Brad Setser

Brad Setser: Follow the Money

Print Print Email Email Share Share Cite Cite
Style: MLA APA Chicago Close

loading...

Should the currency of the country with a large and growing trade surplus and large and growing reserves depreciate against the dollar?

by Brad Setser
December 3, 2008

On Monday China apparently decided to allow the renminbi to depreciate against the dollar.

Let’s be clear: China generally still has to intervene in the market to keep its currency from appreciating. There is no other way reserves could have risen from $1.9 trillion at the end of September to “over $2 trillion” now.* Traders in China bet on where they believe the government wants the exchange rate to go, not its market-clearing rate. Private Chinese demand for dollar assets still isn’t comparable in scale to China’s $400 billion current account surplus.**

Neil Mellor of the Bank of New York believes that the renminbi’s recent depreciation is a very conscious policy choice:

Since the start of this week, however, there appears to have been a further palpable shift in policy. Following a clear shift in the wording in the latest quarterly monetary policy report and a speech over the weekend by President Hu Jintao (warning that China’s competitiveness and trade strength were being threatened), the PBOC on Monday set the central parity rate of USD/CNY aggressively higher. After four and a half months of sideward trading, the market reacted strongly to this apparent change in attitude by pushing USD/CNY to the top end of its band. The reaction in the NDF market was even more dramatic with the one-year NDF jumping 3.16% (its largest ever one day move in either direction). This upward pressure has continued over the last two days to leave the NDF now forecasting a 6% y/y rise (spurred on today by comments from Vice premier Wang Qishan that China will do all it can to stabilise exports).

If other Asian currencies fall along with China’s currency, the net result would be a broad depreciation of emerging Asian currencies against the dollar more than an improvement in China’s relative position in Asia. And right now Asia is the region of the world economy with the largest current account surplus – and the surplus region that stands to benefit the most from the fall in oil prices.

A global shortfall in demand (and contraction in trade) implies that almost everyone is struggling to maintain (or expand) their market share. China’s exports have stood up well to date (in nominal terms, monthly exports are running about $20b a month above their total in 2007). Monthly exports in 2008 are nearly two times as high as monthly exports in 2005. The scale of China’s recent export boom is hard to exaggerate. But there is little doubt that China’s exports – all of them, not just textile exports – are poised to slow rapidly. Korean exports fell sharply in November. It is hard to believe that China’s exports won’t also soon slow if not start to fall; the latest data on new export orders suggest additional weakness ahead.

That slowdown comes at a time when China’s domestic economy is also slowing – and consequently is extremely unwelcome. China’s latest purchasing managers index (PMI) was as almost bad as the United States’ latest PMI index.

Moreover, China — like the US – is feeling squeezed by the dollar’s recent appreciation. In real terms, the renminbi has appreciated by far more after it stopped moving up against the dollar that it ever did when it was moving against the dollar. Allowing the renminbi to depreciate against the dollar as the dollar rises would limit China’s real appreciation. It would be consistent with how a basket peg would work.

But it still isn’t the right policy.

China’s basket peg never really was much of a basket peg: it always seemed more like a crawling peg with a variable rate of crawl. China shouldn’t be pegging to a basket either. Given China’s (still) strong balance of payments position, it should be appreciating against a basket — not keeping its currency constant against a basket.

Remember, China followed the dollar down against the euro in particular from 2002 to 2005. The renminbi’s huge depreciation against the euro – and a tightening of Chinese macroeconomic policy to try to avoid over-heating – contributed to the surge in China’s current account surplus from 2004 on. Even after China moved away from a strict dollar peg, it never quite allowed the renminbi to move enough against the basket to generate a meaningful real appreciation. Renminbi appreciation against the dollar wasn’t fast enough to overcome the dollar’s large slide at that time. In real terms, the renminbi hardly moved – and almost all the appreciation came from the rise in inflation, not a nominal appreciation of the renminbi against a basket of currencies.

That changed with the dollar’s rally. China in a sense is now getting the real appreciation that it should have gotten in 2004, 2005 or 2006 – back when China’s domestic economy was strong and China risked overheating. But just because China’s drew on exports to turbocharge a strong domestic economy over the past five years doesn’t mean it should draw on exports now to try to offset domestic weakness. Even today China’s real exchange rate is only a bit higher than it was in 2001 — and China’s underlying economic growth since then (including the huge expansion of its exports) suggests that its real exchange rate should be significantly above its 1998-2001 levels.

(Note the rise in imports in this graph reflects higher oil and commodity prices; looking at changes in 12m sums tends not to capture short-term swings)

The absence of real appreciation in the past undermines China’s case for reacting to the recent renminbi move by allowing the renminbi to depreciate rather than by doubling down on efforts to stimulate domestic demand. China has by far the world’s largest current account surplus. The latest World Bank report argues, I think correctly, that this surplus should persist next year even as exports slow. China will benefit more than most from the recent large fall in commodity prices. If China is unwilling to accept that its exports will slow as the global economy slows, and instead tries to offset dollar strength by weakening the renminbi against the dollar – or it tries to offset renminbi appreciation with export subsidies – everyone else will face additional competitive pressures.

China can try to support its own growth by taking a larger share of a shrinking pie, but that hardly helps the world. The G-20 isn’t just meant to bring countries together to discuss the global economy. It also needs to encourage countries to take into account the global implications of their economic policy choices. If China – which has by far the best balance of payments position of any major economy – feels like it has to direct its government policy toward maintaining export market share, efforts to rebalance the world economy will be set back.

Martin Wolf of the Financial Times has this exactly right. He writes:

Countries with large external surpluses import demand from the rest of the world. In a deep recession, this is a “beggar-my-neighbour” policy. It makes impossible the necessary combination of global rebalancing with sustained aggregate demand. John Maynard Keynes argued just this when negotiating the post-second world war order.

In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.

Some argue that an attempt by countries with external deficits to promote export-led growth, via exchange-rate depreciation, is a beggar-my-neighbour policy. This is the reverse of the truth. It is a policy aimed at returning to balance. The beggar-my-neighbour policy is for countries with huge external surpluses to allow a collapse in domestic demand. They are then exporting unemployment.

Over the next few months, falling oil prices will reduce the United States deficit almost no matter what. The dollar’s appreciation will only have an impact with a lag. But given Wang Qishan’s statement and the dollar’s current strength, I increasingly worry that the imbalances among the major oil-importing economies will persist even as overall trade falls.

Asia looks more keen to export its way out of trouble than to spend its way out of trouble (maybe someone should mention that supporting exports by maintaining an undervalued exchange rate is a form of hidden spending, as the government will have to pick up the costs of holding reserves it doesn’t need?). And the global slump and dollar rally have made it hard for the United States to export its way out of trouble.

Don’t get me wrong: at this point, counter-cyclical fiscal policy in the United States is essential. Absent an expansion of the US deficit, aggregate demand collapse — further slowing the US and the world. Avoiding too much stimulus in the US in the hope that US inaction will spur more stimulus abroad would be taking a huge risk — one I don’t want to take.

At the same time, Asian economies can not permanently rely on the US and Europe to make up for their own shortfalls of domestic demand. Trying to limit the downturn is one thing. But we should also hope to move out of this crisis with a more balanced pattern of global growth. And that means, among other things, that China ultimately needs to accept an uncomfortable real appreciation of the renminbi.

* Actually there is one way: some of the reserves that have been kept off the PBoC’s balance sheet could have come back onto its formal balance sheet. But that is a topic for later. Suffice to say that the ability to move foreign currency between the state banks and the PBoC gives China a certain amount of flexibility. It can shade its total up or down fairly easily.

** UPDATE. Logan Wright of Stone and McCarthy reports that the renminbi balance sheet of the central bank suggests that China added about $50 billion to its formal foreign exchange reserves in October while reducing its “other foreign assets” by about $25 billion (meaning the state banks were able to run down their dollar reserve requirement). That works out to a net increase in foreign assets of around $25 billion — a level consistent with hot money outflows. Logan also reports that the central bank was a net seller of dollars on Monday, as the surprise depreciation of the central bank induced widespread expectations of further renminbi appreciation and thus short-term demand for dollars. That nuances my point that private demand for dollars doesn’t match China’s dollar inflow from its trade surplus — it remains generally true even if it isn’t true every day or at all times.

p.s. I am on the road this week; I apologize for the sporadic posting.

100 Comments

  • Posted by fatbrick

    American should sell more to China. Begin with the high tech stuff that China really wants. Then we can reduce the imbalance and increase US employment at the same time. After the trade is really free, I believe that the exchange rate can be correctly addressed.

  • Posted by DJC

    Western economists always suggest that the Chinese should save less and consume more. What is really required for Western economists is an honest assessment of the global economic situation: Americans need to save alot more and consume alot less. The national US saving rate is zero or negative. A McMansion with a gas-guzzler SUV parked in the oversized garage represents overconsumption. A home is not an ATM machine.

    The average Chinese-American saves 30% or more of his or her income. Chinatown in high-cost New York City has the highest per capita concentration of banks in the United States simply because even poor Chinese immigrants save upwards of 50% of their incomes. Almost every street corner is crowded with branches of Chase Manhattan, Citicorp, Bank of China, Bank of East Asia, Hong Kong Shanghai Bank, Heng Seng Bank, etc.

    The Chinese are treated with contempt and disrespect, having systematically been denied any voice in global financial affairs by the Washington Consensus, with tiny little Holland holding a larger voting share than 1.6 billion population China at the IMF and World Bank. Not surprisingly, ASEAN+3 group that specifically excludes the Washington Consensus has displaced APEC as the primary Asian forum for Pacific Rim economic affairs.

    Chinese consumers should not have to apologise for not saving the global economy. The IMF systematically looted and pillaged the financial wealth of ethnic Chinese across Indonesia during the late 1990′s. Western economists should “mind their own damn business” from telling foreign cultures and civilizations how to run their family affairs.

    Got it Brad!

  • Posted by ReformerRay

    “But we should also hope to move out of this crisis with a more balanced pattern of global growth. And that means, among other things, that China ultimately needs to accept an uncomfortable real appreciation of the renminbi”.

    Brad – The first sentence above is one that all can agree on. But we cannot agree on how to move to the next step, which is how to get a more balanced growth.

    You keep insisting that surplus countries should act to provide balanced growth.

    Surplus countries, including Japan for the last 30 years, have demonstrated by their actions that they like having a surplus. It enables them to purchase more machines to become even more effective exporters. It also increases their dollar currency reserves, which they view as insurance against U.S. “rebellion”.

    I like to think I am hard-headed. I believe it is the responsibility of those nations who have a trade deficit to restore the world to a trade balance. Deficit countries are unable to increase exports in the face of the competition. That leaves reduced imports as the only means available to the U.S. to reduce the U.S. trade deficit. That means should be embraced wholeheartedly.

    I realize many U.S. individuals and agencies still think the U.S. is strong enough to lead the world to an improved global trading system by accepting imports without serious restrictions.

    That policy has been followed for the last 30 years with disastrous consequences for the U.S. manufacturing sector. The woes of the automobile industry is one among many.

  • Posted by bsetser

    DJC — China has argued that it doesn’t want a bigger voice in the IMF b/c it doesn’t want the responsibilities of a wealthy country like Germany or others (responsibilities that would come if it had a quote commensurate with its strength). I think this is a side issue but I would note that China hasn’t been strongly pushing for a bigger voice in the IMF — that isn’t to deny that there is opposition to reform (especially from Europe), only to note that there is a bit more to this story.

    and i would also note that with the creation of the G-20, the US and others took a major step toward treating the rising emerging powers are equals. Right now my sense is that China is the one that it is prioritizing its domestic interests over global concerns. At least on the exchange rate issue. The one good thing about the recent $ rise was that it finally broughy about a rise in the RMB.

  • Posted by ReformerRay

    “Western economists should “mind their own damn business” from telling foreign cultures and civilizations how to run their family affairs.

    I agree with DJC.

    Reduced acceptance of imports from China, Japan, Germany, Canada and Mexico would slow down world trade but it would also move the world closer to a balanced trading system.

    The interests of the U.S. require this change. The consequences for the world pale compared to the need to position the U.S. economy to participate in the emerging global economy with imports and exports more nearly equal.

  • Posted by Howard Richman

    Brad,

    Your point is exactly correct. China’s currency is weakening right now because of Chinese government policy which is designed to increase their market share in the depressed world markets.

    But I disagree with you when you wrote that a third US stimulus package would help. Two have already been tried and two have already failed. Stimulus packages just cause us to lose market share it in the world’s depressed markets. Even if they worked, the United States would come out of the depression as a shell of its former economy.

    And this is a depression. The collapse in worldwide manufacturing in November makes that clear. Inventories are building up worldwide. The next step will be the collapse in worldwide investment.

    There is a solution for the United States that would increase US market share, instead of decreasing it: Balanced Trade.

    AD=C+I+G+(X-M). Balancing trade would add 5.1% to Aggregate Demand for American products. If we enact Warren Buffett’s Import Certificate Plan, the US economy immediately starts to boom.

  • Posted by fatbrick

    ReformerRay ,

    “Deficit countries are unable to increase exports in the face of the competition. That leaves reduced imports as the only means available to the U.S. to reduce the U.S. trade deficit. That means should be embraced wholeheartedly.”
    ———————————-

    Thias is totally wrong. US can increase exports if it wants to. It just CHOSE not to do that. How can you blame others when you cut your export yourself?

  • Posted by bena gyerek

    it will be interesting to compare the experiences of the usa with the uk over the coming months. like the usa, the uk suffers from excess household indebtedness, a large current account deficit, and a large structural fiscal deficit. unlike the usa, it does not enjoy reserve currency status and also has had ample room to cut rates. as a result the pound has plummetted against all other currencies – presumably the medicine that brad would prescribe to the dollar?

    regarding china, any government that manipulates its exchange rate and that has as large a role in the global economy as china does, has a responsibility to think about the global consequences of its policies. i think it is entirely justified for other governments to criticise china for an undervalued currency and/or excess savings while the rmb continues to be pegged to the dollar. the best riposte china could give would be to allow its currency to float freely.

    and those who criticise the usa and others for excessive consumption should be careful what they wish for. once it has pre-funded its fiscal stimulus, i fully expect the obama administration to aggressively pursue a current account rebalancing (slogan: “us taxpayers’ dollars should benefit us workers”). this may be via a general dollar devaluation, but more likely via taxes and regulatory intervention aimed at china and other asian exporters seen as “unhelpful”. as noted on this blog and elsewhere, china would come off far worse from any such trade war. so why goad the washington protectionists by devaluing the rmb?

  • Posted by veli

    Martin Wolf should account for the vanishing saving glut in the oil producing countries. The price was inflated due to Ponzi scheme dynamics and it was smart thing to save windfall profits.
    If they were stupid enough to take the bait and spend all of the export income they would need an IMF bailout with all necessary conditionalities to relieve them from the burden of their resources.

  • Posted by DJC

    China PBoC message to Hank Paulson

    http://www.google.com/hostednews/ap/article/ALeqM5huuGwQPnieGP_GGUyXKIh1bmnFqwD94RAHA00

    With China’s exporters suffering, the yuan plunged Monday in government-controlled trading — a possible message to Washington to go easy on the issue.

    “The signal China sent on Monday is: We also have our own political problems and issues in a slowing economic environment,” Frank F.X. Gong, chief Asia economist for JPMorgan Securities Ltd., said in a report to clients.

    On Wednesday, the state press made the warning more explicit.

    “U.S. urged not to harp on currency issue at talks,” said a headline in the China Daily, an English-language newspaper aimed at foreign readers.

    The yuan’s fall Monday was its sharpest one-day fall since 2005, erasing almost 1 percent of its value against the dollar.

    Gong said Beijing’s move might have been meant as a warning to President-elect Barack Obama. Chinese exporters have lobbied the government to slow or reverse the yuan’s rise against the dollar to make their goods more competitive abroad.

    LOL. :-)

  • Posted by DJC

    China’s Stimulus Focus Local; Won’t Save The World

    http://news.alibaba.com/article/detail/asia/100026244-1-focus%253A-china%2527s-stimulus-focus-local%253B.html

    BEIJING –China is going all out to shore up its slowing economy, with massive government spending and interest-rate cuts. But countries hoping China will keep gobbling up their exports may be disappointed.

    Beijing’s huge economic-stimulus package will primarily help domestic sectors, while the areas of the economy that import high-end, value-added machinery will continue to suffer from the global downturn, analysts say.

    Of the CNY4 trillion ($600 billion) in measures to be implemented through 2010, 70% will be spent to build railways, highways, airports and the power grid, and for reconstruction from snowstorms earlier this year and May’s Sichuan earthquake, China’s economic planning chief said Thursday.

    “As China embarks on a massive infrastructural spend, while an 8% headline growth rate could be protected, China will only ‘save itself,’” said Stephen Jen, global head of currency research for Morgan Stanley.

  • Posted by DJC

    Off-Topic,

    THE FORBIDDEN “SNL” SKIT

    Apparently, SNL did a “Bailout” skit, which has created some incredible problems for CNBC owned by General Electric.

    They have pulled the video and apparently gone after anyone who put the video out there, because the video has all but disappeared off the internet.

    It was up on multiple sites and virtually all the copies are gone now.

    There are a few new “edited” copies on the net.

    Now how much power would you have to have to pull something from the entire internet?

    Here is one copy still out there:

    http://msunderestimated.com/SNLBailoutSkit.wmv

  • Posted by Global Chessboard

    @Dr. Richman:
    I thought our discussion was interesting yesterday.
    I would agree that there is no medium or long term counter to import certificates. Also it would be difficult to stimulate local demand without import controls, (with the exception of a full faith and credit guarantee to the Agencies to re start the global flow of credit and a housing market recovery).
    However there is just one issue to be sorted out. I’d like to know your opinion on whether China can maintain reasonable levels of imports and exports even in the face of a serious drain of foreign exchange reserves. The reason I ask is that if the dollar loses its reserve currency status, then we would need our own foreign currency reserves to conduct imports.
    The report below outlines China’s free trade agreements with various countries in Africa, South America and so on.
    It’s a report written for Senator Joe Biden by the Congressional Research Service, in his former role as Chair of the Foreign Affairs Committee, in response to specific questions from Joe Biden regarding China’s policies.

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

    Also China’s ability to ensure petroleum supplies from Kazakhstan, Siberia and Myanmar might help them to continue without significant dollar reserves.

    As long as we are able to ensure continuation of reserve currency status for dollars I think import certificates will provide a way out of the crisis both for us and for China, allowing a de coupling over a term of approximately 3-6 months across sectors, in my estimate.

  • Posted by DJC

    Obama for Change? Kleptocrat Robert Rubin’s economic team back in control.

    http://www.globalresearch.ca/index.php?context=va&aid=11273

    “The change that Mr. Obama is talking about is largely marginal to (the top 1%’s) wealth, not touching its economic substance – or its direction.” He may give wage earners some relief (to pay off their bank debts), but top earners “prefer not to earn income” and rely heavily on capital gains. They try to avoid losses and when can’t get the government to bail them out. Obama supports it, so expect billions more for the rich, crumbs for the many, and torrents of high-sounding platitudes to soothe them.

    Obama is the equilvalent to Boris Yeltsin – a giver who kept on giving “for the kleptocrats to whom the public domain and decades of wealth were given with no quid pro quo.” And he’s assembled the same (“anti-labor, pro-financial team”) that empowered Russia’s kleptocrats, let them loot the country, and for the most part keep it.

    His key economic advisor, Robert Rubin, was Clinton’s Treasury Secretary. After leaving, he helped manage Citigroup close to collapse where it may end up anyway since it’s problems are so huge perhaps no amount of billions may save it. Now he’s manipulated his protege team into top posts (including Geithner) with the rest of them profiled below.

    Even the Wall Street Journal criticizes Rubin for defending his role and taking no responsibility for Citi’s problems. The Journal asks:

    “Why are Robert Rubin and other directors still employed? Another Sunday night, another ad hoc bank rescue” with taxpayers footing the bill. “Such a record of persistent failure suggests a larger, (perhaps) systemic management problem. If taxpayers have to risk so much to save Citigroup, then regulators should at least exert the discipline to break up this behemoth so it is never again too big to succeed, much less fail.”

    And Rubin’s protege, Larry Summers was involved in all economic policy decisions ranging from fiscal ones to NAFTA, WTO, and various neoliberal responses to the 1990 decade’s financial crises:

    – in 1995, the destruction of Mexico’s economy by raising interest rates to unmanageable levels and all of NAFTA’s wreckage ;

    – pillaging Russia that began before his tenure, continued throughout the decade, and exploded during the country’s 1998 financial crisis; and

    – the 1997 Asian crisis; manufactured in Washington; debt bondage and open markets became the solution, and human wreckage the price for resolution.

  • Posted by Bob_in_MA

    I can’t help but wonder if China’s “savings” won’t prove as ephemeral as the West’s apparent prosperity. In 1932 the U.S. had a big hoard of gold. When things got tough, how did much did the gold pile help us?

    I expect their $2T in Treasuries will be about as useful to the Chinese.

  • Posted by Global Chessboard

    @ Brad:
    At least as early as 2004 you had predicted a hard landing for BW II by 2008 with 80% probability and almost certainly by 2010. I think it should be clear that there has been a hard landing exactly as you predicted.
    At the same time I think you were also right about expecting a currency crisis in the form of a weakened US dollar exchange rate.
    I’d like to know your opinion on whether a strengthening currency can hide an underlying balance of payments crisis.
    In this context I’d like to point out that both Russia and China are facing reduced exports, both of them have a pegged/managed float exchange rate regime and they are indulging in exactly opposite responses. It’s easy to see that in Russia’s case spending forex reserves on maintaining the Ruble is causing a drain on forex reserves.
    I’d like to know your opinion on whether China’s devaluation of RMB is likely to result in a similar drain of dollar reserves.

    Here’s a link to ‘Simple Russian Arithmetic’
    http://utterlycorrelated.blogspot.com/2008/12/simple-russian-arithmetic.html

    Bank Rossii may have sold $5.75 billion of foreign currency last week, based on the average of predictions ranging between $2 billion and $6.5 billion. That’s likely to contribute to a decline of about $6.25 billion in Russia’s overall cash pool, compared with $3.6 billion in the previous week, the survey by Bloomberg shows.
    Russia lifted interest rates twice last month and drained $148 billion from the world’s third-largest reserves since August to stem a 16 percent currency slide against the dollar.
    At the same time, there seems to be a drain of foreign exchange reserves for China as well, reading from Pettis’s blog post:
    http://mpettis.com/2008/12/is-china-experiencing-dollar-outflows/
    Also a brief overview of similar crises might be useful. In 1998, Thailand and then Korea faced a similar situation of reduced exports. The Japanese yen had devalued to make Japan’s exports relatively more competitive. Both Thailand and Korea in turn defended the Baht and Won against the dollar, in the face of speculative expectations of a currency collapse. Both currencies eventually collapsed, as their efforts to defend their currency drained their forex reserves, and both required IMF bailouts.
    In 1991, India had a balance of payments crisis even as INR strengthened rapidly against the USD. This is usually cited as a curious exception in academic studies of currency crises. India had a high volume of outstanding external borrowings and had spent the borrowed funds on domestic fiscal stimulus. There was a rollover crisis in the external borrowings and the Rupee strengthened as demand to repatriate dollars grew. Even as the rupee strengthened the forex reserves were drained out and India required an IMF bailout.
    (PS: I’m not against IMF bailouts at large. Much of India’s progress in recent times can be attributed to the IMF stipulated economic reforms program which Dr. Manmohan Singh led in 1991. )

  • Posted by Global Chessboard

    @ Brad:
    At least as early as 2004 you had predicted a hard landing for BW II by 2008 with 80% probability and almost certainly by 2010. I think it should be clear that there has been a hard landing exactly as you predicted.
    At the same time I think you were also right about expecting a currency crisis in the form of a weakened US dollar exchange rate.
    I’d like to know your opinion on whether a strengthening currency can hide an underlying balance of payments crisis.
    In this context I’d like to point out that both Russia and China are facing reduced exports, both of them have a pegged/managed float exchange rate regime and they are indulging in exactly opposite responses. It’s easy to see that in Russia’s case spending forex reserves on maintaining the Ruble is causing a drain on forex reserves.
    I’d like to know your opinion on whether China’s devaluation of RMB is likely to result in a similar drain of dollar reserves.

    Bank Rossii may have sold $5.75 billion of foreign currency last week, based on the average of predictions ranging between $2 billion and $6.5 billion. That’s likely to contribute to a decline of about $6.25 billion in Russia’s overall cash pool, compared with $3.6 billion in the previous week, the survey by Bloomberg shows.
    Russia lifted interest rates twice last month and drained $148 billion from the world’s third-largest reserves since August to stem a 16 percent currency slide against the dollar.
    At the same time, there seems to be a drain of foreign exchange reserves for China as well, reading from Pettis’s blog post:
    Also a brief overview of similar crises might be useful. In 1998, Thailand and then Korea faced a similar situation of reduced exports. The Japanese yen had devalued to make Japan’s exports relatively more competitive. Both Thailand and Korea in turn defended the Baht and Won against the dollar, in the face of speculative expectations of a currency collapse. Both currencies eventually collapsed, as their efforts to defend their currency drained their forex reserves, and both required IMF bailouts.
    In 1991, India had a balance of payments crisis even as INR strengthened rapidly against the USD. This is usually cited as a curious exception in academic studies of currency crises. India had a high volume of outstanding external borrowings and had spent the borrowed funds on domestic fiscal stimulus. There was a rollover crisis in the external borrowings and the Rupee strengthened as demand to repatriate dollars grew. Even as the rupee strengthened the forex reserves were drained out and India required an IMF bailout.
    (PS: I’m not against IMF bailouts at large. Much of India’s progress in recent times can be attributed to the IMF stipulated economic reforms program which Dr. Manmohan Singh led in 1991. )

  • Posted by Global Chessboard

    As far as I know India’s BOP crisis in 1991 is the only exceptional case of a country collapsing even as its currency strengthens rapidly. I did read a report that tried to explain how the combination of the strengthening Indian Rupee and high external borrowings led to a complete drain of the forex reserves but I’d like to know your opinion on that since that report wasn’t clear to me.
    My point is that a strengthening Dollar mgiht be hiding an underlying BOP crisis.

  • Posted by Howard Richman

    @Global Chessboard

    –>”I’d like to know your opinion on whether China can maintain reasonable levels of imports and exports even in the face of a serious drain of foreign exchange reserves.”

    There won’t be a drain of China’s foreign currency reserves unless China starts running trade deficits. Balanced trade would tend to keep China’s reserves at their current level.

    –> “The reason I ask is that if the dollar loses its reserve currency status, then we would need our own foreign currency reserves to conduct imports.”

    Import Certificates would not cause the dollar to lose its status as the reserve currency. Foreign governments already have over $4 trillion.

    On the contrary, Import Certificates would preserve the dollar as a reserve currency, because they would prevent the dollar collapse that is inevitable unless we balance trade.

    I do not share your aversion to the Fed accumulating foreign currencies. Bernanke has already been doing that through his currency swaps with foreign central banks. Unfortunately, these currency swaps are just short term and give the foreign Central Banks the option of swapping back at the original exchange rate.

    When the dollar eventually collapses, we will not be able to import, as you point out, because nobody will take our dollars. We will wish, then, that we had had a foresighted Fed that had accumulated foreign currency reserves.

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

  • Posted by --Andrew

    DJC and ReformerRay, I am not an economist however I will posit against your quite valid arguments (that China has no responsibility to save the world and that the US should save itself) that the world economy is in a bit of a prisoner’s dilemma situation. In short, everyone could benefit from betrayal of the world trading economy to benefit their domestic economy (and rightly feels that they should given past behaviour of the other participants). However, like a prisoner’s dilemma, mutual betrayal by everyone on the world economic front simply means that we will all burn together in this crisis, regardless of who has the superior moral argument or entitlement. The alternative is helping each other out and everyone benefiting (and benefiting over the long term). However, short term economic betrayal benefits more and is more politically and emotionally satisfying, if short sighted.

    http://en.wikipedia.org/wiki/Prisoner%27s_dilemma

    What gets me is that most small town banks take it as a matter of faith that they need to be concerned over the long term economic health of their customers and borrowers, (In other words, the economic health of their small local community, which I’d argue the economic exchanges of the world’s differing countries are.) Why is this such a hard concept for surplus and reserve currency countries?

  • Posted by Anon

    DJC: You should read Peter Temin’s book Lessons from the Great Depression. The parallels between the US response to the UK’s requests for dollar appreciation and your response to Brad’s suggestion are notable.

  • Posted by Anon

    One more note. The UK economy performed much better through the 1930′s than the US economy did — in fact the UK didn’t really experience a Depression in the 30′s.

  • Posted by Twofish

    I’m not convinced that the trade deficit with China has the effect of either reducing employment or demand in the United States.

    Here is a thought experiment. Imagine that you have a factory in China and you send it $100 in exchange for a laptop. Suppose the owner of the factory who happens to be an American, immediately takes that $100 wires it back to the United States to pay his workers in the United States.

    Now, cut the trade deficit. What happens to employment and demand in the United States?

  • Posted by LC

    What about the argument that depreciation of RMB will cause inflation in China, which will be welcome in short term for its stimulative effect?

  • Posted by DJC

    There is tremendous economic inequality between the United States and Western Europe on one hand and the rest of the world. The average Chinese earns one-tenth of the counterpart US worker. The typical Chinese corporate executive probably earns one-thousandth of Hank Paulson’s retirement salary from Goldman Sachs. Demanding that China sharply revalue the yuan currency to destroy the global competitiveness of Chinese industrial products is ludicrous. Developing countries, primarily in Asia, where poverty is endemic, won’t accept cuts in their growing industrial base just when the tide seems to be turning in their favor.

    On a footnote, the China PLA has announced a ofiicial change in military policy. Due to increased US belligerence, the China PLA has terminated port visits by the US Navy to Hong Kong and cancelled any further miltary-military contacts with the Pentagon. Replacing the defensive previous posture, the revised China PLA doctrine will take pro-active military action to retaliate against threats along its borders. In the future, any further US Spy plane flights over Hainan Island military facilities will result in Aircraft blown out of the sky.

    The US military and government are well advised to leave East Asia soon.

  • Posted by Twofish

    Let me also point out the important fact that no one in Congress that really matters cares what the USD-RMB exchange rate is, and people often miss what the argument really was about.

    You had two groups of people that wanted to have the RMB appreciate for different reasons. Financial firms and textile manufacturers. Textile manufacturers wanted the RMB to appreciate because China has a huge and unique advantage in textiles. Financial firms didn’t really care about the RMB appreciating but what they really wanted was capital liberalization. You can’t have an open capital account with fixed exchange rates, and without an open capital account, you are limited in you ability to make money off fees.

    You can see this by seeing who was loudest about RMB appreciation. Chuck Schumer of New York, and Linsday Graham of North Carolina. States with huge textile and financial industries.

    People both stopped caring once that got what they wanted. In the case of textile manufacturers you got an extension of the multi-fiber agreement. In the case of financial firms, the RMB was depegged and you have a QDII and QFII program.

    Once both groups got what they wanted, they stopped caring about RMB-USD exchange rates, and no one in Congress really cares any more.

    There are groups that you think might care, but they have reasons for not caring. For example, the UAW and autoworkers don’t care, because any movement in the USD-RMB will just send the factories to Mexico. Also US automakers are doing quite well in China, and they get around the tariff and exchange rate barriers by putting factories there.

    Organized labor are either groups like electricians or plumbers whose work can’t be outsourced or groups like teamsters and longshoremen that benefit from trade. The groups that would get hurt by manufacturing jobs moving overseas like autoworkers have already reached buyout packages between labor and management, and if they protest, then everything has to be renegotiated making them worse off than they are now.

    That’s why you have GM and the UAW on the same side of the table, and why the UAW doesn’t care that GM is selling Chinese made cars in China. Selling made in Shanghai Buicks in China (or for that matter in the United States) is the only way that GM can afford even come close to paying for the pension, health, and buyouts that the UAW and GM agreed to a few years ago. If the UAW complains about GM moving jobs to China, GM will file for Chapter 11, and all of the union contracts that have been negotiated go out the window, and there is no way that the UAW will get a better deal.

    This is the nitty-gritty political reality, and with due respect, some of the conversations on this blog have a very abstract quality that seems to be detached from the facts on the ground.

    Import certificates or any sort of broad trade restrictions are dead on arrival since they would require that the US withdraw from WTO. (And you aren’t going to win by arguing they don’t violate WTO rules, the important thing about WTO is that there is an adjudication process for defining what those rules mean.)

    Anything that threatens WTO will get *EVERYONE* fighting you. Even groups you think are mad about American jobs going overseas (like the UAW) will simply not risk having the agreements they’ve made over the last few years getting thrown away.

  • Posted by Twofish

    DJC: The typical Chinese corporate executive probably earns one-thousandth of Hank Paulson’s retirement salary from Goldman Sachs.

    The typical American corporate executive doesn’t make as much as Paulson.

    If you want to compare apples to apples. Rong Yiren of CITIC Pacific is likely as rich and probably much, much richer than Paulson.

    Something that is the case is that as you get to higher levels of management and higher skill levels, Chinese and American salaries start being comparable to the point that Chinese investment banks are able to hire off people that work in American investment banks with comparable or even superior pay.

    One thing that I haven’t seen anyone comment on is that if you have China revalue the RMB upward, this makes it much easier for Chinese companies to hire high skill, high value US labor and you run the risk of causing a brain drain in the United States.

    The consequence of this is that the wealth distribution in China society is far more unequal than the US.

  • Posted by DJC

    Twofish,

    Let’s compare Apples to Apples.

    Mr. Jianzhou Wang CEO of China Mobile
    Salary: $ 259.00K

    Mr. Randall L. Stephenson CEO of AT&T
    Salary: $ $ 2.28M

    China Mobile CEO earns one-eleventh of the salary of AT&T CEO.

    Source: http://finance.yahoo.com/q/pr?s

    - China Mobile is larger in market capitalization than AT&T by $20 billion.

    - China Mobile is the largest telecom company in the world.

    - China Mobile has over 300 million more customers than AT&T

    - China Mobile also controls Hong Kong and Pakistan mobile phone markets.

  • Posted by Euraussian

    Twofish,

    Several excellent posts. However the question is should a big surplus country’s currency depreciate against a big deficit country and the anwer is of course, ceteris paribus, that is not what basic economics predicts.

    We should see this in a much wider context than just US-China. There is a growing number of Asian countries with trade balance problems (from their own perspective) and whose currencies have been under pressure recently, for various reasons, partially due to deleveraging. China’s exporters (or their export decision makers, not seldom foreign and located in countries where they can manufacture too, or having lots of operational flexibility in switching production from one country to another) appear to have been responding to both declining demand (themselves facing stronger price competition) and increasing opportunity costs from keping production in China. This appleis of course especially to the HK- and Overseas mediated production in Guangdong, which is causing the poliyical leadership so much hardship that Mr Hu has decided to publicly refer to the CCP’ mandate to govern. Serious stuff and no solution. The US is simply the battleground in trade war between several nations with 19th century industrial relations but with (at least, do not forget equally struggling Vietnam) one gvt that cannot completely ignore worker sentiment in affected locations and industries. Strangely enough, in this respect undemocratic China appears to be more “people-regarding” than, say India, that democratic stalwart..

    Incidentally, It would be good policy from China’s perspective, given also CCP imperatives (you may not like them but they belong to the real world) to create some ambiguity around CNY’s external value, especially now commodity prices look like they are going to create some addidional buoyancy to the CNY in the coming year). You want to be competitive, maintain valuable (in the long run those toys should go elsewhere of course) marketshares, etc but you want to get rid of foreign nagging when the moment is right. This is a good time to test the waters and also a good time to communicate with competitors . That these (the real neighbours, not the US) will be beggared if necessary. Perhaps in the not too long future China may start to offer BOP support (loans, investments to Thailand etc, if there is a technical and political way to do that. With some Japanese help (who share the Chinese prdicament and may be worrying about the JPY/KRW), the ADB might be the right vehicle.

  • Posted by Charles

    DJC, what Brad is suggesting is not an insult. It’s that the long-suffering Chinese worker should get a chance to enjoy the fruits of his/her labor.

    The only beneficiary of a weak RMB is the Chinese government. It allows them to keep pressure on workers with low wages. If it followed Brad’s policy prescription, Chinese living standards, both individual and national would rise.

    The likely result of a sustained low RMB policy will be a rise in anti-Chinese xenophobia in the West, and protectionism, a race to the bottom similar to what happened in the Great Depression. This is bad for everyone.

    The natural effect of China consuming more will be the West consuming less. As long as China maintains low prices on its goods, there’s no incentive for westerners to consume less.

  • Posted by Euraussian

    Brad, 2 fish,

    Needless to add to he previous comment that the US would be very wise not to interfere with the inevitable intra-Asian process. It would be costly and unprofitable.

  • Posted by don

    Brad –
    Nice post. I see little chance for a cooperative solution. What seems like a long time ago, I argued that the U.S. would tire of China’s reserve build up before China would. I also made DJC’s point about the question of the moral high ground in this issue – namely, the U.S. gaining at the expense of poorer Chinese.

  • Posted by bsetser

    Don — you may be right, though with China introducing expectations of rmb depreciation into the market, China has at last perhaps found a way to reduce its reserve accumulation in the short-run …

    veli — oil price volatility and uncertainty over oil’s long-term price is a major difficulty for the oil exporters. but rather than addressing that by simply saving all the oil windfall (an outcome that guarantees imbalances if a temporary rise in price turns permanent) i would prefer to see policies that help oil-exporting economies navigate oil price volatility. allowing currencies to move up and down with oil is one possibility. i think we need to be creative here.

  • Posted by Ying

    I doubt exchange rate adjustment will solve trade imbalance problem.

    1. Will appreciation of Yuan increase employment in US?

    2. Will appreciation of Yuan decrease trade deficit in US? How long will this be achieved if it is possible?

    3. What impacts do the exchange rate adjustment have on real economy in US? Which industry will be impacted? What adjustment of the industry is needed?

    4.What impacts will the adjustment be towards exchange rate between US dollar and other emerging market currencies? Will they do the same adjustments following China’s movement or not?

    5. What will be the impact to inflation rate in US?

    Without systemic study or experiment, I doubt anybody have any answer except conclusions of economic theories in textbook.

    The trade imbalance problem probably need a host of a range of remedies.

  • Posted by Twofish

    Charles: The only beneficiary of a weak RMB is the Chinese government. It allows them to keep pressure on workers with low wages. If it followed Brad’s policy prescription, Chinese living standards, both individual and national would rise.

    I really don’t think so. Wages in China have been growing at double digits. I don’t think it is realistic to think that the economy can grow faster than it has without something breaking worse than it has broken those far.

    Also, the argument that China should do something for its own interest is a really bad one. You can’t complain that China is taking advantage of the United States and scream about Chinese behavior on one hand, and suddenly tell the Chinese leadership that the policy that you propose is in their interest rather than in yours.

    Logically, if you say that then either you are lying (if the policy isn’t in their self-interest) or they are stupid (if it is and they can’t see it).

  • Posted by Twofish

    About CEO salaries. The SEC requires US CEO’s to disclose salaries, but there is no such disclosure requirement for Chinese companies traded in Hong Kong, and all of the estimates I’ve seen for the salary of the CEO of China Mobile have asterisks saying that these are very rough guesses.

  • Posted by Twofish

    The other thing about Chinese state-owned enterprise CEO’s is that they have two hats. Often they are CEO’s of both the listed corporation and also the state holding company, so something that lists their salary from one hat, may not include their salary from the other.

  • Posted by MMcC

    I think an argument can be advanced that the yuan’s (very) recent weakness is just a piece of political signalling: the equivalent of keeping someone waiting outside your office for 20 minutes. It may be the case that the regular public/private Chinese buyers of dollars were told simply to lay off for a few days, in the understanding that the market would be allowed to “normalize” next week. It’s setting the table for Paulson’s Beijing visit.

    Paulson, assuming he is able to give China something that it wants, will be able to go home and say that China has redoubled its commitment to a stronger yuan. The public/private buyers will be told to start buying again. The yuan will pop. Everyone will walk away happy.

    Typically, in the week before a major economic discussion between the US and China, some oddity like this occurs, whether it’s a sudden problem with bank licenses, CIC spending, QFII quota issuance or, in this case, an oddball yuan movement. Had this happened in a different week, I’d find it more meaningful than I am willing to do in a week when Paulson visits Beijing.

  • Posted by observer

    There are so many very bad arguments in this thread. The RMB exchange rate issues really seems to make many people unable to think objectively. Especially tiresome are DJC’s nationalistic “the PRC gov can do no wrong” nonsense.

    Twofish: Also, the argument that China should do something for its own interest is a really bad one. You can’t complain that China is taking advantage of the United States and scream about Chinese behavior on one hand, and suddenly tell the Chinese leadership that the policy that you propose is in their interest rather than in yours.

    Please stop manufacturing fallacies where there are none. Keeping RMB artificially depreciated is in the PRC gov’s short-term interest. It is in the Chinese people’s long-term interests to have a roughly balanced trade relationship with the rest of the world. Because anything else is as unsustainable as house prices that never fall.

  • Posted by observer

    bsetser: At the same time, Asian economies can permanently rely on the US and Europe to make up for their own shortfalls of domestic demand.

    I think you mean: “Asian economies can *not* permanently rely on the US…”

  • Posted by Twofish

    I think there is a basic problem here in that the US wants China to do two contradictory things. The US wants China to boost domestic consumption, while at the same time lowering the trade deficit, and absent action by the US, can’t do both.

    Either China expands its money supply or it contracts its money supply. If it wants people to spend, then it expands it money supply, but if it expands it money supply the RMB goes down, and you increase the trade deficit. If China contracts the money supply, then you decrease the trade deficit, but you also encourage domestic savings. Without action by the United States, there is just no way of getting to the desired state of affairs.

    The basic problem is that anything that China does to encourage China to spend money on Chinese products also encourages Americans to spend money on Chinese products, and there is a one-way trap because Americans can use dollars to buy Chinese goods whereas Chinese can’t use RMB to buy US goods, and the People’s Bank of China can’t print dollars.

    If China tries to reduce its US currency reserves, the only supply of RMB is in China.

    Import barriers aren’t going to solve the problem because if you reduce the amount of Chinese goods entering the US, you reduce the dollars that Chinese can use to buy American goods. Having the PBC sell dollars and buy euro isn’t going to change the fundamental problem, it just shifts it from the US to Europe.

    The only way I can see to get the desired goal of boosting Chinese consumption *and* shrinking the trade deficit is for China to expand the money supply to encourage spending, and for the US to expand it’s money supply enough more so that spending gets done on American goods.

    The standard “beggar my neighbor” scenarios assume two mutually exchangeable currencies neither of which is a reserve currency, and I don’t think that they work in this situation where you have one non-convertible currency and the other which is a reserve currency.

    What this means is that the US and China need to coordinate fiscal and monetary policies if the US gets what it wants, which means that we are really living in a brave new world.

  • Posted by Global Chessboard

    Brad: though with China introducing expectations of rmb depreciation into the market, China has at last perhaps found a way to reduce its reserve accumulation in the short-run …

    I’d like to know if Jansen’s blog is telling us about reductions or increases in swap spreads since his November 20 post?

    CDS on Treasury is increasing continuously.

    Now you know why George Soros was writing about ‘the end of an era’ in March 2008 , in his book – ‘The Credit Crisis of 2008′.

  • Posted by adiemuso

    To me, USDCNY is just a punching bag. There are a whole lot of issues which can help alleviate the trade imbalances globally.

    Efficiency or comparative advantage. The Developed economies should stick to what they do best. If the struggling big 3 Autos in US are not a prime example, what else could be better? Take any US made automobile and compare it with a German, it doesnt take a genius to realise how different it is in quality and in costs. Should the US taxpayers or the World continue to subsidise such inefficient manufacturers?

    Moving up the value chain, it is a fact, when economies grow with time, there is a certain stage when some industries,output become pointless to continue/pursue. The Chinese are inteligent enough to know that they cannot ignore that by embarking on an aggressive USDCNY appreciation to boost their exports. Such remedies can only be short term at best. The only way is to boost domestic consumption, government spending and the boosting of efficiency be it through education, infrastructure, R&D, …..

    Im rather disgusted by the fact that World Leaders are conveniently sidestepping the urgent need of coming up with real solutions to Global Ecological Devastations. It is amazing that how myopic people are, isnt cost cutting a big way to improve the balance sheets? And to think about it, the recent boom cycle could be attributed to an increase in credit and not real production. How could banks and companies be bankrupt over some synthetic financial engineered contracts?

  • Posted by Ying

    “I think you mean: “Asian economies can *not* permanently rely on the US…””

    US economies can’t permanently reply on China the same as China can’t permanently reply on the US.

    There seems to be too many suspicion and mistrust in the air in terms of US China relations. For me, US and China are both lung and liver of a body without each the system wouldn’t function well.

    It was and still is the interest of US business sector to seek the lowest cost of production all over the world. The place happens to be China and other developing nations. It is also the interest of US multinational companies seek market share of booming Chinese consumer market. It seems to me more than logical that US business elite doesn’t really care about moving the exchange rate. However, they are interested in increasing market share of China such as financial other industries. If Yuan depreciate against US dollar, it really is doing business sectors both in US and China a big favor.

    For Chinese workers, I don’t think they will be better off if Yuan appreciate. Whether they will be better off depends on Chinese’s government’s enforcement of labor and environmental regulation etc to protect their interest.

    There is very little to address the trade imbalance problems by focusing on exchange rate.

    If US and China really want to permanently independent with each other, they can divorce with each other and tear up all free trade agreement. Then nobody will have the chance to take advantage of the other. Will this happen? The business sectors of both countries will clearly say no.

  • Posted by adiemuso

    Allow me to continue,

    CDS, it is simply a contract between two counterparties trading an insurance against credit events on someone else. Im not too sure if that is a logical way of doing business. Schadenfreunde Trading? Remember the saying? What goes around, comes around. In economics, it is known as correlational risks, doesnt anyone measure and consider the correlational credit risks between companies, governments, entities which are assumed to be near full independent? How amazing!

    And if we are to see a Sovereign Country assumed to go bankrupt because the CDS on their Governments Bonds have shot to astronomical heights, while the country still hold consideral economic and political power and status, should we declare that country to be so?

  • Posted by John Booke

    Won’t higher USD/RMB lead to higher USD/JPY? Will Japanese automakers then reduce prices for Americans? How will this effect US automakers?

  • Posted by observer

    adiemuso: CDS, it is simply a contract between two counterparties trading an insurance against credit events on someone else. Im not too sure if that is a logical way of doing business.

    It is not (a logical way of doing business). In the real world, CDS contracts are very frequently a fraud whose only purpose is to circumvent regulations and not genuine insurance or risk transfer.

  • Posted by Euraussian

    All of China’s competitors have lower USD exchange rates than a year ago. And given that China competes with domestic producers in, for instance, India (a big market for low end goods) I am convinced (and that is also what mr Paulson gets to hear probably) that China and the US will agree that the exchange rate is of symbolic importance but that there will be no clear message as to the future, without the US delegation screaming loudly. Of course, when Brad’s pals get to deal with the Bush legacy, they may want to retain this as a useful nuisance issue, without actually taking sides in what appears to become a trade war in Asia, aggravated by rapid declines throughout the OECD area (forget the China competitors in the OECD like Korea for a while) in consumer spending on excactly the sort of things you find in the non foods department of your local grocery, in clothing chains and electronics. The most potent sign of consumer frugality I came across sofar is that lottery spending in Australia is 11% down..

  • Posted by menomnon

    adiemuso and observer – I think you might benefit from a better understanding of the history of CDSes.

    _Originally_, party #1 makes a loan to party #2. But party #1 may be concerned about repayment (from party #2). So party #1 buys CDS insurance from party #3. If #2 fails to pay #1 back, then #3 will indemnify #1 at some predetermined rate.

    That is, there was a real economic rationale to this.

    However, that, in recent years, CDSes have morphed into purely speculative instruments is true. Something like CDSes against US government debt (i.e. default) is clearly such a case.

    On a very different matter, I was born and raised in the US and am of European ancestry. At 19 I lived 2 years in Paris and still speak and read French; in my thirties, I lived 6 years in Tokyo as an expat for a joint-venture financial firm. My wife is Chinese from SE Asia. We go back there every summer.

    I.e. I have considerable first-hand overseas experience (both in Europe and Asia) and speak several non-English languages fluently.

    (um, it’s also relatively clear form other posts here, what the, ahem, ‘allegiances’ are).

    It’s fine to speak in terms of equilibrium economics and all that. But, for an E Asia country, running a surplus with the US is a matter of pride. It says “We produce and save. We’re virtuous”. “You (the US) consume and presumably don’t produce [even though US manufacturing value added is still the largest in the world and by a wide margin]“. “You are not virtuous”. “You are weak”. “We will become rich and more powerful”. “You will become [or are already] poor and will become less powerful”.

    China’s historical experience is that they are at the center of the world. The problem with that of course is that the world in question was a narrow one: East Asia for the most part.

    But still, they believe they should be at the center of the world again. I mean; 1.3 billion people entitles you to that – right?
    (oh by the way, what was China’s population in 1949 at the time of the Communist victory. Under 500 million. I.e. it’s more than doubled since that time).

    And it’s the US that currently occupies the ‘center of the world’ (whatever that is and for whatever it’s worth – although apparently a great deal to the E Asians).

    Still the strictly macroeconomic analysis is interesting. Even if only as a matter of intellectual satisfaction.

  • Posted by adiemuso

    time has since changed. what used to be logical and of economic rationale has since been thrown out and replaced by greed and speculation.

    so my point is, in case, i have not been clear enough, or you have mistrued me, get the root correct and the shoots will grow into a plant and a big strong tree. otherwise barking up the wrong tree does not help.

    it is naive, or put it mildly, utopian to believe that noone puts their self interests above others. however, basic economic theories have shown that the best outcomes are usually one of collusion and cooperation. sadly, pride rules over logic. hence we are where we are today.

    so i repeat my call..incase it get lost in my convoluted writings. ban these toxic CDSs before a great Nation fall onto its knees.

  • Posted by adiemuso

    menomnon,
    “_Originally_, party #1 makes a loan to party #2. But party #1 may be concerned about repayment (from party #2). So party #1 buys CDS insurance from party #3. If #2 fails to pay #1 back, then #3 will indemnify #1 at some predetermined rate.”

    what if all party 1,2 & 3 happened to be in the same industry or have some kind of exposure to one another? if party 1 happens to default, it might mean that it will default on party 3. so if party 3 has defaults, it might default on party 2. so in the end who wins? noone. and it is possible for the hedges to be way higher than what was needed. thus speculation on CDSs meant to be profitable becomes a loss!

  • Posted by Charles

    Twofish, I do my best not to “scream” anything, least of all basic economics.

    The Chinese government is trying to achieve the highest level of employment, since unemployment/underemployment in China is a serious problem. The fear is that raising real wages would reduce job growth. There are many people in the United States who oppose raising the minimum wage for the same reason. But the evidence on the minimum wage is that raising it (within reasonable bounds) *increases* employment. I don’t know what real wage gains have been in China, but they are not enough to supply a decent standard of living to more than a tiny fraction of Chinese.

    To your statement that “the argument that China should do something for its own interest is a really bad one,” I say au contraire. A bad argument is trying to persuade someone to do something that is against their interest. Since I have not argued that “China is taking advantage of the United States,” there is no contradiction in what I’ve said. Nor have I said that the leadership is stupid. It’s not intuitively obvious why raising the minimum wage should increase employment, either.

    I request that you not use gratuitously insulting language like “lying” in discussing this issue. It does not persuade me of the merits of your arguments. It does imply something about how you were brought up.

  • Posted by menomnon

    > so i repeat my call..incase it get lost
    > in my convoluted writings. ban these
    > toxic CDSs before a great Nation fall
    > onto its knees.

    What one doesn’t hear about is that CDSes are still serving their original function. They’re not going to go away.

    Instead (and this has been in the news) a clearing house is being established. Now. No longer will parties be able to do deals ‘in secret’ (party to party). And the authorities will regulate this market.

    And what prevents parties from cheating? They’ll have to carry this stuff on their balance sheet in one fashion or another.

    Believe me, if the proper regulations are in place, the authorities will know and can do what they need to do.

    What’s happened is that there’s been a gross weakening in regulation going back to the Reagan administration. (‘market fundamentalism’)

    But it’s a fine balance – between regulation and innovation.

    And financial innovation is for real. The Genoese were the bankers to the Spanish monarchy in the 16th century when unimaginable quantities of gold and silver began flowing into Europe. The Genoese invented modern banking in the process of figuring out what to do with all this money. And this played its role in the foundation of modern Europe.

    Everyone knows Santayana – right?

    Well that’s useful, but I’d add to it G. K. Chesterton.

    “The disadvantage of men not knowing the past is that they do not know the present. History is a hill, or a high point of vantage, from which alone men see the town in which they live, or the time in which they are living.”

  • Posted by menomnon

    > What’s happened is that there’s been a
    > gross weakening in regulation going back
    > to the Reagan administration.
    > (’market fundamentalism’)

    Let’s think of another country which labored (suffered) under a false ideology for several decades.

    Oh! How about China under Mao’s Communism.

    And there the price wasn’t denominated in money. It was denominates in 10s of millions of lives and vast human suffering.
    (The Great Leap Forward; The Cultural Revoluation; et. al.).

  • Posted by Global Chessboard

    @ Brad:
    IMF has been focused on regulating CFOs rather than CDOs. CFO = Collateralized Filial Obligation.

  • Posted by bsetser

    yes, i meant cannot rely — i have edited the post accordingly.

  • Posted by Euraussian

    Tkae it easy, Charles.

    The “you” 2fish uses is not you, Charles but the 3rd person “one” You is simply colloquial for “one”. And to be honest, I think 2 fish is, as usual, right…

  • Posted by Twofish

    Charles: I don’t know what real wage gains have been in China, but they are not enough to supply a decent standard of living to more than a tiny fraction of Chinese.

    This isn’t true at all. You’ve had consistent yearly double digit income growth in China over the last thirty years. Some people have gotten richer more quickly than other people but everyone has gotten richer.

    Charles: Since I have not argued that “China is taking advantage of the United States,” there is no contradiction in what I’ve said.

    There is no contradictation in what you personally have said, however, if the person next to you is screaming “China is taking advantage of the United States so we should do want Charles wants.” This looks bad.

    It gets even worse if you have get the political support of the person screaming “bad China” to get something done.

    Charles: I request that you not use gratuitously insulting language like “lying” in discussing this issue. It does not persuade me of the merits of your arguments. It does imply something about how you were brought up.

    I care less about persuading people than finding out the truth of a situation. Those two goals are often in conflict. Using blunt language often turns people off, but it helps to think about the situation.

    If I were a lobbyist, a salesman, or politician, I’d be talking about how smart, moral, and intelligent you are. If I want your vote and your dollar, I can do that. If you pay me enough, I’ll tell you how brilliant you are. The question you have to ask yourself is do you really want me to do that?

    I don’t think you are a bad human being, but you are human, and *all* human beings have a tendency of constructing realities in a way that makes them feel better. People (including myself) unconsciously lie to other people, and they unconsciously lie to themselves.

    If someone gives me lots of money to tell them that a piece of real estate is extremely valuable, I will tend to think that that real estate is extremely valuable. This is a lie, and I have to fight like heck to see the truth.

    If I tell myself that I’m a good human being and someone incapable of being swayed by self-interest and that if someone gives me a million dollars and I *won’t* be tempted to do what they tell me to do. That’s an even bigger and even more dangerous lie.

    A big lie that most people (including myself) generally tell themselves is that they are smarter or more moral than the next person. An even bigger lie that most people (including myself) generally tell themselves is that they don’t believe that they are smarter or more moral than the next person.

    Part of being a politican, a lobbyist, or a salesman is to realize the lies and secrets that people tell themselves and to take advantage of them, while at the same time lying to themselves and the people they are talking to that they really are doing that.

    The real danger is not when people lie. The real danger is that when they get so good at lying that start beliveing their own lies. That’s how we got into Iraq and into this mess. It’s not a bunch of cynical liars telling people how brilliant and smart they are and not believing it. It’s a bunch of liars that started believing their own lies.

    Everyone lies. The really dangerous people are the ones that won’t admit that to themselves, because if you refuse to believe that you are a sinner, you can’t see the truth about the world.

  • Posted by ReformerRay

    Changing U.S. laws to reduce imports from those nations that have a trade surplus with the U.S. is ruled out, by most economists, and others, on the grounds that ANY restriction on U.S. imports, no matter how well defended as serving a valid goal (all nations will benefit from equal trade, unequal trade does not benefit a nation that has a trade surplus) WILL RESULT IN RETAILATION.

    False fear. Retaliation to prevent a nation from working to achieve a valid goal is not reasonable. Second, as long as the U.S. is in a deficit condition with another country, as trade war will benefit the U.S. (reduce U.S. trade deficit).

  • Posted by locococo

    Adiemuso: should we declare that country to be so?

    I wouldn t. However we can safely declare that that country s runners heads bankrupt. If now – somehow – they called this one »a fraud« then
    a) »contracts« turn invalid and we d have a little unwinding to go instead of the settlement s (for counterparties, fiat insurances sold, fiat insurances bought, institutions involved and bets that were placed – sake) “appreciation”
    but
    b) by definition – any such call amounts to no less than to put runners (the caller – oneself) away, thus depriving that country of two of its parties.
    It is from that bankruptcy that other countries got emergingly “cleared”.

    And second, you do seem to forget another fact, being: that the same country continues to be »in default« for the 27th year now, in a straight row. That said does not in-itself imply, that it took the spreads almost three decades to catch up on this point or that this post should have any of sense. So “I ll swap your back if you swap mine if he swaps too” policies climb to the longer ends of the curve…

    Howard Richman and Global:

    That country s currency collapses …
    … in relation to what?

  • Posted by ReformerRay

    Trade deficit – not surplus. I mistype those two words frequently . i know what I mean, but do not type correctly.

  • Posted by Global Chessboard

    @ Twofish:
    I noticed your enormous level of activity and interest. You’re helping this forum a lot even if some of your views are not getting as much acceptance as others.
    Do you think Communist Party will announce a liberalization program? If they were to include points such as increased limits on foreign investment, more liberalized capital markets, reduced capital controls, etc then I don’t think there would be much objection to imports from China.
    And do you have any views on whether China is capable of sustaining imports and exports, including petroleum supplies, without US dollar reserves?
    I would appreciate your views, thanks.

  • Posted by ReformerRay

    Twofish says everyone lies. Perhaps he is right. What is the opposite of lying? Telling the truth? But no one knows the truth and the whole truth.

    However, (here is the important point), the search for the truth is necessary because the truth will set you free. Only by seeking the truth will we approach an understanding of reality. Only by acting in response to reality will our actions achieve our goals.

    The fact that lies are useful does not change the point that we must uncover a whole bunch of half-truths to arrive at some understanding of reality.

    I am not sure that my understanding of the realities of trade between the U.S. and the five countries that account for 60% of the U.S. trade deficit is accurate. The only way to know is to get someone like Twofish to argue with me.

  • Posted by ReformerRay

    Global Chessboard says if China will change some of its internal practices that will reduce the objection to imports from China.

    Not in my case. I object only to those imports from China, and any other trading partner, that is in excess of our exports to them because of the harm that trading relationship does to the U.S. The harm to the U.S. remains, regardless of how or why it is created.

  • Posted by ReformerRay

    adiemmeno says : so i repeat my call..incase it get lost in my convoluted writings. ban these toxic CDSs before a great Nation fall onto its knees”.

    His argument is that these contracts should never have been permitted to have been written.

    That issue deserves to be discussed.

    If valid, it would lead to laws that ban such contracts from enforcement in U.S. courts. That is a way to make them illegeal retroactively and proscriptively.

    I call the question. Unfortunately, I do not know which way to vote.

  • Posted by Tian Chee

    Twofish,

    Why you waste breath and intelligent on blog here. Come China manufacturing. We need smart people like you to help move value chain. What job you have now? Profit here and grow opportunity much more and no need to sinning.

  • Posted by lb

    bset: “i think we need to be creative here.”

    brad, the monbiot article i linked a couple posts had a comment that proposed an idea that was quite creative imho –
    cojock: “I advocate for international trade the unitisation of energy – using a partnership framework, rather one based upon Company law or Trust Law – so that energy producers may issue Units redeemable in energy.
    It is therefore possible to create a decentralised and networked “Peer to Peer” International Clearing Union, with an “Energy Dollar” as a global reserve currency. This would be based upon the intrinsic value of an “Energy Dollar” unit of energy, rather than a purely arbitrary value imposed by fiat and based upon scarcity.
    Credit, or “time to pay” is then supported by a charge paid into a Default “Pool” by both energy seller and buyer for the use of a mutual guarantee. A Service Provider Formerly Known As A Bank manages the system in return for a fee.
    A suitable carbon levy (essentially a payment in respect of the exclusive use of the Commons of non-renewable energy) is made into an Investment Pool. This is then used to invest in renewable energy (MegaWatts) and energy savings (NegaWatts) simply by buying forward the production, or savings, respectively.”

    http://www.slideshare.net/ChrisJCook/equity-shares-a-solution-to-the-credit-crash-presentation

    still trying to wrap my head around if & how this could work. the central concern that struck me is *how* funds from this pool are distributed, *who* allocates them, thus deciding *where* they go.
    from the surface, this smacks of global centralization, but considering that the author promotes ‘peer-to-peer’ decentralization, there must be something i’m missing.
    working to track down the author to ask him but he seems to be a bit mysterious so far.
    anyway, the proposal endeavors to tackle at least 3 issues at once — trade (im)balances, energy consumption & sustainability — so perhaps it’s worth an experiment in thought…

  • Posted by Global Chessboard

    @ Reformer Ray:
    As of end September 2008 Taiwan had Forex reserves of US $ 281.13 billion. Similarly small countries like Singapore, Korea, etc … all have huge Forex reserves compared to their size and population. INR/USD moved from around 42 to around 50 very recently.
    Korean banks are owned by a select few foreign banks, while the Chinese system is owned by State owned commercial banks and state owned enterprises. The real theme of the strategic economic dialogue is not Chinese jobs versus American jobs. It’s who will own the banking system. Corrupt Chinese bureaucrats or a limited few American Banks?

  • Posted by Howard Richman

    @Global Chessboard

    Few people realize that Sovereign Wealth Funds don’t pay any U.S. taxes on dividends earned as part of a gentleman’s agreement among governments not to tax each other. This tax loophole provides an incentive for foreign governments to buy up our banking sector.

    By the way, my father, son and I were published this morning: http://www.americanthinker.com/2008/12/stop_the_borrowing_theres_an_a.html

  • Posted by lb

    p.s. DJC — thanks for sharing that SNL skit. had a nice chuckle. the soros bit at the end was classic.
    tanta would have gotten a kick out of it methinks.

  • Posted by locococo

    on creative pick takin

    If A bought 1.000 $ face value protection againts C s default from B, for say 10$, and C went under, then SETTLE this contract (with nationalization of B as it has no way of providing what s asked and swaps for the flows) will require a 1.000$ flow plus partial nationalization of A and of C given their bets and their ratios. Hiding all this till the phantom clearing house starts its operation, can work as long as it s guarantee fund (where will it come from?) replaces the fund or the assets that B never had as it couldn t. Further defaults of D, E and on do trigger expn growing funding needs which will further up press you curency, depress the emerging markets, they ll start defending at some point hence sink up all trade, it requires bail outs on an non stop basis and a CB (s balance sheet) that ll end up owning everything on a gross basis.

    UNWIND the same contract on D takes just 10$ flow to go but A becomes uninsurred against Ds default which it was thinking of bringing about with phantom shorting it s share (CDO on CDS). The same goes for D on As case + it takes another 10$ to unwind his one. Plus to cover the shorts. So you ll manage to manage the flows and the currency with unwinding but re-open exposure and force shorters to cover – a rally. As »insurance« was fiat to start with after unwinding the winds you can let go of the B and the A and the C and the D also and say – go insure yourselves publicly now.

    Given the rough estimate of 80% of all contracts were naked in nature, do take your pick.

  • Posted by Global Chessboard

    @ Dr. Richman
    Well I agree with you and I never thought import certificates had anything to do with draining Forex reserves of other countries. Secondly as you correctly mention there’ve been various measures to encourage foreign capital inflows both in good and bad times. Currency imbalances, tax laws, interest rates, are all part of that game according to me.
    The current crisis is an on going worldwide conflict of interest between a select few majority stakeholders in US and UK banks and corporations, and a select few corrupt dictatorial leaders of foreign regimes over who will control the banking system, oil supplies and so on. None of these actors have any fundamental moral superiority. But experience has shown that over a period of time common people are better off in democratic countries than in dictatorships. Knowing the correct themes will help you invest your resources and time correctly. Other than that my only interest is to see how quickly they will resolve this, and whether they can do that without causing further humanitarian disasters or further joblessness, bankruptcies, etc for common people that aren’t playing on the global chessboard.
    In the context of this conflict if the US dollar loses its status as the reserve currency import controls become irrelevant; investment demand in the US will automatically result.

  • Posted by RebelEconomist

    Observer,

    I would be grateful if you could explain how CDSs were used to circumvent bank regulation. I have heard this before, and was puzzled – if a CDS offers genuine credit protection against default by a bank’s borrower, is it not reasonable that the bank should be allowed to hold less capital?

  • Posted by Global Chessboard

    @ Rebel:
    To understand the use of credit-default swaps you have to consider the regulations that are commonly applicable to regulated insurance, such as a life insurance contract. A life policy value cannot exceed a fixed multiple of the insured’s annual income. Higher policy value would imply a wager on the insured’s life. The policy holder has to be directly related to the insured, such as member of immediate family. Setting up a life insurance company has minimum capital requirements, and there are stringent regulations on capital adequacy as the company expands.
    In case of credit default swaps these regulations are absent. Counterparties may be independent of the underlying credit transactions, and the outstanding principal is independent of the credit volume. CDS settlements yield mostly off setting gains and losses for counterparties and the net settlement is always equal to reduced recovery losses on the underlying referenced entities.
    You will find several discussions on CDS in past entries at Brad’s blog.

  • Posted by RebelEconomist

    On the subject of the post, I note that deflation would provide just the (real) depreciation against the renminbi that the US is calling for to balance trade with China, yet the Fed is trying everything to avoid deflation.

  • Posted by RebelEconomist

    Chessboard,

    I think I understand reasonably well how CDSs and the insurance regulations you describe work, but that does not explain why the credit-hedging function of CDSs should not justify some reduction in capital requirement. If you know, please explain.

  • Posted by bsetser

    Rebel – that is true. But adjustment through deflation is the most painful kind of adjustment around, as it increases the real value of all long-term nominal debts with fixed interest rates. Argentina’s experience trying to produce a real depreciation through deflation as the peso rose from 99 to 2001 is seared in my memory.

    It also is a policy that benefits creditors not debtors and the US is a net debtor …

  • Posted by RebelEconomist

    Of course, I am not seriously suggesting that the Fed should tolerate significant deflation, but I do think that they should err on the tight side and run that risk for a change. I believe that it is policies that benefit debtors at the expense of creditors that have led the US into the present mess.

  • Posted by Twofish

    Chessboard: Do you think Communist Party will announce a liberalization program?

    I don’t think it is useful to talk about a “liberalization program.” When people talk about “liberalization” they usually talk about a hundred different policies, none of which have very much to do with each other.

    Chessboard: If they were to include points such as increased limits on foreign investment, more liberalized capital markets, reduced capital controls, etc then I don’t think there would be much objection to imports from China.

    If a textile manufacturer in North Carolina thinks that he is going to lose his job because of Chinese textile imports, he *still* is going to want tariffs on textile imports if China imports allows more foreign investment in banking, doesn’t help him.

    Now what you can do is set things up so that you now have an investment banker in New York that you can use to outvote the textile manufacturer in North Carolina.

    But my argument is that this was done several years ago. My point (and I’d be glad if someone can contradict this) is that there are very few groups in the US at this point that oppose Chinese trade deficits, and the people who do so are political insignificant right now.

    It’s also a point that outside of qprofessional economists, few people really care about trade deficits. They care about jobs or national power.

    Things might be very different in a year from now, but looking at the way the discussion is evolving, I don’t think it will be. The fact that no one in the last election ran on a “Lou Dobbs” platform is significant.

    Chessboard: And do you have any views on whether China is capable of sustaining imports and exports, including petroleum supplies, without US dollar reserves?

    As long as people in the US don’t accept RMB for payment and the RMB is not convertible, China has to have US dollar reserves and run a trade surplus with the US. Suppose China had zero dollar reserves. What would it use to pay for imports?

    The fact that the dollar is the world’s currency means that the US *must* run trade deficits in an expanding world economy. It’s the Triffin Paradox.

  • Posted by anon

    The issue is not the avoidance of capital requirements by using CDS within the regulated banking system.

    It is the avoidance of same by CDS writers in the shadow (unregulated) banking system.

  • Posted by Twofish

    Chessboard: The current crisis is an on going worldwide conflict of interest between a select few majority stakeholders in US and UK banks and corporations, and a select few corrupt dictatorial leaders of foreign regimes over who will control the banking system, oil supplies and so on.

    “Rich versus poor” doesn’t really describe the real conflicts. There are various groups of rich people who are in conflict with each other, various groups of poor people that are in conflict with each other. When some person talks about the “common people” its one rich person that wants to get the support of a lot of poor people to bash this other rich person.

    One thing that I find very funny and sad is that every politician that claims to speak for the “common person” against the evil “power elite” is a member of the power elite. So you have multimillionaires or talk show hosts all claiming to be “common people” when they very obviously aren’t.

  • Posted by RebelEconomist

    Twofish,

    The Triffin Paradox is obsolete. It is like saying that you can only make a deposit at a bank by selling it goods and services, and dates back to a time when capital accounts were highly restricted.

  • Posted by RebelEconomist

    Anon,

    I see; you are saying that the shadow banks effectively took unregulated credit risk using CDSs. I suppose that would be particularly dubious if the shadow bank was a subsidiary of a regulated bank to which it had sold credit protection. Did that actually happen?

    Even so, there was still some separation of the shadow bank. I sometimes wonder if the credit crisis might have been more contained if the regulators had simply told the banks not to support their SPV’s. That way, the SPV creditors, who were taking uninsured risk for a higher return than they could get on bank deposits, would have borne the brunt of the initial credit losses, as they were paid to do.

    Thanks for your reply.

  • Posted by Twofish

    RebelEconomist: I would be grateful if you could explain how CDSs were used to circumvent bank regulation.

    The bank regulators will require to have X% of your capital as something as safe as treasury bonds. If you take a AAA bond and then buy insurance on it, it looks like it becomes as good as a treasury bond and you can use that for required capital, and it pays a much higher interest.

    It looks like a very good deal, until it turns out that everyone was massively underpricing risk. Also you can make it sound sneaky and underhanded, but it really isn’t. Because:

    1) When you buy insurance, what do you do? You look for the company with the lowest rates.

    2) Lets suppose in 2005, you had to make a decision between AAA+CDS by “cheap fly-by-night company” and AAA+CDS by “decent good risk insurance”. If you chose AAA+CDS by “decent good risk company”, you made the wrong choice because when fly-by-company cheap insurance failed, the government paid off the CDS’s.

    RebelEconomist: I have heard this before, and was puzzled – if a CDS offers genuine credit protection against default by a bank’s borrower, is it not reasonable that the bank should be allowed to hold less capital?

    Yes. That’s not the problem. The problem is if the CDS is priced too low, and then issuer of the CDS does not have the money to pay off claims when everything falls apart.

  • Posted by RebelEconomist

    Thanks Twofish; I think I see. It was more a case of regulatory “arbitrage” than cheating. The banks found the cheapest way to obey the regulations, which generated its own (counterparty) risks. The phrase that bothered me was used by AIG itself, which reported that the CDS’s it wrote were “for the purpose of providing regulatory capital relief rather than risk mitigation”. Probably mainly a case of a bad choice of words.

  • Posted by observer

    RebelEconomist: Thanks Twofish; I think I see. It was more a case of regulatory “arbitrage” than cheating.

    Regulatory arbitrage IS cheating, isn’t it? At least in theory, a democratically elected government imposes regulations after public discussion and debate for a reason. If a bank disagrees with the regulations, there are democratic methods available to change it legislatively with popular support.

    Deliberately circumventing regulation is highly unethical and is pure fraud just like tax evasion.

    What makes the CDSes especially egregious is that large numbers of swaps were written by over-leveraged hedge funds which knew full well that they did not have the capital to make good on the insurance. See for e.g.:
    http://www.nytimes.com/2008/06/01/business/01gret.html

  • Posted by Charles

    Twofish, wages are not all there is to the standard of living. A clean environment, leisure time, and security in old age cannot be replaced with wages. Yes, sure, GDP has risen in China. With a per capita GDP ca. $1000, high growth rates in income are possible without attaining a substantial change in quality of life. Wealth inequality is at very high levels, and the reduction of poverty of the 1980sis fading.

    As for assigning the opinions of “the person next to you” to me, the United States is a country of 300 million individuals. The xenophobia of some does not reflect the cosmopolitan view of others and vice-versa. To live in a world of stereotypes is to be partially blind.

  • Posted by ReformerRay

    Rebel E says: if a CDS offers genuine credit protection against default by a bank’s borrower, is it not reasonable that the bank should be allowed to hold less capital?

    A company that sells an insurance contract, but is not able to pay up when a default occurs, does not provide “genuine” protection. Cannot assume ability to pay even when the insurer is AIG.

  • Posted by ReformerRay

    Tian Chee responds:
    Twofish,
    Why you waste breath and intelligent on blog here. Come China manufacturing. We need smart people like you to help move value chain. What job you have now? Profit here and grow opportunity much more and no need to sinning.
    December 4th, 2008 at 11:04 am

    Good question. I not Twofish. I American. In my case, the answer is unaccustomed arrogance. I think I know more about the consequences of the U.S. trade deficit on the U.S. economy than anyone else. So, I wish to test ideas. And to propogate any survuving ideas.

  • Posted by ReformerRay

    “Things might be very different in a year from now, but looking at the way the discussion is evolving, I don’t think it will be. The fact that no one in the last election ran on a “Lou Dobbs” platform is significant”.

    Twofish has a very good point. The last person that attempted to run for President of the U.S. on a platform of reducing the trade deficit had the support of the unions and he was from Missouri and well known but he did not survive the Iowa caucuses.

    Got to change public opinion first. Got to change economists opinion first, first.

  • Posted by Twofish

    observer: At least in theory, a democratically elected government imposes regulations after public discussion and debate for a reason. If a bank disagrees with the regulations, there are democratic methods available to change it legislatively with popular support.

    The trouble with this is that the bank agrees with the regulation completely, it’s just got a hundred lawyers that have figured out how to use that regulation to get what it wants. You might say that the bank should follow the “meaning of the law” except that the law was passed with 535 people each with a different idea on what the law means.

    Also very few regulations are legislative. For example the Securities Exchange Act basically says “securities fraud is illegal.” So what actually determines what a regulation means are thousands of pages written by judges and bureaucrats.

    observer: Deliberately circumventing regulation is highly unethical and is pure fraud just like tax evasion.

    People follow the regulations as it is written. What else do you want to them do? Mind read? If you want people to do something, write the laws so that they do it. You can’t write a law and then complain when people follow it.

    Charles: As for assigning the opinions of “the person next to you” to me, the United States is a country of 300 million individuals.

    You support a bill for nice reasons. The guy next to you supports the same bill for nasty reasons, and then you find the day after that the person that supports the bill for nasty reasons has pushed you out of the way, and is determining how the new law is used. Most of the Communists that overthrow the Nationalists in 1949 were absolutely nice, sweet, and wonderful people. It’s too bad that they got pushed aside once the revolution was won.

    Also, if you are supporting something that you think will help China, and the guy next to you is supporting it precisely because he thinks it will hurt China, you simply can’t ignore that other guy, because Beijing is going to be seeing and listening to both of you.

  • Posted by Rien Huizer

    Repeat,

    Twofish is usually right but some people here are a little to prejudiced to look at his arguments. Tian Chee has a point though (Malaysian?) . Such talent could be used more profitably. Unless Twofish is, like me, not interested in making money, but in just thinking and arguing about it.

    Anyway, most people on this blog who think the trade deficit (a) is important and (b) can be reduced by US government unilateral change of trade rules do not impress me by their arguments.

    First of all there is a multitude of underlying business problems. Everyone is familiar with the spectacular failure of US carmakers to hang on to or regain their home market retail base. That started with imports but that is no longer the case. In fact some a big share f US car exports (by value) consist of things like BMW and Mercedes SUV’s or Honda Accords (they even make them with left hand drive for Australia and South Africa). Do you think any government action (barring subsidies to individual firms as are now being considered) and especially action targeting China would change that? And what about the workers in Kentucky etc?

    Second, whatever business China (or in a smarter version of trade intervention, other non-NAFTA countries) would lose would probably not come to the US for manufacturing, because (a) wrong workforce (b) different preferences business owners and managers (c) other parts of NAFTA may be more attractive than the US.

    Third, the movement of manufacturing out of high cost locations began when it became technically possible and cost effective (container transport, telecommunications, computer aided design and manufacturing, etc). And these things were not invented to assist greedy capitalists to rob worthy Ohio workers of their birthright to high wages. It just got accelerated (and is bound to slow down within 10-15 years) when the Chinese government realized that slavery is less productive than capitalism and offered its surplus workers to the outside world on the condition that they would stay (mostly) in China. That was convenient because most high cost countries did not want to import lots of workers (that is legally) from abroad, it suppressed inflation (by alleviating manual labor scarcity) and in fact greatly improved western standards of living (how about a $150K plasma screen or $20K laptop?). Also, it helped end the silly geopolitical situation called WWIII, that kept over 200 million “caucasians” in slavery.

    Fourth,

    Government intervention has to be very good, well designed and executed with absolute credibility over very long periods (one of the true lessons of Asian development), and even then the result may be only a modest increase in living standards and a legacy of corruption (when the model becomes obsolete for the level of development achieved). The US does not have that type of government credibility (administrations come and go, electorates change their preferences) and it does not have even the foundations for a successful implementation system. What you would get is something like the US military, health care or criminal justice system. Would you like any of those presiding over say, Consumer Electronics?

  • Posted by Judy Yeo

    Have to admit, not too sure oif this is relevant or even correct, but have to take issue with Brad’s statement that

    Asian economies can not permanently rely on the US and Europe to make up for their own shortfalls of domestic demand

    Asia’s development has never been too regular or evenly spread. The average Asian consumer, whatever their profile (and however unrealistic that profile is) is miles away from being the typical American or European consumer, there simpoly isn’t the means to consume on the same basis. Unless you’re envisioning a socialist/communist redistribution of wealth, that isn’t going to change any time soon, the concentration of affluence in the hands of the few % of society means that any change in consumption patterns is not likely to be sustainable or quick in any meaningful way, of course, that % is measured against a population that constitues 20% of the world population. Go do the math.

    With a few exceptions, extravagant expenditure on the scale seen before the Asian financial crisis has not quite taken place , least not without sensible hoarding of reserves by the government before expenditure is even considered. In a sense, the chickens have come back to roost for the IMF , the world bank and the governments who gave those lectures on austerity and the folly of reckless expenditure in the years following the crisis. However, it’d be foolish to expect everyone to remain unscathed in the present crisis, just a question of how serious the fallout and therepore the degree of suffering. When you have nothing to lose, there is really nothing that you can lose or for that matter spend. The lack of demand is sometimes tied up to the lack of means.

    There is also the faint line which seperates looser credit policies and poor credit controls – which is something few sensible governments are willing to test, many banks have trodden the ground that angels fear to tread, the results of which are not very pretty.

    This is not a defence of Asian attitudes towards the present situation but rather the questioning of what is entailed by the idea of expanding demand. The means by which you expand demand and the realities of what it takes to expand demand are as important as recognising thaqt demand needs to be expanded. And no one denies that Asia needs to expand demand; after all, that is another aspect of power in this world right?

  • Posted by observer

    observer: Deliberately circumventing regulation is highly unethical and is pure fraud just like tax evasion.

    Twofish: People follow the regulations as it is written. What else do you want to them do? Mind read?

    How about using some common sense? When you buy a CDS from an under-capitalized counter-party and then use it as insurance for reducing your capital requirements, it should be clear to any rational non-mind-reading person, that you are engaging in deception to deliberately violate the plain intent of the regulation.

    If you don’t think that that is unethical, you need to think carefully about your value system.

  • Posted by XvonZ

    judy: many banks have trodden the ground that angels fear to tread, the results of which are not very pretty.

    grameen treads way deeper than countrywide and leaves footsteps full of flowers.

    so how low do ya wanna go before u know?

  • Posted by Judy Yeo

    XvonZ

    Grameen focusses on microcredit , not the “traditional” consumer credit markets as seen in the west. Wonder if anyone tried getting a loan from them to buy the iPhone?!

  • Posted by XvonZ

    “Wonder if anyone tried getting a loan from them to buy the iPhone?!”

    precisely the point dear judy

  • Posted by menomnon

    Rien Huizer: The US does not have that type of government credibility (administrations come and go, electorates change their preferences) and it does not have even the foundations for a successful implementation system.

    You may not see the connection (at least as I do): but the US has the oldest constitution in the world.

    France, for example, is an older nation. But they’re currently in their 5th Republic. Which implies 5 constitutions.

    The continuity (in US governance) is a subtle (and flexible) one which many people from older, supposedly more ‘mature’ cultures often don’t understand.

    There are advantages to being young and naive. For example you don’t think reflexively in zero-sum terms and you can actually come up with (and implement [youthful vigor]) such things as the Marshall Plan.

  • Posted by ReformerRay

    “Anyway, most people on this blog who think the trade deficit (a) is important and (b) can be reduced by US government unilateral change of trade rules do not impress me by their arguments”.

    Now that is just the sort of challenge I like. Unfortunately, I saw it too late. No one around to talk with.

    It is late and I am not up to repeating myself. But I would ask mr. H. to review what I have said above and point out anything that is irrational or not persuasove.

  • Posted by ReformerRay

    steve moody responds:
    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.

    An Important post. We need to look back and try to figure out what caused past problems.

    Why did the foreign Central Banks have the dollars to be invested in the high end of the yield curve? Because of the large U.S. trade deficit.

    Everywhere I look, I see the hand of the large U.S. trade deficit. Am I seeing things or is my vision clear?

Pingbacks