Brad Setser

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A new reason to be bullish on America: It is (almost) Sweden

by Brad Setser
September 30, 2008

A Merrill Lynch strategist seems to have come up with a new reason to buy stocks: The US isn’t far from adopting the “Swedish” approach to managing a financial crisis – and that didn’t turn out to be bad for the Swedish market. Forbes reports:

“The failure of TARP legislation worsens the short-term credit situation. But in so doing it increases the likelihood of a Swedish-style recapitalisation of the banking sector in the U.S,’ says Merrill Lynch emerging equities strategist Michael Hartnett. The Swedish government in Sept 1992 decided to guarantee the whole banking system and transfer bad debt to state ownership. ‘This chemotherapeutic event marked the beginning of a multi-year bull market in Swedish equities,’ Hartnett says.”

This crisis has produced a lot of surprises.

I never thought I would see the Wall Street that pitched privatization as the solution to most of the emerging world’s problems in the 1990s enthusiastically welcome (partial) state ownership through sovereign wealth funds. That though may have reflected my own naivete. Fees talk; many large fund managers have been close to the big sovereign funds for some time.

I never thought David Brooks would channel Dani Rodrik and warn of the danger of too much capital sloshing around – and imply that financial liberalization had gone too far. That concern presumably extends to too much Chinese central bank money sloshing around; China after all was the ultimate source of a lot of the money sloshing through the US housing market.

But you really know there is a true crisis when parts of the Street are arguing in favor of the (temporary) nationalization of the financial sector.

Who knows, if this continues the Street may soon be arguing for taxing carried interest as income and suggesting that the US might be able to reduce the cost of health care by looking closely at the French model …

On second thought, probably not. That is a bridge (or two) too far.


  • Posted by Dave C.

    “That concern presumably extends to too much Chinese central bank money sloshing around; China after all was the ultimate source of a lot of the money sloshing through the US housing market.” – Brad Setser

    Oh please Brad, your spurious argument doesn’t hold any water. If the Chinese were responsible for the global credit bubble, why hasn’t there been a similar subprime fiasco in China’s real estate market? So why are China’s banks the healthiest in the world? Someone should inform Hank Paulson that perhaps the US Treasury should be looking to the Chinese financial model of a well capitalized banking system.

    So are China’s banks at risk of contagion? China’s banking sector is “one of the healthiest in the world,” says Jing Ulrich, Chairman of China Equities at JP Morgan. Chinese banks are awash with liquidity, sitting on bank deposits from thrifty savers totaling $7 trillion. Banking analysts were not alarmed that China’s two biggest retail banks had $280 million worth of exposure to bankrupt Lehman Brothers. Nor is there much sign of the domestic mortgage market triggering an identical, system-wide collapse. Although home ownership levels are as high as 80 percent in some cities—a sign of China’s passion for property—many homebuyers pay cash. Ulrich says mortgage-holders seldom buy beyond their means, so a wave of defaults is unlikely, even in a slowing economy.

  • Posted by Dave C.

    Brad Setser,

    Please cease and desist from scapegoating the Chinese for the US mortgage banking fiasco. The US Federal Reserve should be held accountable for gross mismanagement of America’s monetary policy. Let’s set the record straight. Incurring a loss of $9.7 billion on AAA-rated subprime bonds, the state-owned Bank of China was the victim of shady business practices of Wall Street investment banks.

  • Posted by otto

    A “chemotherapeutic event”?

    My stars, you can tell when they majored in the sciences and not the arts, can’t you? 🙂

  • Posted by bsetser


    “Oh please Brad, your spurious argument doesn’t hold any water. If the Chinese were responsible for the global credit bubble, why hasn’t there been a similar subprime fiasco in China’s real estate market?”

    hmmm. Maybe because China was channeling a lot of its savings into US agency and treasury bonds, freeing up a lot of private US money to flow into housing.

    China now runs a $400 billion current account surplus despite attracting large net private capital inflows (including $100-200b of FDI, though that may include some disguised hot money flows). that necessarily implies an offsetting deficit elsewhere in the global economy. it sure isn’t found in the oil exporters. Recently it has largely been found in the US household sector. In that sense, I do hold China responsible — absent Chinese financing, the financing demands of the housing boom would have pushed up us rates, choking off home price appreciation before it went “critical.” The whole concept of imbalances implies that the surplus countries bear some responsibility too — the creditor always does.

    And to be clear, i always thought that private creditors were partially responsible for the emerging market crises of the 90s. The bad policies the creditors decried after the fact were financed by said creditors for a long time.

  • Posted by algernon

    Sweden, on the other hand, is contemplating lowering its corporate tax rate to 1/3 of the US rate, having noted that their tax system hasn’t encouraged entrepreneurship: The Swedes observe that most of their big companies were founded before WWI.

    Brad, you are on mighty firm ground in attributing some of US housing malinvestment to PBoC buying enormous amounts of US debt & thereby deperssing long-term interest rates. I would quibble with your expression “China was channeling a lot of its savings into US agency and treasury bonds” in that you’ve stated that about half of Chinese purchases of US debt are done with unsterilized, freshly created Yuan.

    Permit me further to assert that China will pay a price in the future–in addition to its 7% inflation rate–for the distortions its policies have produced. Especially that the structure of its production is geared to supply the unsustainable demand of the US & Europe.

    Anticipating DC, the policies of the US are also culpable.

  • Posted by Twofish

    Part of the is that the people that pushed privatization as the
    solution to most of the world’s problems got wiped out when it
    all went bad. Wall Street is extremely Darwinian, and the every
    few years, people end up economically destroying themselves,
    which wouldn’t be bad, except that they tend to take the rest of
    the world with them. The people that were move vehementally
    anti-regulation and anti-government oversight have

    It depends on which part of the Street. For the most part the
    big investment banks are staffed by people whose political
    leanings are “Rubin Democrat” or “Rockefeller Republican.” One
    thing that this episode has illustrated is how huge the
    disconnect is between Wall Street and the conservative wing of
    the Republican Party. There are large numbers of people on Wall
    Street that think that should be taxed more to pay for universal
    healthcare, and Obama’s plan of soaking the rich and giving the
    middle class a tax cut makes sense to a lot of people on Wall

    If it was more obvious to Main Street that a lot of people on
    Wall Street are in favor of things like high taxes on the
    wealthy, universal health care, more money for education, and if
    people saw more charitable giving, then when things go bad, there
    the Street would certainly have more moral authority that it

    What’s really frustrating is that all of the “me-me-me cowboys”
    have self-destructed leaving the rest of us trying to clean up
    their mess while at the same time getting blamed for it.

  • Posted by Joe


    If the Chinese had converted their surplus dollars to another currency and invested somewhere else, those dollars would have still found their way back to the US. The dollars would still exist even if they were transferred to a third party. The source of the dollars is the Fed; you can’t blame the Chinese for our monetary policy mistakes.

  • Posted by bsetser

    Joe — I was using money in a loose sense to mean funds sloshing around, not high-powered money created by the Fed. It is true that only the Fed creates dollars cash. At the same time, China’s current account surplus meant China was supply a lot of financing to US — and if had adopted a different policy, it might have used its export growth to pay for more imports, not to buy more US financial assets.

    The problem i have with the “it was all loose US monetary policy” argument is that long-term rates didn’t rise when the fed raised short-term rates. I do attribute that to the enormous growth in central bank reserves, and associated demand for US bonds. Moreover, the inverted yield curve induced a lot of (silly) risk taking by US investors, who took on more risk to keep profits up. i fault regulators for not reigning this in.

    All that said, one normally would expect a boom in household borrowing in a low savings economy to put upward pressure on rates. That didn’t happen — and as a result the boom went on for longer than it should have. If someone has an explanation other than the growth in reserves and thus financing from China and the oil exporters, I am all ears.

  • Posted by Peter Schaeffer

    Mr. Setser,

    There is one more aspect of the Swedish solution that isn’t well known at all. After Sweden’s financial sector crashed and was recapitalized with public funds, Sweden’s economy rebounded strongly.

    However, Sweden also left the EMU and devalued its currency by 30%. The fall of the Krona made Sweden highly competitive in world trade. Exports rose strongly boosting the national economy.

    Can the U.S. follow the same path? We did devalue in the 1980s via the Plaza and Louve accords. However, that was before BWII. At this point the U.S. is locked into fixed exchange rates (de facto) with many of our leading trading partners. We don’t have the exchange rate flexibility that Sweden had back then (and still does).

    Even worse, there is a serious risk that our creditors might make fixed exchange rates a condition of continued financing of the U.S. This could make U.S. recovery very difficult.

  • Posted by Tamas David-Barrett

    Although the call for socialism on the global markets might come across as daft in its plain form, you could argue that the Scandinavian (or European, if you like) model of heavier government involvement ensures the presence of a useful buffer now. However, arguably, Europe will not be able to use the opportunities this might bring.

  • Posted by charles monneron

    A little detail : US economy is around 30 times bigger and its consumption lifted the boat in the eighties.

    Too big to be swedish (at least successfully) I am afraid…

  • Posted by Murph


    Yes, the Chinese, being the lender, bear equal responsibility with the borrower, (the US)… however –

    Given the National Savings Identity,

    [Fiscal Deficit] = [Savings less Investment] plus [Current Account Deficit]

    Where the Current Account Deficit comes back to the save-haven US economy in the form of Capital flows…

    Wouldn’t the ultimate causes of the imbalance be:

    (a) the US Fiscal Deficit, and
    (b) the negligible US Savings Rate ?

    And, given the Chinese surplus of funds, their options are limited.

    China’s allocation of US holdings, (from March 2008), was:

    91% US Gov’t & Agency debt
    3% US Equities
    3% US Corporate Debt
    2% US Short-term Debt

    This is very different than the US holdings of the Rest of the World (World ex-China):

    27% US Gov’t & Agency debt
    35% US Equities
    31% US Corporate debt
    7% US Short-term debt

    Culture may explain the genesis of this risk-averse allocation, but changing the mix is difficult for more than cultural reasons –

    Were the Chinese to reallocate to the world-norm, this would mean a $600+ Billion acquisition of US Equities. The xenophobic reactions generated by their investement of only $5 Billion into Morgan Stanley last December illustrate the difficulties here.

    What else might China do with their surplus ?

    – Invest in other-than-US (European?) Government debt ? Given the economic importance of exports to the US, sending the dollars back to US Consumers is logical…

    – Infrastructure ? Difficult in an already overheating economy…

    – Military Adventurism ? While a historic favorite for nations sitting on excess wealth, this is probably not the first choice of options from the perspective of the US…

    China has to do SOMETHING with all those funds – so, yes, while China is ‘responsible’ in the sense that lending and borrowing is a two-way street, it would seem that the issue begins with the US’s poor Fiscal discipline and meager savings rate.

  • Posted by Twofish

    The other thing that China could do with the surplus of funds is just hold it in reserve. One of the root causes of the current crisis is the philosophy that if you have any surplus money at all, that you should spend it, and that just having money just sitting there is inefficient.

    The problem is that if you have a crisis and no reserves, you are in deep, deep trouble. Most of the emerging markets found that out in the 1990’s, and the US is finding that out now.

  • Posted by Twofish

    Rather than attribute things to “culture”, it makes more sense for me to attribute things to “experience.” During the 1990’s, the Chinese banks were completely insolvent, but you didn’t have a crisis because the banks were full of cash. If you have cash, then you have several years to figure out what to do. If you don’t, then you have several days.

    One example of this spend, spend, spend attitude comes when people talk about the money used to recapitalize the banks, and the first topic of conversation is “well if we have this money then we should spend it on other things.”

    The other reason to be optimistic about the American economy is that from 2000 to 2008, you saw a huge amount of wealth being generated. The trouble with that was that the beneficiaries of that wealth were overwhelming in the top 5% of the US population, and a lot of the backlash against the economic rescue package is because there is a feeling “well you rich guys cheated us ouot of things when times were good, you all are just doing it again.”

  • Posted by Twofish

    Murph: China has to do SOMETHING with all those funds

    No it doesn’t. It can keep it in a bank vault and save it for a rainy day. Just let the money sit there until something bad happens and then pull it out then, and the fact that you can go into a vault and pull out bars of gold or treasury bonds if you need to, means that it’s less likely that something bad will happen.

  • Posted by Twofish

    algernon: Permit me further to assert that China will pay a price in the future–in addition to its 7% inflation rate–for the distortions its policies have produced. Especially that the structure of its production is geared to supply the unsustainable demand of the US & Europe

    It’s not. Most Chinese production comes from internal investment, and if there is a drop off in foreign demand, China is in a good position to use Keynesian stimulus to make up for the shortfall.

    China has made some radically different decisions on its economy than the United States would have if it had been running the Chinese economy. However, it may will be that China was right and the American experts that were telling China to do something different were wrong.

    This points out the really critical thing about what is going on in Washington right now. No foreign country is going to take the advice of the United States on any economic issue for the next decade. If we run into the situation in which Congress can’t come up with any sensible plan for dealing with this crisis, and the US economy falls apart, then no one is going to take anything that the US says about politics and law seriously either. If people don’t come up with some way of dealing with this crisis, then the next time anyone in the US talks about “human rights”, “democracy” and “free elections” then people in the rest of the world are just going to laugh.

  • Posted by bsetser

    Peter Schaeffer — interesting point about Sweden’s devaluation. Charles — true that the United States size changes the game, but we still can learn a thing or two from the rest of the world.

    2Fish — putting the money in a bank vault (or holding dollars under the mattress) still provides financing for the US — though obviously it would have less effect on us financial markets if China held $ cash than if it held dollar-denominated financial assets.

    Murph –a low savings rate usually combines with a big fiscal deficit to put upward pressure on long-term interest rates and thus to push home prices DOWN. the core issue here has always been why that didn’t happen in the US, and why the housing boom — in the context of ongoing low US savings — didn’t put pressure on rates that would have nipped the boom in the beginning. The fact that China bought so many treasuries and agencies is central to my understanding of why this didn’t happen.

  • Posted by adiemuso

    greed is good, but greed kills

  • Posted by adiemuso

    tried posting earlier but it seems that my posts were not in. so please bear with me.

    anyway, i have to disagreee with Brad on this.

    If the Chinese or the rest of the world were to be blame for buying the US Tbonds, notes, bills and agencies and hence keeping long term rats low and sending the yield curve into inversion, the US banking and financial sector should be held liable for the mass creation and marketing of the toxic subprime financial deriavatives.

    Apparently, the Central Banks and SWFs are more than happy with their buy and hold strategies of AAA US Treasuries, contented with the relatively low risk, low coupon, low yield and holding them to or near maturities.

    HOwever, much cannot be said of the innovative and aggressive financial wizards who had invented relatively high yield, high coupon, high risk, low probability through some arcane financial engineering alchemy. Waste was turned into Gold and sold to the masses.

    And, if there are any excellent statistics available on the US housing market, perhaps a breakdown of the nationalities of the subprime houseowners should suffice in proving that the subprime saga had arisen from the US within.

    Im glad that Brad sees that the acute lack of timeliness and aptness of regulations from the relevant bodies were an integral part to this mess.

    On the other hand, Im quite taken aback that the fact and notion that the financial markets (in this case the bonds and interest rates) are based on and operate on the noble philosophy of laissez faire are conveniently sidesteped when the time for finger pointing comes.

    It is quite evident, that the market has no interest in correcting the inversion of the yield curve then. A multitude and plentitude of commercial and economic reasons can be found and argued. Simply put, it was much more and relatively easier to make money than to correct the inverted yield curve.

    Lastly, they say Greed is good, but they forgot that Greed Kills.

    Apparently, the fact that we need a USD 700 Billion bailout now says it all. Im not arguing against the need of it. However, through financial and budget prudency, the US, in all likelihood, might not have walked down this slippery road.

  • Posted by adiemuso

    And, like Thomas Frieman has mentioned in his article on the NY times.

    It is lamentable that the current bust might be leaving US with nothing but a notorious legacy and heap of worthless financial engineering of derivatives bearing arcane yet amusing names with nothing but letter.

    For sake of those, let me cut n paste quoting Friedman,

    “Many things make me weep about the current economic crisis, but none more than this brief economic history: In the 19th century, America had a railroad boom, bubble and bust. Some people made money; many lost money. But even when that bubble burst, it left America with an infrastructure of railroads that made transcontinental travel and shipping dramatically easier and cheaper.

    The late 20th century saw an Internet boom, bubble and bust. Some people made money; many people lost money, but that dot-com bubble left us with an Internet highway system that helped Microsoft, I.B.M. and Google to spearhead the I.T. revolution.

    The early 21st century saw a boom, bubble and now a bust around financial services. But I fear all it will leave behind are a bunch of empty Florida condos that never should have been built, used private jets that the wealthy can no longer afford and dead derivative contracts that no one can understand.

    Worse, we borrowed the money for this bubble from China, and now we have to pay it back — with interest and without any lasting benefit.”

    I truly worry for US should the game of finger pointing continues without the urgency to embark on the imperious and expedient task of self soul searching.

  • Posted by free lunch

    1994 China devaluation
    2002-3? Japanese Quantitative Easing and its withdrawal

  • Posted by Matt Norman

    Is Hartnett serious about a bank holiday? Is that simply to prevent runs on uninsured deposits?

  • Posted by RealThink


    “What else might China do with their surplus ?”

    That very good question shows that the real problem is the very existence of a long-running big trade surplus, and that the solution is to end it by sharply revaluating the RMB.

    IIRC that view has been proposed by Brad (and Roubini?) for quite a long time now, and it has recently been advocated in China too.

    “The U.S. financial crisis had taught China a lesson and that was: “Why are we piling up these IOUs if they may default?” China’s economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu.

    “Our export-growth strategy has run its natural course,” he said. “We should change course.”

    China should stop intervening in the foreign currency markets and thus allow rapid appreciation of the yuan, he said. While this would cause pain for exporters, China could ease the transition by using its strong fiscal position to aid those who lose their jobs. It also should stimulate domestic demand to offset lower income from overseas sales.

    Without yuan appreciation, China will continue to accumulate foreign reserves, which means further accumulating “IOUs from the U.S.,” said Yu. “This is paper and it may default and it will not increase China’s national welfare.”

    If China doesn’t allow the yuan to appreciate and continues to promote export-led growth it will lead to confrontation with the U.S. and Europe, Yu said.”

    (I add that accumulating IOUs from the EU or from Japan does not make much more sense than accumulating IOUs from the US. In any case, there was a currency (or two) used some time ago which is not an IOU from anyone, a point that Benn Steil mentioned in his recent papers.)

  • Posted by Paul Boshears

    bsetser: thanks for reading, and I apologize for my tone in commenting – I’ve not really expected anyone to read this but myself and possibly family, and so I will strive in the future to be less caustic. Many thanks, also, for not only reading but commenting. Not many are willing to both read and discuss.

    If we blame China for freeing up money for Americans to then go and buy mortgages and invest in Ponze Schemes (as they were told to by those in positions of influence and authority), then we have to blame gun makers for all the people killed by their products.

    The interest rates were kept artificially low because those who could have adjusted the rates (Greenspan, et al.) chose not to raise them. Full stop.

    Why did they decide to maintain these interest rates?

    Because America seems to have a terminal lack of vision at its executive levels, and I am afraid it will continue to be a myopic nation for years to come.

    Because they are invested in the United States playing the same kind of brinkmanship game learned during the Cold War’s Arms Race but now played openly in the economy over the past 15 years. If America goes down, everyone goes down.

    We cannot find fault with China for investing in the U.S. during this time because the U.S. has been very keen to bring China closer to the United States – the U.S. wants China invested in America.

    Having China invest in the United States has been a great first step in the reciprocity that is needed between the two if the world as we know it is to continue in the way we know it. What America should be focusing on with these investments made by China are not finance technologies like these toxic loans, but green technologies.

    China simply cannot maintain its development at this rate, there just aren’t enough natural resources in the world for the U.S. to consume as it does and have China develop at this rate. What the U.S. should have been doing with those investment dollars that the Chinese “freed up” was (and is) to invest in technologies that would reduce the resource limitations placed on China. Then, the U.S. would be manufacturing real goods, meaning China could continue to be manufacturer to the world, and in so doing we create a more sustainable consumption pattern.

    Instead, funding for the sciences (infrastructure innovation for the 21st century) by the Federal government over the past 8 years has been drastically cut, and the American economy has been running on the nutritional equivalent of protein bars.

    Now the economy’s got diabetes: it’s not fatal if managed properly.

  • Posted by Twofish

    Boshears: Because America seems to have a terminal lack of vision at its executive levels, and I am afraid it will continue to be a myopic nation for years to come.

    The one example of decisive executive leadership in the last three weeks was Hank Paulson, and he got instantly screamed at for leading decisively. Until near the end, both major party candidates were waffling, for very good reasons.

    One the other hand, maybe a lot of vision is a good thing. The one major example of a decisive vision leading to action, was the decision to invade Iraq.

  • Posted by linte

    Lets blame China for EVERYTHING Brad….you’re such a clown. With people like you hiding from the truth, lets blame everybody else but ourselves, its no wonder the US is heading for a mega depression. Enjoy your depression Brad!!!!