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Read Dean, Areddy and Ng on the management of China’s reserves during the crisis

by Brad Setser
January 29, 2009

Dean, Areddy and Ng key their story off Wen’s criticism of US economic management. But it is really much more about the political fallout inside China from China’s losses on investments that they considered safe.

The story breaks a lot of new ground. It highlights how China’s losses on Reserve Primary, Lehman, Morgan Stanley and WaMu influenced China’s decision-making It also confirms that China was very very nervous about its Agency exposure.

“The alarm for Chinese leaders started ringing loudly in July and August as problems deepened at Fannie and Freddie. Senior Chinese leaders, who hadn’t been apprised in detail of how China’s reserves were being invested, learned for the first time in published reports that the country’s exposure to debt from those two alone totaled nearly $400 billion, say people familiar with the matter. Fearing that the U.S. government might not fully back the companies, China demanded and received regular briefings throughout the peak of the crisis from high-level Treasury Department officials, including Mr. Paulson, on the market for U.S. debt securities — especially those of the mortgage giants.”

It seems like China’s top leaders knew less about China’s portfolio that American reserve watchers; it is not inconceivable (gulp) that I was the source for those published report about China’s Agency holdings. My own work with Arpana Pandey, incidentally, suggests that China’s holdings of Agencies were closer to $600 billion at their peak – though it is possible that China never held more than $400 billion of Fannie and Freddie debt, as there are other kinds of Agency bonds.

The Journal’s story also confirms that there has been a huge swing in the management of China’s reserves. The TIC data, which has shown a huge increase in China’s Treasury holdings, wasn’t off.

It turns out that one of China’s main criticism of US policy is simple: the government didn’t stand by institutions that China expected the US to support. Lehman. Wamu. And the Reserve Primary Fund. Dean, Areddy and Ng:

“Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …

Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.”

….. The Reserve issue “is causing a lot of concern with a lot of financial institutions in China,” said the Chinese official. Some officials expected that the U.S. and its financial institutions would better protect China from loss. “If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system,” the official said

China’s leaders believed that China’s investments in the US financial sector would be protected, perhaps because that is how things are done in China. They weren’t. At least not consistently.

And that clearly has had a big impact on China’s leadership. And if I had to guess, I would guess that the CIC was not the only institutions in China that had a bit of direct exposure to Lehman. SAFE turned conservative at the same time as CIC. Though it may have been stung more by its losses on WaMu (Via a TPG fund).

China didn’t just stop buying Agencies. It also stopped lending out its Treasuries.

The Chinese central bank last year stopped lending its Treasury holdings for fear the borrowers will go bankrupt, according to people familiar with the discussions — a decision that disrupted the functioning of the Treasury market. Beijing rejected pleas by Washington to resume its lending of Treasurys, the people said.

Fair enough. China owns the Treasuries after all, and has no obligation to lend them out. But, well, its actions in both the Treasury and Agency markets weren’t exactly stabilizing.

China’s leaders have a major problem. They have accumulated an enormous quantity of US assets as a result of their efforts to manage China’s exchange rate But they don’t have a mandate to lose money investing the public’s money abroad. China’s losses have generated a public outcry. However, avoiding credit losses means piling into Treasuries and — well — that has risks of its own.

The internal criticism of China’s central bank and the CIC is a bit incoherent. They are getting blamed both for letting the RMB rise and for accumulating US assets.

“Around October, a lengthy Chinese-language essay began circulating on the Internet excoriating Mr. Lou and other top CIC officials, along with Zhou Xiaochuan, China’s central bank governor, for being too close to the U.S. and then Treasury Secretary Henry Paulson. The diatribe quickly gained wide circulation in Chinese financial circles. One passage charged that Mr. Zhou “colluded with Henry Paulson to buy U.S. bonds, forced [Chinese yuan] appreciation, attached China’s economy to the U.S. and broke China’s economic independence.”"

But the reality is that the RMB peg tied China’s economy to the US, and only by letting the RMB rise more than it has can China stop accumulating US assets.

China doesn’t really seem to want more exposure to the US. Understandably so. It already has way more exposure than makes sense. But China also doesn’t want its currency to rise, especially now. And there is no way to square that circle.

The funny thing?

China’s external portfolio actually has performed relatively well during the crisis. It only invested a tiny share of its total portfolio in risky assets. It holds a lot of long-duration bonds whose value rose as interest rates fell. And it is overweight dollars and the dollar rose …

The true risk in China’s portfolio is one that China’s leaders clearly knew they were taking, namely that the dollar will eventually fall against the RMB. China for a long time operated its own version of the TARP. The troubled asset it bought in huge quantities in 2007 and the first part of 2008 was the dollar.

79 Comments

  • Posted by Indian Investor

    Brad:
    …And there is no way to square that circle.

    The Federal Reserve Bank, the US Treasury and the large US commercial banks are in a process that is commonly defined as “circular trading” in most emerging market stock exchanges.Unless China’s policy makers understand this process clearly it would be hard for them to construct an appropriate policy response to the credit crisis of their own.

    The Treasury issues Bonds, that are subscribed to by the public, and primary dealers in US Govt. Securities, such as Goldman Sachs, purchase these bonds on behalf of their customers in return for cash. The Federal Reserve then gives a credit to the Treasury in its account with the Fed, instead of remitting the cash received against the Treasury Bond purchases to the Treasury. The Fed then extends new credit to the banks, either against a new receivable or against a collateral security (bad loan) that the bank provides the Fed. Overall, the banks have exchanged either a bad loan, or a new liability to the Fed, for real cash in green dollars.
    The banks themselves may have subscribed to the Treasury securities in vast quantities, with a controlled hiking up of the price of Treasury Bonds in the circular trading process described above.
    “The flight to safety” at its epicenter consisted of passing bad loans to the US Taxpayer, and exchanging them and fresh Fed loans for Treasury Bonds and Bills, that can be easily lent out in future.

    To be continued …

  • Posted by Indian Investor

    Before the reported Davos comments China’s premier Wen stated on a more even keel that the underlying problems was that America’s problem is that America’s people tend to spend their income on purchases whereas China’s problem is that Chinese people tend to save their income and not spend it.
    The real problem is that in China, the Communist Party controls the commercial banks. Whereas the United States of America Department of the Treasury, and the White House, are controlled by four banks – Goldman Sachs, Citigroup, Bank of America and JP Morgan. This is a really serious problem and unless the Chinese Government understands this they will also not understand any of the statements, etc coming out of the Geithner Treasury Secretary Office.

  • Posted by Indian Investor

    The recent falls in international trade, especially falls in exports to the US, represent falling aggregate demand, rather than reduced profitability of exports. Some factories can remain open and operate at the same operating margin at reduced capacity levels and with fewer workers. Further reduction in operating margins can trigger factory closures with more mass lay offs in China. I actually have some direct exposure to manufacturing, so it’s easy for me to know from my common sense that a factory has a lot of fixed costs, and at reduced capacity the factory becomes unprofitable if margins are also lower.

  • Posted by 02022009

    Something will occur between Feb. 6-9th. Negative news may happen between Feb.6-9th and markets will move lower the morning of Feb. 9th.

    I’m not sure if the negative news will involve China-U.S. trade flows, but the markets are going lower and the next wave down happens on Monday Feb. 9, 2009. There is a certain anxiety from the eastern front and we should not be surprised if the negative news of this weekend involves something with China.

    A wise investor takes this note and gets out of risky assets prior.

  • Posted by 02092009

    the thoughts of 02-09-2009 are those of my opinion.

    for a pretext please enjoy

    “Chinese Premier Blames Recession on U.S. Actions Beijing Rethinks Some of Its American Investments”

    http://online.wsj.com/article/SB123318934318826787.html

  • Posted by ndk

    China doesn’t really seem to want more exposure to the US. Understandably so. It already has way more exposure than makes sense. But China also doesn’t want its currency to rise, especially now. And there is no way to square that circle.

    Well, isn’t there one way? China could always just “diversify” its portfolio holdings by selling some Treasuries and USD to purchase commodities and assets in other economies such as the Eurozone.

    That would tend to force the USD and CNY down against the EUR or drive commodity prices up. It would lead to greater intervention required against the USD to keep the CNY at its pegged levels. The Eurozone wouldn’t enjoy it much. It’s hardly a stabilizing action, but in the short run, doesn’t it work?

  • Posted by Indian Investor

    Negotiations over exchange rates are part of trade protectionism, and I would like to note that barring severe protectionist moves, the markets are actually showing signs of recovery. Housing inventory is slightly and sales are slightly up, the falling trend in home prices continues, though(for details see Calculated Risk blog. Though we need to wait a bit more to be sure that deleveraging led by falling home prices is coming to a close, we also need to note that stock valuations aren’t below where they were in October, even after the Dec ’08 quarterly results have showing declining earnings.
    The recession will be quite severe but the evidence that markets are looking forward to a recovery in the medium term is increasing. The threat of nationalization has subsided for most Western banks and this is bullish for markets. The only major remaining risk factors are the disturbing RMB/USD exchange rate negotiations, India’s sudden ban on import of toys from China; and several other such protectionist decisions and demands around the world (Pettis has a nice summary of protectionist demands at his blog.

  • Posted by anon

    Indian Investor:

    The Chinese know what circular trading is. Its called “triangular debt” in Chinese. They do know the US is printing money, just read the papers or the blogosphere. Whether they know the mechanics of the debt game being played between Treasury, the Fed, and the primary dealers, I don’t know. But even if they did know, it makes no sense for them to publicize that knowledge, does it ?

  • Posted by Indian Investor

    @anon:
    Given USG Deficit upwards of $ 1 trillion, the “triangular debt” game will produce higher and higher prices and lower yields for USG securities. Any private speculators, or foreign central banks who speculate against this trend will probably lose heavily.
    The impact on banking stocks is obvious. Soon we’re going to have most of the bad loans sitting on the Fed’s books, with a big infusion of capital on to the bank’s books. If you analyze the proposal to change the accounting norms on mark to market, and look at the level of actual “cash” losses from declining home prices, you might think that there is actually much MORE credit available with US Banks than before the crisis.
    It stands to reason that these banks need something profitable to lend to, and to invest in. What better place than China?
    Let’s not be decieved by the “Boeing sales” argument or the “clawing jobs from China” argument. Much more difficult than done. High Tech Discrete Manufacturing isn’t an industry that can just easily be clawed back with a little of exchange rate manipulation. People who’ve been fired from auto manufacturing units, retail stores and real estate brokerages can’t be easily re deployed to manufacture civilian aircraft and electronic chips. It will take a whole new level of education and training for that. Where will the skilled labor needed for these activities come from?
    If the RMB/USD moves too much, you’re going to have collpasing demand in China and intolerable unemployment. If there are millions more of unemployed youth in China, where will the demand adjustment happen in China? How will there be more demand for chips and aircraft to export into?
    From all this reasoning I’m trying to say that RMB/USD moves are perhaps in reality being debated in the context of US private investment in China more than anything else.

  • Posted by Indian Investor

    As of the latest H4 release, new dollar printing in 2008 was slightly more than 8% of the existing stock of dollar bills. Remember, the Fed has an income statement, as well as a balance sheet. Interest on US Treasury securities is one of the main staples of the Fed’s income. So I’d expect that there will be more Fed monetization of credit; new dollar bills need to be printed to move some of the new T-Secs on to the Fed’s books, so that its expenses can be met easily in the short term. In the long term the receivables profile from what are “bad loans” today can improve. Cram downs are therefore more dangerous for the Fed than for any private parties. The Fed has to make up for cram downs by printing dollars.

  • Posted by Indian Investor

    Rice: Chinese :: US Treasury: Goldman Sachs

  • Posted by locococo

    The part that they (Chinese) might have misunderstood is that synthesizing safe assets (triple A-ing the junk and hedging / insuring the counter-party risk) to meet the demand, the side-product got re-used for naked shorting of these (newly created triple A s) at the back door, while premiums paid for (counterparty) risk hedge got distributed to the prior synthetic holders as if original cash flow; while new entrants expected future cash flow depends solely on success of the next cycle or the bail out, as it is.

  • Posted by Indian Investor

    Some things are more picturesque than Hayekian essays. Such as caterpillar wrigglies in charts showing the growth in PBoC’s forex reserves. These wrigglies are steadily climbing up a branch. Then you get caterpillar wrigglies showing China’s exports. These wrigglies are hanging loose and taking a break, after an arduous climb.

    When the debate about repealing the Glass-Steagall Act raged in 1999, representatives of DIs assured everyone that there would be “Chinese Walls” between their various self-reinforcing network of units. Now the same people are trying to convince everyone that the problem orginated in the vicinity of the Great Wall of China, and not around that wall that still surrounds the old World Trade Center buildings.

    At its peak, PBoC has held around $ 400 billion of Agency secs, as Brad’s estimate shows. The US mortgage market was $11 trillion in outstanding home loans. There was credit-swap swaps with a nominal premium total of something like $43 trillion being traded. Plus trillions more in MBO, Mortgage Asset-backed securities, and what have you. Looking at the growth in PBoC reserves growth shouldn’t lead to the automatic conclusion that those reserves were the root cause of credit expansion in the US.

    It’s neccessary to look at the steps that lead from PBoC forex reserves to the US home owner. In between, you have the Agencies, you have the Federal Reserve that regulating US banking, you have banks, you have private sector investment banks, and so on and so forth.

  • Posted by DJC

    Why would the Chinese leadership stupidly believe the Washington Consensus elites would preserve and protect the “real” economic wealth of China’s investments in the US Economy?

    In every other sphere, Chinese interests are absolutely disrespected. The national sovereignty of China is constantly ignored. The Chinese government is continually denigrated by Washington Consensus Neo-liberal news media. High-tech US exports to China are prohibited under the banner of national security threat. Tiny little Holland is granted a larger voting share at the IMF and World Bank than 1.6 billion population China (ie. The IMF is known as the US Treasury’s stooge). And not surprisingly, the Pentagon considers China to be the primary threat to US global hegemony. Relations between the Pentagon and China PLA have completely collapsed over issues impacting China’s national sovereignty.

    One of these days, the China PBoC will discover that the “real” economic wealth of its holdings of US Treasury bond holdings to be worth approximately zero due to either expropriation or monetary inflation printing by Helicopter Ben Bernanke.

  • Posted by Indian Investor

    Adjustment in trade flows is unlikely to happen as a result of exchnage rate adjustments. Trade flows arise from differential wage levels (for the same labor skills) in different geographies. These differentials exist for historical reasons, especially in the current world the US Treasury led manipulation of petroleum prices and petrodollar recycling for around 4 decades now. This manipulation led to very restricted capitalization of what are now called emerging markets while at the same time new information technologies enabled some laborers there to acquire better skills.

  • Posted by DJC

    Defense Secretary Gates says US ready to counter China “threat”
    The Associated Press
    Published: January 27, 2009
    http://www.iht.com/articles/ap/2009/01/27/america/NA-US-China.php

    WASHINGTON: Defense Secretary Robert Gates on Tuesday assured lawmakers that the United States is ready to handle any Chinese military threat.

    Gates, speaking at a Senate hearing, said that U.S. forces “have the capability in place to be able to deal with any foreseeable Chinese threat for some time to come.”

    Gates said the Defense Department is making good progress on developing a “number of programs” meant to counter Chinese technological advances that could “put our carriers at risk.”

    He did not elaborate on those programs. But he said U.S. forces are well positioned in the region, mentioning the nuclear-powered USS George Washington — a floating air base with 67 aircraft and an armory carrying about 4 million pounds (1.8 million kilograms) of bombs, which has a new home port in Japan.

  • Posted by MakeMeTreasurySecretary

    This was, oh, so predictable. China is experiencing “seller’s remorse”. They sold their goods to the USA at effectively very low prices (by propping up the dollar) and that was fine by China though it caused significant dislocation in the USA. But now they realize what they have done and are unhappy. Who could have guessed? I suggest they “mark
    to market’ and move on.

    @Indian Investor. Why, you write so well, you should focus on your own website.

  • Posted by Twofish

    bsetser: China’s leaders believed that China’s investments in the US financial sector would be protected, perhaps because that is how things are done in China. They weren’t. At least not consistently.

    In the end they were. Almost everything that China put its money into eventually ended being backed by the US government, since the Chinese government was only one person in a huge line of people that stood to lose out if they didn’t.

    Also, China ended up doing things a certain way because that ended up being the few politically practical ways of doing things. China ended up bailing out its banks in the 1990′s for exactly the same reasons that the US is going to end up having to bail out its banks.

  • Posted by Twofish

    bsetser: The internal criticism of China’s central bank and the CIC is a bit incoherent. They are getting blamed both for letting the RMB rise and for accumulating US assets.

    It’s not that incoherent. You have different people within China having different criticisms. One problem with the essay is that it treats China as one large monolithic entity when economic decision making is as complex and diverse within China as it is in the United States.

  • Posted by Albion

    As a whole, the banking industry is still a cause of worry as there seems to be no safeguard for the depositors through the actual system (by ways of at least a minimum insurance on deposits). The government interference in the credit allocation is high in the nation owned banks and with no real control (credit risk function).

    A run on the banks may not be able to be matched through government intervention in an equal amount of deposits drawn. The liquidity in the system is frozen in governments bonds which prices will be heavily brought down if paid at all through market forces. A consolidated statement of the total banks assets and liabilities is not available and it is feared that liquidity ratios met through local money market instruments such as wechsel, corporate bonds or Treasury bills may be proved, to be cosmetic accounting at time of crisis.

    This is an excerpt of the banking industry in Ukraine 2000. Banks did not carry large contra accounts.

  • Posted by Twofish

    DJC: Why would the Chinese leadership stupidly believe the Washington Consensus elites would preserve and protect the “real” economic wealth of China’s investments in the US Economy?

    Because in the end, they did…..

    BTW, are you saying that Chinese leaders are stupid? I just want you hear you say that explicitly for once.

  • Posted by Rien Huizer

    Funny story, if true in every detail, Beijing may have lapsed into the Imperial mindset that foreigners do not deal with China on equal terms (was the Qianlong Emperor not the one credited with telling a british envoy that China did not need trade but would accept tribute?).

    Who knows, perhaps the people in charge were really a little surprised. That would imply that they really did not know what they CIC, SAFE, POBC, the lot) were doing. Well I am sure that not everyone there did not know what was going on. But behaving as if expecting the US gvt to assist in a face saving exercise would be interesting. Many possible explanations.

  • Posted by Indian Investor

    @MakemeTreasurySecy:
    Thanks, as I explained before, most of my writing has been for my own reference so far. There’s a lot of risk involved in propagating my views because the list of people and organizations that can easily be offended would include people like Hamas, Mossad, The Tamil Tigers, the Sinhala Army, the US Treasury, Fed, The Taliban in Afghanistan, etc .. the list could go on. Starting with the insight that modern wars are being fought over oil, ever day I’m learning new things and unlearning some old things, and the journey has taken me to study a large variety of previously obscure topics.
    And I’m also slowly learning to be humorous or critical without creating too much offense.

  • Posted by DJC.

    Twofish: In the end they were. Almost everything that China put its money into eventually ended being backed by the US government, since the Chinese government was only one person in a huge line of people that stood to lose out if they didn’t.

    DJC: Oh please, were the $10 billion in financial losses on AAA-rated subprime bonds by the Bank of China fictitious? The Chinese were duped into the 10% equity stake in Morgan Stanley that is presently worth less than half the original purchase investment. There were direct lending default losses to bankrupt Lehman that is listed in the firm’s bankruptcy filing. There were China CIC equity losses in WaMu. The collapsed Reserve Primary Fund returned back less than 95 cents on the dollar to the China CIC.

    Any Yes, those failed investments by the Chinese government were “absolutely stupid”. It’s not just the Chinese Blogsphere that is demanding responsibility and even the death penalty for the China CIC officials, but Prime Minister Wen Jiabao also demanding accountability for the financial loss fiasco from high ranking CIC officials.

    With a per capital income under $2000 USD, China retains developing nation status and can’t afford further multi-billion losses on its US foreign reserve holdings. Nor can China even attempt to bailout the world economy.

  • Posted by DJC.

    Correction

    With a per capita income under $2000 USD, China retains developing nation status and can’t afford further multi-billion losses on its US foreign reserve holdings. Nor can China even attempt to bailout the world economy.

  • Posted by Twofish

    DJC: There were China CIC equity losses in WaMu.

    No there weren’t. CIC didn’t invest in WaMu. SAFE was thinking about investing in WaMu, but someone in the Chinese government with good sense wouldn’t let them.

    DJC: The collapsed Reserve Primary Fund returned back less than 95 cents on the dollar to the China CIC.

    This isn’t true. Treasury ended up guaranteeing principal in money funds so CIC didn’t lose any money off of that.

    DJC: With a per capita income under $2000 USD, China retains developing nation status and can’t afford further multi-billion losses on its US foreign reserve holdings. Nor can China even attempt to bailout the world economy.

    So you agree with Geithner and Brad Sester that China would reduce its US Treasury holdings and therefore it should appreciate its currency, and that it was a big mistake for China to accumulate its current foreign exchange reserves. Right?

  • Posted by MakeMeTreasurySecretary

    @DJC, “With a per capita income under $2000 USD”. Wait a minute. The PPI must be over $8,000. I think the PPI is what really matters. The per capita GDP expressed in dollars does not say much — other that China needs to let its currency appreciate.

  • Posted by Twofish

    Huizer: Funny story, if true in every detail, Beijing may have lapsed into the Imperial mindset that foreigners do not deal with China on equal terms.

    Well they don’t, but that’s something to be expected. In any market transaction, the counterparty will try to do everything to take advantage of you, and you are doomed if you don’t do everything to take advantage of them.

    Huizer: Was the Qianlong Emperor not the one credited with telling a british envoy that China did not need trade but would accept tribute?

    He had good reasons for that position. Qianlong has just finished a series of exhausting wars in Central Asia, and he feared that any sort of weakness shown to the British would have give the groups that he defeated in Central Asia encouragement to start a revolt.

    Also, the Qing dynasty was very careful to present themselves as defending Chinese interests, because a lot of people in China considered them no less “native” than the British. So by trying to get the British to kowtow (literally) the Qing was sending a message to its Han subjects that we are one of you and not one of them.

  • Posted by DJC.

    It’s a pipe dream that China can contribute to a bailout of the world economic demand. The reality is that there is no way Chinese buying power can fill the void left by American overconsumption spending. With a per capita income under $2000 USD, China is still too poor. A 700 million majority of the population still lives a subsistence living on the rural farm.

    Western Economists mostly lecture developing world people on Neo-liberalism economic doctrine without an understanding of how the majority of the world’s population actually lives their daily lives.

  • Posted by Twofish

    Victory has a thousand parents whereas defeat is an orphan.

    Huizer: Who knows, perhaps the people in charge were really a little surprised. That would imply that they really did not know what they CIC, SAFE, POBC, the lot) were doing.

    They did. It’s just that no one quite understand the implications. The sales pitch in 2007 was that Chinese financial institutions should cooperate more with US banks so that China could learn the world’s most sophisticated and advanced financial system. That makes no sense in 2009, but it sort of made sense in 2007.

    US banks had a very strong incentive for this sales pitch sense it gave them a lot of capital with no management control. What I think CIC did was rather sensible. It made relatively small investments in US private equity and IB’s, and saw where it would go.

    The other thing is that there still is a lot of interest in China on the US financial system. Right now the focus is getting something like the Silicon Valley venture capital system going.

  • Posted by Allan Green

    Is China really the world’s Third Largest Economy?

    Doubt it.

    It’s like adding up all of Africa, and saying the continent is the world’s third largest economy.

    PPP, China has now been downgraded. As for all other GDP statistics, China’s consumer market is still a fraction of the world’s actual third largest economy – Germany.

  • Posted by Allan Green

    The whole line of critique by Wen is disingenuous. Either he’d have us believe that the Chinese were blind and dumb, or that they cannot take responsibility for their actions.

    Sounds like someone is looking for a political bail-out in Beijing – and the scapegoat is Washington, while concocting conspiracy theories about Mr. Lou and Zhou Xiaochuan. That someone would be a party leadership ignorant of basic economics.

  • Posted by DJC.

    WMakeMeTreasurySecretary: Wait a minute. The PPI must be over $8,000. I think the PPI is what really matters

    DJC: Comparing the purchasing power (PPI) of McDonald’s hamburgers between China and the US is ludicrous. A Big Mac hamburger meal may retail one-eighth the cost in Beijing compared to New York. Does that translate to an eight times larger PPI Chinese economy?

    The exact same Honda Accord made in both Ohio USA and Guangzhou China cost, $20K and $35K respectively. Comparing the purchasing power (PPI) of the Honda Accord, then the Chinese yuan is overvalued. It all depends on the statistics that you manipulate to make your argument.

    Since the “real” ulterior motive of the Washington Consensus is the conversion of China into a pliant, subservient state, the revaluation of the Chinese yuan is designed to destabilize the Socialist Chinese government. Defense Secretary Robert Gates reiterated the Rumsfeld mantra yesterday that designates China as a “strategic threat” to the United States.

    Defense Secretary Gates says US ready to counter China “threat”
    The Associated Press
    Published: January 27, 2009
    http://www.iht.com/articles/ap/2009/01/27/america/NA-US-China.php

  • Posted by Cedric Regula

    Brad

    I have to admit that me ‘an Nest Eggy are concerned as well about the USG handling of our finances.

    We actually would like to help and stimulate the US economy if we could, but Nest Eggy is only bringing home 2% at the moment, so I haven’t been this close to the poverty level since college days. Not that I fault Nest Eggy for this, I understand she is scared yokeless about what is out there.

    So I’m afraid we are not much help.

    But that did get me thinking about China’s problem. You can break done Treasury holdings into two parts. One is going purchases to implement pegging . The other is China is looking for a place for savings/investment(whatever economists call it when a CB buys another governments debt).

    So it occurred to me the Chinese could reduce existing treasury holdings and convert these to dollars and use the proceeds to buy American goods, like say Boeing aircraft, GM locomotives, medical equipment, and on and on.

    They could continue to buy Treasuries to support the peg.

    So if the Treasury sales are used for domestic economy purchases in the US, it seems to me that this isn’t a flow that would offset or negate their ability to peg.

    It would be like a buy out from excessive treasury holdings.

    Does that work or am I getting confused again?

  • Posted by DJC.

    Twofish: No there weren’t. CIC didn’t invest in WaMu.

    DJC: Yes there were. The CIC invested in a private equity fund that invested in WaMu. Read above Brad Setser’s comments that the CIC lost money on WaMu.

    Twofish: So you agree with Geithner and Brad Sester that China would reduce its US Treasury holdings and therefore it should appreciate its currency, and that it was a big mistake for China to accumulate its current foreign exchange reserves.

    DJC: For the record, I have always stated that China should reduce its holdings of US Treasury bonds with the proceeds invested in natural resource assets of “real economic wealth”. Excepts for lots of scenic mountainous terrain, China is relatively scarce in strategic natural resources. Now 40% of oil consumption in the Chinese economy relies on imports from the unstable Middle East. Before the China PLA Navy patrolled off Somalia, over a dozen Chinese ships were hijacked without any protection from the Superpower US Navy.

    The Chinese simply don;t count. The Washington Consensus never really gives a damn about the Chinese people. Did you know that despite receiving millions in taxpayer dollars, the Ivy League Universities including Harvard and Princeton impose a “racial exclusion quota” on ethnic Chinese with the consent of the Justice Dept? The Dean of Columbia University even brazenly admitted that Asian enrollment is subject to a racial quota of between 10-15% at Ivy League Universities?

    If any equilvalent religious quota were imposed on Jewish students, you can bet all hell would break loose. For the record, a family friend with a perfect 1600 SAT and college courses from John Hopkins university was denied acceptance at Harvard University.

  • Posted by Twofish

    DJC: The CIC invested in a private equity fund that invested in WaMu. Read above Brad Setser’s comments that the CIC lost money on WaMu.

    No they didn’t. CIC invested in Blackstone which didn’t have any WaMu exposure. SAFE invested in TPG which did have some WaMu exposure, but the investment was small ($2.5 billion). This means that SAFE is probably not going to be allowed to invest in anything new.

    DJC: For the record, I have always stated that China should reduce its holdings of US Treasury bonds with the proceeds invested in natural resource assets of “real economic wealth”.

    But you’ve also criticized people that support appreciation of the RMB. Those two positions are not consistent. If China sells Treasuries, then the RMB is going to appreciate.

    The problem is that you tend to take stands that are logically inconsistent, and so pointed out that you support X tends to be pointless when you also seem to support not-X.

    DJC: The Chinese simply don’t count.

    If you have $2 trillion in foreign exchange reserves and buy several hundred billion in treasuries, you count.

  • Posted by Twofish

    Green: The whole line of critique by Wen is disingenuous. Either he’d have us believe that the Chinese were blind and dumb, or that they cannot take responsibility for their actions.

    One problem is that usually when we talk about someone, we end up not talking about what they say or believe, but rather what someone says that someone says that someone says that someone says that they believe.

    It’s also a bad idea to talk about “the Chinese”. Chinese do disagree about a lot of things as DJC and I quite clearly demonstrate.

    Green: That someone would be a party leadership ignorant of basic economics.

    The Party leadership understands basic economics quite well. Probably better than the Bush administration, anyway.

  • Posted by Doc at the Radar Station

    “If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system,”

    It appears that the left hand has not been paying attention to what the right hand has been doing in China, or perhaps the left hand has been happy as long as the results of the right hand’s work has been pleasant. Either way, there has to be an “orthodox” faction in the Communist Party which are going to exploit these developments to pursue their agenda.

  • Posted by Twofish

    To point out why I think it is careful to get original quotes. Wen didn’t mention the United States explicitly, and honestly, I don’t think it meant to single out the US implicitly. The critique he is making is pretty much the same as the one’s Obama and the Democrats make.

    WSJ: Mr. Wen, the first Chinese premier to visit the annual global gathering of economic and political leaders in Davos, Switzerland, delivered a strongly worded indictment of the causes of the crisis, clearly aimed largely at the United States though he didn’t name it. Mr. Wen blamed an “excessive expansion of financial institutions in blind pursuit of profit,” a failure of government supervision of the financial sector, and an “unsustainable model of development, characterized by prolonged low savings and high consumption.”

  • Posted by DJC.

    Twofish: SAFE invested in TPG which did have some WaMu exposure, but the investment was small ($2.5 billion).

    DJC: Now saying that $2.5 billion loss is just a small amount of money is doubletalk. The $2.5 billion could educate a hundred-thousand children in rural China. Why don’t you give a few million to educate poor rural Chinese children?

    Twofish: But you’ve also criticized people that support appreciation of the RMB.

    DJC: For the record, I have always stated that China should reduce its holdings of US Treasury bonds with the proceeds invested in natural resource assets of “real economic wealth”. Nor would the purchase of strategic natural resources involve any revaluation of the Chinese yuan. Those excess trade surplus US Dollars would be intermediated elsewhere by the suppliers of raw material for industrial production. Since the US military provides de facto protection for the Gulf Arab Oil states, I am sure the royal families of the region won’t mind intermediating another several trillion of US dollars back through Citicorp into US Treasury bonds.

  • Posted by don

    As a Japanese central bank official said in answer to a rather stupid analysis by Dale Henderson et al. (the same guy who advised central banks to dump gold at about $200 per ounce, because it paid no interest) “who ever said our goal was to make a profit on our reserve holdings?” The same is true for China’s central bank. The issue of losses is a sideshow to the main event, which remains export-led growth, ala the Japanese example. (Japan still has more foreign reserves than China.) As Keynesian economics shows, if demand is deficient, producing and dumping the output in the ocean can pay. The same is true for buying foreign exchange and realizing a loss. China will continue its currency policies until forced to stop by importing nations.
    ndk – yes, that would work short term, but might precipitate the kind of response China should dread – pressures to stop currency interventions.
    The euro might be a bad purchase right now. As I have said before (and as Paul Krugman said recently), the euro is not an optimal currency area and it will face real strains as the current global malaise spreads. For example, Spain is suffering mightily, but is tied to the euro’s central bank policies. The euro’s linchpin is Germany, the world’s largest exporter. Exports will suffer more than apace with the global slowdown. I wouldn’t be buying euros right now.

  • Posted by Twofish

    DJC: Now saying that $2.5 billion loss is just a small amount of money is doubletalk. The $2.5 billion could educate a hundred-thousand children in rural China. Why don’t you give a few million to educate poor rural Chinese children?

    *That* $2.5 billion can’t be used to education children in rural China, for one thing dollars can’t be used to pay for schools in rural China.

    Also it’s already allocated for other things. Also rural education in China isn’t a money issue. There is plenty of money. It’s an administration/finance issue.

    Also, you have to be a little careful about how you spend money. During the 1990′s there was a huge building boom in elementary schools many of which are now sitting empty because there the number of elementary school students dropped becomes of the one-child policy.

    Invoking “the children” wins arguments, but it often doesn’t make good policy. You have to use your head along with your heart.

    DJC: Nor would the purchase of strategic natural resources involve any revaluation of the Chinese yuan.

    Yes it will. If you use dollars from imports to buy resources that means that you have fewer dollars to convert to RMB which means that the RMB value will go up.

    Also, what are you buying? If you buy spot oil, then you are going to be vastly overpaying. If you buy oil fields, you aren’t buying that much since the US Navy can restrict flow, and the government you are buying from can nationalize if it wants.

  • Posted by Twofish

    The United States cannot destroy China. Only China can destroy China. Remember that.

  • Posted by Qingdao

    Esward Prasad (VOX, Jan 28) worries that macroeconomic imbalances “could actually worsen during the recovery” and therefore suggests:

    “The Chinese need to have an effective strategy to rebalance their economy towards private consumption and away from investment and exports. This will require greater social spending and a more flexible exchange rate.”

    I think Lardy first made this argument in 2004; it was true then and is still true. So why haven’t things changed? For the same reason things are not now changing and will not change any time soon. The relatively small group of families who have been in power since the Truman administration prefer things to remain as they are; or perhaps a book length inventory of China’s political economy leadership (steel, autos, cement, telecommunications, energy etc) in the wealthy provinces will gather and collectively decide to relinquish their wealth and power to those impoverished western provinces. But I don’t think so.
    My guess is those macroeconomic imbalances will melt away in the inflation that accompanies the recovery, while China will resemble Indonesia in the late 90s.

  • Posted by DJC.

    Twofish: That* $2.5 billion can’t be used to education children in rural China, for one thing dollars can’t be used to pay for schools in rural China.

    DJC: That $2.5 billion is still alot of money that could buy 2 Aegis missile destoyers. It could have purchased some product or resource that might have even benefited the Chinese people. While the US government prohibits the export of high-tech products to China, I’m sure that Wall Street would love to unload their AAA-rated Subprime garbage to the Chinese. I’m sure that the Washington Consensus approve.

  • Posted by DJC.

    Twofish: Invoking “the children” wins arguments, but it often doesn’t make good policy. You have to use your head along with your heart.

    DJC: Did US foreign policy have any “head or heart” during the 1998 Asian Economic Crisis. The Indonesian people were looted and raped by the IMF in coordination with Robert Rubin’s Treasury Dept. Politically-connected Wall Street Hedge Funds earned an estimated $10 billion in “blood profits” from criminal currency manipulation. The IMF privatized Indonesian energy assets to Wall Street Banks. Millions of formerly middle class Indonesian women and children were left destitute in the streets.

  • Posted by Ying

    Here comes China responsibility again. The US should really go after the private sector’s flight to security. Central banks just move when everybody else moved.

  • Posted by Twofish

    Qingdao: I think Lardy first made this argument in 2004; it was true then and is still true. So why haven’t things changed?

    Because in the end Beijing has not been convinced by Lardy’s arguments. Personally, I think it would be a mistake to increase consumption.

    You know. It’s possible that Lardy is wrong…..

  • Posted by Indian Investor

    Cedric:

    I’m guessing that the crash was engineered, just as the recovery of the banks is being engineered. Remember, it would have been hard to make out from the Financial Times, and all the other reports, that all the lending to the banks came from Treasury, with the Fed just acting as an accounting conduit.

    One thing that really made me suspicious at the time was that while so many guarantees were provided, the Agencies were left in doubt. Paulson’s policy announcements on the Agencies triggered a worldwide sell off on Agencies, which were already in doubt. Once it was made clear there are limited liabilities for the USG on the GSE receivables …

    Similarly, the overall trend has been that the Fed didn’t make a transparent policy to be applied to all DIs & IBs that might be in trouble. While we obviously can’t verify this, since there’s no publicly disclosed detailed information on loans disbursed by the Fed, IF the Fed had just intended to save only the 4 primary dealers, then they have accomplished that, ensuring either bankruptcy or buy out of all other major players at throwaway prices.

    If the crash was engineered, as Twofish has been pointing out, there is little to fear.

  • Posted by Twofish

    To Qingdao:

    It also gets makes things needlessly complicated when people try to package about four different things in one policy.

    For example, I do think that China needs a less export based economy and much more social spending. I don’t think that China needs more consumption, and at least for the next two decades, I think that China should focus on capital investment. I don’t like the concept of “macroeconomic balance” because makes assumptions about what are good policies that I don’t think are valid.

    I do think that privately managed companies are useful, but I think that at least for China, it’s better that the larger corporations be state-owned.

    So do I agree or disagree with Lardy, it depends on the specific topic.

  • Posted by Indian Investor

    Sorry didn’t intend my previous comment in italics, I was replying to the comment below from Cedric.

    Cedric: I have to admit that me ‘an Nest Eggy are concerned as well about the USG handling of our finances.

  • Posted by Twofish

    DJC: That $2.5 billion is still alot of money that could buy 2 Aegis missile destoyers.

    Actually it can’t. Bill Gates (who has about $50 billion in assets) can’t just write a check for $2.5 billion and get Aegis missile destroyers. Money is necessary but it is not sufficient, and if all you needed to solve a problem is enough money, you are in pretty good shape.

    It’s pointless to bring up rural schools in China in this situation. Suppose BOC hadn’t lost the $2.5 billion, would that improve schools in China, and would China be able to suddenly get an AEGIS destroyer? I doubt it. So what is the point in bringing it up?

  • Posted by Twofish

    Investor: One thing that really made me suspicious at the time was that while so many guarantees were provided, the Agencies were left in doubt.

    And there are good financial reasons for that. Commercial paper and money markets are short term instruments, which means that you can withdraw a guarantee. The GSE’s issue long term instruments, which means that you can’t withdraw a guarantee. The GSE’s are much larger than the CP or money markets.

    Also, Treasury made those guarantees because the world was about to end. The current guarantees on the Agencies are enough to keep things from falling apart.

    Investor: Similarly, the overall trend has been that the Fed didn’t make a transparent policy to be applied to all DIs & IBs that might be in trouble.

    There are good reasons for that. Being in the middle of a fire is not a good time to make policy. Also things were moving much too fast to make coherent policy since anything that you say today would be useless tomorrow. See TARP for example.

    Investor: While we obviously can’t verify this, since there’s no publicly disclosed detailed information on loans disbursed by the Fed.

    But it there was some secret agenda, certain people would be screaming that aren’t. So either there is no secret conspiracy or everyone is in on the secret conspiracy, which makes it not much of a secret conspiracy.

    Investor: If the crash was engineered, as Twofish has been pointing out, there is little to fear.

    Actually there a lot to fear because people that start wars tend to regret it. Once you start crashing things, you end up opening Pandora’s box.

  • Posted by Ying

    Obama should learn from Putin’s mom’s advice to Putin in childhood: “don’t ask for help and don’t complain”.

  • Posted by Qingdao

    Two-fish: So: China needs fewer exports, more govt social spending; those 50 million people living on $1/day do not need more “consumption” but should continue to wait until the central authorities get around to “social spending”; but then: “China should focus on capital investment”; and because you like the idea of govt “owning the large corporations” that is doubtless where the banking system will continue to invest; and you dislike balance; prefer growing imbalances? Re-read what you wrote and ask yourself whether or not this is garbled.

  • Posted by Indian Investor

    Twofish: The GSE’s are much larger than the CP or money markets.

    I’d be glad if you could give me some numbers on this. What’s the size of the GSEs, versus the US Hq’ed money market mutual funds, and the CP market in the US?

    Besides, as I’ve pointed out there hasn’t been much public attention on re-verifying the bankruptcies. The only “scam” that came up was that on the day of the Lehman bankruptcy filing, Sept 15, 2008, a German Landsbank in Bavaria was found to have a $400 million transfer to Lehman still in process. There was a public debate in Germany and a minister resigned, being unable to defend the Landsbank’s action to lend such a large amount to Lehman, knowing very well that Lehman was in a well known process of either a sell out or a bankruptcy.

    At the same time, it might very well be that the Fed was issuing loans to Lehman, and since this kind of info isn’t public, you can’t tell how the 2008 credit pandemonium was being used by profiteers to siphon funds out of large banks, and perhaps even the Fed itself.

  • Posted by Indian Investor

    @Qingdao: I think Twofish is trying to strike a balance between various options that are in different directions. In my opinion this approach is generally good in many government departments. There are various people demanding different things and you have to strike a balance amongst different interests. Usually striking a balance involves just being lazy and not doing anything, which is good, since in any case, as Twofish has frequently pointed out before, bureaucrats aren’t paid much, so it’s ok if they’re lazy.

  • Posted by Twofish

    Qingdao: China needs fewer exports, more govt social spending; those 50 million people living on $1/day do not need more “consumption” but should continue to wait until the central authorities get around to “social spending”

    Since those 50 million people don’t have cash to spend, I’m wondering what you suggest as an alternative. The important thing is for the government to get an education and health system together and then increase credit to rural regions.

    Qingdao: “China should focus on capital investment”; and because you like the idea of govt “owning the large corporations” that is doubtless where the banking system will continue to invest;

    The big banks are likely to continue to invest in SOE’s unless forced not to. Something along the lines of the Community Reinvestment Act would work, as would recapitalizing the Rural Credit Cooperatives.

    Qingdao: and you dislike balance; prefer growing imbalances?

    I think balance is the wrong model to apply here.

    Qingdao: Re-read what you wrote and ask yourself whether or not this is garbled.

    It’s complicated because reality is complicated. I don’t think that I can summarize what I think the policies should be for the Chinese economy in one paragraph. It would take at least four pages, and then another 20 to justify those four pages.

    I’m very distrustful of simply solutions to complex problems, because they tend to make things even worse.

  • Posted by DJC.

    DJC: That $2.5 billion is still alot of money that could buy 2 Aegis missile destroyers.

    Twofish: Actually it can’t. Bill Gates (who has about $50 billion in assets) can’t just write a check for $2.5 billion and get Aegis missile destroyers.

    DJC: Actually $2.5 billion can get you two Aegis destroyers if you are a client state. If Taiwan is willing to pony up the money, the Pentagon will be glad to deliver the Aegis warships from its order backlog. That would be in addition to the PAC-3 Missiles, AH-64 Attack helicopters, Harpoon Cruise Missiles that are already on order from Taiwan’s Ministry of Defense. The US only restricts the export of Nuclear weapons to Taiwan which would cross the declared “red line” of the China PLA for total military assault of Taiwan.

    Twofish: It’s pointless to bring up rural schools in China in this situation. Suppose BOC hadn’t lost the $2.5 billion, would that improve schools in China.

    DJC: Oh please, there are dozens of US and Hong Kong based NGO that if given a fraction of the $2.5 billion wasted on US subprime garbage, could go a long way improving the education of millions of impoverished Chinese children.

  • Posted by Indian Investor

    @DJC: There are plenty of ways to spend the forex reserve amounts on local fiscal stimulus. e.g. China could just subsidize oil prices.
    But the danger involved in reducing the forex reserves at this stage is that there could be a drain out of external loans that are outstanding in China. Overall, it’s important for China to maintain its reserves since avoiding a currency crisis is important.

  • Posted by Indian Investor

    I think China’s one child policy should be replaced with a two child policy. Apart from eliminating the concept of brothers and sisters, a one child policy is simply unsustainable in the longer run. Soon you will get 4 grandparents, 2 parents and 1 little kid if the policy succeeds perfectly. So 2 people have to take care of 4 old people and 1 kid by working hard. Plus, you’re going to have a massive reduction in China’s population. I worry that if the one child policy isn’t changed, soon there may not be any Chinese people left in the world.

  • Posted by Twofish

    Investor: I’d be glad if you could give me some numbers on this. What’s the size of the GSEs, versus the US Hq’ed money market mutual funds, and the CP market in the US?

    GSE’s are about $6 trillion. CP is about $2 trillion. Money market funds are about $2 trillion.

    Investor: Besides, as I’ve pointed out there hasn’t been much public attention on re-verifying the bankruptcies.

    That’s because there aren’t any car wrecks that people are interested in.

    Investor: The only “scam” that came up was that on the day of the Lehman bankruptcy filing, Sept 15, 2008, a German Landsbank in Bavaria was found to have a $400 million transfer to Lehman still in process.

    And that’s because someone forgot to shut down a computer program. The funny thing is that if they had sent that money a day earlier or a day later, they would have gotten their money back. You have a computer send money from the German bank to Lehman. A day later the computer sends the money back.

    Investor: At the same time, it might very well be that the Fed was issuing loans to Lehman.

    The Fed has better computer geeks.

    Investor: Since this kind of info isn’t public, you can’t tell how the 2008 credit pandemonium was being used by profiteers to siphon funds out of large banks, and perhaps even the Fed itself.

    You might not be able to tell, but most people in the industry can, and most of the information is public. You can go through Lehman’s bankruptcy filings.

  • Posted by Twofish

    DJC: Oh please, there are dozens of US and Hong Kong based NGO that if given a fraction of the $2.5 billion wasted on US subprime garbage, could go a long way improving the education of millions of impoverished Chinese children.

    Probably not…..

    1) NGO’s have their limits. They can only target specific counties, and the amount of social improvement they can undertake can be quite limited.

    2) More money sometimes kills an NGO. An NGO that is set up to run programs with $100,000 tends to get blown apart if you give it $1 billion.

  • Posted by Indian Investor

    Twofish, now that I think of it, if a two child policy succeeds perfectly, you get 4 grandparents, 4 parents and 4 children. This means each adult is taking care of one old person and one kid. If the policy is just one child, you get 4 grandparents, 2 parents and 1 kid. This means each adult is taking care of 2 old people and half the work of handling one kid. Both seem to be the same load for a family. But a 1 child policy means that soon there won’t be any Chinese people left. Every 30 years the China Communist Party is planning to halve the number of Chinese people with its miscalculated one child policy.

  • Posted by Indian Investor

    Twofish: You have a computer send money from the German bank to Lehman. A day later the computer sends the money back.

    Why does this happen? I mean, what is the logic of this computer program? Why should $ 400 million go from some state owned German bank to Lehman, just to be sent back the next day, even if this is exactly what happened. And if that’s what happened, why can’t the $ 400 million be paid back to this German Govt. bank, since it has made a computer mistake it can say sorry and everybody can move on.

  • Posted by DJC.

    DJC: Oh please, there are dozens of US and Hong Kong based NGO that if given a fraction of the $2.5 billion wasted on US subprime garbage, could go a long way improving the education of millions of impoverished Chinese children.

    Twofish: Probably not….. NGO’s have their limits. They can only target specific counties, and the amount of social improvement they can undertake can be quite limited.

    DJC: In the United States, non-profit NGO institutions and volunteering account for more than 7 percent of the entire national GDP. That’s approximately $1 trillion annual budget for NGO’s in the United States. What did you say that NGO’s can only undertake a limited tasks?

    http://www.globalphilanthropic.com/subpage.php?p=66

  • Posted by Twofish

    DJC: If Taiwan is willing to pony up the money, the Pentagon will be glad to deliver the Aegis warships from its order backlog.

    Again not true. Taiwan would love to get Aegis destroyers. It’s not getting them. Money is not an issue here.

    If you really want to help rural education in China, you are wasting your time worrying about Bank of China and subprimes. The big issue is the $150 billion bailout that needs to be done for the Rural Credit Cooperatives and the Agricultural Bank of China. Rural credit is basically frozen because all of the rural credit institutions are broken, and they are broken because there are seven other things that got higher priority.

    And then there is the whole system of public finance in China that needs to be overhauled.
    But people have been working on this problem since 2008 and there has been lots of progress. It just takes time.

  • Posted by bena gyerek

    i agree with ndk. china needs to diversify into commodities and the euro.

  • Posted by Indian Investor

    @bena: any idea if the same circular trading pattern is going on with the UK Govt. Bonds … HM Treasury Secs , bought by the public, and then the BOE lends the cash from the HM Treasury money mainly to Barclays and RBS …? And if not, where did the BOE get the huge new credit money from?

  • Posted by Twofish

    Investor: Why does this happen? I mean, what is the logic of this computer program? Why should $ 400 million go from some state owned German bank to Lehman, just to be sent back the next day, even if this is exactly what happened.

    It’s an interest rate swap. The German bank sends Lehman $400 million, the next day Lehman sends back an amount which is more or less $400 million depending on the interest rate.

    The problem is that in between the time the order went from the German bank to Lehman and the time Lehman was supposed to send the money back, it declared bankruptcy.

    Investor: And if that’s what happened, why can’t the $ 400 million be paid back to this German Govt. bank, since it has made a computer mistake it can say sorry and everybody can move on.

    Because Lehman doesn’t have $400 million, and that $400 million gets added to a pot that gets split with all of Lehman’s creditors.

    Now if the German bank had sent the money a day later, then either the contract would have been in effect or not. If in effect, Lehman would have had to send back money since it was a post-bankruptcy contract that has been assumed. If not, then Lehman would not be entitled to the money, and would have to return it.

  • Posted by DJC.

    Twofish: Again not true. Taiwan would love to get Aegis destroyers. It’s not getting them.

    DJC: The Aegis Destroyers weren’t being ordered only because the opposition Kuomintang controlled the Taiwan Legislative Yuan which blocked the Aegis acquisition for the past decade. The Kuomintang stonewalled every DPP legislation from former President Chen Shui-bian. The DPP pro-independence party was booted out of office to the annoyance of the Washington Neo-con elites.

  • Posted by Twofish

    Investor: And if not, where did the BOE get the huge new credit money from?

    Same place the Fed gets it’s credit money. Ye old printing press. Actually, it’s gone electronic, so if the Fed, the BOE, and the PBC wants to lend some cash, it just clicks a few keys and that cash magically comes into existence.

  • Posted by Cedric Regula

    Indian investor:

    I don’t believe the crash was engineered in any grand sense. There were probably moves made by IBs to profit in specific instances as things started to crumble of course.

    But it was just a result of systematic risk building up over a long period, then the underlying economy and weakest parts of the financial system started to go in decline, which started the massive de-leveraging and accelerated the process.

    Lots of people knew it had to happen. Chaos Theory and Game Theory mathematicians tried modeling how it goes and you could read stories about building sand piles until you get an avalanche as far back as 2006. Since I’m half Italian, I’m genetically incapable of performing math at that level, so I was content to let the Asians do it.

    But me an’ Nest Eggy were out of stocks in 2007, the stock market peaked in Oct. 2007. Early in 2008 Roubini called the beginning of the recession in 12/2007. That was confirmed a year later by the USG. Bear Sterns went down in March. The sandpile avalanche began. The Chinese mathematical models caught on in mid year and they ganged up on Paulson for the GSE guarantee.

    So it was a rough time for me an’ Nest Eggy. Nest Eggy is in charge of bringing home the bacon, but we talk about things of course, and she calls me her Trophy Husband. She’s sweet. So we made it thru the year with a few scrapes and bruises and ended up the year in the black and blue. But I’m not letting it go to my head. This year could be just as bad or even worse for me an’ Nest Eggy.

  • Posted by MakeMeTreasurySecretary

    DJC: The PPI is much more than the price of hamburger, it is the price of everything. But then you knew that but you are checking us. China is certainly not as poor as the $2,000 per capita GDP statistic (manipulated as it could be since it depends on renminbi/dollar rate) that you chose to use to make your point.

    The Middle Kingdom has, undoubtedly, the right to play the game as they see fit. The problem is that the US government, in ideological shackles, cannot take the decisive action that needs to be taken: Slap a 30% tariff on anything that is imported until, one way or the other, the current account is balanced. Sounds drastic? Not as drastic as wasting trillions to prop up banks.

  • Posted by Indian Investor

    Cedric: it was just a result of systematic risk building up over a long period

    I think current account “imbalances” and perhaps to some extent the EMI/monthly income outflow of ordinary citizens are being blamed as “build up of systematic risk”.

    Current account imbalances were never the “Cause” of credit expansion. They were always the “effect”, in a world of hard currencies payable in gold.

    It’s important to know how the “imbalance” and re adjustment theories were formulated, by 19th century economists. Remember all international trade in those days were settled with hard currencies, meaning they were payable in gold. As credit expanded in one country, foreigners gained by being “mercantilist”, i.e. they accumulate a lot of the hard currency through exports. Whenever a credit panic got triggered, foreigners would lose faith in the local currency, and trigger a run on the country’s gold reserves. Left with no gold reserves, a new cycle would begin. This time round, imports from foreign countries has collapsed, because the country has no more gold to attract foreign trade.

    In the modern world the “operative gold standard” is the US dollar. This isn’t due to “soft power” reasons. It’s due to the exclusive agreements and control over international trade in petroleum. When Cheney reportedly said that the US Dollar gets 90% of its value from the US military, he was probably right.

    Which is why Afghanistan is so important. Afghanistan and the Caspian Sea Oil Pipeline Palmistry.

  • Posted by Don the libertarian Democrat

    “China’s leaders believed that China’s investments in the US financial sector would be protected, perhaps because that is how things are done in China. They weren’t. At least not consistently.”

    Our investors believed the same thing. Investors all over the world were investing on the assumption that our government had made an implicit guarantee to intervene consistently and forcefully in the case of a financial crisis. They were right, up to a point. Not understanding this is a major failing of the last administration.

    By the way, on the Sunday before Lehman fell, investors were already looking at Merrill failing due to counterparty risk. In other words, the Calling Run, Debt-Deflation possibility, was already understood by many investors.

  • Posted by Rien Huizer

    Twofish,

    A bit late perhaps, but I do not understand your comments to my comments. Qianlong (as you know the same name LKW gave his firstborn son, now PM of Singapore) may have had many reasons for his stance vs a vs the british, but according to you he was posturing (though some historians believe he never finished his PhD in economics) in order to avoid the risk that dealing with the British in the “British” way would create domestic/colonial problems not worth the benefits available from dealing with the British.

    You know more about this than me, probably, so then I should not try to read culturally based posturing into the myth about Paulson’s visit. If Paulson did a favour to one market participant at taxpayer’s expense, that should have been disclosed. If not, subsequent changes in Chinese market participation would appear perfectly rational.

  • Posted by Cedric Regula

    indian investor:
    Current account imbalances were never the “Cause” of credit expansion. They were always the “effect”, in a world of hard currencies payable in gold.

    I think credit expansion is systematic risk, especially when it gets to the point that all the shock absorber is taken out of the economy at consumer, corporate and government levels. The ability to pay back credit is a fundamental building block of capitalism.

    Cheney is full of it. The Deutsch mark wasn’t worth crap in the ’30s and ’40s. All paper currency values are supported by the strength of the economy, financial system and ability to pay back credit.

  • Posted by Jen H

    Brad / Arpana: Liked it a lot. Certainly no back of the envelope effort. Was speaking with one of your colleagues on the ‘what do we do about it’ question earlier this week, so some informal reactions straddling substance and tactics:

    ** Your hunch on China’s quiet, insatiable appetite for US corporate bonds, circa 2006, is one I’ve long suspected as well. My larger concern/frustration is why this wasn’t more of a story, particularly given the healthy above the fold scrutiny that befell the Blackstone deal at the time.

    ** If recessions and wars are both relative, and — if i’m reading you right– your grounds for concern over China’s long-standing and recently revitalized appetite for tbills is the destabilizing potential involved, how do you reconcile this alongside the fact that the Treasury is now a rather more equal opportunity debtor, no longer just China? Wouldn’t this greater redundancy bring more stability than the US-China MAD to which we have grown so accustomed? Broader point: the manner in which so many economists attack on imbalances as bad solely on grounds of their destabilizing potential has always struck me as a bit sterile and an avoidance of the larger geopolitical point. We in the US hold congressional hearings on China currency manipulation less because we are concerned about the stability of the global financial system and more because, in either perception or fact, its just plain not fair. Is there a broader case to be made that imbalances are bad for reasons beyond destabilizing potential? (acknowledging the question as leading and that your formal answer came back in October, just a call to link the two arguments at some point)

    ** Some discussion of the likely fate of the dollar, apart from the imbalances question would seem apt. My own view– so long as the RMB is rising in real terms, even as its appreciation against the $ slows, any SED or other US attempt to bring the Chinese to the table, regardless of the players, will be made considerably more difficult.

    On your assessment of the EM’s role in all of this:
    ** Decoupling questions are always packaged and scrutinized as inherently binary, all or none propositions. While obviously the emerging world is hurting worse than anyone could have expected, their abiding progress remains evident. Certainly compared to previous crises — and quite possibly compared to the US / UK in this crisis– the EM’s will recover more quickly than most economists expect in both absolute and relative terms. And not a minor point, if again we take recessions as a relative game

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