Brad Setser

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Too big to fail? Or too large to save? Thinking about the US one year into the subprime crisis

by Brad Setser
July 24, 2008

Emerging market financial crises in the 1990s followed a fairly consistent pattern.

The country lost access to external financing.

The sector of the economy that had a large need for financing – firms in Asia, the government elsewhere – had to dramatically reduce its need for financing. Asian investment collapsed. Argentina swung from a fiscal deficit to a fiscal surplus (helped along by its default on its external debt). Turkey began to run large primary surpluses.

Financial balance sheets shrank; credit dried up.

The country’s currency fell sharply. And its current account swung into balance, if not a surplus.

That process was incredibly painful. Falls in GDP of 5% or more were not unknown. It also meant that after a year or so, most emerging markets had reached bottom. Their economies had adjusted, as had their currencies.

A year – almost – after its crisis, the US economy hasn’t endured a similar period of adjustment. Economic activity has slumped, but not fallen off a cliff. US households are pinched (and unhappy), but spending hasn’t collapsed. The US current account deficit has fallen, but not by much – the rise in the oil deficit has offset the fall in the non-oil deficit. Banks have depleted their capital, but I don’t think that they have – in aggregate – shrank their balance sheets. Then again some of the expansion of their balance sheets may not have been entirely voluntary, as off-balance sheet assets and liabilities moved on to the formal balance sheet.

Residential investment has fallen significantly as a share of GDP.

But in other ways, the US hasn’t adjusted.

Or rather, US policy adjusted so that the economy didn’t have to adjust as much. And other key countries – notably the countries that finance the US – didn’t adjust the policies (notably dollar pegs) that effectively compel them to finance the US. Many key countries — notably China — have exchange rate regimes that seem to require that they provide more financing to the US when the dollar is under pressure.

The US went into its crisis with a large current account deficit. And – as the Levy Institute (see Figure 2 here, and more here) and others, including Martin Wolf, have documented – the external deficit corresponded with a large deficit among America’s households. Households didn’t save. They also invested in new homes. As a result, US households were net borrowers from the financial system — and ultimately from the rest of the world.

US firms weren’t all that exuberant in the run-up to the crisis. They weren’t investing all that much. PE firms were more exuberant, but their business strategy was based on gearing up existing cash flows to increase equity returns, not new investment. That is likely why the rise in business borrowing (see figure 3) late in the last cycle didn’t prompt a strong rise in business investment or overall growth.

The government was running a structural fiscal deficit. However, that doesn’t explain the persistence of the US current account deficit after 2004. From 2004 to 2006 the fiscal deficit shrank. In 2005 and 2006, the growing deficit of the household sector drove the expansion in the overall deficit.

The resulting overall external deficit was financed, at least in part, by the buildup of dollar reserves by the world’s central banks – not by a buildup of dollar-denominated financial assets among private investors abroad. Someone in London was buying US corporate bonds — a category that includes a wide range of asset-backed securities. But the crisis has revealed (I think) that much of that demand came from vehicles sponsored by US and European financial institutions that funded themselves by borrowing dollars. They took on credit risk, not currency risk.

A year or so later, and not all that much has changed.

The US household sector still runs a deficit. Household savings isn’t falling anymore, but it also hasn’t really increased. Rising oil bills have eaten into spending on other items, but overall spending is holding up. Residential investment is down. But the household sector as a whole still runs a deficit — though a somewhat smaller deficit than before.

However, the fiscal deficit has expanded. The government is borrowing, in a sense, to provide funds to cash-strapped households to support demand.

Mortgage lending hasn’t even collapsed. Demand for “private” mortgage-backed securities has disappeared. But the Agencies stepped in and bought mortgages both for their own book and for the mortgage-backed securities that they guaranteed. The Economist wrote last week:

“With the credit crunch, Fannie and Freddie have become more important than ever, financing some 80% of mortgages in January. So they will need to keep lending. Nor is their scope to offload their portfolio of mortgage-backed securities, given there are scarcely any buyers of such debt. And if the Fed has to worry about safeguarind Fannie and Freddie, can it afford to raise interest rates to combat inflation?”

The Economists thinks the Agencies’ financial weakness is a constraint on US monetary policy. The same might be said of the financial weakness of many private financial institutions. Even if US monetary policy isn’t constrained, there is little doubt that the Fed has stepped in to help the banks and broker dealers meet liquidity pressures without dumping their existing assets. A lack of confidence in “private” collateral that increased demand for treasuries in the US financial sector has been met by allowing a number of institutions to borrow the Fed’s Treasuries.

These steps avoided a super-sharp emerging-market style adjustment.

But a country that runs a large external deficit doesn’t need to just keep credit flowing inside its own economy so that existing “deficit” sectors can continue to run deficits – it also needs an ongoing flow of funds from the rest of the world. The US has gotten that, too.

Not thanks to private investors. Private demand for US debt has almost certainly dried up, though the limits of the TIC data make it hard to demonstrate this conclusively. The last survey concluded that all “private” demand for US Treasuries and Agencies came from financial intermediaries who sold their Treasuries and Agencies to central banks (there wasn’t an increase in private holdings from mid-2006 to mid-2007). If that is still true, central banks total purchases of US financial assets over the last 12 months are now running at close to $680 billion ($330 billion in recorded official inflows — counting short-term flows — and $350 billion in “private” purchases of Treasuries and Agencies). Private demand for US corporate bonds and equities, by contrast, has fallen sharply. Corporate bond purchases over the last 12ms were only $170 billion or so — down from an annual pace of over $500 billion a year before the crisis. Demand for US equities is also down ($65 billion in the most recent 12ms v $175 billion in the preceding 12ms)

And remember, some “private demand” comes from funds that are investing for sovereign wealth funds.

Why has so much credit been available to the US during its crisis, when similar credit wasn’t available to emerging markets facing trouble? My answer is simple: other countries didn’t adjust their macroeconomic policies even as the US adjusted its policies – lowering rates, loosening limits on the Agencies so that they could expand their books and adopting a counter-cyclical stimulus – and the interaction between the shift in US policy and limited policy changes abroad produced the flows the US needed.

Europe kept its rates up. It even raised them recently. That pushed the euro up – and helped the US export sector. It also put pressure on countries maintaining dollar pegs, whose currencies were depreciating against the euro and whose central banks faced pressure to lower rates.

The PBoC didn’t exactly follow the Fed, and the RMB didn’t exactly follow the dollar. But the RMB generally fell v the euro. And while China didn’t follow the Fed’s rate cuts, it kept rates more less unchanged as inflation rose, pushing real rates down. That supported investment in China even as higher rates than in the US led to a surge in capital inflows and reserves growth. The RMB’s depreciation against Europe — and the boom in resource exporting economies — kept China’s export growth up. Net exports contributed positively to China’s growth in q3 07, q4 07 and q1 08 (we still don’t know for q2 08).

No adjustment there.

The Gulf kept its peg to the dollar (or in Kuwait’s case, a dollar heavy –basket); Russia kept its euro-dollar peg. Both increased spending and government-sponsored investment as well. The combination of wildly negative real interest rates, a nominal depreciation and fiscal expansion generated an enormous boom. But with oil prices rising faster than spending and speculative pressure on dollar pegs, it also required a huge increase in the foreign assets of the oil-exporting economies government. The oil-exporters basic macro policy stance – dollar pegs, fiscal expansion when oil is high (and contraction when it is low), and monetary policy imported from the US – didn’t change.

The overall result was an increase in official asset growth — which has been running at close to $400 billion a quarter recently, or over two times the size of the US deficit. A tiny bit of that went into US and European financial institutions during the early stages of the crisis – at considerable cost to the sovereign funds that made the investment. But most has gone into safe US Treasuries and into Agencies.

Kevin Drum – rifting off Dr. Duy’s Magnus Opus – argues that the system will be stable so long as foreign investors continue to have “faith …. in America as a good place to invest their money.”

I don’t think that is right. The US hasn’t been a good place for foreign investors for some time, now: US rates haven’t compensated for the risk of dollar depreciation, and US equity markets generally have underperformed. That hasn’t kept foreign governments from buying. Their demand for dollars reflects their decision to manage their currencies against the dollar — not their assessment of the dollar’s attractiveness as a store of value. The worse the dollar does, the more foreign central banks tend to buy …

Foreign governments have been willing to take on the currency risk associated with financing the US. But foreign governments didn’t want the credit risk associated with lending to US households. The US government – and its intermediaries, notably the public-private Agencies – stepped in, helping the market to clear and avoiding a sharp contraction in global demand.

That, at least to me, explains in broad strokes how we got where we are.

The policy response to the subprime crisis has avoided the sharp adjustment that many feared. But it also meant that many of the underlying imbalances haven’t really corrected. The composition of the US current account deficit has changed – the oil deficit is bigger, the non-oil deficit is smaller; the fiscal deficit is bigger and aggregate deficit of households is smaller – but the aggregate deficit remains large.

And the rest of the world’s imbalances haven’t corrected either. China’s economy remains unbalanced. The oil surplus has gotten bigger.

Hence it is possible to argue — see Yves Smith — that risks are still increasing.

Or it is possible to argue that the existing system has demonstrated its resilience under stress, and there isn’t good reason to think it will break now if it survived the stresses of the last year.

So far, the US has been both “too big to fail” and “too big for the emerging world to save” without incurring real costs.

The costs of dollar pegs are more and more apparent. But the costs of letting go now – before private demand for US assets has materialized or the US deficit has shrunk to a level that could plausibly be financed by a modest pickup in private demand for US assets – are also high.

I have no clue how long an equilibrium based on not letting go can last. Policy makers have succeeded — even the absence of overt coordination — at avoiding the worst. That is a good thing. But I would be a bit more comfortable if a bit more adjustment had happened over the past year.


  • Posted by Rien Huizer


    My suggestions -impracticable, the Us would never be able to execute this- were not meant to be “good for the Chinese people” I have no idea of what is “good for” any people (though when I was young that used to interest me, but as I grew older I realized that this was just Greek philosopy nonsense) I was just thinking as a mechanic how to solve this structural imbalance in a way that is good for US politicians and might just keep the apparatchiks in Beijing in power (they must e aware (LKY must have told them a thousand times) social democracy would wreak havoc with their support base, even more than, say, Korean democracy (The Korean elite has learned how to live with and developed tactics for their variety very quickly). Hence, planting and nourishing it a bit (more or like the extremely successful “Human Rights” in the cold war) is an extremely cheap way of undermining your opponent. And a cause for NGOs that is both worthy and useful. And it makes the common folk at home feel good as well.They might even start to prefer a US economy that is a little more difficult for the current generation of predatory interests (defense, finance and healthcare) and pave the way, politically for different ones (low cost high impact defense, universal health insurance, aggressive consumer movement etc).
    Now, given the fact that the ex-Comrades are historically aware, they will immediately recognize this as a signal that the US is taking them seriously and no longer treating them as cartoon characters and what German marxists used to call “nuetzliche Idioten” (useful idiots), who toil day and night to keep US consumers happy and inflation low, all the while without getting paid.

    The carrot for the PRC leadership would be that the competition in their rear (I am convinced that the populists (not the reformers) believe in a zero sum world, it is the only world view consistent with populism (In One Country) is locked up. Of course somewhere along the line there will be cheating hence my happy world will not last more than a few decades, but, the threat of social democracy is a very powerful one. Pity the US is not organized to execute this. It could keep BW II alive, Japan stationary, educate peasant children in China and urban kids in Cleveland illiterate..

    Just to be absolutely clear, all of my comments here were merely to illustrate that the problem under discussion has no non-oddball solutions (and in return I learned that some people are serious and constructive even in the face of unavoidable disaster caused by human stupidity (prefer Sophocles to Plato any day, Twofish, no Hidden Dragons there, unfortunately). It could have ben avoided only three years ago, if Mr Greenspan and his buddies in the Treasury had ben a little more responsibe and stayed out of weird, expensive international contests. That would have delivered mr Kerry to the White House Hmmmm. But that is history.

  • Posted by Rien Huizer

    Just this little gem from n expert:

    And, not a word about Central Huijin. If this has a base in fact, then CH would be in the wrong place of course. If CIC is a bank holding company, it is not the ideal vehicle for international portfolio investment either. And if it is really an internationally oriented portfolio investor a la GIC, it is no better positioned for BHC-ship than the POBC. Let’s liberate Central Huijing!

  • Posted by gaius marius

    as to what might end foreign central bank credit to the united states — i see some here dismissing the possibility and others considering that it would take a crisis inside china.

    has anyone considered that it might simply be in china’s interest?

    it addresses both inflation and hot moeny problems. much is made of the forex losses china would assume — but the increased purchasing power of the yuan would likely offset these losses in diminished transfers for oil alone. the pain in the export sector would be considerable — but would also be a necessary change, as china is already no longer the low-cost producer for low-end exports. china is moving to more sophisticated exports where it has no natural competitor on volume and price (eg technology, cars) even at higher currency levels, reducing the pain of the change. and there’s also to consider the benefits of becoming a reserve/international transaction currency under a free float.

    we tend to think that the larry summers’ ‘financial balance of terror’ can’t be broken voluntarily, but i would submit that the stage is set for just that — if china’s leadership has the courage to make the move.

  • Posted by Rien Huizer

    Gaius Marius,

    Yes, It tends to cross one’s mind but it would be quite painful, not in line with China’s “transition” (the wrong term by now, it is taking forever). It is even harder to think through the posible scenarios for that than what would happen if “change” was postponed until say 2012, when a determined US should have been able to pss trough the downturn and get used to more difficult credit, lower house prices (say the equilibrium prices you will find in the most recent IMF WP, take your pick as to what kind) and a much tighter federal budget. By then the USD should be at about the current level of purchasing parity, after possibly have gone through a dip. A grat time to say BW II farewell, without too much damage to either partner. From then on, the US will be more of a normal country and China too. Not a bad prospect, but an unlikely one.

  • Posted by Twofish

    Huizer: (They must e aware (LKY must have told them a thousand times) social democracy would wreak havoc with their support base.

    What ultimately should keep the Chinese leadership in power are policies which improve the livelihood of the Chinese people. If the economic interests of the Chinese people are not in the economic interest of the Chinese leadership, then we need to think about changing the system so that they are….

    As far as what policies will increase Chinese prosperity, we just don’t know. Maybe social democracy is a good idea. Maybe it’s a horrible idea. Most likely it’s an idea that may be good or bad depending on the details. LKY is smart, but he could be wrong.

    Huizer: I am convinced that the populists (not the reformers) believe in a zero sum world, it is the only world view consistent with populism (In One Country) is locked up.

    I’m not. One has to be careful not to oversimplify what people believe. The populists are much more suspicious of the market than the technocrats, but no one I know thinks that market economies are fundamentally flawed.

  • Posted by Twofish

    Charles: in help to homeowners and builders, but CTJ thinks it’s structured such that it may not really help. In any event, it’s a few billion dollars for a trillion dollar problem.

    Keep in mind that it’s probably not in the political interests of people to make the real price tag apparent.

  • Posted by bsetser

    Michael McComack isn’t the only one to ignore Huijin/ the banks. Lou and Gao’s public comments to the effect that the CIC never takes controlling stakes are very similar. I also doubt that the world is going to be comfortable with even a pure portfolio managing CIC that reports to the state council if another entity under state control is aggressively supporting the outward expansion of China’s firms.

    Gaius Marius — I take the risk that China would redefine its interest as “not losing any more money on the US dollar” very seriously. There are some inside China who think the current policy isn’t in China’s interest. The data so far though suggests that they don’t drive policy; China right now seems likely to slow the pace of RMB appreciation.

    Rien –my (tentative) approach to China would be the opposite of yours, namely it would prioritize the exchange rate relative to other goals.

    This is because:

    a) the exchange rate defines China’s relationship with the rest of the world, and thus has more obvious spillovers than domestic policies (tho I concede the environment now has large spillovers)

    b) the exchange rate not only shapes China’s monetary policy, but increasingly its fiscal policy (now used to fight inflation in the absence of monetary policy, and in the process, push china’s savings up) and its bank policy (bank loans curbed, high reserve requirement, banks holding fx, etc)

    changing china’s exchange rate (gradually) isn’t obviously in the interest of all parts of the US economy — big swathes of the economy (and corp america) benefit from cheap imports/ cheap borrowing. others don’t.

    I do tho think adjustment is in the US interest. I wouldn’t frame this as “doing what is good for china” for the reasons 2fish articulates. I would frame it as doing what is necessary to be a good citizen in the existing global economic and financial system.

    big exporters historically haven’t intervened to China’s tune on a consistent way — either china changes, or the rules of the game have effectively changed.

    Moreover, 20% growth off a $1.5 trillion base isn’t possible. i am not sure sustained $250b export growth (pushing exports to $2.5 trillion at the end of 2012) is possible.

    And I am sure that sustained $500-1000b of government foreign asset growth will change the world — it implies a much higher level of state ownership of US industry than America has found comfortable, and if not US industry, then European industry.

    Those who talk of avoiding financial protectionism are I think doing China a disservice, as they may be giving China’s leadership hope that the sale of $2 trillion of US stock to China (or less — take your pick on China’s foreign asset growth on current trends, and the share that goes into “risk” assets now that China has more treasuries and agencies than it needs) is politically acceptable. My guess is that it isn’t, even if it goes mostly through third party intermediaries.

    Basically, China has to change if it wants to be an accepted part of the global economic system, as its current course isn’t consistent with global norms. If china believes that the world’s norms should change to accomodate its exchange rate regime andits desired buildup of foreign assets, it then needs to make the case.

  • Posted by Dave Chiang

    Unfortunately, Obama was on “Meet the Press” this morning, and he said he has brought Rubin and Sommers on as part of his his financial advisor team. These are the guys who gave us the repeal of the Glass Steagall Act and pushed derivatives. McCain has Phil “no whining” Graham, the author of the bill that repealed the Glass Steagall Act. “Clowns to left of me, jokers to the right, Here am I, stuck”.

  • Posted by Dave Chiang

    A mandatory weekly read.
    “A GSE Perspective”

    From Doug Noland

    “For some time I’ve viewed these institutions as the key linchpins for a historic Credit Bubble along the lines of John Law’s eighteenth-century Mississippi Bubble. The GSEs, with their implied government backing, forged a fundamental – and momentous – change in the nature of contemporary “money” and Credit. Their financial and economic impact has expanded exponentially since their initial foray into system liquidity backstop operations back with their 1994 bond market/hedge fund “bailout.” I am left to scoff at the CBO’s $25bn estimate for the likely eventual cost to the American taxpayer.

    When I read the various estimates of the GSEs’ additional capital requirements, I again reflect back to one of the great flaws in economic historical revisionism with respect to the Great Depression. Conventional (“revisionist”) thinking today has it that if the Fed had simply “printed” $5bn and replenished lost banking system capital in the early thirties, the worst effects of the depression would have been avoided. But then, as is the case today, the size of lost financial sector “capital” was not the critical issue. Instead, financial sector losses pale in comparison to the huge scope of additional Credit creation necessary to sustain deeply maladjusted financial and economic structures – and the impossibility of sustaining Credit Bubble excess in the face of escalating risk intermediation losses and resulting tightened financial conditions, sinking asset prices, acute financial system impairment, investor and speculator revulsion, de-leveraging, major changes from boom-time spending patterns and economic downturn.

    Treasury and the Fed could today easily “cut” Fannie and Freddie (and the FHLB!) a $20bn check or, ok, $50bn. Yet the reality of the situation is that GSE “Books of Business” must expand at least $600bn this year and then as much next year and the year after that… or very serious problems will unfold throughout the conventional mortgage marketplace. There are Minskian “Ponzi Finance” dynamics at work here, as there were in subprime, “private-label” MBS, CDO, auction-rate and other markets. Only the stakes of a conventional mortgage bust are much greater.

    Without the GSEs, there is no way Total U.S. Mortgage Debt would have doubled in the six years 2001-2006. Without the GSEs, it would have been impossible for broker/dealer assets to have ballooned from $455bn to begin 1995 to $3.10 TN to end 2007. And I believe very strongly that without the GSEs the leveraged speculating community would be but a fraction of its current unfathomable size.”

  • Posted by Simon

    This is an amazing dialogue!! A privilege to read.

  • Posted by Rien Huizer

    Brad, my advice to China would be the same if I were acting in what I would believe are their national interests. But national interests are subjective (and contingent upon many things) and trade can be cooperative or competitive. Many Asian countries (pick up any government sponsored work on Singapore’s economy and it is full of Michael Porter stuff). If China and the US cannot agree on something more balanced and if one or either party works against the market (even if in the opportunistic interests of politicians on both sides during the past four years (I guess most would agree that Chinese funding and low inflation/pressure on US wages were convenient for the current adminsitration, and export-generated employment for the Chinese) then it makes sense to find out what sorts of things could crate leverage in a low cost way when the consensus breaks down, as, I am sure it has meanwhile. The oddball idea of sowing social democracy was inspired by the brilliant use of human rights by the US in WWIII, something which the Chinese leadership will be keenly ware of. But, again, in economics terms, you are right of course.

  • Posted by Dave Chiang

    US Banking System Is Unsound

    From Mish Shedlock

    The US banking system is unsound. I presented the case in You Know The Banking System Is Unsound When….

    Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.

    What cannot be paid back will be defaulted on. If you did not know it before, you do now. The entire US banking system is insolvent.

  • Posted by Dave Chiang

    Latest from Bill Fleckenstein

    Of course, the fantasy has friends in high places — namely the Fed, the Treasury and Congress, which last week engineered a huge bailout for Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs), though Treasury Secretary Hank Paulson has tried to insist it won’t be needed. Never mind what this portends for our economy — Wall Street applauded legislation many of us find repugnant.

    The government’s efforts will not create a bottom for financial stocks because of the fundamental problem in this country: People carry too much debt against homes that are sinking in value, homes they really couldn’t afford in the first place and homes that have become all the more burdensome due to the inflation that’s ravaging their paychecks. That the implosion of the housing debt bubble is dragging the economy down with it will just put additional pressure on jobs and the ability to service housing debt.

    Exhibit A: American Express (AXP, news, msgs). In last week’s earnings release, the company noted that it has now been hurt by the weak economy. AmEx described the weakness as much worse this quarter than it had been in January and said it expects that trend to intensify.

    AmEx noted that even some of its “superprime” card members are feeling the effects of the weak economy. Of course, if AmEx’s customers are having problems, you can be sure that virtually every credit card company is seeing its consumers struggling to pay their bills — despite help from government rebate checks.

    The Fed’s money-printing apparatus has been checkmated by roaring inflation. None of Paulson’s cockamamie schemes, from super SIVs to bailing out Fannie and Freddie (after Bennie and the boys at the Fed bailed out Bear Stearns), will help the economy. Yet we must continually endure the cheering by stock market operators every time this country, the supposed bastion of free enterprise, “successfully” takes another step in its move to nationalize all losses that are inconvenient to those in power. As Jim Grant questioned in a brilliant Wall Street Journal article July 19, “Why no outrage?”

    That is a truly disturbing prospect because the same incompetence and greed that brought us this mess will lead to further troubles if the cabal that surrounds Fannie and Freddie gets more powerful, which appears to be the case from the legislation just foisted on U.S. taxpayers.

    To Paulson, one of the cabal’s powerful members, who last week described the legislation as sending “a very strong message to the markets,” here is my interpretation of that message:

    Yeah, we’re willing to do anything to keep the status quo, as rotten as it is, because reform is too painful to contemplate.

  • Posted by Olkon

    Russia cuts exposure to US mortgage lenders –
    28 July 2008
    Provided by: Reuters News

    MOSCOW, July 28 (Reuters) – Russia has approximately halved to less than $50 billion its exposure to U.S. mortgage lenders Fannie Mae and Freddie Mac , a senior central bank official told Reuters on Monday. “It’s now less than $50 billion,” central bank first deputy chairman Alexei Ulyukayev said, when asked about Russia’s investments in the agencies.
    Russia held about $100 billion at the start of 2008. (Reporting by Yelena Fabrichnaya, writing by Robin Paxton)

  • Posted by Andy

    Great article and I just wrote about my views on the recent housing bill. Your points just conifrm why the housing relief bill will fail. The government again is trying to spend us out of an economic crisis because we and our institutions are too big to fail. The bill is unlikely to work and only add to our national debt and the continued devaluation of the US dollar. Only time and a cleansing of the economic system will resolve the current mess.
    We talk about consumers getting out of debt, what about the government who seems to love debt more than anyone else.

  • Posted by RealThink

    In comment #5 above, I argued that the key point was: “What should the US do with the external financing while it lasts?”, and that the best path for the US would be to let mortgage financing dry up and homebuilding in its current form come to a screeching halt, and employ its labor and (ever more scarce) physical resources in a massive wind farm construction plan like Al Gore proposed recently.

    A recent post from Dave Cohen, one of the sharpest Hubbert’s Peak-aware analysts greatly strengthens this case.

    Dave points out that today a wind farm construction plan of that scale is simply unfeasible because of PHYSICAL constraints, those of steel production being the foremost.

    Which adds further support to the case for bringing suburban McMansion construction to a screeching halt. Like in WWII, when residential construction and car production were stopped to direct all resources to the war effort. Sure enough, 100% of electricity from renewables is unfeasible, but the higher percentage that can be achieved, the better.

  • Posted by bsetser

    interesting article re: Russia — thanks for bringing it to my attention.

  • Posted by Twofish

    bsetser: Basically, China has to change if it wants to be an accepted part of the global economic system, as its current course isn’t consistent with global norms.

    At this point China has enough financial leverage to play a part in setting global norms.

    bsetser: If china believes that the world’s norms should change to accomodate its exchange rate regime andits desired buildup of foreign assets, it then needs to make the case.

    Make the case to whom? As long as the rest of the world accommodates Chinese behavior that the defacto global norm is that what China is doing is OK.

  • Posted by RebelEconomist


    I agree (for my version of the argument see It’s not how big your current account deficit is, it’s how you use it!

  • Posted by david_in_ct

    windpower is unnecessary and peak oil is actually going to be peak oil demand because prices have let in vast amounts of competition. 20 years from now oil is going to be worth a very small premium to the lifting cost of the cheapest wells.

    Gasoline Car Math:

    Current US Car fleet is about 250 million vehicles about 60% passenger cars and 40% light trucks, SUV etc.

    Fleet fuel mileage is about 20MPG

    Total Vehicle Miles Traveled per year ballpark 2.8 trillion (The gov published vehicle miles traveled for trucks buses and car and this is around 3 trillion per year so I knocked off some to get to cars)

    Total gasoline 390 million gallons per day. (per EIA rounded up actual is less now)

    At 20 MPG 7.8 billion miles per day or 365 * 7.8 = 2,847 billion miles per year which is around the estimates from the DOT vehicle miles per year.

    GM volt math:
    The first 40 miles of driving per charge is on the battery so no gas.
    It takes 8KWH of electric to fuel the battery to this level. (the Imiev claims a distance of 100 miles from the same charge but is a much smaller and less powerful car and perhaps not big enough so will stick with the more conservative GM claim)

    Operating Cost Comparisons:
    Current cost at 20MPG and $4 gasoline is 20 cents per mile.
    At 10 cents per KWH (average US retail price) 40 miles is 80 cents or 2 cents per mile.

    Energy Efficiency:

    1 KWH (kilowatt hour) = 3.6 MJ (mega joules)
    .2 KWH = .72 MJ = 1 mile traveled in Volt
    1 Gallon Gasoline = 132 MJ per gallon
    6.6 MJ per mile in gas car
    6.6 / .72 ~ 9 times more efficient energy use in Volt than average car

    Electrical energy needed to replace 100% of vehicle miles assuming all electric:

    7.8 billion miles per day * .2 KWH / mile = 1.56 billion KWH per day

    1GW Power plant produces 1 million KWH per hour or 24 million KWH per day. Put in some down time and you get maybe 20 million KWH per day. Leaving out peak effects it would required about 80 1GW Power Plants to provide enough electrical energy to fuel the entire car fleet assuming it ran on battery power.

    Power Plant Costs:
    AP1000 (Westinghouse) $1.4 per watt to build (ex regulatory madness) So ballpark $100 billion dollars (few months in Iraq so a no brainer)
    Average US operating Costs per nuclear KWH is 2 cents. Of the 2 cents .5 cents is fuel with .2 of the .5 cents being actual uranium cost.

    So the math is pretty straight forward.
    If you electrify the US car fleet you cut oil consumption nearly in half.

    If you simply replace existing cars at the new car run rate it would take about 8 years to replace half the fleet though in reality newer cars are driven disproportionately more to older cars so you would probably replace significantly more than half the gas usage if you replaced half the fleet.

    There is very little that actually needs to be done to get this going. The battery technology exists and will only get better. The power generating side also existing and it too is getting better (Westinghouse has announced plans for a 1.7 GW version of the AP1000)

    The only real impediments to this process are political. If this was outlined clearly to the American people I believe it would take on a life of its own especially if the car production was moved onshore. If I was running someones political campaign this would be my sole platform. If we cut our oil imports by 9 million BPD over the next 10 years a lot of our foreign policy will take care of itself.

    BTW, taken to conclusion around the world this will also end greenhouse gas emission and the whole global warming problem.

  • Posted by Judy Yeo

    Apologies in advance, pooped over for a quick visit and could only read the post and not most of the comments, any repetition of points already made is unintentional.


    Could the preferred mode of action be protection of the status quo; stasis based on not rocking the boat so no one has to face the possibility of getting wet?

    As for the question of why the USA got the help which the emerging markets didn’t – let’s think about it; invrestors pulling out of the emerging markets kaputt could invest elsewhere considering the relative damage of a domino effect was relatively small compared to the tidal wave the world faces shopuld the USA go belly up- bit like Ahab watching Moby. Schadenfreud takes second place to prsactical concerns, crash and burn is bad for everyone.

    Make the case to whom? As long as the rest of the world accommodates Chinese behavior that the defacto global norm is that what China is doing is OK.

    Hmm, the moral of the story could well be – don’t annoy the creditor?


    aah, but deficits are a troublesome thing. The problem is that to finance a deficit you have to find a fool with deep pockets but fools are a dying breed. This means that when you find a fool, you are effectively “locked in”, much like microsoft software (sorry, that was hard to resist!) – to maintain that source of finance, you can’t use that $ in ways that will effectively hijack your creditor’s existing investment- not being able to save your creditor’s investment asset is very different from deliberately sabotaging them.