Systemic crises
A systemic financial crisis is one that affects the “system” — not a single institution. In my view, the US — and perhaps the US and Europe — are now facing one.
Systemic crises aren’t new. Many emerging economies experienced a systemic crisis when their currencies crashed in the 1990s, as most of their financial institutions either than foreign currency denominated debts and domestic loans or had lent in foreign currency to domestic borrowers who had no foreign currency revenue. Nor are foreign currency denominated debts the only cause of systemic crises: Japan experienced a systemic crisis in the 1990s because its banks had lent heavily against domestic real estate.
American financial institutions recently lent too much money to American households on the assumption that real estate only went up. The also assumed that macroeconomic and financial volatility had been vanquished, which meant that higher level of financial leverage made sense. The result is now obvious.
Systemic crises are particularly hard to resolve because most large institutions, by definition, have the same underlying financial exposure. If a host of large institutions all have the same problem and all want to get rid of the same bad bet, the overall result is that there are structurally far more sellers than buyers. If most leveraged institutions made the same bet, the problem is compounded: leverage magnifies the downside as well as the upside. The result is something not far from the “great unwind” — though the trigger for the unwind is a bit different than the one Staiman and Kips initially identified. A host of leveraged institutions all want to cut back on their leverage and sell their risky assets — something that is hard so long as everyone is trying to sell at the same time. Warren Buffet (hat tip Steve Hsu of Information Processing) puts it well:
all the major institutions in the world trying to deleverage. And we want them to deleverage, but they’re trying to deleverage at the same time. Well, if huge institutions are trying to deleverage, you need someone in the world that’s willing to leverage up. And there’s no one that can leverage up except the United States government.
That doesn’t necessarily imply the only possible policy response is buying bad assets; equity injections could play a role too. There are plenty of ideas out there — including this proposal by Morris Goldstein. It does though imply that the government has to play a role in resolving the crisis.
Anna Gelpern* has noted that the dynamics of a systemic crisis also apply to over-stretched households. Normal processes break down when too many households are in the same position — namely underwater on their mortgage. She writes:
In ordinary times, failure is resolved case by case. People and companies negotiate with their creditors, and when all else fails, file for bankruptcy. There is a judge for every case, a plan for every debtor and a price for every asset. But in a mass crisis, there are not enough judges or hours in the day to process failure. When everyone is selling, the right buying price is anyone’s guess. That is when governments resort to wholesale, one-size-fits all solutions.
She is right. If only a few home owners cannot make payments, a case-by-case approach works. But in circumstances when many homeowners are under-water and bankruptcy is, at least in some places, the norm, the case-by-case approach breaks down. The courts — indeed, the banks — are overwhelmed.
While all systemic crises are unique, they do — as Gelpern notes — give rise to similar choices: choices over whether to renegotiate contracts in mass rather than rely on a case-by-case approach even if this sacrifices a bit of equity (Gelpern writes “The good are punished with the bad, and the bad are bailed out with the good “) for efficiency, and choices over how to allocate losses among creditors, debtors and the taxpayer.
The choices that the US has to face now aren’t a surprise — at least not to those who have thought extensively about systemic financial crises. The surprise is that the United States is having to face these choices. As former Treasury Secretary Summers notes in the Wall Street Journal:
“Superpowers do not normally ask their diplomats to reassure other nations on questions of credit-worthiness”
They also haven’t generally had to struggle with the same difficult choices emerging economies faced in the 1990s.
* Anna and I worked together when we were both at the Treasury from 1997 to 2001; she is a dear friend. She also is now a blogger!
The problem with mass contract renegotiation is that it takes a huge amount of time and trust, and time and trust are the two things that you don’t have in a crisis.
I think the focus in systemic crisis management is not prevention or resolution, but to limit the speed of events so that they happen slowly enough so that the political and economic systems can respond to them. This means among other things having capital reserves and reducing leverage.
When the crisis first happened, events were literally occurring on an hour by hour, minute by minute basis, and legislatures can’t work that quickly. What was important was to stabilize the situation so that things started happening day by day so that Congress can get involved. Once we have something that allows us to work on a day by day basis, then we can start to look at the long term and start thinking in terms of week by week, month by month, or year by year.
The Collective View of the US Financial Fiasco from Southeast Asia
http://www.atimes.com/atimes/Southeast_Asia/JJ03Ae01.html
A decade ago, Western-led free marketeers derided Asia’s economic model. The only way out of the financial crisis, they argued, and on what the IMF predicated its bailout packages, was greater foreign participation and management in their economies through asset sales and privatizations.
Governments in the region resisting IMF neo-liberal orthodox prescriptions and market-determined asset fire sales to foreigners were widely derided in the Western press. Many rang the “moral hazard” alarm bell, warning that unpunished profligate borrowers would be prone to return to their risky behavior on the expectation of future government bailouts.
And when Asian countries raised the idea of establishing an Asian Monetary Fund, to rival the IMF and stave off future regional financial crises without the perceived pro-Western conditions imposed by IMF-led bailouts, the US balked at the concept and lobbied against it until it was finally scrapped.
Now many of the same pro-market stalwarts who criticized Asia’s half-market, half-interventionist response to the 1997-98 financial crisis are among the strongest proponents of the US government’s proposed US$810 billion Wall Street bailout package, which the Senate passed on Wednesday – after $110 billion in tax breaks was tacked on to the initial $700 billion plan to lure votes from both parties.
Rather than advocating for a market-price clearing of distressed assets and foreign buyouts of homegrown assets, as they did for Asia, many Western commentators have taken Wall Street’s side in its plea for a government bailout of banks and bankers.
That’s obviously debatable, even as Asian government leaders, whose central banks are flush with US dollar-denominated assets, called earlier this week for the US government to intervene. What is clearer is that global investors have finally lost faith in the US’s debt-binged financial status quo and that a new, less US-centric era of global capitalism is dawning.
The hard truth America is now so desperately trying to avoid is that US economic, financial and human resources – once considered the cream of the global capitalist crop – are in the new market reality worth a fraction of what they were previously priced. US policymakers deliberating the proposed interventionist bailout would be wise to revisit their economics text books and the historically overlooked but now highly relevant factor-price equalization (FPE) theorem.
Simply put, as the world economy becomes more integrated, free trade and capital flows tend to equalize relative prices and real wages across the world. Astronomically high US asset prices and wage levels have long represented the biggest pricing distortion in the global economy, one that until now has allowed Americans to consume a far greater percentage of the world’s resources than their Asian counterparts.
bsetser: They also haven’t generally had to struggle with the same difficult choices emerging economies faced in the 1990s.
And they still don’t. The thing about the choices that the United States makes is that it is still going to be largely dictated by American institutions responding to American voters.
In the case of emerging economies, they were forced to make choices determined by outsiders, with their own interests (such as banks that wanted their debts repaid), who they had no control over, and whose policies were often shockingly bad.
No worries. Foreign central banks will bail out the US. In the short run, it’s much easier to do this than the alternative. Politicians only care about the short term. That’s why we’re in this mess. Any long term problems are someone else’s problem.
There is an interesting bit of psychology in that you have lots of people in the world that want the US to take the awful useless medicine that the US tried to impose on Southeast Asia a decade ago. If you really think about it, it doesn’t make any logical sense. If the policies that the US imposed on Southeast Asia were worthless then logically it doesn’t make any sense for the US to impose it on itself.
The reality of the matter is that most people in Southeast Asia really don’t want the US to recover, and want the US to undertake failed policies so that they can have the satisfaction of seeing the US economy burn to the ground. Having the US economy recover with minimal pain is not the primary goal. The goal is to make the US suffer as much as possible.
It’s understandable. The trouble is that if you watch with satisfaction as your neighbors house burns down, because they did nothing to help you ten years ago when your hours was burning down, then very shortly your house is going to catch on fire too.
Also, the satisfaction of vengnance/justice really doesn’t last for very long.
http://www.atimes.com/atimes/Southeast_Asia/JJ03Ae01.html
Others, reflecting on past Western criticism of Asian developmental state capitalism, wonder why the US media has not asked harder questions about a potential conflict of interest in former Goldman Sachs investment banker turned US Treasury Secretary Henry Paulson’s lead role in devising a bailout package for his former Wall Street associates. They suspect it could be partially explained by much of the US media’s reliance on investment banks for their advertising revenues.
With Wall Street’s collapse, the global capitalist order has reached a watershed moment, one that will fundamentally affect how the US engages with Asia. US trade policies that previously promoted, above all else, opening markets for US banks and financial institutions in Asia’s developing markets will now shift in a new and potentially more protectionist direction.
That the US is opting to bail out its bankers rather than allowing the market forces it championed during the Asian financial crisis to determine the value of its debt-ridden assets represents more than an extreme case of moral hazard. Rather, it undermines global faith in the Neo-liberal capitalist model the US once promoted, and from a Southeast Asian perspective, marks the end of what now seems a highly hypocritical US-led era.
charlie: No worries. Foreign central banks will bail out the US.
The reason I’ve been quite worried is that we have reached the point in which they can’t even if they wanted to. (And they don’t really want to.)
charlie: Politicians only care about the short term. That’s why we’re in this mess. Any long term problems are someone else’s problem.
No. Politicians try to care about the long term. The trouble is that if you don’t survive the short term, there is no point in talking about the long term.
Also eventually the long term will become the short term, and that time is now.
2fish — if Asian economies want the US to fall, they will quickly need to find someone else to buy their exports. China in particular.
Rep. Brad Sherman On Bailing Out Foreign Investors,
“Hundreds of billions of dollars are going to bail out foreign investors. They know it, they demanded it and the bill has been carefully written to make sure that can happen.”
http://globaleconomicanalysis.blogspot.com/2008/10/rep-brad-sherman-on-bailing-out-foreign.html
Brad,
It’s a self-conceited myth propagated by US financial pundits that the Chinese will exclusively pander to any American consumer demands. A decade ago, the Chinese government initiated the stated trade policy for the diversification of exports, and the acceleration of domestic consumption. There is a negligible amount of trade with the United States from the interior provinces of the “real” China. The average Chinese living in conservative Changsha or Chengdu could care less if the US collapsed off from the face of the earth. For instance, the China PLA draws heavily from conservative Hunan province, not liberal cosmopolitan Shanghai or Guangzhou.
From Bloomberg,
http://www.bloomberg.com/apps/news?pid=20601080&sid=ahIhbvfAs3dY&refer=asia
Rising domestic consumption may help shield China’s manufacturers from weaker exports. Retail sales grew 23.2 percent in August from a year earlier, close to the fastest pace in at least nine years. Fixed-asset investment in Chinese urban areas jumped 27.4 percent in the first eight months of 2008, up from 26.7 percent in the same period last year.
“China is not just sitting around, waiting for orders for Christmas toys and mobile phones from U.S. retailers,” said Carl Weinberg, chief economist at High Frequency Economics Ltd. in New York. “The boom in China’s trade has been nice icing, but China’s economic cake is baked at home.”
DC — I deeply hope that Carl Weinberg is right; a China that continues to grow strongly on the back of domestic demand would be great for the global economy.
I would note tho that if this is true, China – as the stronger of the world’s economies — should have no problem allowing the RMB to appreciate, and thus helping the rest of the world along. That would be particularly welcome, as China drew on the rest of the world (via rising net exports) for around 2.5 to 3% of GDP growth per year in 05, 06 and 07 — and perhaps 1.5% of its h1 08 GDP growth A period when net exports subtracted from china’s growth and added to the world’s growth would be most welcome.
Is China up to it tho?
@Brad: “if Asian economies want the US to fall, they will quickly need to find someone else to buy their exports. China in particular.”
Unless they realize that it is most unwise for them to keep exporting so much. China in particular.
“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.”
(As an aside, it’s remarkable Dave C. never quoted this piece. I do because it just speaks my mind on the subject.)
Brad,
Due to US Dollar hegemony devised under the Clinton-Rubin regime, almost every strategic commodity in the world especially oil is sold exclusively in Dollars; if the Chinese were to revalue the yuan, it would destroy the global competitiveness of its exports in every 3rd world market. Any sovereign nation that revalues its currency under the US Dollar hegemony regime automatically suffers a global loss of economic competitiveness. In order to rectify the global imbalances, what the world economy requires is a multi-currency regime. Of course that would put an drastic end to the “free lunch” for the US Economy; the rest of the world wouldn’t be financing military imperialism adventures in Iraq and Georgia.
Here’s a small list of some of the more annoying tax breaks in the senate bill that we are to take so seriously. But what else could we expect. We have had this recurring problem with banksters ever since the Templars invented banking, and the government killed them because they were the only ones who did it properly. After 700 years of banking reform, things have gotten much worse.
Then there is the alternative minimum tax changes for people with relatively high incomes, but somehow have too many writeoffs relative to their incomes.
So vote for the bill quick, before the house adds more stuff making it even more expensive and useless yet.
* $223M for Alaskan fisherman
* $192M for rum producers in Puerto Rico and the Virgin Islands
* $128M for auto racing
* $33M for companies operating in American Samoa
* $10M for film & TV production
* $6M for producers of wooden arrows
Adding to my previous post, the advice of Mr Yu Yondging is all the more urgent and wise because of a reason he doesn’t mention: the constraints imposed by physical reality.
And some influential Chinese are already aware of this issue, as can be seen in this and this posts from the blog of Kjell Aleklett, president of ASPO International and Professor in Physics at the Department of Physics and Astronomy, Global Energy Systems Group at Uppsala University.
“In a few hours I will fly back to Sweden and it is time to summarise the “Swedish Peak Oil delegation’s” successes in Beijing. We are definitely carrying home one or more gold medals in our baggage! We have had meetings with representatives from the energy sector from the university- and academy-world, from up- and downstream operators in the oil industry and from national planning authorities.
One gold medal is a direct inquiry about collaboration from the oil industry. They are fully conscious of Peak Oil issues and incorrect investments can results in billion dollar losses. …
Another gold medal is that we shall now participate directly in calculations of China’s future oil and gas production. My Ph.D. students are staying in China for an extra week to begin the work.
A third gold medal is that we are now drawing up the guidelines for a collaboration between The China Academy of Social Science, the China University of Petroleum in Beijing, Liverpool University and Uppsala University in which we will study the economic importance of oil for industrial production in China and transport of goods to Europe. …
There might be yet one more medal with a possible future collaboration with the “Energy Institute of the National Development and Reform Commission”. It would be very interesting if Peak Oil were to be included in China’s next five year plan.”
bsetser: if Asian economies want the US to fall, they will quickly need to find someone else to buy their exports. China in particular.
I don’t think too many people in China want the US to fail. Lots of people in Southeast Asia do because of the Asian Crisis.
RealThink,
If the Chinese government bureaucrats were wise, they would purchase a strategic stockpile of oil and other commodities with those US dollars. The Washington Consensus elites will remain forever hostile towards China due to the sovereign independent status of the Chinese government. Until the US reforms its foreign policy attitudes, cooperative state-to-state relations with China aren’t really possible.
US State Department Report:
http://www.washtimes.com/news/2008/oct/01/new-us-defenses-sought-to-counter-beijing-buildup/
The United States needs new weapon systems, including missile defenses and other advanced military capabilities, to deter and counter China’s steady buildup of nuclear and conventional arms, according to a draft internal report by a State Department advisory board.
“Using superior U.S. military technical capacities, the United States should undertake the development of new weapons, sensors, communications, and other programs and tactics to convince China that it will not be able to overcome the U.S. militarily,” the report said.
Cedric: Here’s a small list of some of the more annoying tax breaks in the senate bill that we are to take so seriously. But what else could we expect.
What I find funny is that the only group of people that won’t be getting any sort of government handout from the bill are Wall Street investment banks.
It makes sense if you remember that when people complain about waste and corruption, it’s because they aren’t getting any of it.
DC: Any sovereign nation that revalues its currency under the US Dollar hegemony regime automatically suffers a global loss of economic competitiveness.
So what? If the drivers of economic growth are internal then why does economic competitiveness matter?
Mr. Setser,
Deleveraging is not quite as hard as you imply, at least in some very important cases.
Willem Buiter’s Jackson Hole paper (Central banks and financial crises) distinguishes between “outside” debt/assets and “inside” debt/assets. “Inside” debt/assets are contained within the financial sector. He argues that “inside” deb/assets can be more readily disposed of.
See section III.1a(v) “How dangerous to the real economy is financial sector deleveraging? Inside and outside assets”
Of course, you should read his erudite analysis. However, to state this very simply, deleveraging is not always net deflationary because each asset sale in the financial sector is matched by an asset purchase.
This is much more to do this, but the deflationary impact of deleveraging on asset prices should not be overstated.
This is the year we break the world’s central banks with upwards of a $2 Trillion deficit. Not to mention a trade deficit so we can buy oil and chinese stuff.
The only other alternatives are:
1) A stealth tax increase. Don’t know if it would come after Nov.4 or Jan.1.
2) US private investment develops a taste for longer term treasuries.
3) We monetize the debt somehow. There are Japanese style “quantitative easing” tricks that the treasury and fed can play in unison.
Also many people have theorized that the timing for the Chinese to abandon an export to the US driven econ model would be during a US recession, because there is nothing to gain by pegging.
China did report a 30% increase in CPI inflation last month, almost all due to rolling back oil subsidies. So they have plenty of things to spend money on internally if they want to compensate for that, and perhaps provide a safety net for displaced workers.
Also it’s silly to think you can be a developed country and peg your currency low so you are competitive with products made in the 3rd world. You gotta pick which you want to be.
Mr. Setser,
“She is right. If only a few home owners cannot make payments, a case-by-case approach works. But in circumstances when many homeowners are under-water and bankruptcy is, at least in some places, the norm, the case-by-case approach breaks down. The courts — indeed, the banks — are overwhelmed.”
Actually, no. The legal system doesn’t appear to be having any trouble handling the current wave of foreclosures even in the hardest hit areas. I haven’t heard of any problems in the bankruptcy courts either.
This may not be the correct policy choice (although I think it is) and yes bank capital has been impaired. However, the facts on the ground should be stated accurately.
Cedric: Also many people have theorized that the timing for the Chinese to abandon an export to the US driven econ model would be during a US recession, because there is nothing to gain by pegging.
And they really won’t have any choice really. If demand in the US goes down, then it’s going to hit the export industry hard, and so the government is going to have to boost local demand.
The other nice thing from a political view is that anything bad that happens during the readjustment can be blamed on the United States.
Lastly, though Peak Oil, Limits to Growth, and all that stuff may seem a most outdated issue in today’s financially-challenged world, let me remind you all that in November 12 the IEA will publish the results of a study assessing the depletion rate of the world’s top 400 oil fields (announced here, here, and here.
And I am not the first to notice that the release date for the study is most conveniently located after the election, to avoid having to tackle the subject in the campaign, and to allow lawmakers to make wise provisions such as the $128M tax cut for auto racing (hat tip Cedric), which undoubtedly will help prepare the US to cope with an energy constrained scenario.
“I have been told by a reliable source that the IEA has been forbidden by the US administration from updating their absurdly cornucopian oil supply and demand scenarios until the report that comes out late this year (after the election); that report, which will publish the result of a “bottom-up” analysis (ie a summary of all existing oil fields, their production and/or prospects) is expected to show that oil production is unlikely to reach the levels that so many have blithely assumed – notably on the basis of previous optimistic IEA reports.”
This whole comment may not be politically correct, but I just got fed up with so much nonsense about a financial/housing crisis from people who do not realize that the money/houses in question is/are being spent/built on the slopes of the Vesubius.
(The last comparison is drawn from the latest presentation by Matthew Simmons, BTW.)
“So what? If the drivers of economic growth are internal then why does economic competitiveness matter?”
The Chinese economy based on value-added manufacturing is more dependent than ever before on imports of strategic raw materials especially energy imports. Almost 40% of oil usage is imported along with 80% of Chinese iron ore consumption. Any revaluation or devaluation of the yuan currency versus the US dollar drastically changes pricing equilibrium for the Chinese economy. Simply put, for trade exchange of strategic cobalt or platnium imports from Africa, industrial Chinese exports need to remain globally competitively priced.
@Dave C. at 1.15 pm “Any sovereign nation that revalues its currency under the US Dollar hegemony regime automatically suffers a global loss of economic competitiveness.”
And that’s EXACTLY what would be best for China! (and for any other country with a long-running huge trade surplus). And it’s not just me saying this, if you read the quote from Yu Yondging.
Sorry, it was “Yu Yongding”.
Foreign Affairs has been my favorite read for 36 years.
I think leadership at the Treasury, during this economy wide crisis, should benefit our National coffers with huge bounty. Bounty that made Warren Buffet act a bit giddy when he wished someone would give him $700B to invest during this crisis. To work well however, the Treasury must execute his plan to benefit only the National coffers. Not special interests and established or legacy corporate power. Established centers outside the Treasury surely may benefit but fairly and only for services rendered; and indeed lets be clear, executing the TARP plan will need lots of service….. and heck, anything of $700b is a ton of money….. I hope the Secretary is sprited and rooted in his National soil and not too wrapped up in the national disenfranchisement of globalization. I’ve heard he is. I hope he is. He’ll get this money. Look.
There are 44 SWF with $5.3Tr waiting for global IMF and BIS monetary transmission policy to change in favor of a more secure and open terms of trade regime. That should happen very soon. Wouldn’t you want to have some skin in that game?
Dave C:
1) If your currency strengthens, you’ve increased your purchasing power for imports. That would be raw materials and oil in China’s case.
2)”Any revaluation or devaluation of the yuan currency versus the US dollar drastically changes pricing equilibrium for the Chinese economy”
Welcome to the real world. Take a look at a 30 year chart of the dollar index.
3)The big problem is manufacturing is capital intensive and they need volume to amortize overhead.
We always had that problem too, but eventually solved it by becoming a service based economy.
4) The Chinese have nothing to fear from the S. African Rand. It’s one of the few currencies weaker than dollar-yuans.
SLIGHTLY EDITED FOR TONE
Again – Great site
“Follow the Money”
How do you ‘follow the money’ when it evaporates in front of your eyes?
Whats a good hedge for evaporating money? J P Morgan would have said, the ability to print more of it. I say. Buy gold.
RealThink,
The China State Council reportedly has instructed the China PBoC that the Chinese yuan will not be further revalued. It wasn’t an arbitrary decision by top government bureaucrats. Forget about Western textbook economic theories that are mostly political BS for the masses, members of the State Council toured factories nationwide across China to speak directly with Chinese corporate executives and factory workers. The Hong Kong business community pleaded with the Chinese government not to further revalue, and warned of dire political stability consequences. I think the decision not to revalue the yuan is a great example of grass roots representation of important economic decisions by the Chinese people.
@Dave C. at 1:33 pm
Very good comment, stressing the “geo” part of the “geoeconomics” in this blog.
That draft internal report by a State Department advisory board, viewed in conjuction with this article that you referred to a couple of days ago, paint a most gloomy picture: that the “Last One Standing” scenario, predicted four years ago by Peak-Oil theorist Richard Heinberg in his book “Powerdown” as the most probable outcome, is indeed coming to pass.
In which case we may just ignore the financial crisis.
BTW, if China wants to overcome the US militarily, why does it keep financing its military spending? Unless the game plan is to make the US wholly addict to Chinese credit and then all of a sudden cut it off by dumping the trillion dollar reserves at once.
Dave C:
“The Hong Kong business community pleaded with the Chinese government not to further revalue, and warned of dire political stability consequences.”
Which reminds me of this news item in an Easter Island newspaper, some 400 years ago:
***
Leaders of the moai building community pleaded with the Island Council not to allow a fall in moai-building activity, and warned of dire political stability consequences.
“Moai construction and related activities are an essential part of the Island’s economy, providing jobs to a half of the Island’s workforce”, they said. “The ongoing crisis in moai financing has already caused a significant slowdown in moai construction and threatens the prospects for the Island’s economic growth.”
Regarding the concerns by some groups that moai construction was causing an unsustainable rate of felling of the Island’s palm tree reserves, the business leaders said: “The concerns of so-called Peak Palmers are unfounded, and their predictions have already been proved wrong in the past. They underestimate the impact of technological advances and human ingenuity.”
***
Of course, to get the point you should be acquainted with Jared Diamond’s book “Collapse”. Or at least watch this video.
Dave C.
“I think the decision not to revalue the yuan is a great example of grass roots representation of important economic decisions by the Chinese people.”
Just as the decision to enact the tax breaks listed by Cedric is.
To DC:
Your economic policies make absolutely no sense if you think that the US economy is in bad shape, which you seem to, or if you think that the US government is either evil or stupid, which you also seem to think.
If you think the US economy is in bad shape or if you think that the US government is either evil or stupid, then having the Chinese economy dependent on exports to the US doesn’t make any sense. The logical thing to do is to try to boost domestic consumption, and if that domestic consumption is based on import of raw materials then you want to revalue the RMB upward so that those materials are cheaper to the Chinese consumer.
If China’s policy ends up being to import raw materials from the third world and export cheap manufactured goods, then this is classic neo-imperialism/neo-colonialism and China is going to end up causing the same massive resentment that the Western powers did when they followed those policies.
Realthink:
Japan’s biz leaders have been saying the same thing as the Easter Islands folks ever since the 1985 Plaza Accord forced Japan to reval up 100%. They continuously threaten the Japanese government with moving production to China.
It even happened in the US during the 2004 campaign when steelworkers cornered Bush at a rally in Ohio and stated the dollar must fall. Bush made his famous comment “Let it drop!”. Then of course Snow re-affirmed the Treasury’s strong dollar policy.
Cedric,
and neither Japan’s biz leaders nor US steelworkers were Hubbert’s Peak-aware at those times.
That’s gonna change on Nov. 12. Again, a most convenient date.
Twofish,
The Chinese don’t engage in Neo-imperialism or Neo-Colonialism. Period. Those concepts are referring to the financial tactics of the IMF / US Treasury. Sino-Africa trade relations are entirely on a voluntary basis. The China PLA doesn’t station military troops in African energy production regions as the United States is planning under the newly established Africa Command. Nor does the China PBoC demand privatization of a sovereign state’s natural resources to foreign banking institutions such as the forced sale of Indonesian oil fields to Wall Street banks in exchange for an IMF loan.
And yes the US government is pretty stupid to believe its own propaganda for global economic and military hegemony. The US military can’t even control the chickensh!t countries of Iraq and Afghanistan, but the US foreign policy elites still plot the destabilization of Georgia in Russia’s backyard and Tibet which is part of China. No nation in world history has ever conquered the entire planet, and no state ever will.
Realthink:
I think even Hubbert was only peak oil aware a few years back, and now we seem to be peak everything.
“if that domestic consumption is based on import of raw materials then you want to revalue the RMB upward so that those materials are cheaper to the Chinese consumer”.
That’s assuming there is an open, free market in those strategic commodities. With global demand falling, Australia’s BHP still demanded a 60% price increase in iron ore from Chinese steel corporations. I think after the Iraqi oil field occupation by the US military, the Chinese government reassessed its foreign policy strategy to emphasize direct access to overseas national resources.
China’s domestic resource base is relatively small. The Chinese comparative economic advantage is value added industrial production which in certain labor intensive products is extremely currency exchange rate dependent. Any further revaluation of the yuan would significantly damage the Chinese economy.
hate to interrupt the china talk, but i just discovered this:
http://www.isda.org/press/press093008.html
in short, fannie & freddie derivatives go on the auction block next monday, followed shortly by lehman.
so how much you think henry’s gonna ‘invest’ with his new fund over the weekend?
and will it be enough?
and will there ever be enough?
cedric: * $6M for producers of wooden arrows
i was walking in the neigborhood today when i passed by one of those huge demolition dump trucks (you know the ones) when this comes out the driver’s side window:
“six million dollas for wooden arrows for crissakes!”
so tell uncle bruno that the boys on the ground ain’t buyin it either…
Uncle Bruno is very embarrassed. Tinks dey read that stuff in da old country.
here’s my 0.137 yuan (stable…for now) on china (not pro- or anti- in any way, just a perspective from someone who’s lived for 12 years with someone who’s from there and still has family there):
china’s gonna do what’s best for china.
for a westerner to properly understand the thought processes of either chinese officials or the average person on the street is like a native of Brooklyn trying to navigate the streets in Queens, i/o/w it’s always in the exact opposite direction that you think it is 75% of the time.
and when someone from china says that it’s ‘time to change course’, one would save oneself much suffering and angst if one would not second-guess or try to persuade otherwise.
this is not to say that all chinese think the same (that’s actually a large part of the disconnect), but rather simply acknowledges the wide divergence in our cultural attitudes and collective upbringing.
of course, Judy will hopefully have much more sage advice than is contained here when she wakes up.
DC: The Chinese don’t engage in Neo-imperialism or Neo-Colonialism.
Not yet, but the economic policies that you are suggesting almost guarantee that China will be forced to engage in this sort of behavior because they don’t work otherwise.
DC: Those concepts are referring to the financial tactics of the IMF / US Treasury.
Do you really think that Chinese people are somehow more inherently less corruptible or less prone to abuse power than Americans?
I don’t. The cycle of history is one in which the oppressed of one generation become the oppressors of the next. Any group of people that cannot imagine itself abusing power is unfit to hold it.
DC: The China PLA doesn’t station military troops in African energy production regions as the United States is planning under the newly established Africa Command.
If you make China critically dependent on African energy and no one is able to guarantee security then you’ll have the PLA deployed into the Sudan. Right now China depends on the US to do a lot of its economic dirty work for it.
DC: Nor does the China PBoC demand privatization of a sovereign state’s natural resources to foreign banking institutions such as the forced sale of Indonesian oil fields to Wall Street banks in exchange for an IMF loan.
If you make the Chinese economy critically dependent on cheap natural resources and external markets it will.
DC: And yes the US government is pretty stupid to believe its own propaganda for global economic and military hegemony.
So why to you insist on making China so critically dependent on US markets? If the US is dumb, that makes China even dumber for following it. China simply *CANNOT* depend on US markets for continued growth because the US is just too broke and exhausted to pay for Chinese goods whatever the exchange rate is.
DC: That’s assuming there is an open, free market in those strategic commodities. With global demand falling, Australia’s BHP still demanded a 60% price increase in iron ore from Chinese steel corporations.
And you end up with a 40% price increase if you revalue the RMB. The thing about free markets is that they often don’t work, and I think that in buying natural resources, China should overpay, especially to poorer nations.
DC: China’s domestic resource base is relatively small.
Which is why it relies critically on the good will of other nations if it is not willing to use military force to seize those assets.
DC: The Chinese comparative economic advantage is value added industrial production which in certain labor intensive products is extremely currency exchange rate dependent.
China will lose any advantage in labor intensive industrial production in the next ten years, and should start thinking about ways of moving that production to Africa or Vietnam.
Industrial production for domestic use is not currency rate dependent.
DC: Any further revaluation of the yuan would significantly damage the Chinese economy.
How? By reducing exports to the United States? Listen, it’s official, the United States is broke, and at least for the next year, the US is going to be too focused on fixing its internal economic problems to be able to buy anything from China. Those export oriented industries. Those are finished…..
We are in a new age of history, and fortunately over the last few years China has built up a reserve of capital and infrastructure which it can use to make its economic restructuring much less painful than the one that the US is about to go through.
LB: for a westerner to properly understand the thought processes of either chinese officials or the average person on the street
It’s almost as difficult for Chinese to understand each other. If you are a person from Shandong living in the middle of rural Zhejiang, you are almost as much a foreigner as someone from Germany.
Also, Chinese politicians and businessmen think in fundamentally the same way as American politicians and businessmen. How do I get money and power if I don’t have it? How do I keep my money and power if I do?
Simple really.
exactly why the analogy of Brooklyn & Queens was used 2fish.
excellent point tho that needs to be repeated until ‘we’ get it.
the flipside of the coin of why we are even having this particular discussion in the first place:
http://projects.flowingdata.com/walmart/
no words, just green dots.
No successful military power fails to plan for all major moves by all potential participants (not just the obvious enemy of the moment).
As Brad repeatedly notes, in a stable environment for international finance and trade, it’s contrary to their own self-interest for China, Japan, The Gulf Sheiks and Russia to dump Treasuries. He provides the best analysis and the best forum for this discussion you can find.
But…
Do we have a stable environment for international finance and trade? Has our government actually prepared for the Black Swan of Treasury dumping? Were they prepared in advance for the instability created by the credit bubble?
Brad – what actions do you believe could be taken (meaning, planned in advance to be taken) by the Fed and Treasury Dept. to avert the true catastrophe of a momentum-building flight from Treasuries – not after it’s already in full bloom with cries of Armaggedon everywhere (like with the current problem), but as a preventative or early response to avert the catastrophe in the first place?
Until our officials stop pooh-poohing this possibility (as they did the coming housing crash in 2005 and 2006) and start planning for it as a real contingency, no U.S. citizen or investor anywhere should feel safe.
Twofish Says: “I don’t think too many people in China want the US to fail. Lots of people in Southeast Asia do because of the Asian Crisis.”
As a Singaporean living in South East Asia, I believe I am qualified to wake you up from your little mob lynching delusion. USA is a major Trading and Investment partner with the South East Asian countries. It would be delirious for any government or anyone to even contemplate such a demise for our biggest business partner. Either you are biased or you are severly lacking an acute sense of business judgement and sound analytics.
bsetser: “if Asian economies want the US to fall, they will quickly need to find someone else to buy their exports. China in particular.”
We are in a modern global world. Countries and Economies are more interlinked and interconnected than before. Asia and the rest of the world are not insulated from the wellbeing of the USA. And the current episode has debunked the myth which foolishly believes otherwise.
I do agree with Brad, that China needs to step up in the global scene. China has to come out of the world exporter of cheap goods label into a global importer of world goods. It takes time for comparative advantages and rigid foreign exchange regimes to even out and adapt. However, the Chinese has to speed up and fill in the gaps the USA is leaving.
There’s been a lot of talk about Peak Oil. I think what we are witnessing now is Peak Debt. The world financial system couldn’t absorb any more debt. It had to come down.
I like the Yu Yondging comments. Naked Capitalism had a post about it when it came out.
adiemuso: As a Singaporean living in South East Asia, I believe I am qualified to wake you up from your little mob lynching delusion.
One reason I’ve been thinking about lynch mobs, is that while I expected that there would be some hostility toward Wall Street, I didn’t quite expect the huge outpouring of anger that came out this week.
I think it would be irrational and self-destructive for people to try to take the United States down, but just because something seems irrational and self-destructive (at least to me) doesn’t mean that people won’t do it.
Brad – what actions do you believe could be taken (meaning, planned in advance to be taken) by the Fed and Treasury Dept. to avert the true catastrophe of a momentum-building flight from Treasuries – not after it’s already in full bloom with cries of Armaggedon everywhere (like with the current problem), but as a preventative or early response to avert the catastrophe in the first place?
Until our officials stop pooh-poohing this possibility (as they did the coming housing crash in 2005 and 2006) and start planning for it as a real contingency, no U.S. citizen or investor anywhere should feel safe.
answer – SELL AS MANY TREASURIES AS POSSIBLE WHILE EVERBODY STILL WANTS TO BUY THEM.
Brad,
It would be interesting to know your views:
Is there any flight from the dollar as the international reserve currency?
Are there decreased purchases of US Treasuries by global central banks?
You might find a March 2007 paper by Ashok Bardhan interesting: It’s titled ‘Impact of Global Capital Flows and Foreign Financing on US Mortgage and Treasury Interest Rates’; and is easy to google up as a .pdf document.
Best regards,
Chuck
chuck — read my next post! the fed’s custodial data suggests ongoing central bank purchases of us treasuries. i’ll look at the bardhan paper
To think our finest CEOs and economists (one of whom, Bernacke, wrote the book on the “Great Depression)are unable to see ahead, the results of their policy or lack of policy, is ignorant. This started with alan Greenspan’s interest lowering (dollar flooding and cheapening), and relyed upon ones common greed for short term gain, triumphing over the forseeable long term disaster this recipe creates.
Like a game of musical chairs, you only hope to keep your seat while the party still rages and like the card game old maid, hope to hand off the old bag card when it’s accountability time..
This will bring a global cooperation in order to stave off a sure disaster, ending in the revelation that we are better together than apart. Why not have one currency and create together, policy and reform. What a revelation.
The U.S. will not retain status of global superpower. We will and have already lost our hedgemoney in the global marketplace.
This is a necessary destruction in order to erect the new order.
Like the one party system we currently have, none of the candidates will go on to run this country.
We will also have a new political system as part of the financial restructuring package, I believe.