Speaking of China David, you may remember discussing a Chinese trade deficit in terms of a mechanism to deflect any pressure to revalue the yuan. It appears that you were right: China has just posted its first trade deficit in some time. Of course, I realise we can’t trust Chinese statistics completely, and this may be a politically convenient release (remember Geithner’s report for April), but it does make some intuitive sense that as China develops they will begin to import more than they export. And, if China has ambitions to make the yuan one of several major reserve currencies, then they have to get eventually their currency “out there.”
But first they may want to work down their dollar reserves, though I suspect that China has years if not decades before they work them down through trade deficits. Perhaps they will blow up before then. What do you think?
Paul Krugman isn’t playing ball with the administration. Again.
This time, instead of advocating restructuring the banks, he is arguing for a more aggressive response to China’s currency manipulation–import tariffs:
Tensions are rising over Chinese economic policy, and rightly so: China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done.
…In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.
I imagine that this strident view is causing headaches at the White House, the Treasury, and the Fed. Obama has recently angered the Chinese party several times, and I doubt he wants another confrontation. Treasury appears to be captured by a free market ideology, and may slightly fear retribution in the bond market. And the Fed probably fears the impact of higher domestic inflation on inflation expectations, and, ultimately, the need to raise rates prematurely.
Looks like Mr. Krugman is going to get another roast beef dinner at the White House! Speaking of dinner, David, when are you back in Boston?
It appears that the European Union, led by Germany, are about to pony 30 billion Euros to bail out troubled Greece. The cost for Greece? Austerity.
Don’t make me laugh. Given the widespread strikes seen these past two weeks, I very much doubt that the Greek government has enough power to enforce austerity measures. So does this mean there will be no bailout? I highly doubt it: what emerges from this weekend will likely be worded as conditional, but privately known to be unconditional.
In my opinion, what will ultimately happen will be broad unrest in Germany as unemployment benefits are cut at the same time as the Greeks are partying as usual. Think riots can’t happen in Germany?
David, what’s going on with Toyota? Is this just an instance of bad luck blown out of proportion? It seems clear to me that at the very least, Toyota is getting bad press advice, at least as regards the sensibilities of American customers.
I do find it hard to believe that all of the ex-post narratives in the press regarding Toyota’s terrible “culture of centralization” have even a grain of truth in them. What do you think?
Is it just me, or does the world economy seemed to be in suspended animation–a butterfly pinned to the corkboard? Or perhaps a weightless astronaut at the apex of a parabolic rocket shot?
The much-ballyhooed restocking effect finally showed up in the Q4 GDP report, but all was not well in other areas: notably consumption, whose growth delined on a quarterly basis. Where is the final demand coming from? Build it and they will come?
An then there is Greece and Spain and Japan and Ireland and the UK and…how will any of them avoid outright default or the printing press? The overly subscribed Greek debt issue was completely underwater in the span of two days, as spreads continued to widen. Buyers’ remorse indeed. How long until catastrophe?
And then Obama’s call for doubling exports in five years. How will that be possible without a dramatic weakening of the dollar against the people’s currency?
Big changes are brewing. Don’t look down.
The next ten years will be perilous. As much as it did the Aughts, one word will define the Teens: volatility. In my opinion there are three large risks to the world economy over the next ten years:
- Cascading currency crises
- Cascading sovereign defaults
- Geopolitical conflict
These risks are all interrelated, so the likelihood that one occurs and the others do not is slim. The sad fact of the matter is that as we enter the Teens, we have no comprehensive way to deal with the debt overhang that is now plaguing the public sector. Of course, a private sector that wasn’t overleveraged could conceivably shoulder the load and grow the economy by leveraging up and relieving the strain on the public sector. Alas, we are all tapped out.
I personally expect that quantitative easing will continue intermittently (causing great volatility in the process) until some currency or government blows sky high. Then the real fun begins.
Those who know me know that since the beginning of this crisis, I’ve been in the Stiglitz/Johnson/Galbraith/Krugman/Calculated Risk/et al. camp, advocating for a restructuring of the banking system. I believe that only through a restructuring of the debt loads plaguing the private sector could the system be reset to support sustainable economic activity and growth. However, such a course of action involves short-term pain and negatively impacts the banking sector’s interests, therefore it was not tried for lack of political will.
That leaves reflation. But is the course of action we’ve taken in the U.S. the best way to reflate? If I may summarize the current response in a nutshell: the Fed has lowered interest rates and supported asset prices through massive QE and a variety of lending programs, while the federal government effected a weak, temporary, and fragmented fiscal stimulus program. This has led to the worst of all possible worlds: assets that are discounting a highly unlikely stream of income, and worlwide bubbles. Deflation is still entrenched, inflation is an unpredictable institutional risk, and economic and financial crashes are likely–especially in the emerging world.
What should they have done? I’d argue essentially the opposite: the Fed should have considered vastly limited asset price support and stuck with moderate interest rates, and made sure that long term rates were also moderately high. At the same time, the federal government should have instituted a massive, durable, and targeted stimulus program, perhaps 3-5 times the size of the current one and including a guarantee work program, as suggested by Galbraith. The money for this project would have come from printing money to limit the real cost to the government. Done deftly this would have limited the likelihood of bubbles, while allowing income to justify asset values. Debts would be repaid and slack taken up, but new debt growth and new business investment would have been limited. The overleveraged condition of the private sector would have thus been remedied and asset prices would be supported (albeit at lower multiple levels). Sustainable economic activity and growth would resume.
I believe that there is still time to institute this latter reflationary policy. The Fed need only start raising rates into the expansion of a massive government stimulus policy, while printing money to cover the cost.
Unlike some, I don’t believe that government spending and investment is necessarily a bad thing. Government spending and investment can create productive jobs and it can create sustainable economic activity. In this sense, I view government as analogous to the private sector: some investments are duds, some are hopelessly inefficient in terms of labor and capital, and some are spectaculor hits.
My biggest concern with government as an economic actor is that our political process often frustrates wise spending and investment.* Since in my opinion the best government spending and investment programs need to be (a) durable, (b) targeted, and (c) large, our political system–with its frequent bureaucrat turnover, partisanship, and need for compromise and back-scratching–generates programs that are (a) temporary, (b) fragmented, and (c) watered down.
That is why I view the current government-generated global growth with skepticism. I have seen no evidence that suggests that this growth has provided a base from which a new economy can flourish. It appears to be a mish-mash of efforts in the form of the prior economic order–an economic order that didn’t appear to be sustainable. Suffice it to say that I have my doubts about the global economy as government efforts slow down in the face of inflationary and fiscal concerns.
*Yes, it is also true that the government is not solely motivated by profit-seeking behavior. But I see this as a good thing: economies are not just about profits, but about fairness and justice. I believe that government can act as a reasonable economic counterbalance to hyper-profit-seeking firms.
Bloomberg is reporting on how the U.S. government and the New York Federal Reserve funneled taxpayer money to Goldman Sachs via the bailout of AIG (“New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers“, Oct. 27). The article is worth reading in full. In brief, the U.S. government, through the Fed and AIG, bailed out counterparties holding AIG’s credit default swaps (CDSs; essentially insurance policies on financial securities). These bailouts paid the counterparties, including Goldman Sachs, the full par value of the CDSs–that is, the value that the CDSs would have had if the issuer (AIG) had not collapsed. The problem is that the transaction looks suspiciously like a corrupt back-room deal that transferred billions of taxpayer dollars to Goldman and other financial firms. Here’s why:
Before collapsing, AIG had been trying to negotiate with its CDS counterparties to accept reduce payments (less than par value) to terminate the swap agreements.
The U.S. government also began the negotiations under the assumption that the bailout terms would pay the CDS counterparties less than the full par value of the CDSs, as evidenced by the draft term sheet which, according to Bloomberg, contained a blank space for the percent discount to be forced on the counterparties. From the article:
Part of a sentence in the document [the draft term sheet] was crossed out. It contained a blank space that was intended to show the amount of the haircut the banks would take, according to people who saw the term sheet. After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public.
So, in secret discussions, the New York Fed agreed to pay the AIG counterparties the full par value, even though these counterparties would have received far less had AIG been allowed to go bankrupt.
To make matters worse, the chairman of the New York Fed personally made millions of dollars from the transaction:
The deal contributed to the more than $14 billion that over 18 months was handed to Goldman Sachs, whose former chairman, Stephen Friedman, was chairman of the board of directors of the New York Fed when the decision was made. Friedman, 71, resigned in May, days after it was disclosed by the Wall Street Journal that he had bought more than 50,000 shares of Goldman Sachs stock following the takeover of AIG. He declined to comment for this article.
Needless to say, Goldman, which has already reserved more than $10 billion for employee bonuses this year and whose business is “bad for America” according to Paul Krugman, is obviously not a deserving recipient of taxpayer aid. Making this suspect decision in secret and under the authority of someone who stood to profit personally from the decision is clearly unacceptable.
I second the call to appoint an independent prosecutor to investigate AIG the bailout.
I’m in Tokyo most of this month working on my Public Interest Capitalism and Computer-Assisted Organizing research. For the first time in all my visits trips to Tokyo since 1998, I’ve been struck by the number of empty storefronts in fashionable areas such as Omotesando and Roppongi. A manager at a serviced apartment company told me that the number of foreign customers has decreased precipitously since the “Lehman Shock” last year. Indeed, there appears to be little cause for optimism here, and the following comments from “Terrie’s Take“, an often insightful newsletter produced by Terrie Lloyd at Japan Inc., add to the gloom.
On advertising:
Our publications have more than 10 sales people visiting a database of around 5,000 different advertisers. What we are finding is that there is a palpable fear in the marketplace that we’re about to enter a second and more severe down leg in the recession. Once the shoe drops in the stock markets that the first-world governments have spent all their current and future cash on stimulus packages, and they’re out of ammunition, panic may spread again as it did last year. This fear is causing all advertisers and their customers to cut back in their marketing spending. Estimates are that overall media ad spend in Japan fell 9.7% in the first half of this year.
9.7% is a large drop. On luxury goods:
As a sign of the Japanese consumers’ move away from luxury brands, in light of the on-going recession, apparel maker Gianni Versace says that it will close down its Japan operations by the end of year. The company shuttered its three company-owned stores in July, and is moving back to a distributor model to sell its products
All that said, it seems to me unlikely that the global economy will go into a tailspin as long as the Fed keeps rates near zero and the dollar keeps falling. Although I’ve been unable to get any figures on the size of the dollar carry trade, my contacts in finance tell me that the dollars are flowing into Chinese real estate and other emerging market asset classes. As long as the dollar carry trade continues, it will create downward pressure on the dollar and upward pressure on emerging market asset prices, making the trades ever more profitable. With unemployment high and rising in the U.S., it’s hard to imagine that the Fed can raise rates anywhere in the near future, so this positive-feedback cycle could run for quite a while, potentially inflating a global bubble even larger than the last one. Of course, we know how the game ends.