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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.


  • 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:
    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:
    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

  • 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

  • Posted by Counterpointer


    One word: Faust.


  • 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.
    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


    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


    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


    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


    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

  • 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.


  • 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


    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.

    he also said recently that the chinese should buy all the imf’s gold…if it comes up for sale that is.

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

  • Posted by PLovering


    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.