The soaring yen
Back when it was fashionable to talk about the end of macroeconomic volatility, it was also common to note that volatility had disappeared from the currency market. The FT’s resident financial anthropologist Gillian Tett :
A couple of years ago – or before banks started to go bust – economists sometimes liked to talk about a phenomenon they christened The Great Moderation. This was the idea that the 21st-century financial system and global economy had become so stable and sophisticated that dramatic swings in activity had seemingly disappeared. Volatility, in other words, was supposed to be an issue of the past.
The absence of volatility — in turn — made carry trades (borrowing in a currency with a low yield to buy a currency with a higher yields) attractive. Carry trades pay off if not much changes.
Alas, the return of macroeconomic volatility (Jeff Sachs’ back of the envelope calculations suggest that the pace of global GDP growth could fall sharply next year) has also led the return of currency market volatility.
The yen — a favorite source of low-cost credit – has soared. Or, put differently, a host of currencies have fallen sharply against the yen. Just look at moves in the euro and the Australian dollar against the yen.
(thanks to Paul Swartz for help with the graph)
The euro was too strong v the yen — and most Asian currencies. There was a reason why Asian exports to Europe were growing so rapidly. The euro’s strength v most Asian currencies was the most obvious currency misalignment in the world for the past several years. It just took a long time to correct.
But when it corrected, it corrected fast. No doubt too fast for Japan’s comfort. No wonder there is now talk of the resumption of coordinated G-7 currency intervention.
The US dollar isn’t up by as much as the yen against the euro and the Australian dollar, but it has risen significantly too. The US isn’t going to be able to count on global demand to help make up for a shortfall in internal demand. If the United States non-oil trade balance continues to improve, I increasingly fear that it will be because imports are falling faster than exports. And that isn’t good for anyone.
Pity poor Japan. That country can’t seem to get a break. After finally clawing their way to something approaching normality, a crisis originating overseas is going to absolutely slam their economy through export contraction. The yen is up like 40% against the Euro in a few months time? I wouldn’t be surprised if they contract faster and deeper than the USA, where the crisis originated.
On a side note, I was wondering how S Korea’s weak currency will affect them. Everyone is talking about a reprise of 1998 for Korea, but as long as the country doesn’t fold, you would figure that their weak currency would do wonders for their exports of cars, electronics, vs China and especially Japan. What’s the downside to a weak won in S Korea?
Some Korean firms hedged v won appreciation and thus aren’t in great shape now — and some borrowed in fx too. Korea also has a bit of exposure to the shipbuilding industry — which looks to be going through a serious correction.
I remember way back a few years ago someone explained the carry trade, and I was wondering how it was all going to end.
The unwinding of the carry trade is one of those financial things that has a positive feedback loop in which things can cause massive shifts very quickly once the fuse is lit. What lit the fuse is that 1) people are running toward the dollar and treasuries and 2) Japanese stock markets have taking a beating forcing people to sell Japanese bonds to raise cash.
However, once you light the fuse, you end up with a full scale fire. Now what is happening is that people are trying to pay back all of their Yen bonds, which means that they are buying Yen, which means that if you’ve borrowed Yen, you have to pay more, which is causing people to dump their yen bonds which means….
The interesting question now that we have a full scale positive feedback loop is when does this end and how?
The part that I’d be looking at, is that as part of the Yen carry trade, lots of people were making side bets with currency options, and these are likely to lead to some large and unexpected losses.
Brad,
There is a very simple explanation for why the Japanese currency is rising against the dollar, in contrast to the South Korean, European, and Chinese currencies: The South Koreans, Europeans, and Chinese are probably buying dollars, but the Japanese have been keeping with their policy of the last few years of not intervening in currency markets. I expect that Japan will end that non-interventionist policy soon, probably with Secretary Paulson’s blessing. The dollar will then rise against the yen.
There is no reason to expect that the U.S. trade deficit will fall during the worldwide depression, given that Central Banks around the world will be buying dollars with their currencies and lend them to the United States so that they can steal market share from the United States in the diminishing global markets. This will cause American exports to fall sufficiently to prevent the movement toward trade balance that you expect.
By the way, the news media in the United States is just beginning to pick up on the fact that a severe global recession has started. That’s how CNN explained why stocks were expected to open low this morning.
I predicted this depression and explained its cause both here on this blog on October 6 ( http://blogs.cfr.org/setser/2008/10/06/the-damage-spreads/ ) and in my own blog on October 7 ( http://tradeandtaxes.blogspot.com/2008/10/worldwide-depression-started-this-week.html ).
I also provided a solution which would keep the U.S. out of it in my Enter Stage Right commentary on October 20 ( http://www.enterstageright.com/archive/articles/1008/1008buffet.htm )
Howard Richman
2fish — the new york times article on the yen carry trade includes some estimates of how much of the trade has been unwound. the other issue that arises is what happens next — as the buildup of the carry trade was the vector that carried japan’s current account surplus to the world. I guess it is possible that the contraction in trade will be large enough that japan won’t have a trade surplus (tho the oct-dec data should be helped by lower imports — sept may not be indicative). and lower rates globally will cut into japan’s income surplus.
The yen is still too low. And they are proposing exactly the action that made the carry trade so strident - currency intervention to keep the yen from appreciating too fast. Japan can do this easily without help - you don’t need coordinated intervention if your goal is to trash your own currency - you have infinite resources for the task.
The U.S. does not have deficient aggregate demand - aggregate demand exceeds aggregate supply by a substantial margin. The U.S. can’t continue to play economic atlas for the world. If it tries to continue the role too much longer, it will risk default.
Bricky: “Pity poor Japan. That country can’t seem to get a break.”
Hmm, really? All I know about “Japan” is that people there are doing fine, financially speaking. Certainly much better than, well, people in any other country I can think of. But, first, who exactly is “Japan”? If you think of the many salarymen or retired folks on defined-benefit pension, why should an increase in the purchasing power of your salary or pension invoke pity? But will not their boss, Toyota or Honda or whatever, fire them because the export business will suffer? The complete answer is complicated but the short answer is NO!
I am not saying Japan is paradise on earth for everyone. Far from it. But Japan has more people who benefit from deflation and a strong yen than people who hurt. If only we could persuade them to spend more and malinvest less…
Brad,
I recall robust blogosphere discussion about 18 months ago concerning the macro size of the yen carry trade. Debate about it even extended to the definition of it – e.g. whether or not it should include Japanese domestic “real money” invested in foreign currency assets (e.g. pension funds) or should be restricted to leveraged investment.
The yen carry trade doesn’t necessarily require Japanese saving. Yen carry trades can be generated by Japan not only from within the Japanese net foreign asset position (i.e. from saving) but from the gross international position as well (i.e. not from saving). And the latter can include carry trades funded from either yen foreign asset positions (foreign yen carry trades) or yen foreign liability positions (Japan yen carry trades). Furthermore, given the potential for leveraged euro-yen positions (e.g. yen borrowing from banks outside of Japan), grasping the ultimate scope seems very problematic.
I’ve yet to see any analytical framework that is persuasive in capturing the global size of the yen carry trade and the nature of its variations. And I’m not sure the mechanics of the carry trade unwinding are quite as simplistic (or true) as “the yen is coming back home”, as portrayed in the NYT article. International capital flows are a little trickier and more complex to understand than that, I think. But maybe I’ve got it wrong.
Brad, I read your blog daily and just wanted to say thank you for the excellent and ongoing coverage of these issues!
Brad,
Thanks for not wanting to become a successful policy making think tanker.
Successful think tanking involves inventing outrageous lies and foisting them either above or below real graphs and charts, so that everybody can believe them.
Example:
All our homes all around the world went into this one big ‘asset bubble’ in 2000. The bubble grew all the way till April 2007 and then burst.
You can see all this from the graph below …
Japan had the same problem before as in the graph above, and it’s not solved even after 13 years …
(Never mind the Trillion Dollar Yen Carry Trade…)
Also we had the same problem during the Great Depression and it took XYZ years for home prices to come back up once the then bubble had burst.
Look at this chart here …
I’m an optimist and I think our problem can be solved within 2 years…
“Pity poor Japan. That country can’t seem to get a break. After finally clawing their way to something approaching normality, a crisis originating overseas is going to absolutely slam their economy through export contraction.”
Japan isn’t innocent. They created the carry trade in an effort to cheapen the Yen & stimulate economic growth. They contributed to the artificially low long-term interest rates in the US, Europe, Australia, et al. They are now paying the price that in an earlier time would have been paid via domestic inflation–& may be paid that way yet.
Twofish says:
2) Japanese stock markets have taking a beating forcing people to sell Japanese bonds to raise cash.
–> I thought people in Yen carry trade are mostly financial arbitragers including Mrs. Watanabe. What does their raising JPY debt have to do with falling Japanese stock market?
Also, isn’t Japanese stock market more of 2H07 and ‘08 phenomenon unless you are talking about pre-2003 period?
What happens when the carry trade unwinding ends? Does JPY weakens as the strong demand for Yen cash wades?
RGB:”I thought people in Yen carry trade are mostly financial arbitragers including Mrs. Watanabe.”
You are absolutely correct.
The Japanese stock market is going down because export profits are wiped out, and may cease to exist all together if the yen keeps rising.
Unwinding strengthens the yen, and the yen would stabilize at high levels when it is all done.
Except the government won’t allow that because it will put Japan back into a serious recession.
So they will be back to their old tricks of intervention to stimulate an export driven economy.
I keep thinking they should force early retirement on their aging population, which would result in zero unemployment. Then make the retirees spend their savings playing golf, going to sushi bars, and seeing American movies.
But I’m not an economist, so no one is going to listen to me.
jkh — back when i tried to tally up the yen carry trade i convinced myself (perhaps inaccurately) that most euro yen positions were funded by foreign banks borrowing in the tokyo interbank market (Jesper koll if memory serves made this argument) — so the ultimate source of yen liquidity was japanese savers. and i also was convinced that if you summed up outflows via other investment net you could get some idea of the size of the carry trade. that assumes that a lot of derivative positions are ultimately hedged and generate real money flows, which also was a key point in the debate on the size of the carry trade.
Have been saying this for some time, not quite sure if it makes sense; the current currency market volatility hs its roots in the “excesses” of the past couple of years, where asset bubbles and currencies have boosted each other. Just as asset bubbles have or are in the process of deflating, so the currencies are in the middle of returning to some sensible level. A food analogy would be where you take five from the thanksgiving gormandizing ‘cos you’re about to “produce” a turkey complete with stuffing, sauce and pumpkin pie after being stuffing yourself from the word “go”. “Overconsumption” has its price?
RGB:
I should probably add one other dynamic on yen valuation. If it does become a “safe haven” target for global FDI flows, which is probably happening and I know 40% of my money is there now in gov bonds(I’m hoping my bond fund manager is on the ball and gets out before intervention), then the ultimate value of the yen is not only being influenced by the unwind of carry, but FDI flows as well.
sorry, forgot the main part
not so much a spiral but rather a roundrobin correction of excesses?
the euro and pound however have been spectacular, makes you wonder if some old raiders aren’t back in the game?!
brad setser: I increasingly fear that it will be because imports are falling faster than exports. And that isn’t good for anyone.
judy yeo: “Overconsumption” has its price?
cedric regula: But I’m not an economist, so no one is going to listen to me.
bob marley: Them belly full, but we hungry…
I have yet to come across an explanation of why the dollar or the yen has been rising so rapidly inmmore exact terms. I have yet to see someone list a TARGET level as to what a fair value might be. Maybe I’m asking for too much; much like the person who requests a crystal ball. More directly, why is this dollar rising in the face of a great crisis? Does anyone out there ever expect that the dollar’s rally will ever end? Thanks to anyone that might respond: dollarrise@yahoo.com
Mike: Here are a few ideas.
1) Could USD by rising for the same reason as JPY? Obviously there was lots of JPY carry trade but there was USD carry trade as well as US interest rates were quite low versus Europe. Is the unwind of USD carries causing the rise?
2) There is also a lot of non-US USD-denominated debt. Maybe everyone is hoarding dollars to try to avoid future bond defaults.
3) Finally as commodities are priced in USD, maybe everyone is hoarding dollars to ensure that are able to pay for essential goods.
If the latter two reasons apply, then I don’t think we will see a USD weakening anytime soon.
Just some theories. I have no evidence.
Brad,
The above article is a very good example of Jeffrey Sachs’ think tanking which you can learn a great deal from:
Jeffrey Sachs wants to make sure that nobody goes hungry to bed anywhere. Secondly he wants to make sure that people who don’t have good infrastructure like nice roads, ports, airports, etc get them.
So he will just go ahead and invent some really huge lies to justify that happening, and then propagate his lies in the Financial Times, or in any other Forum of his choice.
Jeffrey Sachs has been named as one of Time magazine’s ‘100 Most Influential People in the World’ several times. He directs an institute at Columbia; is a Special Advisor to the UN Secretary General; was a director of some UN projects before; was a Full Professor of Economics at Harvard by 29, etc.
He has to definitely be a guy who can add two and two together and say that it’s four.
On the other hand I’m somebody who’s completely unknown, and don’t wish to be known.
Now here’s what Jeffrey Sachs is saying in his article:
The write downs in US household wealth from the reversals in housing and equities will probably reach $15,000bn (€12,000bn, £9,700bn) and the resulting steep decline in private consumption and investment could reach about one-tenth of that amount.
This is exactly what I was highlighting in the ‘Magic Credit Trick with hat’ analogy.
The above sentence is where Jeffrey is pointing out that $15 Trillion has disappeared somewhere. It’s in the bucket called ‘household sector write downs from the reversals in housing and equities’; which is just completely fictional, as we have seen before.
In the rest of the article you can read Jeffrey’s Magic Solution, with Seven Steps from the Global Talks.
Brad,
While on a well deserved and carefre holiday I could not help but notice all sorts of people exhibiting signs of stress. Having liquidated stocks and non-essential real estate over e year ago, I can only say that part of my agenda for longer term financial stability seems to be in place. However the JPY has a little further to go (too bad for the speculators) commodities etc are fairly priced (incl oil), central banks and government are adopting sensible policies. Stocks are getting close to reasonable levels (in my opinion US stocks were substantially overvalued for a long time, especially the financials - and industry in the final phases of a shake out ). Gvt liabilities from supporting the banking system are not necessarily inflationary and do not require monetary compensation (for the time being). The longer term problem of unwinding all this gvt intervention is quite serious, but not urgent and the US housing problem remains unresolved. Prices should drop a litthe further, unless the combination of current macroeconomic policies results in significant nominal family earnings.
“The interesting question now that we have a full scale positive feedback loop is when does this end and how?”
If Japan, not China, would say that they thought of going very-fiscal? And sort-of swap-like,? A bit.
On another matter, why isn’t there anyone looking-up closely at “the rest of NAFTA”. If numbers hold-up, they both should be-in for a rough-one.
On yet another matter: and yes, we all have us a Europe, don’t we? How would Fed’s issue of, say Euro, to the “domestic theatre” look-(a)-like constitutional-wise? Nevertheless and short of EMF,why not swap some euros to the(ir) EMs. A bit.
beneath: IMF+AMF=+/- 330bn; why not help boc to loosen THE grip. A bit.
Chid:”The write downs in US household wealth from the reversals in housing and equities will probably reach $15,000bn (€12,000bn, £9,700bn) and the resulting steep decline in private consumption and investment could reach about one-tenth of that amount.
This is exactly what I was highlighting in the ‘Magic Credit Trick with hat’ analogy.
The above sentence is where Jeffrey is pointing out that $15 Trillion has disappeared somewhere. It’s in the bucket called ‘household sector write downs from the reversals in housing and equities’; which is just completely fictional, as we have seen before.”
I think you need to abandon your economic theory.
The simple truth is Elmer Fuld and others killed a bunch of silly wabbits, the wabbits kicked the bucket, not fell into one, and the magic trick is we get to work another ten years making wabbits to replace lost savings , which is no where near as fun for humans as it is for Bugs Bunny.
Wow, Cedric. Finally someone got it right. I am waiting for the Met to revive that great opera from the loonytoons repetoire, I Am Going to Kill the Wabbit, the one with the great climactic aria, Oh No! The Wabbit Is Dead!
Jeffrey Sachs is now repenting for the horrifically bad advice that he gave Russia in the early 1990’s. I’m not sure that loans from developing countries to developed ones is such a great idea since third world development loans have done more harm than good. Even the poorest nations can stimulate demand by dropping helicopters of money. The thing that gets poor nations in trouble is external debt and capital outflow, and loans just make those probably worse.
Also, I don’t see a huge role for coordination. There are situations where you do have to coordinate policy (prisoner dilemma situations), but I don’t see the need here.
Also money can disappear. If you take a million dollars and then burn it, it disappears. If you take a million dollars and then put it somewhere where it is impossible to spend forever, it disappears. If you take a million dollars and then put it where people are unwilling or unable to spend it temporarily, it disappears.
Money is this very strange thing, that acts in ways that you wouldn’t expect.
I see Japan’s carry trade is a big part of reasons of their lost decade. Their savings largely flew to foreign markets and their own domestic businesses are lack of credits, despite the low interest rate.
Gee lost my text again.
Brad you seem to imply that the won is rising.
I read the opposite here
http://fr.finance.yahoo.com/convertisseur/convert?amt=1&from=EUR&to=KRW&submit=Convertir
can you explain why the won is falling when all other asian and oil exporting currencies are rising ?
Is it just that the won was not pegged to the dollar and is therefore unaffecte by the recent rise in the dollar value relative to the euro ?
What drives the euro/dollar rate moves ? (I understand what pushed asian and oil exporting currencies up relative to the dollar and euro, but how did pegging to the dollar come to affect the euro/dollar rate ? )
Off-topic here, but have you noticed this?
http://www.bloomberg.com/apps/news?pid=20601087&sid=aH.7.EElweAU&refer=home
Apparently the Fed will purchase the corporate paper of foreign banks, providing dollar financing to a broader array of countries than it does via central bank currency swaps, but on much less agreeable terms (the Fed can always refuse to rollover the paper, whereas inter-CB swaps are presumably of a fixed and long duration).
The politics Brad pointed to in an earlier post are getting interesting. Maybe everyone who needs dollars gets dollars, but some get them on loose and easy terms, while others get put on a tight leash. The Fed had previously branched out well into the realms of fiscal policy. Now it is effectively making foreign policy.
Flabbergasted: Japan isn’t the corporatist paradise that some Americans think it is. Japanese companies do try to avoid laying off full-time workers, but have no compunction about letting go the ever growing number of part-time staff. In fact, Japanese corporate profits have increased this decade in no small part to a stealth (for Americans) change in their employment base. From expensive full-timers to low wage, no-benefit receiving part-timers.
As for malinvestment, how exactly does that go in Japan? Overinvestment more or less died with the 80s bubble, bank support to “walking dead” corporations was more a thing of the 90s… actually Japanese growth this decade has been quite good, considering that every year, the country’s work force shrinks. Productivity growth has more or less kept up with the US. Japan’s big big problem with future GDP growth will be a demographic problem, as the country’s population essentially implodes in slow-motion. Japan will soon be followed by S Korea, and in the not-too-distant future, by China.
Bricky, I am aware of the situation in Japan. But it is all relative, I guess, so I would not worry too much about the Japanese. Overall, the Japanese have stable jobs and this, to a great degree, accounts for household prosperity and wealth accumulation. And, regarding malinvestment, Japanese savings have found their way to financing all kinds of boondoggles, mostly in other countries. Finally, am I the only one who does not see population decrease as a “problem”?
the won is certainly falling (tho the number of won it takes to buy a $ is rising)
Eur is driven by some combination of:
a) shortage of $ abroad, leading firms/ banks to buy
b) deleveraging ($ = low carry currency v eur, so part of carry unwind)
c) momentum
d) downshift in expectations around europe that was more severe than the downshift in expectations around the us.
e) perhaps CBs selling eur to raise $ cash for intervention purposes (least important in my view)
indeed interesting. it seems like the fed is allowing foreign banks holding us commercial paper the same option available to us banks …
KDB tho is very close to being the korean gov (at least in times of crisis, in august the plan was to privatize it .. ), so it has particular resonance.
It was inevitable that the prudential reserve or unregulated euro-dollar (foreign) would “come a cropper”.
Nominal gdp is measured by the volume of money X its rate of turnover. The transactions velocity of funds must be dropping. Otherwise oil wouldn’t have careened.
In the long-run Japan’s current account balance determines its exchange value. Its appreciation is not surprising.
For being a strategic ally of the Washington Consensus, Japan gets favored special treatment such as the Plaza Accord which devalued the yen, worsening the nation’s global competitiveness. Under US Dollar hegemony, the Japanese people work for free supplying “real industrial wealth” of the Honda and Toyota vehicles in exchange for fiat US Dollar paper. In the political sphere, Japan gets to contribute its self-proclaimed “Self-defense military” to the occupation of Iraqi territory. If the Japan LDP leadership wasn’t so subservient to the Washington Consensus, they would realize how long-term untenable the country’s geo-political situation currently is. Both neighboring China and Russia are large continental military and economic powers with national resource bases. Japan is just a few Pacific islands less than the size of California. Just as a reminder, Russian T-160 bombers have resumed military exercises frequently crossing Japanese airspace. With the US Nuclear Aircraft carrier, the George Washington recently homeported in Japan, the China PLA Navy has also increased Nuclear attack submarine patrols around Japan.
DJC: Both neighboring China and Russia are large continental military and economic powers with national resource bases.
Continental powers pose very little threat to oceanic ones, and small oceanic powers can have power far larger than their size would suggest (look at the British Empire).
The Japanese navy is more powerful than either the Chinese or Russian one, but it’s effectively under the control of the United States. It’s actually very much in China’s interest to have Japan under the control of the United States because the last thing anyone in East Asia wants to see is Japan have an independent foreign or military policy.
Getting back to economics, the fact that no one really has an interest in excluding the United States from East Asia is why there is unlikely to be an effort to create pan-Asian institutions. I think that China and Japan would both find it easier to cooperate with the United States than to cooperate with each other.
Twofish,
If the China PLA launched its 2000+ conventional or nuclear, precision strike DF-15 and DF-21 Ballistics missiles at Taiwan or Japan, I assure you that there won’t be much of anything left. The missiles are deployed to be launched in saturation waves of hundreds at a shot. The flight time for missiles launched at Fujian bases to impact is less than 15 minutes. Then there are the 600+ Su-27/30 Strike Fighters, 200+ J-10A Strike Fighters, 200+ JH-7A Naval Strike Fighters, 300 H-6 Strategic cruise missile bombers, 1000+ J-8 Intercepters, 1000+ J-7 Fighters. Defending Chinese Airspace are KJ-2000 AWACS, and S-300PMU2 Air Defense Missile systems.
The 200 US F-22 Stealth Fighters would run out of bullets and missiles before the Chinese run out of Aircraft.
Yeah, but the Deathstar would win.
By the end of 2008, two major things will happen:
1) Huge rally in US equities, especially banking and finance stocks.
2) Collapse of the US Dollar against all major world currencies.
Reasoning:
Most major world central banks are holding huge amounts of USD denominated reserves.
Most major world private banks are holding holding amounts of USD denominated foreign currency debt.
Global Talks:
The talks are basically USD vs EUR talks.
Once everybody switches to EUR:
All the Central Bank USD Forex reserves will become worth much less in terms of their own local currency.
All the foreign currency debt denominated in USD will also become worth much less in their own local currency.
This benefits them tremendously, since they can now return the USD denominated debt, and invest amounts from their CB reserves in US stocks, or just make out loans denominated in USD.
US domestic policy has no issues arising from this, their cheap imports will become a bit more expensive but that should be in line with reducing deficits, etc.
By agreeing to lesser USD domination of the world economy, the new administration can easily claim credit for having solved the mythical ‘CREDIT CRISIS’, having caused US equity markets to rally and US credit markets to function very well once again.
In future the policy of encouraging more production in one economy and more consumption in another using an exchange rate fixed way out of line with the underlying trade in goods and services will continue but it will be executed using the EUR rather than the USD.
Private players who now go short in USD and long in US equity will make a huge profit.
http://www.counterpunch.com/whitney10282008.html
The financial crisis is wringing credit from the system and pushing prices downward across the board. No asset class has been spared, including gold which posted its biggest one week loss in 28 years and has plummeted from $1,040 in March to $734 at Friday’s market close.
As Congress plumbs the causes of our current mess, the main one is hiding in plain sight: Reckless monetary policy that did so much to create the credit mania and then compounded the felony with a commodity bubble and run on the dollar whose damage is now becoming apparent.
The Bush administration has called for an economic summit to be held by the 20 largest economies sometime after the presidential elections. US and EU officials are hoping to stitch together another Bretton Woods wherein control of the global economic system was delivered to those same nations. It’s likely, however, that the outcome will turn out considerably different than anticipated. Already, under China’s leadership, 12 Asian nations have agreed to set up an 80-billion-dollar fund to protect their economies from currency-runs, capital flight or other financial disruptions. China has the world’s largest reserves at $1.9 trillion followed by Japan at more than $1 trillion. Clearly the two richest nations will set the agenda and play a central role in deciding how best to deal with the global recession.
The November summit in Washington could produce some unwelcome surprises which were hinted at by Thailand’s Deputy Prime Minister, Olarn Chaipravat, who told Bloomberg News:
“The message of this initiative is for China to consider whether or not China would open up its banking system and allow the strongest currency in the world, which is the Chinese yuan, to be the rightful and anointed convertible currency of the world.”
Surely, the present financial malaise which has its roots in Wall Street and at the Federal Reserve, has demonstrated that the dollar must be replaced as the world’s “reserve currency” and that America must be deposed as the de facto steward of the global economic system. Leadership implies responsibility and the US must be held to account for its failings. It’s time for a change.
Russian and Chinese leaders promote multi-currency global monetary regime to erode US Dollar hegemony.
http://www.reuters.com/article/marketsNews/idUSLS17337320081028
MOSCOW, Oct 28 (Reuters) - Russian and Chinese leaders called on Tuesday for world finance to use a wider range of currencies, and Russian Prime Minister Vladimir Putin suggested bilateral trade in roubles and yuan rather than dollars.
“At the moment the world which is based on the dollar is suffering serious problems … The situation on the global financial markets remains difficult,” Putin said at a Russo-Chinese forum in Moscow.
“In such conditions, we need to think about improving the payments system for bilateral trade, including the use of the national currencies.” Russian officials have previously suggested that the country’s oil and gas could be traded in roubles.
“We need to diversify the global currency system, to support its stability through the use of different currencies,” said Chinese Premier Wen Jiabao.
DJC: If the China PLA launched its 2000+ conventional or nuclear, precision strike DF-15 and DF-21 Ballistics missiles at Taiwan or Japan, I assure you that there won’t be much of anything left.
So what? Nuclear weapons can be totally useless it some things. You can’t swat a fly with an H bomb and you will get into trouble if you even try.
The Soviet Union had more nuclear bombs than China ever has have, and it didn’t save them. To increase Chinese national comprehensive power, which is incidentally a goal that I support, you have to think about military power, but you can’t think *only* of military power. You have to think about diplomatic power, cultural power, political power, and economic power. Even when you think about military power, you have to coordinate your military strategy with your political, diplomatic, and economic strategies.
Twofish,
If the China PLA military didn’t wield a credible stick, Taiwan would effectively be an unsinkable US Aircraft Carrier off the Chinese coastline. Although Obama’s half-brother lives in Shenzhen, neither Obama nor McCain have spoken favorably about China. The big stick is necessary to ensure that McCain nor Obama violates the 3 “No’s”.
NO Taiwan declaration of independence.
NO Taiwan Nuclear Weapons program.
NO American military bases on Taiwan.
If any of these 3 No’s are violated, the China PLA already has “legal” authorization from the People’s Congress and the State Council to take “immediate and necessary” military action.
DJC: “The message of this initiative is for China to consider whether or not China would open up its banking system and allow the strongest currency in the world, which is the Chinese yuan, to be the rightful and anointed convertible currency of the world.”
And the answer is probably no. Chinese banks and currency have escaped a lot of the mess by being decoupled from global financial systems, and if anything the latest episode makes it less likely that China will make the RMB convertible or open up its banking system. Once you open up the banking system things get very complex.
China has Hong Kong which serves as a way for mainland Chinese banks and businesses to connect to the global economic system without opening up everything.
China really doesn’t care about world power. China really doesn’t care about displacing the United States. China only cares about increasing Chinese standards of living.
DJC: Surely, the present financial malaise which has its roots in Wall Street and at the Federal Reserve, has demonstrated that the dollar must be replaced as the world’s “reserve currency” and that America must be deposed as the de facto steward of the global economic system.
The current financial malaise has greatly increased the role of the dollar. Everyone is running to Uncle Sam and buying Treasuries and the dollar.
Whether it is a good thing or not that the US is as powerful and central as it is is an academic discussion, but a rather useless one. Even if you want to depose the United States, it’s not going to happen soon. The problem is that the US is so powerful, that if it does something stupid, then it hurts other countries more than it does the US.
DJC: Leadership implies responsibility and the US must be held to account for its failings. It’s time for a change.
You have the problem that no one can replace the United States and quite frankly, no one wants to. China has no ambitions of being a global hyper-power, and this means that it will *not* attempt to challenge the United States.
Obama and McCain both unfavorably viewed from Beijing
http://www.atimes.com/atimes/China/JJ28Ad01.html
Obama’s criticism of China’s trade practices and his demand that China “play by the international rules” have irked the Chinese leadership, which fears regular admonishments over its human rights records from a Democratic president.
Obama in April called for Bush to boycott the Olympic Games opening ceremony in Beijing in August, saying he would only go to Beijing if he saw progress between the Chinese government and the Dalai Lama.
Obama has also threatened to impose trade sanctions due to concerns over the yawning trade surplus, currency manipulation and intellectual property rights violations.
McCain, the Republican presidential nominee, has adopted a tough stance on national security, promising to create “a strong military in a dangerous world”. His pledge to commit more troops to Iraq has not been well received in Beijing.
China was angered by the US Defense Department’s recent desicion to sell Taiwan US$6.46 billion worth of weapons, and while John McCain and Obama both endorsed the deal, McCain also said the administration should grant Taiwan’s request for submarines and F-16 fighter jets.
Trying to stay on topic. Here.
One consequence of increased volatility is that people should try to get out of the prediction game. There have been a lot of bets that the future would be like the past, and these bets have fallen apart. Economic systems are simply too complex to be completely predictable. Societies are unpredictable because they are comprised of people that are unpredictable, and having a world of predictable people strikes me as a rather unpleasant world.
Brad:
By conventional thinking, a rising dollar would hurt US export. But at the same time, capital flow into dollar makes it easier to sell treasuries. From a US perspective, is this a positive or negative development?
Also, it looks likely that Japan would start intervention in the currency market to lower yen, which will flood the market with money. Isn’t that also positive for the resolution of the current crisis?
Brad anything you can do to allow for a second chance when posting comments. Lost my post again.
is DJC dave chiang ?
I m still betting China is bound to be the biggest loser in this crisis, hit just like Germany was in the 30’s.
There’s no internal demand over there and I doubt it can be grown in 1-3 years (and it d be a first time under a communist regime)
Anyway hi to gillies, twofish, and others.
Btw, according to you, will the USA go the english way and sacrify its economy on the altar of its international currency ?
Funny how all things happen just as they have in the past, funny how things so far just repeat
“China has no ambitions of being a global hyper-power, and this means that it will *not* attempt to challenge the United States”.
True, the Chinese leadership recognizes that China remains a developing nation. The Chinese don’t want the responsibility of being a global superpower, but are in firm support of a multi-polar world order. That Chinese doctrine has been explicitly stated by former President Jiang Zemin. This applies most profoundly in China’s own backyard, Southeast Asia. The Chinese diasporia has long pulled the strings in the region’s economies even while governments sealed defense agreements with the U.S. Today, Malaysia and Thailand still perform joint military exercises with America but increasingly buy weapons from, and have defense treaties with, China, including the Treaty of Amity and Cooperation by which Asian nations have pledged nonaggression against one another. Indonesia, a crucial American ally during the cold war, has also been forming defense ties with China. Southeast Asia has de facto become a “greater co-prosperity sphere” led by China.
Also it is interesting to see what effect all of this will have on PRC/Taiwan relations. Ma Ying-Jeou went from a 60% to a 20% approval rating because the Taipei stock market has crashed. Fortunately for him, the opposition are too busy with some extremely nasty internal fights to mount a credible opposition or come up with a coherent economic program.
One thing that will be interesting to watch is how economic relations between the PRC and Taiwan develop. If Mainland China turns out to be the economic savior of Taiwan, then we are looking at some pretty major political shifts, similar to what happened in Hong Kong after the Asian Crisis.
Alternatively, if things get very badly mishandled, then we may see the return of Chen Shui-Bian, more angry and radical than ever.
One thing that I am thankful for is that the Beijing leadership really doesn’t see the world in the way that DJC sees it.
Brad — I may be misreading, but I got the sense from the story that the Fed was purchasing dollar-denominated CP issued by Korean banks, not just buying dollar denominated CP they already hold… that puts KDB and Kookmin on par with US firms, banks and nonfinancials, that can borrow dollars via CPFF. However, that program is limited to US institutions. [ http://www.ny.frb.org/markets/cpff_faq.html ] It’s unclear what the article means by “the new funding facility”. (Maybe MMIFF, and sales are being intermediated by money market funds? It’s not clear.)
The issues strike me as analogous to those that come up with sovereign wealth funds — the Fed will be a direct, short-term investor in non-US, sometimes state-affiliated institutions. Right now the reaction seems grateful (as Americans switched suddenly from suspicion to gratitude when SWFs helped recapitalize US financials), but it would be an odd state of affairs to if a country’s core banks were to depend upon another country’s central bank to continually rollover its loans.
The loans discussed in the article are miniscule next to Korea’s FX reserves, though, so sovereignty concerns are minimal for now. But it’s an interesting precedent.
The Chinese diaspora in Southeast Asia needs to realize that Beijing will not put the interests of overseas Chinese over those of Chinese living in China. There is something of a hope among some overseas Chinese in southeast Asia that a rising China will turn into more influence for overseas Chinese.
However, this works against Chinese national interests. It also works against the interest of other overseas Chinese.
One reason I very strongly support good relations between China and the United States and oppose any efforts by China to depose the United States as a global hyper-power is that to do so makes my position as an overseas Chinese in the United States, untenable. So I would strongly oppose any effort by Beijing to displace the United States in East Asia, and I’d argue to anyone in Beijing that cares to listen to me that it isn’t in the national interest of Chinese living in China to do so. So far the Chinese leadership has followed policies much more close to the ones that I advocate than the one’s that DJC advocates.
Part of the reason, is having lived in America for as long as I have, I think that many people vastly underestimate how big and powerful the United States is, even when it is being idiotically stupid. This causes China to make the same mistakes that Japan made in the early 20th century.
I’m predicting a Chinese move against Taiwan within the next four years, if Obama is elected President. The reason is simple: A worldwide depression is getting started. When worldwide investment collapses, it will hurt the countries most that have the largest savings rate, in other words, the Asian countries.
Already China is feeling the pinch with huge layoffs in its exporting sector, as documented in an article in Forbes Magazine today ( http://www.forbes.com/business/2008/10/28/china-toys-pearl-river-delta-biz-manufacturing-cx_pm_1028china.html ).
Whenever there is a depression, despots try to distract the public by engaging in military ventures. The Chinese have been preparing for the invasion and the promised US military package to Taiwan is too little for Taiwan to defend itself, as cocumented in the Vancouver Sun ( http://www.canada.com/vancouversun/columnists/story.html?id=bf959492-1846-4901-9cd2-7b9488594992 )
The Chinese leadership would be much less likely to test the mettle of a President McCain. On the other hand, neither the American people nor the Chinese leadership know how a President Obama would react. They would be very likely to test a President Obama in order to find out.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Mike -
Reasonable value for the euro - $1.15 to $1.25, for the yen, 80 to 90 to the dollar. Basis-
long-run purchasing power parity.
[...] The spectacular rise in the Japanese Yen. (Brad Setser) [...]
People love instant gratification,quick profits to the detriment of his fellow human beings.This is what prompts so-called arbitrageurs to exploit the interest rate differential prevailing in different countries without effort,hard work like it is done by the masses to earn a living,to educate their children etc.The carry trade should be banned as has been short-selling which only benefits parasites in the so-called developed countries.Ask yourself if this trade is necessary and in what way it helps to spur human growth potential.Witness now the chaos resulting from the greed displayed by those parasites.The Japanese
should align their interest rate and not flood the world with cheap money which is essentially the root cause of overconsumption and massive debt leverage,thus provoking a disequilibrium which the markets have now
to re-balance.So let the yen find its own level,without intervention.
If the Taiwan Government doesn’t have any confidence in US government bonds anymore, how much confidence do they have in other political and military spheres?
LOL.
http://online.barrons.com/article/SB122482470725666021.html?mod=googlenews_barrons
Taiwan Dumps Fannie, Freddie bonds
Now Washington might well worry about who lost Taiwan as a major investor in U.S. agency securities as the Republic of China has openly questioned their credit quality — even after the federal government has committed hundreds of billions of dollars to bail out mortgage giants Fannie Mae and Freddie Mac.
Beyond that, Washington might well worry that other nations also no longer view its agencies — and now, by extension, the very credit of the United States of America — beyond question.
Taiwan’s financial regulators reportedly have ordered that nation’s insurance companies to pare their holdings of the debt and mortgage-backed securities of Fannie Mae (ticker: FNM), Freddie Mac (FRE) and Ginnie Mae securities, according to a report on the Internet site of Asian Investor magazine.
Such an order would be a stunning rebuke to Washington, coming a little more than a month after the federal government effectively nationalized the mortgage giants. Fannie and Freddie last month were placed into conservatorships with the Treasury standing ready to inject up to $100 billion through purchases of preferred shares in the government sponsored enterprises.
In either case, the Taiwanese action is a blow to the reeling U.S. mortgage market, which has been supported by the Republic of China’s purchases of agency securities. According to U.S. Treasury data, Taiwan owned a very substantial $55 billion of U.S. agencies along with $43 billion of Treasuries as of June 30, 2007, the most recent date for which these data are available.
Japan just mentions intervention, and the yen goes from 93 yesterday to 97.65 so far today. That’s action.
Re: Korean commercial paper issuance and eligibility
My wild, wild guess is that it’s a function of their capacity to issue from a US domicile and booking point - which would be unlike the foreign currency swaps.
“What issuers will be eligible to sell commercial paper to the SPV?
Only U.S. issuers of commercial paper, including U.S. issuers with a foreign parent, are eligible to sell commercial paper to the SPV. A U.S. issuer is an entity organized under the laws of the United States or a political subdivision or territory thereof or is a U.S. branch of a foreign bank.”
Without meaningful property rights in BRICOPEC, there won’t be any sovereign credit.
There won’t be any meaningful proprety rights in these countries because the regimes are insecure and illegitimate, and so…
Status quo ante crisis…
So the Fed’s purchase of Korean bank CP would be support for operations within the US domestic financial system, which strikes me as non-analogous to either SWF or FX swap directed money.
Gillian Tett’s article is interesting, although a bit crude. She has it right about the importance of VAR (value at risk) type models. It’s a simple point - but it’s at the heart of the financial institution risk problem – both in terms of delusional risk moderation on the way up, and exaggerated effects on capital adequacy on the way down.
BIS is very quiet… something is wrong.
Steve — I don’t think buying the $ debt of a parastatal is really sovereign wealth fundy. Feels more like what a central bank would do — i.e. buy $ high quality $ denominated debt. sov. funds are institutions intended to take equity stakes. So it feels different –
Tis funny but the rise in SWF investment in banks made me nervous not happy –
it felt to me like the US gov was turning to foreign govs with cash to protect us financial stability, which seemed to be a core US gov responsibility — in effect, i worried that the political cost of getting approval for something like the TARP was driving bad policy. I also worried about the long-term consequences of tightening relationship between the us financial sector and non-democratic governments; the street hadn’t exactly spoked out v the rmb peg — and now that the proceeds of currency intervention were being used to recap us financial institutions, it struck me as even harder to get the street (which influences public opinion) to stand up on this issue. finally, i worried that SWF investment woudl make it impossible to wipe out the equity if a troubled financial institution had to be taken over, and thus it would limit the USG’s freedom of action.
as a result, I was far more concerned about the SWF investment in financials that say the sale of Unocal’s mostly asian operations to CNOOC …
DJC: If the Taiwan Government doesn’t have any confidence in US government bonds anymore, how much confidence do they have in other political and military spheres?
Well the US is still selling Taiwan weapons, and it’s not as if Taiwan has much choice in the matter as to its allies.
The US has leverage over Taiwan that the PRC doesn’t have, and I worry that if the situation is mishandled (which Beijing isn’t doing), that it will lead to Taiwanese electorate electing someone crazy in 2012. If Chen Shui-Bian and his allies have even 30% support, this greatly complicates things, and Beijing needs to handle things so that by 2012, Chen is seen as someone totally out of touch with the new realities.
Richman: I’m predicting a Chinese move against Taiwan within the next four years.
This is unlikely. Right now the President of Taiwan is as pro-China as anyone that they can find in Taiwan, and Beijing has been trying to do whatever they can to support him. The earliest a pro-independence candidate could get in power is 2012, and any action by Beijing would undermine the current government which is the most pro-China government that Taiwan has ever had.
bsetser: I also worried about the long-term consequences of tightening relationship between the us financial sector and non-democratic governments;
Personally I think this is a good thing. A tight relationship between the US financial sector makes it impossible for the US to use economic means to promote democracy. I’m against the US promoting democracy, not because I hate democracy. I’m against the US promoting democracy because its been so incredibly incompetent at doing it, that democracy would be better off if the US does nothing.
Historically, tying economics to political change has *destroyed* any indigenous democratic movement. What happens if you link democracy with economics is that it becomes a domestic political issue, and also it allows the non-democratic government to portray democratic activists as foreign traitors in league with the CIA to undermine the local economy. Cuba is the classic example.
In the specific case of China, you will get nowhere if you don’t tap into Chinese nationalism. If the message is “the United States is making China weak and poor.” you lose. The basic message has to be “the United States is making China rich and strong.”
Twofish,
If the present government of Taiwan is sufficiently pro-China, it could avoid the problem through a peacefully negotiated solution giving Taiwan similar independence as Hong Kong now has. Do you see any possibility of this?
Howard
JKH — You may be right, that the Fed is purchasing from US-domiciled subsidiaries for US operations, in which case it’s a nonstory. But that’s certainly not how the Bloomberg piece is spun. There’s no mention of anything other than meeting the Korean banks’ needs for USD financing.
Do the Korean Development Bank and Kookmin Bank have any significant US presence?
I know that CPFF is restricted to US entities. That’s part of why I found the story puzzling.
Brad — I was with you in being more worried than excited about SWF investment in financials.
The Bloomberg story describes such a small arrangement that it’s hardly worth considering. But, if the Fed were to start making short-term loans on a large scale directly to foreign banks, I’d be unhappy about that if I were a resident of the recipient country. No, it’s not equity, but debt that must be rolled-over and for which there are no alternative financing sources confers a great deal of leverage. Multiyear, inter-CB swap arrangements are a lot easier on recipient sovereignty.
Steve,
From the KDB website, they have a New York branch with corporate banking, securities, trade finance, derivatives, and treasury activities.
Probably quite enough to warrant a $ 800 million CP program.
Kookmin also has a New York branch, apparently with similar activities.
Come to think of it, I believe a foreign bank can only issue US commercial paper (legally defined presumably) from a US branch.
My guess is that the trade finance component is quite important - there’s been a lot reported lately about a freeze up in that market as well. These US branches probably do funding for that through CP issuance normally.
Richman: If the present government of Taiwan is sufficiently pro-China, it could avoid the problem through a peacefully negotiated solution giving Taiwan similar independence as Hong Kong now has. Do you see any possibility of this?
Not for another generation at the earliest. They are pro-China, but not pro-PRC. Taiwan already has more autonomy than Hong Kong ever did, and there is no point in negotiating that away. For now, everyone has come up with the very carefully crafted formula in which people agree to disagree.
Americans have this weird idea that you can get everyone at a conference table and solve all of the problems of the world in one second, and live happily ever after. The world doesn’t work that way.
Rien
glad to know you’re emerging unscathed from the current mess but honestly, maybe it’s time to keep a low profile, remember bragging rights are worth as much as my insights (sorry, my insights are worth nothing) if some irate psycho about to lose his job is around you, safety first right?
hmm, what’s christmas gonna look like?
before I forget, did anyone see Gordon Brown’s consideration of the sale-and-leasback arrangement for houses/property owners in distress? what next, cars?
Gordon Brown 2008: “It is to enable banks to start lending again by whatever means are necessary, and we will continue to discuss that with them.”
Malcolm X 1965: “We declare our right on this earth…to be a human being, to be respected as a human being, to be given the rights of a human being in this society, on this earth, in this day, which we intend to bring into existence by any means necessary.”
Jean Paul Sartre 1963: “I was not the one to invent lies: they were created in a society divided by class and each of us inherited lies when we were born. It is not by refusing to lie that we will abolish lies: it is by eradicating class by any means necessary.”
Johnny Rotten 1979: God save the Queen.
much as i benefit from reading this blog, it has certain weaknesses.
the graph of the yen and the euro above performs a violent manoeuvre. volatility ? if that graph were an aeroplane, and the captain said “we are encountering some turbulence ” - i would not believe him. i would be saying my prayers.
the yen is the currency of japan.
but don’t let that stop us getting deep into chinese foreign policy, chinese financial prospects, or other personal obsessions.
40 dollar oil will be good for japan, surely.
but the yen spike (if that is what it turns out to be) will be another event to teach us that we cannot all do the same thing at the same time . . .