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Blog envy: on Europe, the G-7 and the Fed

by Brad Setser
April 16, 2008

Paul Krugman (who hardly needs a plug from me), Macro Man and Steve Waldman (of interfluidity) have all written posts that I wish I had written.

Krugman elegantly shows that a lot of American stereotypes about Europe are based on data from the 1990s. By some measures, Europe’s labor markets no longer look more sclerotic than America’s labor markets. The percentage of French men between 25 and 54 without jobs is now pretty much the same as the percentage of American men between 25 and 54 without jobs.

The similarities don’t end there. The European Union as a whole also now runs a current account deficit financed in no small part by the world’s emerging economies.

Macroman had the brilliant idea to compare the most recent G-7 Communique to the G-7 (and G-5) communiqués that marked big changes in the foreign exchange market. The most recent communiqué clearly contained new exchange rate language – language no doubt intended to give a boost to the sagging dollar. But the G-7’s new language lacked the vigor of the key communiques of the past. Back in 85 and 95, the G-7 didn’t just complain about disruptive moves. It indicated the direction it wanted the market to move.

Moreover, as Macroman notes, the G-7 countries themselves aren’t necessarily the key countries setting G-7 exchange rates. The amount of dollars that China, Russia and the Gulf want to sell for euros, pounds and other currencies also matters:

“it’s far from clear that the G7 are the relevant authorities; after all, it’s not Japan or Germany or the UK that is buying billions of EUR/USD every month; it’s China and Russia and the Middle Eastern Countries. And Macro Man didn’t see their names attached to any document expressing concern.”

I also recommend Dr. Chinn’s analysis and — if you have an RGE subscription/ receive BNP research – Lee and Speranza’s post G-7 rant (link is through the RGE subscription service). They argue that the G-7 spent its time focusing on currencies when currency markets aren’t the problem — as dollar weakness basically reflects weak US fundamentals — and didn’t do anything to address distress in the credit markets. Lee and Speranza, speaking to the G-7:

“Didn’t you notice that the USD assets are at the centre of a global financial storm …. Have you noted that the US has slashed rates when it is has been massively reliant on foreign inflows … to fund its deficit.”

With the dollar heading toward 1.60, the market certainly doesn’t seem to have noticed the G-7 statement.

Finally, Steve Waldman – who has built quite a following with his trenchant commentary on the credit crisis – drew attention to the large recent changes in the composition of the Fed’s balance sheet and the debate over whether the Fed is running out of ammunition. That debate remains a relevant: a host of indicators suggest ongoing trouble in the banking sector. Waldman notes (quite correctly) that it possible for the Fed to expand its balance sheet beyond the monetary base.

“In an excellent summary, Greg Ip describes the various options the Fed would have if it were to run low on Treasuries.

Fundamentally, the Fed would have two options: It could increase the size of its balance sheet by issuing cash, which would require sacrificing its target Federal Funds rate target and letting that rate drop to zero. This option is referred to in the trade as “quantitative easing”, but that’s just a fancy term for printing money and tolerating any inflation that results. Alternatively, the Fed could expand its balance sheet by borrowing from someone else — from the US Treasury, from banks with excess cash, or from the public directly. This would permit the Fed to increase the scale of its asset swaps without sacrificing its ability to conduct ordinary monetary policy.”

Waldman though argues that this is not just a technocratic decision, but rather a political decision.

Fundamentally, the Fed’s balance sheet constraint is and should be a political constraint. The size of the Fed’s balance sheet defines how much capital taxpayers and holders of currency are making available to the Fed to do whatever it is it’s doing … I don’t know whether expanding the Fed’s balance sheet is a good idea, if it comes to that. … What I do know is that a decision to expand the Fed’s balance sheet ought not be treated as technocratic monetary policy. However funds are raised, their repayment would be guaranteed, so all downside risk would be borne by the public. Expanding the Fed’s balance sheet would represent a sizable investment of the public’s wealth, and the public ought have as much say over that decision as over any other investment of public money.

I agree. So does Dr. Hamilton: “[J]ust as I don’t want Congress deciding how much money to print, I don’t want the Fed deciding how much taxpayer money is appropriate to pledge for purposes of promoting financial stability.”

The Fed seems reluctant (perhaps because it lacks the legal authority) to start to issue its own “federal reserve bills” to raise funds that it could lend out. The Fed would rather that the Treasury issue more Treasury bonds than it needs and place the surplus funds on deposit at the Fed. Those deposits in turn could be used to buy Treasuries in the market — and those Treasuries could then be swapped for other assets. Or the funds placed on deposit at the Fed could even be used to purchase risky bonds directly. Relying on Treasury bond issuance for funding has the virtue of requiring a higher degree of “political” approval than a surge in Fed bill issuance.

The high-quality comments on Waldman’s post almost matched the quality of the orginal post. JHK noted that China’s central bank has expanded its balance sheet well beyond the money base as part of its exchange rate policy.

“Finally, at a global and more philosophical level, if China’s central bank can subsidize exports to the tune of $ 1.5 trillion in foreign exchange reserves, and if that policy has helped create the global savings glut, and it that phenomenon has led to the US credit crisis, then why can’t the Fed get creative by doing some balance sheet ‘subsidization’ of its own?”

JKH is right. The PBoC is taking on big risks — risks that likely will have a fiscal cost — to pursue non-monetary policy objectives (like supporting exports). If China had a different political system, I would think that the decision to expand the PBoC’s balance sheet and to take on a truly extraordinary level of currency risk would be one that would need to be ratified by the political system. The PBoC though isn’t independent, so the expansion of its balance sheet necessarily came with the backing of China’s top political leaders.

I wonder though if a democratically elected legislature would have been willing to authorize such an expansion. Buying reserves that you don’t need rather than investing at home is often hard to explain …

It is noticeable that more and more financial risks globally are being assumed by central banks. Currency risk in the emerging world. Credit risk in the industrial world. The old days when central banks issued currency against domestic tTreasury bonds – without taking on currency or credit risk — are starting to seem a bit quaint. Call the expansion of central bank balance sheets – and the evolution in the composition of their balance sheets — part of a new world of state capitalism.

I actually suspect that emerging market central bank activity in the currency market helped create the conditions that has prompted industrial country central bank activity in the credit markets. The IMF hints as much in Chapter 1 of the WEO. But that is a story (or an argument) for a different time.

39 Comments

  • Posted by Laurent GUERBY

    "Krugman elegantly shows that a lot of American stereotypes about Europe are based on data from the 1990s. By some measures, Europe’s labor markets no longer look more sclerotic than America’s labor markets. The percentage of French men between 25 and 54 without jobs is now pretty much the same as the percentage of American men between 25 and 54 without jobs."

    This was in april 2006 (yep two years ago) on my blog, when I was analyzing 2004-2005 OECD data:

    http://guerby.org/blog/index.php/2006/04/23/66-les-manifestants-francais-sont-des-dieux-en-economie

    Since no economist seemed to accept reality, I added it in 2007 in the wikipedia unemployment article:

    "For the fourth quarter of 2004, according to OECD, (source Employment Outlook 2005 ISBN 92-64-01045-9), normalized unemployment for men aged 25 to 54 was 4.6% in the USA and 7.4% in France. At the same time and for the same population the employment rate (number of workers divided by population) was 86.3% in the U.S. and 86.7% in France.

    This example shows that the unemployment rate is 60% higher in France than in the USA, yet more people in this demographic are working in France than in the USA, which is counterintuitive if it is expected that the unemployment rate reflects the health of the labor market.[26]"

    But I’m always happy to see at least 0.0001% of all economists looking at reality even if a few years later than just about everyone else :).

    On the fun side one english wikipedia reviewer asked on what widely accepted economic theory were the two paragraphs based upon. Common sense has no place in peer reviewed economics so I couldn’t point to any :).

    The NYT has a serie of impressive of graphs showing how ridiculous the measure of unemployment has become against the without job in the USA, there’s a huge drift over the years, see Barry The Big Picture blog here for the latest graph:

    http://bigpicture.typepad.com/comments/2008/04/jobless-vs-unem.html

    In 1960 4% unemployment, 6% jobless, in 2008 same 4% unemployment but a whopping above 12% jobless! (in men 25-54 which are all supposed to work in most parts of the world and accross time)

    Which is scary when you think all macro models use unemployment measure as input, how good can be the output in the form of monetary policy when you put garbage in?

  • Posted by bsetser

    Laurent — my apologies for not remembering your earlier work. Your complaints about peer review remind me of my own horror story — i recently got a comment back to the effect that "emerging markets are not financing the US." Tis true that I didn’t include a reference, but the data pretty much speaks for itself, and Summers, Wolf and Bernanke all agree on this point …

  • Posted by Laurent GUERBY

    Brad, it’s a totally obscure blog in french so no hard feeling at all :) :) :).

    About your experience with financing the US, I’d say that your excellent work main point is that we don’t have clear data (we should but that’s another story) so it’s about religion, not anything close to reason. People can get away with any "explanation" in this context and dismiss any hard work on the poor data available without even looking at it.

    When I mentionned employment in men 25-54 as a much better job market status comparison point (for single dimensional crude analysis) accross country and time than unemployment (which I labeled as a measure of the productivity of the local statistics body in turning unemployed into inactive) economists just plain said I was stupid and that everyone knoweledgeable used unemployment as the only true measure in all peer-reviewed publications and models.

    Unfortunately, nothing I can do about it as I’ve no formal training in economics…

    Back on the topic, an interesting thing about USD to CNY FX is that its volatility is also increasing steadily and 20 business day historical volatility is now above 2%.

    I’m also pretty sure USA based multinationals with a foot in China are spending their lobbying money to keep the FX moves smooth and predictable but I’ve nohting to back that up :).

  • Posted by Stephen

    Convert Per Capita National Income for European countries at the current FX rate. About 15 countries now have higher per capita amounts than the USA. What more do you need to say about Europe. And, they have free health care. (I went to a hosptial in England for a day. When I left, I said that I wanted to pay. They said they we are "not set up" to take payments.) Japan is a few cents away from also having a higher per capita income. A group of small islands with few natural resources! Somehting has gone terribly wrong in the USA.

    Stephen

  • Posted by RealThink

    "They argue that the G-7 spent its time focusing on currencies when currency markets aren’t the problem, and didn’t do anything to address very real problems in credit market distress."

    "Very real problems"? How will they describe then the food crisis? And more generally, the fact that the world is hitting the physical limits to growth, particularly in oil production.

    BTW, Prof. Krugman has recently taken notice of both issues in a REMARKABLY SENSIBLE way.

    http://krugman.blogs.nytimes.com/2008/04/02/grains-gone-wild/

    http://krugman.blogs.nytimes.com/2008/04/15/oil-wells-that-dont-end-well/

    http://krugman.blogs.nytimes.com/2008/04/15/oil-numbers/

  • Posted by bsetser

    Real think — if nothing else, your comment forced me to realize that my initial phrasing was rather inelegant, so i made a few ex post edits. I agree very much with dr. krugman’s take on peak oil, namely that the logical result of a slowdown in supply growth is much higher prices. In some meta sense tho it is rather surprising that the world is confronting possible limits to growth even as us growth is collapsing … the heads of americans used to an amero-centric world are spinning

  • Posted by Laurent GUERBY

    Think of spending the Iraq war money (which raised oil prices) on 1/ housing energy efficiency, 2/ public transportation infrastructure, 3/ local renewable energy production.

    Spain just announced such a program (to deal with their housing bubble pop) and exactly in the right order, from biggest gain to lowest. All three innovation and job generating.

    I really don’t think China reserves of FX policy are the root cause of current imbalances, but I’ve already said it :).

  • Posted by NICOLAS

    Stagflation and U S dollar delinquents.

  • Posted by df

    I ve long favored QUANTITATIVE EASING.

    Although inflation seems to be a problem right now, we all know it comes from an unsustainable investment boom (especially in housing), boom that is now clearly over. Quantitative easing is NEEDED because whatever the rates, private banks short on capital will not lend, and private agents with negative wealth will not borrow (they may replace old debt at high rates with new ones at low rates, but will not add to the total).

    therefore the only solution is QUANTITATIVE EASING.

    I read Bernanke 6 years ago. He was boasting the US had a printing press and warning about helicopters with cash. So far I ve seen nothing, and we re 6 years down the road with debt deflation risks bigger than ever.

    So I don’t buy the fuss about complicated schemes. The only way is Quantitative easing by the fed on top of free cahs delivered to citizens (through new spending or lower taxes).

    Of course this will further kill the dollar. Well the dollar is dead anyway. IT’s time to finally adopt 60 years later the Keynes plan and create an international currency emitted by the IMF.

    The USA are now facing the same choices as UK 70 years ago. Drop the dollar or not to drop the dollar ?

    History teaches us : just drop it damn it.

    If you don’t then you will engineer that debt deflation crisis hanging over all of us.

    There is just no reason to let foreign central banks print the money you could print yourself.

    Finally, I d like some directions on how sterilization works and how it curbs inflation down. From what I guess inflation in China should be higher given the amount of money printing and the sterilisation activities have weakened private banks and will turn to have a strong deflationist impact in time. Any comment ?

  • Posted by df

    By the way about unemployement in the USA, i ve read in Le MONde Diplomatique

    http://www.monde-diplomatique.fr/1998/07/WACQUANT/10652.html here brad since I now know you speak french, that the jail population in the USA accounted for 2% of unemployment in the USA, and .2% in Europe.

    For all those who think more prisons is the solution, crunch the numbers.

  • Posted by df

    by the way I m fed up with people taking strong currencies as a sign of a strong economy.

    Japan was not strong in 1989, it had an overvalued currency.

    USA were not strong in 1984 or in 2002 they had an overvalued currency.

    The Euro should be around 1,25 dollars possibly 1,30. IT should never have moved to .8 dollars and now to 1.6… This is just crazy.

    Europe is not strong and Spain may be trying to compensate its bursting housing market the thing remains : IT HAS A BURSTING HOUSING MARKET.

    The housing bubble is exploding right now in europe big time and it is going to be very hard for all of us here. Our social systems are already having trouble to find enough funds, things will worsen, and on top of this ageing population …

    The USA have taken the leadership of household debt, so they ll be hit very hard … But Europe and especially UK Ireland SPain netherlands have followed closely. They re next on the hit list.

    As for China, its power as long been understimated, if you look at PPP valuation, chinese GDP is much bigger than it presently is.

    China is strong.

    I still think it ll be the country facing the biggest troubles, simply because it is so reliant on global trade, it faces its own debt and housing bubbles …

    But my point is : change in currency valuation are no sign of varying economic strength, they are only a sign that the international monetary system is completely flawed unable to adress the economic balances and sending wrong and excessive signals at the wrong time.

  • Posted by jkh

    China, Ben and Ted:

    A highlight of the recent joint congressional hearings on the Bear Stearns transaction was where Ted Kennedy seemed on the verge of escorting Ben Bernanke out to the Senate woodshed to elicit his views on the use of fiscal policy in the housing crisis. This was interesting for several reasons. First was the inherent conflict in insisting that an independent monetary policy chief and specialist recommend directly on fiscal policy. Second was the apparent frustration of the congressional group in trying to glean some value added from the central bank specialist, given the separation of central bank responsibility from the Congress and from a number of related financial regulatory bodies. Third was Ted Kennedy, who while being testy and even unreasonable, was probably making a useful point in principle and practice. Fourth was the larger question of policy co-ordination. The financial regulatory framework is quite chopped up, as has been well advertised. But isn’t there an overarching question about the relationship between monetary and fiscal policy? Who speaks to this with authority? Is a central banker pledged to independence really in a good position to do this? Is the Treasury secretary in any better position, given his presumed allegiance to the notion of Fed independence?

    The Fed’s recent extraordinary balance sheet actions highlight a connection between monetary and fiscal policy. The analysis in Steve Waldman’s blog and others explores this. Is the Fed now monetizing assets that would be more appropriately funded by fiscal policy (i.e. by treasury debt)? Is the Fed now considering liability management contingencies (i.e. balance sheet expansion) that would intersect further with fiscal policy? And should we be reviewing the wisdom of a foreign exchange policy that is supposedly quite separate from monetary policy? How can the Fed be fully responsible for price stability when Treasury is formally responsible for FX policy (e.g. the “strong dollar” policy; presence or absence of intervention)? More broadly, does the US have the correct institutional arrangement for monetary, exchange rate, and fiscal policies? China is obviously no model. The Fed as the Voldemort of US credit risk won’t be popular with taxpayers. But in crisis it has taken the first step. The parallels of interrelated monetary and fiscal policy are interesting.

    Regards,

  • Posted by bsetser

    jkh — I agree in large part; the fed is on track to warehouse a lot of credit risk/ the expansion of its balance sheet does have fiscal consequences. I am not sure tho that the Treasury’s responsiblity for exchange rates is much of a challenge to the fed tho, as in practice the US has generally followed a policy of benign neglect that doesn’t impinge on the fed’s autonomy. Small scale intervention isn’t much of a threat either — tho it also may not be very effective if it goes against the direction of monetary policy (BNParibas makes this point among others).

  • Posted by Dave Chiang

    Oh please Brad, the bankruptcy of the Neo-liberal US Economic model is entirely from self-inflicted factors that include crony capitalism, improper financial regulation, excessively loose monetary policy, US Dollar reserve currency status, excessive military spending, and political corruption of the US government regulatory agencies prevalent during the past two decades. American Neo-liberalism Economics as devised by Robert Rubin for the benefit of narrow special economic interests is Rotten To The Core. The Federal Reserve and US Treasury pledging billions of taxpayer funds for the bailout of Wall Street Investment banks and defaulting Hedge Funds, while simultaneously blaming foreigners including those Chinese for US Economic imbalances illustrates the ideological bankruptcy of the Washington Consensus elites.

  • Posted by Twofish

    One common phenomenon in economics is whipsawing, whereas you take a short term blip and use it to argue that ideology X is really, really good or really, really bad. Then five years later everything changes. Give it about a year and people will be talking about the superiority of the US system.

    bsetser: If China had a different political system, I would think that the decision to expand the PBoC’s balance sheet and to take on a truly extraordinary level of currency risk would be one that would need to be ratified by the political system.

    bsetser: I wonder though if a democratically elected legislature would have been willing to authorize such an expansion. Buying reserves that you don’t need rather than investing at home is often hard to explain …

    Things that are hard to explain are generally very easy to pass in democratic legislatures. The explanation is that if we don’t do policy X, the people who elect you are going be in a bad mood in the next election. If we do policy X, then here are dozens of charts explaining why it might or might not be a problem in five years time. You’ll be lucky if the legislatures don’t sleep during the meeting.

    I really don’t think that Chinese economic policy would be very different if it had a multi-party liberal system since unless something goes boom, the legislature usually leaves the bureaucracy to handle these things. It is "power through boredom." Right now, we in the process of one of the largest restructuring of the US financial system since the great depression, but it’s not making the news since most people think of it as boring.

    Tell me who the hero is, who the villain is, and then you get excitement, but if there isn’t an obvious hero or villain, then people lose interest, which is actually just fine for the people making the decisions.

  • Posted by Twofish

    jkh: But isn’t there an overarching question about the relationship between monetary and fiscal policy? Who speaks to this with authority?

    Fed is responsible for monetary policy. Congress is responsible for fiscal policy. Using fiscal policy to deal with macroeconomic stablity has a problem in that fiscal policy is slow and much more political than monetary policy (i.e. you have to decide who gets the cuts and the pork).

    Congressional committee hearings are sort of a game. Ted Kennedy is trying to get Bernanke to publicly say something that would be embarassing to the Bush administration. If Kennedy wanted to know Bernanke’s real thoughts on fiscal policy, he could ask after the meeting.

    Also on monetary policy I don’t see any institutional conflicts between the Fed and Treasury. (Banking regulation, yes, and the conflict between the Fed and the Office of the Comptroller of the Currency is one of the long standing bureaucratic feuds.)

    The big question is whether or not it is a good idea or not to have the agency that is mainly in charge of monetary policy be the chief financial regulator. The problem is in order to do financial regulation, you have to be able to get massive amounts of money on short notice, and only the Fed can do that, and if you start exercising control by either spending or not spending money, you are going to have an impact on monetary policy.

    We really are in a brave new world.

  • Posted by DC

    "Give it about a year and people will be talking about the superiority of the US system."

    Oh please, Wall Street has only written off less than $250 billion of the estimated $1 trillion in bad debts that the IMF has conservatively estimated. Nouriel Roubini calls the $1 trillion bad debt problem that the IMF estimates only a baseline figure with financial losses potentially exceeding 2-3 trillion dollars in the "L" shaped recession.

  • Posted by Twofish

    One thing that strikes me about economic policy is that the mechanisms for determining economic policy in China and the United States are largely similar. Most of it takes place in administrative agencies, so the fact that China isn’t a liberal multi-party democracy doesn’t make that much of a difference. The debates are technical rather than political so the level and about of debate over different policies in China and the US is basically similar when it comes to things like the RMB.

    The chief role of the democratic institutions is to put in public input, but in the case of economic policy, the public says basically the same thing (i.e. give us wealth and jobs) or we will do bad things to you politicians.

  • Posted by cmc

    @Twofish

    You said I disagree that a legislature would allow bank to sit on (and presumably, control) reserves of 1.5T. Pressure to spend at home would be too great, and the export businesses would probably be subsidized in more direct ways.

  • Posted by cmc

    correction: "I disagree with what" sorry

  • Posted by bsetser

    I am closer to CMC on this than 2fish. When the pboc discloses a $100-150b capital loss in 2009 from the 2008 rmb appreciation v china’s reserve basket, i suspect a democratic legislature would start to ask some hard questions. there is a debate over whether the fed will lose money on the stuff it bought off bear to sweeten the deal for JPM. the fed might not lose money on the deal. there is no debate about China’s losses — only about what big losses mean for a central bank. and i think a democratic legislature would also ask whether the CIC should be investing abroad rather than at home and so on.

  • Posted by DC

    "Bear Stearns Bailout by Fed… 100% Fraud"

    http://www.optionsforemployees.com/articles/idx/0/130/article/Bear_Stearns_BuyOut_100_Fraud.html

    This article is about how the Bear Stearns collapse was artificially created so insiders could get massively short prior and how J.P. Morgan would in effect be paid $55 Billion of US tax payer money to shore up themselves to buy Bear Stearns.

    But this scenario has enormous implications. It means that the deal was already arranged on March 10 or before. That contradicts the scenario that is promoted by SEC Chairman Cox, Fed Boss Bernacke, Bear CEO Schwartz, Jamie Dimon of J.P. Morgan (who sits on the Board of directors for the New York Federal Reserve Bank) and others that false rumors undermined the confidence in Bear Stearns making the company crash, notwithstanding their adequate liquiduty days before.

    I would say that the deal was arranged months beforebut the final terms and times were not determined till maybe March 7-8, 2008.

    Loans to J.P. Morgan total $55 Billion from FED

    The Private New York FED lent $25 Billion to Bear Stearns and another $30 billion to J.P. Morgan. So the bail out cost was $55 billion not the $30 billion that is promoted. This was revealed at second session of the Senate hearings in a James Dimon responce to a question from Senator Reed.

    Who gets the $55 billion? J.P. Morgan got the money on a loan pleadging Bear Stearns assets valued at $55 billion. $29 Billion is non-recourse to Morgan. Effectively the FED got collateral appraised by Bear Stearns at $55 Billion for a loan to J.P. Morgan of $55 Billion.

    If the value of the secondary facility of $30 Billion($29 Billion of which is non recourse) is worth only $15 Billion when all is said and done, then J.P. Morgan has to pay back only $1 Billion of the $30 Billion and keeps the $14 Billion the the Fed loses. If the $25 Billion primary facility is worth only $15 Billion when all is said and done, J.P. Morgan has to pay $10 Billion of the $25 Billion received. If J.P Morgan can not pay, then the Fed loses the $10 Billion.

    If after all is said and done the $25 Billion primary assets are sold for more that $25 Billion, the difference goes to J.P. Morgan regardless of the outcome on the secondary facility of $30 Billion. No matter how you cut it, J.P. Morgan wins.

    If the $55 Billion assets turn out to be worth only $20 billion when all is said and done, J.P. Morgan owes $1 Billion on the $30 Billion and the difference between $25 Billion and the value received on the primary facility.

    The best the FED can do is get their money back with interest and the worse they can do is lose about $25 -$40 billion. The FED would have been far better to just buy the assets at Bear’s and J.P.Morgan’s valuation."

  • Posted by Laurent GUERBY

    Brad, I’m not sure about your point about investing "national" vs "abroad". Does Bear Stein only invested in national stuff? Obviously no. Same for JP Morgan. So the Fed bail out is no more "national" than PBoC holdings of USA treasuries.

    Also, when there were trouble during the asian crisis, USA banks played predator and there were no massive reserves to keep them at bay. 150 billion USD of completely virtual losses are not that a high price to pay not to be a prey (USA banks preyed on one of their kind instead of a poor country in these times of trouble – why?).

  • Posted by JLS

    "he housing bubble is exploding right now in europe big time "

    The problem is not only housing bubble, it’s rather private debt.

    And except Spain and UK private debt is much lower in Europe than in USA.

    And saving rate too are a problem.

  • Posted by Macro Man

    Brad, the Fed isn’t expanding its balance sheet….which perhaps is one reason why these credit problems persist. Rather, it is replacing the Treasuries on the balance sheet with the crap exchanged by the banks and dealers. But overall, the size of the assets and liabilities has stayed pretty steady.

    In a sense, it is turning itself into the RTC rather than waiting for Congress to create a new one, exchanging its UST for MBS, etc; hence Volcker’s recent criticism, as this really Mi>should be a job for the fiscal rather than monetary authorities.

  • Posted by bsetser

    Laurent — my understanding is that the bear assets that the fed basically bought are dollar-denominated, so the fed isn’t taking the exchange rate risk. it seems to have the credit risk tho, at least for any losses over $1 billion. and it has the ability to hold these assets for a long time so it doesn’t have to sell at firesale prices. i would bet that the fed’s losses from the credit risk it took will be smaller than China’s losses from currency risk. that was all i was trying to argue. i also apologize if i have some of the details of the transaction with bear/ jpm wrong — i haven’t checked and i don’t know all the details off the top of my head.

    Macroman — you are right. the composition of the fed’s balance sheet has changed not its size. I hope i didn’t imply otherwise. my point was only to note that if the fed were to expand its balance sheet in various ways that don’t involve monetary creation to be a bigger "RTC" (to use your terms), that is a political decision that should be ratified by the political system, not a technocratic one.

  • Posted by RealThink

    @Brad:

    "In some meta sense tho it is rather surprising that the world is confronting possible limits to growth even as us growth is collapsing … the heads of americans used to an amero-centric world are spinning"

    I have probably posted this some time ago, but there are definitely some American heads who are not spinning at all, as we can see from:

    a) The presentation at ASPO USA 2007 by Dr Vincent Matthews, Director of the Colorado Geological Survey:

    http://www.aspousa.org/proceedings/houston/presentations/Vince%20Matthews%20China%20India1.pdf

    b) The Oct 2007 report by Malcolm Shealy and James P. Dorian of CSIS, titled "Growing Chinese energy demand: is the world in denial?"

    http://www.csis.org/component/option,com_csis_pubs/task,view/id,4150/

    And since this thread focuses on central bank intervention for saving banks, it reminds me of another clear American head, Matthew Simmons, who in his latest presentations refers to prospective oil shortages as a "Run on the bank". This time a physical, not financial bank. The kind that can’t be shored up by the Fed.

    E.g. in his February briefing to the Pentagon, pages 62-66.

    http://www.simmonsco-intl.com/files/Pentagon%20Briefing.pdf

  • Posted by Twofish

    Quote: You said I disagree that a legislature would allow bank to sit on (and presumably, control) reserves of 1.5T. Pressure to spend at home would be too great, and the export businesses would probably be subsidized in more direct ways.

    The trouble is that 1.5T isn’t easily convertible to domestic spending since domestic spending is in RMB rather than in dollars. Also, I don’t see domestic pressure to spend more being that much different in a liberal democracy than in the current mode of Chinese governance. The government is under heavy pressure to spend more on healthcare and education. The trouble with that spending is that that you can only boost spending by about $100 billion/year.

    Quote: When the pboc discloses a $100-150b capital loss in 2009 from the 2008 rmb appreciation v china’s reserve basket, i suspect a democratic legislature would start to ask some hard questions.

    When it is too late to do anything about it. You’ll get your ritual screaming legislators, some heads will roll, some scapegoat will be found, but it’s not going to change what happens very much.

    Also a lot has to do with the role of the legislature. Japan, for example, has a weak legislature that doesn’t tend to ask hard questions. China has the opposite situation, in that the legislature is not democratic, but it does tend to quietly ask some pretty tough questions since the National People’s Congress is the arena in which a lot of bureaucratic fights are fought, whereas the arena for Japan are the Cabinent Policy offices.

    bsetser: there is a debate over whether the fed will lose money on the stuff it bought off bear to sweeten the deal for JPM. the fed might not lose money on the deal

    Note that the debate occurs after the fact when there is no chance of changing anything. A lot of this is "political show." Look good in front of the cameras. Get some votes for being tough, but the reason conversations are happening off-camera. It’s not going to change anything since the major decisions have already been made. Barney Frank and Christopher Dodd could have vetoed the Bear deal but didn’t, so they aren’t in a position to complain too much right now. Ron Paul would if he could, but he couldn’t so he didn’t.

    While the exciting events of mid-March were going on, the Fed and Treasury made sure that the key committee heads of Congress (Frank and Dodd) were kept in the loop.

  • Posted by Guest

    I find most of the anti-china comments silly. Clearly from people who don’t know much, let me give you guys some advice:

    your economy is imploding, your jobs are going, going, gone, your tax is going up and up due to all the wasteful spending and unnecessary wars caused by similar stupid anti-all-others opinions, you keep saying you want peace but are absolutely certain all of other peoples’ evil intentions, and now your CB is accepting garbage in return for cash. What would you think of a country that accepts garbage financial instruments for cash, you think that country will last ?

    Last advice:

    If you have explosives up your behind, don’t try fixing the problems of people in other parts of the world.

  • Posted by Twofish

    The rumor in financial circles (which has been noted in the New York Times) is that some hedge funds went "Bear hunting". They arranged their positions so that they would massively win if Bear went under, and then started spreading rumors so that Bear did.

    Certainly none of the Bear insiders made any money from the deal. The Fed insisted on a low purchase price specifically to punish Bear-Stearns and also didn’t open the discount window to broker-dealers until after Bear was dead.

    DC: If after all is said and done the $25 Billion primary assets are sold for more that $25 Billion, the difference goes to J.P. Morgan regardless of the outcome on the secondary facility of $30 Billion. No matter how you cut it, J.P. Morgan wins.

    Pretty much. The reason for this is that the Fed didn’t have much choice. The second Asian markets opened, there was a chance that the world financial system would have disintegrated if a deal hadn’t been made.

    DC: The best the FED can do is get their money back with interest and the worse they can do is lose about $25 -$40 billion. The FED would have been far better to just buy the assets at Bear’s and J.P.Morgan’s valuation.

    The Federal Reserve doesn’t have the people or the expertise to run an investment bank. To make the deal work, you have to guarantee the trades that you make, which means that you need someone looking over the traders shoulders.

    Also, I don’t think that the Fed has the legal authority to buy a bank, and it wasn’t going to get in less than 24 hours.

  • Posted by Twofish

    Honestly I think that a large part of the China bashing that is going on right now is because the US economy is weak. The logic is that "yes our economy is falling apart but at least we don’t molest kittens (or whatever the EVVVVEEEELLL Chinese government is up to)."

  • Posted by bsetser

    2fish — I started bashing China’s exchange rate regime back when the US economy was strong (by conventional measures) ;)

    Guest –

    "What would you think of a country that accepts garbage financial instruments for cash, you think that country will last ?"

    what is the over under on China lasting ten years? Last I checked, China had a lot more US agencies on its central bank balance sheet than the fed, and a currency mismatch to boot. And then there is the CIC, which handed over cash for blackstone’s equity …

    If you look at my actual post, i think you will see a lot of recognition that the US is in a bit of trouble (the dollar is weak b/c US fundamentals are weak — that isn’t exactly rah rah american is great). at the same time the reality is that a lot of other governments are through their central banks providing a lot of credit to the US … more quite frankly than I think is healthy for the US.

    above all tho i don’t get why a whole set of countries that think the US is the source of much global trouble still link their currency to the dollar, the currency of the prime trouble maker … that ain’t the fault of the yanks, generally speaking, tho we seem guilty of putting some pressure on the gulf to stick to their pegs.

  • Posted by Guest

    "…So what’s different this time? The single-most-important difference between this cycle and previous ones is that emerging markets as a group are no longer dependent upon external capital flows to finance their own economic growth… We are now in the early stages of a sustained growth of consumer credit in EM economies… The still-low level of wages in many countries suggests that income gains for emerging market workers and consumers will continue into the future. Over the long-term wage levels in emerging market countries will likely rise to converge with those in the developed economies. As they do the large population countries will become the largest sources of global demand, and in the process of arriving there the economies will have to “decouple” by definition…" http://www.pimco.com/LeftNav/Featured+Market+Commentary/EMW/2008/Emerging+Markets+Watch+4-08+Mewbourne+Decoupling.htm

    "…With each passing year, the U.S. economy relies less on the production of agricultural and factory goods and more on services to fulfill the American Dream. Today, four-fifths of our jobs are in services… We are a service-sector-driven economy, plain and simple…The United States, like Chicago, can continue to prosper only if it faces economic change head-on, choosing to compete rather than retreat, seeking out new opportunities in a globalizing economy, where goods, services, money and ideas flow freely across international borders.

    One of these opportunities—maybe the best one—lies in exporting services… Data from nearly all parts of the world show us that consumers tend to spend relatively less on goods and more on services as their incomes rise… Once people have met their basic needs, they tend to want medical care, transportation and communication, information, recreation, entertainment, financial and legal advice, and the like…China, India and other countries will shop the globe for what they cannot find at home or what is better elsewhere. Here, we have advantages in many areas. Medicine, finance, education, legal services, forensics, architecture and design, engineering technology, film and other aspects of entertainment—in these service areas and more, America is second to none… Productivity determines pay. And America’s services workers are among the world’s most productive… The capital of our times is human, not mechanical…workers create value with their minds… Economic theory tells us that nations will export what can be produced by factors they have in relative abundance. This is the principle of comparative advantage. Countries with significant mineral wealth will sell oil or copper. Those with large tracts of fertile land will sell wheat, corn or beef. Those with cheap labor and large stocks of machinery—think China—will sell run-of-the-mill factory goods. America’s highly knowledgeable and experienced services workers are our nation’s relatively abundant factor. That is what we sell to the world. That is where our future lies…" http://www.dallasfed.org/news/speeches/fisher/2008/fs080417.cfm

  • Posted by Twofish

    By the way, the "Bear-Stearn conspiracy theory" doesn’t make sense. If you really wanted to make money off the Bear-Stearn crash, then deep out of the money puts would not have helped you. To maximize your profit you’d buy a put option that was only slightly out of the money. If you known the Bear stock selling at 60 was going to tank, you’d buy put options at 50 and not 15.

    The fact that people started selling puts at 15, told you that the market was thinking that Bear was rather jittery.

    Also there is no way that insiders could have benefited from this without sirens going off. Among other things, people in the financial industry are not allowed to short stocks in their own accounts, and all accounts that you or anyone in your household gave control over send regular reports to compliance.

  • Posted by Guest

    "If you really wanted to make money off the Bear-Stearn crash, then deep out of the money puts would not have helped you. To maximize your profit you’d buy a put option that was only slightly out of the money. If you known the Bear stock selling at 60 was going to tank, you’d buy put options at 50 and not 15."

    wrong. more leverage with the out of the money

  • Posted by Twofish

    If the stock price is at 60, then both 50 and 15 are going to be out of the money, and very cheap, and if you know the price is going to zero, you are going to be making much more with 50 than 15, and you can leverage by borrowing money for the options.

    I do suspect that most of the deep-deep out of the money put options were bought by people holding credit default swaps on Bear.

  • Posted by df

    except Spain and UK private debt is much lower in Europe than in USA.

    and Netherlands and Ireland

    Simply put all the countries with low unemployment are country with high private household debt and high home prices…

    China is doomed and DC is just fun to read. If anybody wants sustaible growth then it s easy to understand that it works through balanced trade, strong environmental protection, a fair divide of the value added and stable private debt.

    Do you see that in any country in the world right now ?

    I see developping countries depending on exports, with wages too low to provide home consumption and HUGE environmental destruction and on top of this companies with HUGE debt loads… So it s easy to see that they ll be belly up pretty soon.

  • Posted by MtM

    Twofish sez: "…China has the opposite situation, in that the legislature is not democratic, but it does tend to quietly ask some pretty tough questions since the National People’s Congress is the arena in which a lot of bureaucratic fights are fought…"

    What tough questions? Care to give any examples? how did you hear about these quietly asked questions? sources pls! i do remember a story some NPC members actively argueing against the 3gorges dams during an NPC session and had their microphones suddenly switched off. mind you that must has been years ago under JZM; i wonder how China’s political systems has changed since. I had previously thought your description of Japan’s policy making would apply just as well to China.

  • Posted by Greg Byshenk

    One comment on the European housing "bubble".

    From what I understand, one could argue that there was such a "bubble" in the case of the UK, Spain, and Ireland. But adding the Netherlands to the list seems odd.

    Yes, housing prices are rather high (leaving aside the large rental market), but the current situation hardly seems to merit the epithet "bubble". The sale price of housing did increase significantly in the 1990s. From 1996 through 2001, the sales price of housing increased by over 10% each year, reaching 18% in 2000. But since 2003, such increases have moderated significantly, remaining in the region of 4% per year since then.

    I am not sufficiently expert to say whether a 4% per year increase is still "too much", but it doesn’t seem to be consistent with the double-digit increases that one sees in "bubble" situations elsewhere (or that one saw in the Netherlands in the 1990s).

    Most recent figures are avalable from the Centraal Bureau voor de Statistiek, at:

    http://statline.cbs.nl/StatWeb/publication/?VW=T&DM=SLNL&PA=71533ned&HD=080422-2242