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LinkedInWhat does the US have in common with two of its most important creditors?
One answer: all have a significant population worried about how to make ends meet right now.
China exports a ton of goods, but imports oil and grain. And the price of both is rising. Back in November, there was a story circulating – perhaps apocryphal – that some Chinese workers wanted their wages indexed to the price of pork.
The Saudis are a net exporter of oil. But not everyone has shared equally in the oil windfall. Government employees living on a constant salary aren’t pleased by rising prices …
High wheat prices aren’t bad for Kansas, but not all that many Americans make
their living producing grain — or, for that matter, selling US bonds and parts of some US firms to sovereign investors. Reading the Pew Survey (hat tip: curious capitalist) is a good reality check for privileged New Yorkers working on the fringes of the financial sector.
A majority of Americans cite the rising price of basic necessities as their biggest economic concern.
Not the budget deficit
Not the credit crunch.
Not falling housing prices
But rather the rising price of a take-away slice of pizza. Or its equivalent. A slice is close to a necessity in my book, but eating out is a luxury for many.
Some key findings of the latest Pew Survey:
Fully 58% of the public says that their incomes are falling behind the rising cost of living.
Overall, 24% cite concerns over prices — with the cost of energy and healthcare mentioned most frequently — as the most important problem facing the country.
Substantial numbers of people with very low annual incomes — less than $20,000 a year — say they have difficulty affording basic necessities. Nearly three-quarters (74%) say they have difficulty affording gasoline, 65% report problems affording heat and electricity, and half have trouble affording food.
The recent rise in the percentage of Americans who say that their incomes are falling behind the cost of living has come largely among middle-income and poor people. Roughly seven-in-ten (71%) of those with household incomes of less than $50,000 a year say their incomes are falling behind the cost of living, up 16 points since last September. By contrast, only a third (33%) of those with household incomes of $100,000 a year or more say their incomes are not keeping pace with the cost of living, up modestly since September (four points).
Sobering. And the rise in US prices is lower than the rise in Chinese or Saudi prices.
David Wessel’s column makes a simple but important point that flows directly from another recent poll: the leading Democratic candidates for President aren’t as warm toward globalization as Bill Clinton because a majority of the American public isn’t as warm toward globalization as they were in the late 1990s. Wessel:
if Bill Clinton were running again, he’d probably put some distance between his campaign and his eight-year presidency. It’s the voters, stupid.
In December, a Wall Street Journal/NBC News poll asked Americans whether the increasingly global nature of the U.S. economy was good ("because it has opened up new markets and resulted in more jobs") or bad ("because it has subjected American companies and employees to unfair competition and cheap labor.") By 58% to 28%, the respondents said it was bad.
By contrast, in August 2007, the question drew a much less-hostile response: 48% bad to 42% good. (The rest weren’t sure or deemed globalization equally good and bad.)
And – as Bob Davis also reports in the Wall Street Journal — the rise of sovereign wealth funds isn’t likely to make to globalization more popular. The polling is still incomplete and Americans are not all that informed. Only 6% of Americans have heard of sovereign funds (also a useful reality check). But the US public don’t seem to like the basic idea of selling US companies to foreign governments. Davis:
By ratios ranging between 2 to 1 and 7 to 1, those polled opposed such investments in U.S. auto makers, high-tech companies, banks, oil companies and ports. The purchases of small stakes in banking giant Citigroup Inc. by government investment funds in Singapore, Kuwait and Abu Dhabi, United Arab Emirates, produced a similarly lopsided result: 56% opposed, compared with only 8% in favor.
The opposition appears to reflect a broad distrust of foreign investment at a time of economic uncertainty, rather than a specific reaction against sovereign-wealth funds.
By 49% to 25%, those polled said foreign-government investments harmed the U.S.U.S. national security. But only 6% of the respondents said they had "seen or heard anything recently" about sovereign-wealth funds. The poll was one of the first conducted on U.S. attitudes toward the funds. economy and, by 55% to 10%, that they hurt
I personally don’t think the explanation for the poll results is a lack of information. More information might only reinforce existing views.
10 years ago, the argument was that China’s population would offer Americans new markets for their goods and services. No one tried to make the case the US would benefit from China’s rise because it would allow China’s governments to buy up US companies, supplying needed capital to the US economy. But that is how it has worked out.
The US certainly exports far more debt (and perhaps soon equity) to China than goods.
Full proof won’t be available until the US capital flows data is revised following the Treasury survey, but it is likely that China’s purchases of US financial assets – bonds, companies – now significantly exceed US purchases of Chinese goods.
I find that a stunning fact.
Saudi purchases of US debt are even harder to track than Chinese purchases, but it is also reasonable to think that US spending on Saudi oil will be somewhat smaller than Saudi purchases of US financial assets. Even with oil at $100. Or perhaps especially with oil at $100.
(In 2007, Saudi Arabia added roughly $75b to its central bank’s foreign assets, and maybe 85% of that — $64b – was kept in dollars; US imports of Saudi oil (1.675mbd) at an average price of $70 would total $43b. That would rise to $61b if oil stays at $100. Of course, oil is sold on a global market, so this is more a way to have fun with the data than anything else – so long as the Saudis peg to the dollar they would be buying a lot of dollars even if they sold all their oil to China)
The funny thing is that I am not sure that Chinese and Saudi lending to the US would poll better in China and Saudi Arabia than Chinese and Saudi investment polls in the US.
In general, democratic voters demand more spending and investment at home – not more investment abroad.
Chinese price ex-food only went up sth like 1.2% yoy. And food is tied to energy (through bio-fuel). For both China and U.S. this energy driven inflation is exogenous and should not be addressed through monetary tightening. For the U.S. oil price is actually doing the tightening that Fed should compensate against. In the long term the only way to address the issue is for the U.S. to reduce demand. For China, they should work on the energy intensity issue by letting energy pricing rise but since the economy is growing much faster total demand will still be rising. Now if high food prices benefit Chinese farmers this will be good for generating internal demands (through higher farm income and also higher wages due to reduced labor supply if farm income improves) and will be good for addressing the trade balance.
Mexican workers who have incurred even greater job (including family farm labor) losses as a result of NAFTA would be even more inclined to question the value of free trade than U.S. workers. Migration data reinforce this liklihood. Whatever overall income benefits occur through unimpeded flow of goods and finance capital has to be viewed in the context of greater inequality and rcognitrion of differential benefits by social class and strata.
HZ — I am not 100% convinced it is exogenous, but maybe I spent too much time reading Jeff Frankel. Chinese demand for energy has contributed to strong energy (and food) prices, and Chinese energy demand is at least in part a product of a very stimulative macro policy mix (notably low nominal interest rates relative to inflation/ nominal GDP growth).
There is a part of the me that thinks that “core” v “headline’ in the US effectively counts those products where China has contributed to deflationary pressure but excludes those products where China is contributing to inflationary pressure, and thus headline has been rather consistently above core.
that said, tightening now in the uS would be a mistake — especially after the phily manufacturing data point.
Anonymous — I agree.
What amazes me is that the Presidential candidates don’t talk more about the economy. They may mention it at times, but they seem far more focused on personal scandals and “value” issues, etc., etc., than on the deteriorating financial condition of so many US households. My guess is that as November approaches the economy will become the number one, almost the only, issue.
Brad,
High commodity prices create financial outflows for both US and China (to a lesser degree). They might percolate through the system but as long as wage does not spike there shouldn’t be a cycle of wage-price spiral and people will have to eventually respond by changing their consumption pattern. Fed’s job is to help the economy adjust without going into serious deleveraging. Fed can afford to do this through lower interest rate so long as other countries are determined to run trade surpluses with us. When the situation reverses, Fed can afford to raise interest rate since lowering the trade deficit creates GDP growth here. So it seems to me that Fed has quite a bit of elbow room unlike what the financial media would like us to believe. Trade flow, unlike the financial market, is not going to turn in a short time.
China seems to be more on the verge of an inflation spiral, but unless the ex-food inflation data is totally bogus it is not showing up in the stats. So long as the production capacity can be switched from exporting to meeting domestic demand, higher wages don’t have to lead to inflation getting out of control. And I always though a bit of inflation is good to change the propensity to consume there.
Anon,
Freer market creates more wealth (check the Mexican stock market for example). It is entirely possible that the incompetent (corrupt?) government is the root cause of the problems you described rather than trade.
From a global perspective we are experiencing a correction of pricing mechanism. Socialist-Communist countries caused severe distortions in relative prices of commodities vs industrial goods. End of cold war created an illusion of cheap commodities due to demand destruction and collapse of the energy inefficient industries.
Within two decades a more or less market oriented economy has been established and now we are faced with true relative prices. Namely relative price of manufactures went down because of three billion new capitalists but also demand for commodities went up but their supply is restricted.
This are more realistic relative prices. The only mispricing is relative cost of capital. It is still underpriced.We have more workers but less per worker capital.This is the crux of the imbalance problem.
The coming global financial crisis will eventually correct that mispricing but will cause severe hardship especially in US and UK.
Brad Setser – “…it is likely that China’s purchases of US financial assets – bonds, companies – now significantly exceed US purchases of Chinese goods.
I find that a stunning fact.”
1. Why?
2. Did you mean to say Chinese goods or Chinese production-sourced goods? There is a big difference in the profit centers for both.
Regarding my question to you, Brad, I don’t understand, frankly, why you are stunned at that development. This was a natural consequence of an imbalanced trade relationship based on a number of flawed trade considerations beginning with currency valuations and types of food products, goods (intermediate, component, or final), and services opportunities.
I did not expect any other outcome. The front end analysis supported this potential outcome. Here we are.
QUIZ: What’s next?
Among the most noticeable cost increases facing households on a daily, weekly, and monthly basis are the costs incurred when purchasing groceries for the family. While the tank of gas is noticed briefly, it’s not sitting in a basket staring you in the face as you wander through a grocery for thirty minutes to an hour, subject to change – returned goods or substitution or isle avoidance. The grocery checkout experience is now quite brutal for many families. One can see it on their faces. Many are in shock. The checkout line discussions are no less discouraging on occasion. Those with families and particularly young children are concerned. Deeply.
______
>>>
This is good for Chinese farmers and farmers the world around. Consequently it is good for poverty reduction the world around. Where do you think the 1$ a day guys are in a developing country? In the countryside. With a bit of luck, this might help mitigate migrations from the countryside to towns in China, thus reducing the downward pressure on urban wages. Combine it with the price of pork and you’ve got:
- progress overall in absolute poverty eradication
- your long desired real exchange rate appreciation of the yuan
Further, thanks in part to our financial industry alchemists turning (only for a time, ok) lead into gold, in part to Greenspan and Co pretending alchemy was, (like creationism, me guess), the future of modern financial science, we apparently have a rebalancing US economy: construction down, consumer spending down.
Brad, you are in the process of getting the world you have been wishing for all these years. Now, you may find that some of the results will not be so pleasing to the eyes, but there you are. The great rebalancing seems to have gotten started.
“…In fact, the total volume of product supplied understates the actual amount of conservation because the population of the United States has expanded significantly in the last few years owing to immigration and the high birth-rate among some first-generation immigrant communities. The combined effect has added roughly +1% to the population of the United States each year, and roughly the same amount to the working-age population (18-64 years).
So product supplied ought to have been rising about +1% per year or +3% in the last three years just to keep pace with population increase. Instead, total product supplied is down -1.10% since 2005. Gasoline supplied has risen (+1.67%) but less than the population increase, while distillate supplied has been flat (-0.08%). Per capita consumption of crude oil and products is falling sharply. Fuel conservation seems to have started in H2 2006 and intensified since the start of 2007 in response to the surge in crude oil prices above $60 per bbl…” http://ftalphaville.ft.com/blog/2008/02/22/11112/america-goes-green-shock/
Overall Chinese farmers haven’t done too well in the past couple decades relative to their urban counterparts. Some farmers closer to major metro regions have done better locally selling fresh vegetables to urban dwellers. For the educated urban population across China, there has been a spectacular rise in the standard of living, almost say 100 years of US progress compressed into an equilvalent 30 years of Chinese progress. For many urban residents of Beijing or Shenzhen, today’s standard of living in a luxury condo flat would be unimaginable even two decades ago.
Asian Bloc region to lead Global Y-shape Economic recovery
http://www.atimes.com/atimes/Global_Economy/JB23Dj04.html
It may come as no surprise to readers that I expect Asia to form the upward trajectory. Before anyone starts muttering stuff about how unprecedented all this would be, perhaps they should spend some time thinking about the world economy of barely three hundred years ago. At the time, two economies between them had 50% of global GDP – these two were China and India. What happens for the next couple of decades will simply represent a return of the pendulum to produce the same outcome.
“…farmers should not take higher prices for granted, a report by HSBC has warned… There’s a temptation to say the bad times are over, but input costs are rising too… “We are moving into a period of a big divide between the ‘haves’ and the ‘have nots’. Cereal farmers will see prices much-improved, but everyone else will see less profit…” http://www.fwi.co.uk/Articles/2008/02/20/109514/dont-take-higher-prices-for-granted-farmers-warned.html
“…Wheat has more than doubled since May, reaching a record $11.53 a bushel on Feb. 11 and driving up costs for everything from Eggo waffles and Italian pasta to Pakistani flatbreads and Japanese pastry. This month the world’s biggest securities firm scrapped projections for a price drop within 90 days, and the U.S., the biggest exporter, said it would ship 23 percent more than originally estimated before summer. “The supply shortage has been much more acute than what we had expected,” said Ruifang Zhang, a commodities analyst at Goldman in London…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aOkjUbOT_JdE&refer=home
Movie Guy — unless you own the equity of say Apple, the distinction between Chinese goods and Chinese-made goods is shrinking because of the growing use of Chinese parts in both. I have never been a fan of the processing/ non-processing trade distinction.
Why am I stunned — China is still poor, and the notion that it could be a such a large source of demand for US financial assets is consequently surprising. It is a logical consequence of a lot of trends, but still a surprise.
anonymous with the FTalphaville quote — shouldn’t I get a bit of credit on that point too? I have consistently noted that oil import volumes are down.
four degrees north — it sort of depends on how you define adjustment. the trade adjustment has begun (especially ex petrol), but has been enormously slowed by the rise in oil prices. that wasn’t part of my adjustment scenario (an oversight I concede). the adjustment to a world where the US deficit is financed by private rather than official demand for us assets tho hasn’t even started.
the adjustment in China’s surplus hasn’t really started — at best, net exports won’t contribute to growth. the adjustment in the oil exporters surplus clearly has started, as oil prices keep increasing faster than oil spending.
that said, adjustment will be painful.
Higher food and energy prices are GOOD for rebancing. Higher oil prices mean higher transport cost, hence less international trade, exports, delocalisation etc.
Higher food prices mean higher world wage (and this disregarding currency manipulations by asian countries).
IF europe and the USA had not been stupid enough to subsidize the cost of agricultural products, food prices would have been higher long ago, so would have the minimum world wage and less delocalisation would have occured.
We all welcome inflation in prices. Inflation will lower the banking bills.
The problem is not higher prices. The problem is stagnating wages. We now need pro labor policies so that wages rise, if a price wage loop starts then we’ll be saved. Somewhat.
If our leaders are stupid enough to redo the 30′s policies and stand by the lenders, we are all doomed in a global debt deflation crisis.
Brad, you would be less suprised if you stopped talking about China buying US assets. This is not what CHina does. Or if you think that it is so, then you must believe Ford and GM and building companies are buying US household assets. (after all US households are borrowing more than the US government, they are collectively selling AAA bonds)
China is engaging in massive vendor financing, using all the tools available to the would be mercantilist. It is not very different from all western companies who over the last years have engaged in all kinds of irrational lending to boost the demand of their consumers.
China is stupid, in the long term it would have fared better by relying more on internal demand and allowing real wages to rise. But so have been all western companies. Wages have lagged behind productivity and only the increased household debt has kept demand rising.
China is not a poor country buying US assets, it is a poor country speeding its growth by the use of mercantilist policies. Those policies lead to overinvestment ? Where s the surprise ? Communist countries have long been known for their total lack of interest for their home workers and consumers. China has replaced government planning boosting investment directly by government mercantilist policies boosting investment indirectly.
Chinese workers must wait for real union rights and decent wages. Chinese consumers are not the priority of the chinese government.
China PBoC Officially Rejects US scrutiny over its sovereign wealth fund
http://www.forbes.com/markets/feeds/afx/2008/02/22/afx4684807.html
BEIJING (XFN-ASIA) – The People’s Bank of China said increased calls for scrutiny by the United States and European countries on the sovereign wealth funds of emerging economies will hurt the global economy.
The People’s Bank of China made the comments in its quarterly monetary report.
DF,
It is obvious that you have personally never visited China, but simply repeat the same rightwing Fox channel and Washington Times dogma about China as some sort of massive slave labor camp. Do you want to know why the rest of the world views things alot differently than the typical American? It’s because the managed US Corporate controlled media provides a very jaundiced view of the entire world including news on Iraq, Bosnia, Iran, Syria, China, Venezuela, Cuba, Malaysia, Burma, etc. The typical US citizen doesn’t have a passport and has never travelled outside the United States even into Canada or Mexico. Please admit that you have never personally visited any part of China or even Asia, and you have no idea what you are talking about. At least you can tune into some foreign broadcast news including the state-owned British BBC or the London Finacial Times that is alot less biased than US corporate controlled media. Even China’s Xinhua news is less biased on Middle East affairs than the one-sided US media coverage.
The US is the industrialized country with the most unequal distribution of income.
China, a supposedly “socialist” country has an even more unequal distribution of income than the US. Get rich at the expense of your “comrades” seems to be the thing.
Saudi is a repressive theocracy, sort of like Singapore without comely flight stewardesses and pretty much everything else except for the repression part.
What do they have in common? None have exemplary political-economic arrangements if social cohesion is an objective. They all have arrangements which reinforce inequality.
One big difference is that most Chinese are farmers which means that higher food prices aren’t necessarily a bad thing to them.
bsetser: The funny thing is that I am not sure that Chinese and Saudi lending to the US would poll better in China and Saudi Arabia than Chinese and Saudi investment polls in the US.
I’m not so sure that this is the case.
bsetser: In general, democratic voters demand more spending and investment at home – not more investment abroad.
I’m not sure this is the case, but anyway….
The interesting thing is that if you go back to the 1990′s, the tendency of voters to support protectionism and economic nationalism was widely regarded as a ***bad thing*** among neo-liberal economists, and that it was the duty of enlightened developed nations to fight the “politicians” and create systems of technocratic governance that were less resistant to trade and technology barriers.
(Just like everyone circa 1995 was saying that it would be total disaster if government had a floating currency rather than a dollar peg.)
Invoking democracy is quite funny and unconvincing when it comes from people who spent the last thirty years creating and justifying a world economic system which are dominated by institutions (the WTO, the World Bank, the IMF, and multi-national corporations) that are far more undemocratic and resistant to popular opinion than either the Saudi royal family or the Communist Party of China.
It makes it look like that people just change the rules and standards to meet whatever is in their self-interest at the time…….
China losing its competitive edge to other nations
http://www.chron.com/disp/story.mpl/business/5561042.html
As costs climb, even products sold there often made elsewhere
SHANGHAI, CHINA — The teddy bears selling for $1.40 in Shanghai’s Ikea store may be just about the cheapest in town, but they’re not made in China — they’re stitched and stuffed in Indonesia.
The fluffy brown toys reflect a new challenge for China: Its huge economy, which has long offered some of the world’s lowest manufacturing costs, is losing its claim on cheapness as factories get squeezed by rising prices for energy, materials and labor.
Those expenses, plus higher taxes and stricter enforcement of labor and environmental standards, are causing some manufacturers to leave for lower-cost markets such as Vietnam, Indonesia and India.
Costs have climbed so much that three-quarters of businesses surveyed by the American Chamber of Commerce in Shanghai believe China is losing its competitive edge.
To adapt, many multinational manufacturers, including Intel Corp., iPod maker Hon Hai Technology Group and Japanese companies like Canon and Sony Corp., are expanding operations in Vietnam. Auto parts makers are decamping for the Middle East and Eastern Europe, textile makers to Bangladesh and India.
df: Wages have lagged behind productivity and only the increased household debt has kept demand rising.
This isn’t the case in China where household debt has been small. Wages in China have risen dramatically. They have been rising more slowly than productivity, but that’s a different issue.
The interesting thing about people is that they are very, very happy to be content with say a 20% rise in income, and the fact that behind the scenes there is 80% more money to be made really doesn’t bother them. People tend to compare their incomes with what they made last year rather than what they could have made, since the last figure isn’t quite obvious to people.
df: Those policies lead to overinvestment ?
So what is the rational level of investment?
One thing about Communist countries that people forget is that in the 1950′s and 1960′s, they all had dramatic increases in productivity and standards of living. People in 1955 were really worried that the Soviet Union *would* surpass the United States, and a lot of the politics of the 1950′s and 1960′s was predicated on the idea that the US should learn some economics from the Russians.
It wasn’t obvious until the late-1970′s that these increases standards of living were due to moving people from farm to factory. Once everyone worked in factories, these increases disappeared and people got very upset because the increasing standards of living they had been expecting disappeared. Even here, I sometimes wonder what would have happened if in 1965 the Soviet Union ended up with a leader like Deng Xiaoping rather than Leonid Brezhenev.
One thing to note is that at the time of its collapse, the Soviet Union was far more wealthy than China is now, and that massive state-directed investment in Japan and the Soviet Union *worked* when they were at the same stage of development that China is now.
One thing about China is that its manufacturing advantage is not just cheapness. It also has the type of educated workforce you need for this sort of thing. Most Chinese people can read, which makes a huge difference in manufacturing.
“One big difference is that most Chinese are farmers which means that higher food prices aren’t necessarily a bad thing to them.”
if food prices are rising faster than inputs – if and if they can sell enough of their own production to buy the inputs they need to feed themselves.
“…people can read, which makes a huge difference in manufacturing.”
not if they can’t read the language on the label that warns about chemical toxins etc…
re: “shouldn’t I get a bit of credit on that point too?”
not expressed quite in those terms, at least not that i’ve seen…
i did a post to the effect “relative prices matter, oil edition” or something similar in response to the trade data. oil import volumes have been heading down for the past two years — a big change from the past. nonetheless, the scale of the fall in demand is actually small relative to the rise in prices. the elasticity is low.
2fish — my views may be warped by my experience at the treasury, but from the point of view of the US executive (admittedly the imf’s largest shareholder), the imf is far more democratic than the CIC or the Saudi royals … admittedly, it looks rather different from asia. The same applies to the CIC — it doesn’t seem all that amenable to democratic pressure from the US.
Guest [China losing its competitive edge],
A natural trend given how globalization works. Most of the companies that went to China to tap the Chinese market were a bit (to say the least) premature. Those who used it as an export platform will leave if they find a better (cheaper) deal. Water flows to the lowest level; it’s a race to the bottom to find the cheapest labor, the least taxation, and the fewest regulations.
At the end of the road is a train wreck. Wealthy consumers tapped out; wealth ever more concentrated in the hands of a few; and the poor left behind (they could not compete with even cheaper labor.) Credit is constantly extended and made easier so that the game can continue. It’s a brutal game. No way to run (or ruin) a planet.
Stormy,
Even if what you said may be true about financial wealth, it is obviously not true about how products and services are distributed. Even the poorest countries are having cell phones these days. Would you rather it be the other way around that we all have more paper net worth but less products and services to go around?
Stormy: it’s a race to the bottom to find the cheapest labor, the least taxation, and the fewest regulations.
Not quite. The trouble is that if you have a place with too little taxation and few regulations you end up with a place that has an uneducated workforce and unenforceable contracts and broken financial systems.
it might surprise some people to discover what a small percentage of the price of food goes to the farmer. for some foods it is 3%. different foods – obviously – different percentages. whether rising food prices are good for the farmer depends upon what is causing the rise. a doubling of the farm gate price in such a case should really only add 3% to the cost of the final product on the shelf.
afghan poppy farmers, a highly profitable sector, get 1% of the eventual ‘street value.’ the international banks probably cream off more than that from the laundered proceeds !
the cost of food in our industrial system is made up of processing, packaging, wholesaling, distribution, retailing, advertising, and at the other end – fertilisers, vetinary medicines, sprays, machinery, fuel, rents, etc.
then a lot of people with two-job-mortgages eat out a lot, and incur further eating costs.
supermarkets with food are like garages with ‘gas’ – quicker to hand on increases than decreases in their producers’ costs.
not much for the poor ole farmer . . .
.
“end up in places that has …. unenforceable contracts and [a] broken financial system.”
like the US?
financial system doesn’t look so hot right now, and a lot of mortgage contracts may be unenforceable b/c of problems with assignment, let alone the basic problems (political) with large scale foreclosure and the logjam in the courts.
One DIFFERENCE between the US and China is that China has some relatively easy remedies for inflation such as letting the yuan appreciate, etc. The US has very few remedies for inflation should it break out here. We can’t raise interest rates without sending the economy into a disastrous downward spiral and we can’t “let” the dollar apprciate since it won’t.
bsetser: financial system doesn’t look so hot right now
That’s because people have this weird tendency to compare real world systems made up of fallible and imperfect human beings to some abstract and impractical ideal of perfection.
Compared to any other legal, political, and financial system that exists, the US does extremely well.
bsetser: a lot of mortgage contracts may be unenforceable b/c of problems with assignment
At which point you bring in the lawyers and judges to sort through the mess. In many, perhaps most parts of the world, people would start pulling out guns at this point.
Also to clarify “enforceable”. If the bank poorly drafts a mortgage contract so that the homeowner can argue his way out of the debt, that’s an enforceable contract. If it turns out that a contract works against the bank, then that’s the way it is. If it turns out that the homeowner can’t pay and declare bankruptcy, then there is a process for dealing with that. The bank doesn’t respond by hiring a bunch of thugs to go and beat up the homeowner.
bsetser: let alone the basic problems (political) with large scale foreclosure and the logjam in the courts.
So you get the lawyers, bankers, politicians, and mortgage holders in a room and work out a general settlement.
What amazes me is the power of marketing. If you call it a “bank bailout” people start screaming, if you call it a “program to help working class people keep their homes” then people don’t, even though its effectively the same thing.
HZ–
I would be far happier if China had a more even development, i.e., allowed its populace to benefit more. To do that, before entering the WTO, it should have had in place much more than the now belated Contract Law, to name only one issue. Only now is it thinking twice about being the world’s toxic dumping ground–where we send all those broken computers, for example.
Now, I have heard how nice it is that these poor people are now getting something….even if they have to handle toxic wastes without protection. Or how working in brutal sweatshops is really a step up…and we are just tickled pink about their advancement. I just don’t buy that self-serving Western argument.
As far as the U.S. is concerned, we have absolutely nothing to brag about. Brad’s riposte to Twofish regarding our financial institutions was on the money–not to pun.
Problems can arise when trading partners are radically unequal or radically different. The WTO, in its wisdom, never considered these kinds of consequences. With smaller but poor countries, the West could waltz in and just take. China is poor and huge. Using China as an export platform was like hitting the lottery.
Radical differences–be they in philosophy or in fact–can create issues. Remember how the pitch once was: Capitalism will democratize China. I have to laugh at that silliness. “Just wait, they will all turn into Americans.”
That cell phones sell well in China is great. China has one of the largest cell phone companies in the world. But having a cell phone is not a sign of prosperity.
There are so many questions, but the one on the table seems to be: What is going to happen as inflation starts to bite both sides of the trading post? i.e., Americans, the Saudis, and the Chinese? I am not worried about the rich in these countries–but what about the average worker?
TwoFish,
Looking at percentages, yes, it may “seem” that wages are rising in China. But look at the buying power of that wage.
Can you provide the link to the “increase”—and tell me what that wage is in terms of U.S. dollars?
“like the US?”
relative to what brad? 2fish is right
“program to help working class people [buy and] keep their homes” – many of whom are immigrants, illegal or not…
emmanuel –
good answer (S. Arabia, China, the US all have an unequal income distribution); the US may have more in common with some of its creditors than it cares to admit …
anonymous — there are plenty of US financial institutions looking for new investors, so it is quite easy to express your view in the market.
Stormy,
We are talking about commodity inflation here. The supply has been up so it is demand driven. I don’t think it is the rich Americans driving more (American use has been down) or eating more calories. The demand growth comes from China/India/EMs. If that is not a sign of progress, I don’t know what else is.
Now I wish as you do that everything can be made perfect. But nobody could just hand us liberty, justice and prosperity on a platter. Think of it, both cell phones and AIDS drugs are invented here in the US. How comes people around the world get to afford cell phones? It is delivered exactly by what you lamented as the “race to the bottom” competition from the far east manufacturers. But they can’t afford AIDS drugs, not because China/India couldn’t make them cheaply, but they are prevented from doing so by IPRs — i.e. barriers to competition that you so desired. Farmers in China have to decide whether to scrape by on a farm or live the hard lives of migrant workers. Having the choice couldn’t have changed their lives for the worse. Now if there were free flow of labor in addition to capital, they could migrate to places that offer better labor conditions. I don’t think it is the Chinese law that prevents them from doing so. We will see if the new labor law does anything real for the Chinese workers.
BTW I think the Chinese are clamping down pretty hard on the import of used electronics. Indeed they forgot to give exemption to used printer cartridges that they could soon be facing shortage of refurbished cartridges so users could expect dramatic increase in printing cost (another good example of what barriers to trade could do for you).
Invoking democracy is quite funny and unconvincing when it comes from people who spent the last thirty years creating and justifying a world economic system which are dominated by institutions (the WTO, the World Bank, the IMF, and multi-national corporations) that are far more undemocratic and resistant to popular opinion than either the Saudi royal family or the Communist Party of China.
It makes it look like that people just change the rules and standards to meet whatever is in their self-interest at the time…….
Twofish i agree 100% with this.
Dave Chiang you are a pathetic joke. For your information I am Definetely French. I don t have access to pathetic US corporate media. I have not been in China, that s true. I have not been in Iraq, Iran, Venezuela either, However I still have access to objective information on them. I did not need to go in Iraq to know in 2002 that there were no WMDs overthere. Wake up people, small countries ravaged by a lost war and ten years of embargo are no threat to anyone, and that s the reason why it s easier to invade them than their theocratic neighbour.
Why you chose to stand up behind unsound policies who are putting the living standars of chinese people at risk and possibly the unity of china itself is a mistery to me. You are the one backing the present debt fueled globalisation, its major risks for the earth in general and China in particular.
Twofish chinese workers are happy with their wage raises even though it has not kept up with productivity. That is not an entirely different matter, that is precisely the point. If wages lag behind productivity then you need some ways to boost demand. And if it is not the printing press, then it is a debt bubble. And if it is a debt bubble, then you end up in trouble. We have had a debt bubble. We are starting to experience trouble.
of course boosting investment works for a while, of course the soviet union economy collapsed mainly because it was stupid enough to believe the chicago school economists.
This world is a world in wich both debt and trade have outpaced production for decades now. And this is just not sustainable. So it had to change. And it s changing right now.
To clarify I didn’t mean the ban on importing electronic waste as the barrier to blame for printing cost. It is a barrier that I agree with but they should make exceptions for reasonable recycling, so it shows how hard it is to get bureaucratic rules right. The real barrier in the printing case is erected by printer makers’ business model to make money on the supply instead of the printer so they design their cartridges to prevent copying and competition.
df:
“If wages lag behind productivity then you need some ways to boost demand. And if it is not the printing press, then it is a debt bubble. And if it is a debt bubble, then you end up in trouble. We have had a debt bubble. We are starting to experience trouble.”
Very good point. You need to create debt in aggregate either way. If wages lag, it will be consumer debts (or trade surpluses in China’s case). But if wages lead, you could have debts (on the government or corporate side) AND inflation. Italy is (was?) case in point. Fiscal conservative population coupled with inflation (before the Euro) and huge fiscal debt.
Let’s look at it another way: if consumers put on debts at least they can decide on how the money should be spent, not so if government does it. And if we load the debt (and less profits) on corporates — well we will see less investments — may be the right recipe for China but not US (sorry don’t know enough about Europe).
So short to medium term this is not necessarily a problem. The problem is over a longer time horizon tax policy needs to be effective to right the imbalance. To me inheritance tax is the right place to prevent concentration of financial wealth from passing from one generation to next and creating a stratified and classed society.
What is an ideal credit life cycle? In my view, while one works one should accumulate financial debt and real assets. Wages should cover financing cost and living cost. When one retires there should be transfer payments and draw down on real assets to support retirement. When one dies assets and debts should roughly balance out — a modest surplus corresponding to the national average of net asset may be okay. If one ends up with a net debt, that is forgiven at death. If one ends up with a large surplus, that should be taxed heavily to prevent dynasties. Is there anything unjust about a system like this?
The current American system is not exactly like this but fairly close. But people on both left and right are trying to break it. People on the left wants to tax the accumulation heavily, which will be disincentive to work and invest and lead to stagnation. People on the right wants to get rid of estate tax (“death tax” they call it), which will impede rebalancing.
BTW, debt accumulation is there for everyone whether one recognizes it or not. Government debts could be allocated to tax payers. Corporate debts could be allocated to shareholders.
HK—
The falling dollar certainly contributes to commodity inflation in the U.S. I would not, however, argue—except in some areas such as some raw materials—that commodity inflation is a result of China and India buying more finished goods.
Each commodity has its own story…and that story changes within a specified context.
The story of oil, for example, is complex: Demand is beginning to be the size of the spigot—if you get my drift. And, regardless of the demand, we may be close to not be able to increase supplies cheaply. The falling dollar will affect those oil consumers who peg to the dollar—that includes the U.S., of course. Many of the major oil fields have peaked, flattened, or maybe close to peaking. Being a pivotal commodity, oil affects everyone and everything…from crops to cars. As Matt Simmons has point out: The era of cheap oil is over.
Even though China had subsidized the cost of oil, it, too, has shortages. In fact, it has raised the price of oil to ensure energy conservation.
Commodity inflation is not a sign of the recent success of the Chinese or Indian consumer now approaching the American lifestyle. Far from it. Such arguments sound nice, except when you look under the covers.
df: Twofish chinese workers are happy with their wage raises even though it has not kept up with productivity. That is not an entirely different matter, that is precisely the point. If wages lag behind productivity then you need some ways to boost demand. And if it is not the printing press, then it is a debt bubble.
You can have government spending in roads, schools, hospitals, You can also have a lottery, find some lucky people to give money to and say “here spend it.” This creates a cycle in which you have even more productivity.
The key thing is to boost productivity. A factory or road is in some sense more “real” than debt which is a social convention. You can’t wish a factory into existence or imagine a road.
On the other hand, you can make debt disappear or create money from nothing. If everyone says that there is no debt, then there is no debt.
So my view is to worry about creating factories and universities, and then worry less about debt.
And if it is a debt bubble, then you end up in trouble. We have had a debt bubble. We are starting to experience trouble.
The US has the mother of all debt bubble. Fictitious capital is in the process of being destroyed. Because the problem is too big to solve, all of the attempted bailouts are doomed to failure.
The inflationary pressures the Chinese and Saudi Arabian economies face is imported from excess US Dollar liquidity.
The Chinese economy has exponentially increased its “Real Wealth” producing Industrial capacity. With a larger industrial production sector than the US economy, the Chinese economy size is actually significant larger than Western accounting measures indicate.
“…In the Arabian Gulf countries alone, there are over 200 billionaires… Assets supervised by family offices in North America grew 20% to $305 billion in 2006… Almost one firm in five boosted assets more than 50%… The ranks of the rich grew fastest in Singapore, India, Indonesia, Russia and the United Arab Emirates… All topped 15% growth. China’s wealthy rose 7.8% to 345,000, while the U.S. was up 9.4% to 2.9 million…” http://www.bloomberg.com/apps/news?pid=20601109&sid=agzMMPZAouLw&refer=news
“…Wood’s view is that gradualism will remain dominant in policy-making… This means the structural imbalances are likely to build because the authorities will not tolerate large one-off revaluations for the same political reasons they will not countenance a meaningful rise in interest rates to allow for a more healthy level of nominal interest rates relative to China’s nominal GDP growth… This looks like the inevitable long-term consequence of current macro policy in the context of a still predominantly closed capital account… and, therefore, increase the odds down the road of that monster asset bubble with all the potentially negative political consequences of such an event for China…” http://ftalphaville.ft.com/blog/2008/02/22/11114/greed-fear-the-fallout-for-china-equities-and-the-rating-agencies/
“To me, a bailout means a company that is struggling to meet its obligations… We’re in no need of a bailout.” http://www.bloomberg.com/apps/news?pid=20601087&sid=aHkTNYiHGd2Y&refer=home
brad – if you could elaborate:
“my views may be warped by my experience at the treasury”
“there are plenty of US financial institutions looking for new investors, so it is quite easy to express your view in the market”
“and I’ll take Houget’s numbers over Wesbury’s.”
Thanks for your blog Mr Setser.
The “global savings glut” is pushing up food prices.
This is from June 2006.
“Index funds are having a significant impact on the commodities market.
“There’s $3 trillion in pension money that’s floating around looking for places to invest,” said McDaniel. “A lot of pension managers and institutions are putting 3-5 percent of their capital into indexed hedged commodity funds. They trade futures – they’re betting on the board.”
…..”Some well-placed observers suggest we get $5-10 billion/month coming into the market as positions to buy and hold,” said McDaniel. “That affects all commodities, and its just money on a schedule to come in.”
… index funds may create an artificial floor in the commodity futures market…
http://www.farmandranchguide.com/articles/2006/06/08/ag_news/markets/market01.txt
I expect the same thing is happening with energy commodities, particularly oil.
Perhaps we are taking away the productivity bonus the consumer is entitled to,
This is causing trouble in places like Indonesia and probably coming soon to a store near you.
The French revolution had something to do with the price of bread.
And from this quote form the same story,
“”There isn’t an easy way around a hedge-to-arrive contract – you can carry as much open corn as you can and you can hedge against the next summer premium if farmers have room to carry two years of crops,” ”
Two years worth of crops seems to be about the limit for the storage of corn.
I wonder what the financial wealth storage limit is, that is, GNP times how much?
If Chinese exports are losing their competitive edge, that would have the positive effect of pushing China to expand its internal market for what it produces, so I don’t see that as a negative. And if more of its product went to the internal market it would have less need to keep the yuan’s value artificially low. What the world needs is for the Gulf Oil producers to make better use of the vast savings they are accumulating. Since the US really controls their destiny and their safety, why doesn’t the US use its clout in that sense? It has or could have lots of leverage over them.
Twofish:
“bsetser: let alone the basic problems (political) with large scale foreclosure and the logjam in the courts.
So you get the lawyers, bankers, politicians, and mortgage holders in a room and work out a general settlement. ”
I would like to comment on the two lines above. Recently, I read an article where there are two many lawyers, bankers, politicians and mortgage holders to get in a room and work out a settlement – maybe hundreds or thousands of people would be necessary – to work out a settlement. Some mortgage holders may be bankrupt and not able to be found. One bank does not hold a mortgage anymore, instead it is divided up into hundreds or thousands of pieces and packaged up as CDOs and SIVs and sold around the world. Some house cannot be legally reposed because there are no clear mortgage holders, and courts and judges are allowing defaulting home owners to keep the house free and clear without making anymore payments. Here is the link that describes this happening:
http://www.nakedcapitalism.com/2008/02/some-banks-cant-foreclose-unable-to.html
As far as China, Saudi Arabia and USA – what do they have in common – they all three are coupled together with using the US Dollar as a world reserve currency. China and Saudi Arabia accumulate USD reserves in exchange giving the USA real goods, and the USA prints more money by typing in digits into a computer and pressing the ENTER key. They are like 3 kids at a playground – holding hands – and spinning around and around, faster and faster – but eventually one will let go and all of them will fall to the ground. But who gets hurt the worst? I believe we will all find out soon enough. And when?
DC: The US has the mother of all debt bubble. Fictitious capital is in the process of being destroyed. Because the problem is too big to solve, all of the attempted bailouts are doomed to failure.
I don’t see this to be true at all. The current problems with subprimes are much smaller both in relative and absolute terms than the Savings and Loan mess around 1980, and that got solved pretty quickly.
Part of the reason for this is that the US economy is so huge, that things that would kill the economy of an emerging market are things that are small annoyances in the United States.
Twofish,
As per Washington Post, the credit problems go beyond just subprime. Alt-A, home equity loans, and even prime loans are increasingly at risk. Right now, a record 5% of total mortgage debt in the United States is 30 days late or more. That is very serious. I wouldn’t go that far, but Nouriel Roubini is even predicting a “systemic meltdown of the US Banking system”.
I learned an interesting new term the other day. This term was used in regards to the sub-prime mortgage problem.
“sub-prime financial system”
The sub-prime mortgage crisis (that we hear so much about) is only a very small symptom of a much larger problem, which is that we now have a global sub-prime financial system.
“…$10 trillion of capital that’s now sitting offshore, American money that has been moved offshore to protect it from our tax system… What would happen if $10 trillion of capital poured back into the economy?” http://www.taxjustice-usa.org/index.php?option=com_content&task=view&id=267
DC: As per Washington Post, the credit problems go beyond just subprime. Alt-A, home equity loans, and even prime loans are increasingly at risk.
The Washington Post could (and I think in this case) is wrong. Prime mortgages and subprime mortgages are fundamentally different beasts. Prime mortgages are lent against the holders income, and as long as the holder has a job, he or she is unlikely to default. You will have problems if there are mass layoffs and unemployment skyrockets, but there are dozens of things one can to go keep that from happening.
DC: Right now, a record 5% of total mortgage debt in the United States is 30 days late or more. That is very serious.
What percentage is prime and what percentage is sub-prime?
DC: I wouldn’t go that far, but Nouriel Roubini is even predicting a “systemic meltdown of the US Banking system”.
Well he is wrong then. The basic argument that I am using to argue that things aren’t nearly that serious is that the US has gone through much more severe downturns, and things haven’t fallen apart, and there is no reason to think that things today are worse than the crisises in 1973 or 1980.
Anonymous: .$10 trillion of capital that’s now sitting offshore, American money that has been moved offshore to protect it from our tax system… What would happen if $10 trillion of capital poured back into the economy?
This sounds like a pseudo-statistic and in any case it misunderstands the purpose of the Cayman Islands. Suppose you are a Delaware corporation, and you open a factory in China. The Chinese government gives you this nice fat tax break. This tax break is totally useless to you because, if the Chinese government reduces its taxes, then the double taxation treaties come in and you have to pay those rebates to the US government. So you set up a Cayman Islands shell company so that the business you do in China is subject only to Chinese taxes.
Another example, you have a hedge fund that has some clients that are American but rather that are Saudi. The Saudi clients don’t want to pay US tax, so to keep that from happening, you set up shop in the Cayman Islands. Note there that your US clients are still subject to US tax, and you are still required to comply with IRS reporting for your US clients.
Twofish,
The mortgage default problem is not just confined to subprime. Take a look at Washington Mutual’s shocking deterioration of “near” prime Alt-A mortgages.
Washington Mutual (WM) AAA-rated mortgage pool known as WMALT 2007-0C1.
http://globaleconomicanalysis.blogspot.com/2008/02/evidence-of-walking-away-in-wamu.html
The total pool size is $513,969,100.
$476,069,000 was rated AAA.
92.6% of this cesspool was rated AAA.
Yet 15% of the whole pool is in foreclosure or default after a mere 8 months!
Washington Mutual was the underwriter. If you bought a slice of this cesspool from WaMu, are you going to buy their next offering? One final question: Does anyone have any reason to trust any rating from Moody’s, Fitch, and the S&P?
DC: The mortgage default problem is not just confined to subprime. Take a look at Washington Mutual’s shocking deterioration of “near” prime Alt-A mortgages.
“Near prime” is like “almost pregnant.” The basic question was whether the mortgage was issued on the basis of the borrowers credit and income (in which case they are likely to pay unless they lose their job) or was the mortgage issued on the basis of the value of the house (in which case the borrower was planning to refinancing once house values went up, which causes a problem if they don’t).
DC: If you bought a slice of this cesspool from WaMu, are you going to buy their next offering?
I think the question is whether or not WaMu is going to be around long enough to have a next offering.
Twofish,
Mortgage data on how the WaMu loans were issued isn’t provided. It is apparent that the problems in the US financial system are accelerating. With a 15% default rate on AAA-rated bonds in 8 months, can you imagine how bad it will look in another year???
Citicorp is even in worse shape than WaMu having issued default protection guarantees on its Mortgage backed securities sold.
and STILL no recession! I must say, you Americans have one helluva an economy!
“Note there that your US clients are still subject to US tax, and you are still required to comply with IRS reporting for your US clients. ”
US clients can have multiple identities/citizenships through the use of trusts. Morally I’m sure they feel justified in letting income in these offshore trusts accumulate untaxed. Kind of like a rich uncle that lives in Switzerland who will send you money whenever you need it. When the rich uncles sends a check, they will pay the tax to whichever country they live at that time.
DC: With a 15% default rate on AAA-rated bonds in 8 months, can you imagine how bad it will look in another year???
As you yourself point out, AAA ratings turn out to be total nonsense when applied to CDO’s. You are using the same sort of flawed analysis people make on the Chinese banking system against the US banking system.
Guest: US clients can have multiple identities/citizenships through the use of trusts.
If you are a US citizen, you are subject to US tax on all worldwide income. Any trust that is controlled by a US citizen is also subject to US taxes.
You can try to make it hard for the IRS to find your money, but there will be hell to pay when they find it, and you will find major banks and hedge funds very, very uncooperative in helping you hide it, because they are scared of the IRS shutting them down.
The big misconception is that US companies use offshore tax havens to avoid compliance with US tax and securities regulations. The truth is quite the opposite. US financial companies want to comply with US tax and securities law because of the devastating effects of non-compliance, and if they see a chance to avoid tax and regulations legally by setting up an offshore account, they will use it.
Twofish,
I’m pretty sure the entire US Banking industry will soon be impaired. Alt-A and Option ARM’s are going to be a bigger problem than Sub-prime. More outstanding loans with bigger dollars at stake and negative equity. As per Nouriel Roubini, it’s at least a $1 trillion hole on the balance sheets of the US Banking industry. That’s alot of real money.
DC: As per Nouriel Roubini, it’s at least a $1 trillion hole on the balance sheets of the US Banking industry. That’s a lot of real money.
A trillion dollars is less than people think it is…..
In comparison to the total amount of assets out there, a trillion isn’t a huge amount. The total mortgage market in the US is about $10 trillion. A trillion dollar loss (which is something of a worst case scenario), is just not enough to cause the US banking system to collapse.
BTW, this is why I think that “China is going to control the US economy” or “The US economy is going to collapse tomorrow” fears are way overstated. They hugely understate the size of the US economy and the banking system. The sheer size of the US market is also why the US can get away with things that would totally kill a smaller country.
One thing about news reports. Given that the NYT has such generally bad coverage of China (which is in large part because Howard French tries to fit everything into his worldview), I’m quite surprised how good the NYTimes is at covering SocGen and the mortgage crisis and how bad the Washington Post is.
“…It’s not just Liechtenstein… Along with Belgium, Luxembourg and Austria are criticised for having secured an opt-out from 2005 EU legislation to ensure the sharing of banking information on non-nationals. Liechtenstein’s Crown Prince Alois has said his government would press ahead with reforms to its trust and tax systems that have been in the pipeline for years. But the planned amendments are expected to streamline trust regulations without lessening the confidentiality…” http://afp.google.com/article/ALeqM5gh3nAJEc5sUAzYbXkzy4EoZ6jtJQ
“…the bank “has apparently harbored numerous secret accounts which hid the taxable assets of thousands of citizens from around the world…” http://online.wsj.com/article/SB120363412239584247.html?mod=googlenews_wsj
“…In Europe regulators could do more to force banks to own up to their losses. More worryingly, if the world leaves the Fed to provide risk insurance for everyone, America’s interest rates will almost certainly be too loose for too long… The world would be better off if risk management were not down to one country… many countries have unusual scope to use their governments’ coffers… They should not rely on America to do it for them.” http://www.tehrantimes.com/index_View.asp?code=163427
2fish — a $1 trillion loss concentrated in the banks would be enough to cause the banking system to collapse. $100b loss put the banks in deep trouble, and forced them into the hands of the petrostate/ East asian SWFs. $1 trillion is huge relative to their capital. and at some point, if your capital is too small and you are leveraged, you enter into a death spiral, as you have to shrink and your shrinking moves the market against you.
the real question is whether $1 trillion in losses spread across the global financial system — including to a range of real money investors – can be absorbed. We shall see.
It doesn’t depend on the size of the market so much as the capital stock of the intermediaries backing the market. if all the losses were in real money pension funds, it could be absorbed — tho future pension benefits might need to be cut. if it is in the hands of leveraged intermediaries, including banks, it is a different issue.
@bsester
Is there a limit or end to the amount of bad paper the Fed can transform into cash through its new auction process? Is there any accountability to Congress?
http://www.portfolio.com/views/columns/economics/2008/02/19/Massive-Bailout-Planned-for-Banks
@bsester
What I was trying to get at is the idea that covert (and maybe overt) bank bailouts may mitigate the effect of a 1 trillion dollar loss.
bsetser: 2fish — a $1 trillion loss concentrated in the banks would be enough to cause the banking system to collapse.
Concentrated in one bank in an unhedged way. Sure. It it would kill the reserves. However, the losses seem to be spread around quite a bit. If the investor defaults, and the bank passes through the loss to hedge funds and other MBS investors, the bank doesn’t get hit.
For example, in the case that DC brought up, the main people getting hit are the people who bought the CDO’s, that WaMu issued. WaMu gets hit only to the degree to which it guarantees the senior tranches. This is the pattern in other banks, the banks are getting hit as far as CDO guarantees, but investors in the CDO’s are taking most of the losses.
bsetser: It doesn’t depend on the size of the market so much as the capital stock of the intermediaries backing the market. if all the losses were in real money pension funds, it could be absorbed — tho future pension benefits might need to be cut. if it is in the hands of leveraged intermediaries, including banks, it is a different issue.
And the whole point of securitization is to create the first situation rather than the second.
The reason I am very positive about the US financial and political systems is that you can have people do really stupid things (like invade another country or put all their money in real estate) have everything blow up, and the system still goes on. You simply cannot count on people being intelligent for long periods of time, and rather than count on intelligent people, you need political and financial systems that can absorb damage from when people do stupid things.
Right now the financial system is absorbing impact from the aftermath of stupid loans. It looks like a credit contraction and recession are in the cards, but I don’t see anything close to a meltdown.
bsetser: What I was trying to get at is the idea that covert (and maybe overt) bank bailouts may mitigate the effect of a 1 trillion dollar loss.
If things get sufficiently bad, then we are looking at a Resolution Trust Corporation situation, but I don’t think we are near at that point yet.
Bailouts have to be handled very carefully since you don’t want to end up rewarding bad behavior.
Gloomy: Is there a limit or end to the amount of bad paper the Fed can transform into cash through its new auction process?
There are limits to the degree that the Fed can absorb bad paper. We haven’t hit them yet.
Gloomy: Is there any accountability to Congress?
Yes, but the politics of the situation is that Congress wants to keep hands off of this for as long as possible. The problem for Congress is that if it does get involved, then some people will (correctly) blame it for doing too much and giving a bailout to the banks and other people will (correctly) blame it for not doing enough and letting poor people get kicked out of their houses and causing the credit market to grind to a halt.
The political solution that Congress wants is to look good by allowing for easy credit and providing goods and services to “good honest working class Americans” while not looking bad by providing “corporate welfare to fat-cat Wall Street bankers”, Trouble is that you can’t do one without the other.
So as long as it can be handled by the Fed, they”ll let the Fed handle it, and whatever political costs exist they can get through it by “blaming Bernake.”
Twofish: Bailouts have to be handled very carefully since you don’t want to end up rewarding bad behavior.
What??????????????????????????????????
I’ve never commented on a post of yours since I accept that you’re a Wall Street apologist and nothing I say will change that. But that last line is too much. The whole POINT of bailouts is to reward bad behavior. Privatize profits, Socialize losses. Same old story.
“$100b loss put the banks in deep trouble, and ["forced"?] them ["into the hands of the petrostate/East asian SWFs?"]?
Obviously the US banking system is not going down. Either SWFs will step in to replenish the capital or the government will do it by probably taking ownership of a chunk of the bank, with the promise to privatize it later. Now that the UK has nationalized the Rock, it makes it easier for the US government to partially nationalize a failing bank.
and, while presumably still in the grips of ‘deep trouble’, were the banks forced to withhold payment of multibillion dollar bonuses and multimillion dollar severances? was nouriel forced to go cap in hand to an swf – or the government – to scrape up the funds to cover the costs of his annual trip to the world’s most expensive conference in the world’s most famous tax haven?
Guest — I think Nouriel was comped by the WEF in return for his help on various projects; no need to jump to conclusions. tho I am sure Nouriel would be thrilled in more SWFs wanted to sign up to RGE …
guest (previous post) — true, the financial system won’t collapse a la 30s, in part b/c of a government backstop. but outright government takeovers/ writing down the equity of existing investors (including any SWF with associated diplomatic issues) would constitute a “failure” in my book, and I don’t think that can be entirely ruled out.
gloomy — the fed’s term auction facility could be expanded quite significantly. by emerging market standards it is quite small — only about 0.5% of GDP. And for all the talk about the fed accepting bad collateral, it is lending against dollar denominated securities, and it seems to me that em central banks are taking bigger risks by issuing paper against $ and euro collateral ($/ and euro bonds). I am stretching a bit, but the serious point is that the fed could if it opted to still inject a lot more liquidity into the financial system. it could for example triple the size of the term auction facility to $180b and sell an offsetting amount of treasuries into the market to avoid growing its balance sheet. the result is that the fed is holding less robust collateral — and there are more safe assets circulating around for folks to buy.
Guest: I’ve never commented on a post of yours since I accept that you’re a Wall Street apologist and nothing I say will change that. But that last line is too much. The whole POINT of bailouts is to reward bad behavior. Privatize profits, Socialize losses. Same old story.
The point of a bailout should be the keep the system from collapsing. The trouble with bailouts is that if you have to keep doing them over and over, then eventually you just run out of money and the system does collapse.
Also the situation with Wall Street is that some banks weren’t so stupid, some banks were particularly stupid, and if there is a bailout the banks that weren’t so stupid are going to be rather annoyed if the banks that were stupid get more benefits.
Guest: and, while presumably still in the grips of ‘deep trouble’, were the banks forced to withhold payment of multibillion dollar bonuses and multimillion dollar severances?
The severances were already in contracts and so for the most part couldn’t be rewritten. Bonuses have been lean this year, but if you cut them too much, people start leaving for other industries, and you have no one left.
There is a stereotype of people in the banking industry as people in country clubs smoking cigars, and getting money for nothing. It’s also rather inaccurate. If the bonuses get cut too much, I put in my resignation and then there won’t be anyone to write the computer programs to babysit the databases.
The division between labor and capital is very different today than in the 19th century, and I think that the new division is between skilled labor and unskilled labor. Since I can program, I have skills and hence bargaining power, and if the bonuses are too low, I leave.
There are parallels with the farmers in Zimbabwe. It bothers me a lot that the gap in wealth between people that have skills and people who don’t is growing. If you can crunch numbers and solve complex mathematical equations, then the world is yours. If you can’t then your career prospects are limited.
The trouble is that the obvious solution which Mugabe tried of “attack the rich” makes that people with skills leave, and then production plummets. OK, you have the revolution, you’ve just cut bonuses, and then rich fat cats that used to run the place are now gone. You are now staring at a blank computer screen. What happens now?
The limits that the fed have on injecting liquidity is that if you inject too much liquidity then inflation spikes up. Also the fed injecting liquidity is going to cause the dollar to fall more against the RMB, but right now the dollar exchange rate isn’t what people worry about.
Brad, the question is, ultimately, the “questionable collateral” has to make its way back to the banks (assuming the fed doesn’t take over ownership) albeit at a time when they are a lot healthier but isn’t that just postponing recognition of losses and bad decisions?
two fish, as posted earlier the present crisis is MUCH worse than saving and loans crisis. Back in 1980 the total debt/GDP ratio was half of what it is now.
That is the problem.
Erasing some debt is not a problem as long as the agregate debt rises. But when the agregate debt falls that is a depression.
Of course there is still the hope that we can have a growth not debt induced, that the use of the printing press and a general cancellation erase lots of debts … But I tell you what : lenders won t like it and will resist to any such change;
HK if wages were leading productivity, debt would not necessarily follow. If the government prints lots of money this could be the monetary cause of a wage lead inflation. Government would not need then to borrow. As for companies they would suffer from the wage raises but if there is inflation, then they would enjoy reselling later with a margin.
In fact the debt bubble has appeared because we ve had simultaneously :
anti labor laws
pro trade laws
a tech boom leading to soaring productivity.
all this leading to wage lagging productivity
deregulation of the finance industry and very lax monetary policy.
this leading to a debt bubble and a asset boom
wage leading productivity would not create a debt bubble in the same way because higher wages would lower profits and therefore asset prices. So what would back the increased lending ?
If you look at the 70′s as a decade of wage leading productivity, you don t see a debt bubble happening back then.
then no ‘deep trouble’
judy — yes. but the us may be discovering the cost of quickly recognizing losses may be too big to bear in some cases — and thus may end up playing for time.
bsetser: judy — yes. but the us may be discovering the cost of quickly recognizing losses may be too big to bear in some cases — and thus may end up playing for time.
There are limits to which you can avoid recognizing losses. You can play some games with accounting rules, but the scope of which that you can do so is limited by GAAP. Once the borrower stops paying then the borrower stops paying.
df,
Not sure if people are eager to relive the 70s. Wage price spiral. Eventually you end up like Latin America: high inflation, inflation-indexed wages, little savings, scarce capital, high return on capital, polarization in wealth.
Hz you do not need to have high return on capital. Usually on the contrary you have very low returns on capital, redistribution of wealth. That s what happened in the US And europe in the 70′s.
Latin america had high return on capital when it tried to peg on the dollar to reduce inflation. Fighting inflation in consumption goods with such measures lead indeed to the result you mention. But if you indeed like inflation as a way to get out of debt it s an entirely different thing.
Brad to me the scenario has not changed from 4 years ago, things have only gone a bit more like I expected with each day passing.
The main problem is still the DEBT/GDP ratio. Since that ratio fluctuates and is now breaking its tops constantly, it needs to go down.
Since growth without a rising debt/GDP ratio now seems completely impossible. The only way for the ratio to fall is through debts being erased faster than the GDP falls, say a debt deflation depression.
THe problem is not the 100 bil, 1 tril or whatever other ridiculously small numbers that have seen. The US reel total debt needs be halved and will be halved if historical long term trends are of any use. That means trillions of debt need to be destroyed.
Wether that is through the political decision of generating inflation by the use of the printing press or by massive write downs, wether the system collapses or not is not really important.
The thing is we just have to look at this debt/GDP ratio and think, wow, this ratio will be halved, how can we manage to do that with the less disruption possible ?