Brad, the problem isno one can force another to borrow, however attractive the terms. Being lured into a loan is hardly in the way of duress. Would anyone in their right minds take out a loan they don’t need just because the terms are attractive?

I don’t fully understand the visceral reaction to looking at the supply side (nouriel incidentally shares it) given that sustained low interest rates suggest that easy availability of funds to borrow is a contributing force.

Looking at supply side is fine as long as the overtones of that aren’t an absolution of the demand side. It comes round to the issue of pursuing instant gratification- why bother to wait or save when a loan gets you what you want instantly?

I think if you track the move in fed funds and the bond market from the point the fed started to raise rates, you will find that the bond market did a reasonably good job in tracking the implied forward rates for fed funds. Not perfect, but reasonable –this as opposed to the historic idea that bonds yields must go up and stay up after the fed starts to tighten. As noted, the curve was at record steepness when the fed started its most recent tightening. In fact, bond yields further out the curve were too high, given the return of fed funds back to where they are now, and probably headed lower. The bond market has become far more astute at forecasting the fed funds rate over the years. This is the modern day version of the “bond vigilantes”, who used to punish the market for fear that the Fed wouldn’t tighten enough. That’s long gone. This is why I was always puzzled as to why Greenspan was puzzled. He didn’t learn.

This change is a function of the forces of disinflation and deflation that have been in place since Volcker. This creates a completely different data set trend in recent years than the longer term history of interest rate responses to short rate monetary tightening. The response of the most recent tightening cycle was totally different from the 1993 tightening cycle, for example. The reason is the bond market’s correct read on progressive disinflation.

Many fear a renewed breakout of inflation. It may well be happening outside the US. That’s because their markets are lousy and inflexible compared to the US, even with all its warts. As a generalized inflation process, this can only happen within the US if wages join the inflationary process, as they did in the 70’s. I doubt it. I would look instead for the impact of very high food and commodity prices to be deflationary. This will cause a crack in foreign demand for both. And adding to the deflationary pressure, the US housing market as a source of asset wealth is finished for the next 10 years if not longer.

I do agree with one big part of Nouriel’s criticism of the ERP. tHis influx had nothing to do with superior US financial market performance/ the great appeal of US markets. It had everything to do with a big upsurge in official intervention — itnervention that both pushed up savings rates to reduce pressure on exchange rates (China’s fiscal improvement, the undistributed profits of the SOEs and credit curbs) — and the big uptick in oil savings. All were initially directed into dollar assets despite low returns on us assets.

But objectively, I think the absence of pressure on global rates from us deficits is an important piece of evidence. the imf back in 03 predicted that the cost of big us deficits (fiscal and external) woudl be higher rates globally. hasn’t happened.

what does seem to be happening instead is that the us is exporting inflation to the emerging world — especially the dollar peggers. that may bring down East Asian savings and end up forcing adjustment.

"Increasingly supported by the confluence of both property and credit bubbles, U.S. consumers spent well beyond their means. Personal consumption climbed… At the same time, household debt soared… America certainly achieved the rapid growth that Greenspan felt the body politic wanted. But it was growth based increasingly on fumes. …

Saving rates plunged to zero for the first time since the Great Depression. An increasingly asset-dependent U.S. economy then had to borrow surplus saving from places like China … Greenspan and his disciple Ben Bernanke saw this situation exactly backwards. America, they insisted, was simply doing the rest of the world a huge favor by absorbing its surplus saving. Serious dollar risks were characterized as a problem for a distant day. Suddenly, that day doesn’t seem so distant.

What Greenspan missed repeatedly over the years … are the corrosive impacts this bubble had in fostering the imbalances and excesses of an asset-dependent U.S. economy. … Global imbalances are also an outgrowth of this era of excess—underscored by America’s massive external deficit and, by the way, the protectionist fires it stokes. Alas, these fault lines were made all the deeper by the Fed’s regulatory laxity in an era of unprecedented financial innovation—a laxity made all the more dangerous by the cheap borrowing costs of a Fed-induced credit bubble. …"

http://economistsview.typepad.com/economistsview/2008/04/greenspans-foll.html

Those who bought the products from Walmart that drove the deficit tended to finance it by mortgage equity withdrawals, as per the Greenspan credit magic. Surplus nations facilitated the return flow through low risk treasuries. Sure, they saved instead of spent, and sure their central banks were the driver of the savings via manipulated exchange rates. But the source of US demand for imports was the great US internal financing mechanism that was the precursor of today’s credit crunch.

Indeed, the credit crunch and the internal breakdown of the US financial system is obvious proof that it was US forces that drove the consumption glut and resulting current account deficit, and that the surplus nation recycling was only the tail of the dog.

Case not Closed on the "Global Savings Glut"

It’s totally relevant because this is exactly the point. "It isn’t really the globe" is exactly right, which is why the tag "global savings glut" used repeatedly by Bernanke is an Orwellian lie, as Roubini effectively pointed out. As soon as you tag it as global, even though its not global, the analysis becomes meaningless. That’s why Roach’s analysis is meaningful and intellectually honest – because his premise is based on a global concept. It pretty much complements Roubini’s analysis at the US level.

No so. This is a distortion of history that is also particularly favored by Greenspan and Bernanke.

Look back at the history of the yield curve. When the Fed started to tighten from a 1 per cent funds rate, the curve was at a near record steepness. Fed funds to 10 year treasuries were more than 300 basis points, or triple the level of the funds rates.

The Fed was way behind the curve. Bond yields actually lead the funds rate up. The notion that the savings glut prevented bond yields from rising was ridiculous. Bond yields were already there, anticipating and forcing the fed to move up. This was a matter of pricing in inflation expectations and the required path of short rates. It had nothing to do with the flow of funds. The actual fed move was 425 basis points. Policy had been tightened. The funds rate was 425 per cent above its opening level. The associated temporary "bond yield conundrum" was merely correctly pricing in the next phase of the cycle. Look where we are now. Bond pricing had it right. It had nothing to do with the ‘global savings glut’.

sustained low interest rates have also correlated quite well with the fact that the sun hasn’t exploded since since Volcker beat inflation

Well, I think the following explains it extremely well, from:

http://www.rgemonitor.com/blog/roubini/117412/

Orwellian Chutzpah and Doublespeak in the Economic Report of the President: the US Current Account Deficit Becomes the "US Capital Account Surplus"

Nouriel Roubini | Feb 13, 2006

Paul Krugman has recently written about the Bush Administration attitude of

changing unpleasant facts that do not square with its ideological

biases. A recent example was the attempt to use the

nebulous concept of "dynamic scoring" to "prove"

- using "voodoo economics" cabal – that tax cuts

actually increase revenues while all respected empirical studies

show that such cuts reduce, on net, tax revenues.

But the latest example of this Orwellian doublespeak is the Economic Report of the President (ERP) published today by the White House Council of Economic Advisers. Its chapter on international macro issues is titled "The U.S. Capital Account Surplus" when the more appropriate and honest title would have been "The U.S. Current Account Deficit"

. While Ben Bernanke’s name is nowhere in this year’s ERP, his heavy

hand in this chapter – and the rest of the ERP – is clear.

His March 2005 speech on the global current account imbalances being due to a "global savings glut"

rather than, in large part in 2000-2004, due to the U.S. fiscal

deficit is the intellectual baseline for this "US Capital Account

Surplus" interpretation of the US international financial position.

The thesis is clear: we do not run a current account deficit; we run a

capital account surplus because the rest of the world wants to invest

in the high productivity high growth U.S. Of course, the appropriate

economic causality is here reversed. The logical causality is

that, if we save less than we invest and if we spend more than we have

income, we will run a current account deficit and we will have to

borrow from the rest of the world to finance it. But our

borrowing – now mostly in the form of debt as net FDI and equity

inflows have been sharply negative for the last few years – turns in

the Orwellian language of the ERP into a "capital account surplus". Of

course, as the BOP is by definition in balance, a current account

deficit needs to be financed with a capital inflow that is defined as a

capital account surplus. But having the Chutzpah to title this deficit

as a capital account surplus and then go on for the entire chapter to

interpret all of the global current account imbalances as a matter

of capital exporting countries (i.e. countries who run current account

surpluses) and capital importing countries (i.e. the few countries who

run current account deficits) is to confuse cause and effect.

Also, the "capital inflow driven by superior U.S. returns"

interpretation of the global imbalances ignores a few unpleasant

facts.

First, the inflow is mostly in the form of debt -

i.e. borrowing – rather than equity – FDI and equity portfolio inflows;

such equity flows have been outflows out of the U.S. to the tune of

$200b net per year for the last few years. So much for the

foreigners investing in our superior capital.

Second, the performance of the US equity markets since 2000 has been

dismal both in absolute terms and relative to returns in emerging

markets and even Europe and Japan. So much for the superior

returns on U.S. assets.

Third, the fact

that U.S. net factor income payments have been until now

positive in spite of the U.S. being a net debtor country is

explained by the fact that recorded returns by the U.S.

on its foreign assets are much higher than foreign returns on

their holding of U.S. assets. So much for the superior returns of the

high growth U.S. assets.

Fourth, most of this "inflow" (call it more properly borrowing binge) is

coming on net not from willing private foreign investors

wanting to invest in U.S. assets but rather from political agents,

i.e. foreign central banks that are oblivious to the low

returns on U.S. Treasury bills and bonds (and capital losses once

the dollar falls) and are lending cheaply to the U.S. Treasury. So

much for the rest of the world wanting to buy U.S. assets and we thus

generously running a current account deficit to accommodate this

portfolio demand for U.S. assets.

The ERP makes a token passing remark to the fact that the US capital account "surplus" is matched by

a shortfall of savings relative to investment. But after grudgingly

acknowledging that a shortfall of public savings (i.e. a fiscal

deficit) may cause a current account deficit, it goes – like Bernanke

did in his glut speech – on trying to argue – based on a

calibration, not econometric, study done by the Fed – that fiscal

policy has little effect on the current account. Of course, if you

build and calibrate a simulation model where infinitely lived

agents are Ricardian, by definition you will get the result that fiscal

policy has no effects on the current account (it is like proving

the result by assuming it by the choice of Ricardian consumers).

Contrast this "un-named Bernanke" interpretation of the US current account

deficit as a capital account surplus with the serious concerns

recently expressed by the New York Fed President Tim Geithner about the

unsustainability of the US current account deficit. So, if you want straight talk rather than doublespeak about the US current account deficit, read Geithner. Bernanke

has promised to use plain English rather than the Delphic oracle

language of Greenspan; but if the ERP is an indication, we may be in

for plain English doubletalk about the current account, the budget

deficit, the relation between asset prices and monetary

policy, the lack of savings, the housing bubble and a few

other unpleasant facts and vulnerabilities in the U.S. economy. We will

see his testimony to Congress this week…