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Bretton Woods 2 and the current crisis: any link?

by Brad Setser
December 1, 2008

Last week, I attended a conference on international financial reform. These kinds of conferences don’t really produce consensus; there is no need to agree on anything. But there was a sense — at least I thought — among the speakers that the recent crisis was a financial crisis plain and simple, not a financial crisis linked to the Bretton Woods 2 system of managed exchange rates. That implied, among other things, that current efforts to reform the international financial system should focus on reforming financial regulation — not, say, reforming an international monetary system where the currencies of key surplus countries are pegged to the currency of the big deficit country.

And there is no doubt that the current crisis certainly isn’t the dollar crisis that many — myself included — long worried about. The sense that the current crisis isn’t an exchange rate crisis contributed to the sense that the loci of international effort should be regulatory reform. I nonetheless still believe that that the origins of the credit crisis cannot be entirely separated from the Bretton Woods 2 system — a system where many emerging markets pegged (or managed) their exchange rates at levels that implied large ongoing current account surpluses and the resulting reserve growth financed large external deficits in the US and to a lesser degree in Europe.

Central banks didn’t take on a lot of credit risk directly, or directly finance the most risky loans to American households. Central banks bought Agencies to be sure — but they were betting on the implicit government guarantee more than the Agencies exposure to US households and the Agencies themselves didn’t have the same appetite for risky mortgages as private banks and broker-dealers. Some central banks no doubt reached for yield and took on more risk that they should have in 2006 and early 2007 — but in general they were far larger buyers of Treasuries and Agencies than “private” mortgage-backed securities. But central bank demand for safe debt nonetheless reverberated through the market. It helped keep US long-term rates down even as short-term rates rose. That in turn encouraging (myopic) private actors to take on more risk to keep their returns up.

Of course, private actors didn’t have to do this; they could have said that the risks were too high, and scaled back. Regulatory failures in the US and Europe played a role in the buildup of vulnerabilities that led to such a severe crisis. At the same time, if central banks hadn’t provided so much financing to the US for so long — and kept lending to the US in dollars at low rates even as the United States (gross) external debt rose — the US wouldn’t have built up the same kind of vulnerabilities either. Remember, private investors, by and large, weren’t willing to lend to the US on anything like the same terms as central banks. Without large dollar-denominated flows into the US, the US would have been forced to scale back — and, in the process, delivered a bit less impetus to global demand growth.*

The large surpluses of the oil-exporters and Asian emerging economies could only last so long as someone in the US or Europe borrowed — and borrowed in scale. When the US government stepped down (after 2004), private borrowers — aided by a risk-risking financial sector — stepped up, helped by a financial two step where emerging market central banks were willing to take dollar risk and leveraged financial intermediaries were willing to take credit risk. At least for a while. The game could only last in that form so long as emerging market governments were holding their exchange rates down and pushing up their countries national savings and private financial intermediaries were willing to lend to ever more indebted US households. That allowed say the rise in the oil exporters surplus to be offset globally by a rise in the combined deficit of the US and Europe, not a fall in Asia’s surplus. While the dollar’s rise and the resulting real appreciation of the renminbi has taken some of the urgency out of the debate over exchange rate, it would be a mistake, in my view, to limit the current debate over reforming the international financial system to regulatory issues — as important as such reforms are.

In late October, at the prodding of a newspaper’s features section, I wrote a piece laying out why the current economic and financial crisis is a crisis of the Bretton Woods 2 system even if it isn’t a dollar crisis. In the end, the newspaper went in another direction, no doubt in large part because I haven’t mastered the art of reducing my argument to a few easily distilled points. My draft — which is a bit longer and a bit less technical than my usual posts here on this blog — follows. I hope it is still of some interest.

The current financial crisis has produced its share of surprises even to those who doubted the long-term health of a housing-centric US economy. International economists – at least some of them – have long worried about the risk of a breakdown in what former Treasury Secretary Summers labeled the balance of financial terror and what others have called the “Bretton Woods 2” system of fixed exchange rates — a system where the rapid growth of central bank reserves in China and the oil-exporting economies financed large deficits in the US. They expected a crisis that marked by a fall in the dollar, a loosening of China’s peg to the dollar, a rise in the currencies of key emerging economies and higher interest rate on the US governments borrowing. The current crisis has not followed script: it has been defined by a a rise in the dollar, a tightening of China’s peg, a sharp fall in emerging market currencies and fall in the US governments borrowing costs.

Rather than dollar crisis that triggered a sell off in the Treasury market, a US banking crisis has turned into a crisis for most emerging market currencies. The dollar soared even as the US economy stalled. The yield on short-term Treasury bills has been close to zero for almost a month; the yield on the long bond just touched a record low. So much for even doomsday forecasts.

But in a deeper sense, the current crisis has been a crisis in an international financial system defined by the buildup of large surpluses among emerging market governments, a buildup that financed heavy borrowing by American and European households. Defenders of this system argued that it was win/ win. China could develop on the back of its exports. The US and Europe benefited from low and stable interest rates – a constellation that justified heavy borrowing by households and high prices for a host of risky financial assets. Unbalanced world need not be a risky world. China (and the Gulf) saved so that the US didn’t have to. Conversely, the US households spent so that China’s government didn’t have too – Menzie Chinn of the University of Wisconsin has accurately noted that the great puzzle of the past few years is why China preferred subsidizing US consumption to subsidizing Chinese consumption.

Crises have a way of clarifying the weak links in any financial arrangement. This crisis is no different. In retrospect, the stability of this system hinged on more than the willingness of China – and Russia and Saudi Arabia – to accumulate dollar reserves. China didn’t actually finance US household borrowing directly. Rather China bought US Treasury and Agency (Fannie Mae, Freddie Mac, and Ginnie Mae) bonds. Contrary to what some have argued, Freddie and Fannie weren’t the major sources of subprime, alt-a and other kinds of risky mortgages in 2005, 2006 and the first half of 2007. Consequently, China wasn’t directly making loans to the most risky borrowers in the US – or actually lending to those who were buying Chinese goods. But the inflow from China was still central to the process that allowed the extension of credit in an economy that itself wasn’t saving, and thus wasn’t generating new funds to lend. Think of it this way: when China bought a Treasury bond from an American insurance company or bank, if provided the pension fund or bank with funds to invest in riskier assets that offered a higher yield than Treasury bonds. Wall Street proved more than capable of churning out ever more complex kinds of mortgage backed securities – and securities composed of parts of other mortgage backed securities – to meet this demand.

The flow of credit that allowed American households to keep buying Chinese goods even as they were spending more on imported oil hinged on the willingness of China’s government to take currency risk – converting China’s domestic renminbi savings into demand for US government and agency bonds – and the willingness of Americans to trade their holdings of safe government bonds for riskier, and higher yielding, mortgage backed securities. That meant that American (and, as it turned out European) financial institutions took on ever increasing amounts of credit risk even as China allowed an ever rising share of its national savings to be denominated in dollars. Economists worried that the first leg of the trade might not be stable – China and others might not always be willing to buying depreciating dollars. It turned out though that the second leg of this trade was even more unstable – -and even more risky. China’s Treasuries aren’t likely to hold their value in terms of China’s own currency – but China will get more back than those who bought CDOS composed out of subprime mortgages – or the holders of Lehman’s bonds.

The collapse of confidence in US and European financial intermediaries consequently has brought down a key pillar of a global system that allowed emerging markets to grow on the back of American and European demand for their products. American households cannot borrow against their homes – and thus cannot continue to consume more than they earn. In September, US consumption fell sharply – and it would take a brave man to forecast a different outcome for October. China no longer can rely on US and European demand for its exports to drive its own economic development. Unusually strong global growth over the past few years may be offset by an unusually strong global slowdown. The entire global economy is now slowing sharply.

It almost goes without saying that those who bet that an unbalanced global economy could sustain high valuations for risky financial assets have lost large sums of money. That leads to the second surprise of this crisis: a fall in US home values and a likely severe US recession has turned into a emerging market crisis, with money now flowing out of emerging economies at a pace comparable to that of the Asian crisis of 97-98.

Why? Big banks weren’t just lending dollar to American households. They were also lending to banks and firms in the emerging world. Even as emerging market governments were building up their holdings of dollars and euros, emerging market companies were borrowing in dollars and euros. This is most obvious in a country like Russia: at the end of June 2008, Russia’s government has about $600 billion in foreign assets and less than $50 billion in foreign debts. Russian banks and firms by contrast had about $450 billion in foreign debts. The big US and European banks are now in trouble. They want their money back from borrowers in the emerging world – forcing emerging market banks, firms and governments to scramble to come up with the needed foreign exchange. A global banking crisis is creating problems for anyone who had relied on banks for to financing: US households that borrowed to spend more than they made, exuberant real estate developers in Moscow, Mumbai and Dubai, or a Brazilian firm looking to expand its iron ore production. Actually, it has caused more trouble for those who relied on shadow banks — institutions that raised money by borrowed short-term funds in the capital market rather than from depositors – than for banks –but that is another story.

What then should be done?

In the short-run, the core challenge is to avoid a downward spiral of confidence and cascading defaults. The governments of the US and Europe have acted decisively to avoid the collapse of additional large financial institutions (in the process exposing US and European taxpayers to consider risks, but in the context there was little real choice). A similar effort is needed to limit the fallout from the current run on many emerging economies – and to limit the depreciation of their currencies. This isn’t altruism either: the dollar’s current strength will cut into the United States’ exports at time when the US would like to be exporting more not less.

In the medium term, the challenge is to prevent expanding financial distress from fueling a self-reinforcing downward cycle of contraction, one where consumers cut back leading firms to cut back – and one where governments respond to falling revenues by cutting back as well. This isn’t the time to allow concerns about the long-term health of government’s balance sheets to drive policy: governments around the world need to stimulate their economies to offset what now looks likely to be a severe global slump. That advice applies with particular force to those countries with large external surpluses and lots of external assets: China can help the world right now by spending a lot more at home; the Gulf can also help by drawing on its accumulated stockpile of foreign assets to keep spending at home up. Such a stimulus won’t avoid a contraction; the goal is to keep the contraction from morphing into something far worse.

In the long-run, the challenge will be to find a more sustainable basis for global growth. The last few weeks have once again illustrated the difficulties emerging economies looking to finance fast growth by borrowing from the international banking system face. But the past few months have also highlighted the costs of a world where rapid reserve growth in the emerging world finances heavy borrowing by US and European households. US and European taxpayers have been hit with the bill created when their banks lent against inflated home values; Chinese taxpayers will eventually be hit with the bill for borrowing in a currency that is going up (the RMB) to buy currencies (the euro as well as the dollar) that are going down. No one is going to win. The policies of the past few years have not worked; it is time to try something new.

If nothing else, my short-term policy prescriptions don’t seem that far from Dr. Krugman’s own policy prescriptions.

* Alternatively, slower growth in the US might have put downward pressure on the dollar — and all the emerging economies tied to the dollar. Additional inflows to these economies would be recycled back to the US, so the overall result could have been lower global rates — which ultimately would have had to induced someone to borrow more or key surplus countries to take steps to stimulate their own economies to support their growth and in the process reduce their surpluses. If China say remained pegged to the dollar, the overall result could have been an even weaker RMB against the euro, an even bigger swing in China’s trade balance with Europe and a bigger EU wide deficit rather than a smaller Chinese surplus.

127 Comments

  • Posted by Euraussian

    Brad,
    One of he joys of our era is that we can observe top economists conduct public discussions in a very informal setting but about topics that are important to economists and laymen alike. This family of topics would take years to get proper treatment in an academic journal and even then only be read by PhD students and their supervisors. Everyone else (I forgot the authors and their relatives in Lahore or Chennai) looks at summaries.

    The downside is that we tend to think now more in terms of grand narratives, while the economcis profession hase become quite good at analysing small things, and remains very bad at analyzing the world .

    The issues that you raise in this blog are immensely complex and defy a simplicity-engendering medium like we use here.

    If I had to give only two of the most important comments to this post it would be (1) to forget about what China does or not does, strive for a US economy that can live without importing savings from a country that should (given its stage of development) be importing capital, not exporting it to a mature economy in the early stages of relative decline and (2) be extremely careful with either strengthening procyclical regulatory mechanisms like Basle II, mark to market accounting for long term positions or inventing new regulatory regimes on the fly.

    One of the things that did not work well were the mechanisms that are supposed to protect investors in the financial system. Some of those have now been bailed out, but without putting in place something that will encourage politicians to adopt policies that amount to good government. But anyway, why would politicians do that?

  • Posted by Daniel de Paris

    Of course this crisis is a currency-one. You need to be seriously myopic, biased or both, not to accept it.

    I started to read texts by Jacques Rueff, the sound-money-gold apologist of the sixties.

    http://en.wikipedia.org/wiki/Jacques_Rueff
    http://www.speedylook.com/Jacques_Rueff.html

    Who was Rueff ? A noted “smart brain” with strong academic background, he was instrumental in handling the depression during the 30s.

    Rueff took care of our national interests in the 60s tutoring de Gaulle on monetary management issues, certainly precipitating the decision of Nixon to stop gold-convertibility.

    I used to scorn the kind of words Jacques Rueff would use in during my MBA education by the end of the 70s…

    On the one hand, Rueff was certainly a matter of national pride certainly. On the other one, he represented everything a smart European manager would come to dislike at that time…

    At that time – 70s – all what my generation wanted was:
    - dollars not gold,
    - 50s-70s modernity not the back-and-white gloomy 30s,
    - Ford instead of Citroens, …
    - MBA-style Management science instead “your fathers on-the-job direction générale”,
    …Feed the list by yourself, Eurozone readers including Rock-and-roll and some additional hoopla.

    It is a pity for me to discover that whilst Rueff was wrong on timing and, he was certainly right on a couple of basic issues including currency.

    http://mises.org/books/monetarysin.pdf

    Beware of the Asian Rueff(s). The situation will definitely generate a few of them. Pretty soon IMHO.

  • Posted by globumedes

    Hallo

    B.Setser: “I nonetheless still believe that that the origins of the credit crisis cannot be entirely separated from the Bretton Woods 2 system. ..”

    We can talk a lot about the crisis. But if we talk about the origins, there is (in my opinion)no reason, to bring any other causes, then BW2 and the job of the banks (make money) in account.
    See for example Redeker (BNP),16.sept.08; go to 6.03 min. in the video:
    http://www.cnbc.com/id/15840232?video=857650297&play=1

    globumedes

  • Posted by a

    The stimulus numbers I hear being thrown around are 1 trillion over 2 years. So this is 500 billion/year in new government debt. How does this compare with the rate at which American households were going into debt in 2006 and 2007? Is the American government simply taking on the American household’s previous role in BW II? Is this really something new?

  • Posted by DJC

    While the Japanese economy was sluggish, the Japan Ministry of Finance (MOF) intentionally downplayed Japanese economic strength during the Clinton Administration years. Japan did experience a massive real estate bubble, but Japan also retains one of the most advanced industrial and technology bases in the world. The Clinton-Rubin administration imposed 100% protectionist tariffs on Toyota luxury Lexus vehicles and Japanese auto parts. During that period, the US news media closely associated with the Clinton-Rubin Administration led by Thomas Friedman was relentlessly bashing the Japanese. The Japan MOF also had other disputes with the Clinton-Rubin Administration particularily over handling of the 1997 Asian Economic Crisis. A Japanese friend from Kyoto tells me that their economy over there is far from the boom times during the 1980′s, but neither is the Japanese economy in depression. The Japan depression theme was an intentional disinformation policy and the dumb US media-government fell for the line hook and sinker. And while the Chinese economy also has well documented problems, it is also not as bad as the biased Western media loves to portray.

  • Posted by Sackerson

    Would the Basle Accords also be relevant, since they allowed banks to vary their reserves according to how they defined their collateral?

  • Posted by bena gyerek

    so in summary, the latest mini-bubble (after dotcom, housing, etc) is us treasuries, with the federal govt running enormous fiscal deficits and nationalising bad debts, all in order to expoit the dollar super-bubble for a few more months or years, until everyone (even the chinese) realises that the federal govt’s fiscal burden is unsustainable. the govt’s motto should be “stop the adjustment now!” sounds great.

  • Posted by DJC

    From Mish Shedlock’s economics blog,

    Robert Rubin’s Arrogance and Denial is Appalling

    http://globaleconomicanalysis.blogspot.com/2008/11/rubins-arrogance-and-denial-is.html

    Robert Rubin’s statements display ignorance at best and is a blatant lie at worst. There are plenty of people that saw this crisis coming: Roubini, Shiller, Shostak, Schiff, me, and literally hundreds of bloggers all of which could have run Citigroup better than Citigroup management did. Rubin told the Wall Street Journal that the Citigroup board could bear some responsibility and that some things should have been done differently. How quaint. Rubin is saying: “It’s not my fault, rather it’s the fault of everyone else on the board.”

    Rubin’s arrogance and denial is appalling.

  • Posted by Bob_in_MA

    I have wondered if twenty years from now, the chief cause of the credit bubble will be attributed to the accumulation of dollar assets by foreign central banks, and not loose policy by Greenspan, et al.

    If you look at when it really started, 20-30 years ago with Japan, it coincides with the huge growth in credit that Soros conjectured was the super-bubble now bursting.

  • Posted by Jehu

    Bsetser: “the inflow from China was still central to the process that allowed the extension of credit in an economy that itself wasn’t saving, and thus wasn’t generating new funds to lend.”

    Wow. Those sneaky Chinese, making so much money available to be borrowed by Americans to buy Chinese goods!

    I say we don’t look into why the US began generating a trade deficit in the 70′s, and began relying on government and consumer borrowing to maintain the American standard of living shortly thereafter.

    Most of all, make sure no one mentions NSC-68 and the decades long expansion of unproductive military expenditures which made imports of manufactured goods necessary, as these expenditures crowded out domestic consumption and civilian production.

    Finally, let’s just not remember the credit super-bubble began almost immediately with Truman’s adoption of NSC-68 and headlong plunge into the Korean War, using the threat of Soviet Expansion as the excuse.

    PS: I think we shouldn’t acknowledge the Soviet Union disappeared 20 years ago either. So whatever justification there was for grossly unbalanced emphasis on military expenditures promptly evaporated with it.

    Yep. Those are some sneaky Chinese.

  • Posted by tyaresun

    Brad,

    What are the chances of BW II surviving if the US consumers are forced to save? It seems to me that the fiscal stimulus will just be sufficient to avoid a deeper recession. Once we are out of the recession, US will not go back to its merry ways. Savings rates will be positive because the US consumers no longer have the house and stock equity cushion. This, more than anything else will bring an end to BW II.

  • Posted by RW

    Just as the Fed is repeating the mistake that got us into this mess (artificially low interest rates), PMs are once again chasing yield by investing in risky securities they perceive as riskless:

    http://bit.ly/tuG2

  • Posted by DJC

    “What Mugabe has done to Zimbabwe, the Federal Reserve Bank and the IMF are doing to the world.” – Economist Robert Kiyosaki

    http://finance.yahoo.com/expert/article/richricher/124339

    In 1910, seven men held a secret meeting on Jekyll Island off the coast of Georgia. It’s estimated that those seven men represented one-sixth of the world’s wealth. Six were Americans representing J.P. Morgan, John D. Rockefeller, and the U.S. government. One was a European representing the Rothschilds and Warburgs.

    In 1913, the U.S. Federal Reserve Bank was created as a direct result of that secret meeting. Interestingly, the U.S. Federal Reserve Bank isn’t federal, there are no reserves, and it’s not a bank. Those seven men, some American and some European, created this new entity, commonly referred to as the Fed, to take control of the banking system and the money supply of the United States.

    In 1944, a meeting in Bretton Woods, N.H., led to the creation of the International Monetary Fund and the World Bank. While the stated purposes for the two new organizations initially sounded admirable, the IMF and the World Bank were created to do to the world what the Federal Reserve Bank does to the United States.

    In 1971, President Richard Nixon signed an executive order declaring that the United States no longer had to redeem its paper dollars for gold. With that, the first phase of the takeover of the world banking system and money supply was complete.

    In 2008, the world is in economic turmoil. The rich are getting richer, but most people are becoming poorer. Much of this turmoil is directly related to those meetings that took place decades ago. In other words, much of this turmoil is by design.

    Many Problems, Few Solutions

    There are three major problems with the events of 1913, 1944, and 1971. The first is that the Fed, the World Bank, and the IMF are allowed to create money out of nothing. This is the primary cause of global inflation. Global inflation devalues our work and our savings by raising the prices of necessities.

    For example, when gas prices soared, many people said that the price of oil was going up. In reality, the main cause of the high price of oil is the decreasing value of the dollar. The Fed, the World Bank, and the IMF, like Zimbabwe, are mass-producing funny money, thereby increasing prices and devaluing our quality of life.

    The second problem is that our economic crises are getting bigger. In the 1970s, the Fed faced and solved million-dollar crises. In the 1980s, it was billion-dollar crises. Today, we have trillion-dollar crises. Unfortunately, these bigger crises mean more funny money entering the system.

  • Posted by cam

    Somebody needs to let the economist Robert Kiyosaki know that every central bank in the world is creating money out of nothing.

    His economic knowledge of the world and history is breathtaking.

  • Posted by Brian Shriver

    When deleveraging occurs, not only are high-return assets sold off en masse, the financiers of the leveraged investors discover their holdings are far riskier than they thought, and rush to the safety of treasuries.

    Brad:

    Here’s a link between BW2 and the US financial crisis.
    Savings arises from nodes in the economy running surpluses – receiving more than they spend – with the constraint that aggregate surpluses are zero. Any income imbalances can lead to savings which must flow through the financial markets. So if you have large external imbalances, roughly 6% of GDP must flow through US financial markets annually. No doubt household income polarization further contributes to the volume of primary flows.

    Some of the money is used for business projects (“capital” in the traditional sense), some for deficit spending (including housing), and some for financial market speculation (i.e. leverage). Unfortunately, the financial market cannot always handle so much liquidity. When the amount of liquidity exceeds the availability of quality investments, lending standards deteriorate. More money gets funnelled into leveraged investing, etc.

    Thus, I would argue that external imbalances fueled the financial market liquidity which led to asset price bubbles and excess leverage in financial markets. Within this context, sovereign appetite for treasuries may have pushed private investors further out on the risk spectrum.

    JMHO FWIW

  • Posted by Brian Shriver

    Brad:

    (repost: don’t know what happened)

    Here’s a link between BW2 and the US financial crisis.

    Savings arises from nodes in the economy running surpluses – receiving more than they spend – with the constraint that aggregate surpluses are zero. Any income imbalances can lead to savings which must flow through the financial markets. So if you have large external imbalances, roughly 6% of GDP must flow through US financial markets annually. No doubt household income polarization further contributes to the volume of primary flows.

    Some of the money is used for business projects (”capital” in the traditional sense), some for deficit spending (including housing), and some for financial market speculation (i.e. leverage). Unfortunately, the financial market cannot always handle so much liquidity. When the amount of liquidity exceeds the availability of quality investments, lending standards deteriorate. More money gets funnelled into leveraged investing, etc.

    When deleveraging occurs, not only are high-return assets sold off en masse, the financiers of the leveraged investors discover their holdings are far riskier than they thought, and rush to the safety of treasuries.

    Thus, I would argue that external imbalances fueled the financial market liquidity which led to asset price bubbles and excess leverage in financial markets. Within this context, sovereign appetite for treasuries may have pushed private investors further out on the risk spectrum.

    JMHO FWIW

  • Posted by DJC

    Don’t Buy US Debt
    http://www.cnbc.com/id/27904352

    The US is “issuing the same currency their debt is denominated in, so they will be more likely to inflate away their fixed income,” David Karsbol from Saxo Bank warned investors.

    Inflation will rise again in the medium term as there is so much money being printed, but the economy will become deflationary in the short term, Karsbol predicts.

    Instead, he prefers government bonds in Germany and Switzerland as they have “good inflation credentials.”

    The bear-market rally that we have experienced over the last two days will be short-lived and will be running out of steam by the end of the week, he said.

    “Nothing fundamentally has changed,” Karsbol told CNBC.

  • Posted by Howard Richman

    Brad,

    You were exactly correct in everything you wrote. The only reason it wasn’t published is that the editors were not yet ready to hear the truth. After a few years of this worldwide depression, they’ll start listening.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Belisarius

    Brad,

    I agree. As Keynes said, it only takes one mercantilist great power to cause great global imbalances. The West can do ordinary Chinese people a great favour by telling their leaders (gently, in private) they won’t be playing that game much longer. And yes, a little carefully targeted protectionism can be part of the diplomatic process.

  • Posted by globumedes

    Hello

    Concerning the causes of the crisis:

    R. Bookstaber has another cause:
    “As I point out in my book, complexity of financial instruments is one of the sources of market crisis.”
    http://rick.bookstaber.com/2008/11/my-non-testimony-on-regulation-of-swaps.html

    This is a derivative cause: the fundament of this cause is the banks, that have, as any other company, the only task -as the modern economic-dogma Nr.1 says-: make money. (The rest-economy/society will have profit thanks to dogma Nr.2: the trickle-down.)

    So I still have only two causes: BW2 and the banks, that are doing their job.

    I think, the cause of Bookstaber is based in his profession; an other example would be: a professional of the “logic of management” would see the cause in the break down of the mangement structure. (This too is a derivative causes.)

    globumedes

  • Posted by Howard Richman

    I would just like to add something to the following statement of yours:

    “But the past few months have also highlighted the costs of a world where rapid reserve growth in the emerging world finances heavy borrowing by US and European households. US and European taxpayers have been hit with the bill created when their banks lent against inflated home values…”

    The two key facts that everyone is ignoring are:

    1. The US and European households are not going to be able to resume the increased borrowing to consume increased production from the emerging world.

    2. China’s widely hailed stimulus plan consisted largely of export subsidies. (Michael Pettis called it “Smoot-Hawley-with-Chinese-characteristics.”) It is not going to produce increased US or European income.

    Because of these two facts, you can’t turn the merry-go-round back on where US and European consumers borrow and buy while China and the mercantilist nations lend and sell. That’s why the world depression will continue.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by DJC

    Fed’s ‘Consumer Bailout’ Encourages More Bad Behavior

    http://finance.yahoo.com/expert/article/moneyhappy/124971

    Treasury Secretary Henry Paulson doesn’t want Americans to stop spending, because that will slow the economy. So he’s using taxpayer dollars to make it easier for consumers to dig themselves more deeply into debt.

    More of What Ails Us

    The Treasury announced Tuesday that it will buy $600 billion in mortgages and mortgage securities backed by Fannie Mae and Freddie Mac, and provide $200 billion in non-recourse loans to investors holding investment-grade (BBB or better) securities backed by newly or recently originated consumer loans. That includes credit cards, auto loans, and student loans, as well as small-business loans guaranteed by the Small Business Administration. The $200 billion will come from the Treasury’s Troubled Asset Relief Program (TARP).

    “Millions of Americans cannot find affordable financing for their basic credit needs. And credit card rates are climbing, making it more expensive for families to finance everyday purchases,” Paulson said Tuesday. “This lack of affordable consumer credit undermines consumer spending; as a result, it weakens our economy.”

    It’s an ironic solution to a crisis perpetuated in part by consumers signing on for more debt than they could ever hope to pay off. But it’s not a surprising development amid the scattershot rescue strategy that has the government prepared to pledge $7.76 trillion on behalf of American taxpayers — $24,000 for each man, woman, and child, and enough to pay off half the nation’s mortgages — according to a Bloomberg analysis.

    Taxpayer Stuck with the Tab

    Paulson called the $200 billion in the Term Asset-Backed Securities Loan Facility (TALF) “a starting point.” In other words, at a time when record numbers of consumers have spent themselves into insolvency, and millions of others face increasing job insecurity, the government is hoping to balloon their borrowing — propping up spending in the short-term but potentially setting the stage for another debacle in the future.

    “You have to ask a simple question: Why is this necessary?” says Adam Lerrick, an economist with Carnegie Mellon University and a visiting scholar at the American Enterprise Institute. “Why don’t the markets do this themselves? The obvious answer is they don’t believe in the Triple-A rating [on the asset-backed securities]. Why should the Treasury have more confidence about the rating agencies than the market? What it’s doing is shifting the credit risk of the bonds from investors to the taxpayers.”

  • Posted by john c. halasz

    Now that foreign equity markets have crashed and the U.S.$ has “appreciated” due to a sudden “scarcity” of $ needed for de-leveraging, shouldn’t we expect a rapid expansion of the U.S. NIIP, (the official measure of the U.S. external debt), as $ previously etherealized through financial alchemy come raining back down to earth? And, when the de-leveraging crisis has passed, (exactly when?), shouldn’t we expect steepening roll-over costs for U.S. debt? Were too many economists deceived about the global financial crisis potential, because they took the NIIP figures at face value, and rationalized those ethereal $ somehow, (e.g. “dark matter”, superior U.S. productivity)?

  • Posted by gillies

    the current phase of economic history traces back to richard nixon’s time in office : departing from the gold standard and opening up relations with china.

    these policies presumably removed certain restraints on economic growth.

    at a basic and abstract level, economic growth takes the form of exponential growth – compound interest if you like. at the same time as the nixon policies (early 1970s) a thesis called ‘the limits to growth’ was published. this explained that exponential growth in a finite environment, was unsustainable.

    so what caused the present crisis ? the boom was the cause – and every policy that enhanced and extended the boom, enhanced and inflated the potential bust.

    the sino-american dollar roundabout is only one (major) example of multiple self reinforcing feedback loops in the recent global economy. spend more with them – they spend more with you. money circulates and no global economic constitution, however strictly regulated, can prevent money circulating faster to generate booms and slower to generate busts.

    if wall street fired all those physicists, and hired ecologists in their place – things would become much clearer . . .

  • Posted by Twofish

    I really don’t think that China and the Middle East had very much to do with financial crisis. They might have caused the balloon to expand more quickly, but it still would have popped eventually.

    bsetser: Without large dollar-denominated flows into the US, the US would have been forced to scale back

    I don’t think it’s that mono-causal. If you reduce the amount of dollar denominated flows into the United States, there are about five or six different ways that the US could have responded, and what happens next gets quite complicated.

    But without regulation it all would have blown up in the end, anyway.

  • Posted by Twofish

    Richman: After a few years of this worldwide depression….

    Hypothetically speaking. Suppose by the middle of 2010 it’s obvious that we aren’t in a depression, what then?

    Personally, there is enough unknown about how economies work that I get very worried when someone thinks that they know exactly what is going to happen next.

    Among other things, if you are convinced that a depression is unavoidable, you don’t rack your brain trying to figure out how to prevent it.

  • Posted by Twofish

    Richman: Because of these two facts, you can’t turn the merry-go-round back on where US and European consumers borrow and buy while China and the mercantilist nations lend and sell. .

    Yes you can with the help of massive deficit spending. No politician is going to go to their voters and say “we’ll we just have to live through the depression for a few years” since anyone that tries this will get voted out and replaced by someone else.

    Eventually you are going to have someone in power that will have massive deficit spending and borrowing to keep people employed.

    I think the next few years are going to look like the past few years with massive borrowing from China to the US government, and a huge trade deficit. The only real difference is that instead of being driven by consumer spending, you are going to see demand driven by government spending.

  • Posted by a

    Twofish says:
    “Yes you can with the help of massive deficit spending. ”
    And he says:
    “Personally, there is enough unknown about how economies work that I get very worried when someone thinks that they know exactly what is going to happen next.”

    I hope you’re worried.

  • Posted by Ricardo Smith-Keynes

    I also attended the conference last week and, like you, came to the conclusion that there is a disconnect between the conventional wisdom and the underlying reality. That, or we are both wrong.

    To be sure, there is no shortage of regulatory lapses that must be corrected. But it is myopic to focus exclusively on those and ignore the underlying systemic issues that now threaten the global economy. As one prominent participant at last week’s conference put it, this is a systemic crisis, and we should be looking at the system.

    A few simple questions make the point: How did regulatory failures in one country infect the global financial system if not through the international monetary system? How were monetary policy misjudgements in the anchor currency country magnified if not by fixed, and heavily managed exchange rates that fuelled excess liquidity? How did fears of an Ackerlof “market for lemons” in the interbank market spread, were it not through the international financial system? If we don’t analyse the root problems, we are unlikely to identify the correct solution.

    In some respects, the relevant historical analogue is the collapse of the Bretton Woods system in the early 1970s. At that time, proposals for reforming the international financial architecture were evaluated on the basis of three critical criteria–liquidity, confidence, adjustment.

    The first is whether the system is designed to ensure the appropriate level of liquidity to finance trade and payments is provided.

    The second criterion, reflecting the fatal flaw at the heart of the Bretton Woods system, the so-called Triffen dilemma, is concerned with the overarching importance of maintaining confidence in international monetary arrangements. In particular, does the system provide sufficient incentives for key reserve asset issuing countries to pursue policies consistent with the maintence of the system? This has not yet been a feature of the current crisis.

    The third benchmark against which proposals for international monetary reform were assessed is whether the proposed system encourages the appropriate degree of adjustment on the part of debtor or creditor countries. In the current context, the issue is whether the deficit country (the U.S.) will be required to bear too excessive an adjustment burden over too short a period of time, or whether the surplus country (China) should bear some of the burden. Under the asymmetric Bretton Woods system, the “rules of the game” imposed the adjustment burden on the deficit country at the insistence of the U.S. A flexible exchange rate system is “symmetric” in that the adjustment burden is shared by both deficit and surplus countries. But in the current environment the largest surplus country has tied its currency to the largest deficit country, who also issues the key anchor currency. As a result, the only way for the deficit country to engineer the real exchange rate adjustment that is required to facilitate orderly adjustment is to deflate relative to surplus countries.

    History suggests that we should avoid this outcome if at all possible.

  • Posted by Twofish

    It’s interesting it seems like I’m in the “conventional wisdom” camp that argues that

    1) the large trade deficits really didn’t have that much to do with the current crisis, and

    2) even if they did, talking about fixing it is pointless without focusing on the very real fact that most actors have very good reasons for keeping the system as it is.

    Richardo Smith-Keynes: But it is myopic to focus exclusively on those and ignore the underlying systemic issues that now threaten the global economy.

    I think that the regulatory framework (or lack thereof) *is* the systemic issue, and that the attention placed on trade deficits and balance of payments was missing what was and is the real problem, which is how you have national lenders of last resort and banking regulators in a global economy.

    Keynes: If we don’t analyse the root problems, we are unlikely to identify the correct solution.

    The issue is that we have very different notions of what the root problem is. In my mind the root problem is a fragile financial system that was insufficiently flexible to deal with shocks.

    Keynes: The second criterion, reflecting the fatal flaw at the heart of the Bretton Woods system, the so-called Triffen dilemma, is concerned with the overarching importance of maintaining confidence in international monetary arrangements. In particular, does the system provide sufficient incentives for key reserve asset issuing countries to pursue policies consistent with the maintence of the system? This has not yet been a feature of the current crisis.

    I think the Triffen dilemma is very much relevant to the current situation. Emerging markets wanted large reserves of dollars to deal with a repeat of the Asian crisis, this causes them to take policies which result in a high valuation of dollars.

    I think that the current crisis may increase the tendency for emerging markets to buy dollars since countries with large reserves of dollars have done much, much better than those without, and IMF did not react very quickly to the crisis.

    This reveals a deeper issue that for all of the talk for the need for global balance, its in no one’s immediate political interest to have global balance, which gets at an even more core issue which is that the institutions that regulate the world economy haven’t adjusted to current economic realities.

  • Posted by Twofish

    One other characteristic of the post-BW I system was that, there was a lot of ad hoc evolution. I don’t think that anyone in 1970 could have really predicted what the world system looked like in 1985, and right now we are also sailing into the unknown. There is a limit to which you can design system, and most complex systems are more the result of ad-hoc evolution than intelligent design.

    One important criterion for any workable system is “political viability.” You have to have some reason that the major actors go along with the system, and that reason could be either persuasion or coercion. The major actors are so interlinked that coercion for the most part is not an option. Coercion in the global economy is like threatening to push someone you are chained to off a cliff, and there are limits that you can threaten someone before you hurt yourself.

    So you have to use persuasion, but then you run into the problem that people have different interests.

    One should point out that one reason that Bretton Woods I cam into being was that after World War II, the United States was the only major power left standing and could dictate global economy rules. Bretton Woods I ended when this was no longer the case, and you had Europe and Japan with different interests.

    Something similar happened with Bretton Woods II. For a brief moment in history, the United States could reshape the world in its image, but that moment is fast fading.

  • Posted by Jehu

    Twofish: “It’s interesting it seems like I’m in the “conventional wisdom” camp that argues that 1) the large trade deficits really didn’t have that much to do with the current crisis, and 2) even if they did, talking about fixing it is pointless without focusing on the very real fact that most actors have very good reasons for keeping the system as it is.”

    Galileo Galilei: “Facts which at first sight seem improbable will, even on scant explanation, drop the cloak which had hidden them and stand forth in naked and simple beauty.”

  • Posted by Euraussian

    Twofish,

    “so you have to use persuasion, but then you run into the problem people have different interests” This is exactly the problem babyboomers educated with a heavy dose of marxism-leninism (even with Chinese characteristics) are very familiar with. Lenin grappled with this (domestically) in his early years in government and ended up with coercion. The problem is that our current environment is one of anarchy. There are no credible agreements on how to cooperate and the long term dominant power is (politically) unable to dominate or agree to policies that would spread the adjustment effects for domestic political reasons (I assume, but may be wrong, that the US public is only interested in world affairs in terms of armed conflict and is relatively (compared to, say, Swedes) ignorant about foreign economic policy issues) and lacks the capacity to enforce a regime that would satisfy a domestic audience (little or no decline in living standards) and facilitate adjustment.
    There is no way out. Markets (especially markets for finance and labor) cannot do this because in most countries governments do not allow them to function (and often for good national interest reasons, not always in the context of corruption). So we simply have to wait until the US public gets educated about current affairs and the limits of the country’s power. That will take time because denying the US power myth does not get anyone elected. And nuancing the capacity of markets robs politicians of a convenient excuse. The incoming administration does not appear to have an agenda for adjustment, only for easing the pain.

  • Posted by Ying

    “So you have to use persuasion, but then you run into the problem that people have different interests.”

    People have the same interest. They want peace, financial security, clean air and water, sustainable economic development, innovation, creativity and technology. They also want freedom without fear, love and respect. I don’t see any differences in terms of fundamental values cherished by people all around the world. Don’t be fooled by the western teaching that all people work in their own self-interest. In reality, we are so interconnected with each other that your happiness exactly comes from people who are around you or maybe all humankind. One example is that more and more consumers are interested in fair trade products from developing countries. What people want is to have fair platform to complete and cooperate with each other. Unfortunately politicians and businessman are too obsessed with zero-sum gain sort of thinking that they can’t get out of it.

  • Posted by Michael

    bs: “Such a stimulus won’t avoid a contraction; the goal is to keep the contraction from morphing into something far worse.”

    I thought “the contraction” is what we were afraid of (and are panicking because we are now experiencing). “The contraction” is a phenomenon that includes unpleasant but inevitable effects like falling business earnings, debt and mortgage defaults, and rising unemployment. Is there something above and beyond “the contraction” that you have in mind when you say “something far worse” or do you just mean that the contraction itself gets far worse?

  • Posted by jonathan

    It will be interesting over time to determine the systemic causes of this mess. I suspect that without BW2 the system would have created a similar looking structure because the developing nations relied on US consumption – and sometimes it seemed only China was even trying to create a large consuming model that would shift the burden from the US. Since BW2, etc. eased the financing of risk and consumption by the surplus running economies, yes, it’s clear that international policy must be under continuous review, but an economic system is more than that. If the system were different but within a range, we may have had the same result because the macro changes in China, India et al are of such a magnitude. I don’t know but one would need to include that part of the picture.

  • Posted by Howard Richman

    2Fish responds to my comment saying, “Among other things, if you are convinced that a depression is unavoidable, you don’t rack your brain trying to figure out how to prevent it.”

    Actually, the solution is elementary economics, It’s as simple as AD=C+I+G+(X-M), as I pointed out on my blog yesterday: In 2007, the trade balance was -5.1% of our GDP. If trade were instantly balanced, Aggregate Demand would instantly increase by 5.1%. This would increase the profits and market share of American businesses, thus increasing investment. The increased investment and improved trade balance would increase American income. The recession would be replaced by a boom. Thus Warren Buffett’s Import Certificates would instantly jumpstart the economy.”

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Chidam

    Useful link to a report to help understand China’s engagement in South America, Asia and Africa.

    http://www.fas.org/irp/congress/2008_rpt/crs-china.pdf

  • Posted by Howard Richman

    2Fish:

    You wrote: “Yes you can [fix the depression] with the help of massive deficit spending. No politician is going to go to their voters and say ‘we’ll we just have to live through the depression for a few years’ since anyone that tries this will get voted out and replaced by someone else.”

    I agree that your solution to the depression is feasible in China. In fact, we have both posted our wish that China would do it.

    In the United States, however, massive deficit spending doesn’t work. We’ve already had two stimulus packages (1) $150 in February and (2) $850 billion in October, with no discernable effect, other than the loss of millions of US manufacturing jobs.

    Then there is the problem that borrowing the huge amounts required will eventually cause the US government to default or inflate away its debt, resulting in a US currency collapse that leaves the US in temporary poverty.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Twofish

    Eurassian: Lenin grappled with this (domestically) in his early years in government and ended up with coercion.

    This is one big reason I don’t think that the current situation in which everyone is doing what seems to be in their interests is necessarily a bad one. You can come up with a system in which a Lenin or Mao comes to power and forces people to do the “right” things, but there is no assurance that those things are right after all.

    Ying: Unfortunately politicians and businessman are too obsessed with zero-sum gain sort of thinking that they can’t get out of it.

    Business and politics is all about making agreements that are positive for the people making it. You give me X, I give you Y, we both benefit. Figuring out what X and Y is quite tricky sometimes.

    The trouble is that sometimes (and in fact quite often) you do end up with zero-sum or negative-sum situations. If it is positive sum, then it’s easy, you get people in a room and shake hands and make deals. But sometimes it isn’t. Or sometimes you have a deal that’s positive sum for the people in the room, but negative for people outside. Or sometimes you have a deal that is short term positive but long term negative, or you can have something that is short term negative but long term positive.

  • Posted by Twofish

    Richman: In the United States, however, massive deficit spending doesn’t work. We’ve already had two stimulus packages (1) $150 in February and (2) $850 billion in October, with no discernable effect, other than the loss of millions of US manufacturing jobs.

    Very little of the $700 billion that has been authorized by Congress has been loan, and none of it actually goes to spending. It’s all in the form of loans. You aren’t going to see anything real until January.

    Richman: Then there is the problem that borrowing the huge amounts required will eventually cause the US government to default or inflate away its debt, resulting in a US currency collapse that leaves the US in temporary poverty.

    Except that US debt/GDP is fairly low, and right now there is no shortage of people willing to loan the US money. What will happen if the US does nothing is that you will have increasing amounts of the world’s wealth locked up in non-productive Treasury bills rather being used for useful things like improving health and education.

  • Posted by Twofish

    Richman: It’s as simple as AD=C+I+G+(X-M), as I pointed out on my blog yesterday: In 2007, the trade balance was -5.1% of our GDP. If trade were instantly balanced, Aggregate Demand would instantly increase by 5.1%.

    Assuming nothing else changes in that equation which is not going to be the case. The other problem is that people really don’t care about GDP, they care about jobs and incomes, and most people in the US have jobs and incomes that depend on rather obvious ways in the trade system not changing much, so the first reaction is to try to keep the status quo as much as possible, and then and only then do something radical if it doesn’t work.

  • Posted by a

    “It’s as simple as AD=C+I+G+(X-M), as I pointed out on my blog yesterday: In 2007, the trade balance was -5.1% of our GDP. If trade were instantly balanced, Aggregate Demand would instantly increase by 5.1%.

    Assuming nothing else changes in that equation which is not going to be the case.”

    IMHO this is a major mistake in reasoning. AD=C+I+G+(X-M) is an accounting identity. It’s a priori. What to do about the economy is an a posteori question. Reasoning exclusively from an a priori identity isn’t going to tell you what to do about an a posteori question. It’s like saying that because you know that 2+2=4, you can figure out the temperature that water boils.

  • Posted by Twofish

    The other thing that I don’t understand is why people assume that the “optimal situation” between US and China is one in which you have zero trade deficits when no insists that this is the optimal situation between New York and New Jersey or even between France and Germany. My guess is that if you use some simple comparative advantage arguments, you’ll end up finding that impose an international trade constraint actually reduces total wealth generation. (This also nicely explains why there was such huge trade friction with Japan in the 1980′s. Since Japan and the US have similar economies, there is no extra wealth generated by comparative advantage so things do become zero-sum.)

    I propose this as the solution to the riddle that if global balance is such as great thing, why are there so few people interested in having it.

  • Posted by Ying

    Twofish:

    There are lots of grievance between China and the US right now. China has the worst pollution in the world, slavery wages etc. The US has the systemic job loss. For me, they all seem to be unintended consequences created by invisible private hand in the pursuit of money. Yet both government didn’t
    pay serious attention to the problem till recently. You are right that nobody know exactly what they will get when they first started the cooperation. China may wanted to close up the technology gap. US may wanted to lower the cost of living for its people. So it seemed to be win win solution for both of them to cooperate at the beginning. Then unintended consequences occurred.

    Personally I think that both government should use policy tools to cap the income gap between rich and poor. Beneficiaries of the globalization in both China and US should share some of its profits to the losers. For
    solving trade imbalances, China should higher the labor and environmental standards. For US, it should scale back its spending on lavish CEO bonus and wars. Both countries should spend time and energy on how to improve the efficiency of the economy as a whole instead of engaging in any sort
    of hostile competition. There are lots of rooms(such as education, research, technology etc) to cooperate to provide win win situation for all people. We will all better off by spending time to solve the challenges of climate change, energy shortage instead of engaging in some sort of destructive behavior to beat each other. If politicians let the business sector lead the way, they will always end up pursuing short term interest for each nation rather than the long term prosperity for all.

    Trade deficit shouldn’t be a focus right now. The main focus is to create the social safety net that prevent people from falling into crap and deepening the economic recession.

  • Posted by Chidam

    @Brad:
    The following analysis would be very useful both for your position on China’s reserves and for general understanding.
    We need to compare the 2.x trillion dollars in PBoC’s forex reserve with the trade surplus arising from China’s exports to the United States. Given that exports to the United States are a small fraction of total exports both in dollar and quantitative terms, you’d be able to see that it’s not a case of China accumulating trade surplus with us on to the dollar forex reserve.Accumulating dollars is a separate strategy and it has nothing to do with trade surplus. Also please go through the summary of the link I posted above, it’s a congressional research service summary of China’s trade negotiations, diplomacy and foreign policy.

  • Posted by gg

    The renminbi posted a record one-day fall against the dollar on Monday as speculation mounted that the Chinese authorities might use a weaker currency to spur economic growth
    As dealing started yesterday, traders pushed the renminbi to the limit of its trading band for only the second time. The renminbi closed the session at Rmb6.8842, down 0.9 per cent from Friday’s close. This was the renminbi’s largest one-day fall against the dollar since it was de-pegged from the US currency in July 2005, and took the currency to its weakest level since June 17.

  • Posted by bena gyerek

    question to twofish:

    why do you think that the us govt would have an interest in perpetuating bw2? if i were obama, i would be very keen to devalue the dollar in the next 12 months (once i had prefunded my usd 1 tn fiscal stimulus of course).

  • Posted by gg

    + I m still waiting for capital controls …

  • Posted by bena gyerek

    i think a major root cause of the crisis was celebrity magazines

  • Posted by Howard Richman

    2Fish,

    Your comparison of New York – New Jersey trade with US-China trade misses the fact that there is no distortion of New York – New Jersey trade through currency manipulation, tariffs, and various other import barriers.

    Howard

  • Posted by Howard Richman

    a responds to my blog posting about the Aggregate Demand equation by pointing out that it is an accounting identity. This is true.

    I was following the standard economic practice of dividing up aggregate demand into components (C, I, G, and X-M), in order to discuss the effect of government action upon aggregate demand.

    My point being that instantly balancing trade with Import Certificates instantly improves the trade balance (X-M) while causing a long-term increase in investment (I). The result being that the U.S. instantantly recovers from the depression.

    This is indisputable. The only reason most economists don’t see it is because they do not know that it is possible to instantly balance trade. We had a good converation about Warren Buffett’s Import Certificates plan to balance trade on this blog in response to Brad’s November 13 posting.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Euraussian

    Twofish,

    Looks like you share my view that the current environment is unsuitable for solving the current crisis. If we go back to people Lenin cs did not particularly like, the people who had influence in the City of London in the mid 19th century (probably the last truly civilized period in our history), they would believe that crises should be allowed to simply burn out. But that was without mass home-ownership (and home-debtorship), and especially without the Franchise..I guess someone will find a “win-win” situation (how do you say that in Mandarin?)

  • Posted by Twofish

    Richman: Your comparison of New York – New Jersey trade with US-China trade misses the fact that there is no distortion of New York – New Jersey trade through currency manipulation, tariffs, and various other import barriers.

    So let’s do this. What is the trade deficit that would cause maximum wealth generation on both sides? What is the trade deficit that would exist if the US/China were in a currency union with no tariffs?

    If we can show that is close to the actual level, then there is no distortion, and I claim that if we work out the numbers this will be the case.

    The question I keep asking is if the trade deficit is such a bad thing is there such little political reaction to it. Saying that politicians are somehow “bought off” doesn’t answer the question since you have to answer why 1) politicians in the 1980′s were less bought off and 2) where all this wealth to buy off politicians is coming from.

  • Posted by Corentin

    Brad,

    EM surpluses are IMHO just one side of the coin. The other is increase in earnings inequities.

    Both have for result an increase in amounts of floating money chasing for yield, the so called saving gluts, producing because of investment supply inelasticity : first assets inflation, then, exotics and toxics inventions.

    On the other side, average people needs more and more to ressort to credit, with at the end of the process the plug between too little and too much earnings : subprimes, plastic, and the likes.

    There is also an obvious relation between the deflationnary process of the “great moderation” and the deficits. Diminishing levels of price and earnigs, compensated by cheaps imports.

    Last not least, the retirement issue is also involved. Chasing yield for 401 is in part responsible for the pression exerced on national earning, thus outsourcing for maximizing returns, etc…

  • Posted by DJC

    Latest from Peter Schiff,
    http://www.europac.net/newspop.asp?id=14779&from=home

    On Monday, the $300 billion Citigroup bailout took center stage. Once again Henry Paulson decided to throw taxpayer funds into a bottomless Wall Street money pit. Shockingly the Citigroup plan did not seem to demand any serious curtailment of lavish salaries and bonuses. Paulson’s shameless largesse to his Wall Street friends has elevated financial industry bonuses to entitlement status.

    “Remember Lehman” now seems to be the rallying cry to justify any and all financial bailouts. But Lehman’s demise is in no way responsible for our current problems, and the decision to let them fail is the only bright spot in otherwise consistent record of policy mistakes. We bailed out Bear Sterns and AIG, and what did that get us?

    The Citi bailout greatly increases the chances for a similarly misguided auto industry bailout. After all, if taxpayers ensure multi-million dollar bonuses for Citi executives, how can they refuse similar help for eight-figure auto executives?

    It is no surprise therefore that both Democrats and Republicans offered healthy “huzzahs” to Henry Paulson’s latest bazooka: $200 billion to purchase securities backed by auto, student, and credit card loans. It is hoped that with this transference of risk to taxpayers, lending institutions won’t be so cautious, and the credit-fueled American economy can thrive anew. This is unalloyed insanity that can only lead to total ruin.

    Paulson stated clearly that he would print as much money as it takes to revive the economy. Unfortunately the only industry likely to be revived by such policies is printing itself. But even this will not help the United States as the majority of our printing equipment is imported from Switzerland.

    But what if the root of our financial problem is that American consumers have already taken on too much debt? By trying to force feed even more credit down the throats of already overly indebted Americans, Paulson’s plan will only weaken the economy further.

    The brutal truth that no one in Washington dares acknowledge is that our systemic economic problems can only be solved by a reduction in consumer borrowing and an increase in savings. We must repair our national balance sheet and a painful recession is the only path to achieve this. By interfering with the market’s attempts to bring this necessary change about, all the proposals currently coming from Washington or bubbling up from think tanks and Nobel prize-winning economists, will only exacerbate the imbalances and lay the foundation for even greater losses and a larger crisis.

  • Posted by Howard Richman

    2Fish,

    Actually American economists, not politicians, are responsible for the trade deficits. Most economists continue to buy into the discredited ideology that the free flow of capital into a country, which causes trade deficits, is good for the country.

    In our book Trading Away Our Future we show that even though the inflow of capital lowers US interest rates, it doesn’t increase US investment because it raises our exchange rate, thus taking away investment opportunities in our productive sectors.

    The same thing was found regarding developing countries by three International Monetary Fund economists (Eswar S. Prasad, Raghuram G. Rajan, and Arvind Subramanian). The more a nonindustrial country imports financial capital, the slower its growth. They concluded, as we did, that the deleterious effect of the foreign capital inflows is due to the resulting higher exchange rate that makes the recipient country’s exports less competitive in world markets.

    Incidentally, the next US Treasury Secretary, like all of the Treasury Secretaries since Don Regan, is a great believer in this ideology, as my father and I pointed out in an Enter Stage Right commentary published yesterday.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Global Chessboard

    @bena gyerek:
    @bena gyerek:
    Your earlier post stating that collapse of USD wouldn’t affect the US economy made me re think that problem. I noticed there were three major occasions when policy disrupted import flows: 1971 (10% import duty, non convertibility of dollars to gold, rigid price control, including wage control), 1933 (New Deal) and 1890 (McKinley Tariff – 48% import duty + Sherman silver purchase act – monetary expansion through silver coinage).
    Once import flows stop, there would be tremendous demand for substitution. Substitution would require high capex, very high demand for labor and it would involve hyperinflation till the substitution replaces imports effectively.
    E.g. setting up new foundries for the manufacture of electronic chips, or manufacturing plants to substitute imported automobile components.
    The difference between the US and other nations in terms of imports is that we pay for imports with US dollars, whereas they would need a foreign currency reserve to pay for imports. On the three occasions that we tried import substitution the reasons for it were extremely compelling. I’d like to share my understanding of the reasons. In 1971 we’d accumulated large deficits and Bundesbank among others was requesting conversion of its dollars into gold. It’s debatable whether the gold reserves were sufficient to ensure conversion, whether we could continue to retain domestic confidence in the dollar after the conversion, and how we would pay for our imports if the dollar consequently lost reserve currency status.
    By 1933 inflows from German war reparations to the UK/France and in turn to us, had stopped.
    In 1890 the newly discovered and mined silver had to be coined or priced appropriately in gold.

    If you could discuss the trichotomy between increased demand for labor and upward pressure on wages, high prices for all current imports, and increased capex in a general environment of low demand it would help everybody understand your point better.

  • Posted by Global Chessboard

    @Dr. Richman
    We’ve been accumulating deficits since the signing of the original Bretton Woods agreement. Pre 1971, there were compulsions to exchange deficits for foreign aid and military campaigns to defend the free world. The compulsion came from the competition with the communist block for geo political influence. Post 1971 there have been compulsions to maintain the black gold standard which has replaced the yellow gold standard and Bretton Woods. BW II describes a situation where China’s massive accumulation of USD reserves under the black gold standard gives her power and influence, and our worry is that China’s expansion might be to emerge as an alternative global superpower, or to displace us altogether in international affairs.

  • Posted by DJC

    “In this world, there are still some people who are living in abject poverty. For them, subsistence comes first,” said Chinese foreign minister Yang Jiechi, speaking Tuesday in Hong Kong. The Washington Consensus doesn’t share similar concerns about reducing global poverty. During the Clinton-Rubin administration, billions of developing world families were impoverished under Neo-liberalism. Wall Street hedge funds closely politically-connected to the Clinton-Rubin Administration raped and pillaged the Indonesian economy to the tune of $100 billion. The US Treasury/IMF agenda was to eliminate Chinese financial influence across the Southeast Asian region. It has been well documented that thousands of ethnic-Chinese across Indonesia were executed by CIA trained paramilitary death squads; the rest of the ethnic-Chinese community fled as refugees from the carnage. The entire criminal Clinton Administration led by Robert Rubin should be investigated for crimes against humanity.

  • Posted by Global Chessboard

    @DJC: There’s nothing new in your post above. Right now there’s a US backed mass genocide and displacement of 200,000 civilians going on in Northern Sri Lanka; you can see the reports and photographs on BBC.

  • Posted by bsetser

    john — yes, the NIIP will deteriorate significantly this yaer, largely due to the fall in the market value of the united states external assets. combine that will ongoing debt accumulation and a lot of the improvement of past years in the niip will go away. i don’t see a rollover crisis tho as the current account deficit is smaller and the remaining bit is effectively financed by china and right now china is determined to support its exports (note RMB move). so for now I am far more worried that China will try to support its exports too much than i am at the risk of difficulties refinancing the united states external debt. but the size of the United states gross debt position means that it is now necessarily to consider the risks.

  • Posted by Global Chessboard

    @ Dr. Richman and Bena Gyerek:
    After further analysis I’ve come to the conclusion that import control in some form is absolutely necessary to stimulate domestic demand. As you point out, increasing the flow of credit and fiscal stimulus have both been tried, and have not produced re assuring results in terms of increased demand so far.

  • Posted by Global Chessboard

    @Brad I noticed problems in posting comments with links sometimes. Could you explain that? Just now I posted a comment with links to BBC, barackobama.com and Us embassy on the ongoing Sri Lanka genocide. That was in response to DJC’s comment on the Indonesia issue above, to show that the economists should not ignore much more stark realities and life & death issues.

  • Posted by DJC

    Lawrence Summers on inferiority of women and developing world poverty,

    “Women are naturally less gifted for scientific studies than men. Any possible explanations based on family or social background should be swept aside.” – Lawrence Summers

    “The under-populated countries of Africa are largely under-polluted. Their air quality is unnecessarily good compared to Los Angeles or Mexico (…) There needs to be greater migration of pollutant industries towards the least developed countries (…) and greater concern about a factor increasing the risk of prostate cancer in a country where people live long enough to get the disease, than in a country where 200 children per thousand die before the age of five.” – Lawrence Summers

    http://www.counterpunch.com/millet12012008.html

  • Posted by Chidambaram

    @Brad:
    Can you please clarify?

    I’ve noticed that comments without links always go through.

    at the same time it’s strange to see that only certain posts with links, all of them from the public domain, that too from sources like BBC and the US embassy itself, get marked for moderation?

    And I had the same experience before as well, several comments with links don’t get posted.

    I wouldn’t like to get into a situation of being monitored over my controversial views on US foreign policy.

    At the same time I’d like to clarify I have nothing against the US and I have no connections with any other public or policy making bodies or any other kind of groups or anything like that.

    I’m just a bug fixer and I seem to have run across some really controversial and sinister stuff over the last few days due to my overarching interest to understand what’s happening.

    My secondary school teachers told me to always question what you’re being told, to reason it out and accept only those things as true when you see the reasoning behind them. I seem to have taken it too far.

  • Posted by Howard Richman

    Global Chessboard,

    Thank you for your agreement that import restrictions have to be part of the solution. The great advantage of Import Certificates is that that they not only reduce imports, they also increase exports.

    You wrote that we have been accumulating deficits since 1971. In Chapter 2 of Trading Away Our Future we examined the causes of each of the trade deficits since 1981. Each was caused by the flow of capital, but the causes of the flow differed.

    1981-1984. Fed Reserve Chairman Paul Volcker caused the trade deficit as a byproduct of fighting inflation. He issued lots of Treasury Notes without having the Fed buy those notes on its own account. This caused real US interest rates to climb, which increased the inflow of private foreign savings.

    1984-1986. Treasury Secretary Don Regan caused the trade deficit by passing a 1984 tax loophole that eliminated the 30% withholding on interest paid by private foreigners when lending to Americans. (Giuseppe Ammendola wrote an excellent book about this loophole, From Creditor to Debtor: The U.S. Pursuit of Foreign Capital — The Case of the Repeal of the Withholding Tax.) The result was an increased inflow of private foreign savings that continues until today since foreigners, unlike American savers, earn interest tax free by lending to Americans.

    1996-present. Mercantilist countries cause the trade deficit by building up their dollar reserves and sending them to the United States.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Chidambaram

    @Brad:
    I’d like to request you to delete my earlier comments on your blog site. This is more of a personal request from my side. I’m feeling quite uneasy about certain things and I wish to avoid troubles, dangers or conflicts more than anything else.

    Also please accept my clarifications below:

    I first came across your work sometime in March 2007, and the first thing I read by you was your views on the unwinding yen carry trade. Your blog along with comments from Andrew Rozanov at State Street explained with five steps the yen carry trade which I was not aware of till then.
    I’ve been following your work with varying levels of interest since then.
    Over the last several weeks, given the intense amount of reporting over the financial crisis I was following that news.
    My perspective was to see if I could make some small profits for myself out of understanding the developments and developing expectations.
    While reasoning out various events from public sources I found that there might be linkages between geo politics, the oil industry, military deployments of various countries, selective nationalization of large financial institutions, etc … all tending toward some grand unfolding theme.
    Earlier I used to treat the global news and foreign policy stuff like a sports page, assuming it had little or no connection with financial developments. Looking for connections seemed to reveal patterns that I never knew existed.
    Also I looked up information on past financial disasters and the connections were more evident when you looked at the past data.
    But I have no interest in anything political on an independent basis, and my primary interest is towards my own individual investment activities.
    Now for some time some of my comments with links on them are getting marked as ‘your comment is awaiting moderation’. At other times the comments with links are going through.
    Overall, I’ve decided not to pursue those topics at this forum any more. This is purely because I’m just a private individual with no political connections, no anti-national or anti-US agenda, and just somebody who’s trying to make a little money on the market.
    Now it’s quite possible that those themes and ideas are wrong. It’s also possible that this moderation is either just a technical thing, or just a routine exercise with some simple explanation to it.
    But my sixth sense is telling me otherwise. And in any case I would like my past comments to be deleted and to avoid discussion of those topics at this forum. It’s always better to be safe than sorry.
    If the topics I’m commenting on are too sensitive I hope it will be recognized that everything was from public sources on the internet and my room full of paper books.
    And I would appreciate your help with this.

  • Posted by Global Chessboard

    @Dr. Richman
    I’m trying to guesstimate the direction in which policy is likely to evolve.
    When you first proposed import certificates, you wrote that there is no counter to import certificates. I’d like to know your opinion on the effect if a foreign country were to devise their own import certificates, or if they were to impose high import tariffs in response.
    My view is that given the imperative to stimulate demand in the short run, even if negative effects on exports are likely there is no choice but to go with import controls in some form for now.

  • Posted by Twofish

    Richman: Actually American economists, not politicians, are responsible for the trade deficits. Most economists continue to buy into the discredited ideology that the free flow of capital into a country, which causes trade deficits, is good for the country.

    It’s actually American voters. I’m going to vote against anyone that promises to raise tariffs or restrict trade because I make more money and keep my job the more trade that happens.

    Since I work in finance, if China has a huge trade deficit it’s good for me if I can find a way of turning those trillions into big bonuses for myself.

    The thing about this is that I’m not the only on in that situation, and based on the results of recent elections, I think most Americans have jobs that at this point depend on China trade and vote accordingly. Chip engineer really doesn’t care whether the plant that makes his chips are in California or Shenzhen, and making the chips in Shenzhen means more money.

    The point that needs to be made is that if all this was just shifting wealth around, then presumably, I’d be happy but someone else would be angry as hell. If it was wealth destroying, I might be happy but there would be huge numbers of people angry.

    The fact that there are relatively few people that are angry about Chinese trade should tell you something, and the only explanation that I can come up with is that Chinese trade generates wealth so that you end up with lots of people on both sides of the Pacific that get paid off to support it.

  • Posted by Global Chessboard

    @Twofish:
    I think there are two specific suggestions:
    1) Reduce the exchange rate imbalance – from Brad. He’s been saying that consistently since at least 2004. Reducing the imbalance wouldn’t collapse the imports, it would just help avoid a financial disaster.
    2) Introduce import certificates – from Dr. Richman. Import certificates are again not a ban on imports. They try to ensure a more balanced trade.

    The current situation is that flow of credit has virtually come to a trickle. If I were you I wouldn’t worry too much about getting credit from China at reduced interest rates. That flow has already stopped.
    The moment import controls are introduced, there will be leaps and bounds in demand for workers in the US, including you. The government will have to impose regulations to control the increase in wages as a result of that.
    Import control is the only way Obama is going to be able to deliver on converting America back into a land of opportunity.
    I would agree that few people are angry about imports from China or any other specific country but a lot of people are quite angry about either unemployment or bankruptcy, and those numbers are quite huge; which is a major factor in Obama’s election.

  • Posted by Howard Richman

    2Fish:

    Actually, American voters are way ahead of politicians on trade. Even the majority of Republican voters are for doing something about trade. Republican candidates, on the other hand, have been telling them to vote Democrat, which largely explains why Republicans have been losing elections since 2004. See our commentary How to Recapture the Republican Advantage on Trade.

    Howard Richman

  • Posted by Ying

    Joseph Eugene Stiglitz said that Iraq war cost American $3 trillion. That money certainly could solve all trade deficit problem if it didn’t spend on military. I hope the mistake of hawkish foreign policies will be corrected. If not, American really lose credibility and confidence of the rest of the world. As I said nationalist policy will only produce short term profit, but not long term prosperity and stability of the world. Military dominance has a huge price tag. That’s one of the reason that US run into money shortage.

  • Posted by Howard Richman

    Global Chessboard asks me, “When you first proposed import certificates, you wrote that there is no counter to import certificates. I’d like to know your opinion on the effect if a foreign country were to devise their own import certificates, or if they were to impose high import tariffs in response.”

    We had a big discussion of Import Certificats on this blog in response to Brad’s November 13 posting. As I wrote then:

    Import Certificates cannot be fought with Import Certificates. The country with the trade deficit is always the winner.

    Example: Let’s take a situation where United States imposes Import Certificates on Chinese goods so that every $1 of exports to China allows $1 imports from China. Now, let’s say that China decides to respond by keeping out US imports. Every time they reduce their imports from us, they reduce their exports to us.

    Howard Richman

  • Posted by Howard Richman

    Global Chessboard:

    You were mentioning that you follow economics and politics as an investor. If the US imposes Import Certificates, put everything you have into American stocks, especially American companies that still produce in the United States, because the US would BOOM!

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Global Chessboard

    @ Dr. Richman
    I think that import certificates might boost consumption demand in the short run and lead to sustained increases in investment demand in the long run.
    I was reasoning that in this example China will try to maintain their current level of employment through exports to us, and gradually adjust the trade balance. The import certificates will ensure they will not able to add to dollar Forex reserves directly through trade with us. At the same time I’d like know what you think they will do on currency interventions and USD reserves.
    My thought is that they will temporarily maintain employment levels in China by further devaluing the dollar against the RMB. This will collapse the dollar price of Chinese imports and stimulate consumption demand for imported Chinese goods here.
    That policy is not sustainable for them in the long run. As the RMB devalues against the dollar, and money supply increases in China, soon there will be loss of confidence since the USD reserves won’t increase in parallel.
    As they adjust away from exports to the US, there has to be a similar adjustment away from the cheap imports for us, steadily creating investment demand; and correspondingly our opportunities and markets will improve as well.
    At the same time my concern is that demand levels are at a low more due to unemployment and job insecurity issues caused by close to 7% unemployment and high levels of hidden under employment.
    But if import certificates are introduced, I would probably go long first because it’s hard to time the above adjustment process.
    I’d like to know what you think of the above points.

  • Posted by ReformerRay

    Brad . Terminoly is important. The word “borrower” to me is someone who originates a loan because he needs the money the loan orignates.

    “The large surpluses of the oil-exporters and Asian emerging economies could only last so long as someone in the US or Europe borrowed — and borrowed in scale”.

    The money returned to the U.S. as the Capital Account – to match the Current Account – is returned to the U.S. only because the owner of the dollars wants to send them to the U.S. to exchange for some other more desirable currency – say a Treasury bond, or other asset.

    The U.S. does not initiate that transaction. It does not benefit the U.S., except so far as these transactions raise the price of the U.S. asset acquired.

    This exchange is not needed to maintain the trade deficit. Instead, a large Net Worth of Households in the U.S. is needed to sustain the trade deficit.

  • Posted by lb

    “it is time to try something new.”
    many thanks brad for opening the floodgates of possibilities here.
    there is a case that can be made that a huge part of the link is having the currency of one particular nation-state (in this case the US) be the world’s reserve currency.
    however, there is also a case to be made that the world needs an anchor, but that center needs to be stable, otherwise things fall apart (thank you mr. yeats). to expect any one nation-state to be always stable in its affairs given the geoecopolitical history of the world is maybe the folly here, leading to the current massive imbalances of dependencies (and its corresponding emotions).
    wouldn’t it be worthwhile to reconsider Keynes’ idea of a global reserve currency (aka the bancor)? Keynes originally thought to value the bancor in a basket of 30 or so commodities.
    another idea would be to value it as a basket of currencies — like the SDR but more globally balanced.
    (a good start would be to add the RMB into the basket.)

    as Keynes’ idea was never adopted, hopefully this can still be considered *new* enough to be worthy of discussion.

    this is not advocating

  • Posted by lb

    note: this is not advocating a one world currency by any stretch of the imagination.

    it is also assuming that either the IMF can be radically restructured to earn the trust of the global community or that another organization can be created that will be free from the dominance of any one particular nation-state.

  • Posted by Twofish

    Chessboard: The current situation is that flow of credit has virtually come to a trickle. If I were you I wouldn’t worry too much about getting credit from China at reduced interest rates. That flow has already stopped.

    This isn’t true. China and everyone else in the world are buying massive amounts of US treasuries.

    Chessboard: The moment import controls are introduced, there will be leaps and bounds in demand for workers in the US, including you.

    The second import controls are introduced, I lose my job. The people I know all lose their jobs. If you can come up with an argument that I get a better job, feel free to do so. If you talk with anyone in any high-tech industry the notion that import restrictions will help the economy is totally insane.

    Chessboard: I would agree that few people are angry about imports from China or any other specific country but a lot of people are quite angry about either unemployment or bankruptcy, and those numbers are quite huge; which is a major factor in Obama’s election.

    I know, that’s why I voted for him. The second he mentions import restrictions then that’s the moment I regret my vote and start working against him.

    The challenge you have is put yourself in front of a group of investment bankers or software engineers or auto workers, and explain in simple terms how they will end up with better jobs if you put in import restrictions.

  • Posted by locococo

    To whom it may concern:

    Before engaging yourselves in trade wars just after or on top of the monetary one; might I suggest another – opposite, simple and basically 101 economics – option: you should blow the top off of gold and there might be a miracle – demand surge before inflation + rallies all around + US will definitely reach the housing bottom (thus the bottom) much much faster. If you continue the current, financially, intellectually, morally, politically and what have you – bankrupt path, then well, good luck to us all.

  • Posted by Twofish

    Richman: Actually, American voters are way ahead of politicians on trade. Even the majority of Republican voters are for doing something about trade.

    That something invariably involves some industry specific tariff. But the dynamics are interesting. For example, people in financial services want China to open up financial markets, but you can’t do it as a quid-pro-quo. The problem is that it helps finance if China opens up markets, but it hurts if the US closes markets to China even if China refuses to open up its markets. So its hard to threaten China with closing US markets, since you end up hurting industries in the US if that happens.

    A lot of US industries are like that. You might be able to get someone to go along with a tariff as a bargaining chip, but the moment it becomes clear that it isn’t a bargaining chip, then you lose support, and it’s not a strong bargaining chip to start out with.

    Also trade issues tend to be geographical rather than party line. Trade also tends to be industry specific. Once you make textile producers happy by getting China to extend the Multi-Fiber Agreement, then they are no longer interested in import restrictions with anything else. In fact, they would be opposed to increasing restrictions on other things if it means reopening the benefits that they have.

    Richman: Democrat, which largely explains why Republicans have been losing elections since 2004

    And Democrats are pro-trade enough. It was Clinton that got China into WTO and NAFTA. The other thing was that there was something of an “punish China” coalition that consisted of neo-conservatives, liberal human rights interventionists, and anti-Chinese trade groups.

    Neo-conservatives are totally dead because of the Iraq war. Human rights interventionists are now anti-interventionist. Anti-Chinese trade groups are nowhere longer present since any industry that would get killed in Chinese trade is dead already.

    There are no votes from small electronics assemblers in the United States because there are no small electronics assemblers in the United States. They’ve all moved to China.

  • Posted by ReformerRay

    Twofish is very realistic about why the current trade deficit exists and why economists don’t want to talk about the issue.

    He is non-responsive to the point that the trade deficit has reduced the productive capacity of the U.S. so that it is no longer in the league with Germany and Japan.

  • Posted by ReformerRay

    Chatam says “Accumulating dollars is a separate strategy and it has nothing to do with trade surplus”.

    Wrong. A trade surplus with the U.S. increases the number of dollars in the surplus country, whether they want the dollars or not.

  • Posted by ReformerRay

    Import controls will reduce some jobs and increase others. More jobs will be added than will be lost because more prodution must take place in the U.S. The jobs that will be added are production jobs. Production jobs are valued because in addition to producing income, they add to the goods in the country.

    Some financial jobs are necessary to maintain production. But some financial jobs have been created to cheat others out of financial resources.

  • Posted by ReformerRay

    “Before engaging yourselves in trade wars just after or on top of the monetary one”.

    No one wants a trade war.

    Import restrictions aimed at reducing the U.S. trade deficit, by imporsing import restraints on ALL imports from those countries creating the trade deficit, will not cause a trade war unless some country is determined to refuse to allow the U.S. to cease consuming more than it produces.

  • Posted by ReformerRay

    “Richman: Actually, American voters are way ahead of politicians on trade. Even the majority of Republican voters are for doing something about trade.
    That something invariably involves some industry specific tariff.

    The last sentence by Twofish is accuracte, as applied to past U.S. policy.

    Because industry specific tariffs have been shown by past history to be bad for the country initiating the tariff, I have developed another method for reducing the U.S. trade deficit.

  • Posted by cam

    The old slogan “What’s good for GM is good for America.” needs to be replaced.

    Henceforth it shall be “What’s good for Twofish is good for America.”

  • Posted by ReformerRay

    “The second import controls are introduced, I lose my job. The people I know all lose their jobs. If you can come up with an argument that I get a better job, feel free to do so. If you talk with anyone in any high-tech industry the notion that import restrictions will help the economy is totally insane”.

    I like Twofish’s writing style but I disagee with his focus on high-tech industries as equal to all industries. High tech industries can be outsourced as well as low tech industries.

    No way I can promise Twofish that he or his friends will be better off if the U.S. limits consumption to production. I will guarantee that my grandchildren and his grandchildren will be better off if consumption is limited to production.

  • Posted by Majorajam

    Brad,

    It would seem to me the profound effect of Bretton Woods II on the circumstances that gave rise to this mess are impossible to overstate. As you note, for US households to become as overleveraged as they did required massive infusions of global excess savings that were made perfunctory by the currency policy. But more than that, these infusions depressed risk spreads throughout the financial landscape. That forced many institutions out on the credit and liquidity risk curve to maintain profits. This is where firms like Fortress and Blackstone, etc. became so important to banks, and became so courted by them.

    I think what I’m saying is this: when you’re running 7% of GDP current account deficits that are soaking up 80% of global excess savings, it is no conundrum that term premia disappear. Rational expectations are not the arbiter of these things in a herding world full of career risk and myopia. And it stands to reason that when a junk bond only gives you a few hundred basis points, that a 10 year government obligation isn’t going to go wanting. Money is, after all, fungible, and asset pricing is all relative. Ergo, that tsunami of money was directly responsible for the demise in profitability of normal banking operations, which displaced exploding balance sheets further and further out of the risk and illiquidity spectrum. Of course, all of this was self-reinforcing, as appreciation of risk assets produced more leveraged speculation into them. And it all went wrong badly.

    Of course underwriting standards and the ratings passed out by credit agencies are not directly impacted by any of this, but the tastes of clients has a tendency to influence. It is not a coincidence that loose money and loose lending standards tend to go hand in hand.

    And there is another way in which Bretton Woods II worked to foster this crisis. The simple fact that currency intervention, i.e. trillions of reserve accumulation, was largely not sterilized, especially in Japan but also elsewhere, together with the profound positive feedback of hot money flows lead directly to turbo-charged credit systems the world over, and, as Jeremy Grantham said at the time, the first truly global asset bubble- a bubble in every asset class everywhere en el mundo. The perfect storm. It goes without saying then that those booming credit systems are now also collapsing in unison, profoundly worsening the outlooks for the viability of credits and the associated crisis, (and of course that the reverse effect was also in effect on the way up).

    The way I see it is that we are so deep in goo, and so much more than is precedented, that many planets had to align to get us here, Bretton Woods II and the criminal negligence of policy makers across the board were the two most consequential of these. Frankly, circumstances conspired against us, but the failure of the only people who could have eased these problems before they careened out of control- their missing sense of duty and integrity- this was the final nail in the coffin.

  • Posted by Howard Richman

    Brad,

    You wrote something that I have been thinking:

    “The NIIP will deteriorate significantly this yaer, largely due to the fall in the market value of the united states external assets. combine that will ongoing debt accumulation and a lot of the improvement of past years in the niip will go away.”

    I’m wondering if the NIIP, at the end of this year, will come close to the point that could have been calculated just by summing all of our current-account balances.

    Howard

  • Posted by DJC

    China lives on a per capital income that is 1/10 of the United States. Yet the relatively poor Chinese are relentlessly bullied by the Western powers on almost every conceivable political, economic, and social issue. Hillary Clinton and Barack Obama called for a global boycott against the 2008 Beijing Olympics for which of the following reasons:

    A. Abortion exists in China

    B. Chinese Communist party

    C. Independent monetary policy

    D. Independence for Tibet

    E. Independence for Taiwan

    F. Independent foreign policy

    G. Global trade

    H. All of the Above

    Any concession on any political, economic, or social issue leads to greater demands on other unrelated issues. The Chinese should never compromise any core cultural and political issues. The ultimate strategy of US Intelligence Agencies is the dissolution of China into smaller subservient states like the former Soviet Union and Yugoslavia.

    The solution to 99.99% of US foreign affairs problems is “minding your own damn business”.

  • Posted by Howard Richman

    Global Chessboard asks me, “I’d like know what you think [China] will do on currency interventions and USD reserves” if the US adopts Import Certificates.

    China is already in the worldwide depression. They are trying to get out of it through “Smoot-Hawley-with-Chinese-characteristics.” Today we saw their latest protectionist measure – weakening their currency versus the dollar by the largest single-day amount ever.

    If we impose Import Certificates they will have to stimulate their own economy instead:

    1. They would let their currency rise in exchange rate which would give Chinese citizens much more buying power.

    2. They will increase their money supply so that Chinese citizens will reduce their savings rate. This will probably require inflation.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Ying

    JDC,

    I don’t think that US is intended to break up China. They try to divert people’s attention from their own policy mistakes made. One of the biggest mistakes is their hawkish military strategy that almost broke the country. It’s an psychology game they played with.

    Military dominance will never guarantee economic success. Remember children’s story Lion and Mouse. The powerful lion can kill a mouse with its mighty strength. But a mouse can trick a lion or save a lion’s life. However, even in the face of brutal failure of US security policies, the Administration seems to continue to believe the dogma that they must secure national security and protect energy security by military forces around the globe.

    The last point is that a sound economy in China is the interest of US as well as China. US pension fund is mostly invested in multinational firms. Billions of them invested in China. They want to see continued open and free trade with China and a growing economy both at China and US. I doubt that politicians really want to ruin China.

  • Posted by Euraussian

    Howard,

    Would your relentless pleading for managed US trade (to put it mildly) mean that the US consumer would suddenly start to live within his/her means? Means meaning no additional credit for a while? And would the gvt do the same? Or would you like the benefits of international seignorage plus a cozy cartellized domestic market a la the New Deal period, but now not organized and policed by the gvt? Who is going to make the clothinf, furniture, electronics etc.? At what cost?

    The only realistic way for the world to get out of this mess is a reduction in the amount of credit available to consumers and strict budgetary discipline for the gvt. That is, after this panicky situation has stabilized somewhat and just before the onset of the infltion that will inevitably come if current policies are maintained too long (deficits, huge injections in the financial system, loss of already weak market discipline, etc.

  • Posted by Twofish

    ReformerRay: The jobs that will be added are production jobs. Production jobs are valued because in addition to producing income, they add to the goods in the country.

    Which are precisely the jobs that you **don’t** want to add. The jobs that you do want to add are high value design jobs, once you have designed something then you use the lowest cost method to produce the design, either through human labor or through robotic labor.

    ReformerRay: High tech industries can be outsourced as well as low tech industries.

    Much easier said than done since high tech design relies on social networks which are extremely hard to move. When you do manage to move a high-value jobs are outsourced you usually have to pay someone in China or India roughly what you have to pay them in the United States.

    Also riots over unpaid wages happen in southern China all of the time. There is nothing particularly out of the ordinary about this one.

  • Posted by Twofish

    cam: Henceforth it shall be “What’s good for Twofish is good for America.”

    What’s good for me is good for me. If I’m in the 1% and 99% of the people want to do something else, then I lose the fight.

    But I’ve been counting noses, and it looks like that there are far more votes on my side than against me on the issue of trade.

    It’s not 1985.

  • Posted by Twofish

    Eurassian: The only realistic way for the world to get out of this mess is a reduction in the amount of credit available to consumers and strict budgetary discipline for the gvt.

    I’d argue the opposite. The way out of this is a massive increase in the amount of credit and huge budget deficits.

  • Posted by lb

    found my bancor discussion over @ monbiot’s:
    http://www.guardian.co.uk/commentisfree/2008/nov/18/lord-keynes-international-monetary-fund
    comments are well worth the read with a nice critical discussion imho.

    after reading the article, keynes’ overall idea is actually something quite similar to Buffett’s IC plan (with a bit more of a buffer).

    wondering if somehow an incentive can be made other than imposing penalties or interest, perhaps maybe by decreasing capital and/or voting power in the ICU for large deficits and incentives for investing surpluses into a intl. trust account (which would buy long-term govt. bonds).

  • Posted by ReformerRay

    “The last point is that a sound economy in China is the interest of US as well as China”.

    True. And a sound economy in the U.S. is in the interests of China. A trade surplus with the U.S. is not necessary for a sound economy in China. Both countries would benefit for a more nearly equal trade between the two.

    The above sentence is true for the majority of the residents of the two countries. It is not necessarily the opinion of the ruling elites (if they exist in the U.S.) in both countries.

    I cannot be responsible for what foolish people do.

  • Posted by ReformerRay

    This comment by Twofish is accurate account of past sentiment in the U.S

    “But I’ve been counting noses, and it looks like that there are far more votes on my side than against me on the issue of trade.
    It’s not 1985″.

    But that is because most people are unwilling to think about the issue – it is too complicated and besides economists agree that free trade is always beneficial for all countries.

    Furthermore, the trade issue was settled long ago and economists do not want to hear that new issues have arisen and that the discussion should be reopened. The discussion on this blog has not considered the fundamental issue – which is, what are the benefits of trade for each nation involved in a surplus – deficit trading relationship?

  • Posted by ReformerRay

    “Which are precisely the jobs that you **don’t** want to add. The jobs that you do want to add are high value design jobs

    High value design jobs have not been able to produce goods and services that are saleable on the international market equal to the value of the goods imported into the U.S. – goods produced by production overseas.

    The notion that high value jobs will substitute for the lost production jobs is refuted by the large, 30 year goods trade deficit suffered by the U.S.

    Emmpolyees of domestic auto plants and steel plants would not agree that production jobs are undesirable.

  • Posted by lb

    @locococo — the problem with blowing the top off of gold is that it would incentivize gold mining & smelting — 3 of the top 10 worst pollution problems of 2008:
    http://www.worstpolluted.org/projects_reports/display/56
    thus help to bankrupt the livable environment.
    in this case, maybe the paper asset is much less toxic than the real thing?

    howard: “Smoot-Hawley-with-Chinese-characteristics.”
    funny how those big bad *commies* took a chapter straight from the republican playbook ain’t it?

    “If we impose Import Certificates” (on a strict 1-to-1 basis):
    3) we give the chinese gov’t an easy strawman to blame their internal problems on.

  • Posted by cam

    Twofish: But I’ve been counting noses, and it looks like that there are far more votes on my side than against me on the issue of trade.

    I agree, if the noses you are counting are the elite of the country.

  • Posted by Howard Richman

    @lb & @Belisarus:

    I had no idea until I read your comments on this blog posting just how relevant Keynes ideas are to the present!

    In 1942 and 1943 he already understood that a world trade system that tolerated mercantilism was not sustainable. Too bad so few American economists understand that today. Macroeconomics has both gone forward and backward since he founded it.

    But Keynes system for keeping trade in balance is way too dependent upon international regulation for my taste. I would much prefer a system based upon Import Certificates in which each country insures that its own trade is balanced.

    Such a system would require no international rules, whatsoever. Countries would just need to see to their own interests and the world economy would be kept on a sustainable track.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Howard Richman

    Eurassian asks: “Would your relentless pleading for managed US trade (to put it mildly) mean that the US consumer would suddenly start to live within his/her means?”

    Although your question is unfairly worded, it is a good question.

    It is unfairly worded because the system I propose actually results in less regulation, since it does not need international regulation, such as the WTO and GATT. Each country balances its own trade through Import Certificates. Any country that tries to game the world system by subsidizing an export hurts its other industries.

    However, it is a good question because balancing trade reduces the foreign savings coming into the United States. Therefore, domestic savings have to make up for the missing foreign savings. Investment is financed by savings. Without savings you can’t have investment.

    Half our book Trading Away Our Future discusses changes in the tax code that would enhance domestic savings.

    Let me briefly summarize some of the answers that we have come up with:

    1. Households would save more. Due to the credit crisis, household savings are growing right now. They would grow higher if interest rates went up, as they would if foreign savings stopped coming into the country.

    2. Businesses would save more. If corporations had investment opportunities, they would invest their profits instead of wasting them on stock buybacks, as they have been doing for the last several years.

    3. Government would save more. There would be no need for stimulus packages.

    4. Tax reform is possible. I recommend consumption taxes such as the FairTax and the Value-Added Tax.

    5. Import Certificates themselves would provide money for investment. Under Warren Buffett’s plan, the companies that export American-made products get the Import Certificates which they then sell to companies that import.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Counterpointer

    Brad

    One word: Faust.

    C

  • Posted by Twofish

    ReformerRay: High value design jobs have not been able to produce goods and services that are saleable on the international market equal to the value of the goods imported into the U.S. – goods produced by production overseas.

    Which is completely irrelevant. Suppose I design a laptop computer. It get produced in China at a production cost of $50 and shipped over to the United States and sold for $500. Part of the $450 goes to pay my salary. This is booked as a trade deficit of $50, even though it can generate $450 worth of jobs in the United States.

    If you move production to the United States and it costs $600 to make a $500 laptop, the laptop doesn’t get made and I lose my job as a chip designer. What’s more the fact that you have cheap laptops creates entire new industries and business processes. People want to surf the web at the airport and get plastic screen protectors.

    ReformerRay: The notion that high value jobs will substitute for the lost production jobs is refuted by the large, 30 year goods trade deficit suffered by the U.S.

    No it’s not. See above. My assertion is that high value jobs *HAVE* substituted for lost production jobs, and that completely changes the politics of trade, and that people in the US have been and will continue to be extremely tolerant of the trade deficit because of this.

    ReformerRay: The discussion on this blog has not considered the fundamental issue – which is, what are the benefits of trade for each nation involved in a surplus – deficit trading relationship?

    In the case of the United States, it’s good jobs. This isn’t economic theory. This is hard cold economic reality for me. China trade ends. I lose my job. Convince me that I can get a better one, or you won’t get my vote.

    Fine. Maybe I’m outnumbered on this one, but it looks like this isn’t the situation. Might I suggest that the reason that you aren’t getting a lot of interest in trade restrictions in the US is not because of “elite control” or “economist brainwashing.” It’s because you have people look at their own jobs and their own lives, and they’ve figured out that they are in the same economic situation as me when it comes to trade, because there was a massive jobs shift that happened in the 2000′s.

    cam: I agree, if the noses you are counting are the elite of the country.

    Let me suggest that is also not the case, and people at the lower ends of the economic scale have also figured out the same thing.

    If you look at the cost of an imported shoe, it turns out that the highest fraction of that cost (it’s like 20%) goes to the shoe salesman in the United States. The CEO of the shoe company makes more money, but his costs are divided among millions of shoes. The shoe salesman makes less money, but his salary is divided among only hundreds of shoes. There is also one CEO. There are hundreds of thousands of shoe salesmen, and they vote. Cut China trade, fewer shoes to sell, fewer shoe salesmen, and truckers, and longshoremen, and shoe designers. and advertising reps.

    This applies to the auto industry as well. Can anyone here explain how tariffs would save GM or save more American jobs than the ones that would be lost once you have Toyota and Honda close their plants in the United States? Or how US consumers would be better off if forced to buy big unreliable, gas guzzling Hummer SUV’s rather than cheap reliable Toyota Camry’s that also happen to be assembled in the USA by American workers.

  • Posted by Global Chessboard

    Coming back more directly to the topic of this blog, I’d like to add a brief comment that ignoring exchange rate imbalances also means ignoring the imminent collapse of the creditworthiness of the US Treasury.
    I’m expecting a collapse of the US dollar, followed by default of the US Government, just as the market has been signaling for quite some time now.
    In my mind I have an explanation for the data below but I’d like to provide that explanation only if somebody is interested in it. Also if the US dollar were to collapse that would automatically ensure trade balance adjustments.
    http://goldtent.com/wp_gold/2008/12/01/us-treasury-default-loomingmidas/
    LONDON, Dec 1 (Reuters) – The spread or risk premium on 10-year U.S. Treasury credit default swaps hit a record high on Monday, extending a recent trend as market participants continued to fret about the scale of the government’s financial rescue programmes.
    Ten-year U.S. Treasury CDS widened to 68.4 basis points from Friday’s close of 60 basis points, according to credit data company CMA DataVision.
    Five-year Treasury CDS widened to 52.5 basis points from 46 basis points at Friday’s close, it said.

    The widening of this credit instrument means more and more investors are concerned the US will DEFAULT on its sovereign debt. When that occurs in other countries, interest rates rise in order to compensate for the increased risk. Yet, ours continue to sink. Such an unthinkable event as the increasing concerns over the US government defaulting ought to have the dollar under severe pressure, especially with our sinking rates … and have gold flying … but the opposite is the case.

  • Posted by Twofish

    Chessboard: I’m expecting a collapse of the US dollar, followed by default of the US Government, just as the market has been signaling for quite some time now.

    I’m not. People who have bet against the dollar or against the United States have had a habit of losing their money. (Ask the good folks at Citic Pacific.)

    Also US Treasury CDS’s have got to be one of the *dumbest* financial products I’ve ever heard of. If the US Treasury defaults, what’s the chance that there will be anyone around to pay your CDS?

    One other interesting thing with General Motors and why no one is talking tariffs. Buick happens to be *the* premium car brand in China. The cars are made in China, but they are designed in the United States. Part of the interesting thing is that when Chinese think of American cars and American brands, they think quality and luxury. I also suspect that there is this thing about World War II that keeps people from buying Lexus or Infiniti’s.

  • Posted by steve moody

    Your Feb 2005 paper with Roubini on Bretton Woods 2 is essential reading. It establishes beyond reasonable doubt that foreign central bank purchases of US Treasuries at the long end of the yield curve effectively defeated Federal Reserve monetary policy in 2004–the so-called Greenspan Conundrum. Had long rates risen the 200 bps you estimate in the paper, the US Housing Bubble would have begun deflating as early as 2005 and the dollar- denominated carry trade to Russia and other FSU EM would have stopped in its tracks.
    So the link between the current crisis and Bretton Woods 2 is already firmly established. If policy makers ignore it, we are doomed to repeated crises in the future–assuming we survive this one.

  • Posted by Euraussian

    Twofish,

    Re getting out of the mess. Of course, that would (and I expect it will be the next stage of the current policy direction) solve some of the US’s currenct cyclical problems. However I was referring to the mess that the rest of the world is in and that mess will not be solved by deficits and credit, because in most smaller countries (and assuming lots of mercantilist cheaters, especially in the production-oriented autoritarian ones) that policy would lead to immense import leaks. The US has a very large (how large we have yet to find out) capacity to sustain that kind of leaks, but, say Iceland, has not (!). The best the US can do for the rest of the world is not to restrict imports by tariffs or similar devices (keep in mind that was the context of the comment I responded to) , but have for a sustainable level of consumption. That would hurt world growth for a few years but would result in less violent cyclical swings. What many in the US do not undertsand is that many European countries do not have the fluidity that the US has. A little example: I was in Rostock 18 months ago. Once the largest port in the DDR, lots of industry, 300K inhabitants. After unification port became redundant, shipyards etc closed (not competitive at w. german wages) . Most young workers were recuited away by the west and the people that left were (1) age/gender/skills wise unattractive for “emigration” (2) living in a town where no one wanted to invest except in things around the university (hence influx of Indians etc) (3)never socialized for the modern world. If you look at the unemployment rates of many western european countries, you see lots of unemployable people in economies that have eliminated low skilled work. Apart from structurally (policies for change, if ever accepted by electorates will take a generation to have effect, barring war, depression etc) difficult labor markets, there are much tighter gvt budget constraints and very high taxes (VATs of close to 20% plus high and progressive income taxes. On the plus side cheap/free healtcare and ducation, but that does not help either.

    So I agree with you that a solution (and politically attractive) would be to simply inflate the current mess away and start again. What that would do to the USD (once the deleveraging is over and China plus clones (I think that China is a lot more constructive than some of its neighbours here) finally see the light on financing US deficits and prioritize domestic affluence instead (current reserve levels are ample and China may not need all that much export-at-all-costs anymore, especially if a fairly humble CCP (look at Hu’s latest utterings) manages to retain its mandate whilst the economy passes a speedbump.

  • Posted by Euraussian

    Brad,

    Still puzzled by China’s low and declining employment rate, its possible causes, significance and implications. It was one of the little things in the WB article you discussed in your previous post. But no serious literature to be found. Can you help?

  • Posted by Euraussian

    Sorry Brad, employment share of course..

  • Posted by locococo

    At core, there are ethics, not economics:

    Keynes replied to Hayek’s criticism in the following way: “I should… conclude rather differently. I should say that what we want is not no planning, or even less planning, indeed I should say we almost certainly want more. But the planning should take place in a community in which as many people as possible, both leaders and followers wholly share your own moral position. Moderate planning will be safe enough if those carrying it out are rightly oriented in their own minds and hearts to the moral issue. This is in fact already true of some of them. But the curse is that there is also an important section who could be said to want planning not in order to enjoy its fruits but because morally they hold ideas exactly the opposite of yours, and wish to serve not God but the devil.”

    “This” then is not “that” situation. But playing all of the three monkeys to “this” one as balance sheet surfing we go+ further reducing the joe s role to a guarantor to the counterparties new securities of last-last resort, well, might truly in turn bring about the Roubini one. Add some certificates onto that pile and you ll end up owning one-selves that you owe, in a bureaucratic sort of way. Yes there were ethics at core but soon all that is left ll be just plain old cost /effectiveness.

    That day mr. Summers – as he once wrote – might tell mr. Obama to tell mr. X to blast up that metal.

  • Posted by Euraussian

    Locococo

    Right, but sad

  • Posted by gg

    X not being Ben but the new Applesfed.

  • Posted by a

    “If the US Treasury defaults, what’s the chance that there will be anyone around to pay your CDS?”

    This is a usual source of confusion. A CDS can pay out even if the US doesn’t completely default. There are other trigger events, such as (I believe) a unilateral reduction in the coupon. In 1932, or thereabouts, Britain (comparable to the U.S. today) unilaterally reduced the coupon on at least some of its debt (e.g. the perpetual debt, which had its coupon reduced from 5 to 3.5).

  • Posted by gg

    For any Keynesian policies –those not devised as a blanket for funds appropriation – to take effect globally, repairs to the flows / infrastructure were due first. Do that by clearing the emerging world s $flows away, under some fault (betting practices) terms was dead wrong as it had mistaken economics with black jack as easily as guarantee fund with settlement. So unless that value destroying industry s risk dispersion (to all the joe s of the world) is that “big bang banking financial brilliant quantum leap onward”, that truly needs saving, then capital controls are long due indeed. Actually you were warned about this dead-end path / it was Mundell who was clear about it: do NOT appreciate!

    I did not think this translated to “sitting on long end of curves” while “pinning the shorter one down”.

    Keynes was not as explicit: QE was the point where CB started to “plan”.

  • Posted by Howard Richman

    @Euraussian:

    For an explanation of China’s declining employment rate check out Different Versions of What is Happening in China Today. The November 27 posting on my blog.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Howard Richman

    @Chessboard: I’m expecting a collapse of the US dollar, followed by default of the US Government, just as the market has been signaling for quite some time now.

    @2Fish: I’m not. People who have bet against the dollar or against the United States have had a habit of losing their money. (Ask the good folks at Citic Pacific.)

    There is a counter example of betting against the dollar and then being proved correct. The dollar peaked in 2002. In November 2003, Warren Buffett published his article on his Import Certificate plan. At the beginning of that article he announced that, for the first time, he was actively betting on a dollar weakening.

    The dollar continued to weaken until this year. He must have made a lot of money on that bet.

    Howard

  • Posted by ReformerRay

    Twofish says: “My assertion is that high value jobs *HAVE* substituted for lost production jobs, and that completely changes the politics of trade”.

    I will admit that the source of profits in the U.S. moved from manufacturing to the financial sector in the last few decades, but those gains in leadership does not translate into employment.

    Bureau of Labor Statistics says that the Financial sector has gained 1.1 million jobs in the last decade (1997 -2007) but the Information sector actually lost 0.1 million during that period and the Manufacturing sector lost 3.5 million, for a net loss from the three sectors of 2.5 million jobs.

    The best source for details about Information Technology sector is Catherine L. Mann (Google her name).

    She reports that high wage Information Technology employees increased by 18% between 1999 and May 2005. But they only account for a little over 2 million people, around 2% of the non-farm employment. This tiny segment of the labor force is very important because they provide the tools to increases productivity and profits. But these gains are diffused throughout the world, with the U.S. holding on to an approximate constant share of these activities.

    Mann reports that the exports and imports of Computer and Information Service in and out of the U.S. were approximately equal in 2005. When she broadened to scope to examine exports and imports of all Information Technology products, she found the U.S. exported 84 billion in 2006, led by Semiconductors. The U.S. imported 94 billion in 2006, led by Computers. The U.S. is still in the high tech game but it is not winning decisively.

    Data from the Foreign Trade Division of the U.S. Census Bureau reports that the U.S. exported 119 billion dollars more of services than they imported in 2007. This number was offset by an excess of 819 billion dollars more of goods imported than exported. Net result – 700 billion losses of goods and services combined.

    These data cannot be dismissed as unimportant. They require the transfer of 700 billion dollars of financial assets, owned by U.S. firms and households in the U.S. at the beginning of 2007, to foreign ownership by the end of 2007. Also and in addition, the 819 billion of dollars worth of goods produced overseas and sold in the U.S. means that production of goods in the U.S. is approximately 819 billion dollars less than it would have been with equal trade (approximately because some consumption would be lost due to less imports). These losses of production capacity and financial assets have happened each year for 30 years, though the numbers were much smaller before 1997.

    This 30 years series of losses has a connection to the current financial meltdown. When the manufacturing sector could no longer provide the kind of profits investors expected, they turned to the financial sector to create wealth. If the manufacturing sector had continue to provide a sizable share of U.S. corporate profits, as they did in Germany and Japan, the pressure on the financial sector would have been less and the bubbles would have been less.

    Mann reports that the Information Technology sector is very important to the economic health of the U.S. and the world. But she does not say that this sector will compensate for the inability for the U;S. to compete in the ability to sell domestic production overseas.

  • Posted by ReformerRay

    Twofish provides an example of the production of a omputer overseas as cheaper than in the U.S.

    Equal trade does not require that computers be produced in the U.S. What is produced in each country and sold overseas will be controlled by the comparative advantage in each country. If we reduce imports down to the level of exports, imports will continue to come into this country.

    Consumer choice between a refrigerator produced overseas and one produced in the U.S. will be controlled by the marginal value the consumser sees in each product. This marginal difference between the two products will be some small percentaage of the total costs. By restricting imports, by selective tariffs, some refrigerators built overseas will not longer be sold in the U.S.
    Consumer benefits will be reduced by the marginal difference between the two refrigerators. But the Gross Domestic Product of the U.S. will be increased by the total cost of the refrigerator.

    I want to trade off the marginal difference in consumer benefit for the much larger benefit of increase in GDP.

  • Posted by Euraussian

    Howard,

    Thanks for the link but I am not mystified by the Chinese employment (or unemployment for that matter) rate. But in the employment share of Chinese national income. And I do not think your link deals with that.

    Incidentally, in this week’s Economist there is n interesting piece about Chinese (un)employment, suggesting that the isues (as well as measurement and definition) are quite complex.

  • Posted by lb

    @gg — funny you should mention Mundell. just discovered a couple days back that he’s been advising the bank of china.
    http://www.robertmundell.net/

    he also said recently that the chinese should buy all the imf’s gold…if it comes up for sale that is.
    http://tinyurl.com/5gycj2

    sniff sniff, anyone smell a gold-for-UST deal in the ether?

  • Posted by PLovering

    Chidambaram:

    I hope you will continue posting here.

    I found your comments stimulating, prescient, and agreeable.

    Mods are a PITA from time to time … all the more reason to get your ideas out to MSA.

  • Posted by ReformerRay

    Brad says that the willingness of foreign central banks to purchase U.S. treasury certificates limited the opportuntity for U.S. financial interests to earn large profits by buying treasuries, thus the moved into more speculative and dangerous and profitable activities.

    The important question is: “Where and how did the foreign central banks get the dollars they invested in Treasuries?” The answer, of course, is from the U.S. trade deficit.

    Most U.S. economists, including Brad, see the trade deficit level as controlled by the activities in the U.S. financial system, including the level of domestic saving.

    I do not. For years, I have followed the implications of the assumption that the level of the U.S. trade deficit is controlled by market just like any other good or service. I agree that the market is rigged. That does not change causation. Whatever controls the market for overseas goods for sale in the U.S. and for U.S. goods for sale in foreign lands, it is the interaction of the markets that control the size of the trade deficit.

    All the financial issues that Brad discusses are derived from the results of market choices made by real people.

    When the situation is viewed from this perspective, one does not blame a foreign country for investing funds they earned by exporting for using these funds as they see fit. Once the money is sent overseas to pay for imports, it is overseas property.

    Like so many other practices that bedevil the U.S., purchase of Treasury certificates with money earned from excess imports was pioneered by the Japanese. In the 1980′s, the U.S. public grew insenced when it was revealed that a Japanese businessman was contemplating purchasing Rockfeller Center. After that, the money sent to Japan to pay for imports in excess of exports was quietly invested in Treasury certificates, which the general public would ignore.

    The unbalanced system is sustained by the round trip of dollars. But the flow begins in the U.S. If the round trip is causing problems, the place to correct the problem is where it begins, with the excess purchases of imports over sales of exports.

    Trying to interupt the flow in midstream, after it is in Japan or China, is silly.

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