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Is complaining about others’ protectionism protectionist?

by Brad Setser
February 8, 2009

Dr. Mankiw labels complaints about China’s practice of intervening in the market to hold its currency down protectionist.

But Mankiw isn’t defending a world where governments do not intervene to shape trade flows.

An undervalued exchange rate acts as a subsidy for that country’s exports – and it also protects its domestic producers from competition from imports. Ask Dr. Bernanke. Dr. Subramanian of the Peterson Institute writes: “An undervalued exchange rate is in effect a combination of export subsidies and import tariffs.”

China’s exports would not have grown as fast as they have – goods exports went from $250 billion in 2000 to $1430 billion in 2008 – if China hadn’t added about $2 trillion to its reserves over this period. If the RMB hadn’t say depreciated against the euro over this time period, I rather doubt that China’s exports to Europe would have grown even faster than China’s exports to the US. The weak RMB also created incentives to produce goods in China that might otherwise have been imported, including a lot of the components for China’s exports.

Mankiw effectively is arguing that the US benefits from China’s intervention in the market, and consequently shouldn’t object to China’s export subsidy. Europe presumably is in the same boat.

China cannot subsidize its exports without also subsidizing US consumption of Chinese goods – and US borrowing. Of course, some in the US are on the losing end of the “low-priced Chinese goods for high-priced US government bond” trade – and those losses aren’t equally distributed. Some parts of the country tend to produce more goods than compete with Chinese goods than others. But the US as a whole benefits from China’s willingness to subsidize US borrowing … and the purchase of China’s goods.

Call me skeptical.

For one, China cannot subsidize its exports through a dollar peg without also importing US monetary policy — and it isn’t clear if that is good for China or the world. For example, China didn’t need loose monetary policy at the height of its own boom in late 2007. Yet that is what it got when the subprime crisis led the Fed to cut US rates. Nor will the effects of a monetary policy that is wrong for China necessarily be confined to China. Back in 2007, the loose monetary policy China imported from the US ended up reverberating globally – as the boom fueled by negative real rates in China (and other countries pegged to the dollar) contributed to the run up in commodity prices.

And then there are thethe geopolitical implications of US reliance on China’s government for subsidized financing. China already has close to a trillion dollars of Treasury bonds. It isn’t unreasonable to think that if it bought another trillion it might think it should get a bit of influence over US policy.

Moreover, America’s basic problem is that it consumed too much and borrowed too much over the past eight years. That was unsustainable. Consumption was too high relative to US income, and household savings were too low. We are all now paying a high price for imbalances– internal as well as external — that built during this period.

Yes, the biggest current risk is that it that consumption will fall too far to fast and no one will get access to credit. Gradual adjustment is good; sharp, sudden adjustments are not.

But that doesn’t mean that the US should want China to buy its bonds rather than its goods.

No country really has a comparative advantage “as consumers.” No one gets to trade their consumption for others’ production for ever, even if it sometimes seemed that way back when many emerging market governments were willing to trade their goods for US government bonds on terms favorable to US consumers and borrowers. The US didn’t have a comparative advantage at consumption so much as a comparative advantage at selling dollar debt to emerging market central banks who were trying to hold their currencies down.

Even now, the US isn’t in such dire need for financing that it has no option but to encourage China to hold its exchange rate down and in the process guarantee a captive Chinese market for US Treasury issuance.

The US Treasury can sell ten year debt in the market for less than 3%. That is a bit higher than a few years ago, but it is still a very low rate. So far demand for bonds has grown commensurately with bond issuance. By contrast, global demand for goods is shrinking.

China cannot stop buying more of the world’s bonds (Mankiw’s widely shared fear) unless it starts buying more of the world’s goods. And a world where global demand for US exports allows the US to generate needed jobs without running sustained fiscal deficits is very much in the United States long-run interest.

I would hope that China also would want a world where less of China’s savings is invested in the US. There are already signs that China’s leadership isn’t totally comfortable with its growing financial exposure to the US. And it isn’t clear that China’s public accepts that China’s government will take losses – at least in RMB terms – on all the money it channeled into the US, even though that is a logical byproduct of its policy of holding the RMB down to subsidize its exports.

Should China get credit for letting its currency appreciate 20% against the dollar?

The right answer likely depends in part on what the dollar is doing against other currencies. The 20% appreciation from mid 05 to mid 2008 came after the dollar already had depreciated heavily against a host of currencies. It was never enough to push the RMB back up against say the euro. Moreover, during the period when the RMB was appreciating most rapidly against the dollar, the dollar was still depreciating against a host of currencies: the RMB never moved much against a basket of the currencies of China’s trade partners then. The RMB only started to appreciate in nominal terms against such a basket when the dollar started to appreciate last fall.

The strongest argument against focusing on China’s currency right now is that the dollar’s appreciation at a time when the RMB has been tightly pegged to the dollar has finally generated a significant real appreciation. The RMB is still only a bit above its 2000 level in real terms, despite a huge increase in China’s productivity and a big increase in China’s current account surplus. That suggests the RMB remains under its long-term equilibrium value (more on this later). But the combination of a rising dollar-RMB and China’s own slowdown has led to a dramatic increase in capital outflows from China.

Some of these “hot” outflows are just the reversal of past “hot” inflows. But if China enters into a prolonged slump that leads to sustained capital outflows of around 10% of China’s GDP, China wouldn’t need to intervene in the currency market to offset a 10% of GDP current account surplus. And that would be evidence that the RMB isn’t being held below its current equilibrium level.

Large sustained capital outflows from China though do not strike as a likely outcome — in large part because it doesn’t strike me as an outcome that is neither in China’s interest (sustained capital outflows of this scale would be a vote of no confidence in China) or in the interest of China’s trading partners (as it implies structural RMB weakness). But at this stage it also cannot be entirely ruled out. The entire world economy is in flux.

There consequently is an argument for giving China a bit of time to adjust to the recent real appreciation of the RMB before pressing for more appreciation against the dollar.

But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture …

82 Comments

  • Posted by otto

    Setser sez: “And a world where global demand for US exports allows the US to generate needed jobs without running sustained fiscal deficits is very much in the United States long-run interest.”

    The counteris to say that a world where the dollar remains strong is also very much in the US LT interest. Put in my own naive terms, if the dollar remains strong the rest of the world will be rooting for the US to shed its recession more quickly, thus restoring its place as market of choice (China et al). However a weak dollar, though surely improving the US trade balance, will also see countries looking further afield than the prized US market for serious and large scale trade partners.

    Or put another way: A weak dollar will see higher prices for commodities. This will favour the traditional net exporters over the industrialized nations (i.e. net importers). Will the developed world (for want of a better phrase) want that to happen?

    Or put in really basic terms: Will the US allow Chávez’s Venezuela to recover more quickly than itself?

    Final thought: That “too big to fail” meme could be used on the US macro and its trade deficit. Is it too big a gap the breach these days? It is worth even trying a weak(er) dollar policy to close said gap?

  • Posted by Twofish

    bsetser: But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture

    In the near term (for the next one to three months), I think it’s pretty clear that China pegging to the US is a good thing. The dollar is appreciating, and a peg prevents the world from getting into a system of competitive devaluations. Right now, both the US and China have their hands full with crises, and currency isn’t high on the list of fires burning.

    What happens in the longer term (and by longer term I mean 3+ months) depends on how the US and Chinese economies react to their respective stimulus packages. If the Chinese economy starts booming while the US economy stays stagnant, there will be huge calls for currency revaluation, whereas if the US economy starts booming while the Chinese economy stays stagnant, people will be asking China to keep the peg as an alternative to devaluation. Alternatively it could be that the US and China end up with lock step recoveries, although I think this is rather unlikely.

    bsetser: No country really has a comparative advantage “as consumers.”

    I disagree with this. Rich countries with large amounts of immigration that keeps the workforce young do have comparative advantages as consumers.

    bsetser: But the combination of a rising dollar-RMB and China’s own slowdown has led to a dramatic increase in capital outflows from China.

    It’s hard to figure out cause and effect from this. I’d argue that it was the reverse. That the near-collapse of the US financial system caused people to pull money out of China and this led to devaluation pressures. We can look at the timelines, but I strongly suspect that you’ll see that the capital outflows started before the the devaluation pressures, and probably started the day after Lehman went under.

    One of my strong suspicions is that money from Western investment banks was actually at the core of the informal financing system in southern China. People would borrow money from Western banks and then lend RMB. When Lehman collapsed, the Western banks called in their loans, which led to a massive capital outflow and also caused factories in Southern China to close their doors as their financing was cut. So what you ended up with was a credit crisis rather than a demand shock.

    Something that is still something of a mystery is who are what was responsible for the “hot money” and I think it was Western investment banks financing Chinese export industries through Hong Kong.

    bsetser: But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture …

    The US and China need to be talking on a dozen topics. Currency being one of them. Personally, I’d put banking regulation and capital mobility as a higher agenda item than currency.

  • Posted by NoFear

    UN economists believe dollar is in for a hard landing this year so we better hope Iran and Venezuela default before Fall2009.

    Best thing to happen would be if the current stimulus gets rejected in the senate vote. Don’t know if Brad has read the 700+ pages but it looks worse then TARP documents.

    Speaking of which, banks will soon come begging for another 700-1Trillion bailout. Who’s going to pay for this? 9/10 Americans are outraged by the procedure of TARP funds, banking pay, and the “Wall-Street” Image.

    I think the timing for Geithner to pursue more bailout for the banks is horrific. American Taxpayers feel fooled by the classic episode Paulson put on in Sept-Oct.

    We’re back at it again, Obama claiming “castrophe and depression” without stimulus and additional bank bailouts (what he has yet to realize is we’ll have depression regardless). It’s like an episode of fear factor similar to those used to persuade the Iraqi invasion…

    Although the masses were fooled once, I’m not sure they’ll be fooled twice. The image of banking is horribly tarnished and 300M Americans are fed up.

    Best thing to do to is:

    1. eliminate more stimulus and bank bailouts
    2. let markets crash

    it’s going to happen regardless, only with all the stimulus and bank bailouts we’re setting the stage for a bigger crash.

    3. the u.s. dollar.

    Then again, maybe this default is what it takes to balance the equation.

  • Posted by Twofish

    The circle of money – Summer 2008

    Chinese savers -> State banks -> People’s Bank of China -> US Agency bonds -> US Real estate -> Mortgage securities -> Investment banks -> Hong Kong -> Chinese informal banking system -> Chinese savers

  • Posted by Twofish

    NoFear: 9/10 Americans are outraged by the procedure of TARP funds, banking pay, and the “Wall-Street” Image.

    On behalf of the entire financial industry, I would like to apologize for screwing up the US economy. Now, I’d like everyone to go into a nice comfortable room, put up a picture of an investment banker, and throw darts at it, whatever it takes to get the anger out of the system and then fix the problem at hand.

    NoFear: 2. let markets crash

    I don’t think this is acceptable to the American public. People are already hurting from the fall of real estate and stock market prices. If you really want to let the markets crash and wipe out what is left of people’s 401(k), checking accounts, and jobs, you really need to explain what happens next.

    So you have a middle class worker with no savings, no house, no job, and given all the doom and gloom, no hope for the future. When does it get better? A year. Five years. Ten years. A century. If you don’t have an answer to that then putting off a “bigger crash” for a year or two until we can think of something better, sounds like a good approach.

    One final thing, there are about $5 trillion dollars in FDIC insured bank accounts out there. Unless you want people to wake up one morning with all their money gone, the US government is going to have to pump money into the banks. The only question is how. Simply letting the banks collapse is not a politically viable option because people’s checking accounts disappear, and what you are proposing would literally leave people with *NOTHING*.

    I don’t think that is acceptable.

    What is going to happen with what has been proposed is that private investors recapitalize a lot of the banking system by buying what are now near worthless assets.

    Assuming the world doesn’t end, then those assets are going to be worth huge amounts of money in a year or two, and which point you can enter into a “profit sharing agreement” by massive capital gains taxation on the rich.

  • Posted by Cedric Regula

    2fish:

    Goldman Saks also reduced margin rates by a huge amount during that time frame. Saw a report that hedge fund clients of GS may have had 10 or 20 to one margin reduced down to 30%.

    BTW: In China they shoot people that screw them.

  • Posted by Twofish

    Cedric: Saw a report that hedge fund clients of GS may have had 10 or 20 to one margin reduced down to 30%.

    This is very confused. Hedge fund clients had their margin rates reduced years and years ago after the LTCM blow up. You just couldn’t get 10 to 20 margin rates last year or at any time this decade.

    This is why you don’t hear about hedge funds blowing up.

    Cedric: BTW: In China they shoot people that screw them.

    That’s the stereotype, but it isn’t true. For economic crimes, you do (very rarely) get a death sentence, but it is always invariably suspended.

    Harsh sentences really don’t do very much to solve banking problems. If you have a million people in a system and ten get suspended death sentences, that’s hardly going to make you stop anyone from doing something that is making you money.

  • Posted by Twofish

    Actually you do hear about hedge funds blowing up, but those are hedge funds internal to the IB’s that aren’t subject to capital limitations. Part of the reasons I think that Geithner is a good choice for Treasury Secretary is that I think he did a good job regulating the hedge funds while he was at the FRBNY, and arranged things so that you didn’t have the type of blow up in the mortgage market.

  • Posted by bsetser

    2fish — i suspect that you right that hedge funds weren’t quite as levered as the I-banks themselves thanks to LTCM. but I also suspect that leverage levels increased quite significantly between say 02 and mid 07. the volatility induced by the subprime blowup in aug 07 tho probably did push a lot of Hfs to cut their leverage before Lehman …

    otto — i am not quite sure how a large sustained trade deficit is consistent with the long-term strength of the dollar. i would argue in some sense that the dollar needs to fall (especially against the emerging world) so that it can regain the long-term basis for its strength.

    no return — you are right: “I think the timing for Geithner to pursue more bailout for the banks is horrific. American Taxpayers feel fooled by the classic episode Paulson put on in Sept-Oct.’” American Senators also feel fooled judging from my testimony two weeks ago. the likely result tho is an underfunded bailout, as it seems like the administration is trying to make do with the $300b or so left in the TARP. and while you may accept a crash now, most Americans don’t want any more financial drama either.

  • Posted by jimspassion

    As always enjoying the dialogue Thank-You

  • Posted by pwm76

    This past week’s edition of the Economist once again made the argument that the RMB is not undervalued, and based their argument on adjusted purchasing power parity.

    Brad: I agree with your view, because it is supported by evidence rather than theory, but don’t have the economic nous to dismantle the PPP argument the Economist keeps making. What weakness do you see in the logic of the PPP argument?

  • Posted by Indian Investor

    Brad: In your testimony, you said:
    “Private capital is now flowing out of the emerging economies. The pace and scale of
    this reversal has been comparable to the reversal that accompanied the 1997 emerging
    market crisis. Over $100 billion of private capital left Russia in the fourth quarter of
    2008; the outflow from China likely was similar.”

    Me: That is rapidly changing. Here’s an extract on Russia’s forex reserves from the Bank of Russia:

    ” The External and Public Relations Department of the Bank of Russia informs that the volume of the international reserves of the Russian Federation amounted to $388.1 billion as of January 30, 2009 against $386.5 billion as of January 23, 2009.”

  • Posted by geert

    As a non-economist I’ve always been stunned on how economists are indoctrinated by that one Ricardian sentence on international comparitive advantages that holds little to no sense. Of course they will refer to the nasty effects of protectionism in the second half of the nineteenth century and in the pre-war period of the Great Depression, negating all the imbalances one-sided protectionism created (history is filled with examples).
    They confuse symptons and causes by pointing at the retaliation at the cause of a worsening economic environment instead of focusing on the imbalances created by the lack of protectionism at the right time. A protectionism as a reaction against protectionism to avoid long sustained imbalances.
    Maybe Brad should take his next article a bit farther and ask at which point in time protectionism should be answered by protectionism.

  • Posted by purple

    Protectionism has been going since this thing blew up. Bankers aren’t too worried about getting their handouts, they just complain when GM does. Why ? It helps the worker just a bit, which is too much in their eyes.

    The US dollar is overvalued now and needs to depreciated in some form. Again, the only reason it hasn’t is because that would primarily hurt banks and wealthy people. But it’s hard to have a domestic consumer when people are losing jobs in industries that actually support a family – so in the end this financial empire is built on sand.

  • Posted by Albion

    Very interesting and well balanced post on the precarious balances between currencies overvaluation, countries over indebt ness and over consumption and its creditor (s).
    Hong Kong where monetary policy and exchange rate have been set de facto by the US Fed monetary policy has been the business and economics laboratory of the PRC before reunification. Obviously, the depth of HK domestic economy through its brutal cycles cannot accommodate the interest rates whipsaws of the US economy . Larger economies can compensate a temporary loss of trade balance through domestic grooming where infrastructures, medical cares, plants efficiency have needs.
    I am still at odd with the newly era of striving for perfection on the exchange rates components of the international trades when inflation (money supply) current accounts surplus (deficit) have been totally neglected during the last decade or century.

    As for Russia its macroeconomics components are still healthy, it is not comparable to 98.The commun factors, extensive money supply,currencies mismatch,inflation.
    The private sector is meeting with the fate of financial strategies as opposed to industrial strategy.

  • Posted by cdr

    A dose of (US policy makers’) Europhobia mindset disinflation would also constitute (big) help.

    A lot of that being behind this IMO.

  • Posted by DJC

    So far the US Treasury Dept has thrown over $1 trillion dollars at Wall Street banks to no avail. Another $800 billion is not going to do anything but waste another $800 billion.

    This was the largest credit boom in history, and it will be the largest bust, no matter what the “bailout”. The problem is excess debt in the US Economy and creating more debt isn’t the solution.

    Who benefits from monetary inflation? The answer is government, banks, and already wealthy because they are first in line to receive money. Everyone else is screwed. Inflation is theft from the middle and lower classes for the benefit of bankers and the wealthy.

    http://globaleconomicanalysis.blogspot.com/

  • Posted by cdr

    Off topic but regarding ongoing discussion, an over-simplistic point of view:

    There once was a reason for maxed-out deposit insurance. Guaranteeing it all plus the new debt of IBs , turning the latter into competitors to state debt, and now (while pushing some more for bad/guarantees) using this as an ex-post viable argument strikes me as faulty. This one was “made in UK” back in the panic days and long after Nicholas Unless-Jesus-Christ-Had-Died-For-Thee-Thou-Hadst-Been-Damned Barbon. That was mistake.

    Given the contagion nowadays it is the IMFs place now to outlaw the “above x grains of rice/wheat as expressed by a currency n” deposit insurance. Or, this being too far out of the box, one can think of the new uninsured deposit gambling account above the x and transfer the rest. Or conversely and as a start one can see-through the FIDIC insurance as factually non-existing and continue from there.

    The insurer must earn enough “income” from investing “the deposits” (?) to cover losses and operating expenses for the model to be economically viable. It’s like seeing the FDIC “stamps” as the next (rating) excuse for inflating bubbles until we can figure it out and make tons of money to share.

    Leaving the nature of different deposits and the mystic, surrounding (randomly generated items such as “deposit” “debt” “money” “money creation” “investment” “premium” “asset” “liability” “reserve” “capital” “leverage” “interest” “deposit”) spectacular metamorphosis, completely aside.

  • Posted by bsetser

    pwm76 — i take the economists argument on in a later post. much depends on the weight that is given to a country’s current account/ trade data as evidence of real undervaluation. the chinn et al study cited by the economist — in its initial version, and i want to read the updated version — found that on an adjusted PPP basis the RMB didn’t quite meet statistical tests that would put it in the “obviously undervalued” range, but it was on the lower end of the distribution. before saying more tho i want to read the revised paper.

  • Posted by Kafka

    It amuses me that so many smart people spend so much time on the Chinese peg to the U.S. dollar. Isn’t it a net sum zero gain since the majority of China’s reserves supposedly end up back in the dollar? Isn’t the Yuan essentially a proxy for the dollar in Asia aside from the fact they are almost impossible to acquire outside of China? Or is it the Yen is a proxy for the Yuan? The Chinese government manipulates everything including its faux GDP numbers, so what? The only thing that is semi real is the funds flow, which are almost impossible to track though Mr. Setser does about as good a job as I have seen with quasi public information. The only things you can count on from the Chinese government is its unabashed intent to maximize its own self interest and prevention of its 1 Billion slaves from rebellion (due to starvation).

  • Posted by Vlad

    Brad,

    While I agree with much of what you wrote, I think you underestimate the dependency of the US on China bonds purchases. For one thing: private players may be encouraged to see the dollar as the “safe haven” as long as they see the dip pockets of PBoC on their side. In fact, the current revaluation of the dollar started exactly when the PBoC stopped the currecy appreciation. This signaled that the, let´s say, Bettron Woods II arrangement wuold be kept in place on the short term and, thus, that the place of the dollar as the most important reserve currency was not to be questioned.
    I also think that the US government should focus on stimulating Chinese authorities to pursue policies to increase domestic demanda, while leaving the loaded subject of currency manipulation aside. This finger pointing is not going to produce good results both in China (since they will see it as a dictate form the West) and the US (where it will increase even more the current Chinophobia and the risk of protecionism)
    What do you think of these ideas?

  • Posted by Glen M

    I am so glad you brought this topic up Brad!

    To answer the headline question, It seems that those whom question the current climate are labeled as anti trade. Accordingly we get the precis version of the Great Depression with Smoot-Hawley exasberating it.

    Missing from the dialogue is the fact that the Great Depression was really only great in the one country that had the largest trade surplus, the US. It was bad elsewhere but far less so than in the US.

    You also bring up an excellent point, and I don’t think that this can be stressed enough;
    “And it isn’t clear that China’s public accepts that China’s government will take losses – at least in RMB terms – on all the money it channeled into the US, even though that is a logical byproduct of its policy of holding the RMB down to subsidize its exports.”. The reason I think that it is so insightful is that in a nutshell it demonstrates the real impetus of the policies in play. The low Yuan policies were / are for a policital not financial advantage.

    The analysis of the current crisis has shown that to be true. What is interesting is what might have happened had the pre crisis environment continued. China would have had another unpleasantry to deal with. Namely hyper inflation.

    Looking at China’s increasing appetite for raw materials and its increasing need to import them, the issue of supplying them to industries at below market prices was going to come to a head. It is one thing for China to sell domestic coking coal for $350 a ton to domestic steel makers, while the world price was $750. It is entirely another issue when China has to rely on importing at world prices and sell domestically at below cost prices in order to ‘quell’ inflation. We saw the same with oil. The price refiners were forced to sell at were equivalent t oil at $80 per barrel when they were buying it for $145.

    Complaining about protectionism is not protectionism. It’s is nothing more than a ploy to protect the status quo. The Emperor has no clothes, now lets move forward.

  • Posted by Glen M

    sorry my last point was meant to say that about other’s protectionism while being mercantilist is a means to support such.

    BTW Brad, are you familiar with Peter Navvaro’s China Price erport?

  • Posted by Brian Shriver

    Brad:

    Thank you for this post! You raise a very important point and I couldn’t agree more.

    Mankiw is nuts on this one. To address points he makes in his article: It is not protectionist to push for open but balanced trade. Now is the perfect time to address this issue. And the Smoot Hawley reference is entirely appropriate — countries running persistent deficits are losing out to countries running persistent surpluses and benefit relatively more if trade flows are disrupted.

    The world doesn’t need a disruption in trade flows (which is the inevitable consequence of an unsustainable BW2). The world needs a shift toward balanced trade flows. And part of that shift involves less aggressive currency manipulation by China et al.

    Regards,
    Brian Shriver

  • Posted by DJC.

    Brad Setser is really going to demagogue the Chinese to death. International trade with China accounts for approximately 3% of US GDP. China’s role in the US economic imbalances is even smaller than this number might suggest. The Chinese economy essentially final assembles consumer products that are re-exported to the United States with Japanese and Korean high-tech components.

    Brad Setser’s continued thesis that the Chinese are responsible for the US financial fiasco is simply ludicrous. The Chinese $60 billion trade surplus pales in comparison to the multi-trillion dollar US taxpayer “corporate welfare checks” provided to politically-connected Wall Street banks.

    The enormous leveraging of debt and other forms of financial speculation are responsible for the US financial collapse. This has entailed an enormous transfer of resources out of manufacturing and into finance, and out of the working class and into the pockets of those who have played the critical role not only in destroying living standards, but in setting the stage for the present US economic disaster.

  • Posted by Kafka

    Isn’t China a symptom of the problem? The U.S. don’t make nothin no more. The present American economic paradigm is services, debt financed consumption, social welfare and military might (on which the U.S. spends over 10 times more than any other nation on the planet and more than all the nations combined). Of course such a paradigm is unsustainable no matter how much Americans hope, dream and believe in their presumed ingenuity. And as an aside, Buiter is right on his bad bank idea but no will listen because the Politicos are controlled by those who his proposal would hurt the worst, the very same people who created this mess to begin with..
    ………………………………………………………………………………………………
    The legacy bad banks would, under their existing ownership and with whatever balance sheet they end up with after shedding their insured/guaranteed deposits and after selling their good, easily valued assets, have as their sole activity the management of their existing assets. No new investments would be undertaken, no new loans made and no other new exposures incurred. Their liabilities and other funding decisions would be managed in the interests of the existing shareholders. No doubt many of them would fold. Chapter 11 or Chapter 7 would be ready and waiting for them.
    http://blogs.ft.com/maverecon/2009/02/good-banknew-bank-vs-bad-bank-a-rare-example-of-a-no-brainer/

  • Posted by Glen M

    To add some fuel to the fire;

    http://www.bloomberg.com/apps/news?pid=20601089&sid=as0mUphsMahs&refer=china

    Vice Commerce Minister Jiang Zengwei said.”“I believe China won’t implement a “Buy China” policy,” Jiang said at a press conference in Beijing today. “We just need to boost consumption, whether it’s through domestically made goods or foreign-made goods. We will treat them equally without discrimination. Why in the current climate should we resort to protectionism?”

    Lets be honest. China does not get rid of protectionism. It wants others to get rid of protectionism.

  • Posted by DJC.

    Glen M: Lets be honest. China does not get rid of protectionism. It wants others to get rid of protectionism.

    DJC: Let’s be honest. The Chinese is alot more open to US multinational investment than the reverse. Intel, Microsoft, Coke-Cola, Cisco, IBM, Ford, General Motors have invested billions of dollars across industrial facilities in China. In stark contrast, Chinese firms investing in the United States face overt protectionism under the banner of “National Security Threat”. China CNOOC was prohibited purchasing Unocal despite the fact that the company produced a mere 3% of domestic US production. Hutchison Whampoa of Hong Kong was denied US port operating licenses. More recently, China Huawei was denied purchasing the second-tier 3COM network corporation.

    The Chinese are restricted by the US government only to the purchase of US Treasury bonds that pay approximately zero interest, and AAA-rated subprime mortgage garbage.

  • Posted by NoFear

    Anyone listen to Obama’s speech today? So much rhetoric instead of just being upfront.

    Alot of hype, alot of talk on change. But were i president I’d bring reality to the table. Talks of all this stimulus but no americans even think “where does the money come from”. Obama wants a tylenol to help relieve a spreading cancer.

    I’d tell the American people the way it is.

    “We’ve over consumed for far too long, there are severe global imbalances in the world, we have an increasing national debt which adds foreign geopolitical influence. People we will try a stimulus, but we cannot guarantee much. Great People of America we will likely have a depression. I have to be honest and say we must change our way of life. We must go back to ideals of moderation and cautious consumer consumption. We will recover but understand the next 2 years will be very difficult”.

    Now if Obama issued such statement I would take my hat off.

    @ twofish- if the markets do tank, at least seniors with savings will be “ok”. not everyone is dependent on a 401K or has money in the markets. some just live a plain and simple life, satisfied with a few percent interest. additionally, just because some banks fail, does NOT MEAN all banks fail.
    In life there are always the competent, and the non-competent. It’s called Darwinism.

    Now with all this stimulus you still risking a banking breakdown, best case a Japan #2 where the DJIA sits at 5K the next 10 years, or worse yet a potential devaluation of the dollar. Think that’s what those who worked hard and saved want to see? Your policy does not encourage those who work hard and save.

    Sorry Twofish, you maybe good for some but bad for the majority. And i find a rather arrogant position in your tone with relieve your “anger and put a photo of i-bankers and throw darts at us”…

  • Posted by August

    Brad, the US is well-known to be the biggest currency manipulator of the world. By pegging the RMB to the dollar, the chinese are just following the US boat, of which the US is the driver, not the chinese. cannot you really understand this or you have something else on your agenda?

    Your smartness is often blinded by your ideology bias.

  • Posted by Glen M

    DJC, you do realise that the CN in CNOOC stands for China National, in the most literal sense.

    National companies should be expressly prohibited from acquiring foreign assets. When CNOOC was selling oil at well below cost were they acting as a private company or an agent of the state? Do you think that China would allow the US government to purchase Chinese coal producers?

  • Posted by Twofish

    bsetser: I also suspect that leverage levels increased quite significantly between say 02 and mid 07. the volatility induced by the subprime blowup in aug 07 tho probably did push a lot of Hfs to cut their leverage before Lehman

    I don’t believe that this was the situation. After LTCM blow up, the Federal Reserve Bank of New York was very carefully looking the leverage that investment banks were providing hedge funds. The IB’s did run into problems with their internal hedge funds that weren’t under Fed supervision, but it’s interesting that hedge funds didn’t cause major problems.

    NoFear: . I have to be honest and say we must change our way of life. We must go back to ideals of moderation and cautious consumer consumption. We will recover but understand the next 2 years will be very difficult.

    What we are trying to prevent is something that would destroy the next ten years or more. It may be a good thing to cut consumer demand, but if that decrease in demand isn’t increased somewhere else, then you just end up in a downward spiral.

    NoFear: Now with all this stimulus you still risking a banking breakdown, best case a Japan #2 where the DJIA sits at 5K the next 10 years, or worse yet a potential devaluation of the dollar.

    I’d argue that the best case is what happened after the 1981-1983 recession. Twenty years of solid economic growth.

    The big danger right now is that we head into a decade long depression with 15-20% unemployment and completely unpayable debts at the end. We absolutely have to break this downward spiral of unemployment that we are in. Without jobs, we have absolutely no hope of getting out of debt.

    Right now we are on the same path that Japan and SE Asia faced, and everyone is desperately trying to get out of that path. You look at the number of jobs that have been lost since October, and the numbers look exactly like the first months of the Great Depression.

    NoFear: if the markets do tank, at least seniors with savings will be “ok”. not everyone is dependent on a 401K or has money in the markets.

    No they won’t. People don’t realize how complex and sophisticated checking, savings, and money market accounts are. People go into a bank, deposit money, and like “magic” the money appears, and most people have no idea what is happening behind the scenes.

    Checking accounts are backed by mortgages and commercial loans. If you have bad loans, then the checking accounts have no value to them. The one saving grace is that the government has guaranteed the value of all checking and savings accounts, and right now people are desperately finding ways to “make good” on those guarantees.

    If you have massive unemployment, the loans go bad, and there will be so much effort at pumping wealth in to keep checking accounts from going under that it will starve the rest of the economy.

    NoFear: Some just live a plain and simple life, satisfied with a few percent interest.

    And right now, people are moving heaven and earth to make sure that they don’t lose their money.

    NoFear: Additionally, just because some banks fail, does NOT MEAN all banks fail.

    Every time a bank fails, you stress the system some more. If enough banks fail, then the system is in danger of crumbling. Also there are several major banks that are so interconnected, that if they fail, it will take down the entire system.

    NoFear: Think that’s what those who worked hard and saved want to see?

    Right now, I’m not that worried about the stock market. I’m more worried about jobs and checking accounts. For most people, it doesn’t matter how much you have in the stock market, if you have no job and if your checking account disappears.

    Once you accept the idea that the government has guaranteed checking accounts, savings accounts, and money market accounts, then you are under some severe restrictions on what you can do. If you accept that very sensible idea that people should not lose their checking and savings accounts, then a government bailout of the banks becomes inevitable.

    NoFear: Your policy does not encourage those who work hard and save.

    Working hard is pointless if no one has any jobs available. Saving is pointless if you don’t have any banks to save your money in.

    NoFear: And i find a rather arrogant position in your tone with relieve your “anger and put a photo of i-bankers and throw darts at us”…

    I’m sorry, but I’m freaking scared right now. Bank accounts are like the power grid. You go to the bank put in money, take out money. It’s boring. It’s supposed to be boring. However that behind the scenes there are a whole bunch of things that have to happen to make everything work, and right now things are quite broken.

    Because the system works so well, people assume that it’s just magic and that they will always be able to access their checking and savings accounts. But that isn’t how it works. A demand deposit checking account is one of the most dangerous and difficult investment instruments that has ever been invented. There are dozens of ways of getting it wrong and we’ve tripped over some of them.

  • Posted by Twofish

    Glen M: When CNOOC was selling oil at well below cost were they acting as a private company or an agent of the state?

    The were acting as a commercial entity under state regulation. The Chinese oil companies (for obvious reasons) *hated* being forced to sell oil below cost, and were very heavily lobbying the government to remove those restrictions.

    On the other hand, if you have a situation as currently exists, when the state set price is above the market set price which guarantees nice fat profits for the oil companies, well…. No one from CNOOC is complaining.

    The relationship between the big Chinese oil companies and the Chinese state isn’t all that different from the big American oil companies and the US government, especially during the 1970′s when US oil companies were under the same sorts of price controls that Chinese oil companies are under.

  • Posted by bsetser

    August — I am not quite suer where you are coming from. The US does operate an autonomous monetary policy, which has an impact on the external value of the dollar. But the US has not historically targeted the dollar’s external value. In so doing, its exchange rate and monetary policy regime lines up with that of the other major economies.

    DJC — China has been open to greenfield investment, especially greenfield investment targetting other markets. It isn’t open to foreign takeovers of chinese companies … all such deals need gov. approval, and that is hard to get. I find this policy understandable when china is maintaining an undervalued currency; it didn’t want to sell its firms on the cheap. But it certainly isn’t fully open to private foreign investment. and it is also true that the US isn’t fully open to the purchase of US companies by foreign governments.

    2fish — I’d like to see data on HF leverage levels over time … my strong sense is that they creeped up during the great moderation. Memories of LTCM faded …

  • Posted by Anon1234

    Twofish: I think you’re fear mongering here. Yes, the investment banking system has pretty much collapsed already. The money market funds — which have always been marketed as uninsured investments — could collapse.

    Deposits, however, are insured and the government can print money and/or to make sure that they don’t default. Most likely the government will choose to do the same with conservatively operated money market funds. The only risk to the bank savings accounts of US consumers is inflation (which will probably be avoided due to the collapse of the financial system — which let’s be honest has already occured). I agree that 401Ks are a problem, but I’m not convinced the government has any means of solving it.

    The example of the Depression indicates that inflation for a country the size of the US would be a good way of insulating the country from the worldwide economic crisis — though its likely to be costly in the long run — and some may argue that its immoral.

    In any case its total nonsense that deposits are at risk. What’s at risk is that market forces are allowed to operate and the investment banking all disappear. Isn’t it possible that new investment banks would grow up to do IPOs and the like — obviously on a much more conservative basis, if we just let the whole rotten mess go down?

    No, I’m not certain this is the best solution, but I also don’t know how anyone can be confident that it’s good policy to support a bunch of insolvent, incompetent firms.

  • Posted by DJC.

    Glen M: National companies should be expressly prohibited from acquiring foreign assets.

    DJC: As the largest trans-shipping port corporation in the world, shareholder-owned Hutchison Whampoa of Hong Kong operates containerized port facilities on every continent across the globe except for the United States. Both Hutchison Whampoa and Dubai Ports were denied operating licenses in the United States under National Security Threat grounds. What’s really a national disgrace is that professionally managed foreign corporations from developing world nations are prohibited under National Security regulations from legal US businesses.

    Glen M: Do you think that China would allow the US government to purchase Chinese coal producers?

    DJC: Now that the US government owns preferred equity shares in General Motors and Ford, does the Chinese government require General Motors to divest its ownership of Wulong Truck Corp. Do you think the US government would allow China SAIC to purchase General Motors or Ford? It’s more of the same double standards.

  • Posted by Cedric Regula

    I’m getting tired of the threat of either IBs or commercial banks blowing away my checking and savings account and that is why I need to replace trillions they lost on idiotic and fraudulent business practices.

    So I’ll fix the whole problem now. First we need to go back to the origin of banking. Most people don’t know this, but the emergence of banking began with the Templars in the early 1300s. They offered, for a fee, to store the valuables of Medieval clients in their monasteries. Being honest types, and also being warrior monks, gave depositors confidence in the system. They grew rather wealthy this way, by Medieval standards, and that plus the fact that they were warrior monks made Rome and Kings begin to fear their power. So they killed the Templars and banking has gone downhill ever since.

    Since I concur that checking accounts are a cornerstone of civilization and blowing them away would blow us all back to the Stone Age, or at least Bronze Age, we need to focus our considerable modern know how on how to preserve this 8th Wonder of the Modern World.

    So I propose a good bank. It would charge a small fee for checking accounts. It would pay a bit of interest on savings accounts. Deposits would be invested in the copious supply of treasuries. Fees plus treasury yield would cover operating cost plus savings account yield.

    This way we could take comfort in knowing that the good bank and the USG will last exactly the same amount of time.

  • Posted by Twofish

    Anon1234: Deposits, however, are insured and the government can print money and/or to make sure that they don’t default. Most likely the government will choose to do the same with conservatively operated money market funds.

    Inflation is something of a “soft default” and in any case inflating the currency is an awful solution to the problem since it punishes people that saved their money and rewards people that went heavily into debt.

    Anon1234: . The only risk to the bank savings accounts of US consumers is inflation (which will probably be avoided due to the collapse of the financial system — which let’s be honest has already occured).

    The financial system hasn’t collapsed. I just went to the ATM and it looked like I could get my money out. The system very nearly collapsed in October, but it didn’t.

    Anon1234: Isn’t it possible that new investment banks would grow up to do IPOs and the like — obviously on a much more conservative basis, if we just let the whole rotten mess go down?

    Not likely if you look at other situations in which you have a banking system collapse. Let me give you an example of the problem. Suppose I’m a commercial bank, and I need to sell a set of loans to raise money so that I can pay depositors. Right now, the commercial bank goes through an investment bank to securitize those loans.

    You are a company that wants to raise working capital. Right now you go through an investment bank to access the commercial paper market. Microsoft has $45 billion in liquid assets. You don’t think that they have this all in a bank account. They have it in repo agreements.

    The thing is that people mistake “conservative” for “simple.” In reality, checking accounts and money market funds are *extremely* complex instruments. They are extremely complex and dangerous precisely because they are conservative and boring. You don’t want the checking account owner to worry about anything, which means that someone else has to do the worrying.

    Also people don’t realize how complex the “money market” is. I don’t think most people really know what a “money market” is, and that’s the point, they don’t have to if they don’t want to. But someone has to worry about this.

    Anon1234: No, I’m not certain this is the best solution, but I also don’t know how anyone can be confident that it’s good policy to support a bunch of insolvent, incompetent firms.

    I don’t think it is, but rewarding the innocent while punishing the guilty is something that is very tough to do, and I don’t think most people realize how tough it is. The obvious solution is “shoot the bankers” and “let them all die”. The problem is that this just isn’t a viable solution once you realize the consequences.

  • Posted by NoFear

    @ Twofish.

    So i was thinking about it.

    This year i’ll issue and mail my state tax to Bank of America and my federal tax to I’ll issue and mail to Goldman Sachs.

    Since these guys can no longer sell worthless products to investors I guess it’s time for the taxpayers to consume them. The problem is we’ll consume them at 50% over market value. It’s one thing to sell fraud to investors, but when you start to sell fraud (worthless products) to 300M americans
    then we have troubles…

  • Posted by Twofish

    Cedric: So I propose a good bank. It would charge a small fee for checking accounts. It would pay a bit of interest on savings accounts. Deposits would be invested in the copious supply of treasuries. Fees plus treasury yield would cover operating cost plus savings account yield.

    This is a textbook example of why banking is harder that it looks.

    The problem is that if interest rates go up then the value of treasuries will go down, and you won’t have enough funds to cover your deposits.

    You can deal with the problem by having capital reserves and shareholder equity. The trouble is that capital reserves don’t pay interest, and so if you have large capital reserves it makes no sense to go through you rather than to buy treasuries directly. If you have small capital reserves, then you get wiped out if interest rates move.

    It gets worse, since people know you are 100% invested in treasuries, when interest rates go up and it looks like you are insolvent, that’s when people will be lining up demanding their money.

    OK so there are a number of ways of dealing with this….

    1) You can tie up investor money. Congratulations, you’ve just invented the CD.

    2) You can invest in ultra short interest rate bonds. The trouble is that the shortest maturity T-bill is three months, and that’s enough to wipe you out if there is a sudden interest rate change. But there is an active market in ultra short term corporate paper. This is what is known as the “money market” and you can create a “fund” for that.

    3) You can deal with interest rate fluctuations by going to your neighborhood investment banker and buying an interest rate swap, in which the investment bank agrees to pay you a fix interest in exchange for you giving them a variable interest rate.

    The problem at this point is that what you have is unlikely to be of interest to investors or depositors since they can buy T-bills directly and they don’t pay a whole lot of interest. Now if you are lending to ice cream parlors or transmission repair stores, that’s something different.

    If you can convince the transmission repair store to pay a variable interest rate, that’s wonderful. Since that means that the value of your loan stays constant. However the person borrowing is going to look at you funny and ask why they should be paying a variable interest rate. They want a fixed interest rate, which you can’t give them because it may bankrupt you…..

    Now it would be nice if you could go to an investment bank and buy an interest rate swap, but as we all know investment banks are run by crooks that sell nothing of value, and do nothing useful.

    Hey…..

    You want to sell those Treasuries for cash. I’m wondering who are you planning to sell them to and how.

  • Posted by DJC.

    Everyone already knows Goldman Sachs de facto controls the US Treasury Dept and Federal Reserve.

  • Posted by Cedric Regula

    2fish:

    That’s why I don’t think its a good idea to let bankers handle money.

    For one thing there is a reserve requirement now to handle depositor demand for cash, call it 8%, but it only applies to checking accounts. Savings accounts and CDs are exempted from the reserve requirement, presumably because they are time deposits. I found these facts in Wiki somewhere.

    Banks are are allowed to hold CDOs as their reserve requirement, per the FDIC articles I read.

    So with some judicial use of bond ladders, starting with 3 month t-bills, and probably not going too far into the future since that doesn’t pay right now, we could get far more short term liquidity(you can sell t-bills without a significant loss almost always) and keep maturity mis-match within acceptable tolerance. Unless the the USG does something dumb like start hyper-inflation, or default.

    We don’t need stockholders. A capital structure of depositors is enough.

    Then there still is the lending biz, broker-dealers, and M&A wheeler dealers. We can have lots of small enough to fail companies fill that niche. Stockholders for them too.

  • Posted by locococo

    No the solution is not to shoot the bankers with darts or otherwise. The solution would be to get the misallocated ones out and employ therein someone who is actually able to demonstrate making the distinction between asset over liability, loan over irregular deposit, solvency over liquidity, stock over flow, track ownership in fractional banking processes and who incidentally may understand how the fed has busted the incredibly complicated money market funds and their nature in fractions of reserves and then ever since tried to limit the damage of mm mutual s buck-breakings…

    then get someone that understands what reserves were internationally and a few basic things about G to G and securities settlement and clearing to act as the boss to all the newly appointed above-ones.

    but that was then and now it s too late.

  • Posted by DJC.

    An admission by policymakers that major U.S. banks are insolvent is required.
    There are two explanations why the Obama administration (like its predecessor) refuses to even acknowledge this possibility in public, says Martin Wolf, chief economics commentator for The Financial Times:

    One, policymakers think they have better information than private economists and really believe the big banks aren’t insolvent, i.e. they continue to view the crisis as a “liquidity problem,” and believe so-called toxic assets will return from their currently “artificially low” levels once confidence is restored.

    Two, policymakers “are not prepared to admit the truth” because it means existing shareholders and bank managements will be wiped out. It also means “admitting total failure” of efforts to date to stem the crisis, says the author of Fixing Global Finance.

    Arguing today’s toxic assets are “fundamentally worthless” – and there’s lots more losses coming – Wolf says the lack of political will (or outright cowardice) to admit to reality means “we’re really in trouble.” Why? Because confidence in policymakers will continue to deteriorate as their ill-conceived solutions continue to fail.

    http://www.ft.com

  • Posted by Benign Brodwicz

    Brad,

    With the slowdown in demand for its exports, will China have enough funds to cover the U.S. government deficits?

    Cheers,
    Benign

  • Posted by wildbilly

    Agreed, banking system is 100% insolvent and taxpayers will only be buying worthless assets.

    Maybe Geithner will come out gunning tomorrow and declare troubled banks nationalized!

  • Posted by gillies

    i believe that the process of globalisation, whether the global economy is growing or contracting, is a process which leads naturally to outsourcing to developing and thus low wage regions.

    i believe that this gives opportunities to multinational corporations to arbitrage wage differences.

    thus wages in general are levelled down, even if profits are correspondingly levelled up. cheaper goods also mean that production expands.

    but a point has to come where the lower wages (lower on average, because that is what rises the profitability) can no longer support the increased production with increased consumption.

    at that point the party has to stop, unless the consumer can be lured into debt by some form of wealth effect.

    that in turn has to stop once the attractiveness of debt can be improved no further, by lowering interest rates or producing new asset bubbles.

    at this point the irrational euphoria of consumer/investors turns naturally enough to disappointment and anger.

    the profit and bonus takers say ” calm down. throw darts at our picture if you like. but give us trillions because if you don’t the whole system will implode ! ”

    and the politicians point at chinese ‘manipulation’ to distract the people from seeing that the whole of the last dozen years has been a manipulation. there is no ‘conspiracy.’ just a system which is the sum total of multiple and diverse conspiracies in which the liar (of the ‘liar’s mortgage’) is just another who conspires in the self delusion which is a side effect of greed and hope.

    “throw darts at a picture of the chinese” advise the c f r.

    very patriotic, but the process of globalisation is the opposite of patriotic. it favours profits while levelling wages down. it thus pitches those who make profits against those who earn wages.

    the wall street men are the party of globalisation, they are like the slave owners of the south. the ratio of a c e os bonus to a chinese worker is less equal than that of a plantation owner’s profit to the cost of keeping and feeding a slave. the wage earners are the other side, the north. the southern gentlemen, the globalisers have done so well, that it is coming to the turn of the nationalistic workers, and protectionism. this is not because protectionism is any way superior, but just because its opposite has prevailed so powerfully for so long.

    nationalism is protectionism. in a crisis people instinctively turn to the local and familiar. i have no agenda here. i am not advocating protectionism, but the excesses of globalisation stimulate it, just as the excesses of boom are what catylises bust.

    the ‘stimulus’ is political theatre, staged because to sit still and watch collapse is not politically possible.

    obama is cast, as he knows himself, as abraham lincoln.

    one way or another he faces a country potentially divided over globalisation / nationalism-protectionism.

    there is no way out of over-indebtedness by borrowing, but it is not politically possible to stand idly by. first we have to prove to all that the stimulus is ineffective – then
    we move on to more radical measures.

    debt fuelled escape into further growth, more leveraged gambling and greater globalisation – would set us climbing up to the brink of an even higher cliff.

    the way out of here is the downward path. the great contraction. denial is for wimps. don’t be scared to look down, its where you are heading, now, one way or another.

  • Posted by Indian Investor

    Talking of protectionism, here’s an brief extract and link to an interesting FT article:

    “China’s biggest investment deal in Africa is faltering as western donors create pressure to renegotiate a minerals-for-infrastructure contract in the Democratic Republic of Congo valued at $9bn (€6.9bn, £6bn).

    Under the deal, a consortium of state-owned Chinese companies agreed to build roads, railways, hospitals and universities in return for the right to develop a copper and cobalt mine.”

    http://www.ft.com/cms/s/0/f4d34d3a-f6d9-11dd-8a1f-0000779fd2ac.html

  • Posted by Twofish

    Cedric: Savings accounts and CDs are exempted from the reserve requirement, presumably because they are time deposits. I found these facts in Wiki somewhere.

    You are talking about reserve requirement that the Fed requires, but there are additional reserve requirements that bank regulators require to cover non-performing loans and market fluctuations in loan value above the requirements that the Fed has.

    Cedric: Banks are are allowed to hold CDOs as their reserve requirement, per the FDIC articles I read.

    Which turns out to be an utterly stupid idea, and part of the reason we got into this mess. This was really hit German banks hard. Most American banks got hit less hard by this because US regulators on this issue tended to be more conservative than German ones.

    However, just because the government allows you to shoot yourself in the head, doesn’t mean that you should.

    Cedric: So with some judicial use of bond ladders, starting with 3 month t-bills, and probably not going too far into the future since that doesn’t pay right now, we could get far more short term liquidity(you can sell t-bills without a significant loss almost always) and keep maturity mis-match within acceptable tolerance.

    You have to be careful about the term “acceptable tolerance.” If you make a mistake then your bank collapses. If enough banks make the same mistake, then the banking system collapses.

    The other problem with all of this is that don’t provide much value added. Someone that wants to write checks against T-bills can get an mutual fund account.

    Cedric: We don’t need stockholders. A capital structure of depositors is enough.

    That’s what Citibank thought in the early 1980′s. The trouble is that if something unexpected bad happens and you have no equity shareholders to absorb some of the loss, your depositors get hit, and that is bad. And something unexpected bad will happen.

    Cedric: Then there still is the lending biz, broker-dealers, and M&A wheeler dealers. We can have lots of small enough to fail companies fill that niche. Stockholders for them too.

    Small enough to fail doesn’t always save you. Witness the Savings and Loan crisis of the 1980′s. Also there are regulatory issues to worry about. It takes fewer regulators to manage a small number of large companies than to manage a large number of small companies. You can argue (correctly) that small numbers of large companies may have too much influence on the regulators, but you see similar things with large numbers of small companies.

  • Posted by Indian Investor

    Brad: There consequently is an argument for giving China a bit of time to adjust to the recent real appreciation of the RMB before pressing for more appreciation against the dollar.

    Me: I have a question. If the RMB appreciates a lot, does it have the potential to become an alternative to the USD as a forex reserve currency? Given that China has better Govt. finances, won’t this make China get much farther ahead of the US in terms of geopolitical influence?

  • Posted by Cedric Regula

    2fish:”The other problem with all of this is that don’t provide much value added. Someone that wants to write checks against T-bills can get an mutual fund account.”

    That’s why I do it that way. I was just trying to come up with a way to keep everyone else from being terrified of banks blowing away their checking accounts.

  • Posted by Cedric Regula

    indian:Me: I have a question. If the RMB appreciates a lot, does it have the potential to become an alternative to the USD as a forex reserve currency? Given that China has better Govt. finances, won’t this make China get much farther ahead of the US in terms of geopolitical influence?

    I can even answer that one.If you are a reserve currency, you lose control over it. China would have to want to give up the ability to peg, not only against the dollar, but the euro and yen too.

    Being a reserve currency is generally not good for manufacturers.

    Milton Friedman pointed out that a CB can manage the domestic economy thru interest rate policy, or the external value of the dollar, but not both at the same time.

    So this is why foreign countries get mad at us when the Fed raises rates in response to a overheated US economy. The buck goes up, dollars loans get expensive.

    But on another off topic subject, quarterly refunding starts tomorrow. 67B of treasuries for sale this week.

    Here’s the market pre-game report.
    http://www.guardian.co.uk/business/feedarticle/8349693

  • Posted by Twofish

    Cedric: That’s why I do it that way. I was just trying to come up with a way to keep everyone else from being terrified of banks blowing away their checking accounts.

    But then you have to ask the question of how your mutual fund company converts its T-bills into cash and back, and where does it keeps its money….

    The attitude I’m hearing a lot is I don’t have to worry about the power grid going out because I’ve got this 1000 Watt lamp that will keep me in daylight. So if the power goes out, all I have to do is to plug my light into a wall socket, and I don’t have to worry about a thing……

  • Posted by Twofish

    Investor: If the RMB appreciates a lot, does it have the potential to become an alternative to the USD as a forex reserve currency?

    It’s very unlikely in the next 20 years or so that China will be able or willing to make the RMB a reserve currency. Being a reserve currency means that you lose far more control that I think the government is willing to relinquish right now.

    Investor: Given that China has better Govt. finances.

    I don’t think that China does have better government finances than the United States. The taxation and public finance system is a mess. Better than it was a decade ago, but still a mess. Also, China has this huge unfunded pension and social security problem, that is going to get much more severe over the coming decades.

    Investor: Won’t this make China get much farther ahead of the US in terms of geopolitical influence?

    No. People are making the Japanese, Russian, Southeast Asian mistake. When you have a country in China’s current phase of development, you get extremely rapid growth, and people assume that the nation has found a new magic economic formula when all they are doing is generating growth by pouring concrete.

    It is real growth, but eventually it *will* stall. Over the next few decades, Chinese growth is going to rapidly decrease, and at what level it does stall at will determine the relative influence of China and the United States in the late 21st century.

    That’s something for my kids and grandkids to worry about.

    Also one thing I do find interesting is that in Chinese discussions of economics most of the discussion isn’t about the next year. There are crises, but it is assumed that China will muddle through them. The focus of the discussion is what happens in ten to thirty years.

  • Posted by Cedric Regula

    2fish:”But then you have to ask the question of how your mutual fund company converts its T-bills into cash and back, and where does it keeps its money….”

    I worry about that too, but not as much as I would if I opened up a checking account at Goldman Saks, now that they turned themselves into a “commercial” bank.

    So my good bank idea would be better yet. It puts a firewall between the power grid tentacles the banks have grown everywhere, and provides the closest thing to zero risk/zero return we could hope for.

  • Posted by Cedric Regula

    2fish:”Small enough to fail doesn’t always save you. Witness the Savings and Loan crisis of the 1980’s. Also there are regulatory issues to worry about. It takes fewer regulators to manage a small number of large companies than to manage a large number of small companies. You can argue (correctly) that small numbers of large companies may have too much influence on the regulators, but you see similar things with large numbers of small companies.”

    The other problem with this one is that now that banks have all interlinked themselves together with insuring each others default risk and interest rate risk is that effectively they are all one big bank now.

    So if either the market or Bernanke touches the interest rate lever, whats left of the system goes KABOOM !

    Bet that thought crossed Ben’s mind and may be part of the reason he he’s willing to buy long term treasuries to try and keep rates down.

  • Posted by don

    Brad –
    A really excellent post. Mankiw is turning into a bit of a kook, despite his considerable intellect and economic knowledge.

  • Posted by Ying

    Albion:

    “The private sector is meeting with the fate of financial strategies as opposed to industrial strategy.”

    I always enjoyed your insightful comments. Could you explain a little bit more about what you meant for the above sentence?

    I guess that the private sector has been successful in lowing cost (especially wages) by relocating production overseas. But they haven’t spend lots of resources on improving quality of products, research and development?

    I guess that US stimulus money won’t go into multinational firms. In the face of exchange rate adjustment pressure, what is the fate of multinational companies in the future? Will they scale back to home countries or find even cheaper places to reduce cost?

    thank you

  • Posted by Indian Investor

    In 2008, the Wall Street Bull passed away; and it was embalmed, mummified and buried under reams of the current account imbalance propaganda. Thus was the custom of the ancient Egyptian bull cults.
    After the good bank, bad bank, ‘ugly bailout’ debates are through, The Sacred Wall Street Bull will be re-inaugurated in a new Avatar. Dr.Roubini will hopefully take an Istan-bull vacation.
    A Framingham biotech company has just won FDA approval to extract A Tryn, an anti-clotting drug from genetically modified goats.This could clear the way for more “pharming” (producing drugs with genetically modified animals), even as the Industrial Production Paganism postulates more “farming” as a good industry for the United States.

  • Posted by Howard Richman

    Mankiw is saying exactly the opposite of what Keynes wrote during World War II when he tried to set up global institutions that would keep trade in balance.

    Keynes advocated that trade surplus countries be required to stimulate their economies and that trade deficit countries engage be permitted to engage in protectionist measures. He realized that balanced trade would be necessary for sustained globalization.

    Mankiw advocates that a trade surplus country (China) engage in import restriction and export subsidies, while a trade deficit country (U.S.) stimulates the world economy. He doesn’t yet understand that trade imbalances caused this great recession because the trade deficit country consumers could no longer increased amounts without increased income.

    Check out my blog entry from Saturday for some quotes on this subject from Volume 25 of Keynes collected works.

  • Posted by Albion

    One may wonder whether at this stage of the economic cycle, Keynes or Friedman therapies, theories are relevant ?
    Interest rates do not cure anymore they could have prevented, money supply in abnormal use has been more a deterrent than a help to the economies.
    Solvency is impaired by a lack of revenues and profits, consumption by decreasing and weak real incomes all of these in relation to prices. The rest is trivial good sense omitted by central banks and their partners.

  • Posted by Twofish

    Cedric: I worry about that too, but not as much as I would if I opened up a checking account at Goldman Sachs, now that they turned themselves into a “commercial” bank.

    If is FDIC insured then it’s backed by the same level as guarantee as your Treasury bonds. It’s been extended to all checking and savings accounts.

    Cedric: So my good bank idea would be better yet. It puts a firewall between the power grid tentacles the banks have grown everywhere, and provides the closest thing to zero risk/zero return we could hope for.

    No better than a FDIC insured checking account.

    Then you have a new problem. If the US government is the only one that any dares lend to that means that Lucy’s Ice Cream shop doesn’t get the bank loan to buy the new ice cream machine.

  • Posted by Albion

    Ying@
    This growth cycle was led through finance and not technological innovation or population growth. The mantra of these past years, was leverage the balance sheet, rig prices (book value as opposed to cash flows multiples).
    Central banks and public entities, my bonds against your oil, my bonds against your goods and now my bonds against your will.

  • Posted by Howard Richman

    Albion wrote: “One may wonder whether at this stage of the economic cycle, Keynes or Friedman therapies, theories are relevant?”

    It is necessary to differentiate between Keynes real theory and the comic-book-version practiced by economists who never even take the time to read Keynes.

    Keynes understood trade deficits. Check out the December report from the Keynesian economists at the Levy Economics Institute at Bard College?

  • Posted by bsetser

    Benign — focus on the difference between china’s exports and its imports, not just the fall in its exports. china’s trade surplus is going up not down.

    Gillies. I may be saying through darts at China (really its exchange rate regime), as i do believe that the massive purchases of us assets required to sustain that regime contributed to a host of problems in the us — and ultimately won’t be good for China.

    but please don’t tar the CFR with my personal views.

    indian investor — the rmb is not a potential reserve currency until it is freely convertible and other countries are able to hold rmb debt as a reserve asset. i.e. being a reserve currency means accepting inflows form countries wanting to hold your debt as a reserve asset …

  • Posted by Off the boil

    Brad – Repeatedly, why are you not addressing the US issuing loads of debt every other week ?

    Indian Investor has said the problem starts with US ISSUING DEBT.

    HAd it been controlled the whole implosion that is waiting to happen could have been avoided.

    Someday the auctions are going to fail and all hell break lose.

  • Posted by Cedric Regula

    2fish:”Then you have a new problem. If the US government is the only one that any dares lend to that means that Lucy’s Ice Cream shop doesn’t get the bank loan to buy the new ice cream machine.’

    I’m OK with that.

  • Posted by bsetser

    off the boil — i have addressed the issue. see my post arguing that china hasn’t been the main buyer of treasuries and my post arguing that the us placed $1.6 trillion of debt in the market in 08. i have argued that the stimulus necessarily will be financed far more by domestic than foreign investors, as the aggregate current account surplus (and thus their abiltiy to finance the us) is shrinking. and yes, i support the stimulus — as my previous post made clear.

    giving an answer that not everyone agrees with isn’t quite the same as ignoring an argument.

  • Posted by Glen Mikkelsen

    It is rather surreal seeing someone post frequently here with pretty much exactly the same name as mine. I seem to recall that posting style from before, and I hope I am not being hit by some impersonator (very sorry for offending you, Glen M., it this is not so).

    I find myself agreeing with Twofish’s first post a lot, but apart from currency not being a genuine concern right now in Washington or Beijing (other than for media purposes and politicking) the status of the dollar remains the elephant in the room.
    It is bizarre that it is currently appreciating again and the combination of present valuations, bond yields, the deficit and the economic outlook really should cause everyone to take a good long hard look at some of Trevor Manuel’s comments at Davos and Justin Liu’s very ‘professional’ remarks too. Its a house of cards having the global economy this tied to the dollar, and eventually we will all have to face up to that.

  • Posted by Indian Investor

    Brad: giving an answer that not everyone agrees with isn’t quite the same as ignoring an argument.

    Me: I’ve been repeatedly advising people that the current series of Treasury issuance will be successful, and that an effective US banking system will soon be created. However, the long term stability of the US Govt. is at risk due to unsustainably high levels of US Govt. Debt. The reason for a $10 trillion public debt of the US Govt. is its long compulsions of borrowing money from foreign governments to meet defence expenditures. Given the current levels of Govt. debt, continued policy of global military domination, continued control of relevant Govt. organs by the weapons conglomerates; The US Govt. is inexorably heading for a sovereign default, as simple arithmetic on the USG finances will show.

    I expect another big crisis to occur by around 2014 or so, and at that time the US dollar will truly have nowhere to hide. In the immediate future I expect a stock market rally and a general recovery of major economies.

  • Posted by DOR

    Greetings after a prolonged absence.

    .

    If we ever actually had a consensus that China’s renminbi is undervalued – as opposed to, say the US dollar being overvalued – then the entire annual exercise that Congress and the Treasury engage in might be of some interest.

    There wasn’t a consensus back 7-8 years ago when the first report was produced (the infamous 27% solution: average a bunch of numbers that contradict each other). And, even after a 20% rise in the exchange rate and cumulative 11% inflation (both since June 2005), this nonsense remains one of the key issues between the two countries.

    .

    Of course the US benefits from cheaper Chinese goods! Just ask anyone who shops at Wal-Mart, K-Mart, Target or other low-price stores out of necessity, rather than out of choice. Why in the world would any politician want to punish those consumers?

    Of course “some in the US are on the losing end of the ‘low-priced Chinese goods for high-priced US government bond’ trade. They are the people working for companies that haven’t upgraded their productivity in far too long. They are people who expect to get by on the same skill sets and the same education as they did 20 or 30 years ago. They are also, people seem to forget, about 3% of the US population . . .

    Of course China cannot subsidize US consumers forever, but do we really want this to be the centerpiece of Sino-US economic relations?

    Isn’t it time to move on?

    (And, forgive the analogy, but isn’t blaming China’s influence on US interest rates for the American consumption binge a lot like blaming screw top caps for alcoholism? Access, after all, does not necessitate over indulgence.)

  • Posted by Off the boil

    Indian Investor – why 2014 ? Why not a part of the recession period ? Surely 2010 appears to be a good bet.

    I dont think we can emerge from this recession unscathed.

  • Posted by Indian Investor

    @Off the boil: Fortunately my views on the US Govt. finances aren’t controversial at all and I’m just repeating what something called the accountability office has been repeatedly warning for quite some time.
    USG has a total debt of $10 trillion plus and the lowest estimate of this year’s deficit is “more than $1 trillion”, from Brad Setser. Other commentators are guessing anywhere from $2 trillion to $ 3 trillion.
    If the US Govt. is paying interest on its $10 trillion debt, that interest is being paid out of more borrowings, rather than from its own surplus.
    The US latest annual trade deficit with China is close to $20 billion. Even if you assume trade deficits with China have been at the same level for the last 8 years, you’re only accounting for a max of $ 160 b in USG Govt. debt, with an assumption that each dollar of China trade deficit leads to a dollar of USG debt.
    Where’s $160 billion over EIGHT years and where’s a TOTAL USG debt of more than $ 10,000 billion?
    In this analysis we’re ignoring the estimates that very soon trillions in medicare and social security are going to fall due in the next few years, so the USG deficits are likely to widen further rather than soften.
    Despite these terrible looking numbers I don’t expect the USG to default in the immediate future. To paraphrase Dr. Roubini, let me now explain in detail why.

  • Posted by Indian Investor

    Sorry small correction: China has a trade surplus of around $200 billion and around 40% of its exports are to the US. So the latest US trade deficit with China is likely closer to $ 80 billion, and not $ 20 billion as I mentioned above. The trade deficit with China accounts for something like 45% of the overall US trade deficit.
    Even with this correction, it’s easy to see that the level of total USG debt can’t be explained by China imports, or imports overall, over the last 8 years.

  • Posted by Indian Investor

    Why at least 2014?
    As of now the US dollar has a “unique role in international trade” and thereby offers “an exorbitant previlege” to the US Govt. to run “painless deficits”. (These are official terminologies so there’s nothing controversial in using them.)
    The dollar’s unique role is that most of the international trade amongst third-party nations is settled in USD. Of this, the most compelling is the trade in crude oil, a commodity that most countries import.
    Till recently around 63% of foreign central bank reserves were held in USD. Combined these together, and you get a realistic explanation for why the USD is overvalued more than 1000% in most exchange rates.
    This situation never came about as a result of “mercantilism”.
    This is more a result of US foreign policy objectives since the 1970s, starting with Middle-East military agreements, and the exercise of other geopolitical influence to make sure that the surplus of oil-exporting nations can be accumulated in USD and recycled.
    The USG will stop receiving foreign funding only when foreign central banks shift away from the USD for their reserves. That requires a shift away from trade settlement in USD. This process requires a widespread perception and understanding that the US geopolitical influence is at an end. That influence is derived from the US military.
    Unless the US military loses its ability to dominate the world, there will be no complete drain on foreign funding for the USG.
    Secure in this knowledge, advantages can be gained by asking China to strengthen its RMB, so that the Chinese economy can suffer a further pandemonium, and just as in the case of Argentina in 2001-2002, larger chunks of the local equity market can be purchased by foreign investors at 10 cents on the dollar.

  • Posted by Indian Investor

    Why at least 2014?
    I’ve mentioned this in other deleted comments, but: Since 2008: German foreign minister Steinbruck said in media interviews that he prefers a combination of USD, EUR, JPY and RMB as forex reserves rather than predominantly USD. GBP was conspicuously absent in his list. At Davos, Russia’ Putin warned against excessive reliance on one reserve currency. Iran’s Ahmedinijad made self congratulatory speeches in which he claimed that his decision to replace the USD with EUR in Iran’s reserves was both politically and economically advantageous. Even French President Sarkozy expressed misgivings about the USD prior to the 1st G-20 crisis summit.
    The update is that Russia seems to be rapidly exchanging USD from its reserves for trade & political advantages, a move that Dr. Roubini predicted in his writing with the topic something like “Decline of the American Empire” in late 2008 which is there on his web site.
    Last week, Russia made out a $350 million loan to Cuba in exchange for information and drilling rights in the Cuban part of the Gulf of Mexico. At a summit of the newly rejuventated CSTO (Collective Security Treaty Organization), Dmitry Medvedev offered a full $2.15 billion to Krygystan, $ 2 billion in loans and the rest in aid.
    Now I have given you the direction in which you need to reason to know when the USG may at all be forced to default. You have to know the geopolitics from Darfur to Afghanistan, and it’s no joke. My guess is that it will take at least a few more years for the ROW to come to any drastic conclusions about the “value of the US dollar”.

  • Posted by cdr

    With regard to bonds and the will, why then don’t Europeans just sell the complete collection of their Treasuries and refrain from any further flow in this direction ’cause we are all getting fed up here with US and EU »talking« through BoE, Ponzi, China and both types of commodities (WoT inclusive).

  • Posted by cdr

    and stop the stupid Ponzi prolonging swap

  • Posted by bsetser

    Indian investor — china’s current account surplus is now arond $400b, and its reserve growth is over that b/c f net capital inflows. I published estimates of China’s holdings of US assets/ past purchases grounded in the bop data and the TIC that you clearly didn’t read. Please don’t post inaccurate data.

    DOR — I strongly disagree. There was a consensus that the RMB was undervalued in 06 and 07. The IMF’s analysis consistently reached that conclusion. China’s huge current account surplus amid an investment boom also supports that conclusion. As does China’s reserves growth.

    that consensus isn’t as solid now for a simple reason — the dollar’s rally finally pushed the RMB up in real terms. the 20% nominal appreciation of the rmb over that time never matched the dollar’s depreciation. Your analysis left out a key fact, namely what the dollar is doing v other currencies.

    and the notion that the only reason the us cannot compete with China is because the us hasn’t upgraded its skills is false. furniture production rather clearly moved to china because of the undervalued exchange rate — once wages and transportation costs rose, there were economic incentives to move production back to the US (the raw material inputs are found in n. america, not china … ). Moreover, china is upgrading its skills — as it should. the basic reality is that so long as China maintains an exchange rate that generates a 10% of GDP current account surplus, other countries will be producing fewer tradable goods and shifting the composition of output away from the tradables sector to make space of the excess tradables production generated by china’s undervalued exchange rate. the composition of output globally and in the US changes. I don’t usually agree with Lawrence Lindsey but he got this absolutely right.

    I’ll do a post on the real value of the RMB soon.

    incidentally, the dollar is overvalued — and it can only be overvalued if some other currencies are undervalued. and if china pegs to the dollar and the dollar resumes its slide, the net result is an undervalued rmb. that is the core problem. the us currency and china’s currency should be moving — based on their respective external positions — in different directions.

  • Posted by Glen M

    Glen Mikkelsen,

    No intended impersonation. The similarities in name end at Glen M.

  • Posted by Kaushal

    Hey, I am really benefitted by you Guys. Thank you all.

  • Posted by don

    Brad, In your answer to DOR, reserve accumulation automatically means an undervalued currency. China is doing no service to an aggregated-demand-challenged world by forcing domestic saving, which is exactly what its currency interventions are doing. Time to start strongly discouraging this policy.

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