So long, “Great Moderation”
The great moderation – a theory that become quite popular once the big financial party of this decade really got going after 2004 (see the New York Times graphic on LBOs) – had two components.
One: Macroeconomic volatility was a historical relic. Downturns were not going to be as severe as in the past – in part because of the success of counter-cyclical monetary policy.
Two: Financial volatility also was a thing of the past. The combination of reduced macroeconomic policy and the credibility of monetary policy meant that financial markets weren’t as subject to wild gyrations.
The implication of course was that leverage was safe. Financial firms could enhance their returns by borrowing more and taking bigger bets. And everyone else could increase take on more debt too – whether firms or households.
I guess it is now time to go back to the drawing boards.
Financial volatility has come back, with vengeance. And not just in the equity markets. After a period of (relative) stability, there have been a series of sharp moves in the foreign exchange market. The yield on the thirty year bond has swung wildly. The pros are amazed at some of the strange permutations that derivatives markets have churned up under stress.
And Friday’s employment data leaves little doubt that macroeconomic volatility is back with a vengeance. The pace of contraction in economic activity in the US – and probably globally – this quarter is likely to be brutal. Wall Street economists are increasingly starting to sound like Dr. Doom.
Alas, adjusted to a more volatile world won’t be easy. Belief in the great moderation meant that the US economy was operating with a smaller buffer of capital and liquidity than it had in the past. And here at least much of the world seems to have emulated the US. The easy way to increase equity returns over the last few years was to take on more debt. That in turn is likely to augment the amount of volatility in the economy.
The risk, obviously, is that firms that borrowed to buy back their stock – or hadn’t run down their cash reserves – won’t be able to avoid Chapter 11. Or Chapter 7. And financial firms won’t be able to support their existing balance sheets with their now-depleted capital and will have to scale back (even after government capital injections), adding to the downturn.
Ideas have consequences. Big bets on the “great moderation” throughout the economy helped to create the financial basis for a potentially big slump.
Sensiible and well worth saying.
“Ideas have consequences. Big bets on the “great moderation” throughout the economy helped to create the financial basis for a potentially big slump”. Amen
Buster Setser Gloats over people’s joblessness, offering no solutions, and blames the Great Moderation Theory.
for my solutions, please see the end of my post on Bretton Woods 2 and the current crisis: any link. My answer to the domestic slump isn’t particularly original, but at this stage i wouldn’t want to risk ignoring the lessons Keynes drew from the Depression. And on the international side, I have made over time a series of proposals — some of which are rather more innovative than my domestic proposals.
Whoever Buster Setser is, he is one of those who does not want to face reality and who resorts to name calling when other peoplw try to articulate reality.
“Ideas have consequences. Big bets on the “great moderation” throughout the economy helped to create the financial basis for a potentially big slump.”
I think that’s true. A lot of people sold a lot of downside puts, or the equivalent, thinking that it just couldn’t happen and it was free money. Of course, one it does happen, we’re all suffer.
This is a really important point, Brad. Thanks for bringing it up.
One additional consequence of increased uncertainty and volatility in interest rates is that it will reduce the willingness of banks to lend. Borrowing short and lending long is fun and easy in a fairly stable, disinflationary environment. But we face a deflationary environment now.
Many economists have suggested we could get out of deflation if people just believed that the Fed will do anything to create positive, stable inflation. I’m reasonably sure there is a widespread belief that the Fed, with poor “Helicopter” Ben, would go to any lengths to create positive inflation. It’s the stable part that may lack credibility, particularly now.
The great moderation is a relic of a pattern of disinflation that can’t go another round, as we have hit the zero bound. That left only extreme measures, many of which the Fed has resorted to already. Those measures have resulted in a Fed asset sheet full of creative securities and massive excess reserves in the system. Both of these, combined with the poor balance sheets of banks, could make it very difficult for the Fed to fight inflation in the event it is successful.
Imagine you’re a reasonable banker. You lend, though not often anymore. What would you lend for? Even short-dated assets are risky in a deflationary recession, as solvency fears reign. The Fed has been forced to buy up 20% of the CP outstanding from a variety of issuers. Long-dated ones, even though spreads are comically wide right now, share that risk. However, you not only have the immediate solvency concerns, but now that the great moderation is over, you have no idea what the future path of inflation and short-term interest rates will look like.
The Fed can make a promise to keep inflation around 3%, but why on Earth should you believe they can achieve that in this environment with their recent track record? Thus, because you won’t lend, deflation and the binary outcomes become even stronger. This string looks more like a vortex every day.
@ Buster:
Brad:
In the short-run, the core challenge is to avoid a downward spiral of confidence and cascading defaults. The governments of the US and Europe have acted decisively to avoid the collapse of additional large financial institutions (in the process exposing US and European taxpayers to consider risks, but in the context there was little real choice). A similar effort is needed to limit the fallout from the current run on many emerging economies – and to limit the depreciation of their currencies. This isn’t altruism either: the dollar’s current strength will cut into the United States’ exports at time when the US would like to be exporting more not less.
In the medium term, the challenge is to prevent expanding financial distress from fueling a self-reinforcing downward cycle of contraction, one where consumers cut back leading firms to cut back – and one where governments respond to falling revenues by cutting back as well. This isn’t the time to allow concerns about the long-term health of government’s balance sheets to drive policy: governments around the world need to stimulate their economies to offset what now looks likely to be a severe global slump. That advice applies with particular force to those countries with large external surpluses and lots of external assets: China can help the world right now by spending a lot more at home; the Gulf can also help by drawing on its accumulated stockpile of foreign assets to keep spending at home up. Such a stimulus won’t avoid a contraction; the goal is to keep the contraction from morphing into something far worse.
In the long-run, the challenge will be to find a more sustainable basis for global growth. The last few weeks have once again illustrated the difficulties emerging economies looking to finance fast growth by borrowing from the international banking system face. But the past few months have also highlighted the costs of a world where rapid reserve growth in the emerging world finances heavy borrowing by US and European households. US and European taxpayers have been hit with the bill created when their banks lent against inflated home values; Chinese taxpayers will eventually be hit with the bill for borrowing in a currency that is going up (the RMB) to buy currencies (the euro as well as the dollar) that are going down. No one is going to win. The policies of the past few years have not worked; it is time to try something new.
Interesting link to CBS 60 minutes interview of CIC head:
http://www.cbsnews.com/stories/2008/04/04/60minutes/main3993933_page4.shtml
US: In other words, we’re all but dependent on Chinese investments. Beyond this fund, China holds half a trillion dollars in U.S. Treasury bonds. For that reason economist Navarro says they have us over a barrel. If they don’t like our behavior, he says all, they have to do is dump all their U.S. investments. It’s known as the financial nuclear option.
“What would that do? That will cause interest rates to spike. Mortgage rates to spike. Inflation to spike. The dollar to go through the floor. The stock market to go into chaos,” Navarro said. “We would be in deep, deep, deep trouble.”
Gao:
“Philosophically everything’s possible in this world,” Gao said. “But that’s so unlikely that, you know, if we function on that thing, we just may as well go home and not doing anything.”
Brad,
Thanks for challenging the status quo and for writing this blog. Ben Bernanke wrote a highly self-congratulatory speech on the Great Moderation in 2004, and as you say, his idea (as the brains behind 1% policy rates) certainly did have consequences.
We need influential, leading voices like yours to help achieve a consensus on what really created this crisis. Your work on the implications of capital flows and the global economic regime is invaluable.
“When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down.”
Lord John Maynard Keynes, The General Theory of Employment, Interest and Money – 1936
War has several causes. Dictators and others such, to whom war offers, in expectation at least, a pleasurable excitement, find it easy to work on the natural bellicosity of their peoples. But, over and above this, facilitating their task of fanning the popular flame, are the economic causes of war, namely, the pressure of population and the competitive struggle for markets. It is the second factor, which probably played a predominant part in the nineteenth century, and might again, that is germane to this discussion.
I have pointed out in the preceding chapter that, under the system of domestic laissez-faire and an international gold standard such as was orthodox in the latter half of the nineteenth century, there was no means open to a government whereby to mitigate economic distress at home except through the competitive struggle for markets. For all measures helpful to a state of chronic or intermittent under-employment were ruled out, except measures to improve the balance of trade on income account.
Thus, whilst economists were accustomed to applaud the prevailing international system as furnishing the fruits of the international division of labour and harmonising at the same time the interests of different nations, there lay concealed a less benign influence; and those statesmen were moved by common sense and a correct apprehension of the true course of events, who believed that if a rich, old country were to neglect the struggle for markets its prosperity would droop and fail. But if nations can learn to provide themselves with full employment by their domestic policy (and, we must add, if they can also attain equilibrium in the trend of their population), there need be no important economic forces calculated to set the interest of one country against that of its neighbours. There would still be room for the international division of labour and for international lending in appropriate conditions. But there would no longer be a pressing motive why one country need force its wares on another or repulse the offerings of its neighbour, not because this was necessary to enable it to pay for what it wished to purchase, but with the express object of upsetting the equilibrium of payments so as to develop a balance of trade in its own favour. International trade would cease to be what it is, namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbour which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage.
Lord John Maynard Keynes, “The General Theory of Employment, Interest and Money.”
Mr. Pearson – Understanding of what is happening is not likely to emerge for some time. Right now I am more interested in the question of whether or not Paulson and Bernanke are helping or hindering.
On the helping side of the ledger, the provision of funds to Central Banks in Europe by swaps at the beginning of this crisis was clearly helpful as was Bernenke’s willingness to provide funds to support the short term commercial market.
However, when we review how successful Bernanke was, without using any fund made available by the Congress, we should question whether the original request for money from Congress was justified.
I think not. I think the two of them just panicked. I also fear that Bernanke is not looking at the difference between 1931 and 2008. There was no safety net in 1931, no social security, no sizable number of retired citizes with pensions and investments,no network of non-profits to help those in trouble, and most important, the economy had not shifted from production to service. The service economy, led by Universities and Hospitals, plus the safety net, will put a floor on how low this economy will go.
He and Bernanke should have let AIG collapse. This economy needs a smaller financial sector. We need to get to the bottom or the floor quickly. As long as the uncertainty remains due to the question of how much more decline is in store, all the efforts of the Fed or Congress or anyone to get the economy going again will be wasted.
The reason previous stimuli did not work was not small size or wrong type of stimuli. Uncertainty outweighs everything.
One other point, I am among the outraged at the fact that the profits made in the past are playing no role in paying for the cleanup.
“In the short-run, the core challenge is to avoid a downward spiral of confidence and cascading defaults”.
My advice is exactly the opossite. In the short run, our challenge is to complete the downward spriral as quickly as possible, so that everyone can see that we have reached bottom and the purchasing power of the U.S., which will remain considerable after we hit bottom, is available to rebuild the economy.
The above quote from Lord Maynard Keynes provides good advice for the mid-1930’s but it is poor advice for the U.S. today.
The problem facing the U.S. is not a trade war (Keynes in the last paragraph is talking about a still disguised trade war but nevertheless a trade war). The U.S. has been so intimidated by the thought of a diasterous trade war that the prospect of a trade war only needs be mentioned and all rational thought about the future of the U.S. in relation to international trade is blocked.
The State of Ohio, which is suffering from loss of manufacturing jobs, has 116 colleges and univerisities scattered throughout the state. The service economy will stop the downward spiral. I will agree that the upward spiral will be weak unles Ohio learns how to produce more goods that can be sold on the international market.
perhaps after the great moderation we come to the great contraction ? many of the conditions for a global deflation are already in place. the task of countering this by ‘printing money’ will be exceptionally difficult, if an overshoot into hyperinflation is to be avoided.
part of the solution may be in accepting that a rapid ‘bounce’ back to ‘normal’ economic growth is not going to happen. if i understand what i read – deregulation of some aspects of banking led to dangerous levels of leverage. if an institution lends 30x its deposits, this is dangerous. when it gets into trouble, everyone, the bank included, accepts that this was reckless. 20x would be safer and 10x much better again.
so what is the point in complaining – at least until the level gets back nearer to 20x, 15x, 10x, – that the banks ‘refuse to lend.’ ?
patience is required while the level gently declines, rather than cutting off clients abruptly, or imagining that investors will willingly appear to allow the lending bubbles to reinflate to 30x.
what else should a bank do but be grateful for fed money and stockpile it so that reserves come into better balance with lending ?
* * * * * *
on the topic of brad specialising in chinese policies vis a vis the united states – fair enough. but for non americans – and i suspect you have irish, british, and french as well as contributors possibly from india and from china itself (or u s resident chinese, at least) – policy prescriptions for china come across very poorly.
i suspect that policy prescriptions for china are actually counter productive. they would have the same effect if made to the japanese. as for the irish, we would tell you you were right but go on doing what we wanted to do just the same !
how much china uses its reserves to ameliorate global pain, may depend upon how secure china feels. every policy suggestion is an interference that may be making china feel less secure.
to form a better picture, divide china’s reserves (massive) by her population (massive.)
you numbers guys will want to do it precisely, but i would be satisfied to say divide a trillion by a billion and they have got $1000 dollars each.
from here (ireland) it would seem possible to devise a way forward for the global economy that does not demand the $1000 dollars off the average chinese especially at the moment that he/she may be about to be out of a job.
i know that this vastly simplifies what the thread is talking about. i know you are looking for answers that rescue the incomes of both chinese and americans – but after all of the scams and geopolitical schemes of the past 20 years it just looks bad. really bad.
i think that the dollar will now rise further – look around you. start with the icelandic krona, the rouble, the australian dollar . . . . . and ask yourself : which of all global currencies would i rather have stached in the mattress ?
ok maybe yen ? what else ? can the yen keep the dollar down ?
i think the china spin is a distraction. the more the united states desires a certain chinese policy – the more changes chinese negotiators might think they can demand in return for compliance.
and the more america complains – the more the cynical observers in europe and elsewhere wonder just how much u s money was riding on a massive rmb revaluation that did not happen yet and may not now happen.
“but with the express object of upsetting the equilibrium of payments so as to develop a balance of trade in its own favour. International trade would cease to be what it is, namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbour which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage”.
Mr. Keynes is eloquent.
Keynes says that full employment at home will end the fight to export more and import less.
It should reduce the pressure. But Japan has shown the world that the quickest way to a strong manufacturing sector is excess exports over imports to the U.S. (the surplus funds can be used to buy more machinery and become even more efficient – and they can increase the level of dollars or other claims on the U.S. which serve as an insurance policy against a raid on their domestic currency).
Japan has not followed Mr. Keynes suggestion. None of the other Asian nations that have gone to school to Japan are likely to depart from their script.
If equal trade were the goal of a all nations, the struggle to reduce imports and increase exports would be legitimate ONLY for those nations with a trade deficit.
It is the responsibility of the deficit nations to arrange their trade so as to minimize or reduce the trade surplus with all trading partners.
This is not a beggar thy neighbor policy. It is a respect thy neighbor. All parties are expected to benefit from increasing the level of international trade.
What Keynes wanted cannot be achieved by full employment. It can be achieved by embracing equal trade as the guide for international trade.
If I will shut up, will readers promise to send me an avalanche of objections to my ideas?
Gillies China’s true reserves (counting the cic/ hidden reserves) are around $2.3 trillion, or over $1,500 per resident of China. More importantly, they are growing fast — and (contrary to the assertion made in the previous post) do have a global impact. A seemingly small number (per capita reserve growth in china — though in some sense it isn’t that small when compared to say average Chinese income) times a big number (China’s population) is a big number. And china clearly has a huge impact on global trade.
Yes, telling China what to do comes across badly. I get that. At the same time, certain problems cannot be solved without global policy adjustments — China isn’t just setting its exchange rate, it is also setting the united states exchange rate. And so on. The US does have options it could take on its own — see Michael Pettis and Dani Rodrik on how restricting imports would enhance the effectiveness of any US fiscal stimulus. But those options would if adopted export problems globally — so think of some of my policy prescriptions as an effort to find a solution that avoids unilateral US policy decisions that might have a negative global impact. Like it or not, that means changes elsewhere.
While I strongly disagree with your analysis of China — which is the largest exporter now and runs the largest trade surplus and since it functions as a unified economic block should be thought of as such — I do like the term “great contraction” …
Incidentally, my main suggestions for China don’t hinge on how China uses its existing foreign assets — though resuming purchases of Agencies would help. Rather they hinge on a set of policy adjustments where China would buy fewer foreign assets and spend more at home. The issue isn’t using China’s surplus to solve the world’s problems. It is creating a world where China runs a smaller surplus (and the US runs a smaller deicit) without that adjustment coming through an enormous collapse in US demand. Fundamentally, my argument is that China has relied on the rest of the world for too long to solve the problems created by its own lack of sufficient internal demand growth — and the solution of the past few years (lending to the world so they world buys more chinese goods) has hit a real wall …
When that “Moderation” talk started, I was blown away because the sample size says quite bluntly that it’s likely noise. What is it with intelligent people that they so quickly forget the basic rules of randomness?
Sounds a lot like Minsky’s Financial Instability Hypothesis, Brad.
Brad – Any real solution to the U.S. trade deficit will reduce exports in some country and/or increase imports in some country other than the U.S.
The elite of our export oriented trading nations will consider that consequence a negative impact.
I do not think you will ever find any kind of adjustment that reduces the U.S. trade deficit that will not frustrate the ambitions of those national leaders who have spent so much energy and effort positioning their country to create a trade surplus with the U.S.
Another Tip From Wall Street:
“Leave your stock certificates in your mother’s attic.”
http://www.dagblog.com/humor-satire/another-tip-wall-street-300
Nice Post.
I am still wondering — how on earth does China (a creditor) think it can keep its currency from depreciating WITHOUT financing our fiscal stimulus?
Good post!
Small bit of good news on the China front:
“Dec. 8 (Bloomberg) — China is “highly unlikely” to favor a weaker yuan because the government will rely more on spurring domestic demand than exports to support the economy, a former adviser to the central bank said.”
[...]
“Why should China do something that is not in its long-term interests and whose impact in the short-run is uncertain?”
http://www.bloomberg.com/apps/news?pid=20601087&sid=a4jjnzB8t2KY
@ Brad: What’s your opinion of anti-deflationary measures from Bernanke?
http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
I hope Dr. Yu is right. No guarantees though. My sense is that there is a real battle on this issue inside China right now, with the PBoC (and its academic advisors) like Dr. Yu on one side and some provinces/ export interests/ ministries on the other …
I need to sit down and read Dr. Bernanke’s speech.
[...] las ideolog
Brad:
The US does have options it could take on its own — see Michael Pettis and Dani Rodrik on how restricting imports would enhance the effectiveness of any US fiscal stimulus.
The McKinley Tariff of 1890, the Smoot-Hawley Tariff of 1930 and the 1971 dollar non convertibility with a 10% import duty together were three occasions when we tried trade protectionism in a big way. Could you please elaborate your understanding of the consequences of trade protectionism for the united states in the past?
This dr. says it right there, it was written: “At the end – so long for my great moderation; To swap out my paper for gold is the path that we follow to redemption for sins we committed against the believers, now almost extinct. That shall give rise to the yellow star over this Bethlehem which shall lead all kingdoms to converge on the right spot on the 25th of December, where my balance sheet starts to contract and where “crisis” shall meet its abrupt end in a biblical sense for that is the only confession that purges the past and offers forgiveness”.
it will not stop until all us economists symbolically bow down to long forgotten wall that was hidden behind the two pillars – prices, quoted by sellers, that they refused to sell anything at – as the “official” ones.
To do this will free up one ancient market – the market of decency
To not – is to enter the gates to the brave new world, where it was written:
“Before me things create were none, save things
Eternal, and eternal I endure.
All hope abandon ye who enter here”
It was not Keynes nor Friedman that said:
It is divine, this geo-comedy.
One big question though is how much of the recent volatility is permanent, and how much of it involves movement from one equilibrium to another.
The thing that caused a lot of problems was the notion that since volatility no longer existed, capital reserves were unnecessary.
This should liven up Brad Setser day. From Bloomberg, China ‘Highly Unlikely’ to Reverse Policy, Weaken Yuan.
“China is “highly unlikely” to favor a weaker yuan because the government will rely more on spurring domestic demand than exports to support the economy, says Assistant Finance Minister Zhu Guangyao”.
http://www.bloomberg.com/apps/news?pid=20601087&sid=a4jjnzB8t2KY
But it won’t make a dime’s worth of difference for the US Bubble economy anyway. The US Economy is a debt-infested financial wasteland thanks to Wall Street “special interest” policies of the Paulson-Rubin banksters cabal. The trillions of dollars in capital have been misallocated, wasted, stolen, and looted. American taxpayers on on the hook to bailout trillions of dollars in financial losses from Goldman Sachs, AIG, Citicorp, Washington Mutual, Countrywide, Bear Sterns, Merrill Lynch, Wachovia, Lehman Brothers, etc. The Chinese are the perfect subterfuge to scapegoat US Economic problems that were entirely domestically created by gross mismanagement and lax financial regulation.
Got it Brad!
:Twofish responds:
One big question though is how much of the recent volatility is permanent, and how much of it involves movement from one equilibrium to another”.
We are in transition from an economy based on too easy credit and too much debt to another one where credit is expensive and debt is reduced. The volatility is temporary. But this temporary condtion will be prolonged for years, unless Bernanke, Paulson, the U.S. Congress and the voters will allow failing firms to fail. We continue to place the desire for current jobs to remain in place as long as possible over the need to restrain governmental expenditures.
The former proved to be not a stable position, though it took years for the problem to show itself.
What we are moving to will be stable but most will no enjoy it. Too little excitement. Too little false prosperity.
The future may be an equilibrium but the former was not.
@ Brad:
What do you think of the following direction?
Find another country to replace the US in the vanguard of debt driven consumerist spending. Achieve that through swap line expansion/new swap line extension to that country.
When a country with small forex reserves tries to provide a fiscal stimulus it has to be evry contained due to balance of payments worries. Remove that worry. Get them to import from China.
For example I think Brazil already has a swap line and expanding that would do good. Similarly, extend a swap line to India. Recent trends in India.
1) Falling exports
2) Rising imports
3) Reserve bank of India improves liquidity, libarlizes ceilings on external commercial borrowing.
4) Firms borrow more in the form of external commercial borrowing for the purpose of importing capital equipment.
5) Exports fall further, imports rise further.
Why not exploit this trend and the good ties with India?
Make India the consumerist accumulator of China’s imports.
Allow their ECB to rise and rise and rise. This solves the problem for now.
Get them to agree for a really big stimulus, and make them import more and more. Then one fine day they will be so drowned in dollar debt. They might need a bailout. We can buy them out
Spot Gold Price Up $16.80 per Ounce to $769 this morning http://money.cnn.com/data/commodities/index.html
If the US government wants the Dow Jones stock market to 15000 or 20000, it certainly can be done. Just keep Helicopter Bernanke printing US dollars non-stop to debase the monetary value of the currency. The nominal value of everything in US Dollars will increase. Of course, that 1 gallon of milk will cost $10 and Gold will also be $2000+ per ounce.
China Government to provide $10 billion to Brazil Perobras to develop deepwater oil fields
http://money.cnn.com/2008/12/08/news/international/brazil_china.ap/index.htm?postversion=2008120810
BRASILIA, Brazil (AP) — Brazil’s top energy official says China wants to provide $10 billion to help develop massive new oil fields in deep water off the coast of Rio de Janeiro.
Mines and Energy Minister Edison Lobao told the Folha de S. Paulo newspaper China will offer the financing to Brazil’s state oil company, Petroleo Brasileiro SA (PBR).
Petrobras made the discoveries of between 50 billion and 70 billion barrels over the past year.
Jansen says 30 year swap spreads are now negative 41:
http://acrossthecurve.com/?p=2254
Why China’s Economy will recover first
By Bill Fleckenstein
http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/why-china-will-recover-first.aspx
With a high savings rate, sensible mortgages and heavy reliance on cash, the Chinese are suffering less amid the credit meltdown. And a huge reserve of dollars doesn’t hurt.
I think the most important thing for folks to understand is that China has not suffered the epic credit binge that much of the rest of the world has. China’s savings rate is high. Mortgages require sensible down payments. Credit is something that hasn’t quite come to China yet (although I understand that credit cards have recently become more available, especially in the big cities).
People pay cash for most things, though they do use debit cards. From a credit standpoint, it seems similar to how life in America was back when “Leave It to Beaver” ruled the airwaves. Meanwhile, the people I met were very industrious and their enthusiasm seemed quite high. (As a traveler, I was happy to discover that the airports were new and the bags arrived quickly.)
The biggest problem China faces is its dependence on exports. A large part of the export issue is the fact that China has roughly 150 million itinerant/migrant workers — yes, you read that number right — in the south who’ve moved there from the west. (Away from the big cities, life is difficult and people are poor.)
But China understands this problem. (I have left out many others and don’t mean to gloss over them.) They are working overtime to stimulate the domestic economy, and there’s a lot they can do. More importantly, as a country that has accumulated a couple trillion U.S. dollars, China has the reserves with which to do so. Relative to the problems faced by most countries, China’s seem at least manageable and do not stem from having borrowed and spent like mad.
While I agree that China should increase domestic spending – to what extent can they do this with imports of other than raw materials?
Their current factories have been designed for export – their location and configuration is great for building things Chinese don’t need.
Their domestic problems are two fold – 1) a young urban population supporting an export economy, 2) an older rural population needing food, housing, health care and services. The transportation infrastructure investment to date has been primarily intercity, heavy transport for raw material/energy, and air transport.
It would be helpful if the US had something to export to the Chinese besides debt (perhaps we need to keep Detroit alive just to maintain the precision machinery ecosystem in the US). Maybe we can export medical technology?
Restricting imports as opposed to increasing exports will fight against the trade agreements and philosophy built over the last 25 years. The idea that the rest of the world needs to sacrifice so that the American consumer can be rebuilt to generate demand is not going to fly – that paradigm is over.
“The McKinley Tariff of 1890, the Smoot-Hawley Tariff of 1930 and the 1971 dollar non convertibility with a 10% import duty together were three occasions when we tried trade protectionism in a big way. Could you please elaborate your understanding of the consequences of trade protectionism for the united states in the past?”
The past provides no guidance for the present as regards the consequences of trade protection because the conditions were so different all during the period 1864-1930. During that period the U.S. was in a tremendous growth period due to the spread of industrialization and the spread of farming in the Midwest using modern machinery produced by the industrialized cities. Nothing like it has been seen since (growth pattern – productivity increases both on the farms and in the cities).
During that period tariffs were extremely high (around 40% – see chart on page 147 of Irwin, Free Trade under Fire, 2002). High growth rate and high tariffs coincided but the tariffs were a minor factor. I will agree that they did not impede the growth but they were not the main reason for the growth.
“Restricting imports as opposed to increasing exports will fight against the trade agreements and philosophy built over the last 25 years”. RR says quite true.
“The idea that the rest of the world needs to sacrifice so that the American consumer can be rebuilt to generate demand is not going to fly – that paradigm is over”.
RR says all parties feel aggrieved. More exports from the U.S. is quite acceptable and would be desired by the U.S. That is the goal U.S. negotiators have been pursuing in trade talks for 30 years. The result has been a tremendous trade deficit.
The paradigm that is over is the U.S. purchasing more from other countries than they purchase from us.
Unfortunately, I have not yet persuaded economists, political leaders or the general public that the old paradigm is over but I am working on it.
“Relative to the problems faced by most countries, China’s seem at least manageable and do not stem from having borrowed and spent like mad”.
I agree. The rest of the world has much to learn from China, beginning with the governmental system which insists that the central government is going to be in control of the domestic economy. Of course, the U.S. has exactly the opposite philosophy. I get angry at the unwillingness of the U.S. public to use its central government to control the way the U.S. responds to the harm the U.S. citizens have experienced as a result of international trade in the last 30 years.
I would like to see both nations gravitate toward each other in the role of government.
China has also shown an admirable willingness to learn from the mistakes of the past – no more allowing international firms to exploit the opportunities in China. The also learned from the Russian experience that mob rule cannot be tolerated.
I hope the U.S. will, sooner or later, recognize that this country must appreciate some of the good decisions made in Germany, Japan, and China and integrate some of those good characteristics into our system.
there is trouble in a company called ‘republic doors and windows’ because the bank which is the beneficiary of a bailout (ultimately from the taxpayers) will not make a loan to the company to pay the wages to the employees (taxpayers.) the workers are outraged. rightly so.
this is a straw in the wind. the idea that banks can now ‘decouple’ from a defunct manufacturing economy and live on bailouts from the newly unemployed is ludicrous, ludicrous, ludicrous.
henry ford understood that the worker needs to get a wage at which he/she can afford the model t car. the current problem of the world, after a binge of leveraged speculation (by all – from ‘wall street’ to foreclosed sub prime mortgage hopefuls), and after wage arbitrage by a deliberate policy of outsourcing manufacturing, is that globally wages have been reduced to a level that cannot support global production.
so something has to give.
perhaps the ‘great contraction’ is the benign scenario ?
after all, the idea that an exponentially expanding global population can mine an exponentially increasing quantity of global resources to achieve an exponentially growing level of consumption, is also ludicrous.
perhaps both china and the united states are destined to ‘balkanise’ into a patchwork of competing local economies – some rich and some poor ? perhaps there will be no ‘next superpower’ ?
but rather than develop this scenario let me propose a ‘thought experiment’ :
1 what would be the local characteristics of a global economy that was steadily contracting in the long term even through occasional temporary growth rallies ?
2 what would be the appropriate level of interest rates in a global economy in a sustained long term contraction ?
3 in a global economy which outsourced all model t manufacture to cut price workers abroad unable to afford cars . . . who would be the consumer ? the car company c e o ? who else ? or would all cars belong to the state ? would they in fact have to manufacture buses ?
4 and what would such a world look like ? moscow 1960 ? wide boulevards and plenty of time to cross the road before the next limo comes along ?
RR says “One other point, I am among the outraged at the fact that the profits made in the past are playing no role in paying for the cleanup.”
And on that point we agree. And I would add the bonuses made in the past.
Twofish,
In the arena of credit, quantity of money, velocity of money, debt/gdp ratios, etc, there is a critical difference between the concepts of equilibrium and reversion to the mean.
Equilibrium involves a stable, dynamic balance of forces that have a “flywheel” effect in which specific elements can suddenly accelerate for a while, but their relationship to the dynamic whole usually pulls them back, while the overall speed and direction stays about the same.
The idea of a moving equilibrium – such as the notion of the “Great Moderation” – with rapidly expanding credit and debt/gdp ratio – is attractive when you’re the beneficiary of some aspect of it (such as low interest rates and low unemployment), but it’s a flawed and self-serving fantasy.
There is no flywheel-like stability in consumer-spending-funded growth that requires household debt to rise parabolically beyond 150% of income to be able continue. Rather, there is simply an exponential spike in debt-funded growth, the instability of which may be temporarily obscured by the conjunction of one-time events such as the China Syndrome (rapid insustrialization with the emigration of cast cheap labor pools from the countryside to the city), the sudden explosion of non-regulated new, cheap credit, and so forth.
In such a crdit spike, no moderation or new paradigm has been created, just an old-fashioned “party while the music is playing” debt binge. The inevitable credit contraction is nothing more than a reversion to the mean in debt/income ratio for households and debt/gdp ratio for the nation as a whole. The integration of the world trade and finance system, which once accelerated the opportunities for leveraging the upside, naturally also accelerates the deleveraging once it starts. No mysteries involved, and no equilibriums then, now, or in the future.
Lots of good stuff in the posts above. I plan to go back and read them all. In the meantime, I am very impressed by the perspective expressed by Michael above.
“reversion to the mean” is an accurate description of where we are heading. Less easy credit; housing value distribution established by income level distribution; less debt.
Except that the among developed countries, the US has a low public debt/GDP ratio, and low savings/GDP ratio.
Let’s talk about what did happen and what did not happen. Because of bad financial regulation, you had wealth pump up a bubble in houses which blow up once the price of houses went to unrealistic levels. This caused banks and financial institutions that invested in those institutions to go bust.
What did *not* happen is:
1) we did not have “capital flight” in which large and persistent trade deficits resulted in people dumping dollars
2) we also did not have “government bankruptcy” in which excessive government debt led to fears of default also leading to capital flight.
gillies: 3 in a global economy which outsourced all model t manufacture to cut price workers abroad unable to afford cars . . . who would be the consumer ? the car company c e o ? who else ? or would all cars belong to the state ? would they in fact have to manufacture buses ?
The answer seems obvious. You print lots of money and drop it from helicopters until you have all of the factories running and people employed.
What seems pretty obvious is that people seem to have forgotten that there really is a price to pay for everything. Debt of any kind generally refers to the idea that you could borrow from someone a certain amount of money that you need to get something done. The most obvious price is interest rate , but just as any poor(ok, poorer) student can tell you, the overdraft has always come with the warning that the bank could call back that loan and money at any time. In a sense the economy is facing the cancellation or recall of overdraft credit en masse.
Nothing is for free. What is of greater concern were 2 news items : that treasuries yield was apparently driven near to zero and that Australian PM apparently thinks shopping/spending can drive the economy out of the present gloom.
For the latter, with all due respect to PM Rudd, what did he think got the world into the mess? The boom of credit facilities, overconsumption based on credit fantasies and the spinning of that into structured finance “casino chips” – who wants to add consumer credit into the current mess?
The former is worrying ‘cos it concerns the financing of all the bailout/stimulus plans, whichever nomer you prefer. Maybe that’s just the worrybug speaking but quietly aghast is probably going to be the mood soon and that’s awful.
Yeo: What seems pretty obvious is that people seem to have forgotten that there really is a price to pay for everything.
Not always. If you have full employment and full production, then you can’t expand production without causing inflation. If you don’t, you can.
Yeo: Debt of any kind generally refers to the idea that you could borrow from someone a certain amount of money that you need to get something done.
Savings is a form of debt. When you save something the bank owes you money. All finance is based on debt, the only question is who owes who.
Yeo: Nothing is for free.
Sometimes you can get something for free. You have factories. You have people. If the only thing that keeps things from working is money, then print it.
Yeo: For the latter, with all due respect to PM Rudd, what did he think got the world into the mess?
So we spend our way out of this gloom, create another bubble, and then seven to ten years later it pops, and we start the cycle all over again. The alternative which people seem to be suggesting is that somehow it is better to live in a state of permanent depression and gloom rather than have these boom-bust cycles.
Brad,
I would recommend to everyone interested in the “grate Moderation” the arrticle by Davis& Kahn in the Journal of Econ. Perspectives (Vol 22 # 4). Not only does it look at the noticable reduction of overall output volatility during the past 35 years (of course the data end in 2006) , but also at various ways to decompose that phenomenon, and provide partial explanations. As D & K conclude:
” The Great Moderation brought few benefits in the form of lower consumption volatility or reduced economic uncertainty for individuals and households” Extending the data series into the present might add a little emphasis to that conclusion.
Here is a great speech by Bernake.
http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2004/20040220/default.htm
Also, it too early to say whether or not the Great Moderation has ended or not. If we go through a year of hell, and then things stabilize for another decade, then we are still looking at more moderation than we’ve historically seen. If not, then not.
One thing that was really useful was that Bernake started off by classifying the explanations of the Great Moderation (one of which was “Good luck”). It might be useful if someone exhaustively lists the explanations for what is going on right now on a web page so that we can compare and contrast.
gilles, thanks for the thought experiment.
my 2 sense:
perhaps part of the patchwork (all over the global network) will be cooperating local economies as well?
(some poor may be rich and some rich may be poor)
1 sustainable long term
2 whatever the consumer wishes to pay (as long as they can find someone willing to accept that is)
3 buses running on used veggie oil from mcdonalds and chinese fry joints
4 havana (hopefully with as many colors)