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Chinese Handcuffs? No, Chinese trade deficit

by Mark Dow
July 10, 2009

This is Mark Dow. Brad is away.

China has become the obsession that Japan was back in the 80s. And rightly so. It is a huge place, with a robust secular growth force underlying it (remember the conditional convergence growth hypothesis?). Rumors of China doing this or that have become a daily staple of the market.

Lately, the discussion has focused a lot on their willingness to continue to buy US treasuries. I know Brad does a lot of good work on this issue in this space. Much less attention, it seems to me, has been placed on their need to buy more Treasuries.

It has long been my contention that the large global imbalances were mostly a function of risk appetite and financial innovation leading to an explosion of the money multipliers all over the world—especially in countries with a greater degree of financial sophistication and/or capital account openness (I almost said promiscuity).

Here in the US, we were the leaders. It had less to do with Greenspan, less to do with Congress, Fannie Mae, and Freddie Mac, and more to do with the private sector taking excessive financial risk. After all, it was a global phenomenon. Over the course of history this tends to happen any time there is a period of macroeconomic stability coupled with the observation that others around us are making money. People tend to pile on and take things too far. It is in our very nature. (I would recommend Akerlof and Shiller’s “Animal Spirits”, or Kindleberger’s “Manias, Panics, and Crashes” for anyone interested in these behavioral phenomena).

In this case, it led to a huge trade imbalance with China. Credit allowed us to consume beyond our means, and demand spilled out over our borders into China. The Chinese obliged and became huge holders of Treasuries. While it is true that the Chinese exchange rate regime was an amplifier of this story, I think it was more of a passenger than a driver. The driver was credit.

Today the credit bubble is popping (whence my view on inflation and the money multiplier). At the same time the Chinese are trying to prop up aggregate demand by controlling the only thing they can: domestic demand. This to me means the imbalances are in the process of going away. In fact, I have long said (and have made a few bets with friends) that the Chinese trade balance will likely be in deficit by the end of this year. This means that the need for China to buy our treasuries will have largely gone away. I realize this may be too aggressive a contention over this time frame, but I am convinced the basic story is right. And to my mind’s eye there isn’t an exchange rate regime or Renminbi level that can stop this from happening.

On Monday I posted a chart of the US trade balance, and we saw in it the dramatic swing that took hold as soon as the credit bubble popped. Overnight, the Chinese trade balance figures came out. Have a look at the chart below.

Chinese trade balance, 2002-2009

The chart shows China’s monthly trade balance. You will note that every year around March there is a big dip. It is a seasonal anomaly associated with the Chinese New Year. What you will observe is that the post-Chinese New Year rebound this year was much less pronounced, and, unlike in previous years, it soon rolled over. The trend now appears to be going the other way. This is despite Chinese government incentive to support exports and China increasingly taking market share from other Asian countries. It may well turn out that quite soon a Chinese trade deficit will have allowed us to slip out of—at least from a flow perspective—our Chinese handcuffs.

37 Comments

  • Posted by Twofish

    The Chinese government hasn’t tried very hard to prop up export industries largely because it can’t. But there are knock on effects by the drop in trade.

    The thing that started the Xinjiang riots was a nasty rumor that a fired Han Chinese worker in a Guangdong toy factory posted against the Uighurs that were working there because he was mad that he got fired. When economic times get tough, xenophobia goes up.

    One thing that would be interesting is to look at the rioters in Urumaqi and see how many of them were recently laid off workers that were basically blaming *them* for taking away *our* jobs.

  • Posted by Too Much Fed

    “And rightly so. It is a huge place, with a robust secular growth force underlying it”

    More like exploited cheap labor and lax laws leading to a trade surplus with the high wage countries due to “free trade”?

  • Posted by Too Much Fed

    “It has long been my contention that the large global imbalances were mostly a function of risk appetite and financial innovation leading to an explosion of the money multipliers all over the world—especially in countries with a greater degree of financial sophistication and/or capital account openness (I almost said promiscuity).”

    I would rather state it like this: cheap labor and productivity gains lead to price deflation. The fed and the spoiled and the rich want to keep the lower and middle class spending to maintain stock prices so they sucker them into cheap debt. Negative real earnings growth and too much debt on the lower and middle class lead to excess corporate profits including “bank” stocks. Eventually, the lower and middle class can’t repay the debt.

    Are those large global imbalances really too much debt on the lower and middle classes of most of the high wage countries leading to wealth/income inequality in various parts of the world?

    By explosion of money multipliers, does that mean more and more debt was produced?

    Did the fed “wink and nod” to the debt producers and debt holders that they would back them up if anything went wrong?

    Why has all the debt produced over the last 25 to 30 years not produced price inflation?

  • Posted by Too Much Fed

    twofish said: “When economic times get tough, xenophobia goes up.”

    Is it xenophobia or an oversupplied labor market?

    There is about 6 billion people in the world. Let’s say about 4 billion want jobs (2/3 of the population similar to the USA), and there are only 3 billion jobs. What happens?

  • Posted by Twofish

    Too Much Fed: More like exploited cheap labor and lax laws leading to a trade surplus with the high wage countries due to “free trade”?

    The problem with that explanation is that you’d expect that if cheap labor and lax laws were the issue that you’d have a higher surplus in the 1980′s than in the 2000. The other problem is if it were a case of lax laws and cheap labor, why is the US running a deficit with China and not Ethiopia, Peru, Mexico, Somalia, or Haiti. Laws in all of those places are laxer and labor is cheaper than in China.

    Too Much Fed: There is about 6 billion people in the world. Let’s say about 4 billion want jobs (2/3 of the population similar to the USA), and there are only 3 billion jobs. What happens?

    The point of a functioning economic system is to arrange things so that this doesn’t happen. Unemployment is an example of a market failure since what should happen is prices should rise and fall so that supply matches demand.

  • Posted by Glen M

    Hi Mark,

    I like your contributions here. What do you think about Michael Pettis’s take…..

    “In my response I argued that it is hard to say if excess liquidity growth is both necessary and sufficient condition for crisis since we would need an objective way to measure excess liquidity growth, and that is extremely difficult, at best. The late Frank Fernandez, while chief economist of the Securities Industry Association, spent years trying to do so, but always complained that the financial system was too good at developing new and unexpected ways to expand money.

    I am convinced however – perhaps a little monomaniacally – that excess liquidity is sufficient and I doubt the ability of regulators to prevent bubbles. Part of my skepticism about whether or not a robust regulatory framework can truly prevent credit bubbles is theoretical, and part of it is empirical, with the latter resting on two personal experiences. First, in my reading on financial history and current events there has clearly been tremendous improvement over the past 300 years and more in our understanding of financial risks, the functioning of the financial system, the sophistication of our regulatory institutions, and monetary policy, but absolutely no concomitant reduction in the incidence of credit bubbles.

    Quite the contrary, and if good regulation prevented crises, why wouldn’t we have seen evidence of gradual improvement in the number and viciousness of crises? Second, as a former smart-ass banker/trader I am too respectful of the enormous ability of the market to game any system that can be put into place. Regulators simply cannot outplay the market, and when too much liquidity leads to an increase in risk appetite, the financial system will find a way to take on more risk that might be healthy. As I argue in my piece, “When any part of the financial system is constrained from taking on risk, the market simply evades these constraints in one of three ways: It innovates around them, it generates or develops new and unregulated parts of the financial system, or it conceals regulatory violations.”

    http://mpettis.com/2009/01/168/
    ………..

    If I am reading Michael correctly, he is saying that it was the excess liquidity that played a key role.

  • Posted by Dan Rosen

    UBS still calling for China to run over $300 bb trade surplus this year, Stephen Green at StanChart sees modest X-M growth too. So trade deficit territory by end year would be quite a shocker. The stronger China domestic resurgence, and the weaker the US, the more likely this is: swing factor will be commodity prices.

  • Posted by Too Much Fed

    twofish said: “The problem with that explanation is that you’d expect that if cheap labor and lax laws were the issue that you’d have a higher surplus in the 1980’s than in the 2000. The other problem is if it were a case of lax laws and cheap labor, why is the US running a deficit with China and not Ethiopia, Peru, Mexico, Somalia, or Haiti. Laws in all of those places are laxer and labor is cheaper than in China.”

    china enters wto in 2001. china’s population is bigger. china’s gov’t and/or central bank play along with the fed and GS. china’s gov’t basically stays the same.

    Not sure about the other 4, but hasn’t the USA run a trade deficit with Mexico since nafta was passed or soon thereafter?

    In this article:

    http://www.theatlantic.com/doc/200801/fallows-chinese-dollars/3

    it says “to pay the workers their 1,200-RMB ($160) monthly salary”.

    I don’t have any stats about Mexican workers’ wages, but is it less than $160 per MONTH?

  • Posted by Too Much Fed

    “In fact, I have long said (and have made a few bets with friends) that the Chinese trade balance will likely be in deficit by the end of this year. This means that the need for China to buy out treasuries will have largely gone away.”

    chinese trade deficit with the USA (as in the USA will have a trade surplus with china) or overall?

    From:

    http://finance.yahoo.com/news/May-trade-deficit-apf-2840686452.html?x=0&sec=topStories&pos=6&asset=&ccode=

    “The politically sensitive deficit with China rose 4.4 percent to $17.5 billion in May, but is running 12.6 percent below the record pace of last year. The Chinese government reported earlier this week that its exports and imports fell again in June, but that the declines were less severe than in May, providing further evidence that the world’s third-largest economy also was recovering from its slowdown.

    America’s deficit with Canada, its largest trading partner, dropped to $628 million, the smallest monthly imbalance in 15 years. The deficit with Japan shrank to $1.9 billion, the lowest deficit with that country in more than two decades.”

    What happens if china has a trade surplus with the USA and a trade deficit with countries that china buys commodities from?

  • Posted by Mark Dow

    Glen M – If you read the quote you cite carefully, you will note in the 2nd parpa that the creation of excess liquidity happened because “the financial system was too good at developing new and unexpected ways to expand money”. This is the money multiplier explosion that I refered to.

    Too many people read ‘liquidity’ and assume it must refer to Central Bank provision of liquidity. The most pernicious liquidity is that which we in the market create when we want to lever up and take risk. This is what drives the money multiplier. And once the mania takes hold, it becomes fairly insensitive to changes in the policy rate (if you think you are going to make 100% in two years on your house, a mortgage rate of 4% and a rate of 7% looks like the same number).

  • Posted by Too Much Fed

    “the financial system was too good at developing new and unexpected ways to expand money”

    Not sure how money is defined there. Is it better to say the financial system was too good at developing new and unexpected ways to expand DEBT? Was that debt then used to prop up aggregate demand so price deflation did not occur?

  • Posted by asdf

    I know that this is offtopic, but I’d be glad if anyone (maybe Mark) could make any suggestions.

    When there is talk about the global adjustment, there is nearly always talk about Japan/China/Asia and the USA. We know that asia was lending to the US, they were getting treasuries. But there is very little talk about the other big surplus country, germany. A surplus country is always a global lender. But where can I find out to whom we (germany) have lent money? Do you have to lend money to the country you have a trade deficit with or could it even be more complicated?
    I’m just curious because Asia has trillions of treasuries and we must also have some kind of IOUs, or?

  • Posted by Noah

    “While it is true that the Chinese exchange rate regime was an amplifier of this story, I think it was more of a passenger than a driver. The driver was credit.”

    So, Mark, if I understand this right, you’re saying that the Chinese would not have purchased massive quantities of U.S. debt – and thus would not have held the yuan down against the dollar – if the American finance industry not generated a massive credit boom?

    That doesn’t make a lot of sense to me…

  • Posted by Mark Dow

    Noah – Correct. That is exactly what I am saying. The credit creation generated the American demand for imports, which put pressure to appreciate on the Renmimbi, which led to China buying dollars, which led to China buying Treasuries.

  • Posted by HZ

    Mark,
    What you said makes a lot of sense. You were clearly right that credit was the driver.
    The “positive” (at least for the US) is that shrinking trade deficit will buffer the economic fall. I think people who argue for more fiscal stimulus should at least give the economy some time to adjust — until the trade deficit comes down to zero (< 1% is probably close enough to allow for fluctuations)it is hard to argue that there is not enough domestic demand.

  • Posted by Twofish

    Too Much Fed: china enters wto in 2001. china’s population is bigger. china’s gov’t and/or central bank play along with the fed and GS. china’s gov’t basically stays the same.

    So could it be that those are the reasons that you end up with a trade surplus, and they have nothing to do with lax laws or low wages?

    Too Much Fed: I don’t have any stats about Mexican workers’ wages, but is it less than $160 per MONTH?

    It is, but on the other hand, migrant workers in southern China usually have the company pay for housing and food is often subsidized, so anything that gets made is pure profit that gets sent back home to the farm, where US$160/month is quite a lot.

    Too Much Fund: What happens if china has a trade surplus with the USA and a trade deficit with countries that china buys commodities from?

    Then China will get dollars from the US, and then use them to pay for raw materials from the Saudis. The situation where China ran a deficit with the US, but a balanced trade overall was the situation before 2003.

    Mark Dow: Noah – Correct. That is exactly what I am saying. The credit creation generated the American demand for imports, which put pressure to appreciate on the Renmimbi, which led to China buying dollars, which led to China buying Treasuries.

    I don’t think that that was the main driver for credit. The main driver for credit was US borrowing for the war in Iraq. You have a major war, you don’t raise taxes, the money has to come from somewhere, and it comes from inflated values of housing.

    asdf: But there is very little talk about the other big surplus country, germany. A surplus country is always a global lender. But where can I find out to whom we (germany) have lent money? Do you have to lend money to the country you have a trade deficit with or could it even be more complicated?

    German banks were massive, massive lenders to the subprime mortgage market lending rather huge amounts of money to US investment banks. Of course it was all safe, since in case of default, they were all insured…… By AIG…….

    This is why the Fed had to bail out AIG, because if AIG went kaboom, then the German banking system would have collapsed.

  • Posted by Too Much Fed

    “And once the mania takes hold, it becomes fairly insensitive to changes in the policy rate (if you think you are going to make 100% in two years on your house, a mortgage rate of 4% and a rate of 7% looks like the same number).”

    Let’s say someone thinks housing always goes up in price and will probably keep going up 6 to 12% a year because it has the last 2 or 3 years. If a teaser rate of 2% to 3% is available for 2 years to 5 years, this person is getting a wage increase of 2% to 3%, and this person is experiencing price inflation of 2% to 5%, should this person become a “end-user” speculator in the financial asset of housing?

    Did teaser rates and poor underwriting extend the housing bubble by 2 or 3 years before the policy rate (fed funds) caught up?

  • Posted by Too Much Fed

    Twofish said: “Mark Dow: Noah – Correct. That is exactly what I am saying. The credit creation generated the American demand for imports, which put pressure to appreciate on the Renmimbi, which led to China buying dollars, which led to China buying Treasuries.

    I don’t think that that was the main driver for credit. The main driver for credit was US borrowing for the war in Iraq. You have a major war, you don’t raise taxes, the money has to come from somewhere, and it comes from inflated values of housing.”

    IMO, the main driver for public debt was the war in Iraq and tax cuts.

    IMO, the main driver for private debt was negative real earnings growth on the lower and middle class and the fed encouraging private debt to prevent price deflation from occurring to due productivity and cheap labor.

    It seems to me that it is possible that the fed and the chinese central bank had this arrangement in mind when china got entry into the WTO.

  • Posted by Noah

    Mark –

    “The credit creation generated the American demand for imports, which put pressure to appreciate on the Renmimbi, which led to China buying dollars, which led to China buying Treasuries.”

    So in my mind, that raises the question: Why would China want to stop the appreciation of the RMB in that scenario? If U.S. demand for Chinese goods was caused by a U.S. credit bubble, then China’s exports to the U.S. would rise even if China allowed the RMB to appreciate.

    In that case, China could have A) given its people greater purchasing power, B) saved money on commodity and components imports, and C) avoided buying sure-to-depreciate U.S. government bonds, all while still ramping up exports to the U.S., by allowing their currency to appreciate. It just makes no sense to me why they wouldn’t do that.

    If, however, exploding American demand for Chinese goods relied on Chinese “vendor finance”, then it make sense that they’d buy U.S. treasuries even though doing so would incur significant costs to them. Am I totally wrong here?

  • Posted by jonathan

    Isn’t it fascinating that we each construct our own blame chain? I’m not dissing yours, Mark. You emphasize the private creation and use of money multipliers, which I agree is a neat phrase to incorporate – I assume – everything from leverage to the creation of CDO squared and other even more abstracted instruments. I’m not sure one can win an argument about the role of private versus regulatory failure, if only because the former seems to depend on the latter. Perhaps one might say, in the absence of regulation and transparency in information, private actors …

  • Posted by Too Much Fed

    Twofish’s post said:

    “Too Much Fed: china enters wto in 2001. china’s population is bigger. china’s gov’t and/or central bank play along with the fed and GS. china’s gov’t basically stays the same.

    So could it be that those are the reasons that you end up with a trade surplus, and they have nothing to do with lax laws or low wages?”

    Those other reasons apply, but if wages went up and/or laws were enforced then prices of chinese exports would go up (can anyone say erin burnett?). People in the USA might buy less if prices went up and interest rates would probably go up, which the fed would just hate. Or, corporate america might attempt to go somewhere else.

  • Posted by Too Much Fed

    Noah said: “So in my mind, that raises the question: Why would China want to stop the appreciation of the RMB in that scenario? If U.S. demand for Chinese goods was caused by a U.S. credit bubble, then China’s exports to the U.S. would rise even if China allowed the RMB to appreciate.”

    If the RMB appreciates and leads to higher import prices (tradable goods), that would probably raise interest rates which would probably lower debt creation.

  • Posted by Rien Huizer

    Amazing how people can argue about things that cannot be verified. Try to answer the following questions:

    Q1: did availability of external finance drive the US trade deficit by (indirectly) relaxing US consumer budget constraints?
    Q2. In the absence of Chinese finance (i e the Chinese not spending their surplus USD) would others have financed the same trade deficit and if so would China have had the same surplus (but spent it and the recipient would not have spent it).
    Q3. If Chinese demand for US financial assets (assuming China having a trade surplus with the US and not spending USD on anything by USD financial assets (to keep CNY from rising) was weighted towards long maturities, could that have kept mortgage rates low, and hence made housing ceteris paribus more affordable, creating abnormal demand and hence provided buoyancy to US house prices ?
    Q4. What should the US regulatory system have done preventively in those circumstances if it had performed according to a hypothetical design specification that bail outs (caused by market circumstances that in the absence of intervention would have led to a severe systemic crisis and loss of over, say, 74% of all required capital of private financial institutions)?
    Q5 ditto with respect to foreign financial institutions and investors (not being China) operating in the US or investing in US financial assets (including especially those using using funds borrowed in USD financial markets?)
    Q6 Were there design specifications to that effect?
    Q7 Did the system actually in place provide sufficient preventive effect?
    Q8 Was that a matter of design flaws of managerial/political failure to perform to spefication.
    Q9 What drove what?

    Many of the answers people would tend to give would reflect beliefs. Well supported answers (even to the simple Q1 and especially Q3) are not avaliable, at least not in the public domain. Speculation abounds and the various stories reflect personal preferences.

    All we can say that the opportunity to facilitate a boom in consumer spending may have been the corollary of weaknesses in US financial system control and that the Chinese desire to use currency manipulation to keep exports competitive (very simplistically) may have generated the funds that exploited that opportunity. The weaknesses were long standing and well known, the boom was clearly abnormal (though politically welcome) and China was in the process of marrying a steadily more affluent workforce with steadily rising productivity, thus keeping unit costs very low despite the rise in affluence. It might have taken more risk with the exchange rate or done other things than just hoarding USD. And it probably would have if it were a unitary actor with perfect foresight..

  • Posted by Rien Huizer

    “Q4. What should the US regulatory system have done preventively in those circumstances if it had performed according to a hypothetical design specification that bail outs (caused by market circumstances that in the absence of intervention would have led to a severe systemic crisis and loss of over, say, 74% of all required capital of private financial institutions)?”

    Forgot to complete that ugly sentence by adding: ” from fiscal sources should never occur.”

  • Posted by Ying

    Credit expansion is only one side of the coin. The other side is investment. The majority wealth (pensions, mutual funds etc) of American people are managed by institutional investors. The money are invested in basically the following categories:
    1) Debt instruments – both government debt and consumer debt (mortgage backed securities)
    2) Multinational firms who invest in developing countries and sell in developed countries
    3) Financial institutions
    4) Retails, real estates, technology and others…
    All of these assisted in further integration of global economic system by utilizing cheap labors abroad. The public money has been used by private institutions to achieve short term gain. If American really wants to go on a productive path as many people said here, they need to re-read Keynes’ idea of “socialization of investment” and start to make plan for their economic development to satisfy its own needs instead of relying on cheap imports.

  • Posted by Brick

    There may be a slight fly in the ointment with your theory in that factory gate prices in China continue to decline. Part of that is due to commodity price declines, but part is that investment and credit is tending to reach china’s internal markets rather than its export markets. If true this would suggest china is in a deflationary environment and if they hold their dollar peg we might expect them to increase their share of the US declining market. This would tend to keep the imbalances in equilibrium whilst destroying jobs in the US. In essence China is exporting its deflation, evidence of which would most probably be the likes of big cheap retailers in the US gaining market share. This argument off course also has holes if we start looking at ship container traffic which has declined. I dread to think what would happen if Chinas trade deficit began to accelerate upwards though.

  • Posted by Don

    I have read several places that China was building stocks of commodities over the last couple of months. Could that have suppressed their trade surplus after the usual holiday dip?

  • Posted by Michael

    Frankly, I’m getting a little tired of the “chicken or the egg?” discussion regarding China’s trade surplus/currency controls/Treasury buying and the U.S.’ excessive consumption/trade deficit/credit binge. In an idealized (non-existent) world of unrestricted free trade and currency exchange, the whole U.S.-China Syndrome would never have gone very far because the rising U.S. deficit would have led to a devalued dollar and high U.S. interest rates, preventing even the most creative possible finance from expanding credit growth into the stratosphere. In the real world, all it takes is two (or more) countries in which currency is manipulated (including the U.S. “dollar reserve status” manipulation) and the whole Ricardian fantasy of “equilibrium” flies out the window. So, where’s the mystery that needs to be explained? This “crisis” is just a familiar repetition of trade and credit cycles going back to the 17th Century.

  • Posted by DOR

    Mr Dow, “China has become the obsession that Japan was back in the 80s. And rightly so.”
    Can we try that one again? Are you arguing that it is correct to obsess about a single foreign trade partner, rather than face up to reality and fix what makes our own country less competitive?

    Don’t give me that old saw about exchange rates. We didn’t see any reduction in the US trade deficit with Japan after the Plaza Accord.

    = = = = =

    I agree with Twofish: trying to prop up the export sector when the problem is foreign demand is a no-brainer stupid idea. Hence, the Chinese government hasn’t tried to do that. Instead, they’ve taken rather intelligent steps such as reducing the amount of taxes unnecessarily taken from exporters in the form of reduced VAT rebates. This may be a difficult notion for economists from places where there is no VAT, but the simple notion is that tax refunds are now closer to the original intention (100% rebate of VAT paid on imports when they are part of exports) than in the past, when exports were penalized by smaller tax rebates.

  • Posted by Mark Dow

    DOR – If you read my postings carefully you will see that I think the exchange rate issue has been overplayed. Our exuberant credit expansion and the financial innovation that fed it was the main culprit.

    When I say “obsess” I merely mean that China is an increasingly important player in global economics and finance, and, as such, it is important to know what is going on there. I was not suggesting the China was the principal culprit in anything. Their FX policy was an amplifier, not a driver, is what I believe I said.

  • Posted by ReformerRay

    So, Mark, if I understand this right, you’re saying that the Chinese would not have purchased massive quantities of U.S. debt – and thus would not have held the yuan down against the dollar – if the American finance industry not generated a massive credit boom?
    That doesn’t make a lot of sense to me…
    July 10th, 2009 at 5:17 pm
    Mark Dow responds:

    Noah – Correct. That is exactly what I am saying. The credit creation generated the American demand for imports, which put pressure to appreciate on the Renmimbi, which led to China buying dollars, which led to China buying Treasuries.

    The U.S. financial system did not create the credit alone. Go back to 1997. In that year, the U.S. stock market went on a speculative tear, which induced foreigners to send money to the U.S. to participate, which raised the value of the dollar in international currency markets, which increased imports (U.S. share of world imports went up 3% in three years).

    Credit creation was one of several factors that caused the U.S. trade deficit to increase which played a part in inducing Chinese exports.

    The U.S. stock market and its influence on international currency flows is, in some sense, out of the control of the U.S. financial system.

  • Posted by ReformerRay

    “Don’t give me that old saw about exchange rates. We didn’t see any reduction in the US trade deficit with Japan after the Plaza Accord”. This from DOR.

    Don’t know about the Japanese trade deficit. Do know that the U. S. trade deficit with the world did begin to decline in 1987, two years after the exchange value of the dollar went into a nose dive following the Plaza Accord.

  • Posted by Too Much Fed

    From my post earlier:

    “IMO, the main driver for public debt was the war in Iraq and tax cuts.”

    See here:

    http://www.cbpp.org/cms/?fa=view&id=640

    “The dominant factor in the unprecedented fiscal deterioration thus was not the performance of the economy. Nor was it increases in domestic programs. The key factors have been large tax cuts and increases in security-related programs.”

    It seems to me the fed wanted more public debt (treasuries) because they knew a lot of lower and middle class private debt was being created. They wanted those extra treasuries in case something went wrong, and then they could swap public debt for private debt.

  • Posted by Too Much Fed

    ReformerRay said: “The U.S. stock market and its influence on international currency flows is, in some sense, out of the control of the U.S. financial system.”

    Sorry, but I don’t believe that. It seems to me that the oil market and stock market started rallying about the time that AIG counterparties (especailly GS) got bailed out with enough gov’t debt. Once bailed out, they could borrow at 0.5% (??? or a really low interest rate) to drive oil prices and stocks prices up while hoping to make a nice profit along the way.

  • Posted by Glen M

    I am having difficulty accepting it was the multiplier while ignoring what was multiplied. I also find it telling that as the multiplier increased, the risk premium did not.

  • Posted by Lawrence Kramer

    I’m late to this party, but I’m intrigued by the chicken/egg problem. I would argue that financial innovation does not arise in a vacuum, that the relevant “driver” here is the automobile driver!

    The financial innovation you cite was applied to increase the bandwidth of our capital-reimportation system. Money used to recirculate in our country through Main Street banks, but as more and more of our capital came to consist of repatriated petro-dollars, the port of entry moved to New York, and ways had to be found to create paper attractive to foreign investors. The devices created were easily scaled to permit the explosion of credit that you cite, but I think it was the need to absorb the dollars that created the devices, not vice versa. That those devices then did attract MORE dollars is another story.

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