Foreign central banks seek safety; the Fed, by contrast …
Sometimes a picture is worth a thousand words.
Over the last 52 weeks, foreign central banks have added $321b to their Treasury holdings at the New York Fed (and no doubt more to other accounts) and $147b to their Agency holdings — for a total of $468b. And there clearly has been a big shift towards Treasuries recently. The rise in Treasury holdings over the last two weeks, annualized, tops $1 trillion. The fall in Agency holdings over that period (after the bailout of the Agencies), annualized, also tops $1 trillion.
Stunning? Yes. Stabilizing? Not really. There isn’t a shortage of demand for Treasuries right now. But there is a shortage of willing lenders of dollars to European banks and — to a degree, s shortage of buyers for the debt issued by the US Agencies (Freddie, Fannie and the like). And remember that the Agencies are the main current source of credit for American households looking to buy a home — without their lending, home prices would fall much much further.*
The Fed’s balance sheet by contrast is moving in the opposite direction — out of Treasuries. The Fed has been selling off its Treasury holdings for a while now. But there are limits to how many loans to banks and broker dealers and European central banks the Fed can finance through the sale of its existing stock of Treasuries. The recent increase in Federal Reserve lending has been financed by both the $500b in cash raised by the Treasury and deposited at the Fed through the supplementary financing facility — and a big rise in bank deposits at the Fed. Those two sources combined to provide the Fed with about $750b in financing.
The scale of the expansion of the Fed’s balance sheet is equally stunning. The Fed is currently provided at least $950b in dollar liquidity to the US financial system through various term facilities and its direct lending, and another $450b of dollar liquidity to European central banks — liquidity that is then lent to European financial institutions that are facing a shortage of dollars. Let there be no doubt that this is a systemic crisis.
The falling purple line is the Fed’s total holdings of long-term Treasuries (really holdings of Treasuries that have not been lent out to the dealers); the falling red line is the Fed’s holdings of Treasury bills; the rising green line is the financing from the Treasury supplementary financing account and the rise in bank reserve balances at the Fed; the rising blue line is the financing the Fed is providing to the global financial system. Tim Geithner has been a very busy man this year.
There is though one tiny bit of good news buried in the Fed’s balance sheet: the banks had slightly less money on deposit at the Fed on Wednesday ($261.6b) than they had on deposit over the weekend. That is why the average over the last week ($271.8b) was higher than the Wednesday total. Clearly, there were a lot of worried bankers over the weekend. And they are a bit less worried now.
Thanks to Paul Swartz for help with these graphs; more of his work — and the work of the Council’s Center for Geoeconomic Studies — can be found on the our homepage.
* I am sometimes asked if sovereign wealth funds will participate in the rescue plan for US and European financial institutions. That strikes me as the wrong question. Sovereign funds aren’t really in the business of doing rescues. Rescues are done primarily to keep the financial system afloat; financial return isn’t the main consideration. Sovereign wealth funds have been used to help “rescue” their own banking systems: Look at the recent actions of Kuwait, Russia and even China. But they aren’t going to rescue other countries’ banks. Not when their own economies are under strain — and not when central banks don’t seem willing to take on any risk whatsoever. A few bold funds might try to buy at the bottom — if they think they can get a good deal. But that isn’t really a rescue …
A more pertinent question would be “when will foreign central banks resume lending to the Agencies (Fannie, Freddie, and the like) and in the process, help the Agencies finance mortgage lending that could help to stabilize the US housing market … “
This is an excellent post, portraying two ships passing in the night – the world heading for treasuries and the Fed heading for risk.
But there’s something disturbing about the fact that the world left port already loaded up with treasuries.
“But there are limits to how many loans to banks and broker dealers and European central banks the Fed can finance through the sale of its existing stock of Treasuries.”
The treasury can always issue notes/bills and leave the proceeds for the FED to lend. Where is the limit?
Is the first chart about the last 52 weeks or the last 8 years as suggested by the given time-line?
Best,
C.
Brad,
It’s probably a good thing in the very short term that the “flight to safety” has permitted the Treasury (and ultimately the Fed) to fund the bailing out of the world, because the rate of interest on those short-term Treasuries being bought is REALLY low (as low as one tenth of one percent yield). That reduces the interest-rate burden created by the selling of so much government debt into the markets.
However, this surge of bailout debt is another “weapon of mass destruction” that is going to fall on us somewhere down the road. There is absolutely no way that the bailout debt (like all other U.S. debt since WWII) will be payed down. To quote Dick Cheney, describing the political stupidity of the American electorate, “Reagan proved deficits don’t matter.”
Now, all this short-term bailout debt has to be rolled over each time it falls due. Once the credit panic is over and the “flight to safety” ebbs, the interest rate on Treasuries will snap upward as the debt is rolled over with fewer buyers bidding on it. As a result, the 10 year yield will rise at least to it’s fifty-year average of 7% (not even counting possible conventional bombs going off like inflation from so much liquidity injection or the major devaluing of the dollar).
In other words, the panic has created a “bubble” specific to Treasuries as an asset, and when the bubble pops, the cost of the interest payments on the trillions of dollars in new debt will become a fiscal disaster. With some real bad luck, this can be unfolding just about the time the Boomers are depleting the Social Security trust fund reserves and all that off-the-books Social Security liability will start seriously devastating our already-deeply-underwater annual fiscal budgets.
How high can interest rates go? Can you say 1979?
Brad,
Several days ago, you asked for solutions to our problems.
Instead of seeking solutions first, maybe the problem or problems should be defined in different ways.
A simple summary is that the world seems to have an excess of contracts that will not be fulfilled because the persons or agencies expected to pay up does not have the ability to pay. This formulation includes mortgages and credit default swaps and the other exotic contracts.
The simple solution is to void or change the contracts. I realize this idea would be extremely difficult to implement fairly. However, if the contracts are not going to be fulfilled, any abreviated contract that gets money flowing again is better than a default.
Is this line of thinking more revolutionary than government financing of private corporations? Contracts should be less sacred than private property ownership.
Michael says that the ability of the Treasury to sell securities at very low interest rate is temporary and that “all this short-term bailout debt has to be rolled over each time it falls due”.
Assuming Michael is right, why is so much of this bailout debt short term?
I think part of the reason most of the treasury issuance has been short term has been because that is where the demand is – ie treasury money market funds.
love the graphs brad (& paul).
speaking of graphs, it would be really interesting to see one illuminating michael’s point above showing the dollar amounts of Treasuries and when they’re set to roll over.
sorta like the one below but for Treasuries:
http://tinyurl.com/2ahcsc
michael (or anyone), has there ever been a period in economic history anywhere with high inflation AND high interest rates?
fwiw here’s how the fed is expanding its b/s thru the http://www.econbrowser.com/archives/2008/10/balance_sheet_o.html – “Treasury supplementary financing account” operating http://interfluidity.powerblogs.com/posts/1210513606.shtml – “via a ‘channel’ or ‘corridor’”
but if t-bill rates are below the ‘floor rate’ won’t the fed’s liquidity injections effectively be neutralised as banks just park them risk free back at the fed? no wonder there’s been a drain out of the interbank market… and why everyone is clamoring for fed access now, viz. http://www.interfluidity.com/posts/1223780032.shtml – “To the degree that LIBOR does not reflect banks effective cost of funds, an elevated rate can be viewed as a hidden tax of the nonfinacial [sic] sector by banks. Rather than reflecting the banking system’s pain, a high LIBOR might indicate banks’ ability to leverage their collective insolvency to charge higher rates on nonfinacial firms without complaint.”
like…
http://calculatedrisk.blogspot.com/2008/10/bernanke-fed-may-consider-asset-bubbles.html – precognitively identifying bubbles and using ‘macro-prudential regulation’ to prevent them? oversight and regulation of (even ‘non-bank’) leverage? no more OTC derivative trading?
http://www.telegraph.co.uk/news/newstopics/politics/economy/3204286/Gordon-Brown-wants-to-rewrite-the-rules-of-capitalism.html – bretton woods III?
http://cboblog.cbo.gov/?p=179 – universal healthcare?
what’s the world coming to?
well, at least the FCC is opening up white space! http://online.wsj.com/public/resources/documents/fcc10152008.pdf
The main reason most of the treasury obligations have been short-term rather than long-term is a decision by the Treasury Department to save money by only paying short-term interest rates. This is a risky decision by the Bush Administration, to keep budget expenses down in the current fiscal year. (Hey, if they’re wrong then it’s the next guy’s problem.)
lex sez (the UK at least) should be going long http://www.ft.com/cms/s/1/e6662a52-9b5c-11dd-ae76-000077b07658.html
“…government debt issuance is going to soar [for the US i've seen est's of $1.3tn (9% of GDP)]
“There are two striking features of how the Treasury plans to pay for the £37bn bank recapitalisation plan. The first is that £21bn of the total will be funded in short-dated, fixed-interest gilts. Issuing at less than five years at least signals that ‘part nationalisation’ will not be forever. By 2013, having been paid back by HBOS and the like, the government presumably plans to retire that debt. Even so, this is expensive money. Yields on one- to five-year bonds range from 3.5 to 4.5 per cent. The government can easily do better than that.
“It should, for example, issue more long-dated index-linked debt. There is huge demand for such paper. That is why yields have fallen below 1 per cent. At those rates, this is almost free money, on which the government could turn a tidy profit given that it will charge banks 12 per cent.* Alistair Darling would win immediate political points among taxpayers. It would also demonstrate the government’s commitment to low future inflation.
“Of course, as the government issued more inflation-linkers, the price of these bonds would fall and their yields rise – perhaps to 3 per cent, the long term average. But that would work its own magic. As the risk-free rate rises, the present discounted value of pension liabilities also falls. Hey presto! Pension deficits would morph into surpluses – including for the largest pension provider of them all, the state. Free lunches all round.”
yay
Watch real interest rates, guys. They’re a lot more important than nominal interest rates. They’re soaring, in many cases very near to nominal. Apparently TIPS can have a negative adjustment in the case of brief deflation, so this indicator will retain some relevance, but the bond still pays off at par and the coupon’s downside is capped at zero. If you’re able to hold to maturity, a call option on inflation is pretty cheap right now.
http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield.shtml
http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_faq.htm
http://www.treasurydirect.gov/instit/marketables/tips/tips_negative.htm
” I am sometimes asked if sovereign wealth funds will participate in the rescue plan for US and European financial institutions.”
Sovereign wealth funds??? if they can’t print money their wealth is suspect.. they are dollar borrowers now!
And, by “pretty cheap”, I would be remiss if I didn’t observe that 5 year t-bonds yield 2.84% today and 5 year TIPS 2.88%…
Brad,
You wrote, “And remember that the Agencies are the main current source of credit for American households looking to buy a home — without their lending, home prices would fall much much further.”
I agree. But home prices are going to fall much farther whether or not there is agency money available. There are factors, other than interest rates, that will determine how low home prices go, including:
1. The house-price bubble has not finished popping.
2. Many people lost their downpayments, when they lost their homes. They won’t be quick to put down their savings again.
3. American median incomes are falling, and will likely fall more rapidly during the recession (or depression) that is just starting. Many well-paid American manufacturing jobs will disappear, not only because of the recession, but also *because* of the hundreds of billions that foreign governments are pumping into treasuries and agencies in order to drive down their currencies versus the dollar in order to steal market share in their competition with American businesses.
If our problem were a credit crunch, then interest rates would be much higher than they are now. In fact, we would be better off with interest rates that are high enough to encourage Americans to save. If interest rates were higher, then Americans would save more, and the Jimmy Stewarts of the world would make sure that there were mortgages available.
The money coming into the United States from foreign governments is discouraging American savings and taking away our manufacturing jobs at one and the same time. We would be much better off if it gradually decreased and then disappeared over the next few years.
Howard Richman
http://www.tradeandtaxes.blogspot.com
ReformerRay: The simple solution is to void or change the contracts. I realize this idea would be extremely difficult to implement fairly. However, if the contracts are not going to be fulfilled, any abreviated contract that gets money flowing again is better than a default.
That’s actually what has been going on. When a company files for Chapter 11, or when someone just doesn’t pay their monthly credit card bill, they are voiding or changing contracts. The question that we have now is which contracts get change and how.
One bit of fun over the last several weeks is that there have been moments in which the effective yield of 3 month treasury bills has been *negative*. This has caused all sorts of computer fun.
Invisible Hand Says: The main reason most of the treasury obligations have been short-term rather than long-term is a decision by the Treasury Department to save money by only paying short-term interest rates.
I don’t think so. The reason that treasury obligations has been short term is that the government really can’t do very much about long term interest rates without causing inflation.
bsetser: A more pertinent question would be “when will foreign central banks resume lending to the Agencies (Fannie, Freddie, and the like) and in the process, help the Agencies finance mortgage lending that could help to stabilize the US housing market … “
I really don’t see why they would or should do this, or why a foreign central bank would really care about stabilizing the US housing market. Central banks bought agencies because they were sold as being “just as good” as Treasuries, and now that it’s obvious that they aren’t, then they just aren’t going to touch agency bonds at all. If you want foreign money to go into the GSE’s, then the central banks are going to insist on buying Treasuries, and having Treasury use that borrowed money to buy up GSE bonds and absorb any risk.
I suspect that the issuance has been mostly short-term because:
a) that is where the demand is, so it is cheap
b) the fed hopes that this is a temporary crunch and that money market funds will shift from buying treasuries to buying bank debt, allowing it to reduce its own funding of the banking system.
Full carry. I tried to frame my point around the limits to what the fed could do without treasury issuance. as long as the treasury issues short-term and puts the funds on deposit at the fed, the fed has few constraints!
Christian — the first chart is the one year change in the outstanding stock of custodial holdings of treasuries and agencies over the last year — i.e. it is a measure of the annual flow (the increase in the custodial accounts) on a high-frequency basis. A chart of levels wouldn’t show the change in relative demand for agencies and treasuries in as dramatic a fashion.
the second chart is a chart of the stock of outstanding fed credit v its holdings of treasuries for its own account/ other sources of financing. it is a chart of levels rather than flows.
Michael — the risk you describe (higher rates on treasuries) is the nightmare scenario for the US. I still don’t think it is likely, but if it were to materialize it would cause enormous problems — even more problems that we see now.
Howard, yes, housing prices may fall further. but in absence of mortgage credit (now essentially provided by the agencies) they would fall a lot further …
Brad:
A few bold funds might try to buy at the bottom — if they think they can get a good deal. But that isn’t really a rescue …
I think the SWFs are quietly going long since there are very good value plays available, especially in the financial sector right now.
Is there any way to find out if the SWFs are long in the markets right now?
SWFs invested in Citi and other banks in Jan ‘08 and burnt their fingers on those.
Brad, I asekd you this in my blog but am not sure if you plan to check in the next few days, but given the breakdown of reserve accumulation in China is it possible that the PBoC has quietly shifted its portfolio towards a larger share for dollars? That would be consistent with dollar strength (although in times of global crisis the dollar usually strengthens). Otherwise the implied valuation changes are so large that I find them a little implausible.
Michael – My best guess is that PBOC is quietly writing off its subprime losses. As these are all USD-denominated, they need to buy more USD paper to make up their required currency balance percentages and avoid being overweight in other currency-denominated securities.
I know that gold is a relic but for government balance sheet purposes, wouldn’t doubling its current value cover a lot of future unrealized debt obligations against collateral which in turn would cover this massive increase in global currency dilution…..that is, if you don’t believe that this huge increase in currency a temporary ’sterized’ operation (?) Remembering that the US and Germany (EU) own most of the worlds gold.
So the Treasury is borrowing short and lending long…
the treasury is both borrowing short and lending long and borrowing short and lending short (via the fed)
michael — I also have a sense that something doesn’t add up in the q3 data. it is certainly possible that the $ share is higher than most thought — some recent estimates were in the low 60s, and I was using 67%. The problem with a higher number is that the last survey data suggested more modest inflows to the uS than would be implied by a constant higher share — which led me to revise my assumption down a bit. the scale of the flows needed to keep the pboc’s dollar share up is also potentially hard to reconcile with the post june 07 flow data, tho there are some hard questions of interpretation there.
my own explanation for q3 reserve growth — august in particular — is that the state banks unwound some of their 06 swaps and handed the money back to safe, so hte banks’ foreign assets went down and SAFE’s went up. basically, the banks have invested the money badly in riskier forms of debt — and they retreated, leaving SAFE to buy treasuries …
Sorry to sound like Twofish, but I am actually less worried about the latest increases in US government debt than in previous years. As Brad’s charts show, the recent increases in Treasury debt are being used to fund asset purchases rather than tax cuts or wars (which is why I disagree with Howard Richman that “mercantilists” messed up the US; it was the US government’s choice not to match the reserve capital inflows with assets). The key to maintaining US government solvency is not to overpay for the crud that they are buying. If they can avoid that, they might even end up making money. To avoid a loss on the TARP is going to be politically difficult, but at least the furore over Paulson’s original plan seems to have forced him into being a little less generous (ie buying equity stakes in banks instead of paying “hold to maturity” value for their crud).
Also, I think Brad’s second chart makes the situation look worse than it really is. The treasuries that the Fed has lent remain on its balance sheet (it has not sold any coupon treasuries outright for five months now) and the Fed will benefit from any increase in their value. In fact, the TSLF is reported on H.4.1 as an off balance sheet item.
Brad,
You wrote, “Howard, yes, housing prices may fall further. but in absence of mortgage credit (now essentially provided by the agencies) they would fall a lot further”
Again, I agree. But we need to do a cost benefit analysis here. Separate ones could be performed for the short-term and for the long-term. In both cases, the loans from foreign governments are destructive.
In the short-term, during a recession, every loan from a foreign government causes the dollar to rise in currency exchange markets, and thus causes increased US unemployment, especially in the US manufacturing sector.
In the long-term, no case whatsoever can be made for borrowing from abroad for anything but investment. But, stabilizing house prices will not increase investment in new construction given the glut of reposessed second and third houses on the market.
Don’t forget that when Clinton started the housing bubble in 1998 through his 1997 tax change, his new treatment encouraged building of second and third homes by making their sale free from capital gains taxation.
(see for example http://tradeandtaxes.blogspot.com/2008/09/how-bill-clinton-caused-current-housing.html and http://tradeandtaxes.blogspot.com/2008/09/vernon-l-smith-held-back-in-december.html ). Now there is a glut of second and third homes on the market. No matter how much we stabilize the housing market, there will not be a boom in new house constuction for quite some time.
Howard Richman
http://www.tradeandtaxes.blogspot.com
RebelEconomist,
I think you are extrapolating from the current situation to make an overly general argument when you argued that Treasury debt should always be used to finance asset purchases “(which is why I disagree with Howard Richman that ‘mercantilists’ messed up the US; it was the US government’s choice not to match the reserve capital inflows with assets).”
The goal of Paulson’s asset purchases of preferred stock in American banks was to borrow money from foreign governments at less than 5%, then lend it to American banks at 5%, so that they would lend it, presumably to American investors. The only reason that this is at all a profitable is because the U.S. government has a better credit rating right now than U.S. banks.
Some of this money may result in investment, some of it will result in increased consumption of imports. To the extent that it results in investment, it is good. To the extent that it results in increased consumption of exports it is bad.
There is a general principle that makes much more sense: When loans from abroad finance *investment* they lead to long-term growth. When they finance *consumption* they are paid for in reduced future income.
Howard
Twofish notes that contracts are being voided today via bankrupcy. As long as this process is confined to mortgages, each event is small potatoes. But what if bankrupcy is the way that the contracts are modified or voided for credit default swaps and other instruments sold between finanical institutions? All hell broke lose because the bankrupcy of Lehman’s impacted the market for commercial paper.
Some other solution is needed for these more complex and more expensive contracts.
ReformerRay: Twofish notes that contracts are being voided today via bankruptcy
What is happening is that contracts are being renegotiated by people just not paying. If someone is late or stops paying their credit card bills or mortgage, that’s rewriting the contract.
ReformerRay: But what if bankruptcy is the way that the contracts are modified or voided for credit default swaps and other instruments sold between financial institutions?
You need to make sure in that case that the financial institutions are will enough capitalized so that this doesn’t happen, which involves a government injection of capital into those institutions and having those institutions save up cash so that they can execute those contracts.
The morons at the Bernanke Fed just don’t get it. So far, the massive US government debt from the banking bailouts have caused mortgage rates to keep going up, almost at 7% now if not more. Mortgage defaults will skyrocket further upwards !!!!!
—–
Fed may cut to 0% interest rates
http://www.cnbc.com/id/27236152
U.S., European and Japanese interest rates need to be slashed to practically zero if there’s any chance of a market recovery, Roger Nightingale, strategist at Pointon York, told CNBC Friday.
“I’m not talking about 50 basis points … we really have to take rates down to effectively zero,” Nightingale said, pointing out that U.S. rates “got down to one percent in the last recession and that wasn’t a bad one.”
“The Europeans have to go to zero, the Brits have to go very close to zero, the Japanese of course haven’t got much room, they certainly have to go to zero,” Nightingale said, adding that even zero might not be low enough for the U.S. to escape a deep, protracted slump.
Another good analysis
http://www.econbrowser.com/archives/2008/10/balance_sheet_o.html
Some entertainment for a Friday morning. This is a youtube take on a Greenspan interview promoting his book that he got a $10M advance to write.
Greenspan tells us that the problem with the American economy is that we are stupid, and if we learn something, we make too much. Very enlightening, I think.
http://www.youtube.com/watch?v=62DtPMskSk4&feature=email
Rebel is correct.
Financing asset purchases is vastly different than financing expenditures or tax cuts.
The corollary is that financing asset purchases has no direct effect on the requirement for net capital inflows.
Both aspects are the subject of great confusion in the current election dialogue around fiscal policy, and will probably continue to be so following the election.
RebelEconomist: Sorry to sound like Twofish, but I am actually less worried about the latest increases in US government debt than in previous years.
It’s interesting that there has been a role reversal, since I’ve become very alarmed at the latest increases in US government debt than in previous years.
RebelEconomist: As Brad’s charts show, the recent increases in Treasury debt are being used to fund asset purchases rather than tax cuts or wars
The trouble with that is that those assets are likely to be not worth what they were paid for, which leads to disguised losses down the road.
RebelEconomist: The key to maintaining US government solvency is not to overpay for the crud that they are buying.
Governments are not solvent since they don’t have balance sheets. Nation-states have to remain solvent, but a transfer of debt from banks to government doesn’t change the national balance sheet.
If Treasury is not overpaying for mortgage securities, they what in goodness name is the point of the government buying those securities? If those securities were actually worth something, you could structure this as a loan or sell them on the private market.
The fact that the government is buying securities means that they aren’t worth much and that you need to put in money into the banking system.
RebelEconomist: If they can avoid that, they might even end up making money.
I don’t think so. Again, if the government ends up making money that defeats the whole point of the program which is to recapitalize the banks.
http://www.counterpunch.com/
Secretary of the Treasury Henry Paulson’s $700 billion bailout plan was opposed by over 200 economists.
Half of the money allocated by Congress is being given to many of the same Wall Street giants that are directly responsible for the current implosion of the financial system. Doesn’t this confirm our worst fears about Paulson, that he is merely a banking oligarch who serves the interests of the financial industry?
Robert Pollin: Paulson is a Wall Street man—and Goldman Sachs man, more specifically—through and through. There was never any doubt about that. He will always do his best to serve his Wall Street constituency.
Mark Twain has a funny story about a bluejay trying to fill up a house with nuts through a tiny hole in the roof.
DJC just posted a link to a story that the Fed and the European central banks are planning to cut interest rates to 0% in an attempt to do something equally impossible. Their goal is to prevent a worldwide depression by further reducing American and European savings so that Americans and Europeans will buy even more from Asia using Asian credit.
They are correct that the worldwide depression is being caused by an excess of investment over savings in the world at large, however that excess is *not* in Europe or America. The problem *is* that there is too much savings in Asia.
America and Europe could easily balance savings with investment in their own economies if they quarantined the Asian depression by balancing their trade through Import Certificates ( http://money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm ).
Howard Richman
http://www.tradeandtaxes.blogspot.com
Chinese government Newspaper comments on US Financial fiasco:
http://www.theglobeandmail.com/servlet/story/LAC.20081017.CHINA17/TPStory/National
From Official Xinhua News Agency:
“The financial crisis was evidence that China should not “blindly embrace” liberalism. Many of the problems of the free-market system have been fully exposed,” said a commentary in Xinhua, the state news agency. “China should take a lesson from the American crisis and be cautious.”
From Ta Kung Pao, a newspaper in Hong Kong financed by the Chinese Communist Party:
“China should no longer be sympathetic and kind toward the United States at this rare moment,” said a commentary this week in Ta Kung Pao, a newspaper in Hong Kong with close links to the Communist Party.
“It should seize the opportunity to teach the United States a lesson,” the newspaper declared. “At the very least, the United States should be made to suffer a little bit more, so that it will learn to be more modest and prudent in the future and treat other countries as equals.”
Since the United States could need financial help from China to get out of its crisis, China should use the chance to extract American concessions on key political issues such as Taiwan and Tibet, the newspaper added.
Richman: Their goal is to prevent a worldwide depression by further reducing American and European savings so that Americans and Europeans will buy even more from Asia using Asian credit.
No. Their first goal is to prevent a worldwide depression by insuring that the banks don’t go bankrupt, and people don’t lose their jobs and life savings.
To DJC: No matter how much your neighbor annoys you or how badly they treat you, it’s not a good idea to laugh when their house is on fire, because the fire will spread to your house if you don’t help them put it out.
It’s also particularly stupid to laugh at someone’s economic misfortune, if they happen to owe you lots of money…..
Howard,
You are extrapolating my comment to infer that I said “always”. I did not. I do think, however, that if a nation’s private sector is consuming its way into a dangerous debt burden, then the government can compensate on behalf of the nation by saving more itself. I think the US (and the UK – I am not anti-American) failed to do so for two reasons. One, that the politicians are happy to let people believe that they deserve their prosperity. And two (less so in the UK case), Americans have an irrational aversion to government intervention in the economy (at least, that is, until they start losing).
Unless the US current account increases as a result of the TARP etc, the US is not (at the margin) borrowing from foreign governments to lend to Americans. It is selling safe debt to US investors and buying risky debt from US investors. In fact, if they took this to its logical conclusion, they could just swap government debt for crud, in which case the government debt never hits the market, as in the UK’s Special Liquidity Scheme.
Article about bankers getting honest and confirm that they will sit on the bailout money for quite some time, rather than try and lend it. So it looks like Fed reserves should continue to increase.
So I think we are getting closer and closer to solving deflation, Japanese style. Which would be ZIRP and quantitative easing to hammer down long rates and get those houses selling again.
The Fed is getting rich from this bailout and now can even BUY long term treasuries at Treasury auctions and push long rates down without going to the printing presses. The big benefit is the treasury can spend the money some way besides giving it to a bank.
But you may say “Isn’t this like a proton going one direction and an electron going the other, and the opposite charges just cancel out?”
Sort of, except we have more control over what we do with the money. And if the Fed wants to run the printing presses and push down those long term rates, and give lots of money to the treasury, for say, down payment certificates on houses, we could really get things moving.
http://finance.yahoo.com/tech-ticker/article/97314/Banks-Admit-Bailout-Won%27t-Work?tickers=mer,jpm,xlf,%5Egspc,%5Edji,c
Twofish,
The top Chinese leadership really isn’t too worried about the “US financial fire” spreading across the vast Pacific Ocean. What’s the big deal? Net exports to the US Economy probably amount to 2-3% of China’s GDP.
LOL.
From Asia Times,
http://www.atimes.com/atimes/China_Business/JJ18Cb01.html
China confident in financial storm
HONG KONG – The continued growth of China’s foreign exchange reserves, which reached a record of more than US$1.9 trillion at the end of September, is boosting the country’s confidence that it can maintain stability as the international financial crisis widens and deepens.
China’s not fully convertible currency, its huge foreign reserves and relatively fast economic growth have formed a great barrier against the financial troubles elsewhere, Justin Yifu Lin, the World Bank’s chief economist and senior vice president, said recently.
Chinese Premier Wen Jiabao said, “We have full confidence in China’s economic development and financial stability,” stressing that the most important thing is “to do our own business well”, maintain the stability of the economy and the financial and capital markets. “It is the biggest contribution to the world when a big country with a population of 1.3 billion is able to maintain a lasting, smooth and fast economic development.”
Wang Qishan, the vice premier overseeing the country’s finance, said on Thursday the country is fully confident and capable of overcoming current economic difficulties.
Twofish,
You wrote, “No. Their first goal is to prevent a worldwide depression by insuring that the banks don’t go bankrupt, and people don’t lose their jobs and life savings.”
If the problem is only financial, and not falling worldwide demand, how do you explain the falling price of oil on world markets?
Howard
Setser’s addendum points out that sovreign wealth funds are in the market for profit. There is no obvious reason for them to have what Warren Buffet called a “pro bono moment”.
That said, sovreign wealth did make offers to recapitalise Western banks. Think of the Koreans willing to deal with Lehman shortly before it went into Chapter 11, the Chinese bid for Dredener Bank (etc., etc.). The problem was that the Westerners would not accept the terms offered; terms that we now see were clearly “the market price”.
The stock markets are where they are. We can safely assume that some parts of sovreign wealth are now actively considering moving out of Tresuries into equities – following Warren Buffet’s example. They may yet buy a few of our banks.
RebelEconomist,
I apologize for extrapolating your comment to infer that you meant “always”. I stand corrected.
You are also correct about part of the TARP when you wrote: “[The US government] is selling safe debt to US investors and buying risky debt from US investors.”
However, you were *not* describing the whole TARP. This week $250 billion was allocated to buy preferred stock of American banks. That part of the TARP was simply borrowing from abroad to lend to American banks.
Also, don’t forget that the U.S. Senate tacked on to the TARP an additional $150 billion giveaway that was borrowed from abroad to be given away to Americans.
Now, Nancy Pelosi is advocating that another $300 billion stimulus package be passed in time to get the current congress reelected.
Indeed, a key question is how much the TARP (and the other give-aways that it is engendering) will drive up the current account deficit. I predict that it and the additional give-aways that will occur will drive up the U.S. current account deficit as a proportion of our GDP.
I know that many economists predict that the current account deficit will shrink, just as they have been incorrectly predicting for years. They have never understood the forces at work that increase the deficits.
For example, contrary to their theories, the US current account deficit hardly even shrank during the last two years when the United States economy was slowing down while the rest of the world was growing rapidly!
Howard Richman
http://www.tradeandtaxes.blogspot.com
[...] playing around with this data set. Over at the Council on Foreign Relations, Brad Setser has an important analysis [5] of these trends. This is an interesting way to approach the set. Starting one year [...]
It would seem that somewhere, somehow, if total net debt (not just Federal Debt) keeps rising faster than production (Real-GDP), the burden of interest charges at some point now indefinite and unknown, but nevertheless real, will become too great to carry.
The Fraudacity Of American Finance
I just had to coin a new word.
Audacity + Fraud = Fraudacity.
John Mack yesterday in a CNBC interview said that the capital deployed by Treasury into the banks was going to rebuild their capital ratios – not be lent out. In other words, they intend to hoard it.
This means, bluntly, that not one nickel of benefit will be seen by Main Street, despite claims by Paulson, Bush and others that this bailout is necessary for “Main Street, not Wall Street.”
Liars.
Never mind that Bloomberg is reporting that the so-called “executive compensation limits” that Paulson is touting mean little or nothing:
“Oct. 15 (Bloomberg) — Goldman Sachs Group Inc.’s Lloyd Blankfein, whose $70.3 million paycheck made him Wall Street’s most highly compensated chief executive officer last year, could still earn tens of millions annually under the bank-rescue plan run by his former boss, Treasury Secretary Henry Paulson.”
Very nice. So the taxpayers hand out billions and the executives still rake it in.
Where is the accountability?
CNBC’s Fast Money finally started talking about the outright fraud and lies last night. Dylan Ratigan was absolutely on fire about the fact that Paulson was in fact one of the executives lobbying hard for removal of leverage limits in 2004, just two years before he took the position at Treasury (and cashed out $500 million in Goldman Sachs stock tax free.)
I and a few others have been peppering the media with this, and finally, someone woke up to the fact that the very same people who made this mess now want we the taxpayers to pay for cleaning it up – after they ran off with all your money!
Never mind that its unlikely to work.
Nor does it stop there. AIG continues to draw on their “credit line” with The Fed. Inquiring minds want to know a few things here, chief among them being why suddenly is there $80 billion of hard money required in a business that is “fundamentally sound” in excess of cash flow, and where that requirement did not previously exist.
I’m suspicious as hell on this one guys, and my suspicion generally points in the direction of Lehman’s Credit-Default Swaps.
The claim by the DTCC and ISDA is that the total “actual exposure” is somewhere in the area of $6-8 billion once all the contracts have netted out.
Richman: You wrote, “No. Their first goal is to prevent a worldwide depression by insuring that the banks don’t go bankrupt, and people don’t lose their jobs and life savings.”
Richman: If the problem is only financial, and not falling worldwide demand, how do you explain the falling price of oil on world markets?
A month ago, the world financial system was in serious danger of completely collapsing, making whatever is going on with the price of oil or overall demand to be very minor issues. I think we’ve gotten out of that danger.
Once you’d gotten the financial system into some sort of stability then you can worry about the other issues, but if you have a situation where you don’t deal with the sudden financial crisis then dealing with the long term issues is pointless.
This is an important point because sometimes, and in fact quite often, you have to do something short term that is very long term damaging and I think that what Treasury and the Fed have done will have very bad long term impact on the US economy. But it’s not as if they had much of a choice.
DJC: The top Chinese leadership really isn’t too worried about the “US financial fire” spreading across the vast Pacific Ocean.
They should be. The moment you stop worrying, you get overconfident and arrogant, and if you get overconfident and arrogant, you start making stupid mistakes.
One big problem is that the US owes China about $2 trillion in debt. If the US has problems paying this debt then you are looking at some massive losses. Another problem is that China has an internal bad debt/real estate problem. It’s unconnected with the US issue, but the US is an example of what can happen if you lose track of problems.
DJC: What’s the big deal? Net exports to the US Economy probably amount to 2-3% of China’s GDP.
However, the important number is the number of jobs that this provides, and the PRC will have to likely provide some fiscal stimulus to make up for job losses.
What worries my in the 20 year horizon is that if the US economy stagnates, then people aren’t going to have much in the way of 401(K) for retirement. This means that the US is going to have massive demands on government at exactly the same time, China needs to cash in its bonds for its retirees.
DJC: The continued growth of China’s foreign exchange reserves, which reached a record of more than US$1.9 trillion at the end of September, is boosting the country’s confidence that it can maintain stability as the international financial crisis widens and deepens.
The $2 trillion is a good thing in the context of the current crisis, but over the next ten years, I think that this $2 trillion is going to turn out to be a big liability, since most of it is dollar denominated, and if the US economy stagnates, then it’s value is going to erode.
China is in relatively good shape, but that’s not a reason to laugh. Success is better than failure, but it brings with it’s one headaches and challenges.
What *will* to happen is that China is eventually going to get overconfident and the Chinese economy is going to fall apart. My goal is that this happens in 100 year from now rather than in 6 months.
brad/other,
Comment on the comment by several whoa are calling for fund to zero and punsihing depositors? Would not the logical and rational move by everyperson to pull their money from the banks which pose a credit risk and buy treasuries or agencies or commercial paper or sub debt (which in theory, should all now converge to treasury plus whatever premium)?
The idea of going to a ZIRP is very scary. Those advocating it to scare people itno risky assets are ignoring the systemioc risk it poses.
TwoFish,
You didn’t answer my question. I asked, “If the problem is only financial, and not falling worldwide demand, how do you explain the falling price of oil on world markets?”
Here’s another question for you: If Paulson were primarily worried about saving banks from bankruptcies, not declining world demand, why did he just buy $250 billion of preferred stock in healthy banks?
Howard Richman
http://www.tradeandtaxes.blogspot.com
Twofish,
China’s doesn’t have an internal bad debt/real estate problem. Down payments of 20-30% are still required. The subprime mortgage problem doesn’t exist in China thanks to proper financial regulation by the PBoC. Even during the Hong Hong real estate bubble meltdown during the late 1990’s, mortgage defaults were rare. Most Hong Kong condo flat owners still paid their monthly mortgages despite being underwater in equity.
Not all of the $1.9 trillion of China’s foreign reserve are in US Dollars. We don’t know the exact composition since it remains a state secret, but it is estimated by independent sources that 60-70% are in US Dollars. The China PBoC has previously stated that it would diversify its reserve holdings into Euros, Yen, Ruble, Ringit, pounds which hedges its foreign reserve portfolio.
Twofish:
Answered some of your questions at my new blog page today:
http://theworldoffinanceblog.blogspot.com/
Chidambaram
Brad,
Does the reduction in outstanding oil futures have any effect on the dollar?
Richman: If the problem is only financial, and not falling worldwide demand, how do you explain the falling price of oil on world markets?
I didn’t say the problem is only financial. There are about four or five different things that are going on, and you fix the problem with the most likelihood of damage. There is a problem with falling demand, but that’s not the really, really scary problem. Falling demand is relatively easy to fix. The harder problems are 1) broken financial system and 2) misallocated resources.
Richman: If Paulson were primarily worried about saving banks from bankruptcies, not declining world demand, why did he just buy $250 billion of preferred stock in healthy banks?
Because if the credit markets are still functioning you can deal with the problem of bankrupt banks over a period of months. If you don’t have liquidity in the system, then you are forced to deal with the problem in days. A bad economy and frozen credit markets puts a lot of strain on bad banks.
Putting money into good banks gets some money into bad banks which keeps them alive long enough that you can shut them down in an orderly way. Liquidity is like oxygen, it keeps the patient alive long enough that you can do open heart surgery.
We haven’t even begun the massive restructuring of the financial system.
TJ: China’s doesn’t have an internal bad debt/real estate problem.
Yes it does. There is a $200 billion problem with the rural cooperatives, and a real estate bubble that is in the process of collapsing. The economy downturn and lack of construction causing ripple effects in the concrete and steel industries.
I don’t think that the problems are unmanageable. But denying that problems exist when they do is how the US has gotten into this mess, and it’s one thing that the Chinese leadership has usually not done. You want to deal effectively with problems when they are small, because not dealing with a small problem turns it into a big problem.
TJ: Down payments of 20-30% are still required.
For residential mortgages yes. Not for construction loans. Also, one worry is that people get down payments from informal sources.
TJ: The subprime mortgage problem doesn’t exist in China thanks to proper financial regulation by the PBoC.
Maybe. But there are different problems. The PBC has done a much better job than US regulators in keeping the bubble under control, but success is not an excuse for complacency.
It’s not clear to me that in the end that the volume of bad loans in China will be much worse than the volume of bad loans in the United States, but Chinese banks have a cash cushion which US banks do not.
TJ: Even during the Hong Kong real estate bubble meltdown during the late 1990’s, mortgage defaults were rare. Most Hong Kong condo flat owners still paid their monthly mortgages despite being underwater in equity.
So what? Mortgage defaults in the US were rare in the 1990’s, which is why it caused people to be complacent about them.
Personally, I’m not too worried about mortgage defaults in Shanghai. What I am worried about are construction loans.
Richman: If the problem is only financial, and not falling worldwide demand, how do you explain the falling price of oil on world markets?
Dr. Richman: here’s an interesting link on this topic:
http://www.bloggingstocks.com/2008/08/21/speculation-accounts-for-81-of-oil-trading-volume/
twofish : “Contracts should be less sacred than private property ownership.”
google : ‘tulip mania.’ in 1637 the dutch government declared all tulip contracts to be options contracts voidable for a 10% fee.
twofish : “Contracts should be less sacred than private property ownership.”
I don’t remember saying that, and I certainly don’t believe it Contracts and private property ownership are only social conventions, and if it solves a financial problem, I have no ideological objection to changing them.
If cancelling all CDS and derivative contracts would solve the current economic mess then sure, it’s a wonderful thing, but I don’t think that it would.
Twofish,
Where’s the evidence of a “construction loan default problem in China?
From the Wall Street Journal writes:
http://online.wsj.com/article/SB122417825608241207.html?mod=googlenews_wsj
Despite the global credit crisis, China appears to be a bright spot. The economic fundamentals are still very strong in China.
Analysts say China’s gross domestic product, a broad measure of economic growth, is expected to hit about 10% this year and 9% in 2009 — a drop from the 11.9% the country achieved last year but still high by global standards.
“We still see every day Chinese taking vacations and spending their money,” Shaun Rein, managing director for China Market Research Group says. “They don’t see any fear from the global slowdown.”
It’s amazing how much money those Chinese can spend with average incomes of $2,800 per year, and with 300 million of them living on a dollar a day.
twofish : apologies – it was reformer ray who i was quoting.
may be off topic, may not be -
does anyone know if warren buffet is a republican ? or does he just have a fantasy of being j p morgan 1907 ? or is he just relentlessly investing long term, as ever ?
and can anything recover fully until we all know where that gi-normous black hole of negative equity is hidden, and who is to be left holding the parcel ?
Does anybody see any signs that the People’s Bank of China is easing up on its tight credit policy?
TJ: Where’s the evidence of a “construction loan default problem in China?
There isn’t one yet. The thing about problems is that it’s best if you worry about with them *BEFORE* there is a problem, and if you worry about a problem before it becomes a problem, you can keep it from being a problem.
Chinese banks have been ramping down the volume of loans to construction companies over the last year because of default worries. But this means that companies up the supply chain (steel and concrete) companies are likely to be stressed. We’ve already had one major steel manufacturer in China go bankrupt and there are likely to be more. Earning in corporations are going down. A lot of corporate earning will turn out to be fluff, and we shall see what fraction of that is fluff.
Now I don’t think any of this is going to become a crisis, because people have been worrying about them.
TJ: “We still see every day Chinese taking vacations and spending their money,” Shaun Rein, managing director for China Market Research Group says. “They don’t see any fear from the global slowdown.”
But consumer sentiment can turn negative very quickly, and once things start falling apart, it’s a bit too late in the game to do very much.
Richman: Does anybody see any signs that the People’s Bank of China is easing up on its tight credit policy?
It’s been part of the coordinated global cash drop. PBC reduced its reserve requirements and cut its interest rates when all of the other central banks did.
LB,
“michael (or anyone), has there ever been a period in economic history anywhere with high inflation AND high interest rates?”
How quickly we forget!! Or, maybe some of you guys are just too young to have witnessed it directly. The period from 1975 through 1980 saw inflation increase a cumulative 48% while (10 year bond) interest rates increased a cumulative 73%.
During the decade preceeding the big ’70s run-up in inflation, the leading economic lights on the Fed and in academia proudly assured everyone that the business cycle was completely mastered and inflation was a thing of the past, because we now knew how to control the money supply (which was alleged to be the only determinant of inflation/deflation). In fact, the bond market was driving interest rates up because of excessive credit expansion long before the Fed finally capitulated to the reality of inflation and raised the Fed Funds rate to matching levels in 1980.
Some people believe the “oil shock” of the first OPEC embargo (1973) and later Iranian crisis (1979) to be the “cause” of the hyperinflation of that period, but in fact inflation was already rising so fast (though the total level was low by today’s standards) by 1968 that Nixon took the drastic (and unsuccessful) step of imposing wage and price controls!
Credit does not operate in a free market anywhere, just like any other component of economic life. Not only does “financial innovation” (going back to the invention of paper money, the creation of bank notes, the development of fractional reserve banking, and so on, right up to equity margin accounts, leveraged loans, credit securitization, counter-party hedging, and mathmatically-modeled risk calculation) keep expanding credit supply in uncontrolled ways, governments try to manipulate the money supply, control the rates of interest and of credit expansion/contraction, and do their own borrowing and lending just like everyone else (but on a scale that disproportionately affects credit supply and demand).
Historically, the net outcome is that whenever there is an aggregate credit expansion that exceeds the expansion of aggregate goods and services, the credit risk for lenders is proportionately increasing and the rate of return (aggregate interest rate) should proportionately increase. Anything (government action, miscalculation on the part of lenders, a general societal euphoria that believes we have created a “new paradigm” and entered a lasting “Great Moderation”) that underprices risk will move interest rates below their free-market location on the risk-return curve and set up a (potentially rapid) return to equilibrium through increasing rates.
at this point our gigantic underlying problem – the “cause” of our current crisis – is that since 1982 aggregate debt has climbed to 350% of GDP, which indicates that interest rates should be in the double digits; but as they were suppressed by many forces for a long time, the distortion kept getting worse, and now the contraction underway is unstoppable.
Other rates, such as mortgage rates, credit card rates, car loans, corporate debt, municipal debt, etc, can rise and all you have to worry about is how bad and how long the recession/depression will be until we’re back where we “belong” on the risk-return curve. However, as Brad understands, it will be a whole new movie (”Apocalypse Now”) when Treasury rates start their inevitable climb.
Gillies: Warren Buffet has endorsed Obama and is a Democrat.
i think they will lend when they see that the prices for homes is where they want them and have shaken out all the speculators and weak investors-what needs to happen is to give first time home buyers 30 year fixed home loans at 3% APR to soak up all the oversupply of housing inventory-this needs to happen worldwide-and not give home equity lines out so freely-that way it keeps equity in the house instead of spending it creating more debt and inflation pressure’s…even though greed keeps them(the banks) lending need some controls on peoples greed somehow as to restore sanity to all markets.
«This is an excellent post, portraying two ships passing in the night – the world heading for treasuries and the Fed heading for risk.»
But this is quite crazy. The world is heading for risk too, just a different type of risk: currency risk.
Now, how is this going to play? Well, it largely depend son whether the USA can engineer hyperinflation when things get bad or not.
If people are investing in Treasuries and the Treasury is investing in domestic and foreign private IOUs, there are two possible outcomes, which may both happen, and one after another:
* The USA end up in a deflation. The dollar goes way up, the dollar denominated creditors win big, the Treasury gets in deep trouble owing lots of dollar denominated debt backed by the full faith and credit of the USA, and with lots of local and foreign denominated currency securities that are backed by empty homes in the California and Arizona deserts and on the Costa del Sol and around Dublin and London.
* The USA gets into high inflation, the foreign creditors get wiped out by the currency risk they have willingly incurred, the treasury credits are bailed out by a massive increase in nominal income, and the bubble rekindles.
Guess what?
Now, a lot of people here don’t seem to understand that this is the first time in a very long time that the USA owes most of its debt to foreigners — and when this last happened the world and the USA were very very different places (and most of the debt was private).
Please remember: the USA debt is safe *only* in nominal terms. USA treasuries and their repayments are a shell game between the Treasury (they create IOUs) and the Fed (they create dollars).
Blissex,
You’re right.
It might have read “the Fed is headed for credit risk”.
Or, while continuing to be exposed to foreign exchange risk, the world is attempting to reduce risk in other ways, while the Fed is seeking to take it on.
“Indeed, our ability to address our current economic difficulties (through both financial market interventions and potential additional fiscal stimulus) would be severely impaired if investors were not so willing to invest substantial sums in Treasury securities without charging much higher interest rates.” –peter orszag, director of the congressional budget office
re: “the USA owes most of its debt to foreigners” – for treasuries, but it’s only about 15% of total debt (still a record, on record amounts of a near record percentage of GDP, and in dollars, but still*
so it should come down to whether the ‘investments’ and ‘assets’ the treasury is borrowing to buy pan out, wrt the interest rate investors in treasury securities demand…
unfortunately (or fortunately rather!?) that depends on what happens in the real economy in real time, as opposed to the “virtual” world
cheers!
—
*Lombard: The US bail-out explained
If you owe the bank $10, it’s your problem. If you owe the bank $10m, it’s the bank’s problem.
If you and a million others owe the bank $10 each, it’s still your problem – but it’s also the bank’s problem.
If the bank then sells to an investor the $10 you owe, it ought to be the investor’s problem.
But if you have a problem repaying the $10 – and so do a million others – it’s both the investor’s problem and the bank’s problem.
Your problems and the investor’s problems mean the bank now owes another bank $10bn. That is both banks’ problem. But if neither bank will pay the $10bn it owes the other, it can quickly turn into a $700bn systemic problem.
And if the government then owes the banking system $700bn, it’s your problem.
“Now, how is this going to play? Well, it largely depend son whether the USA can engineer hyperinflation when things get bad or not.”
but extracting $700b, ultimately from taxpayers, to dump into a deep hole of negative equity, in a vain attempt to fill it – is the opposite of inflationary.
if the way things are headed right at the moment holds – a barackish, buffetish, volckerish direction – we are in for a long hard road.
meanwhile, do not put it past bush to default, or to engineer some form of debt rescheduling that is a disguised form of default.
if i were sarkozy i would demand the next ‘bretton woods’ be held in paris, to be symbolic of a change from unilateral to multilateral global financial arrangements.
I think they will go to a basket of currencies approach. The only practical problem being it is convenient to have a single currency for global exchange. So this would be create the need for a new global exchange currency. This would be layered on top of a basket of major currencies. When exchanging it to local currency, you get an exchange rate equal to how well your currency is performing vs. the basket.
It should be pegged to the yuan, since we know the Chinese will not willingly participate.
Then we should call it the Yollar, which would comfortably distance it from being perceived as just another dollar, and also be as good as yuans.
Problem #1
There is by definition no actual trade flows to set the value of local currencies vs the Yollar……..
A couple of points:
One, if you think of a Treasury strip as a dollar with a “not valid until” date – ie, if you treat it as risk-free, as the market generally does – the meaning of financing the bailout with short rather than long debt becomes obvious.
The limit or reductio ad absurdum of this strategy would be to finance with zero-term Treasuries, ie, dollars – ie, do it by printing money. The use of two-year bonds is thus, as others have pointed out, a relatively minor concession in favor of sterilizing the bailout.
The risk of near-term price inflation is minute, because adding trillions to M0 cannot possibly counterbalance the asset-price deflation that is happening right now. But in the long term, the trouble with replacing credit expansion with fiscal expansion is that the fountain of fiscal expansion, once started, is politically very difficult to turn off. Markets are thus much better at anticipating it, and a whole new form of monetary chaos emerges – ’70s style, as Michael points out.
Two, the spread between Agencies and Treasuries is fascinating, as the distinction is blatantly superficial at this point. The reason Treasuries are “risk-free” is not USG’s glowing fiscal health, but Fed’s ability to issue arbitrary quantities of dollars. This informal guarantee has precisely the same form for Treasury as for Frannie – and the two have, if anything, converged as spreads have widened. If nothing else, this illustrates that 800-pound gorillas don’t have to be rational actors.
«continuing to be exposed to foreign exchange risk, the world is attempting to reduce risk in other ways, while the Fed is seeking to take it on.»
Not quite — that may be what they think but what is really going on is lower vs. higher risk, but political vs. market risk.
This is because nobody wants to invest in the markets, so as we all know they lend their money to the USA (accepting political risk) and the USA lends that money to the markets (accepting market risk).
It is tempting to conclude that political risk is lower than market risk, especially if it is the political risk of the USA, but there is a first time for everything…
«but extracting $700b, ultimately from taxpayers, to dump into a deep hole of negative equity, in a vain attempt to fill it – is the opposite of inflationary.»
Well, a lot of Usians and even foreigners have to adapt to a globalized world. For example, years and years of zero to negative real interest rates in the USA and Japan and the UK should have sparked a colossal investment and job and inflationary boom — hey, it did, in China and India…
Also, it matters a lot on *when* things happen. So the $700b+ (as well know the actual limit is a log higher) is being extracted from *foreigners* now. So it may have a vast deflationary effect in China, Japan and the Gulf, but it has a vast inflationary effect in the USA.
The big deal then is what is the effect when the vast debt has to be repaid — never or sooner than never. But that is years down the line. Hopefully for the USA.
Also, there is the question whether it is sufficient. And whether there are enough liquid foreign savings to support the newly expanded USA borrowing requirements:
http://declineandfallofwesterncivilization.blogspot.com/2008/10/ubs-cs-bolstered.html
«American total debt, unlike that of any other nation-state, is large in relation to the absolute pool of global savings which can fund it. on an annual basis, the rate of increase in american debt has effectively consumed 100% of the rate of global savings — in other words, the rest of the world is operating on a balanced budget at an equivalent surplus.
given that, and given further that the american government is set to wildly expand its borrowing rate — a deutsche bank report i saw excerpted by menzie chinn at RGE admitted the possibility of new issuance of treasury debt exceeding $3.3tn to fund government — over the next fiscal year!
the float on gov’t debt currently is just $5.9tn or something [$10tn less $4tn "owed" to entitlement programs like SSA by the general fund] — but (shockingly) it’s not just that they’re expanding the gov’t debt by a thoroughly-argentinian 50% in one year.
they are talking about borrowing from global savings an amount that cannot be borrowed. it can not happen. if anything, the american current account deficit that would theoretically finance this will contract, not expand, as international trade slows with global recession.
so what is the consequence? as far as my meager reasoning can reveal, government will force the liquidation of domestic private debts, hoarding all domestic savings — compelling savers not only to shun new corporate and individual credits in favor of treasuries, but to liquidate existing loans granted to corporate/individual parties to transfer assets to treasuries. and they’ll end up paying whatever rate is required to get that done.»
Please everybody remember that the big story is that a colossal surge of credit/M3/… made the USA housing inventory, probably the largest in the world, go from $8-9t to $18-20t in 10-15 years, and with negative real interest rates a whole lot of people borrowed against their capital gains, which have now largely vanished.
Bernanke has kept disingenuously talking about of a “global savings glut” in the past years. Now the question is whether there are enough actual savings in the world to cover that gap.
Note: the “savings glut” was mostly China (and Japan) effectively underpricing their exports to the USA and capitalizing the difference, thus keeping the dollar high.
bsetser: Warren Buffet has endorsed Obama and is a Democrat.
Also Obama is getting tons of money from Wall Street. Obama is far, far more the candidate of Wall Street than McCain is.
There is an interesting fact which is that, rich people don’t mind paying more taxes. If you are in the financial industry you come face to face with people with frightening large amounts of money and paying more taxes something they can easily afford. It’s also wildly inconsistent to be “anti-class warfare” one second and to bash “greedy Wall Street bankers” the next. Wall Street is all about greed, but the culture of Wall Street is the idea that if careful regulate things then greedy people end up doing things that are socially useful.
The people that are really anti-tax are not the rich people, it’s the “wannabe rich” and the promise of the Republican Party is that we cut your taxes and have less regulation, you too can be rich. The trouble with this is that this made sense in 1980, it makes no sense today.
Michael: at this point our gigantic underlying problem – the “cause” of our current crisis – is that since 1982 aggregate debt has climbed to 350% of GDP, which indicates that interest rates should be in the double digits; but as they were suppressed by many forces for a long time, the distortion kept getting worse, and now the contraction underway is unstoppable.
Maybe it’s not that bad. One thing about finance is that at some point you have to stop looking at finance and look at the “real world.” One has to remember that the financial system is only a mechanism for transmitting wealth, and to see if there is wealth generated, you have to look at the real world.
Since 1982, there have been major advances in science and technology and people have been made immensely richer by things like computers and the internet. You’ve also seen China and India start actually developing and that also generated a large amount of wealth. It’s living off these sources of wealth that has propped up the system.
The problem since 2000 in the United States, has been two fold. One is that the wealth generated hasn’t been particularly well distributed. The second is that a lot of the wealth has come from China, India, and the Middle East, and at some point they are going to want their money.
Blissex:
That indeed sounds like the case to me. And I’ve been listening to gold bug rants on and off since the late ’70s. But now I really do believe we have taken credit expansion as a means of supporting the economy, fiscal spending and fiat currency to it’s limit.
So now we are faced with inflating out of the situation, or defaulting out. Most likely a combination of both.
We will have some deflation first. Well, we already are in housing. And also have deflation’s effect of ripping up the underlying capital structure.
Then we will try and fix that. Well, we already are… recap the banks, attempt to re-inflate housing. Not really working yet. So we get more deflation there.
More government support needed. The rest of the economy may catch cold, and that would be bad for employment and tax receipts. Well, already happening.
The USG needs to go to ROW for financing. Well, been there, done that.
The USG may get it from a tanking stock market, with investors accepting negative real returns and at least getting a promise of seeing nominal dollars someday.
ROW needs financing too. At least something new.
Will it be enough…can’t get financing. But there is a printing press…….or default maybe? But will we ever be able to borrow again, and what would that do to our money???
But at least we have the USG to figure out the answers to these questions.
PS.
However , I am an optimist.
I have a nude Alan Greenspan poster in my bedroom, created by Don Luskin, and produced by Kudlow & Co.
Don’t sell capitalism short. It’s illegal !!!!!
Twofish,
Excellent point. In fact, the case can very easily be made that “bubbles” (usually rapid and excessive credit expansion and/or asset valuation) do much more harm than good, even with the subsequent (and inevitable) “crashes.”
The classic 17th and 18th century “tulip” style bubbles and trading company/land office schemes actually allocated capital for the early industrial revolution and the settlement of North America by Europeans. The period from 1908-1929 saw a fantastic second industrial revolution and technological explosion, and the 1939-2005 period has also been remarkable, especially on a global scale.
In every major historical international “bubble” scenario the resultant “crashes” of credit, asset values and/or business activity are from peaks that were extremely high compared to pre-bubble levels, and the net post-bubble level is ALWAYS higher than the initial conditions (e.g., in order to understand the net effect of the full cycle, you wouldn’t compare 1933 to 1929, you’d compare 1933 to 1908).
Moreover, as you point out, you get all the residual tangible benefits of industrial, commercial, and technological expansion that accelerated during the “bubble” phase (by the way, war, if you’re not physically destroyed by it, can the best “bubble” of all in this regard – e.g., WWI and WWII for America).
Of course, there is always the “rachet effect,” wherein expectations of prosperity reached at the bubble’s peak resist being replaced by a feeling of gratitude for the gains achieved during the bubble, with acceptance of the necessary partial reduction of the previous hyper-prosperity, even when the reduction is by fractions of less than 50%.
But, this is merely evidence of our psychological rigidity, not evidence that the “bubble” itself did any material harm (although arguments are made concerning “misallocation of capital” that I would agree with). For example, you get bizarre recommendations to “bulldoze the excess housing” to reduce capacity so prices will rise. I believe that increased housing stock is one of the BENEFITS of the credit bubble! In fact, housing is still overpriced, or it would be selling better – and it’s still twice the price it was in 1999 (when equities were higher priced than they are now).
Twofish,
Sorry, that’s supposed to be More Good Than Harm.
fwiw, that’s what daniel gross has been saying, viz. why bubbles are great for the economy.
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Michael is impressed by the increase in total real goods and services produced by economic expansions that are usually accompanied by bubbles.
1) Bubbles are not necessary – they are unanticipated consequences of rapid growth. We should try to control them.
2) In the expansion from 1997- 2007, the real goods were produced mostly outside the U.S. As a result, the ability to produce real goods exists outside the U.S. This leaves the U.S. in a doubly vulnerable position – lack of habits and tools producing goods and a negative Net International Investment Position.
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