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The global savings glut and the current crisis

by Brad Setser
January 9, 2009

I have always believed that the debtor and the creditor tend to share responsibility for most financial crises. One borrows too much, the other lends too much. Wynne Godley (ideologically, no Hank Paulson), Dimitry Papadimitrriou and Genaaro Zezza seem to agree. They write:

“The process by which U.S. output was sustained through the long-period of growing imbalances could not have occurred if China and other Asian countries had not run huge current account surpluses , with an accompanying “savings glut” and a growing accumulation of foreign exchange reserves …. flooding the US market with dollars and thereby helping to finance the lending boom. Some economists have gone so far as to suggest that the growing imbalance problem was entirely the the consequence of the savings glut in Asian and other surplus countries. In our view, there was an interdependent process in which all parties played an active role. The United States could not have maintained growth unless it had been happy to sponsor, or at least permit, private sector (particularly personal sector) borrowing on such an unprecedented scale.”

Thanks to Martin Wolf for highlighting the Godley et al paper.

Their argument seems right to me. Absent a large savings surplus in Asia and the oil exporters, rising US rates would have choked off the housing bubble much earlier. High long-term rates aren’t conductive to rising home prices — and without rising home values it is hard to turn a home into an ATM. Felix Salmon writes:

it was the global liquidity glut, and the concomitant demand for a bit of extra yield on fixed-income assets, which encouraged the lax subprime underwriting which etc etc. If the world hadn’t been perfectly happy to throw trillions of dollars a year into America bottomless appetite for capital, the bubble would never have happened, and neither would the subsequent bust.

At the same time, US policy makers didn’t exactly try to reign in US borrowing or leverage in the financial sector. They were far more likely to cheer this process on than to try to get in the way.

Five additional observations:

There is little point denying that there was something of a “savings glut” in much of the emerging world. Just look at Table A16 of the statistical appendix of the IMF’s WEO. In 2006, 2007 and 2008 the developing world’s savings was around 33% of its GDP, well above its 24% average in the late 80s and 90s. That allowed emerging economies to both increase investment above their historic levels (think of all the construction in the Gulf and China) and at the same time lend unprecedented sums to the US and increasingly Europe. (Graph here)

There is actually much more evidence of a savings glut from 2006 to 2008 than there was back in 2003 and 2004. In 2003 and 2004, it was plausible to argue that the emerging world — counting the Asian NIEs — was suffering from investment draught. Savings rates in the developing economies were only a bit above long-term averages. That argument though didn’t work in 2007 and 2008. Average investment rates in the developing economies by then were well above their historical averages – around 29% in 06-08 v 25% in the 80s and 90s — even as the developing economies were running record current account surpluses.

Global savings also rose above its long-term average in the 2005 to 2008 period, though not by as much — as the offsetting deficit in the US reflected a fall in US savings far more than a rise in investment. US national savings was 14% of US GDP in 2007 — and 12.5% in 2008; it was more like 16% of GDP in the late 80s and 1990s. As Godley, Papadimitriou and Zezza illustrate, high levels of household borrowing to support high levels of current consumption kept the US household savings rate down. US Investment by contrast wasn’t above its level in the late 80s or 90s, especially after residential investment started to fall.

Central banks reserve growth in the savings surplus countries carried this surplus to the US. Most emerging economies with large savings surpluses were, until recently, also attracting private capital inflows. Private investors globally, in other words, wanted to finance deficits in the high growth emerging world not in the US. In most of the big surplus countries, reserve growth (counting a sovereign fund if there was one) exceeded the current account surplus (See the WEO Statistical Appendix Table A13). That is telling.

Central banks didn’t buy many subprime mortgages or CDOs of CDOs, and thus were not directly financing the riskiest borrowers in the US economy. They needed some accomplices to finance high levels of US consumption when the US fiscal deficit came down after 2004. Central banks didn’t lend to borrowers trying to home that they really couldn’t afford, or to Americans borrowing against their homes to finance a vacation that they couldn’t really afford. The entire process could only be sustained as long as private intermediaries were willing to take the credit risk central banks generally speaking didn’t want to take.

The process that led to the boom in risky assets was indirect: Central bank demand for safe assets drove down the return on safe assets and encouraged private sector risk taking. Private banks, famously, didn’t want to sit out the dance. James Kwak of The Baseline Scenario writes:

All of the U.S. dollar reserves held by all of these countries were effectively loans to the U.S. Treasury bonds were loans to our government; agency bonds were loans to our housing sector. This large appetite for U.S. bonds pushed up prices and pushed down yields, lowering interest rates and thereby fueling the U.S. bubble. Even though the money didn’t go directly into subprime lending, it lowered the costs for all the investors who were investing in subprime. so at the same time that irrational beliefs about asset prices were driving those prices up, the increased availability of money looking for things to buy also drove prices up. Looking at it counterfactually, if there had not been so much global demand for U.S. assets, it’s unlikely that even the once-divine Alan Greenspan could have kept 30-year mortgage rates as low as they were, since the only lever he had control over, the Fed funds target rate, is an overnight rate. And if mortgage rates hadn’t been so low, the bubble couldn’t have been as big.

Of course, the US regulators didn’t exactly try to stop this process. Nor did the Fed try to counter surprisingly low long-term rates by raising short-term rates more. It was far easier to argue that low long-term rates (and a run-up in home prices) was a natural consequence of the Great Moderation.

The impact of US policies to restrain domestic demand on global adjustment is complicated by the the fact that the large savings surplus countries peg to the dollar. Suppose the US takes steps that restrain domestic demand growth (tighter regulation of risky lending, tighter fiscal policy, higher policy interest rates). The result would tend to be slower US growth — and less US import demand. Less import demand translates into a smaller current account surplus in the exporting countries. Their income falls a bit, and unless spending or investment falls, their savings would fall too. That is the first effect. But a US slowdown — at least one not induced by a strong rise in US rates — tends to put downward pressure on the dollar. The US imports a lot, but a US slump still has a bigger impact on activity in the US than activity in the world. And a slowdown in the US — especially one that leads to lower rates — tends to put downward pressure on the dollar. If say China (or any other major emerging economy) pegs to the dollar, their currencies go down too — and that tends to push up exports to places like Europe that let their currencies float. That keeps Chinese income and savings up.

And if a weaker dollar leads to higher commodity prices even as the US– still a big commodity importer — slows, that helps support savings in the commodity exporters.

That dynamic, remember, is more or less what happened from 2006 to 2008. The US slowed — and US domestic demand growth no longer was the engine of global demand growth. The trade deficit was still big, but it wasn’t growing — and the non-oil deficit shrank. US domestic demand growth lagged European demand growth in 2007 and 2008 (IMF WEO Table A3). But the savings surplus of the emerging world remained large — driven by an expansion of China’s savings and current account surplus and by high commodity prices. The dollar’s depreciation — in a context where China depreciated against the dollar and restricted demand growth to avoid over-heating — helped to shift the deficit that offset China’s surplus to Europe. If China didn’t depreciate along with a slowing US, the dynamics could have been different. Rather than relying on exports to Europe and the commodity exports to keep export growth up even as exports to the US slowed, China might have been pushed to take steps to support its own domestic demand earlier. At a minimum, it wouldn’t have needed to restrain lending and run a tight fiscal policy to limit inflation.

The emerging world’s savings surplus should fall in 2009; among other things, that implies that most the rise in the fiscal deficit of the advanced economies will need to be financed domestically. The oil exporters won’t be saving much at all at current oil prices. Big fiscal surplus will in some cases turn into big fiscal deficits. And I doubt that China’s savings rate will rise enough to offset the fall in the commodity exporters’ savings. In other words, the windfall to commodity importers won’t all be saved. Aggregate emerging economy savings — relative to emerging economies’ GDP — should fall. That would, absent a commensurate fall in investment, bring down the emerging world’s current account surplus. And that, in turn, implies a fall in the offsetting deficit of the advanced economies. The only real risk here is that a huge fall in investment in places like China and Russia keeps the aggregate surplus up … in other words, the investment drought might reemerge.

What then should the world do now that the process where rising consumption and falling savings in the US and Europe supported export-led growth in the emerging world has come to an end? The US has taken the lead in adopting macroeconomic policies to try to offset what most expect to be a sharp slowdown in US — and global — activity. That could, if big enough, eventually trigger a recovery in the emerging world’s exports and thus bring up their income and savings. After a harsh down cycle, the old relationship could be restored — with large US fiscal deficits playing the same role that the large increase in borrowing by US households formerly played. But, as Martin Wolf ably illustrates, it would be a mistake to rely too heavily on a US stimulus to support world demand. Far better if surplus countries do their part. Dr. Wolf writes:

The US and a number of other chronic deficit countries have, at present, structurally deficient capacity to produce tradable goods and services. The rest of the world or, more precisely, a limited number of big surplus countries – particularly China – have the opposite. So demand consistently leaks from the deficit countries to surplus ones. In times of buoyant demand, this is no problem. In times of collapsing private spending, as now, it is a huge one. It means that US rescue efforts need to be big enough not only to raise demand for US output but also to raise demand for the surplus output of much of the rest of the world. ….

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.

Yet we have a golden opportunity to turn away from such a course. We know better now. The US has, in Barack Obama, a president with vast political capital. His administration is determined to do whatever it can. But the US is not strong enough to rescue the world economy on its own. It needs helpers, particularly in the surplus countries. The US and a few other advanced countries can no longer absorb the world’s surpluses of savings and goods. This crisis is the proof. The world has changed and so must policy. It must do so now.

The alternative to global adjustment is a world that relies on huge and sustained fiscal deficits in the US to sustain an acceptable level of global demand. That isn’t very appealing. It works for a year or two. But not for ten.

Godley, Papadimitrriou and Zezza argue — quite correctly — that the more a fall in the US (non-oil) deficit contributes to the United States’ recovery, the less the burden on fiscal policy. But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth.

136 Comments

  • Posted by DJC

    Oh please Brad, the “Savings Glut” thesis is nonsense simply because the global excess US Dollar liquidity can only be created by the Federal Reserve. Unless one believes the US Dollar is counterfeited by foreign central banks, every reserve US Dollar of the China PBoC was originally printed by the US Federal Reserve. The Federal Reserve is the only entity that has the legal authority to print US Dollars in unlimited quantities.

    Federal Reserve monetary policy targeted US inflation levels which were artifically depressed by global labor artitrage from US multi-national corporation. The Federal Reserve made a critical mistake of not targeting “money supply”. The resulting failure has been a historic “credit bubble” that has massively misallocated capital into a “Housing bubble”.

    Furthermore, Alan Greenspan believed that the Federal Reserve could print as much money as possible under “US Dollar hegemony”. US Dollar hegemony is the political construct whereby strategic commodities especially oil are exported in US Dollars only. Everyone needs Oil so everyone needs US Dollars. The US Dollar is de facto backed by the US military protected regimes of the Gulf Arab Oil states.

    Real economic wealth from China was exported for “fiat” printed US Dollars. For the past two decades, Americans were able to consume for free while the Chinese worked for free.

  • Posted by Albion

    Interesting digression on the malfeasance of creditors versus benevolent debtors, whilst right in the essence of today’s banking theory and practices.
    Let us examine the bearings:
    On productivity, it denies that money borrowed could require marginal productivity as a purpose of the loan (to be construed as forced consumption of goods by the debtor)
    On debt borrowing capacity (let us say debt in relation to assets and not cash flow) it implicitly accepts the facts that a major country needs to be steered by its lender i.e. It requires the monitoring of its repayment ability and its excessive indebt ness.
    All in a sad conclusion for a bank, more saddening for a private debtor but a tragedy for major nations and it exemplifies the demise of the banking sector.

  • Posted by DJC

    Brad Setser: .. so its savings rate implicitly is coming down in your forecast

    DJC: I forecasted the US Trade Deficit would eventually decline due to the rising bankruptcy of the US consumer. But no, the Chinese household savings rate won’t be falling, but rising further under current economic conditions. In Japan, recessionary conditions precipitated an even further rise in the savings rate. Even under Communist rule, the China PBoC can’t hold a gun to the heads of the Chinese population to spend.

    The deficit in demand in the Chinese economy can only be offset by Chinese fiscal spending especially for railway infrastructure development. Railway construction in China is sorely required. The United States with a smaller population still has more railway trackage than China. Currently, China Railway can only meet 30% of freight demand since the military and passenger trains are given the highest priority, respectively.

  • Posted by wally

    Too much credit = debt deflation. But rather than allow the debt to be destroyed, the US and other countries try to preserve it by moving it over to government deficits, where it still remains as future debt to the taxpayers. So: no net change.
    Does that policy really make any sense?

  • Posted by DJC

    The Bernanke Federal Reserve is desperately trying to get every American to borrow. I am suggesting you cut all unnecessary spending cold turkey. We cannot spend ourselves to prosperity. It is simply impossible. Job losses are going to skyrocket, few jobs are safe and the best thing to do is to be mentally prepared to be working fewer hours.

    The official unemployment rate is 7.2%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

    There is no official US government definition of depression. Here is mine. When the U-6 unemployment rate rises above 12.5 in conjunction with a stock market that is down close to 50%, it’s an economic depression.

    The United States Economy is now entering an Economic Depression.

    http://globaleconomicanalysis.blogspot.com/2009/01/jobs-contract-12th-straight-month.html

  • Posted by ReformerRay

    Brad – I admire your manipulation of cross-country data flows but your analysis is flawed by your acceptance of the common view that these financial flows control the size of the trade deficit.

    The so-called saving glut is misnaamed, as DJC says. It is really a consequence of two flows from rich countries to the developing world. There is the flow of dollars from the U.S. to pay for the current account balance. There is the flow of investment dollars from all the rich countries to the developing world. That second flow has a long tradition and is valuable in that it increases the earnings in both the developed and undeveloped world.

    These two flows are all there is to the increase in liquidity in the developing world. It is not a danger to the U.S. And it is not responsible for the U.S. trade deficit. Bernanke’s famous speech on this topic may have won him his current seat but it was totally wrong in its assumptions and conclusions.

    So long as the U.S. has a large trade deficit, some other countries will have a large trade surplus. The equation S = I + Trade Balance holds in reality as well as in the formula. Savings in the U.S. will be low if the Trade balance is negative, unless investment is much larger than the negative trade balance. This reverses the usual assumption, but it is the reality that economists are going to have to get used to.

  • Posted by pebird

    I love the quote “Achievements of decades may collapse almost overnight.” Sounds like my retirement fund.

    Isn’t global savings “surplus” a consequence of global demand suppression? Isn’t the cause of having “surplus saving” the restricted consumption in developing countries? Or do they have everything they need already?

    The “global savings” hypothesis just doesn’t fit with the Chimerica thesis. Instead consider that Chimerica was designed for serial bubble generation.

    There is more than enough global demand – the problem is that what is needed isn’t being produced – no one wants more electronics, toys and adulterated food.

    And since wages in the U.S. aren’t going up and every asset source has been drained, the question isn’t where demand is, but where can you find a buyer who has disposable income. It doesn’t matter if the stuff from China only costs a penny if you’re broke.

  • Posted by ReformerRay

    “Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight”.

    It is my devout wish that a form of nationalism will return to the U.S. and will recast the U.S. trade policy to focus on U.S. acts that will reduce the size of the U.S. trade deficit. I want to see a collapse of the tradition that world international trade will increase by reducing the size of the production that occurs in the U.S. Any nation, even a formerly rich one, who expects to prosper in the global economy must create and maintain means to produce goods and services that can be sold on the international market. To get there, the U.S. must reduce imports to the level of exports. That is the only way a rich country like the U.S. can recover its former productive capacity.

    Martin Wolf will lead the U.S. astray. I hope his advice is rejected.

  • Posted by ReformerRay

    pebird has it right: “Isn’t global savings “surplus” a consequence of global demand suppression? Isn’t the cause of having “surplus saving” the restricted consumption in developing countries? Or do they have everything they need already?’.

    Exports are the engine that drives economic growth in all nations. When any nation achieves a trade surplus, their growth rate moves higher than the trading partners (in so far as trade influences economic growth). Thus undeveloped nations grow ther economies faster when they have a trade surplus. The experience of Japan, then Taiwan, then South Korea, then China, then Japan demostrates this reality.

    It is in the interestes of all the other nations of the world who do not have a trade surplus and who wish to participate in the global trading system, to insist that equal trade will be their motto and guide. If the consumer nations, like the U.S. and Great Britain would insist on equal trade, their trading partners would continue to grow, but at a reduced rate, which would be more easily managed. Equal trade for the U.S. and GB would encourage the developing nations to create a more balanced economy for themselves.

    Equal trade is the new trade ideal, to replace free trade. Equal trade for all nations should be the new basis for a revised WTO.

  • Posted by phaedrus

    Always thought “savings glut” was too simplistic and an escapist proposition put forth by Greenspan types.

    Interesting ECB paper – http://www.ecb.int/pub/pdf/scpwps/ecbwp911.pdf

    And nice piece on the so called knowledgeable get it totally wrong – including one mr.summers : Ignoring the Oracles

    http://blogs.wsj.com/economics/2009/01/01/ignoring-the-oracles/

  • Posted by phaedrus

    “Exports are the engine that drives economic growth in all nations. When any nation achieves a trade surplus, their growth rate moves higher than the trading partners (in so far as trade influences economic growth). Thus undeveloped nations grow ther economies faster when they have a trade surplus. The experience of Japan, then Taiwan, then South Korea, then China, then Japan demostrates this reality.”

    Err.. India ? Has trade deficits and grows faster than most (with the exception of China) ?

  • Posted by babar

    > The entire process could only be sustained as long as private intermediaries were willing to take the credit risk central banks generally speaking didn’t want to take.

    Yes: because the central banks and sovereign funds were crowding all the “safe” investments, there was no return to be had there. private intermediaries took risks. because the return of safe investments was low they could justify leverage, thereby increasing the amount of capital they had. this in turn lowered spreads on risky investments and forced players to leverage further to make a reasonable profit. (note that there was no extra return but because everyone was leveraging there was more money so you had to increase notional to make a reasonable return.) the massive inflows into hedge funds and other leveraged vehicles were a symptom of this.

    now it is all reversing.

    wouldn’t it be great if we had strategies focusing on increasing actual productivity ie return?

  • Posted by anon

    Advice for the savings glut debate:

    “He who blames others has a long way to go on his journey. He who blames himself is halfway there. He who blames no one has arrived.”

    – Chinese proverb

  • Posted by DJC

    End Game for Globalization

    China’s Ping An Insurance Company boots out Chief Investment Officer John Pearce from Australia. Since Pearce’s departure, Ping An appears to have decided not to appoint a replacement. Ping An will be stepping back from the international stage to concentrate on the domestic Chinese market. The China Insurance Regulatory Commission (CIRC) commented publicly that it was not happy with Ping An’s aggressive overseas expansion.

    http://www.businessweek.com/globalbiz/content/jan2009/gb2009019_743227.htm?chan=globalbiz_asia+index+page_top+stories

  • Posted by ReformerRay

    India growth and the trade deficit.

    Perhaps India does have a trade deficit today. My image of India and trade is formed by data provided by D. Irwin, “Free Trade Under Fire”, page 44, where he shows how Per Capita growth of GDP took off after 1991, when India opened its door to imports.

    I have no data on either exports or imports into India. I assumed India followed the path of the other nations. If it did not, it is an exception to be explained. Taken alone, the one case does not destroy the generalization.

  • Posted by seatrus

    The current financial crisis started with the economical policies of Regan and Thatcher, and that was the reckless tax reduction for the super rich and the deregulation of the financial system. The root cause of all economical cycles is income disparity and mismatch between investment (by the few who are rich) and consumption (by the many that are poor).

    The current financial crisis demonstrates that low income cannot be compensated with increased money supply and loans, and decreased consumption due to stagnant in real income cannot be propped up forever with credit expansion based on speculative bubbles.

    The Fed kept the interest rate too low for too long, which hampered savings and encouraged consumption and speculative investment. The low savings rate in the U.S. is due to the Fed’s policy of “forced consumption”, not because of cheap Chinese exports.

    On the other hand, the growth of the Chinese export reflected the flip side of the Fed’s loose money policy. It was the foreign investment which fueled the expansion of the Chinese export manufacturing sector, whose products were too expensive for the Chinese consumers. If the foreign investments had geared toward the Chinese domestic market, the consumption in China would have been much higher. But who would have invested for the much lower profit margin of the Chinese market, except a few auto makers? Basically, each country invested in China for the country’s own domestic markets. Free trade should remain free. It is not the cause of the current financial crisis.

  • Posted by DJC

    Quote of the Week:

    “The United States has a Ponzi Economy” – Bill Gross

    http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/IO+Gross+Jan+09+Andrew+Mellon+vs+Bailout+Nation.htm

    Madoff’s scheme has a host of culpable look-alikes and one has only to begin with the mortgage market to understand the similarities. Option ARMs or Pick-A-Pay home loans allowed homeowners to make monthly payments that were so small they did not even cover their interest charges. Two million mortgagees either chose or were sold this Ponzi/Madoff form of skullduggery, believing that home prices never go down and that shoppers never drop. One can add to this the trillions in home equity/second mortgage loans that extracted “savings” in order to promote current instead of future consumption, and one begins to realize that Bernie Madoff and our cartoon’s Wimpy had company all these years.

    What about the shabby performance of the rating agencies? Were they not equally at fault for perpetrating a giant charade that was bound to end in tears? Of course: Aaa subprimes structured like a house of straw; Aaa monoline insurers built like a house of sticks; Aaa credits like AIG, FNMA, and FHLMC where only a huff and a puff could expose them for what they were – levered structures dependent upon asset price appreciation for their survival. Ponzi finance.

    I will go on. Municipalities with begging bowls now extended for over a trillion of Federal taxpayer dollars, based their budgets and their own handouts on the perpetual rise in home prices, the inevitable upward slope of sales taxes, and the never-ending increase in employment and personal income taxes. To add injury to insult, they conveniently “balanced” their books with a host of accounting tricks that Bernie Madoff could never have come up with in his wildest imagination. Now, with cash flow insufficient to meet current outflows, they are proving my point that we have met Mr. Ponzi and he is us – all of us: auto companies that siphoned sales dollars to make labor peace instead of research and design expenditures; hedge funds that preposterously billed investors for 2% and 20% of nothing; a President and politicians who thought they could fight a phony war for free and distract the nation’s attention from $40 trillion of future social security and health care liabilities. Ponzi, Ponzi, Ponzi.

  • Posted by August

    Brad and other “Savings-glut” heads:
    Money itself is neutral. You can use the money to do useful things like building up productive technologies, enterprises etc. You can also use it to buy a gun and kill people.

    China lends the US money for nearly free. The americans use the loan to create the liar-loan for housing, CDO, MBS etc. It’s really immormal to put the blame on the chinese for the mess created by the US goverment and wallstreet.

  • Posted by gillies

    still takes two to tango -

    every earnings glut is a spending glut. every borrowing binge is a lending binge. every bout of extravagance leads to a paradox of thrift. every formula one driver tries to brake harder on the first bend of the grand prix – so there is competitive deceleration. every bust is caused by a boom. every 1932 is caused by its particular 1928. every drunk resents the barman – first for refusing him, then when he thinks about it in the morning, for serving him.

    every nation that outsources employment and arbitrages wage differences, sooner or later reduces global wages, reduces consumption, and thus creates a production glut. thus the exporting of employment ends in the exporting of unemployment.

    ireland imported polish workers to do the low paid work and took up jobs in dell computers, who had outsourced to ireland. now dell is outsourcing to poland, and the irish poles can go home. ireland has taken a body blow from an ‘invisible hand.’

    we had had ‘gorge yourself and swell’ – now we have ‘shrink and suffer.’

    economists complain about imbalances – and yet the whole objective of crude economic activity is to maximise growth – not to balance.

    the globalisation project tends to create a synchronised global economy – fine in the boom. the price is synchronised slump. so globalisation is a nonsensical plan in the longer term. dell goes to poland where wages are still lower. but ireland cannot now afford to buy so many computers . . . globally wages are down, production is maintained, sales are down, that’s slump. more irish houses are repossessed than new mortgage lending is created for new dell workers in poland.

    superpowers and multinationals are dinosaurs. the survivors will be the economic equivalent of the rat – omniverous, small, mobile, ruthless, flexible, resourceful, evasive, ubiquitous, multiple, independent.

    protectionism boosts nationalism, nationalism boosts protectionism. protectionism reduces consumption of commodities and thus global pollution.

    the billionaires should study the 14th century. eventually you can be so successful that a ragged crowd goes down to the harbour and trashes all the yachts, or castles, or whatever.

    don’t take away obama’s blackberry. living entirely in the bubble is what makes these disconnections more likely.

    far eastern nations may yet use up all their reserves to defend their currencies.

    but before that happens we may all see the british – oil exhausted, financial income decimated, muslims with nowhere to turn, zirp process at the end of the road – fall off the cliff first.

    if they fall to printing money – ben bernanke will have another interesting episode to study.

  • Posted by DJC

    $45 Trillion Credit-Default Swap Collapse to decimate US Financial Markets

    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aHCnscodO1s0

    Expect the financial landslide to cascade through high-yield bonds, commercial mortgages, leveraged loans, credit cards and — the big unknown — credit-default swaps, Morris says. The notional value for those swaps, which are meant to insure bondholders against default, covered about $45 trillion in portfolios as of mid-2007, up from some $1 trillion in 2001, he writes.

    Credit hedge funds are now the weakest link in the chain, Morris says. Their equity stands at some $750 billion and is so massively leveraged that “most funds could not survive even a 1 percent to 2 percent payoff demand on their default swap guarantees,” he writes.

    Morris sketches a scenario in which hedge fund counterparty defaults would ripple through default swap markets, triggering writedowns of insured portfolios, demands for collateral, and a rush to grab cash from defaulting guarantors. The credit system would suffer “an utter thrombosis,” he says, making the subprime crisis “look like a walk in the park.”

  • Posted by koteli

    Thumbs up, gillies.

    As Dean Baker says, if globalisation were allowed for doctors, journalists and economists, we’d be in another world.
    Those “classes” are like the roman church: they say one thing and do the opposite, while living from the state milk.

    To bsetser,
    Even the title is wrong, because the savings glut is not global at all; it’s the crisis what’s global. Don’t imbalance it more, please!

    And dear Brad, what kind of “glut” caused the leveraging of debt by anglo-saxon financial engineers to bring the “greatest economy of the world” to its knees? The savings of hard labour employees of china?

    It’s overwhelming that someone makes guilty of his profligacy the neighbour who saves. Even more, when that neighbour works for a tenth of the price.

    And then, you, big-brained economist put the blame in the “neighbourhood”, forgetting the relations between bosses and employees, intermediaries, who benefits and so on.

    You’ve got the reserve currency of the world, you spread preemptive war with borrowed money, then you cut taxes for the riches, later you spread out toxic waste to the world in a race to nowhere to get out of previously created crisis and so on.

    You’ve got the biggest MSM-drums of all time (now in crisis too) to lie all the time. But stop looking to your navel while comparing it to the world.

    Now that we all are subprime, you should start talking about money flows to the military-industrial complex, and all is liabilities. You should talk about those middle class usamericans that can’t go out on friday spending a week-worth of a chinese famili savings, because they have no credit and their wages are not what they used to be. Those millions on food stamps. Those millions without medical insurance.

    It’s very clear that something will change in usamerican economists, journalists and doctors brains if this crisis is to be resolved without a war.

    A reduction by a half of military expenses, and a reality check of “the greatest economy of the world” (Stiglitz words).

    You’ll print dollars as if there’s no tomorrow, calling it quantitative easing. But sooner or latter, you’ll find the truth face to face, as the rest of the world.

    In between, please, don’t talk about imbalances as if they were ruled by Archimedes Principle of fluids flows, for stupids: if I put a stone in the water, the stone goes down and the water comes up.

    It’s the gravity stupid, not the stone not the water, and the globalised connections in between!, used to say a friend of mine.

    The metaphor is to ask you to forget the stone, the water and the flows in between. We need, as you, to analyse “gravity” in globalisation, a word very close to grave in both senses in english, and stop blaming the poor chinese people. And talking about democracy, they are a bit worse, of course, but you’ve lost a lot of it in USA, without realising about it.

    Sorry for the rant to everybody!

    It’s depressing!

  • Posted by ReformerRay

    ” Basically, each country invested in China for the country’s own domestic markets. Free trade should remain free. It is not the cause of the current financial crisis”.

    Free trade is not the cause of the current financial crisis. It’s role was very indirect. Free trade produced a trade deficit in the U.S. which reduced the % of corporate wealth earned by manufacturing from 45% in 1980 to 19% in 2005. Investors and the political elite were happy to learn that the financial sector could create “profits”, some of which could be given to politicians.

    If the U.S. had insisted upon equal trade after 1985, profits would have been less concentrated in the financial sector. POSSIBLY, more sources of profits would have reduced pressure on the financial sector to keep discovering new ways to create “profits”.

    Even as a state this thesis, a little voice is telling me that I have a weak argument. Free trade probably had little to do with the financial disaster.

    My main point should be that Taiwan invested in China, in the early days, to produce goods to sell to the U.S.

    Nothing in Mr. seaturus’s discussion provides any justification for his conclusion that free trade should remain free. Free trade has produced a disaster in the manufacturing sector of the U.S. economy, a disaster that was unnecessary, as the success of Germany shows. The U.S. did not manage trade to its own benefit. Other countries were not so stupid.

  • Posted by ReformerRay

    Credit Default Swaps are frightening precisely because they are unknown, not because their size is known. No one knows the extend of credit default swaps that exist in the world. Before Lehman’s went bankrupt, some had guessed that they were involved with 400 billion in CDS. At bankruptcy, all the positions were settled with an exchange of 5.5 billion dollars.

    I agree that ignoring the CDS is like ignoring the elephant in the room because you are afraid you can’t handle it.

    Forget trying to provide enough money to banks. Instead, provide some way to reduce the size of the CDS in existence. The best, quickest way is to allow AIG to go bankrupt.

  • Posted by RebelEconomist

    Brad,

    No matter how many times you, or anyone else, repeats this argument: “Central bank demand for safe assets drove down the return on safe assets and encouraged private sector risk taking”, it remains at odds with the fact that spreads tightened (ie spread product yields fell by more than safe asset yields) during the boom.

    In my view, the credit boom was domestically driven and drew in imports, and the surge in China’s intervention followed from its long-standing fixed exchange rate policy.

  • Posted by bsetser

    Rebel — as i have argued at length, the fall in spreads reflected the redeployment of funds from safe to risk assets as private investors sold treasuries and agencies to central banks. the desire to keep returns up by increasing leverage even as spreads fell also played a big role — and ended up leading to the ruin of the financial sector.

    Babar describes this process well. And someone like Peter Garber at DB would tend to agree with me on this. Obviously you don’t.

    DJC — nothing required that China (and others) hold onto the the dollars they received in payment for their exports; they could have been exchanged for US goods — China’s decision to hold dollar assets rather than dollar goods was its choice. See the James Kwak link for more on how China’s efforts to restrain domestic growth at the height of the boom freed up its savings to lend to the US; china ended up with more $ assets and less domestic inflation as a result.

  • Posted by koteli

    The CFR is clearer than ever, Brad.

    Tkx!

  • Posted by Twofish

    I still don’t buy this “savings glut” argument.

    Suppose we didn’t have any subprime lending, and mortgage lending was restricted only to prime borrowers with good credit histories and employment records.

    I’d argue that in that situation, there might have been a housing bubble and a bust, but still no crisis, because the people paying those mortgages would still be paying them. If you have no set of defaults, then you wouldn’t have had this spiral downward.

    If you have someone with good credit and a job, then they have the means and the will to pay back a loan even if their house price collapses and they are totally underwater. In that situation, you wouldn’t have had the set of defaults that were the first dominoes.

    This won’t work only if you argue that the large amount of money from China made stupid loans inevitable, which is not the case.

  • Posted by Twofish

    ReformerRay: Credit Default Swaps are frightening precisely because they are unknown, not because their size is known. No one knows the extent of credit default swaps that exist in the world.

    This may have been the case in September, but I doubt that this is the situation today. At some point in the last several months, it’s likely that the Fed got all of the investment banks together and said, show me your exposures to CDS.

    It’s also pretty irrelevant at this point.

    At this point I don’t think that subprimes, CDS, or complex derivatives are major problems. Once a house burns down, there is really nothing to see. The problem now is that the fire has spread far, far beyond the initial spark.

    The big problems now are prime mortgages, commercial real estate, credit cards, auto loans. Basically everything that *hasn’t* been a problem up to this point. Right now you have massive job losses which means that a lot of people with good credit histories will stop paying their bills, simply because they have no income.

    This theory of “no subprime -> no crash” is important because right now the Fed is loaning out massive amounts of money in mortgages. If things are purely interest rate driven then we are going to have a big problem soon.

    However, if you have low interest loans available for people with good credit that actually can pay back loans, then I don’t think you will have a problem, since if a person with good credit does the month and realizes that he can’t pay the loan back, he might (gasp) not take the money.

  • Posted by Michael

    Brad,

    Your even-handed analyses of the U.S.-Chinese trade imbalance’s effect on our domestic lending practices (particularly in Agency-backed mortgages) has been reasonable, consistent, and I believe accurate. It would probably help to drop the vocabulary of “savings glut”, since this is somewhere between meaningless and misleading; in any case it was indeed used politically by Greenspan and Bernanke as a cover for not addressing a dangerous growing domestic and international credit bubble.

    Let’s also not forget that we had trade deficits for decades before the housing bubble exploded. But, during the last decade, a huge amount of “new” credit was created outside the Fed-controlled banking system (and – what a shock – within it!) and made available for both massively-leveraged financial speculation (commodities, anyone?) and for massively leveraged home purchases (what is the leverage ratio at 0% down?).

    At a certain point China and others clearly facilitated our self-destruction, but we originated it and were determined to carry it out to the point of collapse (so VERY much “wealth” for some was being rapidly created) that the same process, if not on the same exact scale and at the same velocity, would have occurred with or without other people’s foreign reserves.

  • Posted by Twofish

    DJC: Credit hedge funds are now the weakest link in the chain, Morris says. Their equity stands at some $750 billion and is so massively leveraged that “most funds could not survive even a 1 percent to 2 percent payoff demand on their default swap guarantees,” he writes.

    I seriously doubt that these leverage levels are accurate. Hedge funds are a very good example of how the crisis could have played out with tight regulation. After LTCM, the Fed took the lead in limiting the amount of leverage and risk that prime brokerages offered to hedge funds, so hedge funds are leveraged at most 3-4:1 rather than 100:1 as occurred with LTCM.

    As soon as a hedge fund starts having any major difficulty, a prime broker will call its collateral and cause the fund to liquidate long before there is a crisis. The result of this is that hedge funds have been dropping like flies, and you haven’t been seeing much in the news.

    DJC: Morris sketches a scenario in which hedge fund counterparty defaults would ripple through default swap markets, triggering writedowns of insured portfolios, demands for collateral, and a rush to grab cash from defaulting guarantors.

    There not much of CDS market anymore. That market as already pretty much collapsed, and any hedge fund that specializes in CDS has more than likely had its collateral called by a bank and has been forced to close. At this point, you have massive losses, but those are then borne by rich people that presumably could lose money and not cause a crisis.

    The reason there hasn’t been a hedge fund crisis is that people have been worried about this since LTCM collapsed, and the Fed really tightened risk and lending limits to hedge funds. So when you have a problem, you end up with a controlled collapse rather than a crisis.

    It’s unfortunate that people didn’t do to mortgage lending what was done with hedge fund lending.

    DJC: The credit system would suffer “an utter thrombosis,” he says, making the subprime crisis “look like a walk in the park.”

    The pre-September 2008 credit system is totally dead. If you go to a credit derivatives desk at a major bank, you’ll see lots of people with nothing to do except wait for layoff notices.

    The good news is that Treasury and the Fed worked feverishly to create a new system.

  • Posted by koteli

    This is USAmerika

    From naked capitalism:

    Rubin’s departure from Citigroup would seem to imply that his continued service there, amid the newly critical commentary on his failure to rein in the bank’s pursuit of risk, was no longer a plus. But the real question is: not a plus for him, or not a plus to the bank?

    Citi has also decided to sell Smith Barney, A brokerage unit, which provide solid revenues even in bad times (brokers have increasingly migrated towards asset under management pricing structures) would presumably be attractive to a large bank. But there are comparatively few well capitalized large retail banks these days.

    SH**!

  • Posted by koteli

    DJC will be a little bit happier, BTW.

    Happy New Year!

  • Posted by koteli

    In those times when ex-president Aznar says that Obama is a “historic exotism” and an “economic disaster for the future”, could have be thinking in Rubin & Summers legacy of themselves?

    It’s getting funny!

  • Posted by koteli

    USAmerikan expensong glut in motion, from CR:

    “[PBGC Director Charles E. F. Millard] estimates that the three auto makers only have enough money in their pension funds to cover only 76% of the pension obligations they have made, if they terminate the pension plans. GM’s plan is estimated to be $20 billion, or about 20% underfunded, while Chrysler’s plan is 34% underfunded, leading to a $9 billion-plus shortfall, the agency said. Ford’s funded ratio is not publicly available, but the company’s pension plans are likely running at a $12 billion deficit.

    About $13 billion of the estimated $41 billion shortfall would be covered by the PBGC …”

    The PBGC is another bailout waiting to happen.

  • Posted by babar

    @twofish
    I still don’t buy this “savings glut” argument…This won’t work only if you argue that the large amount of money from China made stupid loans inevitable, which is not the case.

    Good point, but I think that the “savings glut” argument is that it allowed imbalances to continue and be exacerbated. It allowed both the US government and US consumers to be “irresponsible” because the natural consequences of their actions (mass lending => rate increases) did not occur. once that was established they felt they were beyond gravity and nothing could go wrong.

  • Posted by koteli

    Jobless Rate Surges to 7.2% in December

    “The economy lost 2.6 million jobs in 2008, government figures showed, the most since World War II ended in 1945. Nearly two million of those losses were in the last four months alone, a sign that the recession accelerated as the financial crisis intensified, and should drag on well into the new year.

    (…)

    the unemployment rate, which is calculated using a separate survey of households, jumped 0.4 percentage point to 7.2%, the highest since January 1993.

    (…)

    By some broader measures, labor-market conditions are even worse than the main numbers suggest. When marginally attached and involuntary part-time workers are included, the rate of unemployed or underemployed workers reached 13.5% last month, up almost six percentage points from a year earlier.

    This is clearly a sign of US economic superiority over Europe, as it shows vibrantly flexible labor markets, where companies are not afraid to hire because they know they can fire people at a later point. It’s just as clearly a sign that the US will come out of this crisis faster than Europe, as it goes through structural adjustment a lot quicker than the rigidly bound European countries and companies.

    Soon, as buyers take advantage of unprecedented low prices in the more transparent US housing market to make bargains (and profits) there will be a dynamic bounce from recent lows and a new economic surge is around the corner, leaving old and grumpy Europe behind, once again.

  • Posted by babar

    @twofish

    I seriously doubt that these leverage levels are accurate….so hedge funds are leveraged at most 3-4:1 rather than 100:1 as occurred with LTCM.

    most hedge funds have delevered significantly from _highs_ of 3-4 to 1 leverage.

    of course a lot of their investments are internally levered, and it’s difficult to measure “leverage” for a lot of investments (esp credit derivs) which is one reason why these strategies are basically shut down now.

    figure that HF assets were about $2.5T levered roughly 3x or $7.5T and are now $1.5T levered roughly 1.5x or $2.2T. this is a huge disappearance of liquidity. poof.

  • Posted by bsetser

    2fish — agreed. but w/o those stupid loans financing stupid consumption, there would be a shortfall in aggregate demand in the US (as happened) and that would either lead to:

    a) a fall in the $, so Americans would be employed producing goods for the world — and foreign demand would substitute for US demand (incidentally, this happened for china, as the fall in the rmb let china substitute european for American demand)

    or :

    b) a US slump that pushes rates down until a new borrower emerges. that too is happening — the government is taking up the slack now that subprime borrowers cannot get credit.

    or

    c) the US slowdown that turns into a Chinese slowdown (b/c subprime borrowers w/o credit cannot buy the world’s goods) would lead China to either save less (as income falls) and consume and invest at the same pace or to take steps to stimulate domestic demand (pushing up government spending for example) to employ workers previously employed selling goods to the US consumers borrowing to consume.

    the key thing is that if there isn’t a big household deficit in the US financed with subprime loans absorbing the surplus of savings v investment elsewhere in the world, SOMETHING ELSE has to adjust.

    that is basic global macro. savings and invetment have to match globally. a fall in subprime borrowing = less investment in the us (fewer homes) and less consumption (i.e more savings), and that pushes the global economy out of equilibrium (there is now more savings than investment) so something has to adjust …

    I tried to work through how that adjustment happened after late 06/ early 07 (Europe took over from the US, allowing China and the oil exporters to maintain large surpluses — with the fall in china’s exchange rate playing a key role) and as far as I can tell most commentators ignored that part of the argument.

    I would be more persuaded by the anti-glut arguments if:

    a) someone explained why china was restraining demand growth from 04 on with tight fiscal and lending curbs (my explanation: to avoid overheating when exports are providing a powerful stimulus to activity)

    b) if someone explained how the global economy would adjust with a smaller US household borrowing need …

  • Posted by don

    “Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad.”
    I think we will, indeed, find out what will happen.
    The worst fears:
    1) Instability will grow in China with results that we will all be very sorry about.
    2) Fears of U.S. solvency become very real, which would be a truly unique and deep disaster.

  • Posted by koteli

    Dear Brad,

    B) the global economy would adjust with a smaller US household borrowing, just plainly.

    You’ll see how these “borrowing need…”s you were referring were not needs. Just bad business!

    Nobody is need of borrowing to make a leaving as far as they have a job and some insurance!

    It’s not so difficult to understand!

    How many times have you been asking for a loan if it could be known? And what for?

    Tell it, please!

  • Posted by Michael

    Brad,

    The “anti-glut” argument is not that China-U.S. trade imbalances did not enhance, extend, and faliciltate the development of the U.S. credit (and it’s subunit, housing) bubble – you have been correct about that all along. The argument is that such a trade imbalance is neither necessary for a credit bubble nor is it the most important variable. The U.S. had many credit bubbles and busts for a hundred years while it maintained a trade surplus.

  • Posted by koteli

    @ don: “exporting so much of its demand to sustain jobs abroad.”

    This is a bad joke, don. A very bad one.

    To create jobs a joke, too.

    But, why don’t you try to increase the demand of heroin in USA to save Afganistan from Obama’s military justice? A good demand of heroin from USa would make them enough money to make roads and bridges. Don’t you think?

  • Posted by koteli

    @barbar,

    Read this article please:

    http://www.ft.com/cms/s/0/411f8da0-cd6f-11dd-9905-000077b07658.html

    The age of obligation
    By Niall Ferguson

    “Excessive debt is the key to this crisis; it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 356 per cent by the middle of this year.”

  • Posted by Auskalo

    This is getting interesting!

    New Shoes: Obama’s warning that the Bush bailouts will lead to “trillion-dollar deficits for years to come.” That’s the optimistic view. First the Treasury will try to get the money for free, then it’ll raise interest rates, to keep China interested, then it’ll turn on the printing presses.

    http://seekingalpha.com/article/113809-how-will-obama-s-trillion-dollar-deficits-affect-the-markets?source=feed

  • Posted by ReformerRay

    Betser says: “that is basic global macro. savings and invetment have to match globally”.

    Over what time period? This is one of those assumptions that is true by definition ultimately. But it is mistake to assume that they must match at any given time period. Savings in one period can be stored and used in another. Savings and investment do not have to match globally at any given time period.

  • Posted by bsetser

    michael — classically, the need to import savings from abroad to sustain a credit and consumption bubble might be thought of as impediment to the development of said bubble, as foreigners wouldn’t get caught in the mania …

    and if the us had to rely on private financing, that more or less would have been right. private investors abroad got caught up in the .com mania, but not so much in this one. at least not in aggregate. this bubble developed w/o large private inflows.

    i am not arguing that you need a global savings glut to get a bubble; only that such a glut (one engineered in my view by gov policy, and in the case of china, by gov policy designed to support its de facto peg) played a role in this particular bubble and this particular crisis …

  • Posted by ReformerRay

    Continuing – If the trade deficit is a causal variable in the equation Savings equals Investment plus the Trade Balance, then the level of national savings is a dependent variable, its level controlled or determined by the level of investment and the level of the trade balance.

    We know that Gross Domestic Product minus Consumption (public and private) also is a way to calculate the level of National Savings.

    Betser is trying to make inferences based on a limitation that does not exist in the real world.

  • Posted by Indian Investor

    Brad:
    if someone explained how the global economy would adjust with a smaller US household borrowing need …

    First of all you have to understand why I earlier compared you with Marcus Brutus. The reference is to the dramatis personae in Shakespeare’s play “Julius Caesar”. In the play Caius Cassius is the conspirator for the assasination of Julius Caesar with his ‘he doth bestride us like a Colossus’ stuff. Cassius wants to get Julius Caesar assasinated for no real reason other than to have a military coup and take over Rome.
    But he presents the conspiracy to Marcus Brutus as a means to ensure Rome’s continued democracy.Brutus unknowingly joins the conspiracy for idealistic reasons, leading to Caesar’s famous last words ‘Et tu Brute’.
    The real stuff unfolds after Caesar’s assasination, with the battle of Philippi. Even till the last discussion between Brutus and Cassius “If we meet again why we shall smile/If not ’twere well this parting were well made” Brutus is unaware of the real theme of the Julius Caesar assasination.
    Here all this while we’re talking about a play and NOT about historical records and facts. For actual history the formidable Niall Ferguson should be consulted.

  • Posted by ReformerRay

    “if someone explained how the global economy would adjust with a smaller US household borrowing need” … Make that what would happen if the U.S. households reduced borrowing. We will soon get an answer to that.

    The U.S. must go from an economy based on borrowing to one based on earnings. I hope to see borrowing by consumers reduced.

    The global economy will slow down. But, the U.S. role in the global econoomy will be reduced. Global production will adjust to global purchasing power.

  • Posted by bryce

    Niall Ferguson is spot on.

    One problem with the ‘savings glut’ that I can not seem to get beyond is that roughly half of the US & European debt was purchased–not with the savings of individual Asians or Saudis–but with freshly created Yuan, Yen, et al. This credit creation seems distinctly different than the normal conception of saving.

    Actual saving by individuals or corporations expresses (via a market interest rate) vital information about consumer preference to producers. Credit creation by central banks obscures & distorts & misdirects producers into making mistakes that are presently being manifest.

  • Posted by Indian Investor

    According to me ‘the genius and the mortal instruments’ are in council and the China Strategic Economic Dialogue is about ‘treason, strategem and spoils’. The theme is ownership control over all of China’s banks, industrial sectors, etc. The Council is about the impact of US protectionism on the South Asia Oil Geopolitics.
    Here a few small facts are useful and interesting.
    1) Bank Am’s investments in China Construction Bank. There’s a 3-year hold period on Bank Am equity stakes here. Bank Am started its investments in China Construction Bank in July 2005 with around $ 5 billion. The equity stakes had grown to around $ 20 billion plus by November 2008. There was massive appreciation in the China Con Bank stock price over those 3 years. On November 17, 2008, the press reported that Bank Am has doubled its equity stake to 20% of Chin Conscn Bank, bringing the total holdings to around $ 43 billion. So Bank Am went long for around $ 20 billion plus in November 2008. On December 15, 2008, financial media speculated that Bank Am is about to sell $ 3 billion of its shares in China Conscn Bank. The reasoning was that the investment made in July 2005 was free for exit since June 2008 and Bank Am had turned bearish on the stock. When you look at the trend of the data, this speculation holds absolutely no water.
    Similarly you have to go through all the reports since 2004 on the tug of war between the China Banking Regulatory Commission and various foreign banks over FDI in China’s banking sector to know the actual theme.
    My conclusion is that nothing really changed in mid-December. This was perhaps a story planted by some operators on Chinese exchanges which found its way all the way to the Financial Times.

  • Posted by ReformerRay

    Niall Ferguson’s article says that our problem is excessive debt. He describes the 4 traditional ways debts are reduced. All of these solutions or ways result in those granting credit being paid less than they are owed. I do not believe the debts can be reduced by more governmental debt. Current approaches to escape from current problems seem to be making the situation worse.

    Paulson and the Obama team must define the problem correctly if they hope to solve it. I do not believe for a moment that the world economy will cease functioning. It will slow down but it will not explode.

    The role the U.S. will play in that global economy will depend upon how soon we reduce the level of debt. Our ability to reduce that debt must begin with the recognition that debt foregiveness in some form is the only way out.

  • Posted by Indian Investor

    I can continue in this vien and provide more and more facts and information to show what’s really going with respect to China. But that would take a lot of space; it might be more interesting for people to debate current imbalances and so on.
    This blog discussion about current accounts is like a discussion of the Biblical conflict between Jews, Arabs, Christians, Romans, etc to explain what’s happening as we write on the Gaza strip.
    Or like debating all the other excuses given for the massacre in Darfur, the Sri Lanka ‘Tamil war’ or the ‘Ossetian Nationality’ war.
    The political leaders and real stakeholders are expert at the art of creating hypthetical reasons and excuses and propagating them with loud lies in the media so that the real themes remain hidden from public view which will not accept those themes.

  • Posted by Twofish

    bsetser: 2fish — agreed. but w/o those stupid loans financing stupid consumption, there would be a shortfall in aggregate demand in the US (as happened)

    No there wouldn’t if the excess credit was directed at investment or public goods. This would have required far, far more government intervention than was fashionable in 2005, but if the government took Chinese money and then encouraged student loans or small business loans rather than mortgages, the US would have been better off.

    What you are arguing is that bad lending is a natural result of cheap money, and I’m saying that it took an ideology of governmental indifference to cause all of that cheap money to go into bad lending. There’s no reason a priori that the cheap money had to go into stupid loans. If you want to boost demand, there are better ways of doing it. A crash program to build houses on the moon would have left the US better off than what actually happened.

    bsetser: the key thing is that if there isn’t a big household deficit in the US financed with subprime loans absorbing the surplus of savings v investment elsewhere in the world, SOMETHING ELSE has to adjust.

    Sure, and there are dozens of other adjustments that would have been more beneficial than what happened. If you had fewer housing loans and more loans to build research parks and universities and then loans to people to attend those research parks and universities.

    If the US took trillions of dollars in Chinese money and printed it all in $100 bills and buried it in the Rocky Mountains to dig up later, it would have been better off than loaning to subprime.

    If the US government took those trillions of dollars and just *gave* it to subprime borrowers rather than *loaning* it, things would have been better. You would have ended up the same cost to the US government debt, but it would not have resulted in a banking crisis.

    The savings glut thesis makes sense only if you believe that the subprime loan was the best way of dealing with Chinese money. I’ve given two ridiculous examples of policies that I think would have given a better out come. That tells you how truly dreadful, US policy was.

    If instead of loaning subprime borrowers $50,000, the US government just sent them a check for say $50,000 from the US Treasury. Everyone would be better off today. The cost to the US government would have been the same (since no one is going to pay back that $50,000 now anyhow), and you wouldn’t have had a banking crisis.

  • Posted by Twofish

    bryce: One problem with the ’savings glut’ that I can not seem to get beyond is that roughly half of the US & European debt was purchased–not with the savings of individual Asians or Saudis–but with freshly created Yuan, Yen, et al. This credit creation seems distinctly different than the normal conception of saving.

    No. It’s real savings.

    Each time the central bank of China or Japan buy a US treasury bond, then have take the equivalent amount of Chinese or Japanese currency out of circulation or else they get inflation. So for this to work, there has to be a pool of Chinese or Japanese savings that they can take out of circulation. If China and Japan tried to hold on do these huge reserves without local savings, then they’d end up with massive inflation.

    The Middle Eastern countries don’t try to sterilize so when they bring dollars in, they tend to end up with a lot of inflation.

  • Posted by Twofish

    Michael: he argument is that such a trade imbalance is neither necessary for a credit bubble nor is it the most important variable. The U.S. had many credit bubbles and busts for a hundred years while it maintained a trade surplus.

    And the US has had many credit bubbles and busts before without very nearly destroying the world financial system. In the 1930′s after the last time things very nearly fell apart, people started very heavily regulating financial institutions. It took about 70 years to undo all of these regulations, and we finally succeeded and getting the system more or less like what it was in the 1920′s. Hooray!!! Ooopps!!!!

    I don’t think that it is a coincidence that this financial crisis happened right the moment when people that remembered what happened in the 1930′s are passing on.

  • Posted by Twofish

    I would be more persuaded by the anti-glut arguments if:

    a) someone explained why china was restraining demand growth from 04 on with tight fiscal and lending curbs (my explanation: to avoid overheating when exports are providing a powerful stimulus to activity)

    Because at the time, the Chinese economy was overheating, and the logic was that by shipping savings to the United States, it would have been much better investment, since all Chinese banks would do is to spend it on stupid things like real estate, whereas US banks (so they said) would be more efficient at putting it into productive assets.

    One other thing, if you have to have a real estate bubble somewhere in the world, the best place to have it is in the United States. Relatively speaking, a bubble popping in the United States results in less human misery than a bubble popping in emerging markets. The US will have a difficult 2009, but no in the US is going to go through anywhere near the hell that Indonesians, Mexicans, or Argentines have gone through.

    b) if someone explained how the global economy would adjust with a smaller US household borrowing need

    That’s easy. Things would remain the same if with less household borrowing, the US compensated with more enterprise or government borrowing.

    One thought experiment is to think of what would have happened had the US just issued a check to people that would have taken out a mortgage (call it a negative income tax). I’d argue that if the US had just written a no-strings attached check that you would have boosted demand, but not have had a banking crisis.

  • Posted by Twofish

    DJC: We cannot spend ourselves to prosperity.

    Massive government spending is what got the world out of the Great Depression. Keynes worked this out in the 1930′s.

    DJC: It is simply impossible. Job losses are going to skyrocket, few jobs are safe and the best thing to do is to be mentally prepared to be working fewer hours.

    people spend less -> fewer jobs -> people spend less -> even fewer jobs -> people spend even less

    I don’t see what about this is so hard to understand. Now if you spend lots of money while everyone else is running for the hills, you get crushed, which is why you need massive government spending to break this cycle.

    If the Earth was suddenly threatened by space aliens and we needed to build rocket ships to attack the moon, there would be no shortage of jobs.

    We’ve been through this once before. It’s to much to expect that we will get everything right, and people will laugh at us, but at the very least, we can refuse to do what caused things to blow up from 1930-1932.

  • Posted by Twofish

    One other thing. If people were so willing to lend to people with no income and no hope of paying back loans at 2%, then why should they stop if the interest rate is 6% or 8%.

    The people who were making the loans were making money off of fees, so they didn’t care what the interest rate was. The people where getting the loans didn’t care what the interest rate. They just cared about how much cash they could get up front and the monthly payment and you can get them to sign on the dotted line by doing stupid things like cash back rebates or negative amortization.

    Also the last major banking crisis in the US happened in the 1980′s when Volcker raised interest rates to 20%, and it is a model for how you can have a banking crisis form in a high interest rate environment.

    What happened in 1980 was that savings and loans had decontrolled interest rates and were competing for deposits by promising high interest rates. In order to deliver those high interest rates, they invested in extremely speculative investments that went bad.

    So I’d argue that if interest rates *had* been 8-10% and you had lax regulation, that you would had had a banking crises anyway. Banks would have been under pressure to pay huge interest rates on their accounts. Without regulation, they would have been looking for risky and stupid investments (emerging markets, commodities, etc. etc.).

    They would have ended up shooting themselves. For example, they could have ended up offering very high yield fixed interest bonds to depositors, and when interest rates went down, they would have gotten crushed.

  • Posted by geert

    Brad wrote
    “nothing required that China (and others) hold onto the the dollars they received in payment for their exports; they could have been exchanged for US goods — China’s decision to hold dollar assets rather than dollar goods was its choice.”

    I’ve been waiting here for someone to post an alternative for the Chinese to spend their dollars on and only read this “academic” alternative.

    First of all
    - you will buy what you need and your population will buy what it needs and can afford
    - it is better for a developing country to invest than to consume
    - China did spent a lot of $ on building its infrastructure (thru import of materials and oursourcing) and thus created employment and across the board purchasing power; simply it did what it had to do.

    So it becomes more difficult when you try to figure out what usuful stuff they could have bought (on a large scale). Strategical US assets? Not allowed! Military goods? They’ll get the junk. Toys they produce themselves? To put them in the basement or distribute them for free! Fridges for places that have no electricity yet? Yep, I’ve seen that in Africa. …

    True the Chinese government started to restrict the money supply at the top of the boom. Contrary to what is posted here (DJC) the problem wasn’t printing $ but printing Yuan (as the exporters exchange their dollars for Yuan, the Yuan supply expands, not the dollar supply). Who can blame them for combating inflation that was emerging at that specific moment?

    My take
    - The source of the imbalance is mainly the result of that hailed but wicked Ricardian sentence on international work division;
    - combined with the status of the dollar on an international level.

    On the latter I want to make clear that in my sentence “the perverse privilege of printing international money”, the emphasis should not be on “printing” (after all, every nation can print its currency at will) but on the acceptance of the dollar as an international exchange unit.

    I’m still waiting for the alternative for the Chinese how to spend their dollars. The very moment someone can provide me with that, my theory on the privilege of the dollar will crumble.

  • Posted by Blissex

    «Isn’t global savings “surplus” a consequence of global demand suppression? Isn’t the cause of having “surplus saving” the restricted consumption in developing countries?»

    These are good questions not so much because of their content but because of their style. When Bernanke and Setser talk of the “savings glut” it sounds like a lot of very poor people in the 3rd world have decided to consume less and save more, a lot of individual choices that just about force Usians to borrow those savings.

    What’s instead is happening is that 3rd world governments are subsidizing Usians to buy the exports of their countries, in order to increase foreign direct investment.

    The goal is to bootstrap the capital base of those countries by making it very profitable for foreigners to export capital from their countries to China and India.

    The means have been currency manipulations on a vast scale by suppressing imports in third world countries and subsidizing imports by Usians, by accepting unlimited quantities of their fresh made cash and then “lending” it back to them at nugatory rates.

    These manipulations show up in *accounting terms* as very high levels of “savings”, but only in accounting terms.

    It is not like the fantasy that 3rd world country workers and businesses are saving a lot of their meagre incomes and investing them in the USA; it is vast scale currency manipulation organized by shrewd governments.

    So there has been a flow of “virtual” savings (really as someone was saying above, a return flow of the freshly minted dollars with which Usians pay for their imports) to the USA and a flow of very real physical and private productive capital from the USA to China and India.

    I think that there has been no net investment in productive capacity in the USA for 20-30 years, and the physical/productive capital intensity (and wage growth) of USA industry has gone down a lot, while at the same time the enormous flows of “virtual” financial capital in “import” dollars sent back to the USA has greatly increased the capital intensity (and wage growth) of the USA financial sector.

  • Posted by babar

    @2fish

    you are right that if these inflows had been sandboxed they would not have caused the exact problems they caused.

    they flowed through the banking system creating cheap money, and then some of the products of the cheap money were misvalued and used as collateral for leveraged transactions or prematurely assigned profits which were paid out to individuals as bonuses. in so doing three things happened. (1) cheap capital flowed through the banking system; in fact no bank could ignore this because no bank could compete without tapping into it; (2) perverse incentives were worsened in the banking sector, and (3) valuations based on misvalued collateral were wildly misconstrued.

    i don’t think anyone is saying that the savings glut is the only cause of the problem we’ve got but brad is touting it as a major enabler and i have to agree. for the rest of the picture, you can of course blame human greed, herd mentality, and lack of regulation. you can also blame people for creating a system with brittle interconnections and no firebreaks or effective sandboxes.

  • Posted by Indian Investor

    @twofish:
    Thanks a lot for insightful posts above.
    Is it possible to provide some information about the election system in China. I’m trying to evaluate completely free mutli-party allowed elections can be for the China Communist Party. I’d be very happy for your opinion. I remember asking some Chinese friends how the Premier is chosen in an indirect way. Well to be honest the way they talk about the Premier is whether they “like” or “dislike”, e.g. the present Premier is compared with a past Premier.
    It was the same way as some Indians might perhaps talk about certain movie stars, who are public personalities, but not elected.
    Later I’ve read that in some elections independent candidates are allowed to contest in China.
    I’m not clear:
    1) For which positions there are elections and which ones there aren’t.
    2) How is the candidate chosen for the ones where there’s no election.
    3) What can happen to the Communist Party if it has to hold completely free and fair elections for all the jobs in China?
    If you look at positions in the Indian Administrative Service, these people are chosen through a set of exams and after that it’s a career bureaucracy with designations and seniority. Political alliances of the bureaucrats matter a lot but by and large designation corresponds approximately with years of service.
    The reason I mentioned it is to know whether the China Communist Party has something similar to a career bureaucracy in lieu of the democratic elections.
    And I’m especially curious to know how the Chinese Premier is chosen.

  • Posted by Indian Investor

    sorry I meant I’m trying to see how risky completely free elections can be for the China Communist Party

  • Posted by "Cassandra"

    Since the post is about blame, (and I agree with Brad regarding the broader parcelling of blame) the role of the monolines and AIG should which not be underestimated, and should be mentioned in the same as breath Asian mercantile reserve accumulation, and dually-loose US fiscal and monetary policy, and regulatory stupor..
    Just as interest rates would have naturally throttled the worst of the housing bubble excesses the way they have in past cycles, it is very likely that most of the credit-enhanced paper would never have seen the light of day, since the majority of fixed income investors are/were ratings-driven. This was a primary enabler to massive leverage.

    The thing to remember is that these are not binary cause and effects but feedback loops. And as with feedback loops, they incrementally reinforce and enable each other.

  • Posted by Howard Richman

    As quoted by Brad, Martin Wolf predicted:

    “Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad.”

    I am asking that question now. Why are we sacrificing our country’s economic future in order to keep the anti-democratic Chinese Communist regime in power, the very regime that is supporting the brutal dictators in North Korea, Burma, and Sudan and supplying grad rockets to Hamas terrorists?

    There is a policy option that immediately restores the US to prosperity, jump-starts US investment, and maintains US economic supremacy: Warren Buffett’s Import Certificates to balance trade.

    Protectionism to achieve a trade balance is no vice and unilateral free trade that mortgages our country’s future is no virtue!

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

  • Posted by bsetser

    Cassandra – Maybe we should add AIG’s capital markets division to the list; they seem to have insured a ton of risky securities — keeping the leg of the process that required US and European financial intermediaries assume the credit risk associated with lending to ever worse credits going for longer than might otherwise have been the case …

  • Posted by sixx

    Although it migh be implicitly clear I think it is very important and has to be extra emphasized that one should not mix up savings with liquidity i.e. real savings vs. paper money (liquidity created by the banking system)that does not worth anything.
    The last fact has been proven by the recent economic events in the world.

  • Posted by Indian Investor

    @Dr. Howard Richman
    The Chinese regime isn’t supporting the Hamas at all. It’s quite possible they are close to the Burma (Myanmar) government though, for very practical economic reasons.
    My impression is that Hamas is fully aided and supported by Ayatollah Ali Khamenei the Supreme Leader of the Iranian clergy, who is thought to wield much more influence in Iran than President Ahmedinijad. (this should explain what Obama meant by his “Ahmedinijad may not be the right person to talk to” comments.This is the theme of the Council on Foreign Relations report on “The Latter Day Sultan”.
    As far as Burma is concerned, China National Petroleum Corporation has a Production Sharing Contract for oil exploration in Burma’s territory. Which would be the only reason for China to be friendly with them.

  • Posted by Blissex

    «majority of fixed income investors are/were ratings-driven. This was a primary enabler to massive leverage. »

    “enabler” is perhaps a strong word; perhaps “excuse” is a better one, The primary enabler was the colossal flood of cheap money from Asia and then from the Fed. AAA ratings from sell-side rating agencies were the figleaf for the credit bubble excesses. Just like the stock ratings by sell-side analysts were the figleaf for the dot com bubble.

    «The thing to remember is that these are not binary cause and effects but feedback loops. And as with feedback loops, they incrementally reinforce and enable each other.»

    Sure, but the colossal credit explosion since 1995-1996 was not very much a feedback loop — it was a straightforward growth of available credit pushed by an alliance of the USA political and financial elites and East Asian elites, to transfer productive capital and jobs from the unionized, medium wage USA areas to non union union, low wage East Asian areas.

  • Posted by realist

    lone poster by the name of MRein in forum summed up AIG in looking back at 08, thinking about 09. It was one of the most interesting posts to date…

    According to Mrein

    “So rather than rule out having any high-yielding securities in your portfolio, you simply call up the friendly AIG broker you met at a conference in London last year.

    “What would it cost me to insure this subprime security?” you inquire. The broker, who is selling a five-year policy (but who will be paid a bonus annually), says, “Not too much.” After all, the historical loss rates on American mortgages is close to zilch.

    Using incredibly sophisticated computer models, he agrees to guarantee the subprime security you’re buying against default for five years for say, 2% of face value.

    Although AIG’s credit default swaps were really insurance contracts, they weren’t regulated. That meant AIG didn’t have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what’s called “mark-to-market” accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate.

    Whatever the computer said AIG was likely to make on the deal, the accountants would write down as actual profit. The broker who sold the swap would be paid a bonus at the end of the first year – long before the actual profit on the contract was made.

    With this structure in place, the European bank was able to assure its regulators it was holding only triple-A credits, instead of a bunch of subprime “toxic waste.” The bank could leverage itself to the full extent allowable under Basel II. AIG could book hundreds of millions in “profit” each year, without having to pony up billions in collateral.

    It was a fraud. AIG never any capital to back up the insurance it sold. And the profits it booked never materialized. The default rate on mortgage securities underwritten in 2005, 2006, and 2007 turned out to be multiples higher than expected. And they continue to increase….”

    in conclusion on one thread he states

    “There’s no way to replace this massive credit-building machine, which makes me very skeptical of the government’s bailout plan. Quite simply, we can’t replace the credit that existed in the world before September 15 because it didn’t deserve to be there in the first place. While the government can, and certainly will, paper over the gaping holes left by this enormous credit collapse, it can’t actually replace the trust and credit that existed… because it was a fraud.”

    I would encourage a look at securities fraud and how big of a role it played in the current crisis.

    Brad maybe you could start looking at AIG capital markets and take a real look on just how big of an influence the role of AIG and other rating agencies played in the crisis.

    Some argue the best economists are the real investigators.

    Sherlock Setser, you have some homework involving AIG.

  • Posted by Twofish

    Realist: Using incredibly sophisticated computer models, he agrees to guarantee the subprime security you’re buying against default for five years for say, 2% of face value.

    The computer models weren’t all that sophisticated. What they basically did was to say, the market estimates that Lehman has a X% chance of default, therefore the security will cost you $Y.

    The basic principles of derivatives valuations *aren’t* complex. The reason they are so opaque and complex is that a lot of people have (or had) financial interests to make things seem more complex than they really were. In large part, the trouble is that if you made things simple, it became obvious how stupid some of these things were.

    Realist: While the government can, and certainly will, paper over the gaping holes left by this enormous credit collapse, it can’t actually replace the trust and credit that existed… because it was a fraud.

    One reason that I like finance is that in the long run, honesty pays big bucks as long as people know that you are honest (and you really are). The old business model was give us your money and we’ll let the rocket scientists crunch the numbers. The new business model is that no one trusts the rocket scientists so if you want to convince someone to buy something, you have to made things simple so that they understand it.

    Realist: Brad maybe you could start looking at AIG capital markets and take a real look on just how big of an influence the role of AIG and other rating agencies played in the crisis.

    Huge. Now what? I think we have a more or less good idea of what happened. Fixing it is a lot harder. The sentiment here seems to be to find bad people and put them in jail. The trouble with that is that the system ended up so that no one person did everything that could result in criminal liability. You have a lot of people that did invididual things that perhaps semi-intentionally defused responsibility so that you can’t point to anyone and say “put them in jail.”

    If AIG was a real person, then you could probably easily argue that they belong in jail, but sense it is a large corporation, the responsibility diffuses. The CEO would claim that they were making the best decisions given the data that he was given. The people giving the data would argue that they had problems with the data, but that they were never in a position to give good data or make decisions.

  • Posted by Albion

    Difficult rhetoric but few figures may set responsibilities where they are i.e. Central Banks and Governments

    When reading the ECB monthly bulletin one may look at the item C15 Total gross issues of securities issued by euro residents

    1992 200 Billions euros
    2008 1.4 Trillions Euros

    In all fairness, one should smoothen the exponential through the incremental number of new European members flows but in all fairness new comers economies are not having significant weight in the total borrowers club.

    Without fairness, one should compare indebt ness and the average C15 GDP growth around 2 Pct throughout this period.
    Few purists may as well proof test the average outstanding of the monetary base to GDP (Marshallian k)

    Was it savings glut or Central banks propensity to expand money supply and banks operating on given liquidity . As of today they are more debts than hard assets in many banks books.

  • Posted by ReformerRay

    In my high school debate class, the affirmative always got the last rebuttal. I will agree to that convention. Thus, I invite someone else to provide the affirmative position after my post.

    This is an effort to provide a summary of a negative position.

    1. Occam’s razor is the principle that “one should not increase, beyond what is necessary, the number of entities required to explain anything”. Ben Bernanke, in his famous speech of April 14, 2005 (available on the FRB website) violates that rule. The data that is the foundation of his argument shows the Current Account Balance for several nations for 1996, 2000 and 2004. He claims that this data can be used to show a “Global Savings Glut”. Occam’s razor would urge Bernanke to talk about the Current Account Balance and leave off any discussion of savings as an unnecessary concept.
    2. The accumulation of dollars produced by the Current Account Balance is labeled by Bernanke as “savings”. He then says that these savings are being lent to the industrialized nations. This practice Bernanke labels as undesirable. The developing countries have need for capital to invest in productive enterprises. The industrialized nations have excess capital. Current reality should be reversed. Lending should flow from industrialized nations to developing ones.

    Bernanke wishes for a world different from reality. The dollars accumulated by the developing nations from their Current Account Surplus are precious. They can be used to build up dollar reserves to prevent a repeat of the Asian financial crisis of 1999. They can be used to purchase machine tools that aid their ability to sell goods on the international market. Both of these outcomes are highly desirable to the developing countries. The fundamental reality, which Bernanke avoids by assuming at the beginning that the flow of dollars among nations controls the size of the Current Account Balance, the fundamental reality is that the size of the trade surplus in the developing world is caused, not by dollar flows, but by the ability of these nations the control imports and produce exports that sell. The trade surplus is an achievement of a national goal. It is due to the decisions make by the leaders of the developing nations. Dollar flows are a consequence, not a cause.
    3. This whole exercise by Bernanke results in shifting the blame for the large current account deficit in the U.S. to the developing nations. It is a clever piece. It may be the reason Bush appointed him head of the Federal Reserve Board. But it misstates reality. The U.S. and its policies are responsible for the size of the Current Account Deficit in the U.S. Several commentators in posts above have made this point.
    4. The effort of Betser to figure out alternative scenarios of balancing global investment with global savings is misguided. It commits the same mistake as Bernanke (assuming that dollar flows control the size of trade surpluses or deficits) {I should note that this mistake is shared by almost all of the well trained economists who discuss international trade}. It makes the further mistake of assuming that investment must be balanced against savings in any given time period. Savings can be accumulated in one time period, stored for a number of years, and then used for investment in a later time period.
    5. Several posts above provide reasons for believing that both the U.S. trade deficit and the financial disaster were produced by action of U.S. citizens, acting either on their own self interest or as elected officials responding to the beliefs and pressures provided by their financial supporters. When our voters begin acting like adults who are in charge of our country, we will discover paths forward. The last two posts preceding this one are especially good because they look to creating realism as the necessary first step in moving forward.

  • Posted by realist

    “Only in America”

  • Posted by gillies

    if the ‘savings glut’ is going to moderate – while the borrowing to support ‘stimulus packages’ is going to expand, then interest rates have to respond to supply/demand by rising, and treasuries by falling.

    ireland’s AAA rating is under review. we have just raised money at 1.7% more than the germans pay, in the same euro currency.

    how long can the USA remain AAA ?

  • Posted by Twofish

    geert: I’m still waiting for the alternative for the Chinese how to spend their dollars. The very moment someone can provide me with that, my theory on the privilege of the dollar will crumble.

    One other thing that needs to be explained is how China making different decisions would have ended up with China being better off than it is. Right now China has huge foreign exchange reserves that are going to cushion it from this crisis. Maybe had China done something different, we may not have had this particular crisis, but it is odd to assume that there would not have been some other crisis at some point.

    Maybe export driven industries was not the best strategy for China, but it’s really hard for me to think of a better one. If not exports, then what? Real estate? More public goods. Yes that’s a good thing, but unlike the US, China is a developing nation and it didn’t have the human or financial infrastructure to distribute savings. It does now, but it good a few years to build.

    One problem here is that I think we’ve reached the limits of the monetarist view of economics. Monetarists argue that only interest rates matter, and that in looking at an economy, you should ignore everything else. The trouble with that is 1) I think it’s obviously not true and 2) even if it were true, it’s totally useless for what is going on now. The US has lowered interest rates to zero at which point monetarism becomes useless and you have to think of something else.

    My own feeling is that we’ve also reached the end of the line for “mathematical economics.” This is the notion that you can understand an economy by just looking at charts of numbers rather than looking at the institutions within an economy. Again, the trouble is that 1) it’s obviously not true and 2) even if it was true, it is useless. Telling China to “raise household consumption” is an utterly useless piece of advice if you offer no ideas as to how to go about doing that.

    The whole idea of a “saving glut” is an example of tunnel vision. If someone thinks that the only that thing matters are interest rates and quantifible numbers than “savings glut” is the only answer people can provide for what happened, but that is because they stuck to a theroretical view of the world that rejects looking at anything else, and I think that it useless way of looking at the world in part because it is self-contradictory.

    Suppose you end up saying “Chinese save too much, they should save less.” At that point you are stuck because without looking at things other than interest rates, you can’t come up with ways to have them save less. And if you can come up with ways to have Chinese save less, then you probably also could have come up with ways to have better things done with those savings.

  • Posted by Blissex

    «“There’s no way to replace this massive credit-building machine, which makes me very skeptical of the government’s bailout plan. Quite simply, we can’t replace the credit that existed in the world before September 15 because it didn’t deserve to be there in the first place. While the government can, and certainly will, paper over the gaping holes left by this enormous credit collapse, it can’t actually replace the trust and credit that existed… because it was a fraud.”»

    A Real American would know that these are Communist style arguments. Real Americans celebrate WINNERS who MAKE A LOT OF MONEY, and don’t waste time thinking about the stupid losers who lost it.

    Real Americans know that winners do whatever it takes, and it is only the Communists motivated by envy who use silly words like “fraud” against their superiors, the business heroes who scr*wed a lot of money from many suckers.

    :-)

  • Posted by ReformerRay

    This is perhaps a minor point. I join those who admire the post of MRein, pointing out the role of AIG in expanding the size of the current problem. But I also agree with Twofish, that we should not concentrate of seeking scapegoats. True, people took advantaage of a situation. But it is not fraud to assume that the future will be like the past. That is the most common assumption made by forecasters. This assumption is valid most of the time – except when things change – as they did after 2005.

    The biggest mistake was to assume that home values would not go down in the U.S. and that past default rates could be relied upon to predict the future.

    One lesson we should have learned from the Enron experience, but did not, is that payment of bonuses for contracts signed but not completely paid for provides incentives for irresponsible behavior.

  • Posted by Twofish

    bsetser: i am not arguing that you need a global savings glut to get a bubble; only that such a glut (one engineered in my view by gov policy, and in the case of china, by gov policy designed to support its de facto peg) played a role in this particular bubble and this particular crisis …

    And what I’m arguing is that this may be true but unimportant. China is such a large player in the world market that anything it does will influence what happens elsewhere, but those are unimportant details.

    I’m arguing that if you didn’t have some basic changes in the regulatory structure of the United States, that you would have had another bubble and another crisis regardless of what China did. The details may have been different, maybe an auto loan or credit card bubble rather than a housing bubble, but you still would have had a big crash.

    One issue is that the bad practices are interest rate independent. As it was people took 2% and peddled bad loans so that they could get their bonuses. If you gave them 8% money, they would have done the same thing. Whether the interest rate is 3% or 8% or 20% is pretty irrelevant if people are making money from the loan being made, and no one knows or really cares if it is repaid.

  • Posted by Twofish

    barbar: i don’t think anyone is saying that the savings glut is the only cause of the problem we’ve got but brad is touting it as a major enabler and i have to agree.

    I don’t think that it is a major enabler. Look at the list of things that you mentioned and cheap money has nothing to do with any of it. Sure we had big problems because money that should have been loaned at 4% was loaned at 2%, but you have exactly the same problems if money that should have been loaned at 8% was loaned at 6%.

    The reason that I don’t accept that cheap money causes banking failures is that you have banking crises in high interest rate environments such as the savings and loan crisis in the early 1980′s, and you have examples there where high interest rates seem to cause risky loans.

  • Posted by badending?

    Across the United States now Americans have a growing backlash against “made in china”. This is a very recent development (over last several months).

    I don’t understand how this is going to end well.

    In my opinion the China-U.S. trade story is heading toward a major collision in the summer of 2009. I’m not sure if it will be socio-unrest in China or protectionist U.S. policy but something will unravel.

    The U.S. consumer is insolvent. Not only do we have a U.S. consumer who is in-debted but now they are slowly starting to point the finger at China across suburbs in America. Go to the midwest, go to Chicago. You’ll hear the whispers.

    I would expect that you’ll see a major revision downward in Chinese exports months ahead. I would also expect China’s GDP to be far below analyst calls of 8-10% for 2009.

    I’m not sure of Obama’s policy toward the consumer behavior we are witnessing. Americans can try and spend spend spend again, but say they choose to save, say they choose to pay off debt, and or say they choose to spend but not spend on “made in china”….

    are we prepared for the next crisis which could be far worse than what we are witnessing now?

  • Posted by badending?

    and on that note, it’s when the “mom’s start talking about, we don’t want to purchase goods that say made in china”…

    it’s the stories you hear about poor quality, poisonous leads in children toys, and unsanitary working conditions. It’s the moms across america who shop. When things start getting bad and they start hearing and reading random articles in the news about China they draw assumptions.

    They don’t draw all the pieces to the puzzle and they simply say “made in china”, can’t buy it.

    This is what is happening. I promise you, it’s going from mom to mom and i believe the media is helping this enlarge with the small notices here and there.

    I think the U.S.-China story is going to end really badly. IF someone can argue why it’s going to be a smooth transition please explain. Economists need to focus more on consumer behavior. Word of mouth is so powerful, and the word of mouth now over last several months has gone very negative toward China.
    Just a note….

  • Posted by bsetser

    2fish — There are a whole host of way that China could have increased consumption and investment. The most thing is that China could have not taken steps to restrain demand. Specifically, China curbed lending with administrative lending curbs. Take away the curbs and in 05-07 there would have been more lending more investment and less savings to export to the world. China also ran a contractionary fiscal policy during this period — the WB data shows a swing from deficit to surplus and most in beijing think the 07 surplus was actually understated for bureaucratic reasons (there was a big build up of gov deposits … ). Letting the RMB rise and increasing the external purchasing power of rmb salaries might also have had an impact — though it more likely would have made room for more expansionary domestic policies.

    Other than that, a host of suggestions have been made:

    a) The SOEs could have paid dividends to the government that the government could have distributed to the population — some of that would have been saved but not all.
    b) The government could have created a social security system and made initial payments by borrowing …
    c) Similarly, fees for health and education could be reduced. A health insurance program could have been created.
    d) If all else fails, do an earned income tax credit and subsidize wages — the fall in consumption hasn’t come from a rise in the household saving rates but rather from a fall in wage income as a share of GDP. Fund that with borrowing and you would reduce nat’l savings.

    there were options. There still are options. China made a series of policy choices that led us to where we are. So did the US (not regulating subprime lending, cheerleading securitization, allowing the increase in leverage in the regulated financial sector, not reversing the 01 and 03 tax cuts when the economy recovered, etc)

    and well interest rates do matter. try valuing a home if a mortgage comes at 8% and if a mortgage comes at 5%. Much higher rates would have pushed down home values and made home equity loans to finance consumption impossible. I am quite confidence — mathematical econ or not — that the 02-06 home price bubble wouldn’t have reached its 06 heights IF long-term rates were going up rather than down during this period.

  • Posted by ReformerRay

    8% interests rates would have slowed down the growth in home values. Germany is the example of how that works.

    But, Betser, the motivation to slow down growth in home values was not present.

    Also, Betser, the motivation in China to do anything other than increase exports was not present in China.

    Both countries thought they were acting in the interests of their citizens. History will show that China made a better judgment than did the U.S.

  • Posted by tip

    Brad,

    Good note. Likewise could not agree more with you that we should have focused our excesses on:

    1. Education-reduced tuition costs

    2. Healthcare-improved system

    and

    3. Perhaps Alternative Energy

    instead we used our opportunity on “wasteful” products and investments. The investment of the war in Iraq…could it be any worse?

    Afterall, turns out we’ll be giving portions of the oil to China…

    http://www.cnn.com/2008/BUSINESS/08/30/iraq.china.oil.deal/index.html

  • Posted by tip

    Leaders in the EU and Asia are determined that this is the end of U.S.-world financial order.

    The only way this makes sense is if the U.S. is set to lose it’s power of having the U.S. dollar as global reserve.

    I have a feeling something is brewing…thoughts?

  • Posted by RebelEconomist

    Brad,

    Perhaps I am failing to get across what I see as the logical flaw in the savings glut explanation of the boom. The price of spread product is expressed by yield, NOT spread. If increased demand for treasuries was driving increased demand for spread product, I agree that we could expect to observe a fall in spread product yield. But it is hard to see how this yield fall could be MORE than the fall in treasury yields. It is as if one car is towing another, and the rope is getting shorter. It does not make sense. Do you see the problem?

    You have disagreed with my argument before, and cited well-known analysts who hold the same opinion as yourself, but you have not explained why the logic of my argument is incorrect.

    Unless someone can describe a reasonable mechanism which explains how reserve buying of treasuries can have a greater impact on spread product yields, the conclusion must be that the more plausible explanation for the boom is that it was led by spread product.

  • Posted by ReformerRay

    Badending wants to know how the relationship between the U.S. and China can end well.

    The first step is to stop focusing so much attention on China as the only export oriented country in the world. China is the major contributor to the U.S. trade defict, responsible for 32% of the trade deficit, Jan.-Oct. 2008. That means that 69% of the current U.S. trade deficit is due to other countries. If China did not exist, our trade deficit would not be reduced by 32%. Instead, some other countries would fill the gap and the U.S. trade deficit would still be near the 702 billion dollars sent overseas in the first 10 months of this year.

    The solution is to aim to reduce the U.S. trade deficit to zero as rapidly as possible. That requires rejecting free trade as a goal. Instead, accept equal trade as a goal. To work toward that goal, we need a law which establishes a tariff system that gradually increases the size of the tariff on ANYTHING imported into the U.S. that comes from the FIVE countries of China, Japan, Germany, Canda and Mexico.

    Why those countries? They were responsible for 60% of the U.S. trade deficit in 2005 (the peak of the trade deficit) (now down to 50%). These countries are selling in the U.S. products that could be produced in the U.S.

    This is a responsible way to gradually reduce the size of the U.S. trade deficit by focusing attention only on the countries that are most responsible for the U.S. trade deficit.

    China will hate this change. But they will have to admit that we have a right to control imports into the U.S., if such restrictions are based on valid U.S. goals. And that we are not discriminating against China. Our friends to the North and South are equally impacted, even though most of the exports from those countries are coming from firms whose headqurters are in the U.S.

  • Posted by bsetser

    Rebel — well, once the private sector lost its appetite for risk, spreads did blow out as everyone piled into treasuries, including folks who previously liked “spread” product. but during the boom, i do think folks who sold treasuries to CBs didn’t shift to another portion of the treasury curve but rather took on more risk. i don’t have a better explanation than that — i would highlight three channels:

    a) US (domestic) treasury holdings fell relative to US GDP, implying that Americans were in aggregate selling some of their existing stock to the rest of the world. in the first instance, that sale drove down treasury yields, and would tend to widen spreads. but those funds were redeployed into spreak product, pulling down those yields. in effect, real money types needed higher yields than were available in treasuries — and increased their allocation to risk assets by selling their treasuries to CBs.
    b) the stability of Treasury yields and a general expectation of a low vol world made risk attractive.
    c) the flat yield curve meant that vehicles/ intermediaries that borrowed short and lent long had to take credit risk – and low spreads meant that more leverage was needed to get the same returns.

    Other factors also played a role — institutional investors fell out of love with equities and increased their allocation to alternatives, some of whom do spread trades and so on.

    Probably won’t convince you, but i think a)and c) in particular were a big part of the dynamic that pushed down spreads.

  • Posted by Observer

    I think Brad has been right all along about the need to liberalize the exchange rate. The key thing to keep in mind is not whether the trade/capital imbalance has led to this crisis, but whether this imbalance will retard the necessary adjustments to get out of this crisis. It’s very hard to see how the Chinese could benefit from a 7:1 or even an 100:1 exchange rate if Western consumers decide to drastically alter their saving patterns and shut down their purchases completely.

    It’s time for China to dramatically increase gov’t spending on health services by building hospitals and possibly equip the hospitals with imported technologies paid by foreign holdings. The biggest source of precautionary savings for Chinese is probably for the hospital visits of their PARENTS; this is just a function of the culture and economic necessity. If the Chinese gov’t spends the right amount to keep health care costs down (keep in mind that the China is not a true market economy and that the gov’t can in fact cap costs like they do with oil), then that would create more consumption.

    But even the exchange rate won’t help US export to China as long as intellectual property rights are not properly guarded. This whole mess will take a long time to resolve and a trade war is not out the question.

  • Posted by RebelEconomist

    Thanks for engaging Brad.

    “….those funds were redeployed into spread product, pulling down those yields. in effect, real money types needed higher yields than were available in treasuries — and increased their allocation to risk assets by selling their treasuries to CBs.”

    I agree. Spread product is to some extent a substitute for treasuries and so funds were redeployed. But to narrow spreads, crowded out investors had to pull down spread product yields more than the treasuries they were crowded out of. Assuming that treasuries and spread product are imperfect subsitutes, and given that the total size of the spread product market was greater than the size of the treasury market, this is a tough ask.

    I agree with channels b and c, and I would interpret them as being symptoms of US investor complacency, following the 1998 and 2000-2002 Fed easings. One reason for the long period of expansion was that the Greenspan Fed was more proactive about sustaining this – ie “giving growth a chance”. Of course, to the extent that this was successful, investors should have been prepared to put up with lower yields, because risk-adjusted, they were not lower.

    I think return targeting CAN explain why investor response to reserves buying of treasuries led to narrower credit spreads. But you can hardly assign much responsibility to foreign central banks for the recklessness of those who invested according to what they wanted rather than what was available.

  • Posted by babar

    @bsetzer) the stability of Treasury yields and a general expectation of a low vol world made risk attractive.

    in general, conflating “low vol” and “low risk” is a mark of modern risk management regimes, and this conflation opens up a lot of black holes. not the least of which is that increased market vol will increase the model-measured risk of every investment on the books; this by itself will increase capital reserve requirements and cause sales.

    @bsetzer) and well interest rates do matter. try valuing a home if a mortgage comes at 8% and if a mortgage comes at 5%

    i agree with this. one other point is salient. most of the people buying these mortgages (at least native born americans) had as a point of reference an environment of much higher inflation and therefore assumed that they would get the last 15 years of their mortgage for free.

    i don’t know how to measure this but i have a hunch that a lot of the problems come from setting expectations in an environment of _decreasing_ interest rates over time. when interest rates could not decrease any more, this mentality persisted. this set people up for a situation where reality was bound to move against their assumptions, and so people made nonsense decisions. again, just a hunch here — i can’t put meat on those bones.

  • Posted by Indian Investor

    Between Pandit Jawaharlal Nehru’s India’s tryst with destiny speech at the eve of independence(1947) and the Dr. Manmohan Singh Economic Liberalization and Globalization Program (1991) all the macroeconomic policies were driven by the Bretton Woods system and the local Xenophobic Macroeconomists. Once Xenophobic Macroeconomics was given a big miss in 1991, the Americans got to India in a big way and started developing the country in leaps and bounds.
    Only some parts of the country.
    In 2001 the Americans scored another big victory. The Insurance Regulatory and Development Authority in India was compelled to dismantle the state owned Insurance monopolies. A number of foreign insurance firms entered the Indian market.
    Also a separate Disinvestment Ministry got busy selling off the state owned family silver in the Navaratnas – meaning “Nine Jewels” which Pandit Nehru had Christened as “The Commanding Heights of the Indian Economy”.
    Every month during the credit crisis the Indian financial press has been reporting various liberalizing changes in the labyrinthine sectoral caps on Foreign Direct Investment.

  • Posted by Indian Investor

    China has a really and serious FDI problem, though that problem is still very much there in India as well.
    What the US wants is to liberalize the FDI rules and allow the Americans to come in and invest.Also to remove all the capital controls.
    If the Communist Party doesn’t agree to this, soon democratic elections will be forced on China through various devious means. Even grass is a weapon for true warriors like Henry Paulson.
    That’s why I was asking for opinion on election outcomes in China. If the Communist Party thinks it can rule through a popular vote, then it can carry on defying demands for FDI liberalization.

  • Posted by Twofish

    bsetser: Specifically, China curbed lending with administrative lending curbs. Take away the curbs and in 05-07 there would have been more lending more investment and less savings to export to the world.

    Take away administrative lending curbs and the SOE’s would have had no incentive at all to implement structural reforms. What would have happened is that the money would have been wasted in useless real estate projects, got put in corrupt officials pockets, and you would have ended up with a massive non-performing loan problem.

    bsetser: a) The SOEs could have paid dividends to the government that the government could have distributed to the population — some of that would have been saved but not all.

    The government starting taking dividends from the SOE’s in 2008. The trouble with taking dividends is then you run into the classic problem with SOE’s. Why bother making a profit if the government is just going to take all of it? Also, if you give any official authority to just take money from an SOE, you are asking for massive corruption and bad things, and so you need to organize a system for doing that. It takes time.

    b) The government could have created a social security system and made initial payments by borrowing

    The government had a social security system that is extremely badly underfunded. Even if the government started a new one, you won’t have people saving less because the government torn up the old social security system.

    c) Similarly, fees for health and education could be reduced. A health insurance program could have been created.

    People are working on a health and education system. The trouble is that it is *HARD* to do it, and working out all of the details has taken about a decade. However, even with a health and education system in place, people won’t stop saving because no one will trust that system won’t collapse, like the previous one did.

    d) If all else fails, do an earned income tax credit and subsidize wages — the fall in consumption hasn’t come from a rise in the household saving rates but rather from a fall in wage income as a share of GDP. Fund that with borrowing and you would reduce nat’l savings.

    Most Chinese don’t pay income tax.

    As far as wage subsidies, if you do that, you end up back in the 1990′s. Wage income as a share of GDP has decreased, but that is because the government is no longer paying people from non-performing bank loans. The problem with saying how bad it is that people are making less money that in the 1990′s was that the situation in the 1990′s was unsustainable. The high wages was sustained from borrowing and that was hitting its limits.

    Also there is no particular reason to think that if you increase wages that you will increase consumption. Most likely, people will take that extra dollar and put it into their retirement savings.

    The problem with a lot of what you are suggesting is that it requires a clean, efficient bureaucracy and China doesn’t have a clean and efficient bureaucracy. The other problem is that you are suggesting that China do what the US did, and that didn’t work out too well.

  • Posted by Twofish

    bsetser: well interest rates do matter. try valuing a home if a mortgage comes at 8% and if a mortgage comes at 5%.

    These numbers only matter if you care about paying back the loan. If your salary depends on getting a bonus from making the loan, and the person that gets the loan just wants immediate cash, these numbers do not matter at all.

    bsetser: Much higher rates would have pushed down home values and made home equity loans to finance consumption impossible.

    If the property appraiser gets paid based on whether you have a loan and not if you don’t, he’ll give you a high number if that is what you want. Once you have a few homes that are sold at a absurd prices, that pushes up appraised values, and things go up again.

    The problem with real estate is that there is no easy mechanism to short real estate. If I lose money when house prices are high, then I’ll bribe the appraiser to low ball the price, someone else will bribe the appraiser to high ball the price, and we’ll come at something reasonable. The trouble is that no one is bribing appraisers to give low appraisals so that there is a push to increase the price of the house.

    bsetser: mathematical econ or not — that the 02-06 home price bubble wouldn’t have reached its 06 heights IF long-term rates were going up rather than down during this period.

    Except that they didn’t……

    http://www.freddiemac.com/pmms/pmms30.htm

    The interest rate for a 30 year mortgage from 2000-2008 stayed very constant at about 6 percent. Now *short* term rates dropped dramatically from 2002-2006, which meant that you had all sorts of financial structures intended to make money on that.

    People were getting teaser rates at 2% interest, but there was no chance in hell that the interest rate would have stayed at 2 percent. After two years, the mortgage would have reset at 6% in which case it would have likely been unpayable.

    If people were willing to give bogus mortgages like these, then they wouldn’t have cared if the mortgage resets in two years at 8% or 80%. If you have no chance or intention of paying the loan, you don’t care what the interest rate is.

    As far as short term rates, you can do all sorts of financial magic to make sure that the borrower gets their cash and the lender gets their bonus. The house is worth $100,000. I don’t care, I’ll authorize a loan for $150,000 or $1 million. The house is only an excuse for what I’m really after which is the bonus, and for what the borrower is after which is the cash. Heck, I don’t even care if there is a house as long as I get the cash.

    I would argue that the financial crisis really had nothing to do with interest rates and a lot to do with lax regulation.

  • Posted by Twofish

    Observer: It’s time for China to dramatically increase gov’t spending on health services by building hospitals and possibly equip the hospitals with imported technologies paid by foreign holdings.

    The Chinese government has been spending the last eight years trying to put together a health care system. Google for NCMS and World Bank. The trouble is that you simply cannot put together a functional system overnight.

    Observer: that would create more consumption.

    I don’t think it will. Imagine a peasant reading the People’s Daily.

    A: The government says that they will pay for all our health care costs.

    B: Great!!!! Let’s spend all our money so that we put ourselves in danger of dying if things don’t work out. After all we know that the Chinese government doesn’t lie and does things perfectly, so that there is absolutely no chance that anything will go wrong. It’s not like the last time when that the government promised full health care and then torn up those promises.

    Also I don’t see why everyone here wants to increase consumption. You can increase demand by increase investment.

    The other thing to note is that the huge increase in savings in 2000-2008 was not in households but in enterprises. The Chinese government has some very hugely ambitious plans for the state-owned enterprises. Think of the big companies of the world. IBM. Ford. Walmart. Microsoft. Google. etc. etc.

    The Chinese government wants to take every single one of its SOE’s and turn them into world class companies, and that is going to take a lot of cash, so the government has been pushing companies to save so that they will have enough cash to finance standing toe-to-toe with Western companies.

  • Posted by Twofish

    Don’t be fixated by houses. Houses were just an excuse to find ways of looting bank vaults.

  • Posted by Kien

    China can be faulted to some extent for maintaining a trade surplus and not letting the RMB appreciate. On the other hand, the Asian financial crisis also taught Asian governments that the IMF could not be trusted, and they had to build large foreign currency reserves. Perhaps in addition to blaming the Chinese (for building trade surpluses) and the United States (for not regulating their financial markets), blame also lies with the IMF and the champions of the “Washington consensus” for putting the interests of international finance ahead of financial stability. Perhaps one good thing about the financial crisis is that the IMF is no beholden to the princes of international finance. If the IMF can help establish a new consensus around financial stability and appropriate controls over capital flows, governments of developing countries may be more confident of running trade deficits.

  • Posted by Twofish

    Here are some more graphs:

    http://mortgage-x.com/trends.htm

    http://mysite.verizon.net/vodkajim/housingbubble/united_states_1890-2007.png

    Long term, there is no correlation I can see between inflation adjusted housing prices and interest rates, and there really shouldn’t be one. Why should the value of a house change if interest rates change? Unless….

    It’s not really a house, but an “investment.” The real point at which things started falling apart was in the late 1990′s, when people starting thinking of houses as an investment rather than as a place to live in.

    Suppose China didn’t exist and you didn’t have people pumping money into the system. I’d argue that you still would have had a housing bubble and bust. The argument is that if you have less money coming in, then interest rates would have increased. I argue that they wouldn’t have.

    I can take a rock and if I can convince people that it is a magic rock, then I can get people to sell that rock to each other for a $1 million and we are all convinced that we all are millionaires. People were using houses to print funny money, and you don’t need China to help you with that.

  • Posted by Albion

    Brad
    The interest rates yield curve is not driven by supply and demand, it is too academic for an explanation.

    See the outstanding position in the IRS and interest rates futures (quarterly report controller of currency)
    The latest ten years Bund auction has seen a 87 Pct cover that means 13 Pct of the auctioned amount had no bid. This lack of attraction from genuine bonds holders had no effect on the existing 10 years yield.
    The whole spectrum of financial prices have been perverted since long through cartels and it is no wonder that at some point of time prices are and will be moving from a convex reflexivity towards a concave reflexivity .

    « German bond sale’s fate signals trouble ahead
    By David Oakley in London
    Published: January 7 2009 13:30 | Last updated: January 7 2009 20:45
    A German sovereign bond auction failed on Wednesday as investors shunned one of the most liquid and safe assets in the world in a warning for governments seeking to raise record amounts of debt to stimulate slowing economies.
    The fate of the first eurozone bond auction of 2009 signals trouble ahead as governments around the world hope to issue an estimated $3,000bn in debt this year, three times more than in 2008. »

  • Posted by glory

    global savings glut?

    whatever :P

    a revised WTO?

    the gloves are off!

  • Posted by geert

    I will try a different approach, a more legal one, in an “attempt” to be original. The idea originated when 2Fish wrote that the reserves are “a cushion for this crisis” (2:01)

    The two main sources for international reserve building are: the trade surplus and the FDI / hot money flow. Let us suppose for a moment that both contributed equally to the Chinese international reserves.

    The part coming from the trade surplus is the property of the Chinese people. They earned it and can spend it the way they want (and please do respect ownership on an international level as you do on a national/individual level = the pilar of US civilization). And why not include the $ 9 trillion cash on the sidelines in the saving glut?
    http://www.sfgate.com/cgi-bin/article.cgi?f=/n/a/2008/12/23/financial/f135629S16.DTL

    The second part, they don’t own in the real sense. It is the subject of an exchange/swap/barter whereby the Chinese government accepts dollars and gives Yuan. This swap is a temporary agreement (long for FDI and maybe very short for hot money), with a foreigner who will at some point in time exit and demand the reverse exchange. The Chinese government MUST be able to meet that demand at any moment.
    If I reason as a good family man then I know I shouldn’t spend the dollars but invest it wisely. As I neither want a currency risk nor a debtor risk, the only available instrument is US treasuries.

  • Posted by Indian Investor

    Brad:
    But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth.

    I fully agree with this statement and I’m not clear why there’s a lot disagreement on it. There has to be a lot of Government fiscal stimulus spending in countries like India so that local demand and US exports to that country can increase and allow the Reserve Bank of India “a painful adjustment is now inevitable” conclusions to actually pan out. Somebody has to convince the Reserve Bank of India that “inevitable” things don’t happen all by themselves. Somebody or other has to actually work on the inevitable things of life and make them happen.

  • Posted by ReformerRay

    Indian Investor says: “But the US external deficit won’t fall unless the world steps up to pull itself out of trouble. It won’t happen without policies to support global demand growth”.

    Assuming the U.S. will not change its policy. The U.S. government has not made any seriou attempt to reduce the size of the U.S. trade deficit. It is my firm conviction that this passivity is detremental to the long term interests of the U.S. I cannot understand why it continues.

    Global demand growth will not necessarily reduce the U.S. external deficit. Whoever is supplying goods to the world today will continue to do so tomorrow.

    The only path to reduction in the U.S. external deficit is action by the U.
    S. to change the situation.

  • Posted by ReformerRay

    Any U.S. citizen that provides advice to the Chinese government on what its trade policy should be is wasting their time.

    The Chinese leadership will decide what is in the best interests of China.

    The rest of the world, including the U.S., should concentrate on what their own country should do, in response to what China and all the other trading partners do.

  • Posted by tip

    The formula is pretty simple. Immediately withdraw all troops from Iraq, cut out missions in Afganistan and reduce military capacity around the world by 50%.

    If the U.S. does not do this then it’s going to default on it’s debt. Sooner before later.

    When empires decline, it takes time, but one key component is the decline in the empires military. Of course the majority of Washington is brainwashed and does not see the severity of the crisis, or the severity of the u.s. trade defecit. I think a few of the G20 leaders are becoming aware.

    The transition will not be easy, and i do wonder how Americans will feel when the Dow Jones sits at 3-5K level the next 10 years and suddenly emerging markets start moving higher.

    The Dow Jones will be the Nikkei…but we could be Iceland with a massive default in the not too distant future.

  • Posted by ReformerRay

    I vote for tip.

    Yes, a bloated military is part of our problem. Reduction in military spending is part of the solution.

    Do we have time for Obama to see the wisdom of tip’s advice? And for him to persuade those Republican’s he wants to work with?

    Maybe so; maybe no.

  • Posted by Observer

    2fish:

    You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?

  • Posted by Observer

    2fish:

    Without demand from households, what is the incentive for private enterprises to invest?

  • Posted by seatrus

    # Observer responds:

    2fish:

    You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?
    ———————————————

    It also has a lot to do with the Fed’s policy of keeping interest rate low. A lot of near-retirees jumped the investment bandwagon because the interest on savings could barely keep up with inflation. This is “forced investment” by the Fed. The Fed may have thought that they had discovered the magic bullet to deal with the economical fluctuations: keeping interest low and money supply high, which caused over investment. But where was the demand? The U.S. government under the pressure of investment lobbyists sought to increase demand by relaxing rules about financial regulation, thus paved the way for reckless credit expansion.

    Credit expansion can boost consumption if used prudently, i.e. proportional to income. But in the past years, credit expansion far outpaced the rise in real income. It was a vicious cycle: on one hand increased money supply by the Fed caused over investment and speculative bubbles. On the other hand, to solve the lagging income/demand problem, the U.S. government, instead of sought ways to increase real income for the middle class, allowed financial institutions to create “credit” based on bubbles, which artificially boosted demand to match the fake prosperity.

    The U.S.’ trade deficit with China was mainly caused by over investment by American companies in China, which was part of the overall over investment problem created by the Fed. Protectionism only hurts the poor who have benefited from the cheap Chinese goods, while ignoring the fact that the root cause of the current crisis was a combination of wrong monetary policies, irresponsible deregulations/credit expansion, and most importantly, the ignorance to the stagnant in real income. Bring back progressive taxation, like in the 50s and 60s, is the only way to long term prosperity.

  • Posted by Twofish

    One thing that worries me is that everyone is so much in panic mode that no one seems to be talking about the long term impact of what is happening. It’s easy to start economic stimulus. The hard part is turning it off after it becomes non-useful. If you put lots of money in construction, then you will end up with a construction lobby that will try to keep that money flowing indefinitely.

    Observer: You don’t think social security guarantees and medicare had anything to do with a third of the babyboomers ending up with zero savings?

    Curiously I don’t think so. You aren’t going to have a decent retirement if you rely only on social security.

    Also in the case of China, I can see a situation in which a good health care system and retirement system will result in lower savings in twenty years, but even if you have a magic wand and put in a system right now, it is very unlikely to have any immediate effect on savings.

    One thing that would be interesting would be to compare the savings habits of people who are covered by various health insurance and those that aren’t, and I don’t think that there is much of a difference. Also Chinese saved a huge amount under the pre-1978 socialist system even with health and education (largely because there was nothing to buy).

    You also want to be careful. If your only goal is to stimulate demand, then you want to end up with a bloated inefficient system, because the more inefficient the system, the more ways you can pump money into the system.

    In any case, Chinese household savings have been roughly constant over the last thirty years. What increased tremendously was Chinese corporate savings, and that was because Chinese corporates in the 2000′s were making money.

    Observer: Without demand from households, what is the incentive for private enterprises to invest?

    Expectations of future demand. If you run into a situation where private enterprises can’t find anything that they want to invest in, then at that point you generate demand buy having the government generate public goods.

    Observer: The Fed may have thought that they had discovered the magic bullet to deal with the economical fluctuations: keeping interest low and money supply high, which caused over investment.

    I don’t think it is “overinvestment” rather than “misinvestment.” The prevailing ideology at the time was that all the government had to do was to set interest rates, and the market would react in the most productive manner. This ideology turned out to be wrong.

    This matters for current policy. You can argue that Obama’s policy of cheap money and fiscal stimulus is the same, and you might be right if you just look at interest rates. However, Obama is likely to advocate a far more interventionist role for the government to determine how the stimulus is allocated.

    Personally, I think that with the fall of the Soviet Union, there was this notion that any sort of government intervention in the economy other than setting interest rates and enforcing contracts was a bad thing, and the pendulum swung a bit too far.

    2fish: On the other hand, to solve the lagging income/demand problem, the U.S. government, instead of sought ways to increase real income for the middle class, allowed financial institutions to create “credit” based on bubbles, which artificially boosted demand to match the fake prosperity.

    One thing. I don’t think that there was fake prosperity. Between 2000-2008, you had vast increases in productivity which resulted in vast increases in incomes for the wealthy.

    Observer: Bring back progressive taxation, like in the 50s and 60s, is the only way to long term prosperity.

    Except that the 1970′s weren’t that great.

    There is a problem with political timing.

    I think that Obama is very shrewd for talking about tax cuts now. If the stimulus package works, then he is going to have enough political support to do whatever he wants to in two years, if he really believes that high taxes on the wealthy is a good thing (and we’ll find out then whether he really believes this or not).

    If the stimulus package blows up, then he has bought himself insurance by including tax cuts. If you increase taxes now, and everything falls apart, the Republicans are going to blame the tax increases for everything that went wrong.

  • Posted by Twofish

    ReformerRay: Any U.S. citizen that provides advice to the Chinese government on what its trade policy should be is wasting their time. The Chinese leadership will decide what is in the best interests of China.

    No they aren’t wasting their time. The Chinese leadership is extremely open to listening to outsiders points of view and tends to be very good about listening to constructive criticism. One thing that is fascinating about the Chinese leadership is the amount of intellectual diversity there is.

    You have everyone between hard-line Marxists and people that worship Milton Friedman in policy making positions within the Communist Party. The interesting thing about the Chinese Communist Party is that as long as you don’t oppose keeping the Party in power, there really aren’t that many restrictions on what you can believe.

    The views of foreign economists on the Chinese economy are extremely influential in internal Chinese political discussions. You just have to remember what their point of view is.

    If you come up with clear and convincing arguments that free trade will benefit China and destroy the United States, well, they really don’t care that much what it does to the United States. It will certainly influence the Chinese leadership, although maybe not in the way that you want.

  • Posted by Observer

    2fish: Also Chinese saved a huge amount under the pre-1978 socialist system even with health and education (largely because there was nothing to buy).

    And health care costs were low back then, unlike now. The situation now is that you have a clash of social norms based on filial piety and you also have exploding medical costs as more and more of the most advanced medicine and medical treatment are becoming available. That’s an entirely new dynamic.

    2fish: Expectations of future demand. If you run into a situation where private enterprises can’t find anything that they want to invest in, then at that point you generate demand buy having the government generate public goods.

    Government spending can only be a short term fix. To the people who are unemployed right now and are able to work, do they really care if the government pays them $20 an hour to build highways or to dig holes in the middle of a desert? It surely won’t matter to them, but the effect is that you end up with the government printing money by keeping people on its payroll and not really producing any goods that the private sector demands. If the situation lasts perpetually, then you’d have a boatload of money chasing very few real goods and services, and thus you’d have inflation.

    In the long run, you need people to produce real goods and services, and to do that you need people to consume them. Transactions have to be viewed as delayed barters, so this way, it’s easier to see that for one to produce, one must also consume.

    Lastly, figuring out how all of this is going to impact China is great, but US policy makers are only accountable to their own constituents, and that doesn’t include the Chinese. The Chinese really ought to just stop feeding the bureaucrats and really start to allow individuals and businesses preserve their capital by stripping officials of the power to corrupt their savings. You wonder why the Chinese corporations have saved so much? Perhaps you ought to look at all the layers of government bureaucracy and legal ambiguity that make it nearly impossible to undergo long term investment projects without the fear of having some initial projection going completely awry.

  • Posted by ReformerRay

    After all the above discussion, we have missed the elephant in the room, trillions of dollars of private contracts, constructed on the basis of the false assumption that the people that promised to pay regularly would do so. Until these are “disposed” in some way, stimulus packages, no matter what their nature, will go to increase the balance sheet of all firms that feel threatened by current reality.

    We should reject the notion that private contracts are sacred and must be enforced by U.S. courts. Instead, we should pass a law saying these contracts should never have been written and that they will not be enforced as written in U.S. courts.

    That will open the door to additional laws which specificy ways these various contracts should be valued. Serious discussion will be needed to come up with the least unfair way of resolving the situation.

    I am assuming here a massive change in the Congress. My only hope is that they continue to be responsive to public opinion and that the problem will be recognized before it is too late to deal with it.

  • Posted by ReformerRay

    I still think it is presumptous and inappropriate for citizens of the U.S. to try to tell the Chinese government what policy it should take.

    Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preseves the power of each nation.

    Twofish initially disagrees, then he says that the Chinese leadership will be influenced by what is said in the U.S., but not in ways that you might want. Seems to agree with me.

  • Posted by ReformerRay

    If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    And variable that can only be estimated by calcuations from the level of other variables in the equation cannot be a causal variable.

    The size of national savings in China reflects the combination of investment and a large trade surplus. If the investment level were equal to the level of the trade balance, national savings in China would be zero.

    Personal savings have very little to do with the level of national savings. Governmental savings and business savings outweigh personal savings.

    Think anwew, guys. Most economists view savings as a causal variable but that is a mistake which should be corrected.

  • Posted by ReformerRay

    Instead of “And” the first word in the second paragraph should be “Any”. And that sentence should conclude with the phrase “in that equation”.

    Addendum. Savings is defined as that part of national output that is not consumed. Thus Savings = GDP – Consumption (public and private). Two sides of the orginal equation remain equal after Consummption is moved from the right to the left side of the equation. Thus S = I + TB.

  • Posted by ReformerRay

    I mispoke above. Only when the trade balance is negative, will the savings level be zero, when the positive investment is large enough to balance the negative trade balance.

    A positive trade surplus plus a positive investment will produce a very large national Savings. As in China, currently.

  • Posted by Twofish

    Observer: You also have exploding medical costs as more and more of the most advanced medicine and medical treatment are becoming available. That’s an entirely new dynamic.

    The exploding cost of health and education in China and the United States has nothing to do with technology. The issue is that in the 1960′s in China, it was really cheap to hire people to be doctors and teachers, because there were no other job opportunities. Today, there are, and if you pay people low wages to be doctors and teachers, they won’t be.

    If you look go to a nursing home and see what they spend their money on, high technology is not where the big costs are. Technology tends to be a capital cost that can be spread over large numbers of patients. The really big costs are people. You can share one X-ray machine with 100′s of people, but you can’t do this with nurses.

    Observer: Government spending can only be a short term fix. To the people who are unemployed right now and are able to work, do they really care if the government pays them $20 an hour to build highways or to dig holes in the middle of a desert?

    No. But if the government borrows money, it makes a big difference since highways create wealth that generate tax revenue that pays back loans.

    Observer: It surely won’t matter to them, but the effect is that you end up with the government printing money by keeping people on its payroll and not really producing any goods that the private sector demands.

    If they are public goods that increases the efficiency of the economy, then you don’t have a problem. You print money, but the total wealth of the society increases, and so things balance themselves out.

    Observer: If the situation lasts perpetually, then you’d have a boatload of money chasing very few real goods and services, and thus you’d have inflation.

    But you can have public goods and then taxes can pay for those goods. Public goods can improve private wealth.

    Observer: The Chinese really ought to just stop feeding the bureaucrats and really start to allow individuals and businesses preserve their capital by stripping officials of the power to corrupt their savings

    No. You need to pay bureaucrats *MORE* money. If you pay bureaucrats less money, then you end up with lousy inefficient bureaucrats that figure out how to make money in bad ways anyhow. If you pay bureaucrats *MORE* money, you end up with a more honest, cleaner, more efficient bureaucracy that that ends up generating more private wealth.

    If you want quality, you have to pay for it. If you start nickle and diming everything, you end up paying the same or more, but getting less. An honest banker or bureaucrat will tell you upfront how much he is going to take from you. If you try to go for the lowest bidder, chance are that you will end up with someone that won’t tell you what they are doing to take from you.

    This is the problem that you end up with teachers, doctors, and bureaucrats. People in private parts of the economy make a lot more money (compare the salaries of policemen with stock brokers). The trouble with that is that you end up with a system out of balance.

    Observer: You wonder why the Chinese corporations have saved so much? Perhaps you ought to look at all the layers of government bureaucracy and legal ambiguity that make it nearly impossible to undergo long term investment projects without the fear of having some initial projection going completely awry.

    But then you ask is it a bad thing that Chinese corporations save so much, and it isn’t. Chinese corporations have saved a lot because you have a government bureaucracy that intentionally put in measures to encourage corporate savings. This is a good thing.

    If it were not for government regulation, China would be in the same situation as the United States with busted banks and bankrupt corporations.

    Ronald Reagan may have been right in 1980, but his ideas have outlive their usefulness, and the pendulum needs to swing back.

    Government is not the problem. It is the solution.

  • Posted by Twofish

    ReformerRay: If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    The problem here is that you can’t just change one number and keep all the other numbers fixed. If you change trade balance then all of the other numbers change.

  • Posted by Twofish

    ReformerRay: I still think it is presumptous and inappropriate for citizens of the U.S. to try to tell the Chinese government what policy it should take.

    I think it is quite appropriate. I think that the Chinese government should do X because I stand to make a lot of money if they do X and stand to lose a lot of money if they don’t do X.

    Now if they do X just because I think that they should do X, then they are idiots, but the good thing about the Chinese government is that they have the will and ability to make up their own minds. This isn’t true with the government of Upper Volta. Because China is as powerful as it is, this means that “hard ball” is appropriate in a way that it isn’t for a lot of other countries.

    ReformerRay: Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preserves the power of each nation.

    I don’t see anyone in Beijing or Washington DC that much disagrees. The trouble is that when you get into the details of *how* to do that. People in Beijing and Washington that support free trade do so largely because they think that it is in their national interest to do so.

    The fact that there is very little support for trade protectionism suggest to me that there is a very strong possibility that open trade is in fact in the national interest of the United States. If everyone is making more money doing X than doing not-X, that suggests that X may be a good thing.

    China is largely open to foreign investment, foreign trade, and foreign ideas because it tried for 30 years to close itself off, and it was a total economic and political disaster that no one in China ever wants to repeat.

  • Posted by Observer

    2fish: The exploding cost of health and education in China and the United States has nothing to do with technology.

    I’m not familiar with education costs, but the notion that exploding healthcare costs have nothing to do with technology is flat out wrong. Google some congressional studies on the subject. This point is really not up to debate.

    2fish: If they are public goods that increases the efficiency of the economy, then you don’t have a problem. You print money, but the total wealth of the society increases, and so things balance themselves out.

    The question is not whether new roads will improve efficiency; if one passenger gets to save 10 minutes from his morning traffic, you’d also have an improvement in efficiency. The question is by how much. There’s a reason why the Japanese couldn’t spend their way on public projects to get out of the recession. New roads sound nice, but over the long term, when you neglect the goods and services provided by the private sector, it doesn’t matter how much money your government has printed or borrowed to fund your paycheck, you’d still be in queue at a bread line.

    2fish: No. You need to pay bureaucrats *MORE* money.

    Maybe if we just give them all the national treasuries, that would perhaps solve all of our problems. No political reforms necessary. Just legitimize grey income.

    2fish: This is a good thing.

    The lack of investment by Chinese corporations in China to create jobs and expand business activity is a good thing? I’m not following.

    Again, a large part of China’s social norms is built around filial piety. Even though the middle class has been getting richer, the healthcare costs that they are responsible for have also climbed up. Imagine if you are a engineer in a Chinese firm. Are you going to decline the latest cancer treatments available for your mom?

  • Posted by Twofish

    Observer: I’m not familiar with education costs, but the notion that exploding healthcare costs have nothing to do with technology is flat out wrong. Google some congressional studies on the subject. This point is really not up to debate.

    This may be the case in the United States. It’s certainly not the case in China. The basic health care system has broken down, not because of access to high technology, but because when Communist central planning fell, some of the good things of Communism (like decent basic health care) also fell apart.

    Observer: There’s a reason why the Japanese couldn’t spend their way on public projects to get out of the recession.

    China isn’t Japan. If China were at Japanese levels of development building new railroads wouldn’t be productive, but it isn’t there yet.

    Observer: New roads sound nice, but over the long term, when you neglect the goods and services provided by the private sector, it doesn’t matter how much money your government has printed or borrowed to fund your paycheck, you’d still be in queue at a bread line.

    Governments can provide goods and services also. The state owned enterprise sector of the Chinese economy does everything that the private sector companies do in the US.

    Observer: Maybe if we just give them all the national treasuries, that would perhaps solve all of our problems. No political reforms necessary. Just legitimize grey income.

    The problem with most developing countries is that they don’t have a tax system and so they aren’t subject to central control. The problem with legalizing grey income is that they are then not subject to either market or administrative control and bad things happen.

    Observer: The lack of investment by Chinese corporations in China to create jobs and expand business activity is a good thing? I’m not following.

    What lack of investment? Chinese companies make money, lots of money. They either build factories or put their money in the bank which then loans it out for someone else to use.

    Observer: Again, a large part of China’s social norms is built around filial piety.

    Chinese social norms are changing rapidly enough so that it’s very hard to make generalizations.

    Observer: Even though the middle class has been getting richer, the healthcare costs that they are responsible for have also climbed up.

    The middle class is not the problem. If you have a job at a large Chinese company, the odds are that you have decent health care insurance for you and your family. The problem is that this isn’t true if you are a migrant worker, you don’t have any insurance at all.

    Observer: Imagine if you are a engineer in a Chinese firm. Are you going to decline the latest cancer treatments available for your mom?

    It’s not the latest cancer treatments that are the problem. It’s what happens if you break your arm or get in a car accident. Right now, if you don’t have money to bribe the doctors, there is a good chance that you just end up dying.

  • Posted by Observer

    2fish: This may be the case in the United States. It’s certainly not the case in China.

    That is in fact the case and this is from the experience of a family member. As more advanced medical treats are made available, the cost of hospital visits go up. I don’t know why it’s so hard to comprehend this reality.

    The paradox is that those with greater income automatically share a greater burden as well, because of their ability to pay for more advanced treatment that the lower income people can’t afford.

    2fish: China isn’t Japan.

    I was referring to American fiscal spending, my bad for the confusion.

    2fish: Governments can provide goods and services also.

    As could the USSR and Chinese SOEs of the bygone era. That didn’t work out too well did it.

    2fish: The middle class is not the problem. If you have a job at a large Chinese company, the odds are that you have decent health care insurance for you and your family.

    Like I said in my original post, the problem is not medical care costs for yourself but for your aging parents who do not enjoy adequate state support.

  • Posted by Twofish

    Observer: That is in fact the case and this is from the experience of a family member. As more advanced medical treats are made available, the cost of hospital visits go up. I don’t know why it’s so hard to comprehend this reality.

    Look at where the money actually goes to, and you find that most of the costs end up going to the people that run the machines rather than the machines themselves.

    And in any case, what is true for Kansas may not be true for rural China. The problem in China is basic health care (i.e. getting a doctor to look at broken arm).

    Observer: As could the USSR and Chinese SOEs of the bygone era. That didn’t work out too well did it.

    Well Chinese SOE’s figured out what the problem was and started fixing it. The problem with Chinese SOE’s in the 1990′s was *exactly* the problem that General Motors has, which is that it is getting burying in health care and pension costs. The problem is that if you are buried in health care and pension, you can’t put money into technology and process improvement, and you get into a bad cycle.

    Observer: Like I said in my original post, the problem is not medical care costs for yourself but for your aging parents who do not enjoy adequate state support.

    You are taking your own experiences and assuming that the situation in China is similar when it isn’t.

    For one thing, US hospitals have legal requirement to treat emergency patients, Chinese hospitals do not. If you get hit by a truck in front of a US hospital, they will treat you. If you get hit by one in front of a Chinese hospital, and you have no cash, there is a good chance that you will bleed to death.

  • Posted by ReformerRay

    Twofish says: “ReformerRay: If you use the componenets of GDP to estimate the size of national savings, as in Savings = Investment + Trade Balance, this formula requires that Investment and the Trade Balance control or determine the level of Savings.

    The problem here is that you can’t just change one number and keep all the other numbers fixed. If you change trade balance then all of the other numbers change.
    January 12th, 2009 at 12:53 pm

    Of course, Twofish. My point is that the trade deficit is the controlling variable (along with Investment). When the trade deficit increases (negative trade balance), National Savings MUST decrease, unless Investment intervenes. The question of which is the controlling variable is very important. Larry Summers and others have said, in the past, that the U.S. must increase national savings in order to reduce the trade deficit. WRONG. The U.S. must reduce the trade deficit to increase savings.

  • Posted by ReformerRay

    Twofish says: “ReformerRay: Each nation should defend its own sovereignty. That includes intervening in the world trade system in a way that preserves the power of each nation.

    I don’t see anyone in Beijing or Washington DC that much disagrees”.

    Paying outsiders to produce goods for sale in your nation does not preserve the power of a nation. GDP is reduced by imports. GDP is increased by exports. The U.S. is commiting suicide for the priviledge of consuming more goods than we can produce. We are the suckers because we are childlike in our desire to have it now.

    No, U.S. policy is not protecting the power and wealth of the U.S.

    The fact that people want something does not show that it is good for them.

    Protectionism has a bad name in the U.S. because economists have insisted that there is only one kind of protectionism – the kind that creates retailation. There are lots of ways to reduce the U.S. trade deficit without creatintg retailation. When that message gets across, we will see more support for less imports into the U.S.

  • Posted by ReformerRay

    I find much to admire in the behavior of the Chinese leadership. They recognize that a powerful central government is necessary to keep all the outside preditors at bay. And they are right. Control over the inflow of money into China allowed China to escape from the Asian financial crisis of 1999.

    And I admire the same kind of realism in much of what Twofish says.

    However, I get the feeling that the two of us disagree so much because he is looking out for the interests of China and I am looking out for the interests of the U.S. In my view, China does not need any help in the matter of international trade. They are doing the right things for China in terms of international trade. It is the U.S. that doesn’t understand how to defend its national interest.

  • Posted by don

    The policy of exporting the nation to prosperity has a long tradition and many examples to recommend it. I have long argued that the policy would not voluntarly be foresaken. The habit will be very hard to break, but it is leading ot unsustainable imbalances. What is needed now is cooperation and agreement. Assigning blame for the current collapse probably will not do much to further this effort.

  • Posted by MFMartin

    The “savings glut” theory looks like a repackaged version of Say’s Law — that supply creates its own demand. Focusing the analysis of the global economic crisis only on the financial side can create misleading images of the economic dynamics. While I can see an argument that China and other nations holding excess foreign reserves facilitated the economic crisis, the main force driving the crisis came from the United States and to a lesser extent, Western Europe. The real danger of the “savings glut” theory is that some people will use it to deny the need for the United States and Europe to raise their savings rates and curtail their fiscal, trade and current account deficits.

  • Posted by Massimo GIANNINI - M.G. in Progress

    The “savings glut” theory it’s a kind of “conspiracy theory”. Alan Greenspan elaborated on that in his testimony in 2005 and I discussed it HERE. One could wonder why nothing was done about it…

  • Posted by ReformerRay

    Don – Can’t you see the inconsistency in your first proposition, that nations have exported themsevles to propserity and that the habit will be very hard to break and then your next sentence call for cooperation?

    don responds:
    The policy of exporting the nation to prosperity has a long tradition and many examples to recommend it. I have long argued that the policy would not voluntarly be foresaken. The habit will be very hard to break, but it is leading ot unsustainable imbalances. What is needed now is cooperation and agreement.

    Cooperation and agreement has been sought consistently by the U.S. for 3 decades. Your position should be that any nation that is unhappy with a “unsustainable imbalace” because the imbalance is reducing the wealth and power of that nation, should take unilateral steps to correct the situation.
    Why should a trade surplus nation cooperate?
    The have worked very hard to create a trade surplus – and it is working for them.

    Any change must be caused by the U.S. – unilateraly. Your first statements leads to that conclusion.

  • Posted by df

    well all in all it all sums up to : well nothing new under the sun. We ve seen the scheme already and it was obvious that all this was bound to happen 10 years ago.

    Savings glut has been caused by huge growth with spending habits following with a delay. That also had already been seen.

    Protectionism will rise since it has too. It is a good thing that it does.

    Free trade has led to massive global pollution and social disorder. Free trade has been part and parcl of the present situation.

    Yes

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