime sector. The folly was obvious: Even if decision-makers had deemed the grim forecasts to be of low probability, the potential outcomes were so dire that they demanded contingency plans. On other fronts, experts are issuing warnings about the dollar’s continuing slide, which could worsen international financial stability, and about oil prices, and the hiring slowdown, and any number of potential crises looming in the near future.
We acknowledge these problems and their seriousness — and then put them out of mind. Instead of treating worrisome developments as new information and looking dispassionately at the risks, we tend to avoid working through downside scenarios because they are upsetting. It’s simply easier to put on blinkers and believe everything will work out than to confront the complexities of modern life.
… The end result is a bias against critical thinking. It’s hard enough, in the delicate social web of most organizations, to question the merits of any given proposal offered in good faith. But now decision-makers stagger under the weight of larger social trends and management fads that favor belief and force of personality over dispassionate analysis. Detached, rigorous thinking simply doesn’t fit any of our cultural models.”
http://www.auroraadvisors.com/articles/Optimism.pdf
but “toil of rehabilitation” is also not an economic policy
“…the most pessimistic economist in academe… is more aware of the gravity of the financial situation, and nobody has done more to point out the risks of a systemic crisis. So how are Mr. Roubini’s own funds invested? They are 100 per cent in equities…” - John Authers, FT, 02/17/08
Anonymous 16:25, thanks for the link. Perspective is critical. Brad says saving 5% is brutal adjustment for the US. The world is beginning to move away from the USD as the world currency, and the US is about to start losing its exorbitant privilege. When this process unwinds how many world class economists, like Dr. Setser, will view 5% savings as brutal?
I am certainly not a world-class economist, but thanks nonetheless.
5% household savings would be a fairly low level of savings –
the “brutal” bit would be going from less than zero to 5% in a one or two year period. that is the kind of adjustment many emerging markets endured in the 90s, tho it usually came from a collapse in investment more than a huge fall in consumption. it isn’t pretty. and given the role the us plays supporting global demand, it would spill over to the rest of the world.
see a true world-class economist (dr. Krugman) on his blog today –
bsetser on 2008-02-18 15:12:47 - “raising taxes on energy should reduce the consumption of all oil, not just foreign oil — but foreign oil is about 3/4 of all consumption so it will have an impact. and taxing energy use to make other investments (and bring spending and revenues into balance over the cycle would be a very positive step). It does involve a bit of toil, but I think an good candidate should be able to sell a set of investments that reduce the energy intensity of the us economy.”
You still aren’t paying attention. That type of taxation action would bring about disastrous consequences if implemented in the near term, say the next 20 months. Moreover, that action would drive more industry from the USA.
I’m surprised you continue to ignore the obvious on occasion. Your current potential approach is not workable in a weakened U.S. economic environment. Not even close, Brad.
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“…Data show that corporations nearly never bring home any of the foreign profits during the first fifteen years after incorporating a subsidiary inside a foreign country… the Fortune 500 companies with the most offshore tax havens are dominated by energy firms…” http://www.halliburtonwatch.org/about_hal/taxhaven.html