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LinkedInThe US clearly failed to recognize the risks associated with highly leveraged households and an over-leverage and under-capitalized financial sector. The resulting implosion has reverberated globally.
But I don’t quite see the basis for arguing that the US fiscal deficit is siphoning funds from the rest of the world. It may in the future. But right now it isn’t.
The amount the US borrows from the world is a function of the trade deficit (really the current account deficit, but the trade deficit is a good proxy), not the budget deficit. And the trade deficit is coming down. Calculated Risk estimates that the January deficit could be as low as $30 billion, or only about 1/2 its peak level. Thank the fall in oil prices. Put simply, the US is borrowing a lot less from the rest of the world now than a year ago, two years ago or three years ago.
Moreover, the US doesn’t magically attract funds from the rest of the world. In order to pull in savings from the rest of the world, the US has to offer a higher (risk-adjusted) return than other borrowers do. The ten year Treasury has sold off (see Jansen). It no longer yields 2%, but it still yields less than 3%. And that isn’t exactly a high rate. The way the US pulls in funds from the rest of the world is by offering a higher interest rate than the rest of the world. That ends up driving up interest rates globally and forcing other countries to pay more to borrow. Today though US rates are well below there levels a year ago. If anything that should create incentives for US investors to send funds abroad — not incentives to pull in funds from the rest of the world.
And well, I don’t think anyone can argue that high short-term rates in the US are sucking savings out of the world. If anything, low policy rates in the US should make it easier for other countries to raise funds. It isn’t hard to offer a yield pickup over the US right now. Last fall when the Fed was cutting rates and other countries weren’t, private money was flowing out of the US …
This isn’t to say that the problems emerging economies now face trying to raise funds originated in the emerging world. They didn’t. Not really. They are suffering from the collapse of the US — and European — financial sector. Hedge funds are pulling back. And more importantly, capital constrained banks are pulling back. That — not the fiscal deficit — is what is pulling funds out of the emerging world. Emerging economies in that sense are no different than any other borrower facing difficulties getting a bank loan.
The fact that the financial sector now depends on a government backstop may have prompted the banks to pull back more from foreign markets than their home markets, though they are clearly doing both. Deglobalization — particularly financial deglobalization — isn’t going to be pretty.
But a few emerging economies are also suffering from self-inflicted wounds …
Not the least Russia.
Russia exports a lot of oil. But for a long time it tried to keep the ruble pegged (more or less) to a euro-dollar basket even as oil soared — and even as private capital poured into Russia. Russia though didn’t sterilize these inflows as effectively as China. The resulting rise in domestic inflation led Russia’s real exchange rate to appreciate quite significantly. Now, obviously, there is pressure for the ruble to depreciate in real terms. That could happen through deflation. Latvia has chosen this course. But investors — and Russians — believe that Russia will let the ruble depreciate in nominal terms to bring about the needed real depreciation. And until that process is complete, there isn’t much incentive to old rubles. See Slater and White in today’s Wall Street Journal. They quote Natalya Orlova, chief economist at Alfa Bank in Moscow:
“All the rubles that are out there have been turned into dollars. To get out of this spiral where everyone expects a devaluation will be very difficult.”
Capital isn’t flowing out of Russia because the US fiscal deficit deficit has pushed up US Treasury interest rates to levels no other country can match– or because Russia cannot match the high rates on offer on dollar bank deposits. It is flowing out of Russia because a lot of people believe the ruble is still overvalued.
It actually is fairly common for oil exporters to experience a real appreciation through inflation and a real depreciation through a sharp fall in the nominal exchange rate. The mechanism for real exchange rate adjustment isn’t always symmetric. I though would argue though that the oil-exporters generally would be better off letting their currencies rise along with oil — and also fall along with oil. The right exchange rate for Russia is — I suspect — tied to the price of its key export. But at this stage, though, this is a rather academic point. The key issue is just how many more reserves Russia is willing to spend to prevent the ruble from falling further …
p.s. On a more technical basis, the investors who buy US treasuries aren’t typically the same investors who buy emerging market debt. They rather are the kind of investors who might otherwise buy Agency paper or similar close substitutes for Treasuries. The money market funds now buying Treasuries were never buyers of emerging market debt. Russian debt — particularly ruble debt — is held by investors with a higher appetite for risk. That problems Russia faces right now consequently have a lot more to do with the broader deleveraging process than the scale of Treasury issuance. Yes, there are knock-on effects if the US sucks up a lot of funding with a large fiscal deficit. But those effects are indirect and generally operate through a rise in US interest rates. Conversely, Russia would certainly benefit if a fiscal stimulus pushed up US demand and that in turn pushed up oil prices …
Needs are to differentiate countries borrowing in foreign currencies (private sector and to a lesser extent the public sector for Russia) with countries borrowing in their own currency USA.
Not sterilizing capital inflows and pegging the exchange rate to the fluctuation of the oil export has adverse impacts as the private sector is happy with currencies mismatch in the good time and in disarray when oil, inflation and domestic currency depreciation occur all together.
Smoothing out the future would require sterilization and a better control on the funding requirements of the private sector by….the private sector. These are repetitive problems at crisis time. Asia in 2000 was considering launching its own bonds (basket of Asian currencies) as a mean to avoid being caught in interest rates and or foreign currencies appreciation.
The Banking crisis will not only unemploy millions, but it will also kill millions as funding to aid underdeveloped world gets trimmed.
The World can only blame two main institutions for the situation we are faced with today. Those instituations would be the Federal Reserve and the SEC.
1. Federal Reserve should never have cut rates to 1% after the dot.com implosion. Lowering rates as Greenspan did depreciated our currency, and it is therefore we CANNOT target CHINA as a currency manipulator.
2. The SEC allowed De-Regulation. There was no oversight, U.S. authorities DEREGULATED the U.S. financial system and the Deregulation allowed for Wall Street firms to issue all sorts of products which were more or less fraudulent. Unfortunately alot of these fraudulent products were replicated in Europe (london) and then sold/packaged to the world.
Finally, after all the deregulation it was U.S. companies that threw all the money at consumers. Did banks really expect Sally or Joe to be able to pay back a 500K loan on joint annual income of 40-50K? Did banks giving a 25 year old entrepeneur loans exceeding 1.5M through various credit cards think maybe, just maybe this won’t work?
All the U.S. banks should either be allowed to fail, or 100% Nationalized.
Why are we waiting? ! Dragging on this crisis for a decade plus as seems to be the idea of Bernanke & Co. is going to be a disaster. Let’s just take the hit, once and for all. Start over and rebuild.
Banks have caused many problems for the world it is now time that these banks come under full governmental control.
GS, JPM, MS, BAC, C, please welcome the idea of full nationalization. It is of my opinion that this is only a waiting game. Lets hope the better oversight next time will be worth our tax-dollars. To prosperity and hope!
HONG KONG — More money is moving in a new direction in China — out.
All over the world, Chinese companies are sending home fewer of the billions of dollars they earn from exports, parking them in overseas bank and brokerage accounts instead.
Total outflows in the fourth quarter were as much as $240 billion. Torrents of cash are still pouring in from trade surpluses, as imports shrank faster than exports in the final months of last year. But that inflow has been nearly balanced in recent months by an outflow of private cash from the mainland and a slowing of investment.
http://www.nytimes.com/2009/02/03/business/worldbusiness/03yuan.html?ref=business
DANGER – OFF TOPIC DANGER – OFF TOPIC
@indian investor
I saw you made a post at the end of the “It wasn’t just the market…” thread.
It’s was your Shadow Banker Cartel/IMF Conspiracy to Buy the Emerging World For 10 Cents on the Dollar Theory.
I posted a suggested course of economic research that might help you flesh out this theory a bit more.
The basic problem is the Fed Reserve together with Congress micromanaged the economy into a black hole from which there is no escape. If that sounds grim it is because it is grim.
The enabling force is fractional reserve lending and Congressional spending gone rampant. The only real solution involves time (more of it), housing prices (falling), bankruptcies (more), and an increase in savings. Of course that is a short term solution. The long term solution to prevent this from happening again is to abolish the Fed and eliminate fractional reserve lending.
http://globaleconomicanalysis.blogspot.com/
A different take …
Foreigners investing in US government debt
Will foreigners, particularly China, reduce US government debt holdings and/or avoid new US government debt investment?
China grew its dollar reserves as follows. China exported goods to US companies. US companies paid for goods with US dollars. China’s government required Chinese companies to exchange these US dollars for Chinese currency at a government managed exchange rate. The Chinese government used these US dollars to invest primarily in US government debt.
Here are some questions. Unless China changes this practice, as long as it exports more to the US than it imports, won’t US dollar reserves increase? How could China slow or reverse the increase in US dollar reserves while exports to the US exceed imports from the US? It could exchange dollars with other countries or other entities (individuals and corporations) through the market. But it can’t exchange dollars with the US government because the US government does not hold other currencies. It only has dollars to offer in such an exchange. If China were to exchange dollars with other countries or other entities those countries or entities increase their dollar holdings by the amount that China reduces it holdings.
Broaden this logic globally. Conceptualize the world as two entities, the US government and everything else. Everything else would include all non-US governments, all corporations including US based corporations and all households including US households. The everything else entity holds and trades all currencies including dollars. The US government deals exclusively in dollars. The US government buys products and services and pays US government employees exclusively in dollars. The US government obtains dollars through taxes, borrowing and dollar creation (printing). The total dollars held by the everything else entity can not decline unless the US government absorbs dollars by taxing more than it spends. In other words, the US government would have to run a surplus and would not be borrowing or creating dollars. It would be reducing the deficit. This situation is unlikely for the foreseeable future. For any other situation, the total dollars held by the everything else entity must increase so long as the US government spends more than it taxes and borrows.
What happens if the everything else entity in aggregate finds dollars undesirable? In aggregate they are stuck with the dollars already held. They can only trade among the everything else entity. When US government securities mature they can decide to not invest again in US securities but the US government sends dollars at maturity for which they must find a home. If they shift to equities or corporate bonds traded in US dollars, they simply shift who holds the dollars and who holds the equities and corporate bonds. They can demand higher interest rates for new US government securities. But the US government can say fine and continue to increase the dollars held by the everything else entity.
Conclusion: If we split the everything else entity into the foreign everything else entity (foreigners) and the US everything else entity (US households and businesses), foreigners can reduce its existing and new US government debt holdings only to the extent the US households and US businesses increase their existing and new US government debt holdings.
@ Cedric: You’re right. For instance, in 1982, the Fed funds rate was a full 20%. This led to a major recession in the US, and credit flowed back to the US from emerging markets in South America. Since this coincided with a manipulated steep oil shock followed by a crude price collapse, Mexico was brought to her heels.
Apart from creating opportunities in emerging markets, these Fed interest rate policy manipulations are used to consolidate holdings in the US as well. As I pointed in my 2nd, the US is just as much subject to the manipulations. Weapons conglomerates, bank cartels, and blood diamond dealers don’t understand flags and Eagle symbols; they only care about their profits.
I did a very brief analysis of Russia’s balance of payments to see if Russia is close to a currency crisis or not. This is from the statistics on the Bank of Russia web site. My earlier notes were that as of Jan 09 2009, Russia’s Forex reserves were $ 426 billion. Total External Debt was $ 540.50 b, of which only $ 113.80 b was short term and $426.70 b was long term maturity. Russia has external debt denominated in local currency as well, so the break up is totally $ 427.80 b in foreign currency external debt and $ 112.60 b in local currency external debt.
Russia’ exports were $393.82 b in 2007 (for the full year) and till Q3 of 2008, exports were already at $411.70.
Russia’s imports were $ 282.67 b in 2007 and till Q3 of 2008 imports were already at $277.46 b. I also looked at the graph that I linked to earlier showing rising imports and exports.
Later I did a google check and found reports of rapid falls in industrial output and a small fall in Russia’s oil output.
Now the Joanna Slater article that Brad links to in the WSJ talks of a ruble crash a la 1998.
An important that I have NOT looked at is changes in foreign currency liabilities of banking corporations versus non banking corporations in Russia. But my guess is that the above total external debt statistics supercede non roll over of FC debt to Russia’s banks.
Overall, when the forex reserve is much than the short-term, foreign currency component of external debt, and the country has rising exports and imports, it’s hard to see how a currency crisis/balance of payments crisis can develop.
It’s speculated in the media that while President Dmitry Medvedev is more in favor of “flexibilization” of the ruble exchange rate mechanism, Prime Minister Putin is more in favor of a “strong ruble”.
It’s easy to see that as the ruble weakens against a basket of USD and EUR, imports would be more expensive. Also a weakening Ruble will mean that the Bank of Russia will have to spend more of the forex reserves to strengthen it to the policy rate. But it’s not clear what’s causing the speculation that makes the market expect the Ruble to weaken, given the above statistics.
Brad: … particularly financial deglobalization — isn’t going to be pretty.
I’d like to point out that the financial world has never been in a “de globalized” state in recorded world history. So I’d like to know how “financial deglobalization” mooted by you is expected to come about.
The most famous political commentary on global capital flows was made by the late Adolf Hitler in his work “Mein Kampf”; and the reasoning in Mein Kampf is along the same lines as Brad Setser’s reasoning in his recent monographs on the activities of the People’s Bank of China.
In Mein Kampf Hitler recounts that at the end of the First World War he was wounded by a gas attack and was recuperating in a hospital from temporary blindness, when Germany surrendered and the Versailles Treaty was signed. According to Hitler, the Jews, who controlled “international capital” suddenly choked off funding for the German Wehrmacht even as the soldiers were valiantly struggling on the frontline. The Versailles Peace was followed by the disbanding of large swathes of the then German military forces and Hitler’s first public speaking exercises were to the disgruntled Great War soldiers.
When the Weimar hyperinflation occured, and when widespread unemployment once again hit Germany, Hitler was able to blame “international capital”, symbolized by Jewish banking families as being at fault. Apart from other allegations about Jews manipulating German culture and creating social problems, etc – the main plank that justified the holocaust of millions of Jews was a Brad Setser style analysis by Adolf Hitler of global capital flows.
If Brad succeeds in convincing large swathes of credulous jobless American masses that the People’s Bank of China is at fault for the global credit crisis you can soon expect a more open Brad Setser sanctioned pogrom of Chinese Americans in the world’s greatest democracy, rahter than subtle forms of racial discrimination that is often alleged.
Brad: … china’s agency holdings peaked at $600b … 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 …
Me: The underlying approach taken by Brad Setser in this analysis can be termed as “Structured Information Felicity”. For an understanding of “SIF” read this interesting material titled “The Art of Siffing among adults” from Princeton:
http://www.princeton.edu/~reinhard/pdfs/EC%20100%20SIFFING.pdf
Till recently a lot of the reader’s attention at this blog has been focused on statistics, essays and charts showing the growth, composition, etc of PBoC forex reserves. There was continual suggestion to the reader’s faculties that somehow the accumulation of $ 2 trillion or so of reserves by the PBoC was inextricably linked with the 2008 Credit Panic quagmire.
After this ideation was proved wrong, now a move is being contemplated to another set of misleading statistics:
What is now being suggested that foreign financing led to the crisis, and if we were to look at China’s share percentages amongst foreign financiers, then we would have a good explanation for the global crisis.
The approach suggests that the reason macroeconomics isn’t a science so far is because of economists using faulty methods to derive convenient and politically biased conclusions.
I’m thinking that Brad Setser has already fixed the blame for the crisis on the PBoC. Various different ways of linking any available statistics to this conclusion are being attempted rather than a more direct and straightforward analysis of the issues at hand.
I’ve been worried about this too, so I did a little economic research in my spare time before afternoon tee time. I found this, which may help….
The Fable of Money
Once upon a time, long, long ago, in a galaxy believed to be ours, Kings and Wizards congregated and conferred on threats to the Kingdoms. A King would ask of his Wizards, “What Threats to the Kingdom do thy see?” The Wizards responded, nearly unanimously, “World War Two is a terrible threat to our Kingdoms, Sire.”
The wise Kings concurred, and with sagely wisdom decreed, “World War One shall be the war that ends all wars! So be it!” And applause resounded throughout the courtyard.
With that issue being resolved to everyone’s satisfaction, the Kings asked again, “What Threats to the Kingdom do thy see?” The Wizards responded, “A gold miner’s strike could bring the Deflation Dragon and cause the lands to go into Depression, Sire.”.
The Kings agreed it is always a good idea to banish Dragons, and feared the lands being in Depression, but could not think of a decree to make this into Law. So they asked the Wizards again, “And how could one do this, wise Wizards?” From out in the courtyard, Milton the Wizard answered, “With Fiat Currency, My Lords. They make the gold miner’s strike meaningless. I recommend each kingdom print enough for increases in the kingdom’s population and personal wealth, and maybe a little more to insure a 2% inflation rate as a safety precaution against being visited by the Deflation Dragon.”
The Kings mulled this over for a few seconds, and came to unanimous agreement.” We shall have Fiat Currency!” they decreed in unison.
A huge celebration followed with wine and song and dance, as surely all the Kingdom’s problems were solved. The King of America got quite drunk, then stood at his podium and announced “Wizard Milton, I wed thee to my daughter!”
Elsewhere, enjoying himself thoroughly, and getting braver with every goblet of wine, John Maynard the Wizard spaketh up loudly and said, “I have some more ideas along those lines, Sires.”
And that ends the Fable of Money and the Kingdoms lived happily ever after.
Most – dgcx sweet naked texas cftc fbnymexed ftded bailed out comexed market made cdsed bondsold resolution six – packed post.
My congrats to those new hamphsirians for trying to clarify some of the stuff after just 222 years …
»To provide for the Punishment of counterfeiting the Securities and current Coin of the United States”
God forbid. We mustn t. Who knows what might happen. All hell might break loose (and we surely won t provide punishment to ourselves, hell it s a conflict of interest we can not engage in). Bla bla bla bla
If on the other hand you do end up further rewarding the above mentioned through you guaranteeing their toxic s, plase then, at least, don t forget nationalizing the fed. Even if they governized the state priorly , it ll still look better in the press.
The rational choice for each country is to save itself. Yes, it will lead to collective destruction, but all the joint effort so far has led us to nowhere, so how can it be different this time? Everyone will do what they have to do to stay alive. This will not simply become “beggar thy neighbor” This will become “demagogue thy neighbor”, laying off as much blame as one can, directing the ire of one’s constituents towards others, just for mere political survival. Cannonballs are already being shot over each others bows – Treasury Secretary Geithner is already blaming the Chinese for every US Economic problem. This is only the first inning, where everyone is still playing nice. I think we’ll see bench-clearing brawls by the fourth inning or so.
http://www.nakedcapitalism.com/2009/02/martin-wolf-this-way-lies-catastrophe.html
Talking of the Russian economy and their close interconnection with Russia’s geopolitical objectives; When I said at this blog that I’m not expecting any easy victory for Obama’s troops in Afghanistan, and that the Russians are going to help the Taliban as much as they can, some people called my comment “gibberish”.
Now you can go through this New York Times article titled “Dispute mounts over key Us base in Krygyztan”
http://www.nytimes.com/2009/02/05/world/europe/05kyrgyz.html?hp
If Obama ends up doing something catastrophically stupid in Afghanistan, the US dollar exchange rate won’t decline to the petrodollar levels and stop there … it will fall all the way to being truly “market determined” as Dr. Geithner wants it to be – i.e. INR/USD will be at 4, instead of 48, if Obama’s troops goof up in Afghanistan.
Indian Investor,
Both the Russians and Chinese want the US military base in Krygyztan to be gone. Tiny Krygyztan is surrounded by Superpowers Russia and China. The United States was always peripheral to Krygyztan’s political and economic future. I think the Chinese and Russians were also incensed by the presence of AWACS Electronic intelligence aircraft flying out of the Manas Airbase along their respective borders. The Shanghai Cooperative Organization (SCO) specifically requests that US military bases leave the Central Asia region.
Beijing is showing it is ready to play hardball with trade partners….
Late last month, New Delhi imposed a six-month ban on the import of Chinese-made toys, in a move clearly designed to protect Indian toymakers from Chinese competition. Now Beijing is preparing to fight back. Today’s China Daily, the official government paper, reports China is threatening to fight a new Indian import ban on Chinese-made toys by taking New Delhi to the WTO. “The ban cannot hold water. The Indian side is doomed to lose in the court if the Chinese government appealed to the WTO Dispute Settlement Body.
The Chinese are fighting trade moves the Bush administration made in its dying days, for instance. Beijing is also considering fighting at the WTO against a move by the European Union to impose high tariffs on Chinese-made screws.
“Despite calls to resist protectionism, trade barriers and countervailing duties launched by China’s trading partners have been running rampant,” reports the China Daily, which goes on to quote Fu again insisting the country would defend itself: “In the past, the Chinese government always kept silent. But the situation is changing, and resorting to the WTO is a right choice to prevent the trade partners from abusing the WTO regulations.”
China has only begun fighting the U.S. in the WTO.
http://www.businessweek.com/globalbiz/blog/eyeonasia/archives/2009/02/china_threatens.html?chan=top+news_top+news+index+-+temp_global+business
An interesting insight from Paul Volcker’s reflection on World Economy.
http://www.youtube.com/watch?v=W3CHb8gi-sU
DJC. Geithner correctly is blaming China for intervening heavily (in the past) to hold its currency down in the fact of natural pressure for its currency to appreciation. that decision has consequences for the us as well as china, and it is entirely approprirate to point them out — just as it is appropriate for the world to highlight that buy america provisions hurt them. in now way does this attribute all us problems to china. at the same time, china’s choices have global consequences — and the us should highlight those …
1. I disagree that Russia didn’t sterilize. The fact that it didn’t need to. The tax on oil flew directly into Russia’s treasury. Unlike i.e. in China where most of the money was earned by the exporters.
2. In the past 5 years (actually 10 year since the default) nominal wages in Russia has been steadily growing 20-30% per year. Consumer price inflation was 15-20%. So you’d say that real wages grew 5-10%? Not so. If you consider steady exchange rate with USD then real wages (and real wealth) grew more like 20% per year. Monetary inflation was huge but the exchange rate was stable! So, IMO, 50% drop in the Ruble is the necessary correction. But Russia is still marking money selling Nat gas and oil.
If you want to see some bad case then better look at Ukraine, the Baltic states, etc. They have had even bigger monetary inflation but they never had any reserves. Their currencies will eventually lose 90%.
Latvia’s experiment is ridiculous. They don’t want to devalue. OK. So they need to cut 30-40% of their govt budget. It just won’t work. Did someone said “revolution”?
Regarding “Follow the money”:
Transport of cash-USD from the US to Russia (and around the world) has probably been quite intense lately.
The US-deficit is essentially money-printing as T-bills are quasi-money. Step by step this printing of bills will envigour the world economy.
This printing just causes circulation of USD within the US and has no direct effect on others. Indirectly it will, as the Americans become “richer” in dollars (i.e these days T-bills).
Brad:
I tried posting a reply a couple of times. It never shows up, and the second time I tried I was informed that I was duplicating the initial posting of it.
When you get a chance, would you kindly look into this?
Thanks,
Michael Gordon, AKA, the buggy professor
“Feb. 4 (Bloomberg) — Treasury notes fell for a second day as the government said it will auction a record $67 billion in notes and bonds next week, fueling concern it will issue an unprecedented amount of debt this year to spur the economy.
The U.S. will sell $32 billion in three-year notes on Feb. 10, $21 billion in 10-year notes Feb. 11 and $14 billion in 30- year bonds Feb. 12, the Treasury Department said in a statement on its quarterly refunding of long-term debt. The department also said it would auction seven-year notes for the first time since 1993.”
Would be interesting if Brad u could share with us your insight on this.
Brad,
You’re providing the best analyses and discussion forum available for the general public on critical international and domestic economic issues, which is extremely educational and for which I am very grateful. You have my support to remove Indian Investor – or any other respondant – who uses that forum to make ideological rants and engage in polemics and attacks.
Setser or whomever knows: what does sterilization of capital inflows mean, and what about hot inflows? This blog is awesome. Thanks.
020909 responds: The Banking crisis will not only unemploy millions, but it will also kill millions as funding to aid underdeveloped world gets trimmed.
Not so sure. Most funding from the developed world to the developing world has cause more harm than good, and the developing world has learned from the past and most of them now have huge currency reserves.
02099: Banks have caused many problems for the world it is now time that these banks come under full governmental control.
And then what?
So Indian, from your analysis, how close is Russia to the armageddon scenario ?
Ruble is being devalued every other fortnight. Kazakhs did a devaluation of 25% ?
Capital inflows can finance a current account deficit (a current account deficit either stems from a trade deficit or large interest payments on existing debt), in which case the capital coming in flows out naturally, or can finance reserve growth. If they finance reserve growth, the central bank is stepping into the market to buy foreign currency.
in the first instance, it does so by selling domestic currency for foreign currency. That is inflationary — it is a form of monetary expansion. A central bank that doesn’t want to see the money supply increase therefore has to conduct an offseting operation to with draw the currency is created when it bought the fx with domestic currency from circulation. This process is called sterilization. It classically would be done by selling central bank debt in exchange for cash. the folks who got cash in exchange for foreign currenc would trade that cash in for central bank debt that pays interest. the net effect is that the central bank issues more domestic debt and holds more foreign assets (i.e. reserves).
the BIS has a good (but long) paper going through this in great detail that just came out on its website.
it gets more complicated when a government gets a big oil windfall. spending the entire windfall is inflationary. saving it — by putting fx from the government’s windfall oil profits on deposit at the central bank — is often thought of as fiscal sterilization.
Russia did a fair amount of this, but it also increased spending (the process of spending implies that the govenrment goes to the central bank with fx from oil sales and trades it in for domestic currency, which tends to be inflationary absent central bank efforts to remove the currency from circulation) in a way that was inflationary. And my strong sense is that Russia did very little to effectively sterilize the large capital inflows it recieved for a while.
indian investor — Russia is suffering from a huge shock to its terms of trade (big fall in oil/ commodity prices) and massive capital outflows as banks and firms that borrowed a ton from the rest of the world in the boom years now have to come up with fx to pay their creditors back … don’t quite see how you don’t see the problem there. Russia experienced — per its own BoP data — a $100b plus outflow in q4 alone …
michael gordon — i didn’t see any comments from you in the “awaiting approval” line, so that isn’t the problem. and you posted one comment, so you obviously aren’t blocked.
here are a couple of possiblities:
this evening at 8 pm EST the CFR site was down for maintenance, so you may have lost a comment then …
or you may have spent a long time typing and the spam protection question changed while you were typing (it is always a good idea to save your comment with “control C” before hitting the submit comment. Or your post may have been caught in the spam filter if it had a lot of links (tho i didn’t see anything).
my guess is that you got caught by some site maintenance. my apologies. if you continue to have trouble let me know.
I am wondering if anyone can answer my questions:
1)Will the Fed try to bring the long term interest rate up now to reflect the true cost of borrowing?
2)Does the US try to devalue dollar significantly against major currencies especially RMB to bring back its productive economy?
3)From Bloomberg News, the idea of establishing Bad Bank seems to be dropped now. Asset guarantees were put on table in U.S. Bank Talks now. Paul Volcker said that these banks were just too big to manage. Does anyone see any sign of what direction the financial sector will go? Nationalization, scale back or bailout?
thanks
Ying:
1)Will the Fed try to bring the long term interest rate up now to reflect the true cost of borrowing?
2)Does the US try to devalue dollar significantly against major currencies especially RMB to bring back its productive economy?
It’s very difficult for the Fed to affect long term interest rates or dollar/RMB. These things are going to be affected primarily by fiscal policy.
Ying:
3)From Bloomberg News, the idea of establishing Bad Bank seems to be dropped now. Asset guarantees were put on table in U.S. Bank Talks now. Paul Volcker said that these banks were just too big to manage. Does anyone see any sign of what direction the financial sector will go? Nationalization, scale back or bailout?
I think that what is going to happen is a simple bailout in exchange for slashing executive pay, without explicit nationalization or long term government ownership.
The way I see it working is that if the government bails you out and you owe the government money, the CEO’s pay is capped at $500K, while if you don’t take government money, the CEO can pay themselves whatever that want. If this is the system then every bank CEO is going to try like heck from taking government money, and once they have taken it, the first thing they are doing to do is going to be to pay any loans back, because two seconds after they pay back the government, they are doing to give themselves a check for $10 million.
This doesn’t strike me as a bad set of incentives.
To Indian Investor: You are being awfully insulting to Brad Setser. Personally, I find it is very useful to be polite and assume good faith on the part of people you disagree with, not the least of which is because they might be right about something extremely important.
Basically you have a ticking time bomb, and people disagree about cutting the red wire or the green wire. I think that you should cut the red wire, but if it turns out that you should cut the green wire, then I’m much rather lose the argument and even be publicly disgraced and humiliated than to cut the wrong wire.
Information bias is a huge problem, which is why it is a good idea to argue the issues through with people that just see the world differently than you. The problem with pointing out “bias” is that usually the (false) implication that speaker is more “objective” than the person they are criticizing which is rarely the case.
My personal bias is that I’m doing whatever I can get the economy working running and making people rich for purely selfish reasons. When people are rich, then are less apt to get angry at other people for making and spending lots of money. People tolerated huge Wall Street bonuses in 2006, on the belief that finance was making them rich.
Bonuses were really lousy this year, and most people ended up with a 25% cut in take home pay off last year’s pay which was 25% down for the year before, and that’s assuming that you weren’t among the 20% of the people that were laid off.
If the economy continues to be a mess, then next year is going to be even worse. One bit of “good news” is that they can’t really cut pay much further for people in the middle and low ranks. If they have to make further cuts, then this will involve laying people off instead of cutting salary, since they really can’t cut salaries for most people any lower than they are without people just quitting or getting laid off.
Conversely, if the economy bottoms out this year and start booming the next year, then no one is going to care what Wall Street salaries and bonuses are in 2010-2011.
This is why I assume that there is a way of fixing the economy rather rapidly. If the economy improves, then I’m looking at my take home pay doubling or even tripling over the next five years, and that is a huge incentive for looking at ways to fix the economy. Maybe we are doomed, but in that case all I’ve done is just wasted some time time doing useless things.
Biologist tend to agree that abnormal growth is a sign of degeneration and banks worldwide tend to reach this point.
How to qualify degeneration ? when their functions do not operate anymore.
Their balance sheets are much larger than their respective countries GDP
Their contra accounts are in too large multiple of their own funds
Their CEO’s are unable to assess their risks or their potential risks.
Their operating safeguards such as value at risk have been proved to be doomed math.
Brad Setser: indian investor — Russia is suffering from a huge shock to its terms of trade (big fall in oil/ commodity prices) and massive capital outflows as banks and firms that borrowed a ton from the rest of the world in the boom years now have to come up with fx to pay their creditors back … don’t quite see how you don’t see the problem there. Russia experienced — per its own BoP data — a $100b plus outflow in q4 alone …
Thanks a lot. I need to look up the external debt of banking corporations in Russia. I only looked at the total external debt numbers and those looked ok, I need to check the details. In any case there’s been a massive outflow of FC debt from banks in all those countries.
One other thing. It’s very hard for me to take economic criticisms by Western commentators as being somehow “anti-Chinese” since every single economic criticism that I’ve seen has also be made by someone within China with unchallengeable political credentials and motives.
One reality is that the Western community of bankers, financiers, and even government regulators is not distinct from the Chinese community of bankers, financiers, and government regulators. If you look at who runs the Chinese financial system, you find a very large number of people with Western degrees and work experience, and as far as finance goes, Chinese and Westerners are really part of a single community rather that separate communities.
This is very different from the political, military, or journalist communities. No one becomes an officer in the US Army and then joins the PLA. However, in finance, it is very common for people to move between Chinese and Western schools, companies and even government agencies, so much so that it is difficult to impossible to see where China ends and the West begins.
The meltdown in Wall Street is likely to contribute to this, because Chinese banks and government agencies have been scouring Wall Street looking for people with financial experience. People have this image of a Chinese government bureaucrat as a Mao suit wearing Marxist when at least in financial circles, you are likely to find someone with a Harvard MBA who has worked as a managing director in a major investment bank.
@ Twofish/Brad: I’ll try to be more diplomatic with comments in future, though I frequently launch off with severe doubts about various top policy makers and tycoons being corrupt and manipulative.
Throw (to the paper-only reading confined) geithner out the front door, show larry the same way with a tap on his shoulder, listen to volcker but cut him off forcefully where he engages in other manipulation schemes or regrets. Bring stieglitz in and hold on to brad. Bond sellers of this caliber are hard to come by. Keep an eye on hillary.
Then stop prosecuting the office redecoration cases and start with some serious stuff. For instance the easy cases -oil gold and silver price manipulation (as a sign of good will to the world). Try GS, boa, JP, and C as a good start, should yield heavily, if done properly. Might even yield a few former T secs.
Clean out the sec and the cftc. Might even prosecute a few employees. Make fidic understand their job and their place. Then make em do it. Look at globex closely and do not bailout the hedge funds when market thins them out enormously. It s all a needed re-allocation of physicians out of finance where they were grossly miss allocated in the first place. You might even stimulate fiscally with finishing the collider for them to play with. There are other black holes there.
Start a good bank from scratch and stop the cds ponzi. Ban the naked s. prosecute. Talk to the others with regard to BW2 funeral.
Then there are other things. Many other things…
Basically why don t you follow your constitution?
this as reply to “then what?”
Then – build trust from scratch.
This post treats the price of oil as externally given, as an act of god. Well, it icy wasn’t.
Agree on following fiat (out). But then there were flows of physical gold also (in reverse to the fiat). And then also, the oil might very well turn around sooner rather than later.
As for the new invention, I’d always thought that the role of (any) state is in frame working their system. In case of US in a way where shareholders and bondholders and other debtors can enforce liability for damages incurred to their “wealth” on the management boards’ members where there is evidence in support. I think once upon a time (before ownership going public and pension’s way) this was called corporate governance.
On the other hand if the distinguished membership engaged in fraudulent behavior then they should be prosecuted by state, not the shareholders, for that and not for re-decorations.
Get real.
Imposing limits on their compensation stands for shallow excuse for system not to work and for detachment of equity from execs to continue.
If they took 20 bn out of 350 remaining (on paper while off BS stuff is OFF BS), then it is for the equity and the debt of such institution to approve their obviously great performance. It is to the extent that the state is the equity holder that they can protest (and to the extent that the fed holds the debt).
Purring the 350 at them and then having parts of that gift returned to the sender through lobbying for the bad bank and other miss solutions can cause some disturbance in the general public as it looks like the taxpayers-money being laundered politically for more gifts to come at the same time the other part compensates this system to run another round.
Notice how the 350 remaining (equity) matches the first installment of Tarp. They actually did a great job shaking you up. Outstanding!
It is therefore utterly right for them to be compensated. It s a 5% success fee, well earned.
Suppose though that that (TARP 1) was enough. There is no more. Huh.
If then the taxpayer stays away from the toxic assets in the near future in any way and transfer their deposit into the new good bank or the old smaller good banks remaining – in an orderly manner without the run on the bad ones – then those who remain as sources of assets financing and suffer losses should have a way – to enforce liability to their fullest extent – cleared.
Even and well beyond all compensations ever received.
If there is no liability and no fraud as well, then they have earned every last penny of it.
Brad:
Thank you for your reply to my problems with posting. I tried again, but the post didn’t show up. It may be, then, the length. It is pretty long, though it’s also — if I may say so — pretty well organized and with some hard data to boot.
It may be awaiting your approval or something like that.
Cordially, Michael (Gordon)
Brad,
You say that “the BIS has a good (but long) paper going through this [sterilisation] in great detail that just came out on its website”. I would be grateful for a link as I am not sure how recently you mean and there are several papers that could be the one you are referring to.
Regarding the criticism of Indian Investor:
I have learned to skip over his/her comments.
In general, I would say that very long comments or a string of comments are a sign either that the contributor is not sufficiently selective or that they should set out their argument in detail on their own blog and just refer to it here. Frankly, some people are making the comments here tedious to read these days.
This post treats the price of oil as externally given, as an act of god. Well, it icy wasn’t.
Agree on following fiat (out). But then there were flows of physical gold also (in reverse to the fiat). And then also, the oil might very well turn around sooner rather than later.
As for the new invention, I’d always thought that the role of (any) state is in frame working their system. In case of US in a way where shareholders and bondholders and other debtors can enforce liability for damages incurred to their “wealth” on the management boards’ members where there is evidence in support. I think once upon a time (before ownership going public and pension’s way) this was called corporate governance.
On the other hand if the distinguished membership engaged in fraudulent behavior then they should be prosecuted by state, not the shareholders, for that and not for re-decorations.
Get real.
Imposing limits on their compensation stands for shallow excuse for system not to work and for detachment of equity from execs to continue.
If they took 20 bn out of 350 remaining (on paper while off BS stuff is OFF BS), then it is for the equity and the debt of such institution to approve their obviously great performance. It is to the extent that the state is the equity holder that they can protest (and to the extent that the fed holds the debt).
Purring the 350 at them and then having parts of that gift returned to the sender through lobbying for the bad bank and other miss solutions can cause some disturbance in the general public as it looks like the taxpayers-money being laundered politically for more gifts to come at the same time the other part compensates this system to run another round.
Notice how the 350 remaining (equity) matches the first installment of Tarp. They actually did a great job shaking you up. Outstanding!
It is therefore utterly right for them to be compensated. It s a 5% success fee, well earned.
Suppose though that that (TARP 1) was enough. There is no more. Huh.
If then the taxpayer stays away from the toxic assets in the near future in any way and transfer their deposit into the new good bank or the old smaller good banks remaining – in an orderly manner without the run on the bad ones – then those who remain as sources of assets financing and suffer losses should have a way – to enforce liability to their fullest extent – cleared.
Even and well beyond all compensations ever received.
If there is no liability and no fraud as well, then they have earned every last penny of it.
rebel — here is the link
http://www.bis.org/publ/cgfs33.htm
I have no idea, please observe, who the Michael Gordon happens to be who posted the incomprehensible ramblings about TARP, or why he linked to my web site: bthebuggyprofessor
Michael Gordon
1) A very good analysis, Brad: both illuminating and generally accurate. Even so, you leave unclear what might be the other motives for foreigners —whether private or governmental — to be still investing heavily in US Treasuries of different yields. . . this, even though the baseline short-term Treasury bill yield is now still much lower than in the eurozone or for that matter in Britain or in China (though not in Japan).
And that omission blurs some of the more most significant issues at stake here: in particular, (i)the role of the dollar in the global economy in the next decade or so; more specifically (ii.) the role of the dollar as the major reserve-currency; (iii.) and the future of China’s economy, the exchange rate between the Yuan/renmembi, the euro, and the $US . . . with possible politically charged spillovers onto the trade-sector.
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2) So what are other possible motives behind the investment inflow that, among other things, has led to the $US appreciating noticeably against the British pound, the Japanese Yen, and the Euro over the last few months? Well, among these other causal motives besides (i) interest-rate differentials are several others:
(ii.) A safe-haven refuge, a long-term habit by foreigners with lots of liquid capital to consider the American economy as a particularly safe political and economic country to invest in amid huge uncertainties and insecurity — whether financial, economic, or military-security.
That underscores a political motive related to risk-calculations by foreigners about their own countries stability and near-term or mid-term prospects. And that motive and risk-calculations leads to seeing the US as a desirable haven.
Then, too, there are the traditional motives underscored in economic textbooks about investment flows and related exchange-rate changes
(iii) Likely forecasts of future economic growth in the US (compared to other countries with lots of investment opportunities) That includes estimates of economic dynamism and productivity.
Here, it seems, the IMF forecasts that recently came out are something of a guide: Britain, the eurozone, Japan, China, and most of the rest of Asia are likely to suffer from a much deeper recession in the coming year than the US itself.
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(iv.) Differential inflationary rates.
In the current climate, of course, we’re talking about the likely degree of deflation. And that means, most likely — we’re forced largely to guess here (what with no serious deflation globally since the 1930s) — whether governments faced with domestic deflation won’t try to depreciate their currency. This depreciation could be direct, a form of competitive jump ahead of others to increase exports and reduce imports. Or an indirect effect if, should a central bank miscalculate and flood the country with quantitative increases in the money supply, it would overshoot; create too big a rise in the price-level; and require a nominal depreciation of the country’s currency to offset the real price-level increase.
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(v.) Changes in Consumer Preferences for Foreign Goods (Tastes)
Only recently have international economics specialists noted this phenomenon. It can show up in American preferences for imported foreign cars or a growing preference for foreign cheese or wine or perfume or clothes over their American counterparts.
These tastes for foreign goods have contributed in the US case, to single it out, to our large trade deficits in this and the previous decade. In consequence, compensatory capital inflows will occur to offset the current account deficit.
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(3) Separately or taken together, these four additional causes of exchange-rate changes — assuming flexible rates of various degrees (freely floating or managed) — will influence investment flows in or out of the US directly or indirectly.
Indirectly means, of course, that if the original stimulus to a debit in the US current account (trade in goods and services, plus unilateral transfers like Mexican workers sending money home to Mexico) will be compensated for on the credit-side of capital movements one way or another.
And of course any expectations as to how these five causes – including interest-rate differentials — will influence future movements of the $US, whether upward or downward, could be considered a sixth cause as we3ll.
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(5) Enter, finally, a last cause dealt with by Darrell Balmer (with a slight error in interpretation): the efforts of a Central Bank such as China’s to manage its exchange rate . . . a common practice vis-à-vis the dollar (and more recently the euro) throughout Pacific Asia, though so far Japan’s Central Bank has surprisingly allowed the Yen to appreciate noticeably over the last several months despite a huge plunge in its export-sales and GDP growth-rate
That motive, of course, is for China’s Central Bank — to focus on it — to keep its exchange rate from appreciating to the point that its huge trade surplus with the US wouldn’t be eroded to the point that it would decline markedly . . . or even, theoretically, given freely floating exchange rates, to end up with a fully balanced trade account with the US and other countries whose currencies are pegged to the $US. Its Central Bank does so by exchanging its cumulative liquid $US reserves for US Treasuries (and probably, the exact figure is hard to pin down, some of those toxic mortgage-based assets).
(Darrell: a good analysis except for one slight technical error. The foreign currency reserves of the US consist of foreign currency like euros, yen, British pounds, and Swiss francs, plus some SDRs—Special Drawing Rights issued by the IMF decades ago. They only total about $89 billion. As a general thing, the US Treasury Department — which oversees the exchange rate — hasn’t intervened to influence the dollar exchange-rate except for a negotiated depreciation with Germany and Japan in the mid- and late 1980s When, alternatively, China’s Central Bank uses a large part of its dollar-reserves to invest in US Treasuries, it is simply exchanging one liquid asset for ownership of another fairly liquid asset with interest paid on the investments.)
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6) Back to China’s management of its Yuan/renmembi exchange rate:
It’s here that here that we find the key motive behind such management — again, embraced throughout Pacific Asia as far back as the 1950s: to rely on export-driven growth as the key to long-term economic growth.
Nothing really even controversial here. From roughly 2002 or 2003, more and more capital inflows into the US from abroad were either directly from Central Banks (not least in Asia) and indirectly through so-called sovereign-funds. Why this is considered China-bashing or China-blaming for the existing crisis leaves me puzzled.
Whether you want to call this policy neo-mercantilism or otherwise is a secondary consideration. Do note that China’s very high savings rate by the early part of this decade — somewhere around 35% of GDP — rose to an extraordinary high of close to 50% in a period of unprecedented economic growth. Which meant that domestic Chinese national income — leaving aside the Net Export contribution to final GDP (and hence omitting imports) — was overwhelmingly dominated by investments and export-oriented production. In short, with 1.3 billion people and huge disparities in income by class and regions, private consumption in China has been slightly higher than a third of GDP.
….
More concretely, here’s the breakdown by component of Chinese GDP in 2006. (Note that in 2006 and 2007, private consumption had actually been rising as a percentage of GDP there compared to earlier years.)
— Private consumption (36.4)
— Government consumption (13.7)
— Gross fixed investment (40.9)
— Exports of goods/services (39.7)
— Imports of goods/services (-31.9)
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7) Which brings us to the charge, raised by some posters here, that you are engaged in unseemly China-bashing by shifting blame for the current global financial and economic crisis onto China and, presumably, other big-saving countries with large trade surpluses in Asia and elsewhere.
That seems doubtful. And it seems equally doubtful that Geithner or Obama or former US officials like Henry Paulson had blamed the crisis wholly or entirely on China and other foreign Central Banks seeking to keep their exchange-rates below trade-balance equilibrium — which a freely floating rate-system would entail (whether or not capital movements and assets-driven motives are the main cause or not) — then, of course, that would be blame-shifting and nationalist finger-pointing.
So far, however, I’ve not heard these comments from current or former official US policymakers. That includes Bernanke, who pointed out — quite rightly — that there were and still are huge imbalances between countries with very large savings as a percentage of GDP (China, Japan, big oil-exporing countries, and Germany) on one side and the US (and UK) as having had unusually high rates of consumption. That seems accurate, right?
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What also seems accurate is that at least a large part of the financial crisis — besides the huge pool of footloose capital world-wide($60 trillion plus by 2003, a doubling of the amount accumulated in 2000) looking for solid and safe investments — was created by the run-away derivative financial markets in the US, where regulators failed to do what they should, credit-rating agencies went loco, and banks and other financial institutions scurried in a frenzy of passing risks onto others along a fragile chain of creditors-debtors that soon became world-wide. And that world-wide chain means that not just the high-savings countries and the US financial system and its crashed regulatory supervision are to blame, but governments and financial institutions and investors on a self-made euphoric spasm are to blame as well.
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Essentially, what’s at stake here is that either a new rule-based system for channeling trade and investment flows — which means agreement on improving the adjustment mechanism of exchange-rates for dealing with ever larger trade-surpluses and trade-deficits around the globe — will ensue, or there will likely be surges of competitive depreciations (devaluations) and growing strains in trade and investment movements . . . not least between China on one side and the US and EU on the other, with Japan’s role uncertain.
And that is not a desirable future from a political viewpoint. The chief problem that faced the major status-quo powers in the 20th century — the UK, the French, and the US — was how to deal with the big shifts in global power represented by the rise to great power status of “revisionist” states like Imperial (and Nazi) Germany, militarist Japan, and the Soviet Union.
Above and beyond the short- and mid-term economic issues now beginning to flare here, the crux-problem looming in front of us is how the EU, the US, Japan, and some other countries in Asia (including India) deal with the rise of China is the real stakes here. And of course how China’s CP leadership deals with its economic challenges and its hopes for global power-status and influence someday too.
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Michael Gordon, AKA, the buggy professor
Basically, let s throw the interest rate differentials, future growth forecasts and psychologically engraved consumer tastes away and rely on the central bank monetizing the debt (thus lowering deflationary expectations) but expect this to be slower than other surpluses around engage in nervous breakdowns (competitive jumps) so this action will further enhance the safe haven refuge status of the dollar as a courtesy of derivatives? If this sounds great, it must be a product of great wisdom. How it will fly in the face of animal spirits is beyond me.
And me to is clueless who linked the prior incomprehensible ramblings to those of the buggyproffessor.