Brad Setser

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The return of Bretton Woods Two? (or Bretton Woods 2.1?)

by Brad Setser
June 5, 2009

If you read the headlines earlier this week, you might well have concluded that the dollar’s days as the world’s leading reserve currency are numbered. Yu Yongding of China’s Academy of Social Sciences suggested that China should shift away from the dollar.* He isn’t alone. China’s population is no longer convinced that US Treasuries should be counted among the world’s safest asset.** Try feeding that into the Caballero, Farhi and Gourinchas model.***

On the other hand, if you ignore the headlines and just look at cold hard numbers, you likely would conclude that central bank demand for dollars has picked up — not slowed down. The Fed’s custodial holdings aren’t a perfect proxy for the growth in the world’s dollar reserves. Countries can hold their dollars elsewhere. But they are decent proxy — and data from the custodial accounts, unlike the IMF’s more comprehensive data, are available in close to real time. And over the last four weeks, central banks have added $71.36b to their custodial accounts at the Fed. Their Treasury holdings are up even more: $74.62b.

Those numbers, annualized, imply $900-1000 billion of demand for US financial assets — mostly Treasuries — from the world’s central banks. That isn’t a small number. It is close to half of the Treasury’s likely net issuance this year. It would go along way toward answering the question of who will absorb the expected increase in Treasury supply.

Last fall — and even in January — the rise in the Fed’s custodial accounts seemed to reflect funds that were being withdrawn from the international banking system. Not anymore. A host of indicators suggest that the banking system has stabilized. European banks aren’t scrambling for dollar financing. The Fed’s swap lines are shrinking. Bank stocks have rallied. And nearly every Asian economy that has reported its end-May reserves has reported a big increase. And it isn’t just that the dollar value of Asia’s euros and pounds has increased.

And with oil now back above $70 before global activity has rebounded (Mark Gongloff calls it a few form of decoupling: “decoupling” once described the hope that emerging markets could grow without developed markets. Now it could refer to commodities and economic fundamentals”) a host of oil-exporting economies are likely to start adding to their reserves as well.

Bretton Woods Two has come storming back. As Tim Duy notes, it increasingly looks like 2007 all over again.

So why the angst? After all, a few years ago conventional wisdom held that Bretton Woods two was a fundamentally stable system. That was why bets on a low volatility world made sense even in the face of the obvious imbalances inside the US and in the global economy.

Well, central banks are buying dollars and Treasuries in huge quantities, but they still aren’t comfortable buying longer-term Treasury bonds. There is a glut of central bank demand at the short-end of the curve, and less than usual at the long-end. John Jansen’s ongoing commentary suggests that high levels of reserve growth haven’t translated into demand for five and ten year Treasury notes.

And popular support in key creditor countries for buying dollars has fallen.

Some attribute that to the risks posed by financing the US fiscal deficit. But that ignores the risks that were previously associated with financing the United States’ large household deficit. It isn’t clear that risks actually have increased — not so long as the trade deficit is down (see this chart from my colleagues at the Center for Geoeconomic Studies).

But it is certainly easier to grasp onto the risks created by the budget deficit. The flows are a lot more visible. No one needs my help to follow the money.

I suspect though there is another reason. Bretton Woods 2.1 isn’t quite the same as Bretton Woods 2. In Bretton Woods 2, central bank reserve growth financed a growing US trade deficit. And that it meant the countries adding to their reserves were also enjoying strong export growth.

Now the trade deficit is down. And trade is way down. The countries adding to their reserves are incurring the costs of piling up dollars that some don’t really need. But they aren’t getting the same benefits they used too.

Same costs and fewer benefits means more opposition. Especially when the costs are a lot more visible.

The $1 trillion question: does this make the system less stable than before?

* He also publicly called for China to move away from its dollar peg in 2004; Dr. Yu doesn’t set Chinese policy.
** China’s population seems worried that a Chinese investor who puts a dollar won’t get a 6.83 RMB back, not that a Chinese investor who puts a dollar into a US Treasury bond won’t get a dollar and change back. On the first point, China’s population has every reason to be concerned — but no cause to blame the United States. The United States has never promised to direct its macroeconomic policies to maintaining the dollar’s external value. The US has been absolutely clear about this: the Fed’s monetary policy is directed solely at stabilizing domestic economic conditions in the US. In the past that never prevented China from stockpiling dollars, as China had a policy of in effect overpaying for dollars to maintain an undervalued exchange rate to support its export sector. As the Peterson Institute’s Dr. Subramanian has noted, such a policy has a price.
*** The latest incarnation of this model can be found here. And this offers an accessible version of the argument.


  • Posted by Twofish

    bsetser: China’s population is no longer convinced that US Treasuries should be counted among the world’s safest asset.

    It’s a big stretch to go from an audience Beijing University to China’s population. It’s like seeing that an audience of college students at Harvard University believe one thing and extrapolating it out to the entire country.

  • Posted by Too Much Fed

    “Now the trade deficit is down. And trade is way down. The countries adding to their reserves are incurring the costs of piling up dollars that some don’t really need. But they aren’t getting the same benefits they used too.”

    Is that right? Per CR, isn’t almost all of the trade deficit china and oil?

    How much has the trade deficit come down with china? With oil prices off the lows, how much will the trade deficit go up with the oil exporting countries?

  • Posted by Too Much Fed

    “Well, central banks are buying dollars and Treasuries in huge quantities, but they still aren’t comfortable buying longer-term Treasury bonds. There is a glut of central bank demand at the short-end of the curve, and less than usual at the long-end. John Jansen’s ongoing commentary suggests that high levels of reserve growth haven’t translated into demand for five and ten year Treasury notes.

    And popular support in key creditor countries for buying dollars has fallen.”

    Does something similar to this happen in third world countries right before a sudden stop currency collapse?

  • Posted by Too Much Fed

    If china was trying to bankrupt the U.S., how would they do it?

  • Posted by DJC

    Russian President criticizes US Dollar hegemony

    ST. PETERSBURG, Russia — President Dmitri A. Medvedev, who rarely misses a chance to light into the United States for causing the global financial crisis, told an economic forum on Friday that wobbly American financial policy had made the dollar an undesirable currency for reserves held by central banks.

    Medvedev on Russia’s Economy, Part 2 Russia, along with China and other nations, has floated the idea of forming a supernational currency to supplant the dollar, perhaps using the so-called special drawing rights units of the International Monetary Fund as a basis.

    Given the weaknesses in the American economy, Mr. Medvedev said, relying on the dollar as extensively as is the case today could mean building a post-crisis financial system on legs of clay.

    As Russian officials have before, Mr. Medvedev laid blame for the global recession on what he characterized as “one center of consumption, which is financed by deficit, and correspondingly, an accumulation of debt, one reserve currency that is powerful as never before, and one predominating system of evaluating risks and assets.”

    In other words, the United States.

  • Posted by Jon Livesey

    “If china was trying to bankrupt the U.S., how would they do it?”

    I don’t China is trying to bankrupt the US – currently their best customer.

    However, they might not be averse to being in the same position vis a vis the US, as the US was vis a vis Britain in 1956, the year in which Eisenhower forced a radical policy change on Eden simply by threatening to collapse the Pound.

    Of course, that presupposes that China studies history.

  • Posted by DJC

    China’s Global Times newspaper, which is affiliated with the Communist party, said 87 percent of Chinese respondents in an public poll considered China’s dollar-denominated assets unsafe and opposed buying U.S. securities. “Ordinary Chinese people are discontent with the declining value of China’s huge foreign exchange reserves denominated in U.S. dollars,” the newspaper said.

  • Posted by Too Much Fed

    Jon Livesey said: “I don’t China is trying to bankrupt the US – currently their best customer.”

    What happens when china finds (or even makes) new customers, like in Africa, the Middle East, & Russia?

    When china actually “decouples” from the USA, will they “dump” us into third world status?

  • Posted by bsetser

    too much fed. yes, the bilateral us deficit is more less china and oil. but us imports from china are falling not growing. and chinese exports to the world were down something like 20% y/y in q1. financing an ongoing trade deficit doesn’t generate the kind of growth that comes from financing a growing trade deficit. especially in a world where both imports and exports are shrinking.

    2fish — much as i would like to think beijing u students are not representative, in this case i suspect they are. or at least representative of professional opinion in china. and in some sense they are right. holding a dollar has not been a good way to protect the rmb value of your savings — and it is unlikely to be going forward (notwithstanding some fancy theories that argue that china cannot create enough safe financial assets to satisfy chinese demand for safe assets while the us can create enough safe financial assets to satisfy both chinese and us demand)

  • Posted by Awake

    Everytime the dollar starts to weaken and commo prices run up we see the big exporters start flexing their muscles.

    Its too bad we reinflated so fast. Would have been a fantastic opportunity to absolutely crash the global economy and get rid of some of the more hawkish oil-abundant nations.

    At the end of the day, we’re the breadbasket of the world. We can survive without our financial services, and its not like canada and mexico aren’t going to sell us oil/timber/water in exchange for corn/wheat/soybeans.

    Long term consequences of any inflationary quick recovery will be absolutely terrible for America.

  • Posted by FollowTheMoney

    I can tell you that by my measures, and my relationships retail (at least apparel merchandise) is falling off a cliff.

    The U.S. consumer is not shopping, and Brad makes an excellent point and that is if China continues to borrow us hundreds of billions yet they don’t start to see a turn around in the u.s. consumer habit then is the relationship going to continue year over year?

    Unfortunately i expect some problems for the u.s. to finance and sell the 20-30 tbills at current rates.

  • Posted by FollowTheMoney

    Although i am a supporter of free trade I have some cautious notes and questions. Especially regarding the the current state and the environment.

    If corporations are truly trying to go GREEN then does the Chinese relationship not do more harm than good to the world?

    For example, U.S. corporations outsourcing manufacturing (for example) get everything produced in China. There are very few environmental laws. Then from China the goods have to be shipped all the way across the ocean to the U.S. There’s lots of transportation pollution and at the time little environmental regulation in China.

    So I have to ask, what is so GREEN about free trade? If our government really wanted to discuss climate change then shouldn’t this be something that we need to outline?

    There’s other thoughts i have on free trade, especially what i see when i travel across middle America. This is in regards to some concerns i have about outsourcing, and noting Wal-Mart is now the nations largest employer and everyone on this board knows the hourly wages at Wal-Mart…

    More thoughts next time.

  • Posted by David Pearson


    What would destabilize BW2.1? A Chinese trade surplus.

    China cannot stimulate external demand.

    They have, and can continue to stimulate domestic demand not by fiscal spending, but by the torrid rate of bank loan growth. This is “stimulus by command”, if you will.

    The effect of any material Chinese stimulus plan will be to quickly reverse the trade balance. Why hasn’t this happened yet? Mostly because commodity prices crashed along with demand for imports used for processing into exports. This was “Phase I” of the Chinese adjustment.

    You may believe that Chinese growth can resume on its own. That would be quite a feat given the lack of export demand. It is more reasonable to think that a resumption of trend-line growth will come from the domestic economy, which in turn will be heavily driven by domestic loan growth. In this “Phase II” adjustment scenario, why, exactly, should one expect China to run a trade surplus?

  • Posted by Twofish

    bsetser: much as i would like to think beijing u students are not representative, in this case i suspect they are. or at least representative of professional opinion in china. and in some sense they are right.

    One thing I would like to see is some video of the speech. All of the reports that I’ve seen come down to one report in Reuters, and I’d like to see what the context of the statement was before jumping to some very big conclusions.

  • Posted by Dennis Redmond

    Medvedev’s speech, translated courtesy of RT:

    Sober, pragmatic, forwards-looking, which is exactly what Russia’s leadership has been since 2000.

    Also, Awake wrote:

    Its too bad we reinflated so fast. Would have been a fantastic opportunity to absolutely crash the global economy and get rid of some of the more hawkish oil-abundant nations.

    “We”, whoever that means, has no such power. Neocolonialism is dead. The (mostly democratic) governments of the semi-peripheries are going to use their raw materials and energy resources to industrialize, which means putting a floor on prices. That’s just the way things are going to be from now on. Smart countries will acknowledge this reality, and get into high-tech/info-processing/green jobs.

  • Posted by Dennis Redmond

    As for the return of 2007 – there’s one huge difference: this time around, the BRICs (15% of the world economy) are launching huge stimulus packages and bailing out their regional neighbors (Eurasia, Latin America, SE Asia – another 10% of the world economy, more or less), while also rebuilding their reserves. This isn’t decoupling, this is multipolarity in action. My guess is, we’re going to see trade flows recover on a regional basis — US consumption is going to be replaced by multipolar consumption.

  • Posted by Mitul Kotecha

    Although there has been increasing rhetoric against the dollar from some foreign official investors there was also a strong vote of confidence in the dollar from China, India and South Korea this week. Officials from these countries noted that there is no alternative to the dollar as a reserve currency.

    The problem is that the symbiotic relationship between Asian in particular China and the US is not changing and despite the rhetoric from countries such as Russia it doesn’t look like it will change anytime soon.

    One of the reasons for the increase in foreign official investor demand for US Treasuries is simply that a weaker dollar reduces the dollar value of US assets in portfolio allocations relative to benchmarks. Therefore, as long as the dollar weakens foreign central banks will have to step up their purchases of US bonds.

    The other consequence of broad dollar weakness is that Asian currencies are appreciating strongly. This is being resisted by Asian central banks who have been intervening to prevent their currencies from appreciating more rapidly. As these central banks buy dollars to intervene they are recycling this back into US assets.

  • Posted by guest

    There are thee worlds

    The world of the journal of economics,where everything is calm,logic and can be modelised

    The world of the comptroller of currency see the thread hereunder (the symetrical world of the invisible hand)

    see page ( 9) and so forth

    The trivial world of supply and demand and risk profiles.

    Untill these three worlds read the same, we may think comfort is in the journal of economics untill the trivial world of supply and demand,risk profile takes over.

  • Posted by purple

    It’s not 2007 because the US consumer is dead.

    Look at the savings rates.

    There’s a lot of delusion right now that the bubble can be re-ignited. If that’s the only solution then we are in trouble.

    Stimulus is building up even more over-capacity with even less demand.

  • Posted by purple

    Also, the IMF could conceivably become as disfunctional as California. China really doesn’t want to give a lot of money to bolster the IMF when the US hold veto power.Meanwhile, the US seems obsessed with eroding European sway in the IMF.

  • Posted by Indian Investor

    Dr. Setser,
    Correct me if I’m wrong but your point is that it was risky for China to finance the US household deficit. In comparison, financing the US fiscal deficit isn’t a bigger risk. That would explain the continued rise in the Fed’s custodial holdings of Treasuries – seems to be your thought process. So you’re saying that nothing has recently changed in terms of the overall debt levels that are being financed from outside the US borders.The household sector debt has been replaced by official Treasury debt to a certain extent.
    And reading this point together with Geithner’s speech at the Beijing University, Geithner is asking not that China should not peg to the dollar – but that the RMB should appreciate. This will allow reduced demand for US imports from China, increased demand for Chinese imports from the US – and can be encouraged with a social security net for Chinese citizens – the intended new consumers of the world.
    As you can see, the Treasury Bond prices have dropped, mortgage rates are up, and there is increased concern about inflation in response to this outlined plan.
    If the diplomatic pressure on China is to appreciate the RMB, then it follows naturally that their purchases of Treasuries, in toto, need to decline. In parallel, no reductions in the US Budget deficit are planned, to reduce the requirement for such financing of US Treasury Bonds.This would increase the funding gap to be financed through the Fed’s QE program. Hence the market reaction to that.
    If US interest rates go higher, that in turn impacts demand for homes, and reduces prices further. This feeds into even lower Chinese purchases of Treasuries. This is where you get into a circular loop of ever reducing availability of financing at reasonable rates for the US Treasury’s $1 trillion deficit per year programs.
    What is the impact of the plan on the US private sector, and US consumer confidence?
    Geithner (and you), have a thought process here that the stronger RMB will lead to higher Chinese demand for US exports to China, creating more jobs, and that in turn will offset the effect of higher rates on the US consumer.
    I think I have understood the plan correctly. It would be nice if you could provide your inputs on whether this understand of the US Treasury plan is correct or not, with respect to the economic relationship with China.

  • Posted by Csco

    “When china actually “decouples” from the USA, will they “dump” us into third world status?”

    Yes, China has the ability to “decouple,” all they have to do is find new customers to replace us, and surely the omnipotent Chinese could do this – they just haven’t thought of doing it before. And when they do “decouple,” America will plummet a fiery and broken husk to the bottom of the economic ocean. It may even break apart and cease to be a nation, as the famous Russian professor has predicted. The world economy will pick up, but only in whatever fashion is the least favorable for the United States, ensuring that the United States remains as weak as possible and that the dollar is relegated to third-tier status.

    In short, all outcomes are likely so long as they are profoundly negative for any concept of American power, influence or vitality.

  • Posted by K T Cat

    Those numbers, annualized, imply $900-1000 billion of demand for US financial assets — mostly Treasuries — from the world’s central banks. That isn’t a small number. It is close to half of the Treasury’s likely net issuance this year. It would go along way toward answering the question of who will absorb the expected increase in Treasury supply.

    The world’s central banks are still junior partners to the Fed. The Fed has put up at least $1.2T so far. That’s not annualized, that’s already spent. They could buy yet more before the end of the year.

    The real question is, “What is the Fed’s appetite for debt going out from here?” There is no way that all the savers and central banks on the planet combined could have replaced that $1.2T. The Fed could take the place of an oil-rich state should they choose to stop buying US debt, but no one could take the place of the Fed.

    The system is stable only so long as the Fed is willing to buy debt.

  • Posted by Rien Huizer


    Twofish questions your evidence for growing popular loss of confidence in US assets, but not this clever little dichotomous Caballero model.

    I think Twofish is right here. Whatever may have happened in Beijing is apparently not widely known and hence cannot be interpreted. Extending that then to the Chin. people in general is a bit of a stretch.

    Still, the model is intriguing. When I saw it the first time in its AER version thought it would apply more to capital flight than to accumulation of waste (surplus USD) resulting from trade policy, but, yes looking at it from the perspective of a natural shortage of good assets (there may be an element of circularity here: are good assets the assets that the succesful trade competitor finds in the loser’s market) one could consider China’s accumulation an expression of a subjective asset shortage and predict BW2.1 instability from there.

    I do not believe that the Chinese accumulation process is driven by a “shortage” of local assets, and I doubt many people do. For some OPEC countries this may be very true. And the peculiar funds flows preceding the Asian crisis in some affected countries (locals investing their own money abroad, foreigners buying local stock and funding real estate gambles by the same locals on an effective non-recourse basis.. Clearly a situation where Caballero has a relevant story. But China-US? I do not think so.

    Still, BW whatever cannot be stable as a tacit bilateral agreement and it cannot be made multilateral for the same reasons that the original BW could not last. But so is riding a bicycle, you have to keep pedaling.

  • Posted by Mark G.

    “. There is a glut of central bank demand at the short-end of the curve, and less than usual at the long-end”

    That demand glut for the 2 yr seemed to end abruptly with a one day 25% increase in yield. Curve flattening. It will only get worse. Their is not enough money to soak up all the debt that needs to be sold globally. Mr. Bernanke is not his own master. Foreign nations will decide what rates need to be and they will also force Ben to de-lever the Fed’s balance sheet on their time table, not Ben’s.

  • Posted by MakeMeTreasurySecretary

    China has bough dollar assets to boost the dollar and thus subsidize Chinese exports. For China, the export subsidy has meant jobs to its denizens but also the opportunity to build up the civil and industrial infrastructure. Gradually, the need to boost the dollar is diminishing… Will the dollar collapse? I do not think so.

  • Posted by guest

    15 In the working paper version of this paper (Caballero, Farhi, and Gourinchas 2006), we show that the standard
    view applies for flows from Europe to the United States. Lower growth in the former leads to capital outflows toward
    the latter. The preceding results indicate that the conventional view of looking at the growth rate of the trading partners
    to determine the pattern of net capital flows is incorrect. It matters a great deal who is growing faster and who is growing
    slower than the United States. If those that compete with the United States in asset production (such as Europe)
    grow slower and those that demand assets (such as emerging Asia and oil producing economies) grow faster, then both
    factors play in the direction of generating capital flows toward the United States.

    Above are outlined the essence of the Caballero Fahri Gourinchas conclusion and assumptions. In order to attract capital inflows the USA must grow faster or decline more slowy than its trading partners.
    As of today these conditions are not met but in reverse.As for tomorrow one should incorporate other variables
    Growth quality consumption vs production
    Borrowing capacity fiscal debts government debts.
    Risk tolerance That is a maximum debt ceiling

    The above study is skewed on a debt, price,risk, inelasticity.

  • Posted by DJC

    By its role of lender of last resort to an irresponsible, dysfunctional banking system, the Fed has essentially banished free markets from the financial sector. Worst yet, the Fed has in the past two decades mutated into a lender of first resort, by providing high-power central bank money to commercial banks to create bank money based on fractional reserve to feed a debt bubble the eventually burst in 2007. Structured finance enabled banks to securitize its risky loans and remove them from their balance sheets by selling them in globalized credit markets. Non-bank financial institutions in the so-called shadow banking system could monetize their liabilities through debt securitization and sell the collateralized debt obligation as risk-compensatory securities to investors.

    Alan Greenspan, as Chairman of the Fed from 1987 to 2006, proclaimed in 2004:

    “Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.”

    By “the next expansion”, Greenspan meant the next bubble, which manifested itself in housing. The “mitigating policy” was another massive injection of liquidity into the US banking system. There is a structural reason that the housing bubble replaced the high-tech bubble. Houses cannot be imported like manufactured goods, although much of the content in houses, such as furniture, hardware, windows, kitchen equipment and bath fixtures, is manufactured overseas. Construction jobs cannot be outsourced overseas to take advantage of cross-border wage arbitrage. Instead, some non-skilled jobs are filled by low-wage illegal immigrants.

    Low wages have landed the world in its current sorry state of overcapacity masked by unsustainable demand created by a debt bubble that finally imploded in July 2007. The whole world is now producing goods and services made by low-wage workers who cannot afford to buy what they make except by taking on debt on which they eventually will default.

  • Posted by MakeMeTreasurySecretary

    Indian Investor: “… Treasury Bond prices have dropped, mortgage rates are up, and there is increased concern about inflation in response to this outlined plan…”
    Please stop it. Interest rates rates are going up from record lows because there are clear signs that the world economy and the American economy will start growing again within the next few months. The recession in the US will be over before the end of the third quarter (though the declaration may happen much later).

    Csco: “And when they do “decouple,” America will plummet a fiery and broken husk to the bottom of the economic ocean.” Can it still be burning while underwater?

  • Posted by Mark G.

    Will the dollar collapse? I do not think so.

    A slow, painful grinding down of the dollar may prove to be worst than a collapse. A collapse will force political will on D.C., a slow grind down won’t.

  • Posted by K T Cat

    I agree with Mark that the dollar will not collapse. However, between interest rates and inflation, all the money being created by the Fed and borrowed from others will be accounted for in the value of the goods and services we trade and exchange with each other.

    In order for the dollar to collapse, there would have to be an alternative and there just isn’t one, not even on the horizon.

  • Posted by Mark G.

    “Interest rates rates are going up from record lows because there are clear signs that the world economy and the American economy will start growing again within the next few months”

    Wrong. There is not enough money on the planet to soak up all the debt issuance from the US and the rest of the world. Rates must rise and will continue to rise. Yield curve in the US will begin to flatten as demand on the short end lags supply.

  • Posted by bsetser

    Rien — an online Chinese poll (widely reported) found a similar lack of confidence in the dollar. and for what it is worth, a China-based economist for a major MNC and a slew of Chinese diplomats based in Europe have expressed similar concerns at recent conferences i have attended. And I didn’t get the sense the diplomats were offering a pro forma recitation of the party line.

    Rien — the entire Caballero et al model hinges on the assumption that for whatever reason fast growing EM economies cannot create safe assets in sufficient quantity to match growing demand, generating a capital outflow. They don’t view government asset accumulation as central to the flow from EMs to the US and Europe. At points they have argued, in effect, that China’s government is just accumulating the dollars that china’s citizens would buy if china’s capital account was open. I have always liked the BW2 models better b/c they at least correspond with the observed facts, namely that central bank demand for dollar assets has increased not private demand.

  • Posted by bsetser

    Mark G — re: not enough demand.

    Care to show me your math.

    Central bank demand annualized in may was $975b. that leave a bit over $1 trillion to be absorbed by private investors in the us and abroad. Impossible?

    If so, why, as total Treasury issuance over the last 12m was @ $2 trillion, with maybe $800-900b absorbed abroad and $600-700b absorbed by the official sector (we don’t have tic data for april and may so i am making some educated guesses)

    Total US debt issuance by households, firms and the government is flat through the end of q4 08 despite the rise in gov. issuance, as ABS issuance and corp debt issuance (esp. leveraged loans) fell off a cliff. may be that changed a bit in q2; the data isn’t out. but the aggregate borrowing of the us economy is up only slightly. Why could the world absorb $2 trillion of claims on US firms, households and the government two years ago but not $2 trillion in claims on firms households and the government now (with most of the claims being claims on the gov)?

    Lots of folks — including lots of the big money folks in the market — have your view. So I am quite interested in your answer. I am not totally convinced that demand is there at current prices in the absence of a crisis induced flight to safety. At the same time, i find analysis that says the world cannnot absorb all the treasury issuance that ignores the fall in other kinds of debt issuance in the US a bit superficial.

  • Posted by Indian Investor

    Why could the world absorb $2 trillion of claims on US firms, households and the government two years ago but not $2 trillion in claims on firms households and the government now (with most of the claims being claims on the gov)?

    Me: The previous official flows were to Agencies and Treasuries, and I know from your analysis that there is a massive shift away from Agencies to Treasuries since the 09/15 Lehman bankruptcy.Remember that most investors, including official investors, simply assumed that all GSE issuance had the implicit guarantee of the US Treasury. It was only after the GSEs were in serious trouble, and were placed in conservatorship, that it became clear that such was not the case.
    This is a very natural error. Few people today, if any, realize that the Federal Reserve isn’t a ‘Government Department’. It’s officially defined as ‘an independent agency’ … ‘within the government’. This ambigious definition hides the obvious facts. The Federal Reserve is governed by its member banks, and the Federal government has little or no say in its policies and actions, or control over the terms of its Board of Governors, who are appointed by the banking industry.
    The most striking aspect of changing demand for USD-denominated debt is the official sell-off in Agencies – and that is easily explained by the sudden realization that the ‘Agencies’ aren’t ‘Agencies’ at all … just private entities with a partial government guarantee for the troubled times.

  • Posted by Indian Investor

    Obviously, we don’t know yet that the world is unwilling and/or unable to absorb the annual $2 trillion issuance of Treasuries. That’s a speculation, and the recent changes in yields and FX rates are indicative of what’s to come. This speculation, however, is well reasoned out.

  • Posted by Mark G.

    “Why could the world absorb $2 trillion of claims on US firms, households and the government two years ago but not $2 trillion in claims on firms households and the government now (with most of the claims being claims on the gov)?”

    One reason is the US govt. projected GDP growth figures don’t match reality whereas two years ago the jury was still out. Dr. Setser, allow me to increase my level of superficiality. What was global GDP two years ago? Global GDP and trade today is tracking that of the 1930’s in it’s decline. What was the global issuance of debt two years ago compared to today? What were hard asset values two years ago compared to today? How much presumed wealth has vanished over the last two years? I think you compare apples to oranges. Two years ago the world was a vastly different place. Can you answer these questions in relation to your claims?

    How about if I substitute “won’t” absorb or unwilling to absorb US debt issuance for “can’t”? Though I believe they can co-exist for a time, does that decrease my level of superficiality?

  • Posted by Indian Investor

    Dr. Setser, if you break up “the world absorbed the debt” into components, you will see more clearly what’s happening better. The PBoC never directly financed the US homeowners. They held Agency debt, and moved out once it became clear that Agencies are private entities. They moved into the US Treasury debt in a bigger way after that. But the US Treasury is on a completely unsustainable path. China is willing to finance the US Treasury in its own currency, but not in dollars. The Chinese Govt. needs to have access to its own RMBs in order to buy dollars and accumulate them in its coffers.That involves a lot of effort and sacrifice. Many other countries with a significant export sector haven’t been able to do what China has done in the last two decades. China has been able to raise RMB, either by curtailing its expenses, or taxing its people more, and making up with its borrowings – to raise the RMBs it needs to buy dollars.
    It took them two decades of hard work and sacrifice to build up a stockpile of around $1.5 trillion in USD and another .9 trillion in other currencies – again from your data.
    In three weeks, the US Treasury printed $2 trillion through the Fed, and that’s only a small part of the increase in dollar supply.The original purpose of China’s forex savings was to increase their domestic demand – and support the imports with the saved dollars for a significant period. That strategy is now lost forever. The only hope for China now is to be able to internationalize the Yuan, a difficult process filled with geopolitical minefields.
    I think the onus ideally be on you to explain why the world should absorb the US Treasury debt securities, not the other way round. ‘It happened two years back’ doesn’t provide a sufficient scientifc basis.

  • Posted by FollowTheMoney

    @ Awake

    “Its too bad we reinflated so fast. Would have been a fantastic opportunity to absolutely crash the global economy and get rid of some of the more hawkish oil-abundant nations.

    At the end of the day, we’re the breadbasket of the world. We can survive without our financial services, and its not like canada and mexico aren’t going to sell us oil/timber/water in exchange for corn/wheat/soybeans. ”

    I agree, i think alot will have by Q3 of 2009. The reflation you are seeing now is nothing but a conspiracy of optimism. This is a little “sucker-tease” if that’s the correct phrase.

    If there should be a fallout with China, is there a study looking at the structure of trade between U.S. and Canada/Mexico?

    Could Mexico and Canada supply us with the resources needed? Is it really that much cheaper for our goods to come from China Vs. Mexico? Additionally were there to be more manufacturing here in North America perhaps our UE numbers would get back under 10% in 3-5 years.

    Just a thought. I am a firm believe of the U.S.-Canada-Mexico story, and strongly agree that reflation now would be WORSE case scenario for the UNITED STATES over 10 years. A Drastic deep depression, wiping out the Trillions the Chinese are holding would be more harmful to China than the U.S. I’m very confident U.S. could make relationships in our north or south continent that will be just fine.

    Additionally, our consumers are moving away from the traditional “spend spend spend” society, so in the long run does the United States really need China?

    I say forget China, we’ll be just fine…

  • Posted by FollowTheMoney

    And just remember, it was China, not the UNITED STATES decision to buy all those DOLLARS.

    China will LOSE them, and it’s only China’s fault, not us! Whether it’s through monetizing the debt or defaulting China is set to lose big time on her investment.

    @ Awake-

    Oil in my view will be back below $50 in the fall.

    Unless of course Bernanke and the Fed continue the reflation story which in the long run will be the absolute devastation of this great country…

  • Posted by kaan

    The broadest global credit aggregates were growing at double digit rates driven by shadow banking system which was mother of all Ponzi schemes.
    Despite all the green shoots rhetoric by western fınancial interests developing world lost its confidence in the competence of US leadership. The rise in commodity prices is a warning shot.
    By 2014 US and UK public debt/GDP ratio will exceed 100%.Overseas Chinese, Russian and OPEC wealth will significantly reduce their US, UK and EU exposure.
    I expect US long term government bond yields will reach double digits within 3 years.

  • Posted by BOB

    Average Americans are tapped out and are in hock up to their eyeballs. Most people can’t add another penny of debt to their balance sheets because they can’t even make their existing payments on time. They are literally one paycheck away from a bankruptcy filing and homelessness.

    Those who are solvent don’t need to buy any more stuff. They already have enough stuff.

    Yet the standard response all of our so-called leaders have had to this economic crisis is to borrow more money, mostly for bailouts. Why can’t anyone in power admit that the US won’t get out of this economic hole unless the US economy starts to create real wealth. More and bigger FIRE (finance, insurance, real estate) scams are not going to create real wealth.

  • Posted by FollowTheMoney

    @ Bob,

    There is optimism which is expected on the stimulus, however this will wear off and he’ll be right back.

    And this decline, this upcoming decline, in my view is going to the big one. The one where all hope is destroyed. We need a back up plan in the event of currency crisis.

    I think Geithner has an idea. In 2005 he did study group at the CFR called Currency Consolidation. One idea of this study group may have been the Gov’t response in the event the dollar gets greatly devalued.

    I wish I could get insight into the Roundtable discussion Geithner ran at the CFR in 2005. It would be useful to see what ideas he has for “currency consolidation”.

  • Posted by K T Cat

    I guess I don’t get it. If there’s enough demand for Treasuries and US debt in general, why are interest rates going up while the economy is still contracting? Why did the Fed print $1.2T earlier this year and use it to buy US debt? Was that a one-shot deal? If so, why are interest rates going up? John Jansen opines that it’s an overwhelming amount of supply.

    Maybe I’m completely wrong, but going back to the original question, is this arrangement stable, I’d still stick with the Fed being the lynchpin for stability.

    Finally, doesn’t fractional reserve lending make consumer debt different than Treasuries? That is, if the government borrows $100 from me in the form of a Treasury, I need to hand them the full $100. If I borrow $100 from the bank, assuming 10-1 leverage, the bank only needs to really have $10 in its hands.

  • Posted by MakeMeTreasurySecretary

    Mark G: “There is not enough money on the planet to soak up all the debt issuance from the US and the rest of the world. Rates must rise and will continue to rise. Yield curve in the US will begin to flatten as demand on the short end lags supply.”

    Mark, you are looking at the economic picture upside down. The total borrowing needs in the USA are not higher now than they were two year ago when some of our esteemed leaders were talking about “savings glut”. The debt issuance must be compared with numbers such as dollars in money market funds, the size of market flows, and also the ability of central banks to print money. (We will argue another day whether having fiat money is a good idea. However, you do realize that we have a central bank that could easily buy all the the debt the US government issues, don’t you?) No money in the world?

    At this point in the economic cycle, and they call it a cycle rather than a one way ticket to hell for a reason, the spread always increases. It is in fact a leading economic indicator — one of the few! In other words, it is heralding good things about the economy. Do I need to say more?

  • Posted by Briangobosox


    Is there any information available on what maturity of debt foreign central banks are buying. A Dollar invested in a long bond is a VERY different thing than a Dollar invested in a 3-month bill in terms of their “commitment” to helping fund our gigantic deficits. A stockpile of 3-month bills may well become the equivalent of a geopolitical gun to our head.

    This question has important ramifications for the Dollar. Also, Chinese Treasury purchases were an enabler of the bubble, effectively short-circuiting the corrective influence that the bond market is supposed to have on overly-easy monetary policy. If the Chinese and other CB’s buy only T-bills, the Fed’s efforts to effectively re-blow the bubble, by stepping into the breach formed by the collapse of securitization, will come to naught as bond yields rise to levels that they should have risen to in ’04-06 if it weren’t for the Chinese recycling excess liquidity back into the Treasury Market.

  • Posted by HZ

    But if nobody is willing to lend in USD long term would that imply either A) US has to rely heavily on short term debt (which in effect tie the hand of the Fed on managing monetary policy) or B) borrow in foreign currencies for long term borrowing needs — which is what EMs such as LatAm countries had/have to do?
    So the pretension that US can manage its own monetary policies freely isn’t exactly true if it is dependent on foreign central banks for financing.

  • Posted by FollowTheMoney

    Willem Buiter claims “U.S. is more broke that the politicians may like to believe. Warns people to get out of u.s. dollar assets”.


  • Posted by Rien Huizer


    Thanks, looks like we (more or less) agree of the current applicability of the Caballero model. Just for whoever is interested in these views, another link:

    As to your comments on Caballero’s view “At points they have argued, in effect, that China’s government is just accumulating the dollars that china’s citizens would buy if china’s capital account was open’ it would be interesting to see if that was the case.

    Just imagine sudden openness (ad assume that the SOE and state CNY savings would be in private-equivalent hands) as well as that the current stockpile of foreign assets were first, but only once, offered to those savers upon (irreversible) opening. Probably then those savers would pay, in USD, (purchased from the CB in a parallel auction) just enough(but no more than) to arrive at a portfolio value that could be realized in the world market (assuming perfect liquidity, a big stretch). The point then becomes, would the whole portfolio clear ? Would newly minted investors hang on to those assets or would they diversify?. Would the suddenly competitive environment create a domestic financial asset supply response? Cabalero’s model follows the opposite trajectory (p 367 AER article), they let the share of future output that can be capitalized drop suddenly (confidence crisis etc). That is quite different from my scenario where there would be room for a domestic supply response in a country where the gvt had previously repressed the financial system.

    The suppressed/latent/hidden asset demand is not going to find a static asset supply sector. Financial technology is highly mobile and under suitable assumptions (perfect, imported regulations, governance and rule of law) plus no change in preexisting sound government policy ( OK we live in a world of generous assumptions here), a rapid process of supply capacity mobilization would occur that might lead to increasing “domestication” of the national investment portfolio. Of course, all of this this would need to go hand in hand with a flexible exchange rate (the FX auction would not be a one time event) and probably that would contribute to a narrowing of the trade surplus and increased industrial investment (in productivity), all reducing demand for financial assets. The resulting world would then follow Caballero’s model..

  • Posted by Rien Huizer
  • Posted by K T Cat

    Why could the world absorb $2 trillion of claims on US firms, households and the government two years ago but not $2 trillion in claims on firms households and the government now (with most of the claims being claims on the gov)?


    At the same time, i find analysis that says the world cannnot absorb all the treasury issuance that ignores the fall in other kinds of debt issuance in the US a bit superficial

    Businesses and individuals are not the same as the government.

    I’ve got some experience in running businesses and doing corporate turnarounds. I have a little idea about what good ones look like from the inside and what bad ones look like from the inside. The government looks like a bad one getting worse.

    While I would gladly loan money to Apple or Diamond Offshore and I would gladly make mortgage loans to folks with good credit and a big downpayment, I would not be making loans to the government right now unless I had to preserve my currency.

    From an investment or business management point of view, the government is borrowing money to do things that will increase its losses in the future. Increasing benefits is a guaranteed loser. Buying GM and then forcing it to do things which don’t make a profit is a guaranteed loser. Green energy is a guaranteed loser after you add in the cost of the subsidies. Expanding Medicare to cover the uninsured, which is effectively what the new health care plan will be, is a guaranteed loser. I can’t think of anything they’re “investing in” that isn’t going to be a colossal failure except maybe the survival of the big banks and we dealt with that many hundreds of billions ago.

    I would gladly loan money to entities that can clearly make the payment and return a profit. The current government is nothing of the sort. There is no recognizable path to profitability. That’s why our debtors are all gathered in the short term loans where they earn practically nothing on their money.

    You cannot equate personal debt, corporate debt and government debt. They are not equivalent to lenders because they are not equivalent in terms of their future profitability.

  • Posted by Indian Investor

    Dr. Setser,
    I believe the question you have raised, to identify what has changed with the replacement of private borrowing by government borrowing – and if nothing has materially – why would the world not absorb the new issuance – is perhaps the most significant point of debate in the current environment. To attempt an answer to your question, I spent nearly 15 hours of careful reasoning and several more hours reading up on recent developments.

  • Posted by K T Cat

    Addendum: You can’t be sure that should household and corporate debt demand return that they would be covered by foreign lenders. All you know is that they’ve gone away and the equivalent aggregate US demand for money is not being satisfied, hence the Fed’s actions and the rise in interest rates. It’s entirely possible that after discounting expected future inflation due to continued Fed activity, these debts would be no more desirable than the government debt unless interest rates increased substantially.

  • Posted by Indian Investor

    As of 2007, there were around 128 million housing units in the united states and some 14% of them were technically ‘unoccupied’, with the US population being around 300 million +. (The exact numbers should be available in one of my earlier posts at your blog).Of these, 35% of homes were owned outright – i.e. there was no mortgage on them. Out of the mortgage loans, in terms of numbers, 5% of the loans were both adjustable rate, and sub prime. As you are probably aware, mortgage debt is, for the most part not ‘income producing debt’.Over time, a large amount of speculative profit was available to homeowners from the increased price of their homes. From my detailed discussion with Paul Swartz regarding a paper he quoted from Dr. Greenspan, et al: till 2005, only around 5% of US Personal Consumption Expenditure was financed from increases in home equity. The world was rationally expecting a ‘soft landing’ for the US economy from this information. Our first task, therefore, is to identify clearly what went wrong, why there was a crash landing for the US economy, and how it was transmuted to the rest of the world. That task has become easier in hindsight, though I have a public record expounding on the relevant factors at your blog page, albeit in my more typical manner of self expression.
    The biggest bug in the system was the fact that the national principal on credit default swaps was much larger than the underlying bond, settlements may or may not have been required physical settlements, and the short and long end of the swap could be occupied by parties with or without a direct connection to the underlying credit transaction. As a simplified example, somebody might have guaranteed a settlement of $1.2 million on a mortgage loan of $300,000; and the party purchasing the guarantee and paying the premium is neither the lender nor the borrower of that mortgage.
    In aggregate, at least $43 trillion of mortgage-related CDS was outstanding, and the total outstanding mortgage credit was only $11 trillion.
    As the price of crude rose, the expected ‘soft landing’ was triggered. However, the relatively small amount and number of defaults were magnified, and relatively very huge liabilities were triggered across the banking, investment banking and shadow banking sectors.Precautionary collateral calls on parties at the short end of CDS contracts added to the panic.
    Entities such as AIG – deeply involved in speculative credit derivative positions, and the Bank of America – which was suddenly holding receivables in the form of bonds that weren’t being paid the anticipated amounts – received government support in the form of new credit, government guarantees, new infusions of capital into their equity, etc. All of these efforts were intended to stabilize the creditors, who were unduely affected by the multiplied credit risk exposure resulting from derivative instruments.

  • Posted by Indian Investor

    As of March 31, 2009, the total commitment by the US Treasury to the financial crisis rescue efforts was $12.8 trillion, according to a compliation done by Bloomberg. Of that commitment, $4,169.71 billion is drawn down as of 03/31/2009. The $12.8 trillion includes commitments made by the Fed, Treasury, FDIC, HUD and hope for homeowners FHA. The source of this data are Mark Pittman and Bob Ivry of Bloomberg.
    From my side, I would like to add that the total commitment to date, for the purpose of helping restructure the mortgage contracts – is around $85 billion – that came in from a Geithner objective to partially assist only ‘responsible families’.Also, the total international reserve position of the united states is around $75 billion, including its holdings denominated in SDR.
    As you can see from this data and the account above – very little has been done to examine and address the root cause of the mortgage defaults – the principal focus has been to ensure the immediate continuity of the creditor institutions.
    In this regard the broader objective of these stabilization measures has been to intervene in a manner as to ensure the stoppage and reversal of the deft-deflation process. These stabilization commitments will bear fruit not from the direct result of the longevity of the creditor instituions – but from the indirect intended result of reversing the process of liqudity crisis, followed by solvency crisis, followed by credit deleveraging.

  • Posted by Indian Investor

    I agree with you that in accounting terms, the private borrowings of 2 years back have been replaced by government borrowings, even as those private borrowings have fallen. However it’s important to note that the earlier private borrowings generated a demand for goods and services, though they were to some extent underpinned on speculative profits from the FIRE sectors.In contrast, the US Government borrowing has largely been deployed in the form of stabilization measures that have succeeded in ensuring the continuity of certain creditors, a few industries and helped to reduc the liquidity problems. While the stabilization have been extremely useful, the underlying process of credit deleveraging at the consumer’s level continues unabated, from all available data, including the latest G19 releases.
    The mountain of private debt is continually defaulted, or paid down – and the US Government borrowings stand as a spectacular guarantee that the effect of these defaults, and the resultant triggers of derivatives related liabilities, will not lead to the fold up of the creditor organizations. Apart from this, some smaller outlays have been made to ensure the partial continuity of private companies that have repeatedly proven themselves unable to change their business model to suit the shifting macroeconomic demand environment.
    Since the government borrowings are deployed mainly for the purpose of a credible guarantee, and for the purpose of easing liquidity problems, the level of real demand for goods and services created by these borrowings is not at all comparable to the private borrowings of 2 years back.

  • Posted by Indian Investor

    From the internal perspective of a national economy, the sum total of its currency values the sum total of the goods and services consumed by it, and vice versa.When a government increases the issuance of its currency, the first aspect to examine is whether the government’s expenditure resulted in an increased level of production of goods and services – either by direct or indirect means. As long as there is a proportional increase, for instance, in tangible public works, there isn’t any immediate impact on the value of the currency in terms of the goods and services. A secondary aspect is whether the public works are actively utilized by people at their own expense later on. If a toll road is built on government expense, the value of the currency will be affected if nobody uses that toll road after it is complete.
    From the perspective of solvency of a Sovereign government – the ratio of the public debt to the GDP, in my humble opinion – is NOT a good measure of sovereign creditworthiness. Within its territories, a sovereign functions by the dictat of its legal tender currency issuance. It is only from an external financing perspective that the solvency of a government can be assessed.
    Every nation typically depends on imports of certain commodities, oil etc from other geographies for the sustenance of its economy. In turn, it has to generate revenue denominated in foreign exchange by exporting, to be able to pay for these imports. This latter rule does not apply to the United States. To know why, you need to be able to reason honestly with the petrodollar re cycling based global monetary system. The pricing of oil, the denomination of savings from oil proceeds, the control over the logistics of oil supplies – are all critical to the international monetary system as it exists till date. The relevant considerations cannot be dismissed with a bland statement that ‘the argument is old’. Millions of innocent civilians are subjected to violence, displaced, and literally hundreds of thousands have lost their lives, even in the past few months and years – to the Eagle’s quest for supremacy in the control of oil.The Eagle’s competitors have their hands just as red, of course.
    It is important to acknowledge that the sovereign creditworthiness of the US Treasury is as much a geopolitical subject as it is a macro economics subject.

  • Posted by K T Cat

    Brad, I think the difference is that you’re looking at balance sheets and the people who are worried are looking at balance sheets plus cash flow statements.

  • Posted by bsetser

    Briangobosox — the last data point is from march, and it indicated some central bank demand for notes. anecdotes suggest that these are on the short-end of the yield curve – i.e. 2s and 3s. Until then Central banks had effectively been buying only bills after LEH. from sept to feb there was huge central bank demand for bills. anecdotal evidence suggests continued buying of 2s and 3s but not longer dated notes. we will have some more hard data in about a week, but it will be for April.

  • Posted by Indian Investor

    All the way since March, I haven’t been able to take any position in the market because of uncertainty and confusion.Finally I have a crucial insight – one that can turn out to be extremely profitable.
    I’m reasoning with the FAS157 changes, the Geithner speech at the Beijing University (and Wang Qishan’s comment on the speech), the Obama address to the world’s Muslims at Cairo University, China’s currency swaps, Medvedev’s interview to Maria Baritromo and reports on the activities of the China National Development and Reform Commission. Taken with various other inputs, such as for instance, Zhou Xiaochuan’s paper on reforming the international monetary system, Geithner’s CFR reaction to the paper, the operation of the Treasury Supplementary Financing account, Indian concerns about ‘financial protectionism’, etc – a clear picture is now emerging as to the contours of the planned future course of the global economy.
    I’d like to thank Dr. Setser for coming up with the question that he did, because the question spurred me to reason out various pieces,strategies and moves on the global chess game – to arrive at a valueable insight.I’ve managed to resolve the concern I expressed above about the continued process of credit deleveraging in the US.
    I’m now quite firmly in the ‘the recession has lost its force’ and ‘the world economy will recover in the second half of 2009’ camp. And not in the ‘US Treasury is about the collapse and go bankrupt, throwing the world into a tizzy’ camp. Let me now explain why.

  • Posted by Indian Investor

    Let’s start with the activities of the China fiscal stimulus and currency swaps.

    These activities, and their effect, needs to be understood correctly from past economic history.I mean the accurate version of economic history, and not the Niall Ferguson version of it. In “What Chimerica hath wrought”, Niall Ferguson wrote:

    “But the most important reason why the United States bounces back from even the worst financial crises is that these crises, bad as they seem at home, always have worse effects on America’s rivals. Think of the Great Depression. Though its macroeconomic effects were roughly equal in the United States and Germany, the political consequence in the United States was the New Deal; in Germany it was the Third Reich. Germany ended up starting the world’s worst war; the United States ended up winning it. The American credit crunch is already having much worse economic effects abroad than at home. It will be no surprise if it is also more politically disruptive to America’s rivals. ”

    I hope that Dr. Niall Ferguson is deliberately exhibiting ignorance of the factual economic history of National Socialism in Germany. While Hitler paid for his racial biases, excesses and war crimes with his own life, what was his record in terms of economic performance?

    “We were not foolish enough to try to make a currency [backed by] gold of which we had none, but for every mark that was issued we required the equivalent of a mark’s worth of work done or goods produced … we laugh at the time our national financiers held the view that the value of a currency is regulated by the gold and securities lying in the vaults of a state bank.”

    – Adolf Hitler, quoted in “Hitler’s Monetary System”,, citing C. C. Veith, Citadels of Chaos (Meador, 1949)

    When Hitler came to power in 1933, Germany was virtually a bankrupt nation, riddled with the problems of reparations due from the previous war, high inflation, unbearable unemployment, and the inability to afford imports from other countries. Yet, in the first 4 years of Nazi rule, Germany experienced what needs to be recognized as an economic miracle. Many commoners thought of that period as the best time of their lives – as long as they weren’t Jews, or Slavs, of course.
    Hitler managed to bypass the entire global financial architecture with two major monetary and fiscal measures. The total value of a planned public works program was fixed at DM 1 billion. As the goods and services were delivered to the National Socialist regime, the people were issued Labor Treasury Certificates equivalent to the agreed value of their work. These certificates were tradeable amongst people and were equivalent to the Reichsmark for all intents and purposes. But their value remained high, since they were pegged to the actual physical production.
    A second measure taken by Hitler was to enter barter-based bilateral trade contracts with countries such as Argentina, for instance. Grains from Argentina for instance, were directly exchanged for industrial products from Germany through these contracts.

    As a result of these measures, Germany experiences massive economic growth, and, together with various government sops and incentives, the effect on the people was to create a sudden euphoria and confidence such as they hadn’t experienced since before the First War. Meanwhile, all other global economies continued to languish under the effects of the Great Depression.

    It was only in 1945, a full 12 years after Hitler came to power, that the US won its much-propagandized victory that Niall Ferguson writes about.

    China is now embarked on a path very similar to that of Nazi Germany. Their stimulus is principally directed at the physical production of goods and services. For instance, they have a new high speed railway line between Beijing and Shanghai that is being constructed at quite a high speed. There are 110,000 workers manning the line works round the clock to try and complete it in record time.
    China has now overtaken the United States as the world’s largest market for automobiles. Last month’s sales of cars in China was a huge upward jump from the previous one, and is an all-time record for China.
    The extent of the public works in China is truly amazing, from the Three Gorges Hydroelectric Dam, to the Pearl River Delta development plan, the repair and new construction of thousands of miles of roadways and railways, etc.
    Besides, China’s 800 million rural citizens are smiling all the way to the new local markets for electrical home appliances and back. Chinese farmers are now receiving government rebates and sops to purchase TVs and fridges – something that they couldn’t afford earlier.
    The Chinese fiscal stimulus is the world’s only hope for a recovery as things stand today.
    China has signed currency swap agreements with 6 different countries already. Last week, Brazil and Malaysia expressed interest in this. However, the actual amount of these swaps is extremely small in relation to the volume of world trade, even at these recession levels.

  • Posted by Indian Investor

    Reasoning with China’s currency swaps takes us directly to Zhou Xiachuan’s paper on a new reserve currency (SDRs), and to Getihner’s CFR reaction to it. Since the actual volume of these swaps is quite small, their immediate effect is low. Yet, the strcuture paves the way to reduce China’s dependence on a huge stockpile of US dollars to finance its imports. Remember Giethner saying “we are quite open to it … as long as it happens in a GRADUAL, EVOLUTIONARY sort of way”. The swaps are going in a gradual, evolution sort of way. Their total value doesn’t amount to more than $100 billion till date, even if you allow for the proposed entry of Brazil and Malaysia to make it eight countries in all. Also, the swaps can only be used in trade with China, since the RMB isn’t convertible yet. Now we’ve made quite a lot of good progress, as you notice.
    The US Treasury is basically OK with these swaps. Next we come to Geithner’s speech at Beijing University, and its actual implications.

  • Posted by Indian Investor

    The purpose of China’s stockpile of dollars, euros etc in its forex reserves was to join the club of the rich ‘traditional industrial countries’. It is rarely acknowledged that China is a heavily import-dependent countries. Iron ore from India, oil from the Middle East, minerals from African and Australian mines, Hard wood logs and grains from South America, are all required imports – causing a humungous $1 trillion import bill per annum for China to pay. If China were to sell its electronics and electrical products locally – that market is much larger, and more easily accessible – and, to sustain that – the question of financing even larger volumes of imports needed to be addressed.
    Though the crisis has resulted in a dimunition of the value of China’s Treasury holdings, etc – the ultimate ambition and purpose of China’s forex reserves is to finance sufficient imports to develop the local market.
    It is in this context that Geithner’s speech needs to be understood. Geithner is promising a bigger role for China in the IMF, and is quite tolerant of China’s currency swap arrangements. He isn’t asking China to stop pegging to the dollar. On the contrary, Geithner wants China to continue appreciating the RMB, something that they have been doing for several years now.
    The immediate effect of RMB appreciation is to cause a huge influx of USD investments into China. China will in turn purchase an equally large volume of Treasuries to maintain its new peg. This is the cornerstone of the Geithner plan.
    China’s only other alternative is to crash the dollar. That will not only destroy the US economy, but also cause massive further unemployment in China, and lead to severe effects on global demand for China’s exports.
    Though China might lose out in terms of the value of its forex reserves in the short term, their ultimate objective can be attained more easily with Geithner’s plan.
    The China purchases of Treasuries will ensure that no currency speculator in his/her right frame of mind will try to crash the dollar in a short time frame.
    The dollar will weaken gradually, as China becomes more focused on domestic demand, and imports from other countries; utlimately China will be in a stage where they have no exports to the US, and they are able to sustain their imports with larger swaps, larger share of SDR allocations, and perhaps even the new international reserve currency can get designed in future.
    China’s financing of Treasuries can be used in future to execute Obama’s promised ‘largest investment in infrastrcuture since the 1950s … mainly moves that will reduce the US dependence on imported oil, and prepare the US for a situation where there will potentially, in future, be no financing from China.
    As the US dollar steadily weakens under Geithner’s plan, America once again, in future can become a land of oportunity.
    This takes us to Medvedev’s speech and Obama’s address to Muslims.

  • Posted by Indian Investor

    Medvedev’s interview to Maria Baritromo shows clearly the Russian ambition for the Ruble to emerge once again, as ‘a regional reserve currency’. Yet, there is no display of any hurry to get there. Medvedev is glad that Russia has successfully avoided the worst. If you’re in his shoes, you wouldn’t want a further global catastrophe, especially now that oil is back up at $70 per barrel.
    Oil doesn’t have any market, or any market-determined price. The oil price is decided behind the closed doors of conference rooms in the top floors of the Goldman Sachs towers.
    Obama’s nice speech to Muslims shows the deal pretty clearly. The Saudis get a $70 oil, plus Palestine will finally be given to the Palestinians. In return, the oil exporters will stick to the dollar as the reserve currency for the immediate future. Iran is diplomatically isolated amongst the Islamic countries once again with the ‘Palestine’ Cairo University address.
    Now you can also see why Obama’s meeting with Angela was actually quite formal and frigid in a vieled sort of way. The emerging Eurasian alliance has been broken. The Euro’s bid for global supremacy is on hold now.
    And, the German economy is slated to contract by 6.9% this year. Steinbruck will now be forced to do a difficult volte-face and fiscal-stimulate the German economy like there’s no tomorrow.

  • Posted by Indian Investor

    Now you see why the big leaders are saying things like ‘the recession has lost its force’,’we seem to have avoided the worst’, ‘it looks to me that we have turned a corner’, etc . They’re pretending to be like the tribal African medicine men, or the Oracles. They understand this natural ‘force’ of recession much better than you and I!
    What I expect is a slow, tepid recovery in the US economy. Because the recovery will come only after the US Government manages to stimulate some actual production of goods and services in the US. Meanwhile, I expect the quickest recovery and growth in China.
    As the global demand environment stabilizes and improves, the challenges posed by a steadily declining dollar are postponed for the next few quarters, from the perspective of countries that export to the US.
    The world will be very different in terms of the capital flows and trade flows, within around 4 years from now.But the ever lurking danger of a total collapse of the world economy has, in my humble passed for now.
    The Obama-Geithner plan of solving the problem through alliance with China came originally from Dr. Henry Kissinger. The inventor of petrodollar recycling has saved America from disaster with one more geopolitical brainwave.

  • Posted by bsetser

    indian investor — shorter comments please. thanks

  • Posted by DOR

    “China” this, “China” that. Does “China” study history? Is “the China relationship” good or bad for companies wanting to project a “green” image? A “China” trade surplus. Will “China” decouple” ?

    China ?

    This kind of simplistic thinking is what annoys me the most about the Anglo-Saxon view of the world. There isn’t any problem relating the differences among Fed Governors, between the Treasury and Congress or even between fiscally conservative Democrats and middle-of-the-road Republican’ts (both of them).

    But, when it comes to China, suddenly there is this monolith that doesn’t require anything more than a superficial glance at the data (which is swallowed wholesale and spat out retail) to “know” what “China” thinks.

    Case in point: Zhou Xiaochuan’s comments on the future of the dollar as a reserve currency.


    Read Zhao Ziyang’s memoirs, “Prisoner of the State,” please! There is no “China,” not in the way it is being used in policy discussions.

  • Posted by FollowTheMoney

    Looks like we’ve gotten to a stage of the rally, where even indian investor writes half an econ book expressing market optimism “green shoots”…


  • Posted by Rien Huizer


    “China ?

    This kind of simplistic thinking is what annoys me the most about the Anglo-Saxon view of the world”

    Since when do Indian Investors have typically Anglo Saxon views?

    Seriously, this also something that the PRC seems to encourage. There always this peculiar mixture of Kingdom of Heaven and General Motors. A wannabe monolith perhaps?

    As to the western book ascribed to Zhao’s : this fabrication can only be part of a crude Anglo Saxon plot…

  • Posted by Dennis Redmond

    Indian Investor wrote:
    Oil doesn’t have any market, or any market-determined price. The oil price is decided behind the closed doors of conference rooms in the top floors of the Goldman Sachs towers.

    Not so. Speculators may push prices up or down, but the long-term average depends on a small group of state-owned oil companies, and the state of total demand in the industrial world (shrinking but stabilizing). The Age of the Seven Sisters is long gone, and the governments of the semi-periphery now control the flow of oil. They’ll keep prices reasonably high — not so high as to damage importers, but high enough to finance internal industrialization. This is a fundamental change from the 19th and early 20th centuries. It’s a good thing, too — their economies need the cash, and the industrial world needs incentives to invest in green energy. Everyone wins, noone loses, except maybe the contractors for the US military-industrial complex, who have run out of countries to invade.

  • Posted by atomic

    Those that think that China is entirely dependent on the American consumer to soak up meaningless exports are missing the bigger picture.

    Yes, China’s economy has and will contract severely due to ongoing demand contraction in the US. But the factories and production lines that all those American and Western engineers helped build and design in China remain. So will the knowledge. While MBAs, bankers and marketeers in California and NYC lived it up with their $250k+ salaries, innumerable science and technology graduates from America’s excellent universities spend an unprecedented amount of time abroad in
    China transferring important knowledge to a geopolitical competitor. Huawei is now starting to undercut the American tech giants in emerging markets, and this is just the beginning.

    From a cold war perspective, all of this is almost absurd. The Soviets went to great lengths to steal advanced technology from the west; if only they had thought of saying “hey, we’re destitute and poor, let us build your stuff for you!” they could have had all those American engineers practically working for them.

    For amusement, check out this page:

    (Digital Equipment imprinted on a cold war-era chip: “When you care enough to steal the very best” — in Russian)

  • Posted by Observer

    Brad, thanks again for sharing your thoughts.

    Regarding your opinion that the benchmark interest rates are simply responding to the increase in public borrowing to offset private borrowing, doesn’t that defeat the point, which is to lower private borrowing costs so consumers and businesses can obtain better financing/refinancing terms?

  • Posted by Jeff Benson

    Seems like Bretton Woods 2.1 has the similar risk characteristics to 2.0. I’m betting our hyper vigilant federal reserve won’t allow for a new credit bubble, but the fragility of the current economic system has been exposed. Our monetary system is shockingly rotten. What do we do when we start de-leveraging on a massive scale? Monetizing our own debt. What a sham. The Federal Reserve uses it’s balance sheet to purchase Treasury and Agency debt???? That seems remarkably unstable to me… similar to an Enron or Bear Stearns balance sheet.. where shoddy loans are warehoused off balance sheet on SIVs that are only semi-owned by the loan originator. Or, remarkably similar to the recent accounting modifications that allow banks to post profit on trading gains from purchasing their own debt (at drastically lower prices) in the open market. I suppose these “solutions” have bolstered the market, but aren’t all of them going to crush foreign faith in the dollar. I look at the dollar like an international FICO score. You can’t really manipulate it…. or if you do…. it’s half ass value will eventually be exposed. Our monetary system is so tainted.

  • Posted by DOR

    Rein Huizer,

    I don’t think I made any comment about India or Indian investors, did I? Frankly, I don’t really care about that sort of thing. It is the mindset that bothers me. And, I find it most common among Anglo Saxon financial markets people.

    As for China encouraging a Kingdom of Heaven / GM kind of thing, I really don’t know what that is supposed to mean. Clarification, please.

    Zhao’s book: Did you spend the last three decades analyzing China’s politics? And, did you just this month discuss the origins of Zhao’s book with one of the three editors?
    I have, and I don’t think you have.

    So why did you make up this sad “fabrication” story?

    – – – – –


    The problem with China’s manufacturing-for-export is that the products are, at least to a significant degree, unsuitable for the Chinese market. Ever try to download iTunes to your iPod with a 56k fixed line connection? And, to pay for it in cash?

  • Posted by Rien Huizer


    First, I thought many of the comments that irritated you appear to be made by “Indian Investor”, a regular on this blog but apparently not an Anglo Saxon (neither am I). I thought it was interesting that the anthropomorhism that one my old Asian Studies professor tried to ban from papers and dissertations, as well as the equally proscribed Orientalism seem to be rampant on this blog and particularly in responses from people like Indian Investor. But, pse be generous, “China” is a convenient shorthand and we all know what it means.

    Second, as to my remark about China as a wannabe monolith, that was serious. China (I mean the PRC here, not the Republic of China) and I think that it does not need much adstruction: the Chinese government is very keen on showing unity and does not facilitate a great diversity of (respected) views. So it tries to look monolithic (whether it is or not is beside the point). Occasionally there is attention for apparently divergent views from non-dissidents (I m not so sure about the dissidents, that is not my expertise but I suspect that not all of them are as saintly as some people seem to believe) and that usually has a meaning. But it is not a wise bureaucrat in the PRC who goes out and talks to the press without having obtained clearance. Actually, that was something the GMs of this world do/did too.

    I am not quite sure about your question of spending the last three decades analyzing China’s politics. Not really, but I tried occasionally (and hard) , from the late 1960s. A rather frustrating effort I should say. the USSR was a lot easier. The most surprising (and a delight for collectors of historic curiosa) was of course the cultural revolution. A pity for China but great politics. Never seen anything like it. Is that what you mean or is this inappropriate?

    And let me explain my sense of humor, because my remark that included the word “fabrication” was meant to be ironic (I apologize for my exceedingly bad taste if Zhao was a relative of yours). Books based on some kind of inside story in China and not endorsed officially (too many to list here, but the Tienanmen papers are probably still at the top of my list) are invariably considered “western fabrications”. I have no idea (lack the resources) as to the veracity of Mr Zhou’s speakings. So for the time being, until it has been stamped “genuine” by Beijing, let’s consider this as a work of fiction. I have not read it but if it is like the Tienanmen papers, it may contain quite a bit that is of interest and contains genuine material.

    Your apparently know one of the editors and that may have helped you to form your own opinion. I have not had that pleasure. You are truly lucky.

  • Posted by Rien Huizer


    Welcome! you have been reading my mail. And this is how history develops: trial and error. No one ever learns.

    So let’s hope that all those engineers and factories will do the right thing and not turn their plowshares into swords (incidentally there was a great programme in the US in the 1950s called Plowshare that aimed at peaceful use of nuclear explosions, for instance to extract shale oil from shale deposits in the Rocky Mountains (the heat would melt the shale and the explosion create a huge chamber). For some reason not even the USSR tried something as clever as that but at least the US did the preparatory work.

    I am pretty sure that somewhere in China there are young scientists who returned home (not too many job offerings in the US these days) with things as weird as this plowshares projects.

    But I guess that you expected China to become an economic threat, working hard while the hedonistic Americans are partying. Well, if that happens, it is at least in line with historic patters.

  • Posted by DOR

    Rien Huizer,

    Thanks for the thoughtful response. No, I’m not related to Zhao Ziyang, but Bao Pu gave a talk in Hong Kong recently and I had the chance to ask him about the book.

    The idea that the Central People’s Government has control, let alone absolute control, over the economy is from the 1970s. More than half of all foreign trade – both imports and exports – are fully controlled by foreign-invested enterprises that aren’t even on the Central Committee’s mailing list. Financial institutions are so far out of the reach of the regulatory authorities that it makes headlines if the CPG tries to “guide” lending.

    State Council level (and above) officials frequently float trial balloons in the media. The key to understanding what’s an important signal and what isn’t is more in the reaction than in the original message. When Mao’s (early 1960s) editorials were printed in Renmin Ribao, and nowhere else, we knew he was sidelined. When every paper in the country reprinted Deng Xiaoping’s every comment, we knew he was The Man.

    Zhao Xiaochuan floated a balloon, and the international financial community went nuts.

    Just as many dissidents would qualify for sainthood as would congressmen. But, China’s dissidents are enjoying one of the most open periods that country has ever seen. It started with faxes, then cell phones, text messages, email and now twitter. Newspapers? That’s so 20th century!

    As for The Tiananmen Papers (great stuff!), it is pretty well established among neutral professional analysts that they are authentic, if not complete. Zhao’s book will have to await more analysis, but in my professional opinion, it rings true. Sure, there are some slants, but not enough to call the entire thing into question. Let’s consider both to be works of history, until reliable sources prove otherwise.

    Apologies if I misread your comments.

  • Posted by Rien Huizer


    Of course. I guess our view are not that different then. A good trial balloon needs some sanction (often a tcit one would be most effective), otherwise it is just a personal opinion of an official or otherwise important figure. And I do not really believe that important people in the PRC speak, especially about international affairs without some kind of sanction or belief that they will not get into trouble.

    I also believe that there is far more space for genuinely dissenting opinions and, another aspect (not the trial ballon) of strategic comminication: the public sharing of policy dilemma’s. Sometimes embedded in trial balloons of course but also sometimes normal human communication.

    To return to the good Mr Zhao (I doubt he had been as good as the Jiang/Zhu couple in managing the economy after Deng had his epiphany in the South) let’s see how his former associate Wen responds to this book once it has settled down a bit. Any comment or response would be interesting, but I do not expect any. Anyway, you convinced me I should get it…