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LinkedInJames Saft of Reuters worries that the crisis will lead to a shift away from the “Davos consensus,” especially as the market’s power had pulled so many out of poverty.
“the stuff underlying the Davos consensus really was pretty good at doing lots of things, not least raising living standards in huge swathes of the developing world. States aren’t traditionally all that great at allocating resources either”
Reasonable point.
But the narrative of the past six years isn’t really one defined solely by the retreat of the state and a greater role for markets in allocating resources in the developing world. In both China and many fast-growing (until recently) oil-exporters, the state played an active role in guiding investment decisions. It thus was helping to determine how resources were allocated across sectors.
– Most Chinese investment, as Nick Lardy and Morris Goldstein pointed out a while ago, is financed domestically. And a lot of that investment is financed by the retained earnings of state firms or by loans from state banks. Perhaps all of these investments were done on a purely commercial basis, but there was certainly scope for the state to guide the allocation of resources.
– Most oil exporters have powerful national oil companies that control the oil revenue stream. And a lot of “private” investment in Gulf came from banks and firms that were either owned by the state or by the “palace.” A host of firms borrowed not on the basis of the strength of their own balance sheet but on the perception that they were too close to the state to fail. Dubai is often presented as a model of free-wheeling capitalism. But Dubai, inc remains closely tied to the palace.
Simeon Kerr and Roula Kalaf of the FT:
“Dubai’s sprawling business empire spans government institutions and private companies owned directly by Sheikh Mohammed but acting as quasi-government bodies. The ruler has instituted a culture of competition among state-backed companies and insisted they run themselves as private sector entities. In their quest to satisfy his ambitions, the business groups have come to rely heavily on debt – leveraging myriad commercial ventures, from domestic property developments to international acquisitions. Along the way, Dubai’s finances have become complicated and the line between ruler and government assets blurred.
It turns out that state backed companies weren’t borrowing as private sector entities — or at least no one who was lending them money thought so. They were able to borrow so much largely because of their state backing. And now, given Dubai, Inc’s cash flow troubles, Dubai, Inc may soon morph into Abu Dhabi, Inc.
– Exchange rate policies can also influence the allocation of resources across sectors. China’s de facto dollar peg is an obvious example. Pegging to the dollar as the dollar fell from 2002 to early 2005 produced a large real depreciation in the RMB. The RMB then rose v the dollar, but never by enough to fully offset the dollar’s fall. The BIS estimates that China’s real exchange rate was weaker at the end of 2007 than at the end of 2000 — even though China’s exports grew by a factor of five during this period. The nominal and real depreciation of the RMB encouraged foreign firms to set up shop in China and encouraged domestic investment in the export sector; it is hard for me to believe that as much would have been invested in China’s export sector if China had had a different exchange rate regime.
China’s policies also influenced — in all probability — the global allocation of resources. Before the recent crisis, remember, private capital wanted to finance current account deficits in the emerging world, not the current account deficit associated with the US household sector’s borrowing need. By holding US interest rates down and the dollar up, China’s policies discouraged investment in tradables production in the US while encouraging investment in the interest-rate sensitive sectors that weren’t competing with Chinese production. This isn’t too say that the US didn’t already have a slew of policies in place to encourage investment in housing. It did — from the Agencies to ability to deduct mortgage interest from tax payments. But the surge in demand for US bonds from the world’s central banks reinforced those policies. Larry Lindsey argued — I think correctly — that China’s policy of spending huge sums – to keep its exchange rate from rising, China often had to spend 15% or so of its GDP buying foreign assets — to avoid currency appreciation didn’t affect overall levels of output or employment in the US, but it certainly affected the composition of output and employment. More money was allocated to home construction (for a time) and less to investment in the production of goods for export than otherwise would have been the case.
My point is simple: A lot of global growth during the boom came in countries where the government owned or influenced the domestic banking sector and thus influenced the domestic allocation of credit. And policies that kept exchange rates lower than they otherwise would also indirectly encouraged private investment in those countries export sectors as well as discouraging investment in the export sectors of other countries. Governments were playing a significant role in the allocation of capital even before there was any talk of nationalizing the financial sector of key G-7 countries. Those who attribute the growth of the past several years solely to the market miss the large role the state played in many of the world’s fast growing economies. Conversely, those who attribute all the excesses of the past few years to the market miss the role that governments played in financing many of those excesses …
“the stuff underlying the Davos consensus really was pretty good at doing lots of things, not least raising living standards in huge swathes of the developing world. States aren’t traditionally all that great at allocating resources either”
Isn’t the boom the result of global credit expansion? For me, as the technology gap narrowed significantly between US and Asia countries,there seems to be a diminishing rate of return from global trade for countries all over the world. US was using credit expansion to keep its annual growth rate. China also resorted to credit expansion and increase loans around 10% or so to keep 8 or 9 percent growth rate in recent years. The past successful strategy doesn’t guarantee that the same strategy will be successful in the future as the circumstances are evolving and changing.
Brad,
The influence of exchange rate (RMB/USD in particular) on export must have been exhaustively studied by economists. Do they have a consensus? You seem to believe that the exchange rate plays a big role, but even if RMB/USD appreciated 100%, labor cost in China is still too low. Investors would still prefer opening up a factory in China to produce, for example, lithium batteries, than in the US. Many other factors are involved in shaping the export economy in China. The exchange rate seems to be the least important. I just changed the battery in my watch yesterday in Target. It’s a cheap watch made in China. The sales lady first cited a potential liability to lawsuit as a reason not to do anything to the watch. Then she found that Target actually is still carrying the watch and agreed to change the battery, for $4. I felt lucky, because to change the battery for the more expensive watch that I bought at Macy’s, I had to go to another store and spent $20. I am sure that you have been to China and you know how convenient and cheap it is to ask people to do things, more complicated things than changing batteries in watches. All greedy investors did that little investigation before they decide to open up a factory or research institute in China.
Goldman did a study a couple of years back that found a 1% real depreciation increases china’s export growth by 1%; most econometric work has found that a real dollar depreciation increases US export growth but has little impact on imports (an old fed rule of thumb was a 10% real $ depreciation would reduce the trade deficit by 1% of US GDP). The best evidence that the exchange rate has an impact for China comes from moves in the euro v the rmb. Chinese sales to Europe clearly picked up after the rmb started to fall v the euro. yes, labor costs differ — but there is usually an exchange rate that offsets those differences. I think we saw that earlier this year with the US and China — when transport costs and the rmb were rising, it no longer made sense for example to make furniture in china for the us market.
that said, there has been more work on the impact of the real exchange rate on teh US than on China, and I would say there is a consensus that the RER has an impact of the uS trade balance … on cHina there is more debate, tho my personal read is that the evidence supports goldman’s conclusions.
Wen Says Crisis Shows Dangers of Unregulated Markets
By Robert Hutton and Kitty Donaldson
Feb. 2 (Bloomberg) — Chinese Premier Wen Jiabao said the worldwide economic crisis shows “how dangerous a totally unregulated market can be” as he pledged to maintain growth in his country’s economy.
Excellent post Dr. Setser. You might have put a little more emphasis on the Fed with its 1% Fed Funds rate as another example of gov’t allocating resources, discouraging saving, etc.
bryce, i second that.
also the 1990s deregulation has been spun as the government withdrawing from interference – but in fact it was a massive intervention in what would otherwise have been the course of events. to suddenly let go the rope is more destabilising than to pull on it all the time.
and the chatfest at davos, while theoretically in favour of free enterprise, in fact has a $20 000 000 annual subsidy from the swiss government. no wonder putin lectures them on excessive state interference !
So these Asians in 98 actually organized a devaluation themselves?
bryce:
Ya, but the rate is .25%, nominal, pretax.
Don’t we all like to find “the cause”, the largest single contributor and then just pound it into the ground?
Governments, currencies, sovereign investment are always present. So you take them into consideration when doing business, thereby sparing yourself and in this case the world the ramnifications of stupidity.
Govt. play with things. Real Estate is cyclical. And Leverage is forever.
Brad: “After China dumped its Agency portfolio (to be blunt and less than technical) this fall, I think the assumption that central banks are always stable, long-term investors can be questioned …”
You seem to have such a high expectation of central banks that borders on the absurd. How could they view agencies as stable, long-term investments when Washington fails so miserably in regulatory oversight and the agencies are in such bad shapes?
China’s dumping of agencies is a natural response, perfectly consistent with the expectation that a central bank is a conservative investor.
Foreign central banks are not branch offices of US Treasury. If you threaten them with insolvency, they will cut the loss.
One thing that people often forget about with exchange rates is that companies still need pricing power to follow up an increase in the official rate.
For instance a large multi-national (Wal-Mart is a popular example) exerts a huge amount of buyer monopoly power over an abundant number of local Chinese sources.
So if the yuan appreciates they will tell the numerous partipants in a price negotiation that they expect dollar pricing to remain the same.
Tho I also believe that since a stronger yuan makes imports cheaper, most exporters would benefit on that side.
But it still doesn’t level the playing field for a developed country’s competitors. And I don’t even think we should want it too. Some products will just never be made in the US.
I think the sense of dread surrounding the retreat from Davos and the bloom of protectionism/nationalism is centred on the fact that much of the crisis can be traced to anglo-american markets and the policies that have defined operations in these markets for at least the last decade.
Government intervention , however much laissez faire is respected as the spirit of things, is almost always associated with the sense that protectionism is not far behind. That may be prejudicial but looking at the developments of the past weeks the hedgehog reaction has not been slow to surface.
As the winds of the crisis blow across the continents, and job cuts freeze the consumer end of stimulus packages, you really have to wonder if throwing money at the problem will really solve matters, matters are about to get morbidly interesting.
So it was China, not the Fed, who kept the interest rate too low for too long in the U.S.? It sounds like in the past several years, the Fed did not do much except claiming the real estate market was just a frost instead of a bubble, or solving any problem by throwing money out of a helicopter.
It’s one of the greatest historical ironies of the neoliberal era that neoliberalism, due to its own historical logic, created irresistible economic, social and political pressures for the re-statization, as it were, of the world economy.
I tend to think this is a good thing – it’s part of the rise of the multipolar world, where no one country or elite group makes all the decisions. China’s government needs to talk to America which needs to talk to Europe which needs to talk to Russia – we’re all in this together, and only a balanced, coordinated approach to re-starting the world economy (stimulating consumption, getting banks to lend, working out more rational investment decisions, keeping the world trade system going, letting the yuan rise) will work.
Japan helped. The impact of ZIRP and quantitative easing can be seen if you look at some of Brad’s charts in his new paper. From 2002 thru 2004 while Japan instituted these policies you can see the capital flight out of Japan. If I remember the chart right, Treasury and GSE purchases about tripled up to $700B. Add that to China’s growing surplus. The money has to come from somewhere to hold the entire yield curve down.
Has japan changed? Nope. .1% nominal rate, pretax.
Brad,
Immensely glad to see you point at one of the key features of (heterodox) explanations of East Asian development “success”): using the banking system as an off blance sheet instrument of state support to industry. The world has become too small for all those trade free riders, so now what? Hard to retrain a one-trick pony, as the japanese example shows. Hello protectionism in the west, but, too late: key industries have already left. Good that the new secretary of the treasury is no stranger to EAsian culture.
Rien — any suggestions?
DavidHK
“Brad: “After China dumped its Agency portfolio (to be blunt and less than technical) this fall, I think the assumption that central banks are always stable, long-term investors can be questioned …”
You seem to have such a high expectation of central banks that borders on the absurd. How could they view agencies as stable, long-term investments when Washington fails so miserably in regulatory oversight and the agencies are in such bad shapes?”
I don’t think I was the one arguing last year that there was no concern about the growing presence of state actors in the market because they were intrinsically investors with long time horizons who would act to stabilize markets. that was the argument made by those who believed that concerns about the growth of central banks and sov. funds were overstated. My point is simply that state actors didn’t live up to their own talking points; if you sell youself as a stabilizing presence the market, you are setting up a high level of expectations.
frankly, the bigger problem was the CBanks were so willing to buy agencies for so long; the balance sheet weaknesses that you describe built over time. what changed in july was central banks perception of the risk of holding agencies.
Seatrus. Yes. low policy rates could have pulled down the dollar rather than pulled down long-term rates. and it is impossible to argue that the fed was responsible for the inverted yield curve of 05-07. That was a byproduct of central bank demand for longer dated bonds. this isn’t to say that the fed had no responsibility — it did. it is to say that the enormous growth of dollar reserves reinforced the fed’s policy mistakes. and that it prevented the fed’s tightening cycle from having a bigger impact as the rise in short-term rates didn’t feed through to long-term rates. those who claim it is all the fed’s fault generally don’t have a great explanation for this period …
Judy,
Throwing money at the problem does not work if that money is primarily spent abroad. And that is what happens in open economies. At least it does not help a lot in the short term. That is why only relatively closed economies or trade blocs (and then there is quite a coordination problem) can use fiscal policy, and then only by using carefully thought out strategies.In addition, if you throw money at people who are indebted, and in a sense of crisis, their response is to pay off debt. A place like Singapore (an extreme example of an open economy) would not benefit at all from fiscal expansion (if at all possible given the constitution) that would boost consumer purchasing power. China (if it had the infrastructure and institutions) could. US: perhaps, but far too much household debt; those protectionist proposals were not all that bad given the small scale, but of course a dangerous precedent. UK, Australia: no chance and they still look for ways to do this. EU, Euroland? problem that governments have to coordinate packages and otherwise spending will leak to the least affected economy, Germany..
Politicians know this but they also know that voters expect them to do handouts. Smart authoritarians use these times to improve their infrastructure, let the consumers grumble, kep their currency as competitive as they can, invest gvt savings in priority industries and where possible invest abroad in raw materials producers or marketing campaign that hurt foreign competitors. Democrats pray.
Brad,
See my response to Judy Yeo.
In my humble opinion there is only one way out of the developmental state syndrome (which ends in corruption, bank failures and long term misallocation as so beautifully illustrated by Korea in the 1990s) is trade politics aimed at raising the cost of the developmental state’s chief resource, exploitable labor and making consumers and workers more assertive. Requiring the existence of unions would help, consumer activism, shifting the tax burden from consumers to producers would help too. In essence, a state where there is more social conflict and public dissatisfaction. Unfortunately not the sort of things US diplomats would bring up in trade negotiations: “unless you allow X-type unionization we will no longer import your mobile phones” .
But that should have been done years ago, and applied to any state that uses this model, once it is beyond a basic level of industrialization. The west let the genie out of the bottle when container transport and information technology pulled over one billion cheap workers into the west’s production system. You cannot have democratic capitalism and authoritarian developmentalism live side by side. The authoritarians will hollow out he more advanced econmies (after which they will stagnate) because the democrats have to keep their consumers happy. The reason the west defeated the Soviet developmental state economically was that the state of conflict legitimized Soviet lack of access to both western factors and western markets, resulting in relative stagnation after a period of rapid mobilization, whilst the Soviets themselves had a mistaken fondness for autarky. China (less naturally autarkic) knew this and shifted its model in the early 1980s and once again in the early 1990s. Someone has to get them to understand that they are only a few years away from the point where major reforms become too hard and no-reform will lead to a very destructive effect on the world economy that will eventually hurt them too. I wish I could be more elaborate but this is probably already much too long.
And then we have the GOP’s proposed intervention, encouraging banks to loan at rates lower than ever in history against real estate, and forcing Fannie and Freddie to buy the mortgage bonds.
I suspect classical fiscal stimulus has a better chance of avoiding punting the problem a few more yards down the hill, and improving infrastructure probably would have a higher payback over the long term than increasing the subsidy for housing. What exacly would we do for housing some time say 10 years down the road when the Social Security trust fund stops buying more treasury bonds, and more boomers choose to sell their over-sized homes right around the time long term treasury rates hit 8% while there is a raft of homes with 4% mortgages and owners that want to sell?
The market has pulled few people out of poverty, unless accompanied by powerful state intervention. That’s the story of the East Asian ‘miracle’ – from Korea to Japan, to Taiwan , to eastern China. That anyone educated could think otherwise suggests a dangerous level of Friedmanesque group-think in our esteemed institutions. But their world is imploding anyhow.
State regulated and influences markets are still markets. When the state decides to exercise control using market mechanisms that is a very, very long way from central planning. The market is still at the core of any current economy.
The big problem is this idea that the state and markets are in opposition. In fact both the state and markets have this symbotic relationship. The state needs markets to provide wealth, markets need massive amounts of state regulation to function properly.
bsetser: My point is simply that state actors didn’t live up to their own talking points; if you sell youself as a stabilizing presence the market, you are setting up a high level of expectations.
I think the question is “stabilizing” as compared to what? Sure the PBC stopped buying agency bonds, but it hasn’t started dumping them which would be the reaction for private actors.
Looking at the PBC and the Federal Reserve, I don’t see how you could argue that either have been destabilizing forces. Central banks are the last line of defense before total economic chaos, and if either the PBC or Fed had been “destablizing” we’d all be doomed.
Huizer: In my humble opinion there is only one way out of the developmental state syndrome (which ends in corruption, bank failures and long term misallocation as so beautifully illustrated by Korea in the 1990s) is trade politics aimed at raising the cost of the developmental state’s chief resource, exploitable labor and making consumers and workers more assertive.
The thing about developmental states is that people keep talking about how badly they work when you end up being a developed country, that they forget how well they worked while you are industrializing. South Korea in 1990 was at a level of economic development that China will not reach for another thirty to fifty years, and the relevant experience for China is South Korea in 1960.
This is one big problem in economic discussions which is that people seem to be looking for this perfect economic system that works for all time, when in fact I don’t think that such a system exists. The best that you can do is to have economic policies that work for a while, after which time, you are likely to have to change everything.
In the case of China, it seems reasonable to me for China to copy parts of the South Korean economy knowing full well that it’s all going to stop working in about ten to thirty years. If we get to the point where China has the same economic problems that Japan or South Korea or even the Soviet Union had in the early 1990′s, this would be a sign of overwhelming economic success since this implies levels of development that China will not reach for another generation.
The other thing is that people when people talk about Japan and South Korea they often just try to fit what happened into a particular story, and that always involves leaving out some relevant and interesting parts. For example, one thing that people always seem to leave out when talking about the Japanese economy was the massive financial deregulation that happened in 1984.
Developmental states work well when you find large productivity gains by pouring concrete and moving people from farm to factory. They work much less well once you reach the point that there are no more gains to be made by pouring concrete. At that point, economic growth will slow, and you will have to have a lot of economic restructuring. Much of the current thinking in Chinese economics involves creating the economic institutions that will work when China reaches that point. China won’t reach that point for another ten to thirty years, but it takes ten to thirty years (or more) to create mature economic institutions, so people are thinking and acting on this now. A lot of seeds are being planted.
Huizer: You cannot have democratic capitalism and authoritarian developmentalism live side by side. The authoritarians will hollow out he more advanced econmies (after which they will stagnate) because the democrats have to keep their consumers happy.
First of all, it’s a bad idea to “two-tone” economics and try to divide all economic decisions and systems into two groups.
Second, I see absolutely no evidence that the Chinese government has less public pressure to keep consumers happy then the US government. The reason people are willing to put up with authoritarianism in China is because the Chinese government has over the last thirty years provided a rapidly growing economy, and if that stops and someone comes up with a better idea, then the Chinese government is doomed, and everyone in Beijing realizes that.
Huizer: Someone has to get them to understand that they are only a few years away from the point where major reforms become too hard and no-reform will lead to a very destructive effect on the world economy that will eventually hurt them too
The problem with “reform” is that it means nothing. The question becomes “reform what?” at which point you figure out that different people have different ideas what “reform” means. The Chinese economic system in 2008 is massively different than the one in 1998 and the one in 2018 will be massively different than the one in 2008. Convincing people in China that things need to change is easy. Life is all about change. The hard part is “change what?” and at that point having a “two tone” view of the world where you get to choose either A or B becomes dangerous, because limiting your choices to two makes you miss the trade offs, compromises, and choices that are possible.
The basic problem is that people were in the habit of thinking in terms of capitalism versus communism for so long that people didn’t notice that there are more than two choices in how organize an economy.
The way that Dubai organizes its economy looks absolutely nothing like what “capitalists” think an economy ought to be organized like, but it also doesn’t look like what “communists” think an economy should be organized like. Also, the economics of Dubai and China really have nothing in common other than the fact that neither fits in with the “Chicago school” or “Leninist.”
People have this idea that because Dubai and China look nothing like the United States that there must be some deep connection between the two, and there isn’t. Same with the “Asian economies”. Mainland China has made a different set of choices than South Korea did and has an economy that looks very different. One thing that has very strongly influenced economic thinking in the PRC is the return of Hong Kong. In order to make the Mainland Chinese system interface with the economic system of Hong Kong required a huge amount of effort that has created a lot of positive results. One big advantage is that Beijing is forced to use pragmatic criteria for economic decisions rather than ideological ones.
Huizer: Immensely glad to see you point at one of the key features of (heterodox) explanations of East Asian development “success”): using the banking system as an off blance sheet instrument of state support to industry.
Except that in China since around 2001 it has been the reverse. Industrial companies have bailed out the banking system rather than having the banking system bail out the industrial companies.
One thing that makes Chinese state owned enterprises very different from Soviet ones is that Chinese SOE’s are expected to make a profit to fund government social spending. This means that there isn’t any government incentive to keep the cost of capital low, which means that you don’t have the skew toward heavy industry that you find in South Korea or the Soviet Union.
More consumption is what got the world into this mess – jobs created from infrastructure “investment” that produce long term stability carefully planned to bring a vacuum of consumption from imported and locally made products and services balance with exports are the only fix going forward – over time the world came out of WW2 with a the US in surplus and the greatest advancement in production, jobs and prosperity – now I acknowledge that we ran into problems late 60′s to early 80′s but and its a big but this time we could be more vigilant?
Twofish,
You raise a lot of points, and interesting ones at that. I wish I had the time and the space to respond in more detail but that is not the case. The core of your argument seems that (China’s) developmentalist policies are justified as long as the negative aspects are still remote and/or kept in check (like with the banks). That may well be the view of the leadership as well. One of the best books on the developmental state was written by a Chinese scholar. From a hypothetically “neutral” and realist perspective I have only two objections (the Americans would have more) (1) it is at odds with peaceful trade relations, because the western democracies cannot afford (politically) to lose too many jobs to developmental states that suppress consumption (and related imports) in order to gain market share via low cost strategies * and (2) large parts of China are not many decades behind Korea etc. I would argue that the economically relevant part of China has about 600 million people and that those 600 million have at least 4 very large urban areas with industrial capacities more or less equal to similar areas (Busan for instance) in Korea. The people in Dalian or Tianjin are not less well equipped or trained, they are just a little cheaper and they have less opportunity to organize themselves. And keep in mind the Koreans are the lowest unit cost workers in the OECD with near EEC average levels of skills and socialization. And their government likes to keep it that way. If necessary through FX policies when the opportunity arises.
So, the debate is probably from the Chinese side:”on average we are far behind” and on the US/EEC side: where it counts you are pretty developed and we will treat you accordingly.
*China differs from Korea in the sense that it is not (yet) supporting local companies to displace in western markets, western companies, but that it simply displaces western production, leaving western marketing intact. If that is what you mean by China is where Korea was in the 1960s (i e the late Rhee and early Park era?) then you are right. Korea was still at the stage of having many companies (not yet the chaebol stratification that occurred in the late 1970s) competing with each other for subcontracting work. But of course Korea played an insignificant role in world trade then. China does not.
Huizer: it is at odds with peaceful trade relations, because the western democracies cannot afford (politically) to lose too many jobs to developmental states that suppress consumption (and related imports) in order to gain market share via low cost strategies
But the United States have gone through this with Japan and South Korea, and the solution is to have Japanese and South Korean companies site production in the United States. Once you have US workers being hired by Japanese and South Korean companies, the political dynamics changes considerably.
In any case, China is a different situation because there hasn’t been much of conscious effort to support Chinese exporters. Chinese exporters tend to be private companies that don’t get low loans or government support. The *only* government policy that has really been supportive to exporters has been the currency valuation, and I’d argue that this was a side effect of other motives.
Huizer: large parts of China are not many decades behind Korea etc.
But most of it is. Even if you assume reasonable growth, median incomes will not reach South Korean levels for decades. What this means is that there are still rather large productivity gains to be made by capital investment. You can put a farmer in a badly run, inefficient factory, and they are still generating more productivity than farming.
This brings up another difference between South Korea and China. China is big. Unlike South Korea or even Japan, you have various parts of the country in wildly different economic states of development, and this changes the dynamics of the situation considerably.
One thing that is important is that without massive government intervention, capital flows uphill. Rich people, rich countries, and rich regions tend to suck capital from poor people, poor countries, and poor regions, and you need government intervention to reduce this flow.
Huizer: . I would argue that the economically relevant part of China has about 600 million people and that those 600 million have at least 4 very large urban areas with industrial capacities more or less equal to similar areas (Busan for instance) in Korea.
One other thing. The Chinese government does not have the ability to govern in this way. The Chinese government ultimately stays in power because it is promising economic growth to 1.2 billion people. Some people will get rich first, but if you have half of the country get the impression that they are irrelevant or if they cannot see themselves getting rich eventually, then the government simply cannot stay in power.
From the point of view of the Chinese government, the welfare of the 600 million people that the US/EU don’t care about because they have no trade impact is probably more important than the people that do influence trade.
This brings up another point. China is big. Very big. The impact that China has had on the world economy is breathtaking when you consider that China is still a very poor nation, that only a fraction of its population is linked in to global trade systems, and we are still, very, very early in the story.
One long term consequence is that China has gotten as far as it can with exports. Even if the economy goes back to “normal” you simply cannot continue 30% y/y growth in trade. China is just too big and the United States is just too small. The question is where does the next source of growth come from, and I think it is going to be dominated by investment and government spending rather than consumption.
Part of the reason that I tend to be an optimist is that the amount of restructuring that needs to be done is extremely small compared to the things that have been done before.
The real problem with my above comment is that going forward will be meet with some real issues – one of these risks is protectionism – as slowing demand and excess supply weigh in on unemployment and instability in those heavily invested export producing economies – protectionism will only make things worse for global trade and unemployment – economies stimulating their already indebted industries and citizens for political reasons could create subsidies and bail outs that may be view as protectionism by other trading partners because it may involve local entities and by-pass foreign ones – this may cause retaliation as protectionism creeps in under the radar.
If governments are becoming the investors of last resort, they should prove their records of accomplishment as investors. Public expenditures have in many cases been a social utility curve and benefits difficult to quantify. As Brad wrote the invisible hand behind these ebullient economies was nowhere to be found but with governments and central banks and their medium of transmission the banks. There is an incestuous relationship between the private sector and the political motivations with an end result that is fiscal (more taxes) less savings (misallocated) more debts public and private.
Twofish,
Right, see your point, hope you see mine. But those 600 million poor people are not the west’s concern (more than 500 mm poor people in Africa etc) but hose 600 fierce competitors are. And that’s where the problem lies. I agree that the Chin. gvt does not have the micomanagement capacity that those smaller countries had/have. That does not make China a state with developmentalist intent. And that is a patriotic intent, not to be scorned upon, only a great nuisance if you are at the wrong end of the stick. You did not mention that Korea and Japan were client states. China has is not. The US should cut it less slack, but it has not , so far. Interesting.
Brad,
2fish’s topics and points of view deserve more elaboration and critique.
Strange detour of history, at the time of Tseu hi (19 C) xenophobe and unwilling to open China to international trade, the Western world thought that justice should be given to the traders.
As of today the Western world not satisfied of the term of trade is again addressing the issue as if it had natural appropriation and a given right to that end. My suggestion it is a trade with its terms take or leave it.
Mr. Setser, though I am just a scummy short seller and currency trader, isn’t the main reason for China’s export growth its 1 Billion slave labor work force and lack of regulatory and environmental constraints? The financial machinations no doubt have an impact and certainly your work on disclosing fund flows is the best public information I have seen but my experience with the Chinese government, is they lie about most things. Certainly China is manipulating its currency but I suspect due to the size of its economy, such manipulation washes out in the markets through the actual trade of goods. Comparative advantage can not exist when your competitor has a slave labor of the magnitude of China (the market for services is only so much and as we have seen the value of financial services is dubious at best).
From the policy debates, especially on state roles in finance, I’m trying to apply to expectations relevant to markets. I’m expecting a successful bank bailout plan consisting of fresh capital injection to the banks, and further purchases of doubtful securities by the Fed. Also, a successful resolution of the minor differences over the US stimulus program is almost assured. The bank bailout will lead to realization of dues for the Fed in the long run and good return on equity investments for the Treasury, but this will happen in the long run.
There will be no trade protectionism since it’s a short sighted demand from labor groups and not a state-led or business conglomerate led policy stance.
The next flow of global capital is from savers in the US/UK/EU region to consumers in the Emerging market countries, but that process starts with a focus on the large infrastructure projects mooted by the stimulus programs of those countries.
The resolution of the Russia-Ukraine dispute, followed by agreements on Soth Stream and Nord Stream, etc shows a rapid thawing of geopolitical tensions amonsgt state actors over petroleum resources.
Moves towards rapid conclusion of the Georgia, Gaza and Sri Lanka medium intensity wars also portends resolution of the underlying challenges.
Put all this together, and you get the stock market now looking ahead towards economic recovery. There’s a subtle shift in the public discourse on equities from “things will get worse before they get better, to ‘by when will things get better?’”
II: Moves towards rapid conclusion of the Georgia, Gaza and Sri Lanka medium intensity wars
How significant is Sri Lankan war ? Are there any geopolitical implications with the war ? I know there is oil in the gulf of mannar but do you think explorers could have paid a lot to Sri Lankan Govt to oust LTTE ?
One may introduce human and humanitarian consideration when it comes to the « made in China ».
There are not so many countries where shoes can be produced with labour working 12 hours a day (200 USD a month), living in camps (males in one building women in an other) , holidays at Chinese new year (10 days maximum)
Or
One may look at the profits made by the listed companies in the western world and agree to jack up the salaries and social benefits.It could mitigate the pre industrial and dour outlook of the society.
Brad,
I linked to the CFR study you just completed with Arpana Pandey in my Seeking Alpha commentary this morning.
In fact, the content of the commentary was inspired by a combination of Geithner’s written comments to the Senate Finance committee and the conclusions of your paper with Pandey. In the commentary I have Geithner make your arguments to the Chinese leadership.
You really ought to take the time to learn about China’s economic strategy. A good place to start would be Heng-Fu Zou’s 1997 paper about Viner Mercantilism. Alternatively, you could finally read our 2008 book Trading Away Our Future.
There is an astounding naivete about Chinese motives that I see in your writing as well as the writing by other top-notch economists.
Although you understand that the trade imbalances are not sustainable, you think that you can talk China into ending them. We’re going to have to end those imbalances ourselves.
Kafka: Mr. Setser, though I am just a scummy short seller and currency trader, isn’t the main reason for China’s export growth its 1 Billion slave labor work force and lack of regulatory and environmental constraints?
No. It isn’t.
First of all, you can’t run a factory putting out any sort of reasonable product with people that don’t really want to be there. Second, there are reasons other than cheap labor that companies site production in China. China has great infrastructure in the form of freeways, airports, and ports which means that you can move product out very quickly. Chinese workers have basic education. You have a 85+% literacy rate, which means that you can have people read instruction manuals and memos. Also, you have an very entrepreneur pro-business culture which means that people will try to start businesses.
If it was the case that Western companies were brutally exploiting slave labor in China, it doesn’t explain why the government is now totally terrified now that the US is no longer buying Chinese products.
Richman: There is an astounding naivete about Chinese motives that I see in your writing as well as the writing by other top-notch economists.
This is going to sound harsh, but I think that the economists understand Chinese motives better than you do. Western economists have talked a lot with Chinese people both within the government and outside the government, and it’s not a big secret what China is trying to do.
You can try ask someone who *is* Chinese what China is trying to do. Like me, for example.
Any idea that the China RMB is hugely undervalued versus the US dollar now seems far-fetched….
From the New York Times,
“The government offered a telling indicator Monday of the slowdown in China’s once-galloping economy, announcing that more than one in seven rural migrant workers had been laid off or was unable to find work, twice as many as estimated just five weeks ago.
The new statistics followed a hint on Sunday by Prime Minister Wen Jiabao that the government might have to expand a recently announced $585 billion stimulus plan to deal “pre-emptively” with growing economic problems.
About 20 million of the total estimated 130 million migrant workers, whose cheap labor underpins China’s manufacturing sector, have been forced to return to rural areas because of a lack of work, according to a survey conducted by the Agriculture Ministry that was cited at a briefing.
In late December, employment officials estimated that at least 10 million migrant workers had lost their jobs in the third quarter of 2008 as waves of factories and businesses shut their doors.”
Regardless of what China’s motives are relative to their place in the world, I think size does matter. We now really have two Chinas. The 600 million that are near developed nation status, and the 600 million who are not.
Compare that population to 300 million in the US, 150 million in Japan, and if I remember the number correctly, 800 million in Europe. So whatever Chinese policies and motivations are, they are bound to have profound effects on the status quo in the rest of the world. And it will be increasingly difficult for China to come up with coherent plans that address both the undeveloped and the developed China without rattling the ROW. They face both losing older, low tech, labor intensive industry to underdeveloped countries in Asia, and have a grand strategy to move up the value chain and develop aerospace, defense, automotive, machine tool, consumer electronics, and semiconductor industries which will compete with the crown jewels of Japan, the US and Europe. That’s not a bad thing if demand increases proportionality, but will it? And if it is attempted with low wages in skilled and higher educated professionals, while ignoring social costs and environmental costs of developed countries there is bound to be friction.
Think about how China would keep tennis shoe production in China and also grow the semiconductor business at the same time with exchange rate policy. That gets quite scary if you have a Silicon Valley mortgage, and now Silicon Valley mortgages are scary even if you are merely a US taxpayer living in a lesser part of the country.
Similar problems are on the financial side. We have a huge amount of “savings” held by the CB and SWFs looking for a place to go. I always lump these together in my mind since they seem to act the same. But when it all headed to the US along with most of Japan’s money, I do recall news reports with both Treasury officials and Greenspan marveling at our ability to finance the Federal deficit. As a US taxpayer I was not as excited about this development as our leadership was.
So somehow this has to change. Protectionism is not the answer since it would just start global multi-nationals rearranging things in the least disruptive manner, but is still inefficient and costly with questionable benefit. For instance, I’ll give 5:1 odds that Wal-Mart buys tennis shoes in China, shoe strings in China, ships them to their new tennis shoe assembly plant in Tijuana, installs the shoe strings, boxes up the product in a retail box and imports the product from our strategic trading friends in Mexico. Price of tennis shoes goes up 20% for the US consumer.
On the financial side we are realizing that using the US as the world’s bank has serious problems as well.
The problems are huge and numerous. But I’m tired of typing, so that’s all I’ll say for now.
@ Brad:
What are the policy steps you recommend for China?
You’ve already recommended they should “increase the ratio of consumption to GDP” – what does that specifically translate to?
A very important contribution, Brad.
Governments play an important role in the achievement of a trade surplus in our competitior countries – RIGHT.
The creation of a trade surplus via using monies comming from the trade surplus with the U.S. to purchase U.S. financial assets (not goods) and thus reduce the U.S. interest rate does have some impact on what goods and services are produced in the U.S. – RIGHT.
Two fish, it is likely you live in a land of fantasy, I never suggested exploitation I suggest you can not compete against some one who is happy to work for two meals a day (as opposed to one) and will work long hours as opposed to believing they have an inalienable right to take off time for their kids’ soccer games or spouses maternity leave. When you add into the mix currency manipulation and no regulatory or environmental constraints, competition evaporates. The only factor which impedes the competition is transport costs. Comparative advantage is a myth in a world where the playing field is not level though I know the debt subrogators love purveying it, Read Squanderville by Buffet (though he seems to have forgotten his own writings), the U.S. has a 70% debt financed consumption based economy with unsustainable debt financed social and defense costs. The only thing propping the U.S. up is the greatest ponzi scheme in history, the Fed. Schumpter. Fischer and Darwin were not wrong no matter how much people want to ignore the simple math.
Kafka: The U.S. has a 70% debt financed consumption based economy with unsustainable debt financed social and defense costs.
It actually doesn’t. At a national level the US debt level is rather low, and there is nothing unsustainable about the social and defense costs that the US currently has.
The way the US political system has turned out is that you have people who ideologically believe in smaller government and who want smaller taxes in order to “starve the beast”. The trouble is that people want smaller taxes, but they don’t want smaller government, and at some point there was going to be a conflict. My guess is that the ideology of small government is dead so you are going to end up with big government and big taxes, and this is perfectly sustainable.
Kafka: . The only thing propping the U.S. up is the greatest ponzi scheme in history, the Fed.
If you can prop up an economy by printing money or rearranging pieces of paper, then go ahead and do it. That’s what finance is all about.
What really props the US up is the fact that if the US self-destructs then the rest of the world goes down with it which means a) that everyone in the world wants to prop up the US and b) when push comes to shove, people pump money into the US because if the US goes, there is nowhere else to run.
Kafka: Two fish, it is likely you live in a land of fantasy.
I try not to. One thing about markets that is good is that it keeps you from leaving in fantasy too long, because if live in fantasy in a market, you end up self-destructing.
Brad: My point is simple
Brad, either you want to convince some people who aren’t very smart about your points or you want to convince smart people about them. You’ve frequently pointed to China “excessive reserves” with dat that basically shows $ 2 trillion, its growth and composition over a certain period of time.
Any smart person will look at the following data points:
1) While PBoC’s maximum Agency holdings at any time were around $ 400 b, the US mortgage market was $ 11 trillion, only in outstanding home loans. We have to count the $ 43 trillion CDS, and a seemingly infinite series of MBS, MBO, etc to arrive at the total size of credit on US mortgages.
IF PBoC was only financing less than 5% of US mortgage debt, how do we justify the view that PBoC was “the lender”?
2) “Mercantilism” is a valid strategy in a world of hard currencies payable in gold. The US dollar is held up only by petrodollar recycling and otherwise it’s just a fiat currency that doesn’t have value for foreigners. So what justifies your view that everybody has a reason to “accumulate Treasuries”?
3) All countries plan their reserves based on annual imports, external debt, other capital flows. Given China’s size and trade, having a $ 2 trillion forex reserve to support annual imports of $ 1 trillion, in a country which has one of the largest levels of FDI inflow despite capital controls, seems reasonable. Earlier you pointed to Western models that advocate that an emerging market should keep reserves not more than 3 months’ imports., and not more than 10% of their GDP. The validity of those papers and the reasoning behind them is as questionable as your conclusion that China’s mercantilism caused the US Mortgage crisis.
4) There is a 2007 paper by Ashok Bardhan that estimates a fall of 1.5% in US mortgage interest rates due to global capital flows. To what extent does a 1.5% fall in mortgage interest rates influence buying behavior for the Chicago Man? Is the Chicago expected to be able to do basic artihmetic on monthly EMIs versus monthly income, or does he simply go by the interest rates?
5) It’s impossible to guard against the actions of 87 different foreign central banks in the world. The Federal System was never set up in such a way that the Us economy was vulnerable to any and all kinds of foreign manipulations. Clearly the Fed has failed in its mandate to ensure the stability of the US financial system, despite having been given powers, monopolies and independence to meet that mandate. If at all it were true that PBoC manipulations led to the crisis, we have to reason more with the Fed’s failure to regulate and less with the PBoC’s imagined intentions.
Now either you want to have an intelligent discussion with people who apply their common sense to things, or you can write for people who are just gullible and willing to believe everything you write without thinking about it. There are plenty of people writing in glossies to inform the latter, so there can’t be much exclusive contribution from you in that regard.
Either you are capable of intellectual debate to convince reasoning minds, or you are simply writing for people who can look at a few nice charts and accept all conclusions as true without reasoning them out properly.
Yes, and this is a major reason why we face a higher risk of depression and why stimulus may not work as we hope in many countries. That is, in much if not most of the world, underlying demand, whatever that might have been under a more market-oriented system, has been altered, affected and enhanced by the interplay of government roles. We have enabled that steroidal growth by consuming so much, but now that we can’t carry the load one question becomes: how much dislocation will occur as the domestic economies of this other world adjust? And then will domestic demand materialize at a level commensurate with the massive distortions of the last decade plus … or will it solidify at a lower level?
It may sound odd but it’s become clear we don’t completely understand the mechanisms of demand. And I’m not talking Say versus Keynes. Or maybe we do but we don’t apply the logic well. That is, we recognize that tax incentives fueled the property boom and we see the effect that is now having … and similar distortions have appeared around the world in a variety of categories. That is why the future scares me.
Cedric: The 600 million that are near developed nation status, and the 600 million who are not.
That’s very off. There are maybe 100 million or so Chinese that are near developed nation status. On the one hand, that’s less than 10% of the population of China. On the other hand, that’s one third the population of the United States, so even getting a small fraction of Chinese to developed world standards is going to have huge effects on the global economy.
If you think about adding 100 million Chinese people every ten years to the developed world for the next century, that is going to be extremely disruptive. And that is just China. Lots of Arabs and Indians want their piece of the pie.
Cedric: And it will be increasingly difficult for China to come up with coherent plans that address both the undeveloped and the developed China without rattling the ROW
The economic problems that China faces now are trivial in scope compared to the one’s that it faced in 1980. I think the really hard part has already been done. China today has a more or less functioning economy which wasn’t true in 1978 or in any time in the last 150 years of Chinese history.
jonathan: It may sound odd but it’s become clear we don’t completely understand the mechanisms of demand.
That’s what makes this an interesting game. We know a lot more about how economies work and don’t work than we did six months or even three months ago. In three months, we’ll know a lot more than we do now.
Two fish, very nice, the only thing that is real is the market price, no doubt. I would submit reliance on GDP to national debt as a measure is fantasy. GDP is fake, hedonics imputations and understated deflators. What is real (if you believe the numbers) under Bush the national budget doubled, the national debt doubled and there is no end in sight. Bush presided over the largest increase in government spending and deficit in history. The best measure is total debt in the U.S. which again under Bush went from about $20 Trillion to $52 Trillion, the largest increase in history and more per capita than any time in history. Some suggest it takes $5 dollars of debt to create $1 of GDP which can’t be profitable after interest costs. Of course, the real cause of the real estate bubble was Bush deciding to stop issuing the long bond in 2001 and the switch by central bank’s to agencies which allowed the agencies to clear their balance sheets and continue the sham, over and over and over. As for fractional reserve lending, yes I guess it is kind of working but for how long, the consumers have not had a real wage increase for 10 years, how much more can they borrow? Name one civilization in history that has successfully used financial alchemy to navigate the unsustainable system of fractional reserve lending using fiat money controlled by thieving Politicos? It simply has never worked over time, not once.
America Is Completely Broke, And Here We Are Funding Fantasy Wars at the Pentagon
“any president would be damn happy to have more F-22s around if we had to get into a fight with China.” – Secretary of the Air Force Michael W. Wynne
Until we decide (or are forced) to dismantle our empire, sell off most of our 761 military bases (according to official statistics for fiscal year 2008) in other people’s countries, and bring our military expenditures into line with those of the rest of the world, we are destined to go bankrupt in the name of national defense. – Chalmers Johnson
http://www.alternet.org/story/124881/
@ Kafka: I’ve read George Soros 2008 Credit Crisis but I haven’t read his earlier “financial alchemy”, which you seem to be referring to. Do you have any view on markets. The new Treasury issuance in 2008 was exchanged for an electronic credit in the Treasury accounts with the Fed. The Fed then lent real dollars (and Treasury secs) against the bad loans held by primary dealer banks. The Fed never had $ 2 trillion extra before the crisis began to lend it to banks.
I’m expecting this process to continue in the 2009 deficit financing and also additions to 4 banks’ capital accounts from the same process. This means higher and higher Treasury Bond prices as long as there is new issuance.
So speculation about the good-bank bad-bank bailout failing, or stimulus bill not passing Congress, or imagined problems with Treasury auctions, etc is incorrect.
As for USD exchange rates, they will decline gradually rather than suddenly. Neither the US nor the trading partners can afford a sudden collapse of the US dollar.
indian investor:
I’ll try and come to Brad’s rescue since I was a former California homeowner and was as much interested in the US housing phenomenon as Brad is in the China phenomenon.
Size matters less than you think. For one thing CDS is not credit, it is swaps that are like the long and short side of an insurance policy. That in itself was a big part of the overall problem, but the size of the mortgage credit market really is 11 Trillion.
But I recall a Fed study that concluded foreign investment caused long term rates to be 1.5% less than they would be otherwise. Also it doesn’t all need to into into GSE’s. Treasuries are the zero risk baseline and all other debt sells at some spread to Treasuries.
I also am suspicious of the Fed 1.5% number because there was the short term/long term treasury carry trade going on in the US, and when the Fed finally started raising rates you could still do it with swiss franc or yen as the funding source. So I think US private money had a lot to do with bending the yield curve as well. And this was highly leveraged. Plus I think the treasury deliberately refrained from selling large amounts of longer term treasuries in order to hold down long term rates of all debt instruments.
But the conclusion you can draw is that housing prices are very sensitive to interest rates, especially when you start a stampede mentality.
What happens is lenders will lend you everything you can afford, and the home buyer spends the most money they can get their hands on. This is not dumb behavior on the homebuyer’s part. There are many good reasons for it.
So interest rates averaged around 5%(historical norm before then was 8%) and the Fed says they could have been 6.5% without foreign investment.
So even if we forget about the 8% as a baseline, the ratio 6.5%/5% = 30% more buying power chasing housing than in the past.
Then we can look at what percent of income a lender will loan. The long term rule was 33% of gross income, if you didn’t have a large amount of other debt already. In recent years that was upped to 38%.
So take that ratio 38/33 = 15%
Another 15% of buying power. The total is 45%, which is eerily close to what the increase was in the national median house price.
These calcs work backwards too.
Agree with Cedric Regula that China can’t ignore the social and environmental problems for being the world processing workshop.
Twofish:
The problem of China is not trivial comparing to 80s. In 80s, the air was clean and the water was pure. You wear blue jacket all seasons long with no deposit in bank. Today, you breath toxic air and drink toxic water. You have to visit hospitals to cure cancer or some type of disorders. We are creating problems for our children and generations to come. Comparing to the social cost, I don’t think their is enough merit to be the world market leader in producing things.
The more we consume, the more we produce and the merrier we are. Somehow, most people are all sucked up in this commodity or money fetish and forget what really counts in their life. Being the winner is not such a good choice if you have to sacrifice too much, then you lose the goal of why you want to win.
I think that Chinese government’s approach to encourage immigrant workers to go back to their own land and develop local communities with financial support from the government is an excellent approach to deal with the crisis. Staying in overcrowded city is not a solution.
Agree with Cedric that protectionism is not the answer.
Cedric: the ratio 6.5%/5% = 30% more buying power chasing housing than in the past.
@ Cedric:6.5%/5% is actually just a price rise of not more than 16% at best.
I calculated that for a $300,000/= home mortgage the EMI on a reducing balance 6.5% loan for 30 years would be $1878.67 versus $ 1597.93 if the rate is 5% instead – a saving of $ 280.74 per month.
So somebody with a gross monthly $5000 income would pay $280 less per month in EMI due to PBoC for a $300 K home loan.
Assume that ALL of the benefits of the reduced interest rate are consumed up in home price increases. The price of the same home would rise to $350,000, since a $350,000 home loan at a 5% rate would require an EMI of $ 1864.25, which is very close to $1878.67. So, we get a 1/6th price increase in homes in the above example, in which the assumptions are quite liberal towards the mercantilist argument.
If somebody were earning $ 5000 gross per month, they would be eligible for an EMI of $1900 if 38% of gross income can be lent and for an EMI of $1650 if 33% can be lent – an increased EMI eligibility of $250 per month.
PBoC interventions don’t mean anything for whether somebody can borrow 33% or 38% of their gross income in the US. Any price increases due to this need to be blamed on the Fed.
indian investor:
ok, I didn’t have my loan calculator handy. I don’t even remember where it is anymore. So maybe I should be thinking that pre 2001 housing prices where based on affordability with the historical average of 8% for a mortgage.
Agreed that the PBoC can’t set up the internal US channels that get the money to the homebuyers. Congress did that when they doubled F&F loan limits from $225K to $450K.
I am wondering what level of consumption will be in US if we factor in all social and environmental cost into the cost of goods imported to US. People can’t scale back on necessities, but most luxury goods and services will take much smaller proportion of whole consumption. Perhaps everyone will live like Chinese in the future and give some hope for future generations.
@ Cedric: I calculated EMIs for a reducing balance $300 K home loan with a term of 30 years. As discussed above, if you assume that prices rise overnight as the interest rate decreases, you get a maximum 16% price rise from the PBoC actions to reduce mortgage rates from 6.5% to 5%.
Apart from increasing “prime” eligilbity to 38% from 33%, you have to reason that there were sub prime loans, (NINJA = No Income No Job/Assets), mortgages were available for terms up to 50 years in the boom, and you had various loan structures, such as interest-only Adjustable Rate mortgages. Overall, the contribution from these factors on home prices would be so much higher than the global flow impact of -1.5% that the global flow impact seems insignificant in comparison.
But apart from this, I was looking at the factors in my post above, as well.
PS: You can calculate EMIs on Excel, by using the goal seek function. Set up the formulas for monthly interest and principal repayment, then set the last principal repayment to “zero” using goal seek with the int rate fixed and by changing the EMI cell.
Indian Investor, unless the world implodes or the U.S. starts another unjust War, within five years the dollar will have devalued and rates will have risen, substantially. The math is relatively simple.
Here’re the latest Public Debt numbers:
02/02/2009
Current Debt Held by the Public
6,363,558,989,801.84
$ 6.36 Trillion
Intragovernmental Holdings
4,304,404,278,591.44
$4.30 Trillion
Total Public Debt Outstanding
10,667,963,268,393.28
$10.67 Trillion
http://www.publicdebt.treas.gov/
indian investor — earlier i indicated that i supported david dollar’s suggestions for increasing consumption in china. as for you points that $2 trillion is needed to backstop china’s $1 trillion plus in imports, there is no real point in my trying to respond, as I already responded in a way that you dismissed. note tho that i agree that 10% of GDP in reserves is too little for countries with lots of short-term external debt or large foreign portfolio flows. china doesn’t fit either category tho.
china’s agency holdings peaked at $600b (clearly you don’t bother to read things i link to or my analytical papers before criticizing me), with peak purchases of $200b a year or so (most of the agency portfolio was bought from 05 to mid 08). that never financed the majority of the us mortgages, tis true. but it did help sustain the low interest rates environment that supported the housing boom, and as I have argued in the past, it plus china’s treasury purchases sustained an inverted yield curve that encouraged risky credit bets.
the bigger issue here tho is whether stocks matter or flows matter for prices, and whether or not we should be looking at china’s share of external inflows or its share of new mortgage financing …
It’s interesting that people talk about free markets in an environment where traders live by maxims such as “don’t fight the Fed”.
What kind of free market has all the market participants waiting around to see what the central monetary authority is going to do next before making significant moves?
Brad: but it did help sustain the low interest rates environment that supported the housing boom, and as I have argued in the past, it plus china’s treasury purchases sustained an inverted yield curve that encouraged risky credit bets.
I agree China’s Agency holdings were $ 600 billion instead of $ 400 b as I mentioned in my previous, and thanks for acknowledging that looked at purely in terms of a nominal percentage of direct outstanding mortgages, PBoC funding was not significant.
My example above which is obviously inappropriate in a more professional study shows that at most an impact of 16% can be expected on home prices due to a reduction of long term interest rates by 1.5%. The latest mortgage rate is 5.33% for a 30 year fixed rate loan. So one issue is sorted out … neither the absolute level of PBoC intervention nor the direct price impact of reduced long term interest rates directly caused a US mortgage boom. Instead, I’m reasoning with your theory that the resulting inverted yield curve encouraged risky credit bets. I need to think more about that.
I did go through your earlier comment on the recommended level of forex reserve cover, and you referenced another paper written by two economists on that. The reason I’m dismissing that paper is my understanding of the IMF economics paper patterns.
All the papers are publicly available at no cost and you can see that all papers written by IMF economists at times of economic crises recommend liberalization of foreign investment, privatization of domestic industries, reforms of the financial infrastrcuture for more efficient stock and capital markets.
This pattern makes the rest of the IMF writings lose credibility. It makes it apparent that the IMF economists had something perhaps to gain when private global investors were able to buy equities at low prices after largely the same investors had executed a run on foreign currency debt in those markets.
So a couple of Western economists recommending to emerging markets that they should have a 3 month cover on imports, or a 10% of GDP cover, etc has already lost credibility due to more than 5 decades of IMF manipulations of global stock markets; though they might have a model and a logic to the recommendation.
If you had done a paper yourself making that estimate I would be more disposed to go through or accept the estimate.
I wanted to clarify I don’t think there’s anything fundamentally wrong with foreign investment in an emerging market, or trade relations amongst countries. But when a small coterie lends a lot of money in dollars to an emerging market, does a run on that debt,crashing the local markets, andn then uses the IMF institution to enforce FDI policy changes and makes big investments at low prices, they gain an unfair advantage which makes it risky to deal with those people.
On the other hand a foreign investor who invests in the local market without trying to gain this type of unfair advantage should be more than welcome.
Every few years recessions have been triggered in the united states using similar processes. The issue is a dominant cartel of investors with extensive global influence rather than a nationalist issue between the US Govt. and various other Govts.
Ying: The problem of China is not trivial comparing to 80s. In 80s, the air was clean and the water was pure.
And with enough money and political support you can fix the environment. The political support is or will be there shortly. What makes this an “easy” problem is that for the most part, every industrializing nation has gone through the same process.
Without technology and industry, you might not have air pollution, but what you end up with are increasing populations living off smaller plots of land until people start starving. There were cases of famine in China in until the late-1970′s.
Ying: The more we consume, the more we produce and the merrier we are. Somehow, most people are all sucked up in this commodity or money fetish and forget what really counts in their life.
But living a “spiritual live” is impossible with some material basis. In the past, there were a limited number of people that could be philosophers and poets because to have philosophers and poets required a lot of backbreaking peasant labor to support philosophers and poets.
The higher the industrial capacity a nation has, the more it can support artists, philosophers, poets, and physicists. If you want to work on a farm and grow rice, you can. The trouble is that without industrial capacity, you are forced to do it.
Ying: I think that Chinese government’s approach to encourage immigrant workers to go back to their own land and develop local communities with financial support from the government is an excellent approach to deal with the crisis.
Let’s be clear that the real reason that the Chinese government wants people to go back to their own land is so that you don’t end up with mobs of angry people in the cities. People find it much easier to organize in the cities. On the other hand, paying people large sums of money to stay in the countryside probably isn’t a bad way of handling things, if the money is there.
Ying: Staying in overcrowded city is not a solution.
People tend to be financially rational about these things. If they find that staying in the city makes is financially rewarding enough, they’ll stay. If it isn’t they’ll go. The thing with industrialization is that usually factories encourage urbanization.
Twofish, Ying,
Interesting debate between a Chinese modernizer (2F) and a Chinese green/conservative. Is one living in the West and the other in the East?
@TwoFish, re your numerous excellent comments here, informative and possibly a very good analogue of what a leadership person, speaking informally an honestly, might comment here. One more observation: you admit that this export led model has run its course (incidentally you never commented on the key difference between China and Korea/Japan, apart from size: China is not and has never been a client state (you may disagree with sticking that offensive label onto Japan but I think it still is, be it a very large one with lots of qualifications for sovereignty).On that we agree.
The game is over. It’s global depression until China and Russia concede sovereignty and finance their domestic demand in either SDR’s or USD.
World government, here we come! Get ready for war first, though!
Things have lost clarity of late here.
Indian : You sound like there is a Ponzi scheme that the west (and IMF) run against Asia (or EMs). Could you please explicate in lay man terms ?
@Off the boil: It started in the 1970s with Dr. Kissinger petrodollar recycling. The petrodollars were lent to South American countries, and then there was a run on that debt, causing local markets to crash, and the sovereign to be out of external financing. In the juncture IMF economists wrote scholarly sounding papers with a simple bottomline – please open up your sectors for FDI. The same lenders then purchased equity at cheap prices in those markets.
Oil producitng countries like Mexico are targeted by hiking and then crashing the crude prices, the same treatment as what’s being given to Iran and Russia right now.
This process was first applied to the SA countries, then after Citigroup branches came up in many of those countries, and puppet regimes were installed, etc, it was applied later around the world, the last big example being the East Asian Tiger economies. In July 1997, China got the handover of Hong Kong from the UK; the credit crisis was then triggered to target China’s influence with Korea, Indonesia, Singapore, Thailand, etc with Japan being a US ally.
China lost influence but managed to escape the US Treasury dragnet that time. Once again, they’re getting off this time, because they have a good forex reserve.
People like Brad are employed to go on a witch hunt blaming People’s Bank of China for everything with un related charts.
Paulson was demanding FDI liberalization in China till Dec 2008, since the Chinese exchanges have crashed. Geithner has gone one step ahead. He wants to RMb to be strengthened so that more and more factories can shut down in China, riots can happen, the Chinese exchanges will fall further, the Communist Party will be in deep trouble and then they will be forced to sell their state owned family silver to the primary dealer banks.
I can’t say about Brad, but this Geithner, who is an ex boss of Brad’s is clearly a paid stooge pigeon for those primary dealer banks.
In India we believe that democracy is the institutionalization of doubt. Unless you are free to doubt people holding high positions, and call them to account in an accurate, democracy is just a fiction and not a reality.
Note that the RMB/USD demands from Geithner have nothing to do with US exports, etc that are tom-tomed – it’s just unreal as many commentators have pointed out. China even has their own domestic aircraft manufacturing now; there’s little or no chance of any exports to China from the US in the absence of wage adjustments.
@Off the boil: The same thing has been done to the US economy, with some differences. The weapons companies have sold trillions worth of the unneccessary fighter/bomber planes and nuclear sailboats and the Us Govt. has borrowed some $ 10 trillion and blown much of the money on these weapons and gone bankrupt. Similarly, the primary dealer banks also exploit the Us laws and fed system to make profits out of the Treasury borrowings.
Thanks Indian. I will check regarding the PETROCYLCING and LATINO bust.
But you are very right on the WEAPONS companies.
HEre is an excerpt from the inimitable Economist of India :
“The story goes like this. The US gives away $1.5 billion worth of weapons to Pakistan. In effect, the US is paying its own producers of weapons, who in turn support the US policy makers by locating their factories of weapons of mass destruction in the policy makers’ constituency. Read more jobs for the merchants of death. Then India’s defense establishment looks over the border and says we now need $2.5 billion worth of stuff from the US. More jobs for the merchants of death. Total benefit to the merchants of death: $4.0 billion. Total cost to the impoverished populations of Pakistan and India: $4 billion. “
»state backed companies«
»able to borrow because of their state backing«
»state plays an active role in guiding investment decisions«
»borrowing on perception of being too close to state to fail«
»private capital wanted to finance current account deficits in the emerging world«
»private capital«
»us policies«
@ Off the boil: One of the big things that’s being avoided in the whole PBoC debates is discussion of the US Govt. Debt. The sequence starts with the US Govt. A new breed of weaponry comes up, and then the old breed is sold to some other country. This justifies new breed purchases by the US Govt. And on and on. There’s an aero show in Bangalore next week and China will participate with its own aircraft for the first time. F-16s and F-18s will be on display, and Govt. of India will buy some of that. Arms dealing is a completely corrupt business everywhere in the world. But the gullible American public believes that these weaponries constitue something nationalistic which benefits the common people. Apart from a few jobs in the weapons companies, there’s no benefit, and the loss of literally trillions to the exchequer is simply amazing.
Now after the US Govt. does this kind of stupid budgeting, just like emerging banana republics and least developed banana republics, the United States B-52 Republic gets some of their economists to analyze the PBoC reserves, and such like, trying to figure out how the whole 2008 bust came about.
Please. Let’s just say that someone’s obvious (and only) obsession is to »beware of the euro«. Obvious to many but not to ECB. This OCD was and still is being played at in many mysterious ways that gave and gives rise to stupidity never before seen which needs to be blurred constantly in many different ways and in an expotential manner. The slope of this function demanded a recent recruitment of even the ECB.
Off the boil
“Indian : You sound like there is a Ponzi scheme that the west (and IMF) run against Asia (or EMs). Could you please explicate in lay man terms ?”
indian investor: Regarding: The Witch Hunt
I’ve got an interesting study for you. Get a long term chart of the dollar index and Fed interest rates. Line this up with the years…1994 Mexico deval, 1998 Asian Crisis, and maybe it works for the 1980s Lat Am blowups, I don’t remember.
My theory is since EM countries have to borrow in Dollars at government and corporate level (since they print their own currencies faster than a speeding bullet),then whenever the dollar strengthens, they have trouble paying back loans and that is what causes first defaults at highly leveraged businesses, then currency crisis and gov defaults or devals.
The dollar goes up when the Fed raises interest rates (ie 1994 to Mexican crisis)or the Dollar is high due to FDI coming to the US (ie late 90s stock market boom to Asian Crisis).
It didn’t happen this decade. The Dollar went down except for a brief reversal in 2005 when Greenspan finally started raising rates.
My gut feel conclusion:
Greenspan is the Witch. Modern Economics is his voodoo.
We haven’t got any EM fallout yet because the dollar was weak on average this decade, and most increased reserves to guard against strains on their currency. But now its not. Does that mean that now we will be seeing EM crisis coming up soon?
“Larry Lindsey argued — I think correctly — that China’s policy of spending huge sums – to keep its exchange rate from rising, China often had to spend 15% or so of its GDP buying foreign assets — to avoid currency appreciation didn’t affect overall levels of output or employment in the US, but it certainly affected the composition of output and employment”
You could argue that the govt intervention in China reduced the welfare of Chinese…which is in line with the thesis of James Saft and against your argument that state was helpful.
Huizer: Interesting debate between a Chinese modernizer (2F) and a Chinese green/conservative. Is one living in the West and the other in the East?
Be careful of dualisms. I see my own political philosophy as being quite conservative and traditional, and I reject “modernism” (in the Roman Catholic sense) and very strongly reject “Westernization”. East/West is another dualism that I think doesn’t make any sense at all.
The reason that dualisms are bad is that because you find out that people believe X, you assume that they believe Y, which isn’t true. The fact that I say very nice things about the US economy is because I’m quite “anti-Western.”
Huizer: One more observation: you admit that this export led model has run its course.
I think you can reasonably expect export industries to continue to employ several tens of millions of Chinese. I don’t see how you can use export industries to get another 600 million people up to first world standards, but neither does anyone else.
I don’t think it is wise to think in terms of economic models. You really need economic diversification.
I’m prepared to accept your premise, Brad, but one should go a bit deeper and look what caused the banking crisis. It would have come anyway, even without over-leveraging, because the global savings glut and the export-led-growth models that helped encourage it were doomed sooner or later.
Indian investor – your conspiracy theories are entertaining, but methinks they ascribe rather too much wisdom to insiders. Kissinger once said the U.S. was finished and due to come under Soviet domination. I rather think that any good economist knew better.