RGE - Crises of too much v. crises of too little
リンク: RGE - Crises of too much v. crises of too little.
I was not all that impressed by the “day after” coverage of Thailand’s capital controls in the financial press.
Everyone initially looked for parallels to 1997 – and signs that the most recent bout of turmoil in Thailand could lead to a cascade of trouble in other emerging economies.
Most stories quite rightly noted that the risk of contagion much smaller this time around. However, the overall tone of the coverage still often struck me as off. The focus was on the impact of a new round of Asian contagion could have on American and European investment in emerging economies. But parallels to 1997 were played up a bit too much without noting the enormous changes that have taken place since 1997.
The coverage today – particularly the Wall Street Journal’s reporting on the thinking of the Thais and the New York Times’ reporting on the pressures facing all Asian economies -- has been much better.
But I still want to put forward my list of the key differences are between 1997 and today -- and note a couple of parallels that in my view haven't gotten enough attention.
1/ Emerging Asia doesn’t need capital from the US, Europe or Japan. That is a bit of an over-generalization, as there are some economies in emerging Asia that are running current account deficits. But in aggregate, emerging Asian economies save more than they invest – and are net lenders to the rest of the world. Thailand itself ran a current account deficit in 2005, but is on track for a significant surplus in 2006. In aggregate, all the private capital that flows into emerging Asia is effectively lent back to the industrial world, whether by private investors, or, more often by central banks. That is a key change from 1997.
2/ Private investors betting on a rise in the baht or won or renminbi are effectively betting against the central banks of these countries every bit as much as those who bet against the baht or won or rupiah did in 1997.
In 1997, central banks were intervening to keep their currencies from falling. Speculators would say borrow baht, and then sell the baht to the Bank of Thailand for dollars – a bet that pays if the baht falls. In 2006, Asian central banks are intervening to keep their currencies from rising. Foreign investors have dollars and want baht. And there is more demand for baht than demand for dollars in the private market. That normally would lead the value of the baht to rise. But right now the central bank often steps in, selling the baht foreign investors want and buying the dollars foreign investors don’t want.
That means that the central bank loses – and foreign investors gain – if Asian currencies rise in value over time. The central bank also has to remove the baht it sold to foreigners from circulation (sterilization) to avoid too-rapid money growth, but that is a separate issue.
3/ As a consequence of (2), almost all Asian economies are looking to discourage foreign capital inflows in various ways while encouraging their own nationals to invest abroad. Private investment abroad helps reduce the central banks need to step in to balance the market – there is more private demand for dollars. Steps that discourage foreign inflows also help reduce the need for central bank intervention to balance the market.
Thailand is an extreme case. But the same basic trend is clear in other countries. Think Korea, Lone star and KEB. Think of Korea’s efforts to make it harder for Korean banks to borrow funds from abroad -- though that is a policy designed to make it harder for the local banks to bet against the central bank. Think of China’s evolving attitude towards foreign investment – and reluctance to change the existing de facto rule that basically makes it impossible for foreigners to come in and buy existing Chinese businesses. Greenfield investment is still welcome, but probably a bit less welcome than before. Think of China’s desire to liberalize controls on capital outflows – while tightening controls on inflows.
The basic trend is pretty clear. Most Asian economies do not particularly want more money to come in. Asia already has more savings than it can invest at home -- it doesn't need the rest of the world's savings.
That is a change from 1996 and 1997. Then many emerging Asian countries not only needed to borrow from abroad, but actively encouraged short-term foreign borrowing. Thailand did so through the notorious Bangkok Interbank facility.
The changed context means that investors are fleeing for very different reasons now. In 1997, they were fleeing from a potential devaluation -- along with large pontential losses on foreign currency loans that local borrowers without export revenues (think office parks) couldn't repay. On tuesday, investors fled policy measures designed to keep them from coming in the first place.
There is a point here that is worth highlighting. The interests of players in the local markets are not necessarily the same as the interest of the central bank. Thai stock brokers like a rising stock market as much as US stock brokers. They hold baht and hold equities, and foreign inflows bid the value of both up.
The central bank, by contrast, is often left holding the dollars foreigners bring in. It either buys the dollars or lets its currency be bid up. And since the Thai central bank was intervening, it ended up being long dollars -- and short baht. Which isn't fun if the baht is rising.
Here I would say FT did a bit better job highlighting the key issue than others did on Tuesday. The FT leader noted:
But given an exchange rate that has appreciated by almost twice as much against the dollar as its neighbours this year, in spite of rapid accumulation of foreign exchange reserves, the central bank obviously felt it had to do something.
The FT argued that the market reaction to Thailand's controls will keep other central banks from following Thailand’s path. I would add that it hasn’t changed the fact that many other central banks still feel the need to do something.
There is a fourth important point -- one that is in someways similar to 1997 and in other ways very different.
4/ Pegged exchange rates constrain policy choices. In 1997, Asian countries with current account deficits were pegged to a dollar -- which at the time was rising v. the yen. That didn't help. Today Asian currencies with current account surpluses are pegged to a falling dollar. Which also isn't helping.
But there is a big change. Back in 1997 and 1998, China's resistance to RMB depreciated helped the rest of Asia. Right now, China’s resistance to faster RMB appreciation constraints the policy choices of all other Asian economies. China’s government – through its central bank – offers buyers of Chinese goods a bigger consumption subsidy than the Thai government offers buyers of Thai goods.
Here, I would say press coverage has been very good. Many economists – Roubini and Roach for example -- tend to be critical of American criticism of China’s peg on the grounds that American criticism of other countries lets the US off too lightly for its own economic sins. The pot shouldn’t call the kettle black.
I increasingly think that this is a bit too Amerocentric a view of the impact of China’s peg. China’s peg isn’t just a subsidy for a bunch of over-consuming Americans who wouldn’t save any way. African textile producers, Brazilian leather goods manufacturers, Mexican auto parts makers, Thai auto producers, Eastern European machinery firms and Malaysian electronics companies are impacted by the subsidy of the consumption of Chinese-assembled goods as much the machinery producers in the US Midwest and textile and furniture makers in the US south.
And the size of the subsidy China is offering Europe, Korea and Thailand for the consumption of Chinese goods is increasing more rapidly than the subsidy China is offering Americans for the consumption of Chinese goods. The RMB is rising v. the dollar. But it is falling v. a host of other currencies. That matters.
I found it interesting that the research direct of China’s central bank criticized the Thais for not emulating China’s own macroeconomic policies. Thailand’s mistake was letting the baht rise in the first place.
Tang Xu, head of the research department at the People's Bank of China, suggested that the steep losses on the Bangkok stock market were due to a willingness by Thai authorities to let the baht rise too fast. (Lex has a nice chart illustrating the relative rise of different Asian currencies).
The Thais didn’t criticize the Chinese. Rather today Thailand’s central bank governor joined China in criticizing the US. The problem, according to the Thailand, is that the US isn’t doing more to help support the dollar – and thus is creating problems for a host of other countries. Particularly countries that either peg to the dollar or countries that compete with countries that peg to the dollar!
The NYT:
The steep decline of the dollar is punishing Asia’s smaller economies and should be addressed by global financial regulators, the governor of the Thai central bank, Tarisa Watanagase, said Wednesday. As the Thai stock market rebounded from a record one-day drop of 15 percent, closing up 11 percent Wednesday, Ms. Tarisa defended the government’s abortive attempt to block short-term foreign investment, portraying Thailand as a victim of the huge imbalances in trade and savings that send trillions of dollars sloshing in and out of developing economies.
“This is not a problem unique to Thailand,” Ms. Tarisa said in an interview. “I’m sure that if this sort of problem is not cured in a cooperative manner, we could see similar measures elsewhere.”
That suggests a fifth point, one that has some parallels with 1997 though the context has totally changed.
5/ Asia and the US increasingly disagree on macroeconomic policy
The US government would like to see Asia decouple their currencies from the dollar -- gradually to be sure, but a bit faster than say China is moving now.I am sympathetic: Asian countries that have tied themselves too tightly to the dollar for too long, financing widening imbalances rather than putting more pressure on the US to adjust.
Many in Asia would like the US to do a lot more to make their preferred currency regime – one still based on a tie to the dollar – a bit easier for their central banks to maintain. They don't think their link to the dollar is a problem; they think US policies that don't support the dollar are the problem.
I wouldn’t count on any changes in US policy. The US has never geared its macroeconomic policies toward maintaining the dollar's external value.
I also wouldn’t count on Asia’s willingness to finance the US no matter what policies the US adopts – particularly if they are asked to intermediate not just local savings, but the savings of folks around the world who would rather finance Asian than the US even though Asia doesn’t need the money and the US does.
One thing is I think relatively clear. Unhappiness with the policy choices required to sustain the current system is growing. Especially among Asian central bankers themselves. They just don't agree on any way out.
Comments
Thank you for your blog. I have been learning a lot from reading it regularly.
Written by Guest on 2006-12-21 20:14:39
Brad, thanks for insight.
Given the US over consumption and Asia's over saving I don't see a way out that would be palatable for anyone.
Seems like any approach would wind up with a depression somewhere - and possibly everywhere.
Do you have any thoughts on that?
Thanks again for your blog.
Given the US over consumption and Asia's over saving I don't see a way out that would be palatable for anyone.
Seems like any approach would wind up with a depression somewhere - and possibly everywhere.
Do you have any thoughts on that?
Thanks again for your blog.
Written by stuart mills on 2006-12-21 20:34:12
Brad,
Excellent analysis!
The only point I might add is that this time around, we know what happened in 1997-98.
That isn’t trivial. Back in the day, the very strong convention wisdom didn’t allow for a crisis. “Asia’s different” and “the Asian miracle” were very deeply believed, right across the board. Krugman & Co got credit they didn’t (fully) deserve, but they didn’t really challenge the fundamental proposition that East Asia doesn’t do crises the way Latin America and others do.
Now, we know better.
.
Written by DOR on 2006-12-21 20:38:43
Brad--I completely agree to your excellent analysis on the Thai situation.
Of course, the Thai officials cannot criticize the Chinese, since China is so strong and important for Thailand. But, in private, they bitterly criticise China's exchange rate policy, which has been making their macroeconomic policy almost impossible. For Thailand, there are only three options;
1)accept inflaition and/or asset price bubble, caused by heavy currency market intervention and/or loose monetary policy,
2)follow the Chinese policy which includes heavy curency intervention coupled with market-distorting sterilization and bank lending cap which could avoid inflation and/or bubble, or
3)allow the currency to appreciate indefinitely.
I deliberately excluded the option of capital controls, which were tried, but curtailed after the stock market crash.
Of course, the Thai officials cannot criticize the Chinese, since China is so strong and important for Thailand. But, in private, they bitterly criticise China's exchange rate policy, which has been making their macroeconomic policy almost impossible. For Thailand, there are only three options;
1)accept inflaition and/or asset price bubble, caused by heavy currency market intervention and/or loose monetary policy,
2)follow the Chinese policy which includes heavy curency intervention coupled with market-distorting sterilization and bank lending cap which could avoid inflation and/or bubble, or
3)allow the currency to appreciate indefinitely.
I deliberately excluded the option of capital controls, which were tried, but curtailed after the stock market crash.
Written by HK on 2006-12-21 21:25:06
I get so tired of specious arguments placing the blame on the US. Trade balances are driven by forex rates, plain and simple. In the absence of investment flows, forex rates will tend toward "trade flow parity", the rate required to balance trade flows. But if you peg your currency below trade flow parity, then *presto* you get (a) a healthy trade surplus, and (b) an increase in financial wealth vis-a-vis the rest of the world in the form of reserve buildup and/or private investment outflows.
It is a simple, brilliant, and effective developmental strategy. Japan (in its day), China, and perhaps a growing list of other countries are starting to play the "currency game". Are there costs to playing the game? Sure - look at Japan, which has played the game longer than anyone. Their economy is choked up by excess money supply - interest rates near zero, zombie companies, overpriced everything, chronic deflation threat, etc. But every year a 3% trade surplus - just like clockwork. Every year Japan gets wealthier, despite their other "problems".
Note that when you play the currency game long enough, the competitive peg becomes self-sustaining. Once interest rates fall low enough, carry trade outflows replace central bank reserve builup, doing most of the heavy work for the central bank. Witness Japan.
All this seems pretty straightforward, self-evident even if you do a little analysis of forex supply and demand curves.
Now compare this to the deficit-as-a-lack-of-savings argument. Here you start out with a definition:
S = I + NX
But like "capital", both "savings" and "investment" are oddly defined, and not consistent with common usage. With assumptions, "investment" is roughly the increase in "capital" (ignoring depreciation, etc). NX equals the increase in the nation's financial wealth vis-a-vis the rest of the world. So we can interpret "S = I + NX" roughly as "savings" equals the increase in physical wealth plus the increase in financial wealth. Okay, so "savings" is equal to the change in wealth, more-or-less.
Now, the pundits turn the equation around:
NX = S - I
This equation "shows" that a trade deficit is the result of savings insufficient to match investment opportunities. But this is nonsense. First, we have inadvertently switched meanings for "savings" and "investment" from their terms of art to their vernacular meanings. The US is in trouble because they don't save enough - we hear over and over from people who should know better.
Second, if you look at the equation in its original sense, the modified form lacks causality. Let's say your change in wealth is due to your salary and profits on your investments. In equation form:
change in wealth = salary + profits
But could I also say
salary = change in wealth - profits?
Mathematically sure, but if you are complaining about a low salary and I say your salary is too low because your change in wealth is not high enough, you would rightly roll your eyes!
Yet this is essentially what we hear every time someone says that we run a trade deficit because domestic "savings" is not high enough. If you look at how "savings" is initially defined, it is really a measure of change in wealth. The argument does not hold for the reasons described above.
If inadequate savings (in the common sense) were really the problem, then interest rates might be very high. They are not. Savings is not the bottleneck.
So please, keep the focus on simple forex supply and demand analysis, trade flows as a function of forex rates, investment flows as a function of interest rate (or equity return) differentials, etc. I think it would help advance the discussion greatly.
It is a simple, brilliant, and effective developmental strategy. Japan (in its day), China, and perhaps a growing list of other countries are starting to play the "currency game". Are there costs to playing the game? Sure - look at Japan, which has played the game longer than anyone. Their economy is choked up by excess money supply - interest rates near zero, zombie companies, overpriced everything, chronic deflation threat, etc. But every year a 3% trade surplus - just like clockwork. Every year Japan gets wealthier, despite their other "problems".
Note that when you play the currency game long enough, the competitive peg becomes self-sustaining. Once interest rates fall low enough, carry trade outflows replace central bank reserve builup, doing most of the heavy work for the central bank. Witness Japan.
All this seems pretty straightforward, self-evident even if you do a little analysis of forex supply and demand curves.
Now compare this to the deficit-as-a-lack-of-savings argument. Here you start out with a definition:
S = I + NX
But like "capital", both "savings" and "investment" are oddly defined, and not consistent with common usage. With assumptions, "investment" is roughly the increase in "capital" (ignoring depreciation, etc). NX equals the increase in the nation's financial wealth vis-a-vis the rest of the world. So we can interpret "S = I + NX" roughly as "savings" equals the increase in physical wealth plus the increase in financial wealth. Okay, so "savings" is equal to the change in wealth, more-or-less.
Now, the pundits turn the equation around:
NX = S - I
This equation "shows" that a trade deficit is the result of savings insufficient to match investment opportunities. But this is nonsense. First, we have inadvertently switched meanings for "savings" and "investment" from their terms of art to their vernacular meanings. The US is in trouble because they don't save enough - we hear over and over from people who should know better.
Second, if you look at the equation in its original sense, the modified form lacks causality. Let's say your change in wealth is due to your salary and profits on your investments. In equation form:
change in wealth = salary + profits
But could I also say
salary = change in wealth - profits?
Mathematically sure, but if you are complaining about a low salary and I say your salary is too low because your change in wealth is not high enough, you would rightly roll your eyes!
Yet this is essentially what we hear every time someone says that we run a trade deficit because domestic "savings" is not high enough. If you look at how "savings" is initially defined, it is really a measure of change in wealth. The argument does not hold for the reasons described above.
If inadequate savings (in the common sense) were really the problem, then interest rates might be very high. They are not. Savings is not the bottleneck.
So please, keep the focus on simple forex supply and demand analysis, trade flows as a function of forex rates, investment flows as a function of interest rate (or equity return) differentials, etc. I think it would help advance the discussion greatly.
Written by Brian Shriver on 2006-12-21 22:50:59
"Right now, China’s resistance to faster RMB appreciation constraints the policy choices of all other Asian economies."
You pointed out that JPY was the wrong currency to look at but Japan is larger than all the other Asians-sans-China combined, so maybe you do not think Japan Asian. That surely would please the Japanese but it would be clearer if you make it more explicit -- Asia-ex-Japan, e.g.
HK played the pegging very successfully. Sure it has to live with external gyrations of USD but that is the fact of life it has to live with in a currency union (albeit an unilateral one). Even within continental U.S. (not to mention Hawaii/Alaska) economic conditions vary greatly. How much say does a regional bank president have if his region is out of sync with the rest of the country? Not much. Indeed the Washington appointees have more votes than all the regional banks combined at any given time. The Euro-zone has even more variability. But people form a currency union for a reason, right?
You pointed out that JPY was the wrong currency to look at but Japan is larger than all the other Asians-sans-China combined, so maybe you do not think Japan Asian. That surely would please the Japanese but it would be clearer if you make it more explicit -- Asia-ex-Japan, e.g.
HK played the pegging very successfully. Sure it has to live with external gyrations of USD but that is the fact of life it has to live with in a currency union (albeit an unilateral one). Even within continental U.S. (not to mention Hawaii/Alaska) economic conditions vary greatly. How much say does a regional bank president have if his region is out of sync with the rest of the country? Not much. Indeed the Washington appointees have more votes than all the regional banks combined at any given time. The Euro-zone has even more variability. But people form a currency union for a reason, right?
Written by HZ on 2006-12-22 00:09:11
Hi Brad,
The one dimensional view that currency exchange rates are solely the cause of US Economic imbalances is too simplistic. Besides exclusively pandering to the narrow economic interests of the Wall Street financial services industry, what sort of industrial policy does the US government have. President Bush's response to the problems of the US automobile industry, not caused by Chinese competition, has been essentially to tell them to drop dead. Travelling to China, Hank Paulson and Ben Bernanke mostly pressure the Chinese for financial deregulation for the narrow economic benefit of Wall Street investment bankers. And finally President Bush when asked how Americans can help the war effort in Iraq, responded by stating, "Americans should go shopping to stimulate the economy". Since consumer spending accounts for 70% of the US economy's GDP, any drop in consumption would implode the multiple asset bubbles in Housing, the bond market, the US Dollar, and financial derivatives that have been inflated by Federal Reserve monetary policies.
Regards,
Written by Dave Chiang on 2006-12-22 06:32:30
Dave Chiang:
Under a floating rate system, the consequence of all the sins you mention is a declining forex rate. US consumers, etc, would be less able to afford foreign goods, etc.
But, if forex rates adjust, US production is not hollowed out; and there is no $1 trillion per year annual wealth transfer out of the US.
I have no problem with the assertion that the US is idiotic sometimes. But let the punishment fit the crime.
Under a floating rate system, the consequence of all the sins you mention is a declining forex rate. US consumers, etc, would be less able to afford foreign goods, etc.
But, if forex rates adjust, US production is not hollowed out; and there is no $1 trillion per year annual wealth transfer out of the US.
I have no problem with the assertion that the US is idiotic sometimes. But let the punishment fit the crime.
Written by Brian Shriver on 2006-12-22 08:58:55
Very excellent review of status of EM's in Asia at moment, thanks.
BrianS- the problem that one runs into is a difference of focus - whereas David feels the "financial" economy is the cause and solution to most imbalances, many others feel the "real" economy is where to find both the cause and solution. I have no doubt that under a floating rate system of FX, the imbalances in the "real" economy would straighten out in 24-36 months. Yet what most stock/bond/derivatives markets financial types fear is that those same solutions would unravel a web of leveraged bets.
For example, the simple expedient of fully flexible exchange rates with China and Saudi Arabia would soon double the cost of imported oil and manufactured items. My view is: good, get the pain over with ASAP. Skip the vacations in Berlin and get a hybrid Cadillac.
Others including many senior Washington and Wall Street kingpins are aghast at such pain in the real economy, because it would unravel the elaborate webs of customer financing schemes from which they profit, using cheap Chinese and Saudi dollar lending. (Think subprime mortgage lending, zero percent car purchases, HELOC's, furniture with no payments for 24 months, etcetera.) Wall Street helps keep market prices in the US high by substituting cheap financing for wage income - which pleases those who export to the US. But that same policy, which is abetted by inaction in Washington and Beijing and Riyadh, has the effect of transferring wealth, technology, and fundamental industrial infrastructure out of the US. When Wall Street and Washington argue for "managed solutions" they are really insisting on the status quo. Merry Chrismas.
BrianS- the problem that one runs into is a difference of focus - whereas David feels the "financial" economy is the cause and solution to most imbalances, many others feel the "real" economy is where to find both the cause and solution. I have no doubt that under a floating rate system of FX, the imbalances in the "real" economy would straighten out in 24-36 months. Yet what most stock/bond/derivatives markets financial types fear is that those same solutions would unravel a web of leveraged bets.
For example, the simple expedient of fully flexible exchange rates with China and Saudi Arabia would soon double the cost of imported oil and manufactured items. My view is: good, get the pain over with ASAP. Skip the vacations in Berlin and get a hybrid Cadillac.
Others including many senior Washington and Wall Street kingpins are aghast at such pain in the real economy, because it would unravel the elaborate webs of customer financing schemes from which they profit, using cheap Chinese and Saudi dollar lending. (Think subprime mortgage lending, zero percent car purchases, HELOC's, furniture with no payments for 24 months, etcetera.) Wall Street helps keep market prices in the US high by substituting cheap financing for wage income - which pleases those who export to the US. But that same policy, which is abetted by inaction in Washington and Beijing and Riyadh, has the effect of transferring wealth, technology, and fundamental industrial infrastructure out of the US. When Wall Street and Washington argue for "managed solutions" they are really insisting on the status quo. Merry Chrismas.
Written by OldVet on 2006-12-22 09:49:37
Hi Brian,
Don't you think your argument is alittle oversimplistic to state that America's problems would be resolved if only the Chinese agreed to a faster revaluation. Certainly the US has become addicted to low price imports to fuel its loose monetary policy based on US dollar hegemony. But US doesn't just run a trade deficit in low priced, labor intensive imports from the Chinese who mostly final assembly products. A large percentage of the US trade deficit is associated with high-value added imports from Japan and Europe: those imports consist of high-tech semiconductors, hybrid automobiles, airbus aircraft, machine tools, etc.
Regards,
Written by Dave Chiang on 2006-12-22 09:51:32
Brian -- I tend to have a great deal of sympathy for your views. An accounting identity doesn't imply causality in either direction. And i have found Martin Wolf's explanation for how a weak real exchange rate forces China to adopt policies that hold investment below (very high) levels of savings persuasive, and i think the World Bank's work on China has identified how the weak RER can raise both business savings and investment (exports more profitable, cost of borrowing goes down as interest rate are held low to reduce inflows, etc).
That said, there is no doubt the US doesn't save very much -- the government runs a small deficit (now under 2% of US GDP), and households now run a huge deficit (no savings, still some residential investment). In principle, that could require that the US pull in savings from the rest of the world -- i.e. interest rates would need to be high not just in the US but globally. High US rates would pull in savings from the world. High interest rate globally would suppress investment globally, freeing up more savings for the US. That doesn't describe today's world -- interest rates are low globally. Bernanke has been right on this point. And that is why i do think that steps to reduce the savings surplus of the emerging world are key to global adjustment.
But that doesn't imply a totally painless process for the US. we have grown used to cheap credit .. as FTX highlights. The financial sector especially. so as the rest of the world changes, the US would be forced to change as well. in ways i think would contribute to the long-term health of the US. but the shift might not be so pleasant. Savings would need to increase -- and consumption growth would need to slow. Exchange rate adjustment (especially if meant less Chinese and Saudi central bank intermediation of their surplus savings) would help trigger the internal adjustment in the US.
That at least is how i see things.
Now back to conditions in Emerging Asia ex Japan ... (yes, I do think Japan has a different set of problems/ issues ... it isn't attracting big net inflows of foreign money right now; rather foreigners are borrowing japan's savings to finance their various carry trades ...)
That said, there is no doubt the US doesn't save very much -- the government runs a small deficit (now under 2% of US GDP), and households now run a huge deficit (no savings, still some residential investment). In principle, that could require that the US pull in savings from the rest of the world -- i.e. interest rates would need to be high not just in the US but globally. High US rates would pull in savings from the world. High interest rate globally would suppress investment globally, freeing up more savings for the US. That doesn't describe today's world -- interest rates are low globally. Bernanke has been right on this point. And that is why i do think that steps to reduce the savings surplus of the emerging world are key to global adjustment.
But that doesn't imply a totally painless process for the US. we have grown used to cheap credit .. as FTX highlights. The financial sector especially. so as the rest of the world changes, the US would be forced to change as well. in ways i think would contribute to the long-term health of the US. but the shift might not be so pleasant. Savings would need to increase -- and consumption growth would need to slow. Exchange rate adjustment (especially if meant less Chinese and Saudi central bank intermediation of their surplus savings) would help trigger the internal adjustment in the US.
That at least is how i see things.
Now back to conditions in Emerging Asia ex Japan ... (yes, I do think Japan has a different set of problems/ issues ... it isn't attracting big net inflows of foreign money right now; rather foreigners are borrowing japan's savings to finance their various carry trades ...)
Written by bsetser on 2006-12-22 10:23:25
Brian - I agree that the exchange rate, for the most part, determines flow.
However, the low pegs of the Asian and other export countries are the result of too much savings and too much capital investment. They have to export their surplus.
On the other side of the coin we support this by insufficent savings of financial assets.
If America reduces consumption then foreign governments will be forced to institue policies promoting domestic consumption or risk severe recession.
However, the low pegs of the Asian and other export countries are the result of too much savings and too much capital investment. They have to export their surplus.
On the other side of the coin we support this by insufficent savings of financial assets.
If America reduces consumption then foreign governments will be forced to institue policies promoting domestic consumption or risk severe recession.
Written by stuart mills on 2006-12-22 10:36:24
Brad, thanks for the response about the need for the export countries to reduce savings.
You said it a lot better than I did.
I am also always amazed that you take the time to read all these posts and comment on them.
Thanks very much for doing so.
Happy Holidays to all.
You said it a lot better than I did.
I am also always amazed that you take the time to read all these posts and comment on them.
Thanks very much for doing so.
Happy Holidays to all.
Written by stuart mills on 2006-12-22 10:43:31
Hometown Makes Good: The Kansas side of Kansas City has long faced scorn from its larger, wealthier counterpart across the river in Missouri. But in a major upset of the metro-area social order, KCK suddenly is fashionable. A native son returns home to survey the boom.
Written by Guest on 2006-12-22 14:19:46
Based on the above replies, there seems to be a good deal of confusion about “savings”
I urge you all to think clearly about what you mean by “savings”. In my opinion, the standard textbook macro definition of savings (S = I + NX) is sufficiently different from its common meaning as to cause real confusion.
So let’s look at “savings” with a fresh pair of eyes. Imagine a typical macro diagram with households (H), firms (F), government (G), and world (W) as nodes. Now add all the “real economy” payment flows: expenditures, salaries, taxes, transfers, rents, royalties, payments for exports and imports, industrial production, etc, etc. If you like you can include also interest payments, although I prefer to think of the financial economy separately.
What do we know? (1) Each of our nodes (H, G, F, and W) will likely run a surplus or a deficit during a given period (which will be mediated by financial flows and/or by changes in cash balances). (2) But, and this is *important*, the aggregate surplus is always zero. Why? Because (ignoring new money creation) every payment flow has both a sender and a receiver. For every act of savings there is a corresponding act of dissavings. Draw any diagram, add any flows – you will see that the surpluses and deficits sum to zero.
Now, the common definition of savings is precisely a given node’s surplus during a period. If you make $5000 and only spend $4000 then ipso facto you have saved $1000. Similarly, government savings (or deficit) is tax revenues less spending (or spending less tax revenues). The World node’s (USD) savings is simply imports minus exports, or negative NX. Firms’ savings is also just their income (not borrowing) less expenditures.
But then what are the implications of Point 2 above: that aggregate savings must always equal zero? One implication is that if W runs a surplus then H+G+F must run a deficit, and vice versa. In other words, if there is a trade surplus, then there is an aggregate domestic savings surplus; and if there is a trade deficit, then there is an aggregate domestic savings deficit. Automatically.
There is no problem of excess and/or inadequate aggregate domestic savings (in the common sense) that isn’t solved by adjusting the forex rate to restore trade balance. It is only when the forex rate differs significantly from its trade flow parity rate, either because of heavy investment flows and/or central bank intervention, that we see aggregate domestic savings surpluses or deficits.
If you want China to “save” less, or the US to “save” more, just change the forex rate. Simple, but true.
I urge you all to think clearly about what you mean by “savings”. In my opinion, the standard textbook macro definition of savings (S = I + NX) is sufficiently different from its common meaning as to cause real confusion.
So let’s look at “savings” with a fresh pair of eyes. Imagine a typical macro diagram with households (H), firms (F), government (G), and world (W) as nodes. Now add all the “real economy” payment flows: expenditures, salaries, taxes, transfers, rents, royalties, payments for exports and imports, industrial production, etc, etc. If you like you can include also interest payments, although I prefer to think of the financial economy separately.
What do we know? (1) Each of our nodes (H, G, F, and W) will likely run a surplus or a deficit during a given period (which will be mediated by financial flows and/or by changes in cash balances). (2) But, and this is *important*, the aggregate surplus is always zero. Why? Because (ignoring new money creation) every payment flow has both a sender and a receiver. For every act of savings there is a corresponding act of dissavings. Draw any diagram, add any flows – you will see that the surpluses and deficits sum to zero.
Now, the common definition of savings is precisely a given node’s surplus during a period. If you make $5000 and only spend $4000 then ipso facto you have saved $1000. Similarly, government savings (or deficit) is tax revenues less spending (or spending less tax revenues). The World node’s (USD) savings is simply imports minus exports, or negative NX. Firms’ savings is also just their income (not borrowing) less expenditures.
But then what are the implications of Point 2 above: that aggregate savings must always equal zero? One implication is that if W runs a surplus then H+G+F must run a deficit, and vice versa. In other words, if there is a trade surplus, then there is an aggregate domestic savings surplus; and if there is a trade deficit, then there is an aggregate domestic savings deficit. Automatically.
There is no problem of excess and/or inadequate aggregate domestic savings (in the common sense) that isn’t solved by adjusting the forex rate to restore trade balance. It is only when the forex rate differs significantly from its trade flow parity rate, either because of heavy investment flows and/or central bank intervention, that we see aggregate domestic savings surpluses or deficits.
If you want China to “save” less, or the US to “save” more, just change the forex rate. Simple, but true.
Written by Brian Shriver on 2006-12-22 15:46:15
"If you want China to “save” less, or the US to “save” more, just change the forex rate. Simple, but true."
Brian,
It may be true, but I'm not so sure it's simple. I appreciate the basic point you are making, but extending it to the realpolitik of today - what do you do if a foreign actor or group of actors pegs their currency to yours and prevents that equilibrium adjustment taking place? Are you utterly at their mercy, or are there strategies that can be pursued to break a currency shadow?
I'm sure there are a hundred theories as to how that can be achieved, but I'm willing to bet that all of them involve some pain. And temporary pain for long term benefit has become intolerable in the US (as it has in all Western economies and now many of the Asian ones too), be it for current account adjustment, social & medical benefits, or energy security.
In short, though you've eloquently articulated your point, you haven't offered a meaningful solution. If it were so easy to change the USD/RMB rate then Paulson and Bernanke wouldn't have flown cap-in-hand to China, and Tarisa Watanagase wouldn't have urged the IMF and the ADB to "work urgently to find a general solution to the hot-money problem", probably the most desperate admission of impotence I've ever heard from a senior central banker.
Brian,
It may be true, but I'm not so sure it's simple. I appreciate the basic point you are making, but extending it to the realpolitik of today - what do you do if a foreign actor or group of actors pegs their currency to yours and prevents that equilibrium adjustment taking place? Are you utterly at their mercy, or are there strategies that can be pursued to break a currency shadow?
I'm sure there are a hundred theories as to how that can be achieved, but I'm willing to bet that all of them involve some pain. And temporary pain for long term benefit has become intolerable in the US (as it has in all Western economies and now many of the Asian ones too), be it for current account adjustment, social & medical benefits, or energy security.
In short, though you've eloquently articulated your point, you haven't offered a meaningful solution. If it were so easy to change the USD/RMB rate then Paulson and Bernanke wouldn't have flown cap-in-hand to China, and Tarisa Watanagase wouldn't have urged the IMF and the ADB to "work urgently to find a general solution to the hot-money problem", probably the most desperate admission of impotence I've ever heard from a senior central banker.
Written by FTX on 2006-12-22 18:00:08
Brian, money creation by new debt is the key to our economy, it cannot be ignored.
Even in a closed economy debt creation in the boom times can result in a debt deflation crunch, as projected income cannot support the debt service requirements.
Our housing bubble, for example, while facilitated by cheap prices, was not caused by our trade deficit. It was caused by "animal spirits", misperception of risk (actually part of "animal spirits"), and the Fed focusing on CPI instead of more important metrics such as asset price inflation and debt growth relative to national income.
The Austrian School believes that your zero sum game is the only approach for achieving a stable economy - fractional reserve banking allows "mis-pricing" assets and activities which results in instability resulting from "unbalanced" savings, investment, and consumption even in a closed econmony.
Even in a closed economy debt creation in the boom times can result in a debt deflation crunch, as projected income cannot support the debt service requirements.
Our housing bubble, for example, while facilitated by cheap prices, was not caused by our trade deficit. It was caused by "animal spirits", misperception of risk (actually part of "animal spirits"), and the Fed focusing on CPI instead of more important metrics such as asset price inflation and debt growth relative to national income.
The Austrian School believes that your zero sum game is the only approach for achieving a stable economy - fractional reserve banking allows "mis-pricing" assets and activities which results in instability resulting from "unbalanced" savings, investment, and consumption even in a closed econmony.
Written by stuart mills on 2006-12-22 19:22:10
Is it in the US interest to fix this problem? Look at the alternatives.
Look at how much money the US spent on the cold war. Somewhere in the vicinity of 6% to 7% of GNP went to the military. Today even fighting two hot wars, military spending is closer to about 4% of GNP last time I checked, and this is temporaily spiked upward because of the two hot wars.
Right now China is transitioning from a planned economy toward a market system. They have a lot of people who are unemployed and being transfered from low productivity farm labor into higher productivity tasks. As long as there are jobs in China and no one is starving, you have domestic stability in China and the government doesn't need to rile up nationalism to justify itself like the governments in Iran and North Korea do.
The US blew a lot of money for 45 years on the cold war. Right now, China has found that supplying Walmart is in more of its national interest than starting an arms race.
I acknowledge that the global trade imbalances are a transfer of industrial capital to China and people in midwest are being hurt. But would the remedy be worse than the disease?
How much is the present value of 2% of GDP for 45 years (the increase in spending during the cold war)?
The central bank of China wants to gradually strengthen the value of the RMB over time. They feel a slow transition would keep things from getting out of hand in China.
While the US economy and society is dynamic enough to handle a quick rapid transition, is the same true for China? Would a really bad economic spell create the conditions for another Tianimin Square situation?
Look at how much money the US spent on the cold war. Somewhere in the vicinity of 6% to 7% of GNP went to the military. Today even fighting two hot wars, military spending is closer to about 4% of GNP last time I checked, and this is temporaily spiked upward because of the two hot wars.
Right now China is transitioning from a planned economy toward a market system. They have a lot of people who are unemployed and being transfered from low productivity farm labor into higher productivity tasks. As long as there are jobs in China and no one is starving, you have domestic stability in China and the government doesn't need to rile up nationalism to justify itself like the governments in Iran and North Korea do.
The US blew a lot of money for 45 years on the cold war. Right now, China has found that supplying Walmart is in more of its national interest than starting an arms race.
I acknowledge that the global trade imbalances are a transfer of industrial capital to China and people in midwest are being hurt. But would the remedy be worse than the disease?
How much is the present value of 2% of GDP for 45 years (the increase in spending during the cold war)?
The central bank of China wants to gradually strengthen the value of the RMB over time. They feel a slow transition would keep things from getting out of hand in China.
While the US economy and society is dynamic enough to handle a quick rapid transition, is the same true for China? Would a really bad economic spell create the conditions for another Tianimin Square situation?
Written by Jimbo on 2006-12-22 19:42:18
More on savings:
When I say that American's need to "save" more I am suggesting that the financial obligations to income ratio needs to stop increasing, and should actually decrease from the current historically high levels.
I am also suggesting that more household wealth should be held in dollar denominated assets (currency, debt securites), currently at a record low relative to debt and wealth, rather than in market priced assets (stocks, tangible assets), which are subject to significant repricing as the result debt deflation.
The emerging economies need exactly the opposite prescription - they need to increase debt load relative to income.
When I say that American's need to "save" more I am suggesting that the financial obligations to income ratio needs to stop increasing, and should actually decrease from the current historically high levels.
I am also suggesting that more household wealth should be held in dollar denominated assets (currency, debt securites), currently at a record low relative to debt and wealth, rather than in market priced assets (stocks, tangible assets), which are subject to significant repricing as the result debt deflation.
The emerging economies need exactly the opposite prescription - they need to increase debt load relative to income.
Written by stuart mills on 2006-12-22 20:09:17
Ecuador Bonds Tumble as Patino Signals Possibility of Default
By Lester Pimentel and Helen Murphy
Dec. 22 (Bloomberg) -- Ecuador's bonds had their biggest- ever decline after the incoming finance minister said the government may restructure its $11 billion debt in a way similar to Argentina, which defaulted on $95 billion in 2001.
NOTE: Quote edited by BSetser -- please do not paste entire articles into the comments section; an article isn't a comment by my definition.
By Lester Pimentel and Helen Murphy
Dec. 22 (Bloomberg) -- Ecuador's bonds had their biggest- ever decline after the incoming finance minister said the government may restructure its $11 billion debt in a way similar to Argentina, which defaulted on $95 billion in 2001.
NOTE: Quote edited by BSetser -- please do not paste entire articles into the comments section; an article isn't a comment by my definition.
Written by Anonymous on 2006-12-22 23:11:20
One question i wanted to ask is physically speaking, (leaving aside the monetary aspects) how mistallocated are the resources of China?
If the US consumer reduces his buying, how well are the chinese positioned to move their production to satisfy the needs of the people of the oil producing nations, or BRIC (including themselves) nations?
Physically speaking, the US has lost of factories and probably a lot of expertise. But they are trying out new things like cheap pricvate space launches and all. But is China misallocating or allocating correctly, takiong int acc. their future?
If the US consumer reduces his buying, how well are the chinese positioned to move their production to satisfy the needs of the people of the oil producing nations, or BRIC (including themselves) nations?
Physically speaking, the US has lost of factories and probably a lot of expertise. But they are trying out new things like cheap pricvate space launches and all. But is China misallocating or allocating correctly, takiong int acc. their future?
Written by Lucian on 2006-12-24 12:20:07
Brad Shriver: Two problems.....
Cause and effect. If you have two variables that are linked, then you need to figure out which is causing the other. I'd argue that the savings deficit is *causing* the trade deficit, rather than the reverse.
The other thing that is missing is that the United States is at a trade deficit with just about everyone, so changing the RMB value isn't going to change anything, what you need to do is to cause the dollar to drop with respect to everyone. If you just change the RMB value, then you change the US-China trade deficit but not the deficit with respect to other parties.
Also, it's not clear to me that it is a good thing for China to save less given the demographic shift that is going to happen once the baby boomers retire, nor do I think that replacing labor with capital is such a bad idea, given the demographic shift that is going to come.
It also concerns me that when talking about optimal policies for China, that Western economists ignore demographics. If you ask your average Chinese peasant *why* they are saving so much, they will respond with healthcare, education, and retirement, and that seems to be a lot more sensible an answer than what is coming out of economic think tanks.
Cause and effect. If you have two variables that are linked, then you need to figure out which is causing the other. I'd argue that the savings deficit is *causing* the trade deficit, rather than the reverse.
The other thing that is missing is that the United States is at a trade deficit with just about everyone, so changing the RMB value isn't going to change anything, what you need to do is to cause the dollar to drop with respect to everyone. If you just change the RMB value, then you change the US-China trade deficit but not the deficit with respect to other parties.
Also, it's not clear to me that it is a good thing for China to save less given the demographic shift that is going to happen once the baby boomers retire, nor do I think that replacing labor with capital is such a bad idea, given the demographic shift that is going to come.
It also concerns me that when talking about optimal policies for China, that Western economists ignore demographics. If you ask your average Chinese peasant *why* they are saving so much, they will respond with healthcare, education, and retirement, and that seems to be a lot more sensible an answer than what is coming out of economic think tanks.
Written by Joseph Wang on 2006-12-27 13:23:40
