Brad Setser

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Not putting your money where your mouth is

by Brad Setser
May 13, 2009

In March, China’s premier expressed concern about the safety of China’s (large) investment in the US, including China’s investment in Treasuries. China’s citizens have realized — rather belatedly — the risks associated with holding more reserves than China really needs.*

And some in Japan are also now starting to worry about the safety of Japan’s dollar-denominated Treasuries.

You might think — based on all this chatter — that central bank demand for US Treasuries has waned.

It hasn’t.

Central bank holdings of Treasuries at the New York Fed have increased by over $500 billion over the last 12 months. Central bank purchases in the 12ms through March set an all-time record – and purchases in the 12ms through April are only a bit lower.

Central bank holdings of Treasuries at the New York Fed rose by close to $100 billion in the first quarter of 2009. That is down from the $250 billion increase in the fourth quarter of 2008, but it had to fall from that pace: $ 1 trillion in annualized Treasury purchases is rather hard to sustain when central bank reserves are falling. The $100 billion central bank added to their Treasury portfolio at the Federal Reserve over the last three months of data is still more than central banks bought in late 2003 and early 2004 – a time when Japan was buying what then seemed like huge quantities of Treasuries.

Indeed, the rise in central banks’ Treasury holdings over the last 6 months is far larger than can be explained by the (non-existent) growth in central bank reserves. It reflects a shift out of Agencies — and (less discussed) a shift out of large deposits in the major international banks. Treasuries aren’t free of all risk, but central bank reserve managers have concluded that they are less risky than other dollar-denominated reserve assets.

The pace of outflows from the Agency market is a warning against too much complacency on the United States part. If central bank reserve managers do lose confidence in an asset, they can go from buying large sums to selling large sums quite rapidly. Confidence is a mysterious thing. Reserve managers stopped buying Agencies rather suddenly; there wasn’t much advance warning. The fact that most most recent central bank inflows have gone into short-term bills is also a signal of sorts. Central banks either are desperate for the most liquid asset of all — or they haven’t been comfortable buying lots of ten-year dollar-denominated notes at yields under 3% and risking mark-to-market losses if Treasury yields eventually rise.

At the same time, most reserve managers worry far more the risk of visible losses, especially credit losses, than about returns. They also need to make sure that they hold enough truly liquid assets to cover their countries immediate needs in a crisis. Right now most central banks seem to be more worried about the risk that they will find themselves with too few liquid US Treasuries rather than the risk that they will hold too many.

Indeed, it isn’t inconceivable that if the gap between the yield on short-term bills and longer-term notes gets large enough, credit-risk adverse reserve managers who want a bit more yield will shift out of bills and into longer-term notes. Central banks do need some income. And they are more comfortable taking interest rate risk than credit risk. Optics.

All the talk about the risks of holding Treasuries, central bank demand for Treasuries also has held up far better than central bank demand for almost any other asset. Central bank demand for Treasuries hasn’t grown as fast as new issuance. Indeed, for the first time in years, central bank reserve managers aren’t absorbing the majority of the Treasury’s new paper. But that is entirely a function of the huge size of the US Treasury’s borrowing need, not a function of any fall in central bank demand.

And in some sense it is strange that the major central banks haven’t publicly talked about the risks of the assets that they are selling, while the national leaders of a few key countries with big reserve portfolios have publicly discussed the risks of the assets that they are buying …

* The usual argument is that the US will inflate away the value of China’s Treasuries. That argument clearly puts blame for any fall in the value of China’s Treasury holdings on US policy makers. The bigger risk though is that the dollar will fall against China’s currency, reducing the CNY value of China’s external portfolio. That fall could happen even if inflation in the US never picks up, as there are strong fundamental reasons to think that renminbi should rise over time against the dollar — and, for that matter, the euro. However, it is far harder to attribute losses from currency moves to bad US policy — as China’s leaders opted to build up their dollar reserves in order to keep China’s currency from rising. That policy helped China’s exporters, but it also exposed China’s taxpayers to the risk of future losses — as they were effectively “over-paying” for dollar reserves that China didn’t need for its own financial stability.


  • Posted by Twofish

    A lot of what is going on is because the financial media makes things more dramatic than they really are. Wen Jiabao mentions some concerns about Treasuries, and then CNBC starts screaming “CHINA ABOUT TO DUMP TREASURIES” or better yet you have talking heads talk about “IS CHINA ABOUT TO DUMP TREASURIES? ARE WE ABOUT TO HAVE INFLATION? IS THE WORLD ABOUT TO END?” and you get people screaming at each other which is good for advertising revenue.

  • Posted by djc

    China warns US law proposal could cause dangerous protectionism

    BEIJING, May 14 (AFP) May 14, 2009

    China Thursday criticised a plan by US lawmakers to retaliate against countries that allegedly manipulate their currencies and warned the move could lead to protectionism.
    “Any groundless accusations against China on this issue will only encourage the trade protectionism,” foreign ministry spokesman Ma Zhaoxu told reporters.

    “The international community, including the United States, is clearly aware that the Chinese government has never made any profit in international trade by manipulating the exchange rate,” he said.

  • Posted by djc

    For 20 years, China has accelerated into the most rapid and sweeping large-country industrial revolution we have ever seen in world history. The changes are real. We are seeing a transfer of industrial production from many locations. Transnational firms from the US, the euro zone and Asia have come for the infrastructure, wage rates, environmental policy, workers and market.

    For many years the US and China have shared a transnational economy. Chinese lending and export are inextricably interwoven with US import and borrowing. China is now the world’s second-largest exporter and is responsible for 9% of world trade. China is the largest source of manufactured imports for the US and the European Union.

  • Posted by RED

    Both Japan and China know that if they stop buying dollars, their export economy’s will be ruined as their currencies appreciate.

    So by all means China, make your currency convertible, it should be quite amusing to see their economic collapse.

  • Posted by q

    brad, are you going to respond to roubini’s op-ed in the times?

  • Posted by bsetser

    nouriel should have given me a heads-up! i will probably comment on it, though maybe not today.

  • Posted by anon

    Your blog is a must-read.

    Usage note:
    The adjectives adverse and averse are related both etymologically and semantically, each having “opposition” as a central sense. Adverse is seldom used of people but rather of effects or events, and it usually conveys a sense of hostility or harmfulness: adverse reviews; adverse winds; adverse trends in the economy. Related nouns are adversity and adversary: Adversities breed bitterness. His adversaries countered his every move. Averse is used of persons and means “feeling opposed or disinclined”; it often occurs idiomatically with a preceding negative to convey the opposite meaning “willing or agreeable,” and is not interchangeable with adverse in these contexts: We are not averse to holding another meeting. The related noun is aversion: She has a strong aversion to violence. Averse is usually followed by to, in older use occasionally by from.

  • Posted by guest

    Should the global negative growth be prolonged it may impair the global resources.
    It would be informative to have in amount and time schedule the debts issuance program for the G7 countries? The debts issuance programs banks and sovereign are sizeable.
    China may as well have to divert more and more external surplus to cushion the banking sector recent consumers and others loans programs.
    Whilst it may have an adverse impact on the net worth of the banking system, proclivity domestic growth may be aversed to this scenario.

  • Posted by Glen M

    While it is true that “the Chinese government has never made any profit in international trade by manipulating the exchange rate”, that is not the point. First, it is interesting that Ma Zhaoxu admits that China has manipulated its currency. Secondly, while it is correct that China has not profited (directly), its manipulations have also not caused schistosomiasis. By nature, devaluing your currency cannot be profitable.

    As Howard Richman, Peter Morici, etc. have stated, it was a tool of mercantilism.

    PS. Is there a Chinese translation of “Animal Farm” available?

  • Posted by Jian Feng


    Sorry to bring up an off topic issue that you might want to follow. What do you think of Dr. Doom’s Op-Ed piece on today’s NYT and the quasi-ultimatum by Mr. Gao? It’s alarming to hear that many shops in China now do not accept dollar-based credit cards.

  • Posted by FollowTheMoney

    I’m curious where we can find the % increase of T-bills the Federal Reserve has been buying the last 6 months?

    Be interesting to compare Fed purchase of government debt vs. China purchase of U.S. govt debt.


  • Posted by guest

    The Hong kong dollar is pegged to USD since ages Do they accept HK dollar credit card or shall the USD be converted to HK ?

  • Posted by LawrenceW

    When I visited Germany(Frankfurt area) recently, the decline of the dollar’s allure was very real at the retail level.

    It is especially striking in comparison with my trip to Germany in 1999,
    when dollars were freely accepted at close to wholesale rates.

    Shops and hotels were all reluctant to accept dollars. I was either
    asked to go to the bank,
    or given such a bad exchange rate (1.5 dollar/euro or worse) that they
    clearly do NOT want dollars.
    Banks and currency exchanges(e.g. Travelex) are no better, with commission and fees.

    Best deal – withdrawal at Deutsche Bank GeldAutomat(ATM) with Bank of America debit card, e.g. 1.3257 vs 1.3125 wholesale rate on April 27th.

  • Posted by WStroupe


    I would assume from reading this blog over the past several weeks that a significant portion of China’s purchases of short-dated Treasuries since the fall of 2008 have been due to its ongoing conversion of Agencies into the short-dated Treasuries, correct? Can we perhaps see this in a graph that depicts China’s purchases for this conversion and also depicts its purchases related to keeping the rmb “stable” against the dollar? Could such a graph also include lines for the other big central banks?

    I would suppose that, being patient and deliberate, China’s CB managers would like to come near to finishing their conversion out of Agencies before they take on any other potential conversion, say from longer-dated Treasuries to short-dated ones. Is it possible to see if China is beginning this second conversion of assets? This is the one we should especially watch for, I think.

    You task China’s leaders to put their money where their mouth has been recently – you just might get what you asked for when their conversion from Agencies gets sufficiently far along. Once they get into the short-dated Treasuries, it’s much easier to sprint from there to somewhere else that’s more desirable from a safety and/or return perspective. While short-dated Treasuries are certainly the safest and most liquid financial assets around, there might turn out to be other assets (not necessarily financial assets) that are even more desirable, going forward. Conversion from short-dated Treasuries into such other assets could be the planned 3rd leg of a 3-leg strategy. 1. Get out of Agencies and into short-dated Treasuries. 2. Get out of a significant measure of long-dated Treasuries and into short-dated ones. 3. Expend a large measure of short-dated Treasuries for other non-dollar assets.

    All over time – not too suddenly. China’s leaders probably know they have a couple of years or so to get this all done to a sufficient degree so as to measurably decrease China’s exposure to the dollar. And the increased U.S. domestic savings rate relieves China of some of the burden of financing the U.S. Treasury as U.S. citizens step up to buy Treasuries, thus affording China an opportunity and some breathing space to execute its 3-legged strategy.

  • Posted by bsetser

    Jian — American retailers don’t accept RMB or euros either; a world where the dollar was accepted globally but foreign currencies aren’t accepted in the US isn’t likely a long-term equilibrium. Most internal transactions in large economies (US, Eurozone, China) will be in the local currency.

    WSTroupe –you are asking for quite a lot. on a 12m basis, the fed has been a seller not a buyer of treasuries, but that is obviously changing, and isn’t true on a 3m basis. my updated paper on china’s treasury holdings (just out at the CFR/ available on my cfr bio page) has some data comparing chinese purchases to pruchases by other big central banks and the global total.

    and as for 3), china clearly has been doing more deals that involve large (dollar, i think) loans to resource exporters who need s-term financing …

  • Posted by John McLeod

    Brad, Something weird must have happened on January 1st of this year. Any idea what?

    Nine days after Bruce Harting’s 7/7 2008 research note, July 16th of last year, foreign central bank holdings of agencies peaked at $985.9 billion. The holdings then went parabolic for 24 weeks, with an average weekly sell-off of $7.1 billion until the holdings reached $814.5 billion on Dec 31st.

    Over the 18 weeks following that (all this year, not including yesterday’s number that is due out in 3 hours) the holdings have been nearly perfectly flat ($811.1 billion plus/minus just $6.7 billion — most recently $812.1 billion; data set transcribed from NY Fed available at our web site).

    My assertion is that from the beginning of the year some central bank(s) must have been undertaking to buy agencies whenever others have sold. Thoughts?

  • Posted by John McLeod

    Just to save a bit of time, here’s the Roubini NYT Op-Ed referred to above:

    “The Almighty Renminbi?”, by Nouriel Roubini, New York Times, May 13, 2009.

  • Posted by Cedric Regula

    The Across the Curve blog that Brad has a link to here is a daily blow by blow of the bond market. The blogger knows when the Treasury is auctioning what, and when the Fed is buying. He doesn’t know what the Chinese are doing however.

    Last week has a big week for long end treasury sales, and we got a big move down in prices, at least by bond standards. Across the Blog described Thursday’s 30 year auction as “almost failed”.

    This week the Treasury is on hold, and the Fed is doing QE buying, quite a bit of it longer dated. Prices have rallied and made back maybe half of last weeks losses so far.

    Of course this may have been aided by some bad econ data this week. The stock market is beginning to have concerns that the recent economic recovery we had on Wall Street may only be a virtual recovery, and the real recovery may not come as soon as expected.

    So typically this means flow from stocks to bonds, but then again we get the “short dated” vs “long dated” question and the volume seems to go for the short end.

    Also, it’s hard to imagine the Fed wants or can spend a lot of QE on the long end. No one wants the stuff for a buy and hold long haul.

  • Posted by WStroupe

    bsetser said: “WSTroupe –you are asking for quite a lot.”

    I know, but who else on the planet could put such numbers together, and have it turn out pretty reliable?

    Such a graph(s) would be very enlightening as to China’s strategic direction and strategies, especially if it was updated periodically going forward, no?

    But I know this might not be possible to pull all together. But if it was, Oh Baby!!!

  • Posted by bsetser

    John — Russia was a big seller, but it cannot sell more than it has, and it no longer has any agencies. Chinese sales seem to have slowed a bit (or Chinese sales are offset by someone else buying). I suspect that other central banks were comforted by the fed’s purchases — they know the us isn’t gonna default on something the fed holds a lot of. Signalling. And a dem congress and dem president aren’t hostile to the agencies in the way the Rs are, so there might be more confidence there as well.

  • Posted by FollowTheMoney

    I believe Geithner is in Europe (Greece) now, and then later in the month heads over to China. Some pretty big meetings…

    Greater chance of deflation than hyperinflation for now. But some one needs to cool down the T-bill bubble. If not, the pop of the t-bill bubble will potentially be much more harmful than the pop of the real estate bubble. Chinese taxpayers, certainly have alot of risk as the chinese government has but all it’s eggs in one basket.

    Now what?

  • Posted by Don the libertarian Democrat

    “Indeed, it isn’t inconceivable that if the gap between the yield on short-term bills and longer-term notes gets large enough, credit-risk adverse reserve managers who want a bit more yield will shift out of bills and into longer-term notes. Central banks do need some income. And they are more comfortable taking interest rate risk than credit risk. Optics.”

    This is indeed the plan of QE. The point is to keep short term interest rates low,in order to give an incentive for higher yield, and have longer term interest rates rise, attacking deflation and showing a recovering economy. Both are aimed at the Fear and Aversion to Risk.

    Eventually, there should be a move to longer term bonds with higher yields. In my mind, this would be a good thing.

  • Posted by WStroupe

    Wait a minute, here – isn’t the aim of QE to flatten the yield curve by LOWERING longer-term yields and interest rates tied to them, and to thus fight deflation via reflation (low interest rates tied to low yields)?

    If the yields on the longer-term Treasuries rise, then that’s a sign QE isn’t working. And Brad, who’s going to buy the longer-dated Treasuries with larger yields if a trend of escalating yields on such assets is recognized by investors? Why buy something whose base value is getting eroded after you purchase it?

  • Posted by Cedric Regula

    Don:”Eventually, there should be a move to longer term bonds with higher yields. In my mind, this would be a good thing.”

    Yup. It would be more stable because we would have “hold to maturity” investors at the long end. Right now I think we just have nimble traders looking for a little yield, but they intend to trade out at the first sign of rising rates.

    Problem is we are addicted to low rates on so many levels. USG debt, housing prices, consumer debt, and corporate financing.

    The adjustment here won’t be pleasant, but then again if any government could just quote what interest rates will be, and then print an infinite amount of money as needed to make it so, wouldn’t someone have tried it already in the history of Mankind?

    That was intended to be a joke.

  • Posted by Cedric Regula


    The Fed has been arguing among themselves if they should spend their QE on the long or shorter end.

    The problem is the best answer is buy everything, and of course they really can’t. So far the market has been buying the super short end, but that could change as risk aversion fades.

    They have to keep longer treasuries from bumping up mortgage rates, because they are trying to support housing prices.

    A mortgage banker told me once that 30 year mortgage rates really are a 7 year rate because stats show that is the average life of a mortgage due to people selling and moving… either up, down, or different geography.

    If the mortgage industry still believes that, then the fed would want to flatten the middle of the curve and keep some powder dry in case the short end tries to get away.

    I can almost see them just discontinue selling new 30 year bonds.

  • Posted by WStroupe

    Cedric Regula,

    Yes, the U.S. economic model (asset-based) damn well won’t run without very low interest rates – it suffocates without them. See the present crisis, which the Fed is trying to resolve by reviving bubbles (sorry, “reflating”) via extremely low interest rates. As Roubini points out today at the NY Times, unless the U.S. gets back to a traditional income-based model of economic growth, we’re just about hosed going forward.

    This isn’t merely a cyclical downturn – this is the full-blown crash of the asset-based economic model. In that perspective, you now have very potent rivals like China ready to capitalize and step into the forefront. Roubini has it just right today.

  • Posted by John McLeod

    Thanks for your insight, Brad.

    Today’s new H.4.1 found cenbanks’ treasuries rose $29.341 billion in week, agencies up $5.393 billion. The treasuries number is the 2nd highest weekly figure ever (or at least since Feb 2000). It eclipses the old #2 mark of $26.762 billion from just four weeks ago. What does it take to make these guys excited?

    “Foreign cenbanks buyers of US debt in week — Fed”, by Chris Reese, Reuters, May 14, 2009.

  • Posted by KnotRP

    Buying something while you talk it down is called “talking your book”….why are we suprised?

  • Posted by Cedric Regula

    John McLeod:”My assertion is that from the beginning of the year some central bank(s) must have been undertaking to buy agencies whenever others have sold. Thoughts?”

    It’s the Fed! They are buying $1.25 Trillion in MBS and $200B in GSE corporates.

    This blog here is tracking all the Fed and Treasury program dealings and is posting an updated weekly cumulative total. They blog on a number of other topics as well, so you may need to dig around to find the charts on USG participation in all our debt markets.

  • Posted by Twofish

    Cedric: The adjustment here won’t be pleasant, but then again if any government could just quote what interest rates will be, and then print an infinite amount of money as needed to make it so, wouldn’t someone have tried it already in the history of Mankind?

    Strangely enough no. There’s this thing called the “paradox of thrift.” People assume that because it makes individual sense to cut back in a credit bust, that the thing to do is to have society cut back, when in fact it’s the worst possible thing that you can do.

    In the 1930’s, it took about ten years before people figured out to get out of a depression, you need to print massive amounts of money and then do something completely unproductive with it. (It’s called World War II).

    The other time it’s been tried and succeed was in the mid-1980’s, when the US got out of the recession of the early 1980’s. Again, you print massive amounts of money and do something completely unproductive with it (i.e. build a massive military).

    In every single case where I can think of a deflationary credit bust, the solution to getting out has been to print massive amounts of money. I can’t off hand think of a single case where a deflationary credit bust has been cured by cutting back.

    Now if you have an *inflationary* or *stagflationary* situation, it would be very different, but we don’t. The fact that unemployment is at 8% and rising says that we aren’t getting out of this by cutting back.

  • Posted by Twofish

    Since the 18th century people have tried to make points about their own society by talking about China. Voltarie does this a lot. The trouble with this is that even though they mention China, they really are totally ignoring what is going on there.

    It’s part of the literary tradition that goes back to Tacitus who talked about the virtues of the barbarians as opposed to the decadence of Rome.

    Anytime you have a fill in the blank story, you have to wondering if you are really seeing what is going on rather what you want to see.

    There is just no possible way that the renminbi will displace the dollar as a reserve currency in the next twenty years. The only serious competition that the dollar has is the euro.

    A lot of the “we are doomed if we don’t learn from China” sounds a lot like the “we are doomed if we don’t learn from X” that happens every ten years or so.

  • Posted by Twofish

    One other question that is interesting is why do people always mention China. Why don’t people do a comparison with India or the Middle East.

    The reason I think is that China is big and diverse, and whatever political or economic point that you want to make, you can use China to support it.

  • Posted by Cedric Regula


    Yes, I’m familiar with this abbreviated and economically censured version of history.

    But the credit busts were always preceded with massive credit expansion or printing of money.

    The Roaring 20s, German Hyperinflation, Johnson’s Vietnam plus Great Society, Reagan’s Winning the Cold War(which started in 1980 by the way), Greenspan’s Fighting Deflation.

    Then I guess it means we are going to have WWIII? Which reminds me, the world printed a lot more money after WWII than before. England had to build a new London. Similar problems many other places.

    And yes, I can’t think of anything else to do, but we have never figured out a good way to distribute all the new money.

  • Posted by Don the libertarian Democrat

    On QE, see Nick Rowe here:

    “Good News! Interest rates rise.

    This Bloomberg story reports the Fed saying that rising bond yields are a good sign. They don’t precisely say that monetary easing is what caused the rise in interest rates; they are perhaps too modest to claim credit? But I will say it for them: by buying bonds, and easing monetary policy, the Fed has caused the price of bonds to fall, and interest rates to rise. Yep, an increase in demand for bonds causes the price to fall.”

    Read on.

    For my main views about Helicopter Money, read here:

    Read W.Buiter “Helicopter Money” here:

    and here:

    Read Remarks by Governor Ben S. Bernanke
    Before the National Economists Club, Washington, D.C.
    November 21, 2002 Deflation: Making Sure “It” Doesn’t Happen Here”

    My view:

    “I thought that the plan of QE was to keep short term interest rates low, giving investors an incentive to invest in other higher yielding pursuits now, and have longer term interest rates rise, showing that deflation is being defeated and signaling a recovery in the future when rates will have to go up. In other words, QE attacks the Fear and Aversion to risk with short term incentives and longer term confidence. As far as I can tell, it’s working pretty well, if slowly.”

  • Posted by jonathan

    Why do you put your best observations in the footnotes? Modesty?

    You raise a very interesting point.

  • Posted by DOR

    Two questions on the outlook for the Renminbi:
    -o- Has there ever been a reserve currency issued by a nation that doesn’t have the rule of law, or even internationally accepted accounting practices?
    -o- Has a reserve currency ever been issued by a nation that is generally poorer than those who hold its currency in reserve?
    -o- The key value of issuing a reserve currency is the ability to issue debt in your own currency. The debt the US issued, over the past many decades, was mainly for global defense (it sure wasn’t for healthcare!). What would another reserve currency issuer issue debt for?

    = = = = =


    My Hong Kong dollar credit card is just as good today as it was when I first got it, 25 years ago. What’s your point?

  • Posted by Tono

    WSTroupe, I agree with you that a if long-term yields signifies a failure of QE. In my blog, I track on a weekly basis the status of the different purchase programs and plot them versus the UST30 yield and USD index because this is where I believe the hidden costs will show up first. Their deterioration, a barometer of market perception of QE, has indeed happened, with yields rising 40bps and the USD dropping 7%.

    I have posted my latest update today on:

  • Posted by WStroupe

    Exactly, Tono. And that’s why it’s called Quantitative EASING, because the Fed is trying to EASE monetary policy, not tighten it. Higher yields and higher interest rates tied to them would amount to a tightening, not an easing.

    This asset-based economic model is suffocating in the absence of the requisite massive credit excess the model thrives upon. Credit excess means easy money, not tight money.

    Far too many people here and most everywhere evidently fail to see this crisis in its correct fundamental perspective, namely, the crash of the asset-based model itself. The crisis emerged here in the U.S., spread havoc around the globe, and now manifests itself in many forms. But let’s not fail to see the root cause, as both Krugman and Roubini have very lucidly reminded us – the asset-based model, and all the shenanigans it facilitated and encouraged, has failed, utterly. Hence, this crisis’ resolution for the U.S. is about far more than rebooting a crashed model. It’s about switching back to a more traditional income-based model. That will be a gut-wrenching process entailing far more pain and suffering than the U.S. has experienced so far, and it only gets worse the longer U.S. leaders waste precious time and money trying to revive the asset-based corpse.

    Taking all of the moves of China and its global partners together in a big picture, looks to me like they know this stuff and they’re steadily and incrementally working to really bring about decoupling – over the next 2-3 years – so they won’t be so exposed to what happens (the REAL ugly stuff) to the U.S. going forward.

  • Posted by guest


    My point, It seems illogical to have doubts on the USD when you own currency that is the HKD is pegged on the USD and reserves the same.
    As irrational as subprime derivatives not looking the primary function that is the mortgages lenders and the underlying prices of their assets.

  • Posted by Twofish

    WStroupe: Far too many people here and most everywhere evidently fail to see this crisis in its correct fundamental perspective, namely, the crash of the asset-based model itself.

    I’m not seeing it because I don’t think it is true. You’ve had asset booms and busts happening for the last 200 years, and I’m not seeing anything in this bust that is fundamentally different from what happened in the 1920’s.

    In fact, I would argue that the big mistake that people made was the notion that the economy fundamentally had changed, when in fact it had not.

    WStroupe: It’s about switching back to a more traditional income-based model. That will be a gut-wrenching process entailing far more pain and suffering than the U.S. has experienced so far, and it only gets worse the longer U.S. leaders waste precious time and money trying to revive the asset-based corpse.

    I really don’t think so. What the US has to do is to boost savings and cut consumption.

    Annoying yes, but not the end of the world. What happens when you boost savings, is that you increase productivity so the amount that you save comes back to you in higher wages. OK, people go from -2% savings to 5%. Moderately annoying, but no one is going to starve, and that money is going to come back to you. You save 5%, a factory gets built, you get a higher paying job.

    Take your 401(k), people were assuming 10% growth, now assume 3-5%. The numbers that come out are somewhat ugly, but they aren’t disastrous. What will cause massive financial disasters to most people is if they lose their jobs for an extended period of time. If you are typical and the return on your pension goes from 10% to 5%, it’s ugly, but not the end of the world.

    For most people under 55, if you are out of work for a year, then it is the financial end of the world. Imagine what happens to you if you lose your job for three years. You are never going to bounce back, so this is why it’s vital to get people back to work, because most people under 55 people have personal financial situations in which even if you have a massive boom after three years of unemployment, it’s not going to be of any help to you.

    And God help you if you get sick during those three years. Without fundamental changes in the social system, if you get hit by a car while unemployed, you are going to be in poverty for the rest of your life.

    I don’t see anyone trying to revive the corpse. If you disagree, go to a bank and try to get a subprime mortgage today. The money and effort being spent involves burying the corpse, which can be frightfully expensive.

    There is this very popular notion that in order to get something you have to undergo a lot of pain. What that ignores is that you can undergo a lot of pain, and still get nothing. I’m extremely skeptical of the idea that just because an idea is painful, you end up getting some benefit out of it. It has something to do with Stalin, Mao, and the Great Leap Forward. In the 1950’s, Chinese were told that if they sacrificed for the common good, there would be a few years of pain and then this economic boom. So there was a lot of pain and then nothing.

    So when someone says “you have to go through this pain to get to the boom” I’m really skeptical because I’ve heard that before. There is also the early-1990’s when you had large number of people saying that Russia would boom and China would stagnant because Russia was taking strong medicine whereas China was not. Things didn’t work out that way. The first thing I ask, is “is this pain *really* necessary and if it is then what are the ways that we can reduce the pain?”

    Also if you talk about getting rid of the old system and going for this wonderful new system, I keep thinking “wasn’t that what Mao and Stalin promised?” OK, you claim you are different. That’s fine. Explain to me how you’ll end up with a boom, and give me numbers. How much needs to be sacrifices, for how long, and at what point do you throw up your hands and say, well maybe I was wrong about what the problem is, and we need to do something different.

    If what you propose will have me accept a 5% return on my 401(k) and a 5-10% tax increase if I hit the jackpot and make more than $250K, that’s fine. Annoying, yes, but survivable.

    If what you propose has me out of work for two years, at which point I lose my house and savings, and have no insurance, then this will not work because I’m busted even if the economy comes roaring back, and if you multiply me by fifty million, I don’t see how the economy is *ever* going to recover.

    Also, this plan has another big, big problem. If I lose my job for two years, I’m wiped out. The ex-CEO’s of Bear Stearns, Lehman Brothers, General Motors, AIG, Citigroup, and Enron all can survive two years without a job or health insurance. If you blow up the economy for two years and then you have a massive boom, I’m going to be in poverty for the rest of my life. They aren’t, because they have enough money in the bank so that two years without work or health insurance is a vacation, and so a bust then boom is going to benefit them, not me.

    If the choice is between is between two years of hell followed by a boom, and Japanese style zero-growth economic stagnation then I vote for zero-growth stagnation, and so will most people. If this doesn’t work for you (and it doesn’t work for me), then come up with another choice.

  • Posted by a

    “You need to print massive amounts of money and then do something completely unproductive with it. (It’s called World War II).

    The other time it’s been tried and succeed was in the mid-1980’s, when the US got out of the recession of the early 1980’s. Again, you print massive amounts of money and do something completely unproductive with it (i.e. build a massive military).”

    I don’t think so. You’re conflating the US and the world.

    WWII was extremely productive *for the US* – it destroyed American industrial competition, especially in Japan and Germany. So when the US switched from war- to peace-time production at the end of the war, it was able to sell its goods abroad without too much competition. It also benefited from an influx of European skills (they bred and educated them, we got the rockets to the moon). So WWII, from the U.S. eyes, was an incredibly good investment. It wasn’t, however, so hot for the rest of the world, which suffered a loss of living standards for a long period after WWII. Great Britain didn’t get off rationing until the mid-1950s.

    Again, that cold war spending in the 1980s turned out to be a good investment for the US – at least, it wasn’t money just thrown away. Granted a certain amount of luck was involved, but in the end it destroyed the Soviet Union, which allowed for reduced defense spending on the part of the US in the 1990s and in general it increased the American sphere of economic influence. As an added bonus, the defense spending helped, to a certain extent, technological progress in areas such as computers. It wasn’t so hot, economically speaking, however, for the Russians.

    In general printing massive amounts of money does not convince foreigners to send you their commodities and goods. You need to have offsetting commodities and goods, or promises about delivering future commodities and goods which are credible. So long as the US is a huge importer of commodities and goods – and it stays that way, although the trend has recently been in the right direction – it is not simply able to do what it wants.

  • Posted by WStroupe


    Yes, asset bubbles aren’t new. But what is new is how the U.S. economic model, the so-called “New Economy”, evolved under the tutelage of such slipshod architects as Alan Greenspan, so that an inordinate portion of GDP was deliberately intended to come from the generation of ‘paper wealth’ from the deliberate creation of serial asset bubbles of huge proportions, one after another in rapid sequence.

    Under this shortsighted model, the Fed deliberately created the extremely loose monetary environment where Wall Street banks and the rest of the banking sector could create the massive credit excesses where bubbles can be grown. Then you had securitization, a process that enabled the banks to radically heighten their profits leveraged from the artificially created asset bubbles. This asset-based model facilitates enormous wealth creation, but at the obvious expense of radically decreased stability and reliability, since bubbles inevitably burst, leaving huge swaths of wreckage in their wakes. Witness the present crisis.

    So what is new is the deliberate and reckless Fed policies, the deliberate banking sector complicity, and the resulting excessive extent to which America’s asset-based model relies upon serial bubble creation to achieve its $14 trillion GDP.