Read the annual report of the Bank of International Settlements
International institutions usually put out reports filled with turgid and overly-qualified prose.
But not the BIS. At least not this year. The introduction and conclusion of its 78th annual report are a pleasure to read. The prose is clear and direct. An example:
“If asset prices are unrealistically high, the must eventually fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off. Trying to deny this through the use of gimmicks or palliatives will only make things worse in the end.” (p. 145)
Outgoing Chief Economist William White’s is unsparing in his criticism of both the big private banks and the major central banks. Central banks, in White’s view, held rates too low for too long after the equity bubble burst – creating asset bubbles that fueled excessive demand growth to offset what he views as the natural fall in prices associated with the integration of large new pools of labor into the world economy. Private banks ignored the risks building on their balance sheets
And central banks and private bankers alike failed to appreciate the risks created by the new world of securitized mortgage finance – particularly a world where a lot of exposure was held off-balance sheet in “vehicles” of various kinds.
“Recent innovations such as structured finance products were originally thought likely to produce a welcome spreading of risk-bearing. Instead the way in which they were introduced materially reduced the quality of credit assessments in many markets and also led to a marked increase in opacity. The result was the eventual generation of enormous uncertainty about the size of losses and their distribution. In effect, through innovative repackaging and redistribution, risks were transformed into higher-cost and, for a while at least, lower-probability events.”
It isn’t hard to get the impression that White thinks innovation increased the both the cost and probability of a crisis by contributing – along with low policy rates – to reduced credit standards and asset bubbles. He clearly thinks that the credit losses that followed the bursting of the bubble cannot be “cleaned up” easily.
“It is not clear where the losses [on “new financial instruments”] are, how they should currently be valued or how large they might grow given ongoing declines in the prices of underlying assets.”
The solution? In the first instances, the banks who originated and distributed (sometimes to their own treasury or internal hedge) the bad loans should take their losses.
“Both dividends and bonuses should be cut in order to increase capital cushions.”
I would guess White didn’t approve of the large bonuses many banks paid in 2007. Come to think of it, some of the investors who put money into the big banks in late 2007 also may have second thoughts about the wisdom of these bonuses.
It is striking that US banks had far higher returns on their assets in 2005 and 2006 than the banks in other countries (see the table on p.119). Those high profits were achieved even as the yield curve was inverted - -normally something that isn’t good for bank profits. That should have been a warning sign. Those profits proved to the illusions – as they gave rise to large losses later.
And if cutting dividends and bonuses doesn’t provide the capital needed to absorb the losses associated with valuing assets at their “true” value, public funds should be used.
“The valuation of many of many structured products is difficult, because there is effectively no market for them and valuing them using models has many drawbacks. The banks might agree on a common template for valuations … nevertheless has significant merit. Of course such an evaluation might also reveal that losses are uncomfortably large, a possibility for which the authorities should make preparations in advance. … Mergers, takeovers, the establishment of a “bad bank” to house bad assets, recapitalization using public funds and even nationalization are all procedures that should be contemplated.”
White puts a bit more weight on lax credit and a bit less on policies that pushed down emerging market exchange rates and pushed up savings rates than I would. The Fed can be faulted for not raising policy rates more during the housing boom, but the Fed’s actions alone cannot explain why long-term rates remained below short-term rates for a long time. Nor can a “US only” explanation fully explain why rising rates and a falling fiscal deficit produced an expansion of private housing credit rather than more of an adjustment. To White’s call that “If savings rates are unrealistically low, they must rise” I would add that “If savings rates are unrealistically high, they must fall – and if exchange rates are unrealistically low, they must rise.”
White doesn’t criticize excess savings in many emerging economies – or if he did, I didn’t see it. He certainly doesn’t criticize the policies that have pushed up Asian savings and led to record Asian current account surpluses even as oil rose to $70 last year (see Chapter III of the annual report) with the same vigor as he attacks the argument that central banks shouldn’t try to stop a credit fueled asset bubble. He didn’t spare the emerging economies from criticism though. He writes:
“Upon closer scrutiny, doubts about the longer-term health of emerging economies began to surface. In China, the extraordinary rapid pace of fixed capital investment, much of it in heavy industry, fueled worries about a misallocations as well as the broader effects on both global commodity prices and the environment. In the Middle East, fears intensified that different countries might be pursuing similar strategic development plans that might eventually result in problems of excess supply. And in central and eastern Europe, large and rising current account surpluses seemed increasingly unsustainable.”
I guess he doesn’t think Qatar, Abu Dhabi and Dubai all need huge new airports. And, I rather suspect, he isn’t a big fan of the credit fueled real estate booms in many emerging economies – booms fueled by negative real interest rates and rapid credit growth.
White clearly calls for emerging economies to tighten monetary policy, and recognizes that tightening monetary policy in response to rising inflation requires that many emerging economies allow their exchange rates to rise (p. 144). I suspect that call will have as much impact as White’s efforts to get the US to preemptively prick the housing bubble.
The BIS report concludes, as Martin Wolf notes, with a call both for for a more “macroprudential” focus for bank regulation. The current system is both procyclical, as rising asset prices tend to support credit expansion that pushes asset prices (and risk premia) down and overlying focused on the health of individual institutions rather than the resilience of the overall system to large shocks. Emerging market banks in “liability dollarized economies” have often been devastated by exchange rate moves that pushed many borrowers into default at the same time. The US financial system seems to have had a similar exposure to housing. Rather than looking at how individual institutions could weather a shock to their specific balance sheet, regulars need to worry more about how the overall system could weather a large common shock. Shocks that impact many institutions simultaneously have a much greater risk of triggering a broader decline.
A macrofinancial regulatory framework would include greater attention “on the dangers associated with many institutions having similar exposures to common stocks, for example a turn in the property cycle …. While such an approach would not imply paying less attention to the health of individual institutions, it would certainly imply significantly enhanced oversight of firms that were very large or had complex relations with other parts of the system.”
That presumably includes Goldman Sachs, not just UBS and Citi.
Regulation would also be tightened when the good times are rolling and all looks good (and institutions look both profitable and well capitalized), not just when the music stops. Indeed tighter regulation in good times creates more room for forebearance in bad times. Such a framework would include greater willingness on the part of central banks to try to restrain rapid asset price rises fueled by rapid credit growth.
A more “macro-prudential” approach to regulation makes sense to me.
(p.s. anyone who thinks I am exaggerating global reserve growth should look at the table on p.83 – a table that leaves out most of the $75 billion increase in Saudi foreign assets). Take the total, adjust it for Saudi Arabia and then add in another $150b or so to the 2007 total for the increase in the sovereign funds of Norway, Abu Dhabi, Kuwait and Qatar)
Glad to see this brought to everyone’s attention. Pity the horse has fled and they were the ones who hosted this crazy compromise of an international system for prudential supervision (Basle II). Banks are payment utilities with a hedge fund, a money market fund and finance company attached. Regulate the payments function (nationalize it if necessary, and leave the rest to the market, or do it right. In 20 years of studying this subject, I have not come a good intermediate solution. Not to say of course that Basle I, or US leverage ratios are better. Only if combined with very restrictive product powers. Like in he old days..
“He certainly doesn’t criticize the policies that have pushed up Asian savings and led to record Asian current account surpluses …”
In other words, he pays little attention to the importance of global imbalances, an issue you would think should be among the most relevant to the global mission of BIS (whatever it is exactly)…
Of course “If savings rates are unrealistically high, they must fall”, but are they? With few countries of economic significance not ageing, one would expect the present global savings rate to be historically high, which (as Stephen Roach has pointed out) it is not. As the BIS report says, China is struggling to cope with its present volume of investment. The sensible answer for them is therefore to purchase foreign claims instead.
Frankly, I see the way that surplus countries organise themselves internally to purchase these claims - whether by building official reserves or by private saving - as relatively small picture. Likewise, it is up to the debtors how they prepare for repayment. I grant that China (but Japan less so) deserves criticism for making it hard for Americans to purchase Chinese claims, but the big picture problem is that America is not preparing for repayment. It needs to consume less and invest more. And unlike China, the USA has plenty of unexploited investment opportunities.
In my opinion, the problem is global underinvestment, not a glut of saving.
Believe me, unlike some non-Americans, I take no pleasure from the mess that America is in, because we in Britain have similar problems.
Nationalization of banks? Use of public finds?
Sure if the rewards accrue to those that venture the capital, that is, if nations are the arbiters and recipients of credit and its’ proceeds. As it stands now the public takes the risk and the private sector, the rewards.
What we need are public central banks that do not use fractional reserve banking but through their sovereignty grant directed credit, at a price, to banks.
The game of unlimited growth is over. It worked while resources were abundant and through technology, marginally cheaper. That is no longer the case as we see with oil.
The leveraged arbitrage of money, based on goods, is over and in for a very painful death. Without a new credit system based on sustainability we perish.
Michael,
Nationalization of the payments system (possibly cheaper than regulating it, externalities included) is of course an extreme measure and clearly unfeasible (even the discussion would be taboo) politically. But I did not mention nationalization of the banking system, only suggesting that either it should not be regulated beyond the payments function (very few people would accept that, but NZ has extremely light regulation and an OK banking system (entirely foreign owned, where it is regulated.So the only living example is not really appetizing) or it should be regulated rationally. And the latter is not easy from an economics point of view (not only the fashionalble discourse of credit risk models etc, but even the old issue of liquidity has proved to be highly elusive for an increasingly formal rulesl optimizing industry (see also the BIS’s latest proposals). And any economically promising ida is immediately captured by the industry’s interest groups/factions and national representatives with a variety of motives. Hence my cynicism about the political context of this genuinely interesting and tragic document (even slightly dated by now, it appears). Far better than anything coming out of the IMF recently. Economics is not a science..
Rien Huizer,
The comments I listed were in the BIS report!
” recapitalization using public funds and even nationalization are all procedures that should be contemplated.”
Indeed I think this is a good idea but only when a public central bank that can authorize and prioritize all credit creation is in place. It is time for a sustainable model of money and credit creation, not an auction of credit based on consumption.
Remember Japan. Trying to avoid these steps will only prolong bad times-we need to clean things out. Times are bad. I was surprised by how much some good stocks are down. See Chart @
http://www.theinvestingspeculator.com
Back from vacation in Florida. According to a friend who lives in Tampa, the real estate maket in Florida is a financial disaster with prices collapsing 50-60%. Too many speculators purchased luxury condos and properties, that combined with loose credit complements of the Greenspan-Bernanke Federal Reserve’s policy of “cheap money” and lax financial regulation.
There doesn’t appear to be any recession in Disneyworld or Seaworld which are swamped by British, German, and Brazilian tourists. If you are not through the entrance by 10 AM, the park gates are closed until later in the afternoon. The luxury resorts like the Disney Grand Floridian are at 100% full occupancy, and restaurants like the Tappan Edo in the Disney Japan Epcot pavilion need to be booked months in advance. In one tour group from Brazil, there were literally several thousand tourists visiting Seaworld occuping half of the Shamu whale stadium. There were only a handful of tourists from China or other Asian nations. But Seaworld seems to have alot of exchange college students from different Asian countries working at their facilities including Taiwan, Thailand, and Malaysia.
The end of the superbubble
By Bill Fleckenstein
http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/TheEndOfTheSuperbubble.aspx
That sound you hear is the popping of a financial bubble in housing, the economy and the market. And you can trace it all to Alan Greenspan’s Federal Reserve.
Meanwhile, the aftermath of this housing/credit bubble is far different from that of the stock bubble. Now the lending institutions are swimming in bad debts. Homeowners have mortgages they can’t pay, just as the assets (houses) behind those debts are dropping in price.
As if that weren’t enough, consumers’ paychecks are eroding, thanks to galloping inflation created by the money printing that fomented the housing bubble (and by the credit that Greenspan’s replacement, Ben Bernanke, has subsequently thrown in to ameliorate the aftermath).
Behold the wretched beast he created
The truly sad part is that this outcome was foreseeable.It was possible to anticipate a catastrophe of such dimensions even when the housing boom was still in full swing. Unfortunately, the very institution that had the regulatory authority to supervise the banking system was the one leading the cheering — namely the Fed, in the form of Greenspan. (That was sort of like putting a bartender in charge of adjudicating disputes over breathalyzer readings.)
The collapse of the housing bubble is taking the economy with it and pressuring the stock market as well. Thus we will have all three markets feeding on each other as each deteriorates.
I would note that the time frame of this superbubble roughly approximates the career of Alan Greenspan, who in my opinion was responsible for its creation — and the enormous pain caused by its collapse.
You are linking to the 2007 report, not the 2008 one.
Thanks for the informed analysis.
Dave Chang,
You were incorrect when you wrote: that the Florida real estate bubble was caused by “loose credit complements of the Greenspan-Bernanke Federal Reserve’s policy of ‘cheap money’ and lax financial regulation.”
The Federal Reserve under Greenspan and Bernanke has not had a “cheap money” policy. If they did, then the United States would have experienced inflation.
As we document in Chapter 2 of our book, Trading Away Our Future (published by http://www.idealtaxes.com ), the cause of the falling US real long-term interest rates since 1996 has been the same inflow of dollar reserves from the mercantilist countries that caused the exploding trade deficits.
Economists have an equation that Demand for Investment equals the Supply of Savings at a price known as the real long-term interest rate. The savings involved are a combination of foreign and domestic savings.
The increased foreign government savings coming into the United States caused the US real long-term interest rate to fall. Normally, this would have caused increased fixed investment except that the same factor that was lowering the interest rates (foreign government mercantilism) was also taking away investment opportunities. The result was that the increased foreign savings coming into the country lowered domestic savings instead of increasing fixed investment.
Howard Richman
http://www.trade-wars.blogspot.com
Dave Chiang,
Brad made the same point in a different way in his June 27 posting, “Does the Fed’s mandate now extend to Beijing, Moscow and Riyahd?” He wrote:
“Second, the large amounts of financing the US now receives from countries that are managing their currencies against the dollar is a mixed blessing. It has helped some parts of the US economy, but hurt others. Large reserve inflows from 2002 to 2006 likely contributed to the excesses in the housing market that are now causing the world so much trouble. And it has had costs as well as the benefit to those countries that have managed their currencies against the dollar: their export sectors have been helped, but they have also sunk a large share of their national wealth into depreciating dollar-denominated assets.”
Howard
I know little about international economics. But I know that the so-called “dismal science” is mythology. Economic forecasts are all but infallable.
First, there is no ambiguity in forecasts. In contradistinction to Bernanke (and using his terminology), forecasts are mathematically “precise” (1) nominal GDP is measured by monetary flows (MVt); (2) Income velocity is a contrived figure (fabricated); it’s the transactions velocity (bank debits, demand deposit turnover) that matters; (3) “money” is the measure of liquidity; & (4) the rates-of-change (roc’s) used by the Fed are specious (always at an annualized rate; which never coincides with an economic lag). The Fed’s technical staff, et al., has learned their catechisms;
Friedman became famous using only half the equation, leaving his believers with the labor of Sisyphus.
The lags for monetary flows (MVt), i.e. proxies for real GDP and the deflator are exact, unvarying, respectively. Roc’s in (MVt) are always measured with the same length of time as the economic lag (as its influence approaches its maximum impact; as demonstrated by a scatter plot diagram).
Not surprisingly, adjusted member commercial bank “free gratis” legal reserves (their roc’s) corroborate/mirror both lags for monetary flows (MVt) –– their lengths are identical.
The lags for both monetary flows (MVt) & “free gratis” legal reserves are indistinguishable. Consequently it has been mathematically impossible to miss an economic forecast. There are no inaccuracies, just some non-conforming & unavailable data This is the “Holy Grail” & it is inviolate & sacrosanct.
The BEA uses quarterly accounting periods for real GDP and deflator. The accounting periods for GDP should correspond to the economic lag, not quarterly.
Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired roc’s in monetary flows (MVt) relative to roc’s in real GDP. Note: roc’s in nominal GDP can serve as a proxy figure for roc’s in all transactions. Roc’s in real GDP have to be used, of course, as a policy standard.
Because of monopoly elements and other structural defects which raise costs and prices unnecessarily and inhibit downward price flexibility in our markets (housing being most notable), it is probably advisable to follow a monetary policy which will permit the roc in monetary flows to exceed the roc in real GDP by c. 2 percentage points. In other words, some inflation is inevitable given our present market structure and the commitment of the federal government to hold unemployment rates at tolerable levels.
Some people prefer the devil theory of inflation: “It’s all Peak Oil’s fault.” This approach ignores the fact that the evidence of inflation is represented by “actual” prices in the marketplace. The “administered” prices of the world’s oil producing countries would not be the “asked” prices were they not “validated” by (MVt), i.e., validated by the world’s Central Banks.
“equation that Demand for Investment equals the Supply of Savings at a price known as the real long-term interest rate. The savings involved are a combination of foreign and domestic savings.”
This is a generalization. There are leakages. And all flows have to be “validated” by Central Bankers:
The problem with this equation is the problem with Keynesian economics:
In the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”
In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary in order to make the statement correct. Perhaps this is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, Reg Q, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, etc.
thanks un estan
“White doesn’t criticize excess savings in many emerging economies – or if he did, I didn’t see it. He certainly doesn’t criticize the policies that have pushed up Asian savings and led to record Asian current account surpluses even as oil rose to $70 last year”
I wonder if anyone will ever react to this. Is it the fear that trade wars would ensue? Overly lax U.S. monetary policy can be viewed as competitive devaluation, too. So far, it seems only the euro area is resisting attempts to devalue their currency to export unemployment. But they can’t (and shouldn’t) be forced to sustain world demand on their own.
Flow5,
Although the equation that Investment equals Savings is a cornerstone of Keynesian theory, it is not a derivation of Keynesian theory. It is true be definition. It can be derived from the fact that total production equals total income.
Howard
un estan — thanks for letting me know. I’ll fix the link — which I added after I wrote blog. the quotes are from the 08 report.
Richman: Normally, this would have caused increased fixed investment except that the same factor that was lowering the interest rates (foreign government mercantilism) was also taking away investment opportunities.
Nope. The savings that were going into to the US couldn’t be used for investment because it was going to pay for tax cuts and the Iraq War.
There are lots and lots of investment opportunities in the United States.
I just took the time to read the introduction to the BIS report. While it is indeed clearly written and while it does provide a pretty complete survey of the trees. It seems to me that it is a case of BIS missing the forest. Apparently they do not understand modern mercantilism.
They note that the mercantilist countries (especially China and India) have high levels of domestic fixed investment while the victim countries (especially the United States) have inexplicably low levels, but they don’t realize that this is the intended result of mercantilism.
As I read their description of why US companies are not investing — that they could see the Chinese building factories to take over their industries, I thought of the meeting that the head of Bucyrus had with Senator McCain. Bucyrus is one of America’s premier export-oriented heavy mining equipment manufacturers. With world demand for raw materials escalating, they should be adding production right and left. But instead they just saw their exports to China diminish because of a new 40% Chinese duty on while China builds three new heavy mining equipment factories to take over their business. (See http://www.jsonline.com/story/index.aspx?id=741187 )
BIS notes that the US consumption growth has slowed because it was being sustained by increased borrowing, not increasing income, but don’t seem to realize that mercantilism kept that income from increasing. Eventually, in a mercantilist world, the victim countries lose their industries and stop growing, which ruins the market for the mercantilist countries’ exports. That’s why mercantilism is not sustainable.
I didn’t read the conclusions carefully, but they all seem aimed at improving the banking systems in the victim countries. But it is the mercantilist countries that have to change in order to return the world to sustainable trade balance.
The mercantilist countries have to let their currencies appreciate. They have to expand the credit and consumption of their own citizens instead of sterilizing their savings to buy foreign currencies. They have to dismantle their barriers to the victim countries’ products.
Howard Richman
http://www.trade-wars.blogspot.com
Howard, the main theme is in their own backyard: regulatory failure. All kinds of environmental factors influencing the financial system (and vice versa), like gvt trade policy, institutional structures at odds with free markets, etc may be important but financial stability is their topic, and they are the international forum for regulatory diplomacy aiming at prudent financial suoervision combined with non-discriminatory practices. So, financial mercantilism might be a topic. However, as many authors from the new-institutionalist school of political economy (eg Robert Wade)would agree, the financial sector is a tool that governments use in the process of rapid industrialisation. So the mercantilists are rarely exporting financial services in a predatory fashion. If they did, the BIS would probably mention it. For a short while the Japanese economic boffins thought that they could establish a dominant position in finance, and the consequences of that have received ample attention in the 1980s and 1990s. In fact, alleged prdatory Japanese competition was the trigger for Basle I.
My concern remains that it is extremely difficult to design a regulatory framework for the financial sector that is reasonably effective and efficient, AND facilitates a level playing field AND is not procyclical. I am afraid (and this report confirms my concerns more than refutes them) that the official response will be more regulation and that via the same process (a dialog with producers of services, where the posibility of capture is large. The current mess is partially to blame on the incessant promotion of functionally inappropriate statistical concepts (like for instance VAR based capital adequacy for arbitrage books consisting of structured assets and credit default swaps; non consensual models combined with unobserveable data and inappropriate market structure assumptions) . One could compare this by allowing airlines the use of planes that have not even completed their test programs (and even that could be more responsible than a supervision framework that pays more attention to industry complaints than managing the enormous externalities of financial systems, as well as the state’s contingent liabilities.
So, what I fear is that we will not see more of a market solution but more (either expensive, risky or both) attempts at regulation, probably by making models more comprehensive and realistic. A normal bueraucratic response.
What I do not expect to arise is a tructuring of the financial sector businesses in such a way that market discipline dominates and that the gvt role is that of a provider (via contractors if necessary) of a few things that are close to a natural monopoly plus a well resourced watchdog, educating the public authoritatively about pros and cons of financial products, and, very importantly, supervising rating agencies.
In such a world, also US (or similar ones in other countries, the US happens to be an easy example of very good and very bad regulation in cyclically lethal combination) entities involved in housing finance (like FNMA) should be either fully privatized and credibly exposed to bankruptcy, or issueing true claims on the Federal gvt, while the Fderal gvt should organize a mutual lower government insurance company, backed by the federal government but charged with seeking private sector reinsurance (and charging market-conforming premiums) for municipal bond insurance.
I can’t post!?
Howard Richman,
I agree with Twofish; there are plenty of productive investment opportunities in the USA. Start here: http://www.asce.org/reportcard/2005/actionplan07.cfm
As for mercantilism, how do you justify a 54 cent per gallon tariff on imported ethanol that encourages production from nutritious and needed food rather than sugar?
But just for today, I will forgive your irrational patriotism!
Mercantilism seems to be the new slag word, and seems too close to scapegoating for comfort. Commercialism isn’t a new phenomenon, and it is better to refer directly to which practices are unsound rather than labeling whole countries with a vague word like mercantilist.
I have always struggled to understand exactly why savings equaled investment in economic theory. I could grasp that one could invest ones savings, but how ones savings are invested prior to ones own investing of them requires a more flexible mind than my own. But I accept that, provided savings are deposited in a financial institution and not in the underwear drawer, those savings can be lent to another investing party to generate interest. Still seems to me they would be invested twice due to the bank’s sleight of hand, but then I’m not a banker either.
If savings are low it is not hard to see why investment would be low. Both saved and lendable funds to invest would be low.
Foreign savings would by definition equal potential foreign investment, it would seem. Foreign savings, a direct result of trade imbalance, can only be saved or spent. Saved as somehow invested in US assets, or spent as in buying US products.
Foreign reserves held in US dollars were originally intended as a buffer against future trade imbalances, for when the tide would turn and US would enjoy a trade surplus with the holding country. SWFs would seem to indicate that these countries are less concerned about that eventuality. Fx holdings become savings to be invested, and that seems to me to be a change in the nature of foreign exchange holdings as such. But perhaps they were “savings” all the time.
A healthy US economy being the objective, indirectly for trading partners and obviously for Americans, it is not too clear what needs to be done. Clearly, the Chinese peg distortion is working against US economic interests, but what about the oil exporter’s peg? In fact, it is difficult to foresee the oil exporter enjoying anything but a huge trade surplus for the foreseeable future, all economic theory aside. How will the resulting savings translate into investment? Would it make any difference if, for example, Saudi Arabia became the 51st state? (Not to be understood as a likely or feasible turn of events. Just a mental exercise) In theory, would that change anything? Well, the trade balance would be affected for sure, but what would be the net effect on the US economy? Savings and investment up to the tune of a whole bunch of billions, but weren’t these already destined to be invested in the US to a large degree? The price of oil would still be as high. Possibly even higher if the US economy was more vibrant and other economies none worse off at the same time, due to stronger demand for oil.
So what is needed for increased profitability in the US economy? How do other economies need to play ball, and why would playing ball make practical sense to these?
Brad
Hate to be the contrarian or the broken gramophone for that matter, there are at least 3 minor points of disagreement with your stance on the asian savings situation
- the savings glut in Asia could not possibly push the USA into “effectively borrowing” to finance its various needs. The savings identity/equation has been an excuse for not examining attitudes towards expenditure/consumption that form a contributing cause to current problems.
- surpluses built up from an export oriented economy might explain part of the Asian phenomenon, but how much of that actually comes from American (and other western) industries taking advantage of labour and other cost savings to produce in the east and export west? Should the ever rising profits of these companies in recent years be subject to closer scrutiny?Should industry leaders be forced to accept lower profits and shift jobs back on home turf?Would western workers be willing to accept lower pay and lower standards of living?
- The savings identity might look logical when applied to nations on individual basis or generally in the long term, but not in the short run. If the Asians were forced to consume at the rate of an average American, the planet will probably have run out of resources, as it is, there’s Bush blaming Indians and Chinese for eating too much , ok, the affluent ones. Besides, some may have forgotten that the IMF lectured Asians on the need for stringent budgetting when the asian financial crisis hit, perhaps it could be a case of learning your lesson too well?
If there is oversupply of infrastructure/edifices in the Middle East, it will show up.They will then decide what readjustments are needed. Besides, misallocation of resources isn’t an innovation. The rest of the world has had to live with it for a very long time. Ditto imbalances. If foreign imports are the problem, consume less of foreign imports, no one can force consumption, not even marketing experts!
P.S. This was meant for posting yesterday but there was some kind of glitch on the comment section.
The links have been updated; my apologies for the earlier error.
Judy — your points of disagreement aren’t minor; they are fundamental. The BIS touches on these points as well in its conclusion, where it notes that not all countries can raise their savings simultaneously.
Let me start with your last point, about IMF lectures. I would note here that the IMF has also been lecturing about exchange rate flexibility, and it didn’t have much impact. I don’t think this has much to do with the IMF. Moreover, the IMF’s lectures on budgeting were generally directed at Latin America and Africa more than East Asia — which generally doesn’t run big deficits. the advice to tighten fiscal into the crisis that the IMF initially made in East Asia is now widely recognized — even by the IMF — as a mistake.
the questions concern savings and investment on a global scale. You say that the “savings glut” in asia (in the oil exporters) could not push the US into borrowing. Let me rephrase that to shift the focus away from the US — the argument in effect is that a glut of savings in one part of the world (relative to investment) wouldn’t push the rest of the world to borrow more. Here i disagree. Say one country implements a set of policies (restricting bank lending and building fiscal surplus to maintain an undervalued exchange rate) that have the effect of pushing up its savings relative to its investment at the prevailing domestic interest rate. Those savings by definition aren’t used at home — they have to be lent to the rest of the world. This isn’t a question of what one believes, it is a matter of accounting.
The increase in the supply of savings internationally would all other things being equal tend to push down the price of borrowing. this basic supply and demand. and increase in supply pushes down the price to generate more demand. More savings — generated by a policy choice — pushes down the price of borrowing until the supply of funds available to be lent is matched by the supply of willing borrowers.
Now you can argue my example is a bit unrealistic, because i assume that the supply of savings is fixed — and that a fall in the return on savings doesn’t induce a fall in the supply of savings in other “savings surplus” countries. and that is certainly one way the world could balance — one region with surplus savings (say the oil exporters) saves more, pushing down the return on savings and pushing other savings surplus countries to save less (i.e. China would save less) rather than pushing “savings deficit” countries to save less/ borrow more.
But that isn’t how the world adjusted to the rise in the price of oil — china’s surplus savings and the oil exporters surplus savings both increased (see the chapter on emerging economies in the BIS). Again, this isn’t something one believes or doesn’t believe — it is simply what the data says. the current account surplus of both emerging asia and the oil exporters rose from 02 to 07 (in 08, the surplus of emerging asia should fall a bit given the huge increase in the oil surplus).
so that leaves us with a world where an increase in the supply of savings by asia and the oil exporters pushes down the price of borrowing and induces more borrowing.
now nothing says that the US necessarily will be the one responding to the shift in price — the increase in borrowing could come from any country that hasn’t increased its savings as a result of a change in policies. It could from australia. it could come from europe. and so on. And the reality increasingly is that the rise in borrowing (the increase in the deficit) isn’t just coming from the US. over the past few years, the European union has swung into a significant deficit.
Your point about the entire world — especially the rich world — needing to reduce its consumption to help the environment is a fair one. but if the US reduced its consumption of energy intentsive goods and instead “saved” more, the world would still need to adjust to the shock. less consumption means less production, and less income for producers. the price of the goods they produce would fall, given the (hypothesized) fall in US demand. Those producers — let’s call them china and the oil exporters, as i focusing on the int. adjustment — could respond by cutting their own savings and keeping their current level of consumption. that would reduce the US deficit and the savings surplus simlutaneously.
Or the rest of the world could respond to the fall in US demand/ fall in price for the goods the US demands by continuing its current level of savings and reducing its consumption.
but that leaves the world even further out of equilibrium — the fall in us demand has been matched by a fall in demand in those countries that produce goods for the Us market, and the rise in Us savings hasn’t been matched by a fall in savings elsewhere. there is a new “glut’ of savings, so the price of borrowing falls. Eventually a new equilibrium is found.
finally, let’s consider the case where the global glutton (call it the US) decides to become even more of a glutton. say it chooses to increase its fiscal deficit to finance a new round of tax cuts — or us preferences change and the level of desired savings falls for a given interest rate, so consumption goes up. that too forces an offsetting adjustment abroad.
more us demand = more demand for the produces the world sells to the us = higher prices = more income.
that income could be fully saved — and lent to the US, which would generate equilibrium in the market for borrowed savings.
Or that income could in part be spent, adding to the stimulus to global demand.
but if the income stimulated by the rise in us demand is spent, the world is out of equilibrium — the US now wants to consume more and save less at the prevailing interest rate. and the world hasn’t increased its savings correspondingly. there is a shortage of funds to borrow — so the price goes up. i.e. interest rates rise.
the point i have been trying to make is that we haven’t lived in the last world — the policies the us adopted to stimulate demand during the last recession produced a bigger structural fiscal deficit, but didn’t push up US interest rates. that tells us something. the same is true now. and when rising home prices left many americans convinced that they could spend more and save less ’cause of the rising wealth, there wasn’t pressure on long-term US rates. less private savings didn’t drive up rates. again that is puzzle that should be explained.
Bottom line: I am not defending the United States low level of savings on moral grounds. I don’t think it is good for the world. I am tho arguing that the availability of savings outside the US has prevented the US from paying the usual price for a lack of savings - namely that the scarcity of savings pushes up the cost of borrowing, and thus drives up interest rates until folks consume less and save more.
my apologies to all who experienced difficulties with the comments yesterday. there were some difficulties with the cfr.org site that have been resolved, related in part to the introduction of the new mozilla browser. if it is any consolation, i couldn’t access the blog at all using firefox for a while yesterday. it was a broader problem than just a problem with the comments.
Rien,
You wrote, “Howard, the main theme is in their own backyard: regulatory failure.” Indeed you are correct. But they are also the central bank for central banks. As such, central bank policy is also their province. The policy of the Peoples Bank of China has been to constrict lending by China’s banks to Chinese citizens while buying ever increasing amounts of foreign currencies and lending the dollars and euros to the west.
Howard
Richman: The policy of the Peoples Bank of China has been to constrict lending by China’s banks to Chinese citizen
No it hasn’t. Consumer lending is the fastest growing sector of Chinese bank lending. We had this discussion on another thread, when you challenged me to provide examples of Chinese banks lending to consumers, and I gave you several links where banks are looking for consumers to lend to, and also links to balance sheets that show that this lending is a large (and growing) part of the bank lending.
China is just not Japan.
“…the banks who originated and distributed (sometimes to their own treasury or internal hedge) the bad loans should take their losses…..And if cutting dividends and bonuses doesn’t provide the capital needed to absorb the losses associated with valuing assets at their “true” value, public funds should be used.” - BIS
Are you kidding me? There is plenty of private money sloshing around the world that would do that job. Using public money, that of the prudent to bail out the profligate, is wrong. And right and wrong still exist as do honor, integrity and moral hazard. I don’t buy the expedience argument made by public officials & lawyers. I’m for letting these knuckleheads fail. It won’t be the end of banking.
Howard & Rebel Economist; I was selling raw materials to southeast Asian manufacturers when an acquaintance who manufacturers coal (mine) degasification equipment asked me about selling the China market. He was preparing to go on one of those “junkets”. His problem; he knew that if he were lucky enough to get an order he would have to recover his entire development cost on the first unit as it would be disassembled for study, reverse-engineering and local production. Consider this against the background of approximately 4000 work related coal mining deaths / year in China as against about 22 in a bad year here. This example is not meant to minimize the tragedy of loosing 22 souls in our mines. So, certainly we could use some investment here too. But the better investment would be to overcome that unconscionable callousness and to fix that other problem. Seen from here, the investment opportunities seem to be there. We can discuss why more of that isn’t happening. What should be policy for open market advocates when confronted with clearly mercantilist action?
bsetser: I am tho arguing that the availability of savings outside the US has prevented the US from paying the usual price for a lack of savings - namely that the scarcity of savings pushes up the cost of borrowing, and thus drives up interest rates until folks consume less and save more.
And I agree with this completely. I’m just confused what this is necessarily a bad thing. The two arguments I can think of are 1) sustainability and 2) social welfare.
As far as sustainability, the current situation can’t continue forever, but just because something has to happen eventually doesn’t mean that it has to happen now. Eventually, we all are going to die, but that doesn’t mean that shooting ourselves is the most desirable course of action. There is this bizarre economic obsession with equilibrium states, which misses the point that equilibrium is not necessarily the best situation. Living organisms are fundamentally out of equilibrium, whereas the adjective that describes an organism that is in equilibrium with its surroundings is “dead.”
As far as social welfare goes, I’m not convinced that lending money to the United States was the worst possible situation. Yes, Chinese loans did help cause a real estate bubble in the United States, but if the money had stayed in China it would have caused the stock and real estate bubble there to be much worse than they are, and the US economy is much more able to absorb a real estate bubble and burst than the Chinese economy is.
2fish. I think the downsides come both from the the lack of social welfare — too much investment in energy inefficient housing stock in the us financed by China and the Gulf, too much lending of Chinese and gulf savings to the US on terms that produce losses — and the risk of instability.
And then throw in the inflationary consequences of massive reserve growth in the surplus countries. that inflation will cut into the savings surplus over time. But i still wouldn’t think it is a good thing. Or a good way of making the unsustainable sustainable.
p.s. China is at risk of an investment bubble in physical assets and real estate. I wouldn’t want adjustment to come from higher investment in china (tho that is what negative real rates encourage) but rather from higher consumption/ less savings. and i think — unlike you — that there are creative ways to distribute funds to china’s poor if the constraint created by the undervalued exchange rate was lifted.
MacroPolo: Consider this against the background of approximately 4000 work related coal mining deaths / year in China as against about 22 in a bad year here.
There’s actually an interesting point in these statistics in that if you look at the death rate per hours worked, China is only slightly worse than the United States. The death rate per hours worked in China about twice that of the United States.
The reason for the huge death rates in Chinese coal mining is that like everything else in Chinese manufacturing, coal mining is extremely labor intensive and it takes a lot more people (and deaths) to mine the same amount of coal.
This also explains why mine safety is such a tough issue. Whenever the government tries to enforce laws, the workers complain that they end up out of work, and the reason people are willing to go down into the mines is that for the individual miner, the risk of death or serious injury is not that much higher than that in the US.
Marco Polo — are gulf sovereign funds and Chinese state banks “private” money?
Palij,
You had several questions. Let me try to answer them:
1. Is “mercantilism” a vague term?. No. It is a precise word to describe a foreign trade policy that involves maximizing exports while minimizing imports.
2. Why do savings equal investment?. This is true because the total income in a country is equal to the total product of the country. Savings is that part of income that is not spent on consumption while fixed investment is that part of GDP that is not produced for consumption. (I oversimplify, but that’s it essentially.)
3. What’s the difference between the terms foreign savings and foreign investment? The two terms are synonyms for the net savings coming into a country from outside the country whenever a country is running a trade deficit.
4. Does the inflow of foreign dollar reserves cause increased buying of US made products?. No. Just the opposite. Foreign governments buy dollars in order to “sterilize” them, i.e., to prevent them from being used by their citizens to buy US made products.
5. Do foreign governments buy US dollars to hold them as reserves against future trade imbalances? Some governments accumulate reserves in order to prevent future currency collapses like the collapses experienced by the Asian Tigers in 1997. Governments can also accomplish the same goal by buying International Monetary Fund credits.
6. Clearly, the Chinese peg distortion is working against US economic interests, but what about the oil exporter’s peg? I believe that the oil exporter’s pegs are working against long-term US economic interests. Brad does also. The US Treasury disagrees. If the oil exporters were loosening their pegs to the dollar, Brad and I reason that their people, and others around the world, would be buy more US products.
7. So what is needed for increased profitability in the US economy? Investment in American production, including energy and manufacturing production.
8. How do other economies need to play ball, and why would playing ball make practical sense to these? There are two things that could cause them to play ball: (1) After the current system collapses they will realize that mercantilism is not sustainable, or (2) The United States and other victim countries can force them to gradually move their trade toward balance. If they don’t do so voluntarily, we could force the issue using Import Certificates, an idea originally proposed by Warren Buffett ( http://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm ).
By the way, the currency pegs should be loosened gradually (over five years) giving time for three adjustments to take place:
1. Increase in domestic savings in the victim countries.
2. Increase in fixed investment in the victim countries.
3. Increase in domestic consumption in the mercantilist countries.
Howard
The problem here is that whether or not something is “realistic” or not is only obvious post-facto. In any bubble there are always lots of people that can come up with arguments why current prices are “realistic.”
Everyone wants regulation after they lose money, but imagine what would have happened in 2005 if the Fed intentionally and explicitly tried to lower housing prices and stocks.
I’m pretty sure that they next time we have a bubble (and there will be a next time), people will be screaming left and right if the government tries to take actions to force prices down.
Brad,
You say that “the BIS…..notes that not all countries can raise their savings simultaneously”. I do not see this in the conclusion of the report. And it would be incorrect - since globally savings must equal investment, every country in the world could save more if it invested more.
I would argue that the world does need to save and invest more, because it is ageing, but it is unlikely to be economically efficient for every country to try to invest more. It therefore makes sense for those countries with investment opportunities to invest more using the surplus savings from the rest. Since China is already investing 40% of GDP, it is already doing all it can. For various reasons, the country with the comparative advantage in investment opportunities is the USA. The USA should do its part by accepting the savings from the rest of the world and increasing its investment.
The problem is that the US pig-headedly refuses to do so, partly because it has been using the capital inflows to disguise the necessary fall in consumption that its relative economic decline requires (Judy’s point that the world cannot all consume like the US did), and partly because many of the investment opportunities are public or require government intervention, and the US does not do “big gubmint”.
Global imbalances are not the problem; the problem is the failure of the US to do its part in a more equal world.
PS - at least you are doing your bit by working on a public holiday!
Richman: The mercantilist countries have to let their currencies appreciate. They have to expand the credit and consumption of their own citizens instead of sterilizing their savings to buy foreign currencies. They have to dismantle their barriers to the victim countries’ products.
And if they don’t? To get the Chinese government to do something, you have to convince them that it is in the Chinese national interest to do so, and if you can’t convince them of that, it doesn’t get done.
The Chinese government really doesn’t care what its economic policies do to the United States just like the US really doesn’t care very much what it’s economic policies do to China.
Also squeezing China through trade negotiations might not work. Suppose China comes back and says that will keep tariffs, but allow foreign mining equipment companies to own factories in China. What then?
Finally, one can get a very distorted view of things if one takes one industry and then assumes that the restrictions in one particular industry are typical of all industries. I’ve noticed that you keep mentioning specific tariffs in specific industries, which misses the point that those tariffs are unusually high and aren’t typical of those that China has.
Twofish wrote:
Richman: The policy of the Peoples Bank of China has been to constrict lending by China’s banks to Chinese citizen
Twofish: No it hasn’t. Consumer lending is the fastest growing sector of Chinese bank lending. We had this discussion on another thread, when you challenged me to provide examples of Chinese banks lending to consumers, and I gave you several links where banks are looking for consumers to lend to, and also links to balance sheets that show that this lending is a large (and growing) part of the bank lending.
–> Check out Brad’s December 10, 2007, posting, “The Search for China’s Missing foreign assets”. There you will find the following statement:
“China recently increased the reserve ratio by a full percentage point.”
China has taken many other measures as well to decrease the availability of credit in China as part of their anti-inflation policy.
They really have two choices if they want to fight inflation: (1) decrease their loans to foreigners or (2) decrease the availability of their loans to their own people. They have chosen to decrease the availability of loans to their own people.
Howard
Richman: If the oil exporters were loosening their pegs to the dollar, Brad and I reason that their people, and others around the world, would be buy more US products.
I don’t think so. I think what would happen is that China would buy more domestic products so that exports would go down. What Chinese would buy are not US products but US assets, and this would cause some huge issues.
Twofish:
I agree with everything you wrote in posting #39. I have indeed been improperly isolating out specific industries. The Chinese tariffs on American goods are usually 25%, plus they have a 15% VAT duty, plus they have a 40% hidden duty caused by their currency being kept artificially low. Thus, almost all exports from the United States to China face the equivalent of an 80% duty.
If they decided to stop practicing mercantilism, they could move trade with the United States toward balance by gradually reducing these duties.
Howard
Richman: China has taken many other measures as well to decrease the availability of credit in China as part of their anti-inflation policy.
But these constrict lending overall. The statement you made implies that Chinese banks are set up along Japanese lines in which they give preferential credit to associated industrial companies (the kerisatsu system).
Also because the RMB is non-convertible Chinese banks can’t lend significant amounts of money outside of the PRC.
Richman: The Chinese tariffs on American goods are usually 25%
We can go into the trade schedules but the numbers for most goods are in the 2-10% range.
Richman: plus they have a 15% VAT duty
Which is irrelevant here since it applies to all products whether Chinese or non-Chinese.
Richman: plus they have a 40% hidden duty caused by their currency being kept artificially low.
At this point you are adding apples and oranges here.
Richman: If they decided to stop practicing mercantilism, they could move trade with the United States toward balance by gradually reducing these duties.
I think you are vastly overstating the amount of tariff. The VAT tax is not going to change since this is what China uses to finance its government. Changing the RMB rate is going to reduce the trade deficit, but I seriously doubt it will do it in ways that will increase employment and incomes in the US.
Richman: So what is needed for increased profitability in the US economy? Investment in American production, including energy and manufacturing production.
Increased corporate profitability is not necessarily a good thing for workers. One thing that a worker needs to remember they are liabilities. The more money goes to investors, the less money goes to workers.
Also, investment doesn’t lead to more employment. One thing that seems to be true in developed economies is that they more investment there is, the less the need for workers, and in particular the less the need for unskilled workers.
I think you are ignoring the real problems with the US economy. Globalization is generating huge amounts of wealth and lots of jobs. The trouble is that that wealth and those jobs require social capital and education. Wealth generation is not the problem. Wealth distribution is, and there is no particular reason to think that increased investment is going to result in more equitable wealth distribution in the United States.
There are a lot of tensions between different parts of the economic system. I distrust utopian economics, because people that present utopian visions of economics generally miss those tensions and tradeoffs.
In particular, there is this obsession with manufacturing that resembles the “physiocrats”. During the 19th century, there were lots of people who believed that all real wealth came from agriculture, and so it was a very bad thing that fewer and fewer people were working in agriculture.
The fact that fewer and fewer people in the US are working in manufacturing is precisely because US manufacturing is very efficient, and the more efficient you make manufacturing, the fewer workers you will need.
Twofish,
Thank you for that perspective. The point is that the technology to mine coal more safely is available and the capital to employ that technology too.
TwoFish,
You wrote: “Wealth generation is not the problem. Wealth distribution is, and there is no particular reason to think that increased investment is going to result in more equitable wealth distribution in the United States.”
Actually, the United States suffers from both problems: (1) a wealth generation problem and a wealth distribution problem. Both have been caused by the mercantilism of our trading partners. Let me explain:
1. Wealth Generation. Americans are consuming more than their incomes. This is largely a result of artificially low interest rates which in turn are due to mercantilist governments sending their countries’ savings to this country.
2. Wealth Distribution. Workers wages have been going down as well-paid manufacturing jobs get replaced by service sector jobs. The manufacturing jobs are lost because the growing economies of the world are practicing mercantilism in order to maximize their exports and increase their imports.
The reason why more investment helps both problems is because it generates present GDP, future GDP, and future better-paying jobs. Furthermore investment usually involves the development and instantiation of improved technologies.
Howard
whoops, instead of: “the growing economies of the world are practicing mercantilism in order to maximize their exports and increase their imports” I meant to write “the growing economies are practicing mercantilism: They are maximizing their exports and minimizing their imports.”
Howard Richman
http://www.trade-wars.blogspot.com
“Marco Polo — are gulf sovereign funds and Chinese state banks “private” money?” - Brad Setser
Kind of a blur, huh? Not sure. But it wouldn’t seem likely that their money be used like Chris Dodd and others would like to put a floor under other peoples’ losses. And if a bottom were found that capital would be around to recapitalize.
Richman says :
” This is true because the total income in a country is equal to the total product of the country. ”
By product I take that to mean GDP. But one must look at the components of product. It has come to the point where 20% of our GDP is waste , fraud and abuse causing dissavings.
We have a financial sector that in 2005 was 30% of GDP. Historically is has been well below 15%.
We have a health care sector that was 17% of GDP, despite 50 million unisured, whereas the other G7 nations average for health care for all of their population was 9%.
We have a military and security sector that was 10% of GDP whereas we spend as much as the rest of the world combined thereby wasting at least 5% of GDP.
Add it all up 15% waste in financials , 8% waste in health care , and 5% military and security and you get 28% of our GDP that is non productive vis a vis historical or comparative analyses.
Rebel — higher savings could finance more investment, though right now the odds of that are rather low. The section of the BIS report that I was referring to is found on p. 140 “unfortunately, everyone cannot save more simlutaneously, since one person’s spending is another person’s income.” The context of this discussion was focused on the US, but the point applies globally. And White discusses and discounts the possibility that higher levels of investment could offset a fall in savings.
Finally, I don’t think anyone can look at the current state of US housing finance (i.e. dominated by Agencies and the Home Loan Banks) and realistically conclude that the US doesn’t do big government. It clearly has no real aversion to big government financing of home purchases. An awful lot of global savings has been channeled into us housing finance b/c of the mechanisms the US has put in place over time to securitize and guarantee mortgages so that they can be held as a reserve asset.
Howard,
Re yr # 29: BIS is often called the “central” bank of central banks but that does not involve any authority over those CBs. The BIS is jointly owned by over 50 central banks who re also its only clients. It is hence very different from the IFIs (IMF etc) who have states as their members, have a far larger membership and financial resources for the execution of policy. BIS does commercial banking for its clients (for instance selling gold, placing eurodeposits with commercial banks, safekeeping, etc. A second, and much better known role is that it acts as a forum and intellectual resource for central bankers and financial supervisors (banking, securities, insurance) and facilitates a number of multinational committees aiming at the international standardization of (prudential) regulatory policy governing these industries, thus trying to prevent mercantilist tendencies within these industries, plus a “race to the bottom” that could undermine global financial stability. All of my comments were in reference to the second function.
It is interesting to read the IMF’s WEOs in conjunction with the BIS annual report. Partially the same topics, but very different focus. IMF macro things like growth, inflation, plight of developing economies etc. BIS report more micro-economic: institutional factors, financial stability as resulting from regulatory, rather than monetary policy, etc. Of course there are overlaps. I have not had the time yet to seee if there is strong disagreement between the two. One has to keep in mind that the IMF is far more “political” than the BIS.
TwoFish,
You keep misunderstanding my economic philosophy. I am not a proponent of manufacturing; I am a proponent of balanced trade. I am not a proponent of protectionism; I am a proponent of balanced trade. I’m even featured in the wikipedia entry for “balanced trade” ( http://en.wikipedia.org/wiki/Balanced_trade ).
If US trade were balanced because of US service exports or raw material exports, or agricultural exports, then I would not be at all concerned about manufacturing being out of balance. The fact is that US trade is out of balance because something is wrong with American manufacturing.
You were incorrect when you wrote: “The fact that fewer and fewer people in the US are working in manufacturing is precisely because US manufacturing is very efficient, and the more efficient you make manufacturing, the fewer workers you will need.” In fact, Japan and Canada have similar levels of technology in their factories as the United States, yet employment in manufacturing as a percentage of the US workforce is declining much faster than employment in manufacturing in Japan and Canada.
Howard
Rien,
Re yr #52, thank you for your information about BIS. I am really not faulting BIS for anything that they have done. They have been an invaluable source of current information. They are honest, current, and accurate in their reporting of what is happening in the world of international economics. I am not expecting them to do anything that they are not already doing. I am just faulting them for their failure to identify and verbally oppose modern mercantilism.
Howard
Michael McKinlay,
There is certainly much inefficiency within the American economy. However when calculating national income and national product, economists value products at the price that people pay for them. There is no efficiency judgment involved.
Howard
Twofish,
You wrote: “I think you are vastly overstating the amount of tariff. The VAT tax is not going to change since this is what China uses to finance its government. Changing the RMB rate is going to reduce the trade deficit, but I seriously doubt it will do it in ways that will increase employment and incomes in the US.”
Let’s apply your analysis to the sitution faced by Bucyrus. According to the commentary ( http://www.jsonline.com/story/index.aspx?id=741187 ) Bucyrus is one of America’s premier export-oriented heavy mining equipment manufacturers. With demand for raw materials escalating, China should be buying Bucyrus mining equipment, but instead they have placed a 40% tariff on Bucyrus equipment while they build three of their own factories to compete with Bucyrus.
This is an example of how China intentionally minimizes their imports from the United States. If they were to reverse that policy, Bucyrus would be expanding its production in the United States which would be providing high paying manufacturing jobs in Wisconsin which would be raising US manufacturing employment and income.
Howard
Brad,
Thanks for locating the quote from the BIS report. I can only assume that they are referring to financial saving, since it is a national accounting identity that saving equals investment.
As a toy practical example of what I mean, the US might put a tax on tequila, which could be expected to reduce liquor imports from Mexico, and spend the revenue on cement from Mexico instead to renew some highway bridges. The trade balance with Mexico would remain the same, but US investment would have risen at the expense of consumption, and the US would benefit from safer bridges in future years. I suspect that Americans would be less inclined to vote for such a tax and spend policy than, say Swedes.
Your GSE example shows that the Americans will accept state intervention in a crisis. And, if necessary, that is how they should deal with the rise of Asia.
2fish — german manufacturing is v. efficient, and it employs a higher fraction of the german labor force than us manufacturing. tis true that employment tends to fall in the sector of the economy with most rapid productivity growth (ag is a classic example; a man and a tractor can do more farming in a day than twenty men and horse drawn ploughs … ). But it is also the case that all other things being equal, the US manufacturing sector would be larger if the US traded its goods for the world’s goods and the world’s oil, rather than trading IOUs for goods and oil. as I noted in an earlier post, US exports to the emerging world are only a tiny bit higher — relative to GDP — than they were in 1980, while US imports from the emerging world are much higher. One implication of the US trade deficit is that the composition of US output shifted away from tradables toward nontradables, and as a result the composition of US employment changed.
Brad
Apologies for not responding earlier, thought everyone was on holiday.
Your view :Those savings by definition aren’t used at home — they have to be lent to the rest of the world. This isn’t a question of what one believes, it is a matter of accounting.
When you look at the savings identity equation (which I presume is what you’re referring to), there are 2 ways of looking at it, you could look at it as a cause -effect with savings as a driver or you could also isolate expenditure (an approximate substituite for consumption) as the driver.Just because you have easy credit available does not mean you are forced into greater consumption or debt, lower/easy credit terms do not cause nor necessitate the consumption or debt that requires the sourcing of cheap loans, whether as an individual or as a country. There is choice. If you choose to spend beyond Income/budget and run a deficit thereby necessitating loans, then there is a fundamental problem of accounting, youneed to balance your books, not continue ballooinig your spending and thereby get into greater debt and then blame your creditors when you find yourself in great debt. It’s not a matter of belief, it’s a matter of attitude to debt. Asimilar situation may be seen in the practice of “withdrawing equity” from one’s proprety equity (when prices were booming) and spending it. When the housing problems started and prices went into decline, that source of finance dried up and some who are used to spending a certain way could not re-adjust. Should these people be justified in blaming those who suggest such a source of finance? No one can force another into taking a loan they do not need. The spending and consequent debt rdives the quest for loan finance. Easy credit does not and should not drive expenditure, not unless one lacks a proper attitude towards debt and neglects the idea of repayment.
This is not a moral discussion or matter of belief, it’s pragmatism and looking at some simple equations in a more prudent way where expenditure should be after Income-savings. As I have pointed out in an earlier comment, the savings equation may not be applicable on a bigger scale where several different economies are involved (where equilibrium, if you believe ultimate equilibrium will prevail, exists in the long run) as versus in individual economies where the system is assumed to be in theoretical equilibrium (hence surpluses and deficits, it’s an accounting trick to balance everything as double -entry).
Hmm, as for IMF lectres on exchange flexibility, after the disastrous handling of the crisis, many asian nations seem to hear only what they deem is reasonable, what the limits are I’m not privy to.
Actually, this all sounds quite familiar - wasn’t there a similar discussion some months back?
Richman: The fact is that US trade is out of balance because something is wrong with American manufacturing.
And this is where I disagree. The US trade is out of balance because the US dollar is being used as the world’s reserve currency. This means that there is a constant demand for dollars which creates a trade imbalance.
Richman: Let’s apply your analysis to the sitution faced by Bucyrus.
Let’s not.
You are using Bucyrus as if the policies that the Chinese government uses toward mining equipment are typical of Chinese policies toward trade, when they are not. Whenever someone uses the same example over and over again, that brings up the question as to whether or not that example is a special case, and for mining equipment, it very clearly is.
The Chinese government considers minerals and mineral exploration a strategic resource which means that government restrictions in this area are far more severe than in other industrial sectors. One thing that is relevant here is that all Chinese minerals are owned by the state, and even within China, the government has been less willing to adopt liberal policies toward mining than in other sectors.
What would be more useful is to take about a dozen random sectors and then go through Chinese trade policy. American mining equipment manufacturers may be quite upset at Chinese policies, but American software companies and chip manufacturers are not.
bsetser: The US manufacturing sector would be larger if the US traded its goods for the world’s goods and the world’s oil, rather than trading IOUs for goods and oil.
And the US manufacturing sector would be smaller if the US traded services for the world’s goods and oil.
Maybe its because my background is with software companies that do large amounts of export business with China, but it’s not clear to me how increasing manufacturing is going to increase the general welfare of the United States.
Richman: Americans are consuming more than their incomes.
But still the United States is generating much more wealth than any other nation on the planet. The reason that Americans are not saving I think is largely cultural. There are many, many Indian, Chinese, Japanese, and Germans who know what an empty belly feels like, and there are not many Americans that have actually been face to face with starvation. Hence Americans tend to spend slightly more than their income, whereas people in most of the world tend to save a lot of their money.
Richman: Workers wages have been going down as well-paid manufacturing jobs get replaced by service sector jobs.
Median wages have been going down, but wages for the “working rich” have skyrocketed over the last decade. What has happened is that well-paid low-skill manufacturing jobs have disappeared, and low-skill service jobs don’t pay very well. High-skill service (expert doctors, lawyers, and computer programmers) jobs pay very, very well.
The problem with trying to fix this problem with more investment is that if you invest into a modern manufacturing plant, you are going to put lots of automation and technology, and this is an environment in which people without skills do not do very well.
So more investment in US manufacturing is just not going to help deal with income disparity, because the new automated high-tech plant that you build is going to need lots of engineers, project managers, and computer programmers, but not too many people that can do assembly line work.
Judy — I think you are still missing my point.
First, tho, I would note that debtors usually don’t default until their creditors cut them off — otherwise you can borrow to cover the interest and pile up your debts. In that sense it isn’t just a matter of the debtor’s attitude toward debt; the creditor gets a vote. and here my views were the same back when emerging markets were the ones running up debts; i always thought the creditors bore some responsibility for lending to high-risk debtors.
More on point, your analysis is what economists call partial. You argue that the debtor should just refuse to borrow even if creditors make available credit on easy terms — because debtors should take a moral view and not borrow more than they can pay (i would protest here that creditors should start to raise rates to discourage more borrowing if there are questions about repayment, but let’s set that aside). Fair enough. but if the debtor isn’t willing to borrow and the creditors are still saving the same amount, the world is out of equilibrium. The price of borrowing would have to fall to encourage someone else to borrow, or the fall in returns on savings needs to reduce the total supply of savings.
Let’s take a concrete example. suppose the US tightens fiscal policy, slowing the US economy (reducing import demand) and reducing US demand to borrow funds from the rest of the world.
Now let’s assume to make things interesting that the fall in US demand for the world’s exports (a reduction in the world’s income) is matched by a fall in consumption abroad, because the rest of the world has a high desired level of savings. the world is then out of equilibrium — US demand for the world’s savings has fallen, but the supply of available savings hasn’t fallen. There is excess supply of funds to borrow …
Something has to adjust. The US govenrment has to start borrowing more. Or US households need to borrow more. Or european households need to borrow more. Or the desired level of savings in the creditors has to fall, i.e. they don’t cut consumption even as their income falls, so savings would fall and exports would fall and everything balances out.
what i didn’t see in your analysis was any notion of how the world would adjust to a fall in US borrowing at prevailing global interest rates b/c of a change in US attitudes toward debt. There would be excess savings, and something else would need to adjust …
p.s. so long as the world accepts low returns on lending to the US and strong equity market returns on invetment outside the US push up the value of US external assets, the overall us investment position won’t deteriorate, so in some sense the US isn’t a bad credit. conversely if the world demanded say a 10% interest rate on its lending to the Us, the US debt dynamics would go bad really fast .. this isn’t quite as clear cut as is sometimes implied. sustainability hinges in part on creditor behavior — i.e. you can sustain a higher debt level if the int. rate on the debt is low.
Richman: I am a proponent of balanced trade.
You sure about that?
You can bring trade into balance by having the PRC adopt policies that reduce exports. This would have the effect of reducing the trade deficit. It would also likely reduce American jobs, since jobs that rely on imports would disappear whereas jobs that rely on exports would increase.
The PRC and the US had very balanced trade in 1965. I don’t think that too many people think that this is better than the current situation.
In any case, one important skill in politics is to figure out what people really want. It turns out that I don’t think many people really care about balanced trade per-se. Most people are interested in keeping their jobs and making more money.
It’s really important to know what people really want, since you need to watch your back sometimes. I have this strong suspicion that the management of Bucyrus would suddenly stop complaining about import tariffs if they were allowed to own mining equipment factories in China.
Twofish:
1. You argued that our trade deficits are necessary in order to fund international transactions. There are already plenty of dollars available outside of the US to fund international transactions without governments adding to them by building up their dollar reserves in order to steal our industries.
2. You argued that cultural factors explain why the US savings rate is near zero. But those factors don’t explain why the US savings rate has been falling. On the other hand, in Chapter 2 of our book we make a compelling case that falling interest rates and changes in the tax code have caused the fall in savings. It’s really obvious if you think about it. When credit is cheaper, people buy more on credit!
3. You argue that the US trade surplus in services compensates for the US trade deficit in goods. You are trying to say that the slow trickle leaving the United States compensates for the huge river coming in. For example, from 2006 to 2007 our trade surpluses in services with China grew from $3.6 to $5.0 billion while our trade deficit in goods grew from $229.4 to $251.6 billion
Howard
Twofish:
You wrote that Chinese policies toward mining are different than their policies toward other things. But we weren’t talking about mining, we were talking about mining equipment!
You wrote that I was using the example of Bucyrus too much. OK. There’s that great commentary about Bucyrus which says it all.
So, let’s take automobiles, instead. Economists who don’t understand mercantilism thought that with the Chinese market for automobiles growing, they would buy automobiles from the United States.
We now know better. Ford and GM even located automobile factories in China, but then China slapped a 25% or more duty on autoparts, later found to be illegal by the WTO, yet still in place.
So Ford and GM are seeing their stock prices plummet and may eventually go bankrupt, and there’s this growing Chinese market for automobiles that is totally out of reach of American companies.
You continued, “What would be more useful is to take about a dozen random sectors and then go through Chinese trade policy. American mining equipment manufacturers may be quite upset at Chinese policies, but American software companies and chip manufacturers are not.”
Not yet!
Howard
TwoFish,
One other thing, you were incorrect when you wrote that balancing trade would cause unemployment “since jobs that rely on imports would disappear whereas jobs that rely on exports would increase.”
Actually, balancing trade would increase American jobs because demand for American-made products would increase.
Howard
Sad to see these apologists for the failure of leadership here. The finger pointing at other countries and complex theories serve only to excuse the disastrous policies here.
US leadership (the Fed deserves the lion share of blame) has encouraged a consumption society at every turn. “Hold hands and buy an SUV” has been the Fed mindset. Nobody is prepared to tell consumers they have to save and compete. The culprit is clear, so please don’t muddy the waters with issues of other countries.
Bravo BIS. At least some sanity out there.
Could it just be that Stephen Roach and Roubini have an audience somewhere in Switzerland. The Davos crowd couldn’t get its hands off Roach this time around - although they kept him off the panels in the last two years!
So when will rates go up, like they were supposed to, 8 years ago?
Brad,
Your argument to Judy is what my grandmother would have called partial (as in the opposite of impartial). You usually attribute China’s reserve accumulation to its currency policy. Presumably, therefore, if a US fiscal policy tightening (which would not be a bad idea) reduced import demand, China’s dollar reserve accumulation, and its sale of sterilisation debt at home, would automatically fall.
I have a little sympathy with the view that cheap loans encourage irresponsible borrowing. But I dare say that US interest tax exemptions are worth more to the private sector borrower than the impact of reserves accumulation. Anyway, China has lent most of its money to the US government, not the US private sector. Are you saying that the US government cannot be a responsible borrower when offered low interest rates?
It would be interesting to hear mo