RGE - Global adjustment -- the US, Europe, Asia and last but not least the oil exporters

リンク: RGE - Global adjustment -- the US, Europe, Asia and last but not least the oil exporters.

Brad Setser | Mar 28, 2007

Folks have been worrying about the current account deficit for so long that “Wall Street is downright bored with it.”    Trust me, I know.

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But just because the world’s central banks have financed an expanding US deficit – at least the fraction of the US deficit that private market don't want to finance – up until now is no guarantee that they will finance large US deficits forever.    Indeed, rumblings about excessive dollar exposure (and low dollar returns) are growing just as the US economy is slowing.   If the Fed started to cut and the dollar lost its interest rate edge over say the euro, the odds are that sustaining the status quo would require more, not less, dollar reserve growth.   

The Peterson Institute, Bruegel and the Korean Institute for International Economic Policy recently sponsored a workshop on global adjustment.   Alan Ahearne, Bill Cline, Kyung Tae Lee, Yung Chul Park, Jean-Pisani Ferry and John Williamson then joined forces to outline a set of policies that would facilitate global adjustment. 

They argue that waiting until the markets “conclude the present situation is unsustainable” to take action to reduce the world's imbalances is risky.   I agree, though I might also have said that unless something changes, the real risk is that market pressures will grow to the point where even the most determined central banks give in.  The moment central banks stop making up for shortfalls in private flows to the US, watch out.     

It is rather hard to come up with a novel list of policy changes to support global adjustment.  Adjustment by definition means that US demand growth has to slow relative to income growth (a fancy way of saying the US needs to save more).   The most obvious way to increase national savings is to reduce the US fiscal deficit further.    Dollar depreciation – additional dollar depreciation – would help support income growth in the US as demand growth slows.   And it would certainly help if other countries – particularly China -- took policy steps to support domestic demand growth.   

The authors though tried to push the debate forward by trying to put some numbers around the scale of the needed real exchange rate adjustment – think a 10-20% real depreciation in the US and a 10-15% real appreciation in Japan and a 5-25% real appreciation in China.  Like most of the IIE, I personally suspect the needed real appreciation in China will be closer to 25% than 5%.  As the authors note, to get a small change in the needed real appreciation, you have to assume that Chinese exports are very sensitive to small changes in the value of the RMB.   Generating a large real appreciation of the yuan and yen requires quite significant moves in their value against the dollar.

I was lucky enough to have been among those invited to participate in the seminar that preceded the development of this statement, and a couple of things really jumped out at me.   

First, most countries (setting the NAFTA countries aside) trade a lot more with each other than with the US.   So if everyone lets their currency move against the dollar, the scale of the needed adjustment in other countries real exchange rates needed to generate a big change in the US real exchange isn’t as large as might be expected.   If all of Europe appreciates against the US, some European firms will be hurt – but the overall real appreciation is actually rather modest.

Second, most European countries have let the currencies appreciate against the dollar, but only a few Asian countries have.  The Korean won hasn’t just appreciated relative to the US.  It also has appreciated v. the yen and the Chinese yuan.   That really matters.   The Koreans are feeling rather lonely right now – they are quite worried by the won’s current strength.    If all of Asia appreciated v. the dollar, Asian real exchange rates would move – obviously – by far less than their bilateral exchange rate v. the euro.

My own contribution focused on the role of the oil exporters in global adjustment (alternative link).   As I started digging, I discovered -- somewhat to my surprise -- that the pace of adjustment in the big oil exporting economies really seemed to pick up in the course of 2006.   Current account surpluses were coming in smaller than initially forecast.    It looks like a higher fraction of the 2006 rise in oil revenues was spent on imports – and a smaller fraction was saved – than in 2005 or 2004.    Setting Saudi Arabia aside, rising inflation rates also emerged as an important force for real exchange rate adjustment.

Partially as a result of the ensuing low (usually negative) real interest rates, pretty much every oil exporting economy was enjoying a real estate boom.   The cranes of Dubai are just the most visible symbol of a far broader process.   In 2006, I – with help from Rachel Ziemba and Mikka Pineda – estimated that oil would need to average about $35 a barrel to cover the oil exporters’ broad import bill.  In  2007, the oil exporters look set to need oil to average $40 – using the IMF’s oil price – to roughly cover their import bill.   That looks rather likely.

I think it is fair to say that there wasn’t a consensus that oil exporters should accelerate the pace of adjustment and embrace a set of policy changes that would push imports up to a break-even price of say $45 a barrel.    There is still a bit of uncertainty about the long-run price of oil, among other things.   

I also argued that the process of adjustment in the oil exporting emerging economies would be facilitated if they adopted more flexible exchange rate regimes.    Exchange rate flexibility would help the oil exporters manage oil price volatility – and the volatility in government revenue that flows from oil price volatility.     That applies both on the upswing and on the downswing.    Right now, too much of the adjustment to higher oil prices is coming from a rise in inflation and too little from a rise in the currencies of the oil exporters. 

Work by the IMF suggests that, historically, a 100% rise in the price of oil leads to a 50% real appreciation, so this process still has further to go.  Inflation rates will likely remain high and real rates interest rates low for some time.    The overall adjustment will be back-loaded -- much of the increase in domestic absorption will come after oil prices have stabilized or even turned down.

I also argue that dollar pegs have prompted oil-exporting economies to hold more of their savings in dollars than otherwise would be the case, and the availability of dollar financing contributed to a world where almost all of the rise in the global deficit that offset the rise in the oil exporters surplus came from the-importing country with the biggest pre-existing deficit.   In my judgment, the process of adjusting to the recent rise in oil prices has been both slower than it should be and too tied to a big expansion of the deficit of a country that already had a big deficit.

I am interested to know what you all think of my argument – as well as what you all think of the broader policy brief.

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I tend to agree with the borad sweep, but am more pessimistic on the details. 

One phrase that jumped out is that dollar depreciation would support US income growth. I suppose it's true in the sense that if you lower wages a lot, then you may be able to afford to raise them a little. 

The FX people say that the Europeans say they have a strong resistance against the Euro/dollar going above 1.35. My guess is they might be willing to go to 1.40... or even a bit further if the Asian countries allowed their currencies to strengthen. But they are not too far from their limits. So, the burden of adjustment will fall on the US and on Asia. 

My intuition says that the dollar needs more like 20-30% adjustment so that American living standards can fall to the level that the rest of the world can tolerate. That will force the US to adopt the energy efficiency that Europe and Japan already have adopted, force people to live closer to work, put strong pressure on employers to provide employment security, and so on. But it sounds like a 10-year work through, a nasty recession, ala Reagan I but longer. 

And, of course, it means an end to dreams of empire and the grandiose military that comes with them.
Written by Anonymous ibid. on 2007-03-28 23:43:21

The funny thing about the global imbalance problem is that, often in a single breath, writers whose intelligence and understanding are beyond any conceivable dispute will (a) state very frankly that the situation is caused by CB policy, and (b) analyze it as if it was the result of fickle market "animal spirits," which might evaporate at any time.

No personal flaw can explain this odd logical lacuna. It is obviously the result of excessive interaction with policymakers.

Why would the markets "conclude the present situation is unsustainable?" It has been sustained for quite some time now. The market is clearly responding rationally given the present pattern of CB policy. Given the large number of channels of communication between CB economists and the private sector, there is no reason to think that market projections of CB policy are terribly inaccurate - and if you can do better, you can make some serious bank.

I would be curious indeed to see anyone propose a realistic scenario in which financial markets force CBs to take the kinds of austerity measures recommended in this paper.

My suspicion is that this non-credible hypothesis is an elliptical way of discussing the real political problem facing the CBs, which is that their short-term interests are in conflict with their long-term interests. Their long-term interest is in shutting down BWII, because the longer it goes on - like any spiral of dilution - the harder it is to escape from. But the pain of austerity is already very great, and would cause serious damage to the rosy and avuncular institutional image that the CBs have spent the last 25 years rebuilding.
Written by moldbug on 2007-03-28 23:44:47

The discussion on global adjustment is directly connected withthe issue of the adequacy of current exrates! Are mkts irrational? Or if they aren't, why do they keep the US$ spot rate at levels where it is not clear that the US CuA deficit is sustainable? 

To evaluate whether a REER (say: the $ REER) or an pair (say: $/Yen) is broadly in equilibrium, one should not focus on the spot rate, but should consider the whole term structure of exrates (as described by the forward rate, or if you prefer the UIP). In other words, interest rates matter for equilibrium in forex mkts. 

It is the whole forward exrate maturity structure that has to be consistent with the sustainability (and solution) of global imbalances. A spot exrate, if considered fixed over time, may not be consistent, while the term structure is! This is the solution to the puzzle of current spot rates that you claim are too low (Yen, FFSS etc) and that in fact are in broad equilibrium (unless of course interest rates change) 

This is why private mkt participants, by setting the overall dollar level (and the spot Yen/$) at levels that are inconsistent with the solution of global imbalances, at the same time are not (may not be) irrational nor wrong. 


Written by Gheorghius on 2007-03-29 01:15:04

ibid actually a break of Euro 137 would set new resistance at 157

Written by rpbwalsh on 2007-03-29 01:16:59

"The most obvious way to increase national savings is to reduce the US fiscal deficit further. Dollar depreciation – additional dollar depreciation – would help support income growth in the US as demand growth slows. And it would certainly help if other countries – particularly China -- took policy steps to support domestic demand growth." 

Brad are we not perhaps already at the point of no return? Multi-nationals evidently were not waiting for these imbalances to "fix themselves" indefinitely as opposed to simply taking labor needs to the source of savings-gluts overseas. To increase savings by inflating the dollar results here in a deflationary scenario; in real terms such savings only increases "on-paper" as a result of 'jiggin the ratio used to calculate-it. Its like fixing corporate earnings when firms buy shares. Perhaps the next grand CDO play will be for credit tranches to be packaged to rebuild factories destroyed 20+ years ago that got us in this mess to begin with. Would having more dollars back here in the U.S. as a result of bond sales support OUR demand growth? Demand can only grow if WE MAKE something that is desired for utility, value, etc... (o.k. movies thats one). Or stated inversely, "made in china" today is the "made in japan" crappola of 20 years ago. The 3400 people that lost their jobs at Circuit City today get-it!
Written by rpbwalsh on 2007-03-29 01:42:50

Let's assume that the dollar significantly falls against the euro. What would that mean for the EU economy? Wouldn't they intervene in some form? The EU goods trade already has a deficit, while a few years ago it had a surplus. The ECB report on this gives the trade balance only for the euro-area. And this area has a surplus with the rest, non-euro EU countries, UK+Sweden+Denmark+.... I wonder what the trade numbers are for the whole EU, including these non-euro countries. Does anyone have the data?
Written by AC on 2007-03-29 04:26:01

Brad Setser's colleague Nouriel perfectly summarizes the "real" state of the US Economy writing, "Durable goods data and investment data point to US hard landing in 2007". The Global Adjustment epicenter will be the overleveraged US consumer strangled by higher energy costs, increasing unemployment from foreign outsourcing, and higher mortgage adjustable interest rates. Since consumer spending accounts for 70% of US Gross Domestic Product, no amount of creative accounting on the economic statistics by the Federal Reserve will be able to hide the reality that the US Economy faces a deepening recession.

By the way, Economist Paul Kasriel is also on board the Roubini Express Train. “Kasriel Recession-Warning Indicator” flashing Code Red. The rest of the politically correct Economist crowd led by Helicopter Commander Bernanke has their heads buried in the sand. 

“Kasriel Recession-Warning Indicator” 

" In sum, barring upward revisions in the LEI and KRWI and sharp increases in the immediate months ahead, both of these indicators will be sending a signal that a recession is on the horizon. Perhaps this will be the first time in over 45 years that the KRWI will emit a false signal and only the second time that the LEI emits a false signal. Perhaps. " - Paul Kasriel

*Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy " 

Written by Dave Chiang on 2007-03-29 08:45:56

LC -- eurostat releases data on the EU's trade balance (as well as the eurozone). The ECB has data on the eurozone's trade and current account balance as well. Incidentally, the eurozone's current account balance looks set to swing back into a surplus on the back of lower oil prices (well, formerly lower oil prices) and growing exports to the oil-exporting economies. Its balance with the US is not improving in euro terms -- the gap is shrinking in $ terms. So the source of the improvement in europe's overall balance is elsewhere.

Gheorghius -- markets aren't setting the spot or the foward rate on the RMB. the real issue for "policy makers" v "markets" is the yen -- and the yen is where it is b/c of interest rate differentials (the famaous carry trade) and perhaps - and this is where policy expectations come in -- b/c the markets expect the japanese to resist any sharp appreciation of the yen. That of course makes it more attractive to borrow yen to buy other currencies, since the BOJ/MOF effectively would cap your downside losses and provide a way of getting out of the trade (you can sell the dollars you bought with borrowed yen to the MOF in a real pinch). the shadow of intervention expectations may still be present. plus, by holding its $40b in annual interest payments in $ rather than selling its $ for yen, the MoF/ BoJ are effectively taking one bit of demand for yen out of the market ... does that matter? perhaps.

by income growth i meant national income growth -- i.e. production ... i was writing in the national accounting framework.

Moldbug - the situation where markets force CBs hand isn't that hard to envision. Rather than borrowing yen to buy $, the markets borrow yen to buy rupee and real. Indian and Brazilian reserve growth goes through the roof -- and they conclude that they cannot take it anymore (negative carry) and either let their currencies appreciate or slap on really restrictive controls. the CHinese decide that they don't really want to eat more than $350b in $ claims a year. and as the $ comes under pressure, the oil exporters decide they want to hold claims on Asia rather than the US. The internal equilibrium among central banks who are accumulating reserves breaks down -- no one in that scenario wants to hold $ on the scale needed to finace the uS deficit. the flows to the eurozone bid it up, and eventually a new equilibrium is established, but it isn't the current equilibrium. remember, the current equilibrium seems based on a world where CBs increase the pace of their $ reserve growth when the $ is under pressure. that implies someone has to absorb an awful lot of $. let's see exactly how many when the q1 data starts to come out.

i would, as a result, watch all the signs that some CBs are rather worried by the scale of their existing $ holdings very closely. the status quo requires cBs who already think they have too many $ buy more $ than they do now in bouts of $ weakness.
Written by bsetser on 2007-03-29 09:09:41

Brad -- Thanks for the info. I did not mean that the EU trade balance would deteriorate with a strong euro/dollar rate because of an increased US export,but because of an increased Chinese export to the EU.
Written by Guest on 2007-03-29 09:26:44

To everything, there is a season, and to every deficit, there is a surplus. Moldbug hits the nail on the head I think...the US C/A deficit is sustainable as long as the people holding the surpluses desire to run such large surpluses. 

Given that many/most of the holders of large surpluses have agendas other than maximizing their purchasing power in global goods/services markets, conventional analyses of what could or should occur based on private sector behaviour could be misplaced.

A number of private sector Europeans have noted that they can live with a stronger euro. Airbus will probably continue to struggle, but it is difficult to believe that the Ecofin will sanction intervention unless the level is very substantially higher than currently, or the volatility of the move rises substantially (USD/Europe historical and implied volatilities remain near all tiem lows.)

Private sector markets do occsaonally care about imbalances and position themselves accordingly, but such a strategy, applied on a consistent basis, has been a money-loser over long peiods of time.
Written by Macro Man on 2007-03-29 09:51:53

I agree with moldbug and here is how I would put it. It s impossible to discuss the changes needed for inter national adjustment as far in exchange rate policies, reserve portofolios, commercial deficits-excedents, balance of accound deficits-excedents without discussing the change needed for intra national adjustment in wage policy, budget priorities, composition of money creation ... 

I mean basically what I understand from moldbug is this : the current BWII is a way to boost global demand by a continuous influx of credit. THe credit extension is not sustainable in the long term, but putting an end to credit expansion is not politically possible in the short term. The world needs the growth in demand in order to absorb the productivity gains in Asia. 

So basically Brad you need to discuss the schemes by which demand is to be boosted. 
In other posts you discussed major government programs boosting social spending, especially in CHina, but they would not hurt in the USA either. You also advocate more spending on the part of oil exporting countries.
You could on top of this, advocate direct financing of the government deficits by home central banks. THis would generate a healthy inflation necessary to reduce the present debt bubble. 
You could also by the way advocate the nationalisation of central banks in the only country where it is still a private bank (the USA). 
You could finally advocate policies boosting the minimum wage in all countries especially in those where they are the lowest (asia), pro union policies would also be very useful. 

ANyway you put it, if the present addiction to credit is to be fought it can only be by boosting nominal revenues. In fact the world faces two option : radically pro wage and pro inflation policies or a global debt deflation depression with the collapse of BWII. 

Roubini s post and Your s indicate there is a growing urgency in adopting adjustment policies. It might be time to join the 2 faces of the problem and realise that some policies must be enacted if reliance on credit is to be fought and they can not all be in the international realms. 

There s another way to put it : you reckon that the RMB is undervalued that this has caused chinese exports, US deficits and that the RMB should be reevaluated, this would lower the value of the US debt. But it would be a just compensation for the fact that chinese kept their currency too low for too long. 

On top of the US debt to china, chinese policy (asian policy let s say, Japan is no different) has favored Debt in general. Profits have been boosted in the USA, wages have stagnated, more US wage earners owe more money to US asset holders (and more US small asset holders owe more money to US big asset holders and their intermediaries). 
Why should it be OK for the US to repay the chinese with a devalued curency and not for the poor people to repay the rich ones with a devalued currency ?

Written by df on 2007-03-29 10:00:10

as an aside, can anyone explaine to me why central banks have been so pathetically asymetric. 

We all know there are two kinds of goods : 
those needed by the consumer, food clothe games health 
THose needed by the producer : factories, companies, brands, patents, housing
And yes there are some stuff in the middle, semi durable goods used for production, like cars, computers ..

All countries track different indexes of the general consuming good prices level. 
No country tracks a general index of the general producing good prices level. 

Central banks act when they see a rise in the level of consuming good prices, they also act against any rise in the general wage level as it may lead to further increases in consuming good prices. 

Central banks do not act when they see a rise in the general level of producing good prices. And we do not need a general index to know that all asset prices have risen recently, housing and stocks. They also do not act to figh a general rise in profit levels although it may lead to further increases in producing good prices. 

Indeed everybody seems to care that you don t get the same quantity of food for one dollar, but no one cares that you don t get the same quantity of a company or of housing for one dollar. No one is protecting the power of purchase of the producer ... How come ?

What happened to monetarists ?

I mean. Is it because they relied on that lousy equation : 

Is it this equation that blinded us to the fact that inflation happens whenever there is money creation it s just that it can be inflation in consuming goods or production goods. 


Is there any works that try to asses the importance of the stock of consumption goods and production goods stocks trade in the use of money ?

I look at the policies link posted by Brad and I hear the same appaling fear of consuming good prices inflation. 
Why are central banks and economists so happy when production good prices rise relative to consuming good prices ?

It seems to me some people speaking too much to say wrong things are friends of some people who have huge stocks of producing goods and enjoy the overvaluation of their properties, enjoy what would have been labelled 30 years ago : the terms of the trade. 

I say bring up the consumption good prices or face a free fall in production goods prices. 

Written by df on 2007-03-29 10:28:03

I should have started like this : 
Folks have been worrying about the too high PE ratio for so long that “Wall Street is downright bored with it.” Trust me, I know.

may be it would have made it all funnier. 

Written by df on 2007-03-29 10:30:19

DF -- right now the PBoC subsidizes Chinese demand (and exports) by subsidizing US (ane European consumtpion), and by holding US and european rates down, US and European asset prices ... no wonder macroman is happy ;) ... I all in favor of China starting to subsidize Chinese consumption rather than US consumption ... even if that means larger fiscal deficits in China. right now, China's fiscal deficit is all being run off balance sheet in the form of expected capital losses on China's reserve position -- tis a massive off balance sheet fiscal subsidy for Chinese exports (and US and european consumption of CHinese goods)

macroman -- actually, the simplest "rebalancing portfolio" has done pretty well since say 2003 -- it is to be overweight a broad portfolio of foreign assets v. a broad portfolio of US assets. the $ has trended down (v. pretty much everyone but the yen) and us equities have underperformed global equities. the more complicated bets on imbalances have done badly. and of course going long the yen as part of a rebalancing bet has done badly. but the really simple strategy of going overweight non US assets v US assets has done quite well
Written by bsetser on 2007-03-29 11:04:21

RPBWalsh, there's a difference between what the technicals say and what can actually happen. If the Euro gets too high, Europe can force it lower through policy changes. What I was saying is that Stephen Jen of Morgan Stanley has stated (12/4/06) that the Europeans intend to take action if the Euro gets too high. 

Moldbug, while it's true that unsustainable situations can be sustained longer than any of us imagine, this is a case of Wile E. Coyoteconomy (cf. DeLong) plunging down toward the canyon below. He will hit bottom. 

There are strong reasons for those who have been sustaining the US deficits to decline to do so further. Chief among them is the propensity of the US to intervene abroad. When they choose to act is unknown, but certainly hostile action against Iran will greatly increase the probability that it will be sooner rather than later.
Written by Anonymous ibid. on 2007-03-29 11:08:09

anonymous so you mean we should wish that US invade Iran so that finally the adjustment begins ?

Brad, I was saying that the FED and the BCE should reset their consumption goods inflation goals to something like 10% annual rate. 

I guess this is the only way to absorb the debt load we all face. 
Do you back a policy which would intentionally push consumption good prices higher ? 
Or are you part of the crowd that believes for a reason I can not grasp that consumption goods prices must not increase, while production goods prices can. 

I think such a position is similar to people thinking that the dollar-RMb real rate can rise indifinitely. 

Written by df on 2007-03-29 11:44:37

if the fed and ECB want inflation in Cons Goods Pr (CGP from now on) at 2% then they should keep monetary creation at around 2%, which means curtailing credit very very strongly and or raising rates. 

If they don t do it, then they are increasing the prices of things not monitored by the price indexes used, mainly asset prices. 

This is a recipe for disaster since the credit bubble can only explode if overextanded. 

Brad I wonder what mechanisms you think link low rates to higher asset prices. 

May be you think low rates mean higher expected profits therefore higher asset prices
may be you think low rates mean more incentive to use leveradge to increase again profits and higher asset prices

Or do you realise that low rates means simply increased endogeneous money supply and higher asset prices since more money chases the same quantity of goods ?
If that is not the main reason, then how come P/E ratio are rising everywhere ?

Don t you think it would be easier to allow money creation to flow into consumption good prices and boost inflation than to allow the massive destruction of money that is needed to bring back asset prices in range ?

Phrased other wise, to rebalance asset prices relative to consumption good prices, do you prefer : debt deflation, or inflation ?

Is everything I just wrote really that diferent than advocating a higher RMB to rebalance the US-China trade deficit, rather than a massive recession in the USA to bring the deficit down and defend the US dollar value ?

I think it s pretty much the same. the USA are the asset holders of the world, the chinese the workers of the world.

So I say increase workers pay and consumption goods prices, all central banks unite in boosting inflation worlwide, or we ll see a major collapse in asset prices and a huge global debt deflation.

Written by df on 2007-03-29 12:13:14

df: I agree with you; central banks should target a price index including asset prices. Their arguments for not doing so are mostly rubbish. I think the real reason why central banks don't include asset prices in their inflation objective is that assets are what people own, and consumption goods are what people buy. Although central bank independence is supposed to avoid such influences, in practice, politicians tend to select central bankers who do not rock the boat (except in extreme circumstances like 20% inflation). Greenspan kept being reappointed because he showed himself willing to bail out financial markets, and I was sure that Bernanke would succeed Greenspan after his speech in 2002 when he promised to finance the government deficit in a slump. And even central bankers not up for reappointment like to be liked!

Brad: I see that the policy changes to facilitate adjustment did not include the possibility of US intervention against the dollar. Did no-one at the workshop even consider it?

Written by RebelEconomist on 2007-03-29 12:42:46

Face the facts, the US government loves the Chinese government financing of a capital account surplus. Under the current US Dollar hegemony regime, what the hell else can the Chinese government do with the money. Why does the US government love Chinese government money, because as the world’s largest borrower, the US government can fund its global empire project with its little wars around the world (ie. only small nations are attacked). No complaints by Congress about selling unlimited quantities of US Treasury Bonds to the Chinese Central Bank, but the sale of equity ownership in Unocal to China's CNOOC was vetoed by Congress. Despite the fact that Unocal's primary energy assets were in Southeast Asia, any equity purchase by the Chinese is automatically deemed a "National Security Threat" to the United States. Unocal produced only 2% of US domestic production, and CNOOC was willing to divest those assets. The hypocrisy and intellectual dishonesty boggles the mind.

Written by Dave Chiang on 2007-03-29 13:12:09

rebeleconomist I would have loved it if Bernanke had walked the talk. However so far the credit bubble goes on and on. 

My points is that workers in the World are subsidising the asset holders in the very same way as the chinese are subsidising the USA. 

THe difference is, people can buy consumption goods and production goods with the same money. 

THis make me think that may be there should be a new economic system where asset prices would be labeled in a different money than consumption goods. 
THis would make more evident the impact of monetary creation on prices and it would give a supplementary tool for adjustment, instead of forcing the asset good prices down or consumption goods prices up, the CBs could just adjust the rate between the 2 money. 

That would be fun. 

Of course it s just a dream. 

By the way Rebeleconomist my main point was not CBs should track a general price index, but rather they should raise their inflation and proactively try to boost inflation NOW. 

Not doing it, is one of the reason that prevents global rebalancing. 

Let s not forget that there is one single ratio that sums all the imbalances world wide : the DEBT GDP ratio.
This is what we need to rebalance. FOr instance chinese-US policies are wrong because they widen that debt/GDP ratio. 

Inflation caused by exogeneous money creation is the solution to our woes. I wonder why it takes so long to everybody to take notice of it. 

Written by df on 2007-03-29 13:32:28

Certainly, if CBs decide they don't want to buy more dollars, the game will be up. But it is not the "market" that is forcing CBs to buy dollars, and it is not the "market" that can force them to stop.

The Banco Central do Brasil is a monopoly producer of the Brazilian real. It can create as many reales as it wants and exchange them for dollars. The only conceivable "market" force that could abort this activity would be a point at which a new real could not be exchanged for the goods and services needed to create it. Given the declining importance of paper notes, the ease of adding zeroes, etc, I don't think it's too outrageous to say that this constraint is negligible.

I repeat: if the central banks that are creating the BWII situation stop buying dollars, they will do so because of political forces in their own countries. Specifically, they will do so because the political power of anti-inflationary interests exceeds the power of pro-inflationary interests. The only way to forecast the end of BWII is to forecast the relative political power of these forces.

Comparisons to the past political situation of emerging-market inflation - in Latin America, for instance - are unlikely to be effective when applied to BWII. In the inflation of the '70s and '80s, when pegging to the dollar meant you were trying to support your currency, not devalue it, currency competition from the dollar (capital flight) caused serious pain and provided substantial political impetus to the anti-inflationary interests.

As consumer prices start to rise, we are starting to see some anti-inflationary politics in, for example, India. But this is a very, very long way from the movements that resulted in austerity in Latin America. At present there does not seem to be a real political base in the BWII dollar buyers to support the pain of austerity. What there does seem to be is a lot of very smart economists who understand the problem and wish it could be made to go away. But if they had the political power to cause an adjustment, one would think it would have happened already.

In contrast, the mercantilist factions that benefit from the ongoing debasement of the dollar-pegged currencies strike me as very substantial and very well-organized. Dilution is always popular among developers and producers, because it is effectively a subsidy to them, at the expense of people who hold cash or currency deposits.

BWII is a very interesting case of the old mercantilist-inflationist pattern because the actor responsible for debasing the dollar, the financially irresponsible US government, really is politically independent of the actors who are responsible for BWII continuing, the pegging central banks. (I don't subscribe to the "empire theory" of BWII, though I can understand why others do.)

Politically, for the pegging central banks, this creates a pattern which is much more sustainable than the pattern of self-reinforcing dilution that has resulted in past hyperinflations. The peg gives a CB a precise and politically defensible rule for how much new money to create. Most important, it distributes the profits of dilution in a pattern that is passive and Hayekian, and that is very hard to tamper with politically. In the past, when inflationary governments printed money to fund their various unprofitable enterprises, the political cycle of hyperinflation involved a constant stream of bigwigs showing up and demanding more money-from-nothing to pay off their rising bills. The nature of BWII makes it very hard for any such pattern to appear.

It will be very interesting to see what the effect of the US credit contraction on this system will be. If Dr. Summers' advice is taken, the result will not be austerity but a new flood of liquidity, possibly outprinting the continuing gains of the techno-hedonic revolution and causing significant increases in consumer price indexes. Is the 2% PCE really a red line in the sand? Can we find Michael Boskin and get him to jigger the numbers some more? Sooner or later, some kind of stagflation dilemma is inevitable and it is US policymakers that will have to make the choice. Which I don't envy them.

The wild card of BWII is and continues to be currency competition from gold - or from any central bank that decides to defect from BWII and let its currency rise, mercantilists be damned (but this seems unlikely). If the IMF really reforms its accounting of gold loans, as proposed in the recent RESTEG draft, and lets us know how much of the yellow stuff is in the big rooms, it will be of great assistance to anyone who wishes to understand this mysterious market.
Written by moldbug on 2007-03-29 13:54:04

Brad, you've cherry picked a bit in your performance statistics. Pundits have been moaning about the unsustainability of the US current account deficit for more than ten years, and it's certainly not clear that US assets have underperformed the world in single currency terms over that period. 

Moreover, if the US needs to adjust, surely every country with a large current account deficit or surplus should adjust as well. And a systematic strategy of selling deficit currencies/assets and buying surplus currencies/assets is a long-term loser.

Dave Chiang, if the US government loves China purchases of Treasuries so much, why do they keep asking China to quit buying so many dollars and let the currency strengthen? And if one wants to talk about hypocrisy, well...when the Chinese start allowing foreigners to own more than 49% of JVs, let alone Chinese firms, then perhaps they can start moaning about not being allowed to buy "strategic" assets elsewhere.
Written by Macro Man on 2007-03-29 13:56:59

Rebel Economist, the currencies against which the dollar most needs to weaken are a) not convertible, and b) kept artificially weak via their own domestic central banks. I'm pretty sure that no one needs to see the unedifying spectacle of the NY Fed calling out and selling USD/CNY and USD/RMB NDFs , with PBOC and CBR on the other side.
Written by Macro Man on 2007-03-29 14:09:48


Wouldn't you agree that allowing foreigners to own 49% of Chinese firms is alot better than US Congress allowing China's CNOOC or Dubai Ports to own "Zero" percent of an US corporation under the guise of "National Security Threat" regulations. By the way Dubai Ports is a legitimate business enterprise that just happens to be based in Dubai in the Middle East. And yes, Dubai Ports owns and operates facilities in Hong Kong, Shanghai, and Dalian. 

Why does the US Treasury want the US currency to devaluate now? After trillions of dollars in debt obligations to foreign central banks, a devaluation of the US Dollar wipes away the monetary value of these debts. Essentially, the US Treasury gets a free lunch off the productivity gains in the Chinese economy. All of those Blue Jeans, Tonka Toys, furniture, and auto parts shipped by the Chinese to the US are now essentially worthless IOU's with the dollar devaluation. The Wall Street financial geniuses have stacked the entire global economic system for their personal benefit and self-enrichment (ie. Greenspan, Rubin, Bernanke, Paulson, etc). 

Written by Dave Chiang on 2007-03-29 14:21:28

macroman --- I wasn't among the pundits who worried about the US CAD for all of the last ten years. for the first five years, i was busy working for the treasury and imf bailing out emerging markets ... and was much more worried by argnetina's 00 current account deficit, or turkey's deficit. my concerns date (privately) to 02-03, and publicly to mid 04, basically from the time when the financing of the US CAD shifted from private equity inflows to CB debt inflows. so by that metric, my little "rebalancing portfolio" has worked. what absolutely hasn't worked is anything that is implicitly or explicitly overweight yen. and a little depends on the timing re" the eurozone if you bought fixed income rather than equities -- buying euros in q4 04 and q1 05 didn't pay off, buying euros at most other points in time did.
Written by bsetser on 2007-03-29 14:24:21

Brad, I wasn't fingering you specifically among the pundits. It's just that stuff like ISK and NZD have done very well in real (i.e. nominal + carry) terms over the past several years, despite recent hiccups. Indeed, one could credible argue that amongst free floating currencies since, say, 2003, those with current account deficits (AUD, NZD, GBP, and latterly, euro) have typically done very well, while those with surpluses (JPY, CHF, SEK) have not. Norway and Canada have admittedly done well, but obviously they have a ToT fillip that has provided a tailwind.

Dave Chiang, I absolutely think the Dubai ports thing was a farce. However, the complaints over the RMB have been going on for three years, during which period China's FX reserves have doubled in size.
Written by Macro Man on 2007-03-29 14:36:09

Macroman -- one virtue of my little hypothetical portfolio (long non-everything non-US) is that it picks up the high carry countries with big current account deficits ... it isn't a short all CAD currencies kind of portfolio. it is underweight the $ b/c there isn't $800/900b of demand globally for $ at current int. rates and exchange rates. Now you can certainly argue that by just focusing on the uS, i am cherry picking, but i could also argue that given the absolute size of the US CAD, it normally would need to pay a premium over some other high carry current account deficit countries b/c of concerns about portfolio concentration and the like .... it just has been able to avoid that b/c it has generous central banker friends.

moldbug -- apart from your little pro-mold bit at the end, i generally agree with most of the points you make. the future fiscal cost of a central bank export subsidy from excessive reserve growth are very hidden and haven't emerged as a political concern, so the only internal political force against rapid reserve growth comes from the inflationary consequences. two points there -- one, the big surprise to me is the absence of bigger inflationary consequences in China and two, as you note, among the winners from inflationary low real int. rate adjustment are property developers and the like, which explains in part the absence of more opposition to inflation in the gulf right now. the sheik of Dubai isn't worried about 15% y/y inflation so long as his little property biz is doing really, really well ...
Written by bsetser on 2007-03-29 14:46:17

What's remarkable, though, is that in local currency terms, risk-adjusted returns in the G3 have been virtually identical. So a lot of what looks like alpha is actually beta, though granted there is also a currency kicker.
Written by Macro Man on 2007-03-29 15:04:28

Macro Man

True the US cannot buy RMB, rupees or roubles freely, but it can buy euros, yen, pounds etc. If it did, it would spread the load of China's policy by effectively converting it into a peg against the rest of the world. If the shared burden was still too heavy, America would not be alone in lobbying China.

The US reserves are way too small by any measure I have ever heard of. It could do little to make any loss of confidence in the dollar even orderly. The US has behaved like a bank which spent its depositors money in the belief that nothing will go wrong and it will be able to repay out of income when the debts are due. And if not, well s*&t happens!

Any other country doing what the US has done would be regarded as irresponsibly complacent, yet the possibility of US intervening and building a buffer of official savings abroad is hardly mentioned.

Written by RebelEconomist on 2007-03-29 15:30:19

If you imagine what price index trends would look like in a world with an idealized closed-loop financial system (a fixed money supply and no fractional-reserve banking or other Ponzi finance), you can see a whole nother world of numbers which would presumably exhibit trends, especially in individual basket components, every bit as drastic as those introduced by monetary policy. Look at the price of a transistor - it's hyperdeflation squared.

Fisherine price-index "inflation" takes these numbers (a) and blends them irretrievably with (b) the effect of monetary policy and (c) the seldom-arbitrary policy choices of the experts who design the baskets, hedonic indexes, etc. It's like trying to conduct a symphony orchestra in the middle of a Metallica concert in downtown Baghdad.

So there is a lot of (b) going on in China. But there is certainly also a lot of (a) and most likely a certain amount of (c) as well. We know a+b+c and we have a pretty good idea of (b). It would be interesting to construct an independent index and try to figure out the balance between (a) and (c).

I'm sure you're not endorsing the present double-counting of monetary mold... interestingly enough, the same anonymous fellow who reconstructed M3 claims to show a .97 correlation between ECB market operations and the mold price in euros. Maybe we're still on the mold standard after all...
Written by moldbug on 2007-03-29 15:31:59


I don't think it was ever the Chinese Central Bank's intention to buildup a trillion dollars in foreign reserves. What the Chinese have been is remarkably patient with the credit card abusers in the US Economy. The Chinese bear no responsibility whatsoever for the Global Economic imbalances that emanate from the dysfunctional US financial structure that propagates numerous credit bubbles in equities and housing. If the US were any other nation on the planet, the IMF would have already initiated a restructing program to slash government spending to a surplus. It is the not the responsibility of the Chinese to restructure their economy when the credit card abusers reside in the United States. 

Written by Dave Chiang on 2007-03-29 15:50:16

RE, for import cover, yes, US reserves are very low indeed. For foreign currency debt cover, US reserves are infinite, as the Treasury doesn't issue foreign currency debt.

The problem with intervening in the currencies you mention is that most free floating currencies save the yen have already shared the burden, and in the case of the euro, sterling, AUD, etc. continue to do so via central bank repurchases.

Vis a vis the yen, intervention would (eventually) meet with the same problem as RMB, RUB, SAR, etc.- they'd see MOF on the other side. While Japan does have a tasty current account surplus, investment income now makes up more than half of that, and the US trade deficit with Japan has been broadly stable for 20 years. Moreover, the Japanese private sector is, if anything, underweight foreign assets compared with international norms. A possible solution there would be for MOF to chuck $600 billion of its reserves into a national pension fund, which would invest overseas, thereby mitigating the need for Mrs. Watanabe to do it herself.

Written by Macro Man on 2007-03-29 15:55:34


Hahhahahahaha... oh stop...hahahhahah hehehehehe hahahah. That was hysterical.

The blame rests on both sides. You should use drugs and you shouldn't deal them either. They are co-dependent and both achieve a utility from one another.

Your regular spite for our country is tiresome. We have plenty of problems but the Chinese are faaaar from innocent. I just read a week ago in the Economist about how they put down a rural peasant revolt that ended with several people beaten to death. Apparently this is not out of the ordinary. Spare us the "Chinese are righteous and American is evil" routine.

They need the drug addict just as much as the addict needs his Range Rover and castle - both will pay a price for playing a game that should not be played (timing unknown).
Written by Gamma on 2007-03-29 16:10:11

"You should use drugs and you shouldn't deal them either"

Freudian slip on my part? :)

You shouldn't use drugs... but it is much more fun to use than to deal. The parallel is that it is much more fun to buy cheap crap than to sweat and toil all day making it. At least in the short run...
Written by Gamma on 2007-03-29 16:13:57

If China bears no responsibility for global imbalances, than smack dealers bear no responsibility for heroin use (it's all down to the addicts) and guns bear no responsibility for violent crime (blame the bullets.) 

Sure, the Fed took too long to tighten monetary policy. But it didn't help that PBOC hijacked the Fed's ability to tighten through massive intervention and subsequent purchases of Treasury/agency securities- remember the conundrum? Many econometric models suggest CB bond purchases have knocked 50 bps + off of Treasury yields (I think Brad wrote an entry on this a few weeks ago)- I have no doubt that had PBOC, BOK, SAMA,et all buggered off for a year and allowed the private sector to set borrowing rates, we would find that US household borrowing and consumption would have been substantially lower.
Written by Macro Man on 2007-03-29 16:16:17


I don't deal in drugs nor do I have the average 8 credit cards like the average US consumer. I don't have a Jumbo loan for that MacMansion, nor drive around in a gas-guzzler SUV Hummer. 

Since it is always politically correct to blame the Chinese around Washington beltway, it must have been an evil Chinese plot to force America's Joe6pack into buying that MacMansion, SUV Hummer, Flat Screen Hi-Def television, and vacation condo by using the home as an ATM spending machine.

Funny that no one in the United States can visibly see the insanity of overconsumption during the past decade. 

Written by Dave Chiang on 2007-03-29 16:25:29

df: I think we agree on most of the analysis, but draw different conclusions. I do not think a free-fall in asset prices would be too bad.

Yes, inflation would restore the relationship between consumption and asset prices in a way that might be easier in the near term, but long term, inflation is worse. Look at Argentina. My country (Britain) tried it in the 1960s-70s, and it left us in a mess which it took Mrs Thatcher mitigated by a North Sea oil windfall to get us out of. Don't go there!

Unless the monetary authorities are prepared to let asset prices go from time to time, investors will take ever more risk and hit the central bank safety net ever harder until it breaks in a catastrophic way. Let the prudent, who will otherwise end up paying for the bail out, have their day for once.

The fear of debt deflation derives largely from the 1930s, when the state was a small part of the economy, which tried to balance its books in the face of falling revenue, and imposed various ill-advised restrictions on trade flows and business. I think the fallout from an asset price crash could be managed more successfully today. The problem in Japan has been that asset prices were not actuall