Reserves are meant to be used in bad times
Tracy Alloway of the Financial Times’ Alphaville blog — echoing Robert Sinche of the Bank of America — thinks that spending reserves to defend your own currency and support your own banks is a form of economic nationalism.
Funnily enough, I always thought that building up reserves through thick and thin — and accumulating more reserves than a country ever needed for its own financial stability — was a far more egregious example of economic nationalism. A country that only adds to its reserves is presumably pursuing a policy of intentionally holding its currency below its equilibrium value in order to support its export sector. A country like China isn’t just accumulating reserves because it enjoys financing the US, UK and many European governments at low rates ….
The tone of the the FT’s excerpts of the Bank of America report suggest that a country that sells its reserves to support its own economy hurts the global economy. Not true. It may drain liquidity from some parts of the financial market, but the sale of reserve assets finances policies that add liquidity (so to speak) to parts of the goods market.
Reserves are meant to provide a buffer against external shocks. And right now a host of emerging economies are facing a major shock. Remember, a country that is selling its reserves is trying to keep its currency from falling. That means it is trying to keep the price of the world’s goods in its market from rising — and in so doing, it is keeping demand for the world’s exports up.
And a country that draws on its reserves to make up for shortfall in export revenue is substituting the sale of foreign assets for a fiscal contraction — a contraction that would subtract from global demand growth.
Suppose for example Russia stopped intervening, let the ruble depreciate, didn’t bailout its banks (so they defaulted on their foreign debt and couldn’t finance domestic firms) and budgeted for $40 a barrel oil next year. Russian imports would collapse. That would have a big impact on Europe’s exports. The UK doesn’t make all that much these days, so this shift would hurt Germany more than the UK. But just because it helps some countries (and sectors) more than others doesn’t meant that the world doesn’t gain when a country draws on its own reserves to avoid a major contraction in demand.
Indeed, if — and it is a huge if (see below) — private savings and investment do not change as a result of the government’s decision to run a bigger fiscal deficit, selling foreign assets to make up for a shortfall in say oil export revenue and to finance a budget deficit leads directly to a larger current account deficit and more demand for the world’s goods. It isn’t a beggar-thy-neighbor policy.
Nor does it necessarily mean that the US and others won’t be able to finance large fiscal stimulus.
Remember, the big if — a rise in the fiscal deficit only leads to a rise in the external deficit if private savings and investment do not change, so the extra call on savings from the deficit has to be met by the world. And right now private savings and investment patterns are changing — particularly in the US. Goldman forecasts private sector in the US will go from rough balance in q2 2008 to a large (10% of GDP) financial surplus by the end of next year. That means private savers in the US will be in a position to lend to the US government. Some money that say would have been spent on a Toyota instead will be lent to the US Treasury. In this case, the rise in the fiscal deficit will offset a rise in private savings and fall in private investment, allowing the US current account balance to improve even as the fiscal deficit expands.
And in the off chance the emerging world spends so much that demand for US exports prevents a large US slump, the US wouldn’t need such a large stimulus in the first place.
Bottom line: the US and Europe need emerging markets to buy their goods at least as much as they need emerging markets to buy their bonds. Consequently, a fall in central bank demand for US Treasury bond is no bad thing if it is the product of a set of policy choices that increase demand for US exports. Changing the basis of global growth requires, well, change.
One technical note: foreign exchange reserves cannot directly be sold off to finance a fiscal deficit most of the time. Fiscal deficits are usually financed by selling off domestic bonds — and only indirectly put pressure on the balance of payments as higher spending (or lower taxes) leads to more demand for imports. Foreign exchange reserves can only directly be used to cover an external financing need. But if a country has grown accustomed to financing a high level of domestic spending (and an associated high level of imports) with the government’s revenues from commodity exports, reserves can substitute for a shortfall in the government’s export revenues.
This gets to the difference between central bank reserve purchases through intervention in the foreign exchange market (China) and Treasury reserves accumulated through saving the revenue from a commodity windfall. If the Treasury has lots of foreign assets on deposit at the central bnk, the Treasury can withdraw some of its foreign exchange, sell it to the central bank for domestic currency and draw on its external assets (rather than issue domestic liabilities) to cover a fiscal deficit. Fiscal spending in turn leads to higher demand for imports, and thus a current account outflow that reduces the central banks foreign exchange reserves: for example, government employees looking to buy the world’s goods may sell domestic currency for foreign currency. The overall result is a fall in the country’s overall foreign exchange assets, not just a shift in ownership of the foreign asset from the Treasury to the central bank.
Apologies if this is confusing; of all balance of payments concepts, the way Treasury foreign assets can be used to cover a fiscal deficit is one of the more difficult.
nice post. agreed that drawing on reserves can cushion domestic and thus global consumption. but doesn’t it make a difference whether reserves are used to implicitly finance a such spend rather than to slow the depreciation.
Will countries like Saudi Arabia, which now has almost as much reserves as Russia ($440b as of the end of Oct) borrow against their reserves domestically?
Brad,
You are absolutely correct. The United States is better off when foreign countries buy our exports instead of lending us money. That’s why Bernanke’s currency swaps with foreign central banks were so brilliant. He instantly gave them reserves that they could use to stabilize their falling currencies, helping US products in their competition in foreign markets and in US markets.
I would love to believe Goldman’s prediction that US private savings will be up to 10% next year, but it is obviously wishful thinking by those who do not understand mercantilism and want the numbers to work out so that they can pretend that the stimulus packages they advocate won’t be borrowed from abroad and result in larger trade deficits.
Throughout next year, the Chinese and other mercantilist governments will be driving their currencies down versus the dollar in order to gain market share in depressed US and foreign markets. As a byproduct they will be building up their reserves making the Tracy Alloways and Robert Sinches happy.
In the meantime, the unfair foreign competition will drive US corporate profits down, US unemployment up, and US income down. US savings would have grown if US income were growing, but will not even come close to 10% due to the income contraction.
On the other hand, if the United States were to adopt Warren Buffett’s Import Certificates to balance trade starting when Obama takes over in January, American incomes would be heading up throughout next year and the 10% private savings rate would go far toward financing growing US investment.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Using purchasing power parity, US dollar is highly overvalued for a very long period of time. I agree that $ should be devalued and Yuan and perhaps all currencies in emerging markets should appreciate in time.
The question is how weak $ will be before US consumers start to complain about the price of food, oil and products. Remember it wasn’t long time ago that everybody worried so much about the price of oil and food before the deflation effects set in. Yes it will force consumers to spend less. But it will be a painful process. The US government really need to do something to alleviate the pain and improve the efficiency of the economy. Otherwise it might threaten social stability.
The same challenges will face Chinese workers. Low value sweatshop and high pollution factories have to go. China will not be able to complete on low wages but technology and innovation. That’s why the Chinese government is trying very hard now to build up social safety net, social housing, etc to help the poor.
The question is the speed of adjustment. Are the both government ready for the adjustment regarding to the consequences it might occur to their people? Are business sectors ready for such a change without incurring too much cost or waste? The Chinese side is promoting to use a gradual approach. The US’s position is not that clear to me. US leaders seem to change their stance often and it’s hard to guess if they really care about exchange rate given their strong dollar policy.
The last point is that we shouldn’t forget the environmental concerns. Both countries need to come up with bold commitment and solution. For example, image a world without cars on roads and turn GM and Ford into bicycle factories. Till now, I don’t see any commitment from both sides.
Did you see that Nigeria limited central bank auctions of US dollars to $100 million this week, leading to a fall in the Naira of 5%, given an appetite for upwards of $800 million?
Given that the US consumes a little over half of Nigerian oil production, is this is a sign that oil revenues are not covering the cost of unwinding US$ denominated debt?
If so, would the Fed extending swaps to Nigeria–and other oil exporting nations facing a similar dilemma–make sense?
If not, what gives? Thwarting folks betting on the Naira in order to maximize impact of oil revenues on domestic public works doesn’t make much sense to me.
“Goldman forecasts private sector in the US will go from rough balance in q2 2008 to a large (10% of GDP) financial surplus by the end of next year.”
hile the idea that the private sector rebuilding a surplus does not strike me as silly, it still remains the point that you might want to check very carefully how Goldman derive their calculation. The macroclosure of a model is both the most misunderstood and the most important feature of a macromodel. Much of the time, these models close around the current account and its financing, making the concept of a forecast of the private sector financial balance a technical joke (ie. disguised guesswork). Which was incidentally a big part of the reason why I commented a while ago that something was not adding up in the worldview.
Does anyone know the levels of China’s foreign currency debt?
obama’s strategy: borrow first. devalue second.
@bena wrote: “obama’s streategy: borrow first. devalue second.”
Bena hit it exactly on the head. Except that the devaluation will not be intentional. It will be forced by the currency crash. Here’s how events will unfold as described on pages 188-9 of our book Trading Away the Future:
“Once the dollar starts to plunge, there would be such a rush to sell dollars on foreign exchange markets that the dollar would collapse in value. The United States would experience inflation. Interest rates would skyrocket. Trade would become balanced but at a severely reduced level of imports.
“The skyrocketing oil prices and need to cut back on oil imports would force the United States to begin rationing gasoline, probably using an equitable electronic system like Martin Feldstein’s 2006 ‘Tradable Gasoline Rights’ proposal.
“If the Federal Reserve decides to inflate the money supply in order to pay off US debts with cheap dollars, we could experience runaway inflation. At the most extreme, the dollar might even be replaced with a new currency as has happened in Brazil multiple times. The Brazilian reis was replaced with the milreis, the milreis by the cruzeiro, the cruzeiro by the mil cruzeiro, the mil cruzeiro by the cruzado, the cruzado by the milcruzado, and finally the real.”
Obama could have chosen to listen to Warren Buffett’s and enact his Import Certificates plan. If he had done so, he would have presided over four years of prosperity. Instead he picked a free trade ideologue for Treasury.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Not sure what is meant by economic nationalism.
Some economic behavior is done by an individual solely for his own gain. Some is done with others for group gain. Some by nations for national gain. Some by individuals for the gain of the whole world.
In the long run, what’s good for the whole world, should be good for each nation, group, and individual.
China is no different.
Problem is ; will using up the reserves at this time prove effective or should you keep the bulwark for “sustained warfare” against the crisis and its challenges? Almost the reserves version of interest rate cuts. what do you think?
Excellent post by Brad, also good comments. Don’t yet know where I stand.
Another move, breaking news:
NEW DELHI (AFP) – India and Russia on Friday signed an agreement covering the building of four new nuclear energy reactors in southern India, as well as a cooperation accord on manned space flight.
Russia becomes the third country to sign an atomic energy agreement with India after a decision in September by the Nuclear Suppliers Group to waive its ban on trade of nuclear technology with India.
The United States and France are the other powers to have signed agreements with New Delhi.
Under the US Dollar hegemony regime, since the US repays its foreign debts denominated in its own currency, it isn’t necessary for the US Treasury to retain large foreign reserves. Developing nation states especially China require large foreign reserves for the payment of dollar denominated overseas debt, but especially to defend national sovereignty from predatory Neo-liberal economic policies dictated by the IMF. During the late 1990’s Asian Economic Crisis, the Indonesian economy was systematically looted by Wall Street Hedge funds closely affiliated with the Clinton-Rubin Administration. Millions of women and children went to bed starving to death without an iota of genuine concern by the Washington Consensus. The national Indonesian energy sector was privatized to Wall Street investment banks. Across Southeast Asia and South Korea, the US Treasury controlled IMF is still labelled, “I aM Fired !”
When one considers myriad the of issues that separate the Washington Consensus and the Chinese people, one can only imagine what would be demanded from China in an IMF restructing program. Perhaps the Chinese would be forced to grant formal independence to Tibet and Taiwan. Since Al Gore believes the Chinese give off too much CO2 gas, electricity production would also be eliminated across the Chinese economy. Then Vice President Al Gore also vetoed the US export of hydropower equipment for the Three-Gorges Dam so hydropower dams would also be destroyed. Since Hillary Clinton opposes abortion practices by the Chinese government, we can even include eliminating population control practices to be included in any IMF restructing package for China.
On a footnote, I personally wish the China PBoC would pay alot less attention to used car salesman Hank Paulson. With the $8.5 trillion US taxpayer bailout of Wall Street banks, Paulson exclusively panders to the narrow economic interests of crony capitalists especially at Goldman Sachs. Surely, the economic wonders of the US financial services industry can be exported to China. Wall Street turned the US economy into a debt-infested wasteland with their toxic AAA-rated subprime garbage; the same can be done for the Chinese economy with Paulson’s expertise.
Low interest rates are long term destroyers of
a) capital (forcing deleveraging) and
b) labour(rising unemployment).
Where does this particular “gift” originate from?
Keep it Simple:
This might be a bit long but I’m trying to make things simple for people who don’t specialize in international finance terminologies.
When a country exports, it receives payments in dollars and when it imports it has to pay for the imports in dollars. A country can also borrow in dollars, and the amount borrowed in dollars is payable back in dollars.
When common people in a foreign country borrow in dollars, they convert the borrowing into local currency to use it locally. So common people have a foreign currency debt, and that doesn’t show up as a government debt.
You have to look at the imports and exports of a country, the total of their foreign currency debt, and the total of their foreign exchange reserves. Subtract the foreign currency debt from the foreign exchange reserves. Now see if what you’re left with is enough to pay for say, a year’s imports.
If it’s enough, then the country can withstand a run on its foreign currency debt, practically forever.
If you use the above framework you will be able to calculate that countries like Russia and India are headed for a serious balance of payments crisis in the near term, whereas China can hold out indefinitely.
But the credit crisis is usually accompanied by falling exports. This is because of low demand in the customer country. It will automatically result in capital inflow back to the exporting country and that will facilitate a re adjustment towards the local economy. We will leave this second part of the reasoning for later to keep this post simple.
Consider Russia’s situation:
“…At the end of June 2008, Russia’s government has about $600 billion in foreign assets and less than $50 billion in foreign debts. Russian banks and firms by contrast had about $450 billion in foreign debts.”
Now there’s a credit crisis, US banks aren’t allowing rollover: private Russian banks will have to buy dollars and repay the loans as long as the credit crunch lasts.
If Bank Rossii appreciates the Rouble through exchange intervention: they have to spend dollars from the reserve. This helps the private banks because they have to sell lesser Roubles to repay the dollar loans. At the same time it makes for lesser profit margins from exports, and higher profit margins from imports for the private sector.
Whenever a foreign central bank defends the local currency, currency speculators will bet against the local currency. George Soros is a good example of somebody who correctly bet against Baht, Won, etc in 1998.
The reason for this success is obvious. The reserves are getting drained by the central bank interventions, and there will be higher imports. Recollect that imports are also paid for in dollars. Sometime soon, Russia will have no dollar reserves left.
If the dollar is still the reserve currency, they would require a bailout say from the IMF or from us, and that will come with conditions. The connection is that as long as the dollar continues to be the reserve imports have to be paid for in dollars.
Suppose Bank Rossii doesn’t appreciate the Rouble. Since private banks are buying dollars and selling Roubles to repay dollar loans, the Rouble will devalue. This will increase profit margins from exports and decrease profit margins from imports. As the Rouble devalues, banks will be more and more motivated to sell Roubles, buy dollars and repay the foreign loans. Since the total foreign currency debt is $ 450 billion, the drain will leave very little by way of foreign currency reserves to pay for imports. Not having dollars to pay for imports is once again the result, and they will come to that result much faster in this case.
In China’s case when they devalue the RMB and allow foreign currency debt to flow out, they will still have more than enough reserves to pay for imports for quite some time.
The example of India is even more obvious:
As of March 31 2008 India had forex reserves of $ 309.72 b and external commercial borrowing of $221.20 b. The projected exports for 207-2008 are $159.01 b and projected imports are $ 239.65 b. Trade balance is – $ 80.64 b.
Suppose there’s a run on the ECB, India will be left with only ($310-$221) ~ $ 79 b in reserves. That won’t help them pay for annual imports of ~ $240 b. It will last them ~ 4 months. (~ 80/240 * 1 year)
Now exports are falling and imports are rising. The textile industry there has estimated ~ 500,000 more workers will be fired in the next 6 months.
Ceteris Paribus, a situation of forex reserve drain and IMF bailout application is assured.
But the credit crunch appears to be easing. Indian companies are borrowing more from foreign countries to import capital equipment. Their government is expected to announce a fiscal stimulus package tomorrow…
(the data is from Reserve Bank of India web site and other things from India’s ‘Economic Times’ Daily)
Good grief.
The US has run epic trade deficits through much of my long life. Instead of increasing tariffs and barriers so this doesn’t happen, the US has instead, created the ‘floating currency’ game which has been a total, utter, complete disaster!!!
Free trade is KILLING us!
And Setser, why on earth can’t you talk about Japan? Japan blazed the path towards using a huge FOREX reserve as a export tool. Gads.
@ Elaine: Free trade isn’t killing you. It’s helping jobless people survive and afford basic stuff. Right now people don’t have jobs and they’re going bankrupt.
Once free trade is gone everybody will have jobs. But you can no longer buy everything you need for your home for less than $500 at Wal Mart. And there will be high interest rates, or wage controls, price controls, etc. People will be slogging it out for less pay and many of them will go bankrupt without being able to afford basic stuff.
People who can set up new companies will make money once the trade is gone. Ordinary people will be working many more hours and they won’t be able to afford anything.
This crisis isn’t a natural phenomenon; it’s created deliberately all the time. The only objective is to make foreign countries ask for IMF bailouts. Then they will be told to open up their country for foreign investment. All their stocks and their currency will be really cheap in the crisis. For a little bit of money the big four American banks will buy up chunks and chunks of their banking and corporations.
Japan, Taiwan, Singapore are all countries where we own the banking system. That’s why we don’t need to complain about their exports and reserves.
China is different. We’re trying to deal with the Beijing Red Dragon like it’s a puny little Seoul. And it won’t work, and they’re not stupid.
“The United States is better off when foreign countries buy our exports instead of lending us money. ”
This is daft. Exports are real costs, imports are real benefits. We are ultimately better off if other people in the world wish to send us stuff in exchange for bits in a Fed computer than if we have to send them stuff (which we could use instead) in return. Since any country with a floating exchange rate can maintain full demand in its own currency, we can run a deficit adequete to keep everyone in this country employed and receive the benefit of China subsidizing us.
I’m against people being ignorant. If the big 4 US banks are playing a game to buy everything, you have to see what regimes like the Chinese Communist Party are doing as well. They’re completely corrupt. All those State Owned Commercial Banks and State Owned Enterprises are riddled with bankrupt holes in them. The Party has been looting millions of people, keeping them dirt poor. You always have exceptions; you always have some good people in any system. But those good people get overshadowed by the system they’re working in.
We’re wasting so much time and effort at this forum arguing about non issues like free trade, and especially American jobs versus Chinese jobs.
We need to understand that the big ones are fighting amongst themselves. They’ve deliberately created a phony crisis to settle this fight over who will control more. Unless they get that settled things won’t improve in the economy. If this turns out to be like 1929 or 1971 when they just didn’t settle their feuds, then it leads to more and more wars. In those wars Presidents don’t get killed. That kid looking up at the helicopter will have some bombs shoved at him.
@ Global Chessboard:
The static analysis re: run on sov currency has a huge assumption built in and that is the export and import level of a country remaining the same during a crisis. It is important to strip from the EX-IM equation the items that ar deemed “can do without” vs. items such as oil, grains etc.
The other important flaw in the analysis is the maturity profile of the external debt. My point being that actual debt payment+debt servicing should be used to calculate the period that a country can survive in case of a run rather than the total debt.
I think that including the above two in the analysis would add a lot of insight without comprimising the simplicity.
I don’t think the reality is quite as simple as you make it. There are several elements that need to be factored in:
1. What do the buyers of these reserve do? Who are the buyers? Are they domestic or international? Are they saving the dollars or circulating them back for investment or lending?
2. What are the expectations of the consumers? Do they expect inflation or deflation? If (as it seems now) a deflationary environment is upon us, then does selling reserves expand demand or cause a contraction due to consumer expectation?
3. Seems the cases you made for selling reserves assume that it will have an expansionary effect, i.e. similar to an effect of interest rate cut or a tax cut on consumption. Evidence on that isn’t clear.
@ Dynamic Chessboard: Yes, you’re right. @ Dr. Richman: You seem to have the only constructive approach but I’m not sure if people are really listening. The really smart people are busy in their who will control the money feud. The ones who’re ignorant are arguing about whether millions of Chinese or Americans need to go jobless.
Nobody seems to be interested in how trade can get balanced or other such things.
Global Chessboard,
Some Chinese government officials are really punished for corruption. Occasionally some even end up with a bullet in their head including the former China FDA Chief, a China PLA General, former Deputy Mayor of Beijing. But nothing compares to Paulson’s brazen corruption of looting the US taxpayers of $700 billion for Wall Street banksters. Period.
Chinese officials punished for lavish US tour
http://www.businessweek.com/ap/financialnews/D94SMEI00.htm
The documents chronicle the adventures of 23 officials from the eastern city of Wenzhou during five days of a three-week trip that cost taxpayers $94,000, Xinhua reported. Their Communist Party committee has demanded repayment of all unapproved expenses.
Xinhua said the group visited nearly a dozen cities, many more than authorized, and spent just five days on official business — far fewer than ordered.
State media reported that four Wenzhou officials had been given warnings over the trip, a light punishment that appeared to reflect lax attitudes toward such abuses despite repeated demands by communist leaders to crack down on corruption.
The party’s top official for discipline, He Guoqiang, was quoted Friday as calling for intensified efforts to combat corruption among party members.
The Wenzhou officials might have gotten off lightly because they denied gambling — an illegal act in China — during a two-night stay at the Sahara Hotel & Casino in Las Vegas.
“It was a first overseas trip for most of them and they were very discreet,” Tao Shimei, the director of the disciplinary department for Wenzhou’s Communist Party committee was quoted as saying in the China Daily newspaper Friday.
@ DJC … and who disciplines Wen Jiaobao?
Sorry if that offended you. I’m not questioning a great and powerful leader. But my point is that you have to rely on various different officials competing against one another and discipling one another in the system. At higher levels the stakes are really huge. So they benefit by coming together and sharing the loot. At lower levels the stakes are low, so there will be more discipline. Even democracies are pseudo plutocracies. But there’s a higher level of public accountability when you have to go and justify everything in front of blazing footlights and allow for everybody freely commenting on you. And those things are going to be played right back at you in 4 years or less and you lose heavily if you’re not able to maintain at least a perception that things are right.
Gobal Chessboard:
See pictures of unemployment undergraduates attending a job fair. I can’t even think of people who don’t have a degree. It’s the political pressure that urge the Chinese leaders to crack down corruption. It’s the same reason you press your government for a change.
http://news.xinhuanet.com/photo/2008-12/05/content_10458893.htm
@Ying: It’s a disturbing photo.
“Privatize or Nationalize” should be yelled at those Communist Party people.
Either they should go with what Paulson wants, which is allow the American money, culture and business into China freely.
Or else they should go the way of Chairman Mao. Nationalize everything all across the country. No more property rights in the People’s Republic. Then everybody will be given instruction manuals and jobs and equal salaries.
This is a litmus test for the People’s Republic. Either it will turn Citibank Blue, or Mao Zedong Red.
Or else they can turn Green to get jobs for all those people. I say to go to New Delhi and get lectures from crooked Indian policy makers, instead of going to Vegas and losing all your hard earned Yuans on roulette wheels.
The crooked Indians solved this problem by creating a plethora of confusing rules and bureaucratic loopholes with muddled interpretations of mysterious laws.
They made a Foreign Investment Promotion Board, a Directorate General of Foreign Trade, a whole Ministry of Disinvestment, and so on and so forth.
The whole architecture is meant to make sure that any state owned looting is cleverly hidden, and that the Americans end up paying huge bribes so that they can buy all those state owned thingies at throwaway prices.
Also the Americans get to run all the major businesses and industries in big cities and the taxpayers still fund some old boring banks that lend money to penniless rice farmers
…and oh I almost forgot they even something called “Special Economic Zones”. If you pay the policy makers in gunny bags full of cash then you can set up shop in one of those “Special Economic Zones” where basically they don’t tax you much, and give some mysterious justifications to their Parliament why there’s no tax only in those Zones.
bsetser: Remember, a country that is selling its reserves is trying to keep its currency from falling.
Sometimes it ends up selling reserves in order to keep from defaulting on foreign denominated liabilities in a panic.
Also, if China taps into its reserves and sell dollar and buys RMB, then the dollar falls, and imports go down, and that increases the trade deficit.
I suspect that you have very different dynamics between China/US and Saudi Arabia/US. The balance of payments for Saudi is not very sensitive to local currency exchange rates, but the balance of payments for China is sensitive to RMB/USD.
US Economic Depression has Arrived
http://www.europac.net/newspop.asp?id=14825&from=home
If we adopt a far longer-term perspective, we can find some parallels to the Bush-Greenspan bubble that we now see unwinding: the bursting of the South Seas bubble in 1720, and the Stock Market Crash of 1929. Both events led to unprecedented losses and took years to recover from. We believe that history will record 2008 as the year in which a decade long boom, which began with the tech boom of the late 1990’s and continued with the real estate boom of the middle years of this decade, was finally pricked.
All three crashes were based, essentially, on massive, irrational, speculation. But the potential depression that will follow the most recent crash will face two problems not seen by the first two: massive leverage and institutional corruption.
Today, vast numbers of consumers are highly leveraged with credit card debt, auto loans, student loans, overdrafts and mortgage debt. In normal times, such levels would have been considered grossly imprudent. But the past 10 years have been anything but normal. Given that many of these consumers have scant ability to service the loans they have taken, the debt has been characterized as the “toxic waste” of the financial industry.
The banking system carefully hid most of this “toxic waste” within derivative structures and an abuse of off-balance sheet accounting to a degree that amounts to the greatest financial fraud in history.
The fraud was directly caused and tolerated by policy makers. In an effort to avoid healthy recessions and to perpetuate the good times, the Administration, under Bush and Greenspan, pumped trillions of unearned dollars into the world economy, laying the foundation for the unprecedented real estate and consumption booms of the 2000’s.
In order to postpone and disguise the inevitable pain of America earning less than it was spending, Bush and Greenspan quietly depreciated the currency and borrowed massively.
Although the risks were systematically dismissed for years by the Government, banks and corporations, the horrors that result from the ‘deleveraging’ from such massive speculation, debt, leverage and fraud, are now dawning with ferocious intensity.
The credit rating on American debt will be cut and the U.S. dollar and markets will plummet, delivering a blow to the standard of living of most Americans that will threaten insurrection.
Donald Trump declares that the US Depression is an Act of God, so he doesn’t have to pay a $40 million debt that he personally guaranteed to Deutsche Bank.
http://www.nytimes.com/2008/12/05/business/05norris.html?em
“Would you consider the biggest depression we have had in this country since 1929 to be such an event? I would,” Donald Trump said in an interview. “A depression is not within the control of the borrower.”
He wants a state judge in the Queens borough of New York to order the bank to delay efforts to collect the loan until “a reasonable time” after the financial crisis ends.
Deutsche Bank thinks the idea that an economic downturn should free people from the obligation to pay their debts is laughable.
Mr. Trump, it may be noted, does not think remorseful condominium buyers are in a similar position. When I asked him if he would let them walk away from contracts to buy apartments at predepression prices, he said he would not. “They don’t have a force majeure clause,” he said.
Chessboard: They’re completely corrupt.
Actually it isn’t. There is a lot of corruption in China, but its South Korea-1960’s corruption rather than Nigeria or Indonesia.
The difference between China and the United States is that in China the rich and powerful break the law to pay themselves off. In the US, the rich and powerful change the law to pay themselves off. China is gradually moving toward the US system which has some advantages.
Chessboard: All those State Owned Commercial Banks and State Owned Enterprises are riddled with bankrupt holes in them.
No they are. The remaining state owned enterprises are quite profitable. Chinese state banks are *insanely* profitable.
Things have changed since 1998. In 1998, the Communist Party was faced with bankrupt companies and bankrupt banks, everyone rolled up their sleeves, got to work, and fixed the problem. The SOE’s that were losing money were closed or restructured. Banks were recapitalized. Regulations passed. Old officials fired, and new officials hired.
This is one reason I’m optimistic about the long term future of the US. If China can fix its economy, than so can the US.
Chessboard: The Party has been looting millions of people, keeping them dirt poor.
No they haven’t. The are power-hungry ruthless dictators, but they aren’t *stupid* power-hungry ruthless dictators. The way you stay in power is to focus on the economy.
Chessboard: Either they should go with what Paulson wants, which is allow the American money, culture and business into China freely.
The one thing big advantage has China had over the US, was that China was not afraid to learn from the US, whereas over the last ten years, most Americans thought that they had nothing to learn from China.
To be fair, I don’t think Paulson is in that category, and I’m pretty sure that one thing that Paulson is looking for is talking to people in CIC and SASAC to find people that know how to run a state bank to give some ideas on what to do with AIG and Freddie/Fannie.
I expected commentators here would poo-poo the business of free trade screwing up America.
But facts are facts! We have a gargantuan trade deficit that has run up more debt than even our wild-spending government. Manufacturing jobs are being ruthlessly eliminated.
Oh, I forgot! If you want to live in the Deep South, you can work for Toyota! Which sends all profits of their massive auto sales to Tokyo, not Detroit.
PROFITS MATTER. We have American corporations selling us ‘cheap’ stuff but our wages are dropping! So where is our benefits here?
NONE!
Amazing that people can’t see the painfully obvious.
emsnews.wordpress.com
By the way, I include cartoons with my economic chatter.
Twofish,
The Chinese know what to do with the AIG executives as well as the others who screwed up the global banking system. They can have a big stadium filled with angry savers who lost their retirement funds. Give each of them on rock. Let them start throwing when the whistle blows.
Chessboard: and who disciplines Wen Jiabao?
DJC: In both Hong Kong and China, the Chinese blogs are extremely informative exposing blatant government corruption. Wen Jiabao is considered by many Chinese bloggers to be one of the good guys. A higher level of corruption in China occurs at the rural provincial level than at the national level. There is a lower level of corruption in Guangzhou than rural Foshan, which also accounts for faster economic growth in major cities with checks and balances.
China Shuns Investments in West’s Finance Sector
http://www.nytimes.com/2008/12/04/business/worldbusiness/04yuan.html?em
HONG KONG — The chairman of China’s sovereign wealth fund said on Wednesday that China had no plans for further investments in Western financial institutions, nor did it have any plans to “save” the world through economic policies.
The comments by Lou Jiwei, the chairman and chief executive of the China Investment Corporation, are the clearest signal yet that after taking heavy losses on initial investments in the Blackstone Group, Morgan Stanley and Barclays, state-run Chinese institutions have no appetite for further purchases in this sector.
“Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have,” Mr. Lou said.
Asked whether China might pursue economic policies aimed at saving the world, Mr. Lou said that the country’s leaders had a narrower focus. “China can only save herself because the scale of China is still rather small,” he said, adding that while China has more people than any other country, economic output is still low enough that the Chinese economy is not yet big enough to have a big effect on the global economy.
He did not rule out overseas investments, however, noting that, “Right now, the value of many investments is underestimated.” But he suggested that China might find some of its best opportunities in low-income countries.
Global Chessboard: less than 1 yr maturities of ECBs are in the order of 10-15% not the 100% you seem to attribute. Unlike what happened to Korea during the Asian crisis. So they all can not come due at the same time and deplete the reserves.
All this speculation and guessing about what is going on in China is rather pointless, isn’t it?
China will do what it wants to do. The U.S. can only react to it. Wait and see. You can expect action aimed at benefiting China, but you do not know what form it will take.
The U.S. needs to put its own house in order.
“adding that while China has more people than any other country, economic output is still low enough that the Chinese economy is not yet big enough to have a big effect on the global economy.” (quoted above.)
a lot of what i read here goes over my head. but that is crystal clear. thanks mr. lou jiwei. straight talk and no numbers. message received and understood.
he is saying to the leverage addicted bankers – “keep your hands off our piggy bank because even if you broke it open and looted the lot it would not be enough to finance your habit.”
if saving the world means re-stimulating incoherent policies then china has no plans to save it. that’s how i understand what i am reading.
so i would amend your headline, brad. “reserves are meant to be used coherently and effectively in bad times.”
@reformer ray. what you read here is is politics as much as economics. look at the top of your screen > cfr.org > and make allowances. don’t expect japan to get a lecture, or you will risk disappointment. like lou jiwei, brad setser – to whom we are all indebted – has to ‘talk his book.’
2fish: “most Americans thought that they had nothing to learn from China.”
and continue to think…including certain individuals posting here (not to be critical but simply a kind & humble suggestion to open the blinders of ideology a bit).
by the way, that lying liars post you wrote a couple days back? sartre called the condition you described *bad faith* aka ‘mauvaise foi’. but he never had the faith to openly admit that he also was inflicted by it. that you did has continued to resonate. one of the most truthful & honest pieces i read in quite awhile…cheers…
ray: The U.S. needs to put its own house in order.
thank you sir…well said.
Suppose that the G20 agreed to something like Keynes’ International Clearing Union as a non-private international payment & settlement system that eliminated the need for nations to maintain foreign currency reserves. (With a fixed exchange rate regime, Jane D’Arista describes the mechanism as allowing each nation to use its own currency in international transactions and clear transactions among national central banks in the same way that these national institutions clear for their commercial banking systems).
In his book Making Globalization Work Stiglitz writes (p. 250), “The money put into reserves is money that could be contributing to global aggregate demand; it could be used to stimulate the global economy. Instead of spending the money on consumption or investing the money, governments simply lock it up.”
Question: Give my fantasy G20 agreement in which there would no longer be a need for foreign currency reserves, *how* could China unlock and spend its $2 trillion reserves to stimulate domestic aggregate demand?
[If I read your above technical note correctly China could only spend its reserves on external non-China things: “Foreign exchange reserves can only directly be used to cover an external financing need.”]
p.s., I am still confused by your explanation. Could you either put into pictures (e.g., t-accounts) how both China and Saudi Arabia accumulated their massive foreign exchange reserves (e.g., the flows from US consumer to Aramco [commodity windfall case], or US consumer to China factory [fx intervention case])–or suggest a tutorial textbook (Wikipedia recommended a Bank of England pamphlet but the Bank’s website is down)?
mike, been thinking about the ICU myself.
you may have struck on an interesting idea.
what if the ICU was centered around the G20 instead of the current IMF/world bank/BIS model that is chockful w/ dysfunction & badwill?
however, the IMF model would maybe fit better in respect to china conundrum as it’s currently so balanced against their interest so there’s room to negotiate?
e.g. include RMB into the SDR basket or exchange gold for UST’s.
of course, this must just set the stage for the rest of the G20 (and beyond) to be able to meaningfully participate in order to be truly *international*.
Brad’s article is as usual, well argued, but from a perspective that many elites in surplus countries do not share. Last time (Asian crisis) they had (welcome) depreciations (to match China’s earlier one) but an unintended consequence was intrusive behavior of westerners in areas like institutional development. That while Asian elites were perfectly happy with their institutional arrangements; they helped to keep the outsiders out. This time around, not need for intrusive westerners. Look at the KRW/JPY (the poor Japanese cannot do what the rest does, pity for them) and in a couple of months, look at Thailand and Indonesia. Depreciation and maintaining market share is a painless way to lower factory wages. Losing market share and closing factories a painful one and one that can lead to social unrest.
BWII was a wonderful device, with effects analogous to Nato after WWII: it prevented war, in this case trade war. The more the US saves, the harder it will be on the East Asians. So the last thing the Koreans would like to do is support their currency, especially now import prices will be going down fast. The dilemma facing Greater China (this time including a cooperative Taiwan) is to follow the others down (and risk US ire but not much else) and easily maintain market share (of a shrinking Atlantic market) or give up and let the small ones keep their workers busy and quiet and meanwhile redirect spending to infrastructure etc. But that means that the provinces that compete directly with SEAsia will be very unhappy.
Mike: *how* could China unlock and spend its $2 trillion reserves to stimulate domestic aggregate demand?
Buy oil with the reserve dollars and make it free for the Chinese
Global Chessboard:
Once you’ve baught the oil you have to refine and distribute it. Also free? But you are right, it is hard to think of an import that does not compete with a lot of domestic production.
If you are looking for goofy ideas, what about NAFTA and the EU banning all imports that have not been produced under health and environmental standards of Sweden and by workers receiving at least the Spanish German minimum wage (and work no more than 40hr/w). Would not that put a lot of money in the pockets of all those Chinese etc consumers? It would solve the reserves problems within one year and all those hundreds of millions of semi- and unskilled workers going hungry now roaming the streets of Western cities would be employed overnight! A level playing field! Trouble is, where are those workers.
And if not for those workers (and their votes), what politicians care about where widgets are being made, as long as we can get them, and afford them. And when we cannot afford them anymore (’cos no one believes our IOUs will be exchangeable in any goods/services worth having), we can always go back and make hem ourselves, until we’ve become so good and cheap that we will have a giant surplus with all those ugly foreigners and they will beg us to supply on credit, so that their citizens stay quiet.
That is what we call the business cycle, right? About halfway now.
@ Rein Huizer:
Well the traditional way to trigger a crisis is with interest rate policy. We reduce the interest rate. The foreigners borrow from us to set up shops to export to us. Then we hike the rates. That makes pretty sure there’s a run on their foreign currency debts. They come and ask for an IMF bailout. We make the rules. The big 4 buy up their banks and businesses. That’s your friendly neighborhood ‘business cycle spiderman’ swinging across the new emerging market buildings to defeat them.
This time round things have gone totally awry.
@ Rein Huizer:
BW involved everybody agreeing to a fixed exchange rate. USD was pegged to gold. Most of the gold was in Fort Knox. The system was designed perfectly. With a fixed exchange rate, foreigners had a choice between monetary policy and capital controls. Most opted for capital controls. We couldn’t have accumulated deficits endlessly in a perfect bretton woods world. Because that would make everybody convert their dollars to gold and Fort Knox would get empty. But deficits were forced on us, all the way from 1944 to 1971. Why?
Russia had a system that didn’t have property rights. So they didn’t need any gold to control their empire. They needed to think about gold only while trading outside their empire. So they tried to build as big an empire as possible. We couldn’t let that happen. …the bigger the Russian empire, the greater the erosion of the bretton woods world …
So we had to stop them building an empire, and expand the bretton woods world.
We had to send troops everywhere, we had to send aid to our friends, expand our influence; and all that meant that we exchanged our dollars for deficits. The dollar was payable in gold coin.
Ultimately other people had too many of our dollars. The Bundesbank wanted us to pay Fort Knox gold for their dollars. We couldn’t do that without losing everything. So we defaulted. August 15, 1971. Nixon told them dollars aren’t convertible anymore. That was the end of gold.
We made deals with OPEC. Nobody could get rid of all their dollars. They would need those dollars to buy oil from the sheikhs. The sheikhs would stockpile our dollars.
Again we had to fight wars to keep that going. That meant more deficits. Plus we got on an accelerated track to Chinese Freeware, in exchange for our dollars.
Now the Chinese have too many of our dollars. They’re getting as big as we are, standing shoulder to shoulder with us, smiling photos and all, demanding their place.
Brad has a job to discuss that.
Brad,
What about the argument that a country with serious demographic structural issue would have a need for external savings? One may argue that investment should take the form of private investments overseas or in the form of sovereign funds.
@ Nice Job: I agree with you fully. I was posting to keep it simple for those who aren’t slaves of the defunct global hegemonists. You have to look at a country in a simple way. It has dollars coming in from exports, dollars going out in imports it buys. It borrows in dollars and has to pay those loans whenever they’re due. Exchange rate can motivate people to export more and import less, or the other way round. The fundamentals are the level of dollars they have to survive.
Brad: Apologies if this is confusing; of all balance of payments concepts, the way Treasury foreign assets can be used to cover a fiscal deficit is one of the more difficult.
It’s a deliberate attempt to confuse the issues. Russia has very little forex reserves compared to their external debt. So they’re defending the rouble by selling their forex reserves. China has more than $ 2 trillion in forex reserves. Annually they export $ 1.2 trillion and import $ 1 trillion. Barring their external debt and runs on them, they have enough money to pay for 2 years’ imports even with ZERO exports. Take away whatever their external debt is. That still leaves them with more than enough reserves to pay for more than a year’s imports. They want to keep their exporters motivated. They want their exporters to find new markets. They want to keep people in their jobs.
You’re trying to argue that China should drain out her reserves by strengthening the RMB. Tell that to your Indian, Taiwanese, Singaporean pals.
where exactly is chinese growth supposed to come from next year? momentum? when your car skids, the faster you are driving, the nastier the crash can be.
what would a recession (negative growth) in china do for trans-pacific relations? what can we learn from ahmedinejad, w bush and others about the relationship between domestic troubles and foreign policy?
Well either we beat a retreat now, or we suffer a tremendous collapse. If you don’t want the oil-dollar system to get dismantled, then give up the phony speeches to open up China, strengthen the RMB and ask to buy them up. They’re not Seoul or New Delhi or Taipei.
If you want to see how long the Red Dragon can resist those job seeker crowds in that crowds, the Red Dragon will wait and see how long you can sustain sustain collateral damage of half a million American jobs a month in this stupid financial crusade to get a Citigroup bank branch in every Chinese street corner.
Bena Gyerek:
where exactly is chinese growth supposed to come from next year? momentum? when your car skids, the faster you are driving, the nastier the crash can be.
That’s a delusional defunct global hegemonic world. Look at imports of other countries. Look at a refusing to emerge market like India. 20% of their non oil imports are from China. China is Australia’s largest trade partner. There’s demand for Chinese goods across the continents, even South American countries at our doorstep have struck deals to import goods from China. As of 2007 70% of China’s GDP was from exports. Less than 40 % of that export was to the US. They can change that proportion. Comfortably. Replace the Americans with any and all commercial thinking people. Everybody likes the cheap and effective Chinese goods. Except us. Because we want our Citibank Blue banks to take over the Chinese.
Brad:
Bottom line: the US and Europe need emerging markets to buy their goods at least as much as they need emerging markets to buy their bonds.
That’s the biggest lie of them all. PBoC can’t weaken the RMB all by themselves. The Fed can buy RMB, and sell USD whenever the Chinese intervene. But we’ll never do that. We’re not in the business of exporting civilian Boeing planes. We’re in the business of flying B-52s over to carpet bomb innocent kids.
No country can accumulate dollars by being ‘mercantilist’. They have to work hard. When they export more, they have to make sure they don’t blow it up on imports. If all the Chinese had been like Americans, there wouldn’t be any dollars left in the PBoC reserve. They’ve worked hard to produce useful things for others while we were killing Iraqi kids and coming back with mental problems.
Now Obama wants to serve you old wine in a new bottle. He claims he’s giving you anti-terrorist wine in an Afghan bottle. Look closer at that bottle. It’s not anti-terrorist wine. It’s the blood of some Afghan kid that’s looking up at the Obama helicopter. Look at that bottle, under the anti-terrorism label. It’s cushioned up with Afghan poppy. And what does Obama get? An oil pipeline south from the Caspian Sea.
Here’s the real bottomline: This whole crisis is a phony crisis, to help Citigroup, Bank Am, JP Morgan and Goldman Sachs take everything over.
See what really happened. Everybody was highly leveraged. Oil went from $ 68 to $ 146. Food and energy prices more than doubled. We didn’t report that in our inflation statistics. Ordinary people spend the most on food and energy. They started going bankrupt. The crisis hit, home prices started dropping.
We did everything cleverly so that only our friends get help. Bear Sterns was bought over by our friendly wolves. We let Lehman collapse. We gave new loans. Selectively. Then we bought bank equities. Selectively. We gave FDIC guarantees. Selectively.
Krugman says we should nationalize. Selectively.
Our selectively funded friends are wolves. They’re waiting. To see how much more things will crash. So that they can buy.
They’re not going to lend, anytime soon.
We’ve sacrificed millions of jobs already, to help the big 4 takeover. And we’re blaming the folks in the Chinatowns. Folks who’re used to burying their heads in their work, and not fighting, saving peanuts like squirrels.
We’re doing that to crash the Chinese exports, get them to go bankrupt, get them to run out of reserves. Then the big 4 can continue the buying spree.
When they’ve bought everything, they will finally lend. Meanwhile, we’re going to put everyone through the hoops. GM won’t get anything from us, easily. Till we’re sure they can be easily bought by the wolves.
Global Chessboard,
Take a break
@Rien Huizer:
DO you or does anyone else have an alternative explanation?
Please don’t tell me that one emerging market crisis every year and one global crisis every few years is a natural phenomenon.
Global Chsboard,
It may very well be. We know a lot about economics s a form of applied mathematics, but unfortunately, we know very little about how it works in practice. I’m afraid that crises belong to the real world. But cheer up, fortunes are made in times of crises as well as prosperity. You might be lucky..
Chessboard: DO you or does anyone else have an alternative explanation?
Read Hyman Minsky and Charles MacKay.
What happens is that when times are good people just borrow, borrow, borrow until things crash, then when times are bad people stop borrowing, and save, save, save which actually makes things worse.
Chessboard: Please don’t tell me that one emerging market crisis every year and one global crisis every few years is a natural phenomenon.
It is. Without external intervention there are lots of feedback cycles in markets that tend to cause things to blow up. In order to keep things from blowing up too bad, there are all sorts of systems to limit those cycles, but they tend to work imperfectly.
The reason I think that financial crises are a natural phenomenon is that there has been one every few years for as long as there have been markets.
The other thing is that I’m close to the center of the supposed conspiracy, and I can say with reasonable confidence that the people that run the world financial system are as confused, baffled, and scared by what is going on as everyone else, and more importantly, they are not making money from this mess.
Chessboard: Here’s the real bottomline: This whole crisis is a phony crisis, to help Citigroup, Bank Am, JP Morgan and Goldman Sachs take everything over.
This doesn’t make any sense at all.
Question: How does “taking everything over” help a Wall Street firm make money and pay big, big bonuses?
Answer: it doesn’t.
People on Wall Street are very practical people. If it makes money, they do it. If it doesn’t make money they don’t. Giving that the crisis has caused jobs and bonuses to evaporate, it just doesn’t make sense to think that someone intentionally is causing or controlling this mess.
Greed is good. It’s stupidity that causes problems.
To Chessboard: Who exactly is “we” and who are “they”?
One of the nice thing about the internet is that you meet all types of people, so when you start talking about “us” versus “them” there is no reason to think that “they” aren’t reading and responding to posts on the internet.
Much of the reason that I post is that I’ve ended often the defacto representative of the “evil corporate banking conspiracy.”
As far as why no one is lending, the answer is quite simple. Suppose you magically get a check for $1500 in the mail. Now you know that you might lose your job next year. Now someone knocks on your door and asks you to lend him that $1500. He is a good friend of yours, and you like him very much, but you know that he might lose his job next year, and he can’t guarantee that he will be able to pay you back if he loses his job, which may be a problem since you might actually need the money to pay the rent and buy food.
Are you going to lend him the money?
Probably not. What you are likely to do is to just put that cash in a bank account.
Why should people who work at Citigroup (which cut 50,000 jobs last month) behave any differently?
“They” are owners of big banks, sheikhs, dictators and quasi-dictators. All the rest of the billions are “us”.
I agree with Howard on the point that it will be just too difficult for US households to raise their savings rate to anything close to what Goldman expects or what is needed.
Private debt in the US at the end of 2007 was 177% of GDP (compare with 84% of GDP for Italy and 75% for Belgium, two countries Americans think of a economically weak). The point that gets little attention is that this debt was partially accumulated by households that simply tried to maintain a “modest” American-style middle-class standard of living in suburbia in the face of stagnant wages and rising cost of living. Most of money was not spent on trips to Bali but on ballet lessons. Not on tulips but higher-education tuition and health care. Many of these expenses are either impossible (in the short term) to cut or, if the cuts are accomplished, will affect the income of other Americans.
I will leave it to people smarter than me to find a way out of this mess. I see that market imposed solutions do help a lot (the drop in asset prices forces people to reconsider their spending priorities and re-organize their lives accordingly) but are painful to large segments of the population and will take a long time to show their benefits. We need innovative solutions to get us out of this mess in a politically acceptable way AND policy changes that will lead to a more sustainable economy. My humble opinion is that we should consider measures like the Import Certificates that Howard advocates at least as an interim measure to balance trade. Just worshiping at the alter of “free trade” will not lead us anywhere.
To Global Chessboard:
I think your idea of China using its reserve dollars to buy oil and give it away for free to stimulate domestic aggregate demand is *brilliant*! … except that probably most oil consumption is used for industrial purposes and only upper middle income Chinese own cars — not to mention its impact on global warming.
Question: So am I interpreting Brad right that foreign currency reserves *cannot* be spent for domestic purposes such as recapitalizing China’s banks, environmental remediation, or providing a safety net (health, pension) for all of China’s citizens?
Twofish: Greed is good.
Some people never will learn. Oh well.
“Greed is good.”
Compassion is better.
Global Chess board and Twofish,
You seem to represent the traditional populist and elitist (respectively) American views on situations like the current economic downturn, its causes, preferred solutions and (unintended) consequences.
I agre with Twofish that the current crisis does not prove that our market system, including a private financial system is bad. It would take a lot more time and analysis to do that. So far, it looks like a large, but not qualitatively abnormal fluctuation, but with some unusual ingredients. Market economies are dynamic and they have many moving parts. One of those unusual ingredients is that a big part of the financial system that emerged during he past 30 years contained a variety of firms providing (more popular) substitutes for what used to be mainly banking products (once delivered in utility fashion by a government-tolerated cartel, with a very high dgree of geographic fragmentation). Among these providers were investment banks, fund managers, insurers and finance arms of industrial firms (like GEC). Technological change in the financial sector was mainly pushed and funded by the near-bankers (the banks were often followers, with defensive strategies) . That resulted in derivatives technology and -popularization (with regulation always following) and securitization, in turn enabling private equity and hedge funds. Widespread incentive compensation led to a predatory culture in investment banks and fund managers,ultimately constituting a large interest group of risk-loving agents, unchecked by regulation, feeding off a variety of ignorant or reckless principals.
The banking regulators controlled the banking system, but not the investment banks, the SEC and other regulators a variety of components of the investment and investment banking industry but not the most competitive suppliers of near banking services. That resulted in massive gaps in regulatory oversight (compared with, say the 1970s) and government -applied friction in the financial system as a whole. This combined with a poor monetary policy response to the conditions pertaining after the worst effects of the 2000-2001 crisis were cured, led to (or more cautiously) must have at least contributed to the current crisis. An unintended consequence of the crisis of the demise of the investment banking industry and probable improvements in the regulation of insurance and housing finance, that (1) this exact type of crisis will probably not return (2) that we have a “reset” of the banking system with important components that enabled a level of economic activity that was unsustainable with the resources available. I believe, (but very open to debate) that US GNI growth of the past 7 years and possibly longer was in fact a distributed “jump” to a level commensurate with the incidental availability of (a) foreign savings and (b) an apparent abundance of risk capital (dressed up in many forms) where that had previously ben much scarcer, leading to relative, but temporary overinvestment.
The trouble is now, that we will have to find a new level that is commensurate with (a) greater uncertainty around the availability of foreign savings ( a BWII like situation but less apparently stable and (b) a much less abundant supply of risk-tolerant funds. Trying to stimulate an economy in a situation like that is very difficult, and the 1930s (not that the extreme hardship of those days is likely to return) have many lessons (as well as unsolved riddles, see Amity Shaes’s brave attempts to challenge received wisdom.
So the reason that “banks” have become more difficult to borrow from, nota bene after getting so much government largesse, is simply that they do not have the capacity (including the risk capacity and appetite) to refinance what the near banking system is abandoning. The unintended (but for bank shareholders pleasant) consequence of that situation is that banks can very quickly rebuild their balance sheets by growing selectively yet highly profitably. But this assumes that the crisis remains cyclical in terms of time (I just explained that in my opinion this has a structural element, since we will have lost, for a long time, things that gave a short term boost, so it may well be a prolonged crisis, for the same reasons Japan has needed so much time)) . If the real economy is unable to quickly find a new “equilibrium”, the banks will have more problems within their original books of business and will have a contractionary effect even among the non-customers of the near banks. At that point in time it may well be necssary to consider structural non-regulatory intervention in the banking system.
Now to Global Chess board. What you may have seen as evil Wallstreeters manufacturing a crisis to build a stronger cartel, or something to that effect, is in my most humble but also strongest opinion, an unintended consequence, although not an entirely unpleasant one. JPM and a few others look strategically stronger than ever. To what extent trade restrictions/intervention would have any benefits now, I doubt that there is a case for a US shift mercantilism outside traditional sectors like agriculture, transportation, healthcare and defense. Most consumers would be facing higher priced goods but not high enough to encourage investors (foreign or US) to reopen (US) factories that were closed years before. On the other hand, US government budgetary policy could have been much more dsiciplined, not so much looking at the overall level of gvt debt (that is still quite healthy, especilly in view of demographics), but looking at the perverse incentives from the way housing is treated for taxes. Maximize interest deductability (gradually), scrap home equity interest dductibility (may be tchnically difficult) and introduce a tax to equalize as much s posible housing costs between buyers and renters (also very difficult). But of course in the current environment the economy needs the exact opposite of housing finance scarcity and costlyness. Another US tax weakness is a very low petrol tax (I believe I am in good company here) and an imbalance between income (mainly payroll deductions) tax and taxes on consumption. Given that the machinery for sales tax and excise exists, all that neds to b done is change the rates.
Ok having shown how easy it is to govern well once the crisis is over, how to get there and remind people of the hardship they just left behind? No idea. But Chinese reserves are a minor part of the solution, it looks. How to spend them? How to make them grow more slowly? How to do that in ways that benefit the Chinese people as well as the rest of the world? No idea. But it does not look like the US gvt is presenting the CCP leadership with any real incentives here (in a Twofish sense)..
@ Rein Huizer: Brilliant essay there …
Brad: Fiscal spending in turn leads to higher demand for imports, and thus a current account outflow that reduces the central banks foreign exchange reserves:
I say ingore the ingorant kids from Hyde in fancy think tank jobs. Get all your lectures from crooked Delhi policy makers.
Step 1) State run oil company buys oil with dollars and sells it at a subsidized rate, accumulating losses.
2) Impose a Central and State Government tax on the oil purchase.
3) Use the tax to spend on fiscal stimulus in any sector of your choice.
Ok, pls excuse the vicious Hyde Park sideswipe. The point is that Beijing knows very well how to use their dollars for local spending and improvement. But they want to be a global superpower, in competition with the US, and their accumulated dollars are meant for that.
Where is Hyde Park? London (OK place to walk a dog) or Chicago (good education, bad recipes for the real world but very pleasant intellectually). Or one of the many other ones throughout the British Empire?
Global Chessboard,
How could Beijing ever become a (global) superpower? It has no airforce, army or navy (I would like Beijing to have a nice navy, with dragon boats or even boats made of marble). Even China would find it very very hard tobecome a superpower (i.e. something like France or the UK) and if it did try, Japan would activate its latent nuclear capacity, in, say, 24 weeks? 1500 warheads as a minimum? But what about delivery vehicles? Ah..Still, do not hold your breath, the Chinese leadership does not consist of idiots. Superpower status is like having a Ferrari as the only car you can use. The US is in that position, I am afraid.
Seems that the CIC’s lesser lights are having their day in the sun during a week of generally assertive Chinese statements:
http://www.reuters.com/article/privateEquity/idUSSHA33450020081206
What does he mean? Why does he not blame his own firm’s (?) lack of diligence? What is going on? I thought that CIC was a simple SOE oversight function (especially the banks) this looks like someone who forgot to read that script. CIC officials believing this SWF nonsense. A disgrace
06 December 2008
US Treasuries and our Horribly Distorted International Currency Exchange Mechanism
At some point as the Fed seeks to create inflation it will cut the reserve deposit returns to banks until they are forced to lend.
Can the Fed create monetary inflation? That is the question and Bernanke believes he has the answer.
It will require the cooperation of foreign buyers of US credit seeking to underwrite their mercantilism and low domestic wage and consumption policies.
The key to recovery is the median real hourly wage, not the further expansion of credit and the perpetuation of an economic system based on an inefficient drag on economic growth by percentage-taking banks and rent-seeking elites.
We have a ‘chicken and egg’ standoff between aggregate workers wages and profits at the moment which only the government can move forward, but with care.
The seemingly radical but all too obvious answer is to begin to tax imports from nations who continue to refuse to float their currencies. This merely reverses the decisions that were made by Clinton and Bush to allow China to devalue and fix their currency and still obtain favored nation trading status without consequence.
It was always the answer. It will disadvantage the global financial sector through the dollar, but will begin to breathe life into economic reform around the world. The key is not taxes, but a market free of draconian industrial policies such as that which spawned the long deflation in Japan.
Countries which discourage domestic consumption and wages to build up the wealth of the State on the backs of the workers in the name of growth, and manipulate their currencies to promote trade policies must be discouraged from doing so, as they will.
This seems a radical solution because it is a change from the accepted economic dogma of the past thirty years, more ingrained as slogans than sound thinking. Smoot-Hawley, classic error. It will make things worse. Rubbish. The tariffs and trade barriers are already in place because of currency manipulation and artificial fixes. Why do some countries accumulate destabilizing and enormous deficits and credit balances? Because of the artificial thwarting of the markets. One only has to work the math.
But the alternative is almost certainly economic stagnation and global conflict.
At some point even mighty China will find itself sitting on a pile of useless bonds with fire in the cities, unless it accepts change and stops hiding behind a Great Wall of Paper.
This is not to say that the fault lies with China or Japan. The primary cause of our distorted global economy is in the dollar reserve currency arrangement that is the mother of artificial imbalances.
The solution may be the adoption of a trade balanced basket of currencies, including some commodities not so easily manipulated by the central banks such as gold and silver and oil, as the basis for continuing world trade based on market economics.
This is a link from naked capitalims (Cafe americain) Best BMH
“The seemingly radical but all too obvious answer is to begin to tax imports from nations who continue to refuse to float their currencies”.
This is a step in the right direction but it is too timid. Germany, Canada and Mexico allow their currencies to float, I think, yet they have a large trade surplus with the U.S.
I prefer a solution which does not discriminate against China and Japan. Those two powerful countries are very sensitive to slights or lack or respect, due to their history of receiving just that.
In addition, whether a currency is allowed to float is a matter of degree. Difficult to determine a cut-off point to say country A is floating but country B is not. Besides, currency is only one of the factors that control trade balance.
If the situation is faced squarely, we should be able to agree that the U.S. is being harmed by the existing trade deficit and it is the responsibility of the Congress and the President to pass laws which will reduce the deficit.
Tariffs (or taxes) on imports from the 5 countries that have the largest trade surplus with the U.S. is a direct and would be successful attack on the problem.
Perhaps it should be stated explicitly that I have long abandoned as naive the view that all would be OK if we could just get all nations to cease interfering in the market. Nations do interfere in the market. Nations will interfere in the market. Accept that, and you will be moved much closer to finding a solution to the U.S/ trade deficit.
RMB,
What, float?
Dr. Doom Foresees Much More Pain: So Why Is Roubini’s 401(k) All in Stocks?
Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor, has earned the nickname “Dr. Doom” for his dire predictions about the economy over the last couple of years (most of which have come true).So it was a shocker when word got out on Wall Street that Roubini was the most bullish guy in the room at a recent dinner he hosted in NYC. There were even rumors Roubini’s retirement account was 100% in stocks (since confirmed).Has Dr. Doom become a raging bull?Not quite. But with the financial meltdown in full, protracted swing, it seems as if the rest of the world has caught up with him.”The mainstream is getting closer to my views about a very severe U.S. and global recession,” he says. “On the other side, I’m not in the Armageddon camp,” forecasting a severe recession through 2009, but not a repeat of the Great Depression.So why is Roubini’s 401(k) 100% in equities? He’s not an active investor, and “over 10 to 20 years equities outperform any other asset class,” he says in the accompanying video.Unlike so many others, Roubini’s not calling a bottom, for sure: He sees another 20%-30% downside risk for stocks, and advises that investors avoid all “risky assets,” including commodities for the foreseeable future. Instead, he recommends Treasuries and, over the medium term, corporate debt.In case you need further proof that Dr. Doom hasn’t lost his edge, Roubini predicts that macroeconomic news and earnings will be much worse than expected in the coming months, as the dollar weakens even further. “The surprise is how bad the the economy [will get].”At least there’s some things you can still count on in an uncertain world.
lots of interesting comments, only so much time.
rien — yes, depreciation is a fairly painless way for countries with limited fx debt to gain manufacturing market share — and yes, asia prefers reserves and autonomy to no-reserves and the imF (note: the US also values its sovereignty; remember all the un-bashing a few years back? so this isn’t just an Asian thing — tho it has a particular focus on freedom from IMF conditionality in the Asian context).
But right now many asian countries are intervening to keep their currencies from falling too fast. Asia also likes to avoid too much “volatility” and to give firms with fx debts a chance to adjust (among other things). I agree that once pressure eases, Korea is likely to resist won appreciation — but that is a different issue.
Elaine — as you know, my focus is on countries that are actively taking steps to hold their currency down to gain a competitive advantage. That currently doesn’t seem like an accurate description of japan. Look at the yen right now. Particularly the against say the won … and Japan’s recent trade data suggests a waning surplus as US/ EU demand shrinks. i would have expected longer lags here tho — as in the short-run japan benefits from the fall in commodity prices.
2fish — re Saudi and China. China’s exports are influenced by its exchange rate — certainly the pace of growth. This is pretty clear in the data — Goldman found a strong relationship between China’s RER and real export growth. there isn’t as clean a relationship with imports. Saudi imports will be more affected — as the price of Saudi exports is a function of the global oil market. But Saudi imports are above all determined by the amount of government sponsored investment and spending — which is financed either by the oil revenue stream or selling reserves. So a Saudi decision to keep spending and investment up even as oil falls — financing the resulting budget gap out of its accumulated savings (the treasury’s fx reserves at SAMA) — means far more imports and more global demand.
all — yes, reserves can also be lent to private firms to help them repay their external debt. that doesn’t generate demand for imports. but by avoiding widespread defaults, it can avoid a sharp contraction that would lead to a big fall in demand for imports. sometimes you act to avoid a adverse outcomes, not to generate a positive one …
This is a bit long but these numbers would be quite useful to discuss the above:
http://www.guardian.co.uk/business/feedarticle/8111117
Emerging reserves haemorrhage as currencies fallReuters, Wednesday December 3 2008
By Peter Apps
LONDON, Dec 3 (Reuters) – Vast foreign reserves built up by emerging export countries are vanishing faster than they came as governments fight to defend currencies and economies, disappointing foreign investors who saw them as shock absorbers to the global economy.
In the years of good global growth, Asian manufacturing economies as well as resource producers such as the Gulf states and Russia saw reserves grow drastically.
Some analysts had hoped that would help compensate for the massive deleveraging and capital flight that has hit emerging markets in particular as the global financial crisis intensified after September.
That has seen emerging stock markets lose close on 60 percent of their value this year and emerging currencies come under increasing pressure and export revenues from manufacturing or resources dry up.
South Korea said on Wednesday its foreign exchange reserves — which were the world’s sixth largest at the end of October — had dropped to their lowest level in four years. One government adviser said it was pointless squandering the rest of the country’s reserves trying to lift the won currency, which has lost nearly 40 percent against the dollar this year.
Russian foreign reserves have fallen by around a quarter from their peak of $600 billion in early August to around $450 billion now, with attempts to prop up the rouble again accounting for the lion’s share of the fall.
Russia has since widened the band within which it allows the rouble to trade against a basket of currencies, effectively allowing gradual depreciation.
“The global economy is rebalancing and the buildup of forex reserves we saw in the last two years has been reversed,” said Lars Christensen, chief analyst and head of emerging markets at Danske Bank in Copenhagen. “It is hard to see how it can be (changed) as long as investors keep pulling out of the emerging asset class.”
Korea saw its exports fall by more than 18 percent last month, their biggest drop in seven years, while oil exporters such as Russia have seen crude prices plummet from close on $150 a barrel earlier in the year to under $50 now.
CHINESE PRUDENCE?
Overall, Asian foreign reserves excluding China’s shrank by $119 billion in October to $2.34 trillion, central-bank data showed.
But bucking the trend appears to be China, with $1.9 trillion in its reserves, making them the largest in the world having increased by an average $41.9 billion a month in the first three quarters of the year.
China says its reserves are continuing to rise, with the chief economist at the National Bureau of Statistics telling Reuters they would exceed $2 trillion by the end of the year. It releases data quarterly, not monthly.
In mid-November, the deputy governor of the People’s Bank of China said Beijing would not resort to “panic selling” of reserves, instead maintaining a “prudent and responsible” stance.
At the end of September, India’s reserves stood at $286.3 billion, down from $295.3 billion the previous month.
Korea’s foreign reserves dropped $11.7 billion to $200.5 billion last month — a fall of around 5 percent that itself followed a record $27.4 billion decline in October. Worries reserves might dip below $200 billion have themselves put greater pressure on the currency, with the government openly admitting it could not stem the fall.
“South Korea does not have enough capacity for massive forex intervention,” senior presidential economic secretary Bahk Byoung-won told reporters, saying that instead Korea would carry out “smoothing operations” in foreign exchange markets.
Russia also had little choice, analysts say.
UNSUSTAINABLE SUPPORT
“In this environment, currency “devaluation” should be part of the policy reaction for most export-oriented and commodity reliant countries,” Stephen Jen, global head of currency research at Morgan Stanley, said in a research note. “For Russia, oil prices have fallen by so much and the quantity of demand for oil and other minerals has collapsed as well.”
Lombard Street Research said in a research note Russia would ultimately have to float the rouble completely as it could only hold its current position for roughly 9 months given its reserves.
Few emerging economies have found haemorrhaging reserves to support their currency to be sustainable. Ukraine saw its reserves fall from a peak of $38 billion in August to $32 billion by the end of October before abandoning its band.
Its hrvynia is now down 30 percent this year, amongst the worst performing currencies, and Ukraine has had to turn to the International Monetary Fund for support.
Morgan Stanley’s Jen also said this week he had changed his view on the Chinese renminbi, now believing China could allow its currency to modestly and temporarily depreciate by five to 10 percent against the dollar even though it would strengthen again after the global recession ended.
Danske’s Christensen sees further risks to investors as governments look at other tools to protect currencies, with a rising danger they might be unable to get their money out.
“The only other way to protect your currency is to tighten interest rates and not many governments are going to do that right now,” he said. “There is a growing risk that some emerging countries could resort to capital controls.” (Additional reporting by Mike Dolan and Sebastian Tong, editing by Andy Bruce)
As you can see, my previous analysis above tells you exactly why the Chinese reserves alone are going up, and not any other country’s …
The United States is better off when foreign countries buy our exports instead of lending us money. ”
This is daft. Exports are real costs, imports are real benefits
(this last sentence by jimbo above, near the top)
Here is a sentence worth discussing. Sorry I did not see it earlier.
My perspective is derived from the Adam Smith insight that real wealth is created by a nation by the value of the goods and services created by the domestic economy (GDP based on that insight). Exports require increased domestic production. They add to GDP. Thus they are good.
Imports reduce the need for domestic production because they substitute for domestic production.
However, when exports and imports are equal, the exports add to GDP while the imports increase the options available to consumers and producers (producers want quality and cheap inputs into manufacturing).
Thus, equal trade is the best of all possible worlds. It eliminates export-led growth. It eliminates financial transfers. It makes both nations better off.
With equal trade (imports and exports equal) the nation with the smaller economy shows a more rapid rate of growth, compared with a nation with a larger economy. Hence, equal trade does not eliminate the trend toward equality of level of living througout the world. It does, however, slow down that trend, as compared to the realtiy of the past 30 years, when Japan, Taiwan, South Korea and now China are sending much more goods to the U.S than they purchase from the U.S.
THE U.S. MUST CHANGE PAST REALTIY BY UNILATERAL ACTION TO MOVE TOWARD EQUAL TRADE.
Some like to argue that moving toward equal trade will eliminate all imports.
Wrong. 1) The tariff schedule that I advocate will only reduce imports by 50% because the tariffs are limited to only 5 nations. 2)The total goods exported from the U.S. in 2007 was 1.1 TRILLION dollars. If I could get to equal trade, which I cannot, the U.S. would imports 1.1 trillion dollars a year, or however much the exports from the U.S. totalled
[...] More here. [...]
Well, but is’s been also truth that contries have accummulated reserves as a result of protection of domestic currency to appreciate. Selling reserves now can easily eliminate the past effort if the domestic currency is not under pressure. Domestic banks need liquidity in domestic currency, domestic social scheme is in domestic currency, etc. I’d wonder how reserves that have been kept out of the market for decades can be exchanged swiftly in domestic currency to compensate lower proceeds from oil, from exports etc. If the SWF sell FX to central banks than the question is: Did it make sence to create a SWF if at the end FX is in central bank B/S?