I usually don’t post a new entry so soon after the last post, but there was an interesting article in today’s Wall Street Journal by Andrew Batson.
China is center stage when it comes to fears that buyers will one day spurn U.S. Treasurys. The bond market has been the source of much political theater between the U.S. and China in recent months, with Chinese officials passing up few chances to lecture the U.S. on its profligacy.
But that has obscured an important change: The market for Treasury bonds is now more reliant on U.S. buyers — including the Federal Reserve after its recent buying spree — than the Chinese.
China held $801.5 billion in Treasury debt at the end of May. The Fed at that time held about $598 billion, although that has now risen to $704 billion. The latest figures for U.S. households, from the first quarter, showed holdings of $643.9 billion — more than double the $266.6 billion in the fourth quarter of 2008.
The rising budget deficit, which has led to record issuance in recent months, doesn’t necessarily mean the government is becoming more indebted to foreigners. While the U.S. government is borrowing furiously, the current account deficit has actually halved from an annualized $829 billion in mid-2005 to an annualized $409.5 billion in the first quarter of 2009. That shows the U.S. is now less dependent on external financing, because it is saving more domestically. The U.S. government may be in hock, but it is increasingly to its own citizens.
This shouldn’t be a surprise. The reason for the growing US fiscal deficit is to slow the economic impact of a rise in US household and corporate savings. This means that the period in which very high Asian savings were matched by very low US household savings is changing to one in which the pressures to save in Asia remain while US households are increasing their savings (or reducing their borrowing, which amounts to almost the same thing). The pool from which the US Treasury can borrow is increasing, not decreasing.
In addition, as the US current account deficit drops, foreign net purchases of dollar assets must also drop. The rising US fiscal deficit will increasingly be financed by Americans and less and less by foreigners, and the much-decried impact on US interest rates of the massive US borrowing turns out to be very small.
Brad DeLong, who also expected this to happen, has a very similar take from a different angle, which he discusses in a recent blog entry:
And the interesting thing is that I knew that this [that the market would easily absorb a huge increase in government debt] was going to be what would happen–or, rather, I strongly believed that this was going to be what would happen–and all because I had read John Hicks (1937).
Let me give you the Hicksian argument about what happens in a financial crisis–a sudden flight to safety that greatly raises interest rate spreads, and as a result diminishes firms’ desires to sell bonds to raise capital for expansion and at the same time leads individuals to wish to save more and spend less on consumer goods as they, too, try to hunker down.
In Hicks’s model, the immediate consequence is an excess demand for (safe) bonds in the hands of investment banks: bond prices rise, and interest rates falls. As interest rates fall, (a) firms see that they can get capital on more attractive terms adn so seek to issue more bonds, and (b) households see the interest rate they can get on their savings fall, and so lose some of their desire to save. The market heads toward equilibrium. But as the market heads toward equilibrium, something else happens as well: the fall in interest rates and the rise in savings is accompanied by a greater desire on the part of households and businesses to hold more of their wealth safely–in pure cash. And so the speed with which cash turns over in the economy, the velocity of money, falls. And as the velocity of money falls, total spending falls, and workers are fired, and as workers are fired and lose their incomes their saving goes from positive to negative.
Batson goes on to say in his article:
History suggests there is plenty of room for households to increase their holdings.
The Chinese government may be politically uncomfortable with lending money to the U.S., but it remains locked into purchasing Treasury bonds because of its currency’s tight peg to the dollar. The challenge for the U.S. government isn’t just reassuring China.
It also is to maintain the confidence of the domestic investors who are an increasingly important source of financing for the wave of government debt supply hitting the market.
The only point with which I disagree is on the need to “reassure” China. As I have pointed out many times, although there are plenty of good reasons for China to worry about the value of its dollar holdings, and I hope many people, not just the Chinese, are looking warily at growing US fiscal deficits and making disapproving noises, the fact is that there is little China can do about its dollar holdings without either causing a damaging rise in trade tensions with Europe (or any other country whose currency is an alternative to the dollar) or causing a collapse in its export industry. As long as China’s trade surplus directly or indirectly is connected to the US trade deficit, China will have to recycle the surplus into the dollar pool that ultimately funds the US fiscal deficit, and it is in the best interest of the US that the US trade deficit decline smoothly, which means that it is also in the best interest of the US that foreigners, including the Chinese, buy fewer US dollar assets.
What is confusing is the conflict between China’s natural position and its stated position. Rather than demand reassurance that the US will control its fiscal spending, China should be secretly hoping that the US fiscal deficit will mushroom. It is after all largely the size of the US fiscal deficit that will determine the speed with which US imports and the US trade deficit contract, and it is in China’s best interest that these contract very slowly.
On a similar subject, I was recently interviewed for a TV show about – yet again – the awful continuing prospects for the dollar as a the dominant reserve currency. Besides expressing my deepest skepticism that the most recent hullabaloo about the dollar was likely to be more reasonable than during all the previous the-sky-is-falling-on-the-dollar periods, I also said that it seems to me that the argument had somehow gotten backwards as far as its proponents and opponents were lining up.
In my view it is the US who should be agitating for an end to the US dollar as the default reserve currency, because this means that any time a country needs to grow reserves or turbo-charge domestic growth with mercantilist industrial policies, thanks to the flexibility of the US financial system and the foreign desire to accumulate dollars, it is almost always the US tradable goods sector that is forced to adjust. In a similar vein it should be foreigners, especially Asians, and most especially China, that should want to maintain the existing currency system.
I also suggested to the interviewer that in two or three years no one would be talking about this topic anymore. She was surprised and asked me why. The reason has to do, I think, with the expected evolution of the US current account deficit. For several years the US has been running, as we all know, very large current account deficits.
This means that the net accumulation of dollars by foreigners (foreign purchases of dollar assets minus American purchases of foreign assets) has been extremely high – just as in the 1960s when the combination of a trade deficit, foreign military spending, and large foreign aid programs created a dollar glut, along with heated arguments about the international role of the dollar. If the US current account deficit remains high, foreigners will continue to be large net acquirers of dollars.
But if the current account deficit declines quickly, as it has and as I expect it to continue doing for a while longer, the problem of too many dollars being held abroad will disappear – or, more technically, it will simply be the obverse of the change in investment flows into the US. Once the world stops accumulating hundreds of billions of dollars every year through the US current account deficit, the argument over the dollar will fade away and, not coincidentally, a larger portion of foreign reserves, and probably international trade, will naturally be denominated in non-dollar currencies.
[...] Read the rest of this great post here [...]
the USG is not reliant on foreigners???
how sustainable is it to put a great deal of personal savings contributions into treasuries? this is de-facto spending all savings, forced or voluntary, and promisig to repay it with increased taxation on the very same savers.
this is the greatest con game of all time!
Echos of Brad Sester!
I would like to ask, if US savings reach the point of fully covering its deficit requirements, what could China do to maintain its weak Yuan?
“The only point with which I disagree is on the need to “reassure” China. As I have pointed out many times, although there are plenty of good reasons for China to worry about the value of its dollar holdings, and I hope many people, not just the Chinese, are looking warily at growing US fiscal deficits and making disapproving noises, the fact is that there is little China can do about its dollar holdings without either causing a damaging rise in trade tensions with Europe (or any other country whose currency is an alternative to the dollar) or causing a collapse in its export industry. As long as China’s trade surplus directly or indirectly is connected to the US trade deficit, China will have to recycle the surplus into the dollar pool that ultimately funds the US fiscal deficit, and it is in the best interest of the US that the US trade deficit decline smoothly, which means that it is also in the best interest of the US that foreigners, including the Chinese, buy fewer US dollar assets.”
China & Russia have started to reduce its holding of Dollar asset according to this report.
http://finance.yahoo.com/news/Foreign-demand-for-longterm-apf-3909793395.html?x=0&sec=topStories&pos=5&asset=&ccode=
“China, the largest foreign holder of U.S. Treasury securities, trimmed its holdings, to $776.4 billion in June from $801.5 billion in May. Russia also reduced its holdings 3.7 percent to $119.9 billion in June.”
China Dollar holding went from $801.5 billions to $776.4 billion so it is -3.07%
I guess that whenever foreign government, private investor or the Fed start buying long term bond then China could start selling their long term holding to them without causing any ripple in their Dollar denominated asset.
[...] The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? (China Financial [...]
Does it mean that american people will have to work more and to consume less ?
such a programm would’nt be very popular and politicians trying to apply it or not trying to prevent il would not have much chance to get reelected !
Well, baychev
Depend on the interest rate for long term bond! If the Fed keep printing money like there is not tomorrow, then the dollar would lose its value through devaluation so the Fed can pay back all the bond buyer with heavily de-evaluated dollar! So the Treasury Department need to start to raise the interest rate of the long term bond in order to attract buyers. Imagine if the inflation were like in the early ’80, then the interest rate of the bond need to be above 10% to attract buyers on the long term (5 to 10 years) bond! However, the Treasury department can not do that since it would collapse the housing market and worsen the recession so the USA is trapped in a liquidity trap all due to the Wall Street crook! The Obama administration should have left those Wall Street crook failed rather than destroying the Dollar as an international reserve status!
“baychev | 17/08/09
the USG is not reliant on foreigners???
how sustainable is it to put a great deal of personal savings contributions into treasuries? this is de-facto spending all savings, forced or voluntary, and promisig to repay it with increased taxation on the very same savers.
this is the greatest con game of all time!”
[...] This post was Twitted by stan224 [...]
From what I have seen, the flight to safety (in recent quarters) has been associated with dollar strength and lower spreads on dollar debt – corporate or otherwise because the reference rate is driven down and liquidity keeps a lid on corporate spreads. The flight to yield seems to be accompanied with greater confidence in things ex-US and ex-Japan, which send the dollar down, and spreads up. The 1937 analogy doesn’t seem to apply because then the US economy was manufacturing driven, and global capital flows moved at a relative snail’s pace. Household propensity to save in the US seems to be more sensitive to cyclical factors like unemployment and productivity gains (that drive income), than simple yield considerations. Consumer desires and excesses don’t care about a few, or few dozen, basis points. We are not talking here about savings on the margins; we are talking about saving to make up for trillions of dollars in equity losses on real estate and shares.
Andrew Batson in the article Professor Pettis quotes makes the same factual mistake as Professor Pettis himself. He writes: ‘While the U.S. government is borrowing furiously, the current account deficit has actually halved from an annualized $829 billion in mid-2005 to an annualized $409.5 billion in the first quarter of 2009. That shows the U.S. is now less dependent on external financing, because it is saving more domestically.’ (my emphasis)
This statement is neither logical nor factually true – as I have set out previously. The US current account deficit is necessarily equal to the balance between US saving and US investment. Factually the US balance of payments deficit has declined not because US saving is rising as Andrew Batson claims, which would be healthy for the US economy, on the contrary US saving has been falling, but because US investment has been declined even more rapidly than US saving – and sharply declining investment is not healthy for US economic growth. In short the US balance of payments deficit fell not for beneficial reasons for the US economy (rising savings) but for malign ones (investment falling even more rapidly than savings). The facts on this have been set out both in comments here and in much greater detail elsewhere so I won’t repeat them again – I simply point out that the claims made by both Andrew Batson and Professor Pettis are not correct.
This issue relates directly to perspectives for both the Chinese and US economies. Professor Pettis recently set out again his views on the two largest, in real PPP terms, economies in the world with admirable clarity: ‘I continue to stand by my comment last year – which infuriated so many people – that the US would be the first major economy out of the crisis and China one of the last.’
Although this prognosis is inaccurate the attempt should not be made to turn it round with a neat symmetry and the prediction made that ‘China will be the first major economy out of the crisis and the US one of the last,’ because the second part of such a prediction would not necessarily be true – although the first on China would be.
The US has a variety of means, above all the ability to borrow in its own currency, which means via de facto managed devaluation the ability to unilaterally mark down its debts, which are not possessed by other countries. This may well allow it to emerge from crisis before a number of other major economies – but not China. The correct proposition which is counter posed to Michael Pettis’s, and which I certainly defend, is ‘China will be the first major economy out of the crisis and it will emerge from it before the US.’
This fact that US saving has been declining, and US investment declining even more, under the impact of the financial crisis does relate directly to the perspective for the US and Chinese economies. China’s investment has risen sharply, leading to year on year 7.9% growth in the second quarter of 2009. US investment has contracted sharply – with US GDP in the second quarter of 2009 3.9% lower than a year previously and US private fixed investment down 21.1% year on year. Given this contrast Professor Pettis’s claim that the US will be first out of the crisis and China one of the last is factually false.
It is also rather easy to trace what is continuing to happen to US saving from its trade figures. While strictly speaking balance of payments figures are necessary to calculate the US saving rates, and not only trade figures, nevertheless the US trade balance so dominates the US balance of payments it is reasonable to use the trade balance to indicate direction of change when the movements are as clear as at present.
Professor Pettis states he considers the US balance of payments deficit will continue to fall rapidly: ‘if the current account deficit declines quickly, as it has and as I expect it to continue doing for a while longer’.
But in fact the US balance of trade has already ceased falling in any significant fashion. It is true that from July 2008 to February 2009 the US balance of trade, which dominates the balance of payments, did fall extremely sharply exactly as Professor Pettis states – from $64.9bn to $26.1bn or by 60%. But since February the US trade deficit has not declined in any meaningful way – it was $26.1bn in February, $28.5bn in March, $28.9bn in April, $26.0bn in May, and $27.0bn in June. In short, on the US side, correction of one of the major ‘global imbalances’ has essentially halted since February. As US investment has continued to fall this means US saving is falling in parallel – i.e. there has been no halt to the decline in US overall saving. The rise in US household saving has been more than cancelled out by deterioration in combined US government and corporate sector saving. Such falling saving and falling investment is precisely a ‘malign’ shift in the US economy.
Rising investment producing growth in China, falling saving and investment in the US producing first recession and then relative stagnation, means that ‘China will be the first major economy out of the crisis and it will emerge from it before the US.’ Professor Pettis statement: ‘I continue to stand by my comment last year – which infuriated so many people – that the US would be the first major economy out of the crisis and China one of the last’ is wrong. That is what is the practical significance of the debates about both economic logic and economic facts.
What are being presented are two testable counter positions – both in terms of coherence of their economic logic and agreement with the facts. Given that what is being discussed are the two largest economies in the world, the US and China, developments in one affect developments in the other – and developments in both affect everyone else. That is why the issue of the relative dynamic in the US and China is so crucial.
So far the facts support the view that China is emerging from the crisis well before the US and not the contrary view that Professor Pettis has presented.
So Ross you think the global crisis is already over and that you’ve won? Is that your real opinion or are you just disagreeing with Pettis on principle? If the former, I’m surprised. I would say that we aren’t even close yet to deciding who comes out of this crisis first. Given everything he has been saying recently, which like many others I think you deliberately misread for whatever reasons you choose, Pettis’s response would be pretty obvious: by 1988 it was clear to people like you that Japan had emerged from the 1987 crash triumphantly and long before the US did. Yeah, right.
Dear Mr. Ross,
Mr. Pettis is discussing about the evolution of US savings over the future and how it will affect Chinese savings. This is very clear, and to nearly everyone who reads him regularly. But it seems no matter how many times this has been pointed out you won’t recognize it. I think we should agree that this is an insurmountable point between you and it would be more interesting if we moved on to his main concern, which it seems to me is the prediction about Chinese growth in light of the US adjustment. Unless you insist that US consumption will continue to grow quickly and the US trade deficit with it in the next few years, your arguments seem presented more out of animosity than clarity. This is tedious.
Also I must disagree strongly with your supposition that the global crisis has finally ended and that China has emerged from it first. This may be true, but only if all the concerns about the fiscal stimulus package, expressed by both Mr. Pettis and many analysts in China and abroad, including me, are to be wholly dismissed. Perhaps they are wrong, but it is foolish to dismiss them so easily.
this page clearly shows a surge in the personal savings rate, which is the key rate pettis is talking about: http://www.bea.gov/briefrm/saving.htm
if total savings declined, that actually could exacerbate his point because the savings rate could rise in an environment of declining GDP, with a decline in savings. you’re missing the point, i think.
STOCKS AND BONDS
U.S. Savings Rate at Highest Point in 15 Years
By JACK HEALY
New York Times
Published: June 26, 2009
Tax cuts from the stimulus package and increases in Social Security checks lifted personal incomes sharply in May, the government reported on Friday, but it appeared that many people were putting that money away instead of spending it.
Although personal spending increased slightly last month, the saving rate climbed to its highest level in 15 years as consumers tried to build a buffer against the threat of job losses and more economic hardships.
The personal saving rate, which dipped below zero during the housing boom as Americans tapped home equity loans and other easy lines of credit, rose to 6.9 percent in May, the Commerce Department reported. That was its highest point since December 1993.
On Wall Street, investors saw little reason to cheer the increases in incomes or spending, and stocks ended mostly lower, undoing some of the gains from a day earlier. Stocks closed lower for a second week, offering more fodder to bearish investors who say that this spring’s stock rally has largely run its course.
The Dow Jones industrial average lost 34.01 points, or 0.4 percent, to close at 8,438.39 while the wider Standard & Poor’s 500-stock index was 1.36 points, or 0.1 percent, lower at 918.9. Strength in technology stocks helped to lift the Nasdaq index 8.68 points, or 0.5 percent, higher, at 1,838.22.
For the week, the Dow fell 1 percent, and the S.& P. 500 was little changed. Interest rates were steady. The Treasury’s benchmark 10-year note was up 1/32, to 96 19/32, and the yield, which moves in the opposite direction from the price, was at 3.54 percent, unchanged from late Thursday.
As personal savings return to more normal levels, the increase prompts what economists call the “paradox of thrift.”
Although saving money helps individuals repair their finances and pay debts, a sharp rise in overall personal saving can actually deepen a recession and hurt the people who are saving more. As people save money, fewer dollars circulate through shopping malls, Main Street businesses, and large employers and subsequently back to workers through their paychecks. This thrift pulls the economy lower.
Economists say the recent spike in personal saving is likely to fall back slightly as the effects of government stimulus fade, but they have said that Americans are becoming thriftier and are not likely to return to the free-spending patterns that fueled much of the growth of the last nine years.
Steep declines in home values and individual stock portfolios have erased trillions of dollars in household wealth. The economist Joshua Shapiro of the consulting firm MFR noted that he was “clearly seeing signs of households altering their behavior in the face of large capital losses in investment and real estate portfolios, an abysmal labor market and tight credit.”
Still, while consumer spending did not increase last month as rapidly as savings, it did post a small increase. Personal consumption rose 0.3 percent in May after falling or remaining flat in the two previous months.
The rise in personal incomes, 1.4 percent, was an indication that money from the government’s $787 billion stimulus program was beginning to flow through the American economy.
“That’s the whole point — put money back in the pockets of consumers and households, and they’ve accomplished that,” Nariman Behravesh, chief economist at IHS Global Insight, said. “The good news is, it’s working. The question is, how much of this is a blip?”
Although disposable personal income rose at a seasonally adjusted rate of $178.1 billion in May, the Commerce Department also reported that private wages and salaries had decreased $12.4 billion.
Also, consumer attitudes rose for a fifth month in June, and were actually higher than in the period a year ago, when gasoline prices were peaking and the struggling economy was heading for a steep drop. The Reuters-University of Michigan consumer survey reported Friday that sentiment rose to 70.8 in June, up from 68.7 a month earlier.
But many consumers are still living on the edge. A majority said their financial situation had deteriorated in June as they either lost jobs, worked fewer hours or otherwise saw their incomes decline, according to the survey.
The recession has already erased some six million jobs since December 2007, and economists expect the losses to continue through the rest of the year, despite the effects of the stimulus package.
Don’t believe the Major Foreign Holders data that says Chinese holdings dropped from $801.5 billion to $776.4 billion. Much of what is purchased by China actually shows up under the UK until the annual survey results are known. UK totals jumped from $163.8 billion to $214.0 billion. Each year China gets a big upward revision as a result of UK holdings being reclassified:
http://www.treas.gov/tic/mfhhis01.txt
http://www.treas.gov/tic/mfh.txt
A better idea of what China is doing comes from looking at the Fed’s custodial accounts. There has been plenty of growth in foreign official accounts held at the Fed in June, July and August.
Every week for the past several years I’ve entered data from the weekly Fed’s H.4.1 report because I find the Fed’s actions to be extremely important in determining the future direction of the markets and the economy.
There will always be demand for US treasuries. The question is what the yields will be. If individuals and institutions choose to put their money in savings accounts and/or money market funds instead of US Treasuries, the banks and fund managers will buy up treasuries with that money.
The Fed’s purchases of Treasuries, Agency Debt, and Agency Mortgage Backed Securities are mainly about keeping yields down and the money supply up. Without that buying, cash would be tighter in other sectors and interest rates would be rising out of control.
China’s purchases have been about propping up the value of the dollar relative to the RMB and continuing the flow of wealth, knowledge and productive capacity out of the US and into China.
China’s demand for Agency MBS helped fuel the US housing bubble by keeping mortgage interest rates low. Home equity extraction was the major means by which many US consumers bankrupted themselves and it couldn’t have been done without full Chinese support. China has been reducing their MBS holdings steadily since around last August, and have been buying up US treasuries at a higher rate. This is facilitating the likely eventual bankruptcy of the US government.
The net investment position of the US is now a net negative $4 trillion. The real question is one of debase (the US Dollar) or default (on US sovereign debt). For now the Fed is choosing to debase with about $900 in money creation for securities purchases year to date. The alternative is to let yields soar and credit tighten, crippling the US economy even more rapidly and exposing the real burden of the Government’s $11.7 trillion debt (plus tends of trillions more in off-balance sheet liabilities).
Long term the US debt position doesn’t bode well for Chinese exporters, which is a major reason why they are retooling their industries to export a wider range of products to more of the rest of the world. For now China buys US treasuries to keep the RMB weak. From mid-2005 to mid-2008 they bought more securities from other countries (and the dollar fell steadily) and China will likely do so again as more countries pull out of their recessions and the US recession deepens.
Exactly US saving has been rising since the winter and very sharply too. The US is less dependent on foreign savings – or at least has been over the last few months – as US investors returned money home in a flight to safety and foreign investors had smaller surpluses to lend them, a product of both the collapse of raw materials prices hitting the oil exporters and general implosion of world trade following Lehmans. If you’re going to moan on about being factually correct – at least be factually correct!
This article from Brad state the same thing as Pettis on the premise that the USA does not rely on foreigner for finance.
However, the USA depend more on private finance rather than foreign central bank for financing. Foreign central banks has been selling their long term debt.
http://blogs.cfr.org/setser/2009/07/28/doesnt-a-smaller-external-deficit-mean-less-dependence-on-external-creditors-including-china/#more-6041
“Give US debt managers a bit of credit. Over the last several months, they have sold more notes and fewer bills, financing more of the deficit with longer-term borrowing. That is good debt management. In the month of June, they sold close to $220 billion of notes while reducing the stock of outstanding bills by $60 billion. And they did so in a market where central banks remain reluctant to buy long-term US Treasury bonds, so most issuance is being bought by private investors.”
Also, here some respond of readers to Brad Setser blog about the risk of depending on private investors as opposed on depending on Central Bank to purchase long term bond.
# uly 28th, 2009 at 5:54 pm Michael responds:
First, the good news:
“Give US debt managers a bit of credit. Over the last several months, they have sold more notes and fewer bills, financing more of the deficit with longer-term borrowing.”
Now, the bad news:
“When I look at a chart showing note issuance v estimated official demand, I don’t see any evidence that US dependence on foreign central banks — or China — or financing is rising. Rather I see evidence that the US is relying more on private demand for long-term Treasuries to finance its deficit.”
Why is the shift from foreign central banks to the private sector bad news? Yes, it’s true that China or Japan (or even Russia, Norway, etc) could move the market quickly if they started to sell their Treasuries. But the single most stable fact throughout the pre-crisis, crisis, and current eras is that they don’t tend to sell their Treasuries. Private investors, on the other hand, have been exceedingly unstable in their willingness to hold onto any depreciating (or potentially depreciating) asset during every era. Combine that with Twofish’s observation that the ballooning growth in total U.S. gov’t debt is itself a destabilizing factor and it’s not so clear we’re in an improving situation.
# July 28th, 2009 at 6:27 pm WStroupe responds:
Yup! ‘To have and to hold’, or more accurately, ‘To KEEP BUYING and to hold’ is what the U.S. desperately needs, especially as it runs up huge budget deficits to deal with this crisis. All that piling into short-dated Treasuries is a big strain on the Treasury, ’cause it’s too refund/rollover intensive, and if for some reason investors decide in significant numbers NOT to roll over their short-dated Treasuries, but want refunds instead so they can put their money elsewhere, then the Treasury could potentially be flooded with refund demands it can’t meet. So getting investors long on Treasuries is absolutely necessary. How you gonna do dat if China balks at deepening its long position on Treasuries? It’ll move the market, allright. Move it to stay short, if at all. And China won’t have to sell off in order to see this happen.
It’s all OK for now – the extremely precarious U.S. Treasury balancing act is working better than I thought it would. But only a proverbial sneeze by China or in the form of some unexpected phase of this crisis or by some Washington policy blunder (or more likely a combination of the above)could push things off the ropes to the hard ground below.
All the while, as the posters above point out, U.S. financing is deteriorating as far as quality goes.
Olivier Blanchard of the IMF states;
“That means U.S. consumers are unlikely to return to their free-spending ways, and both the United States and its trading partners will have to adjust. Emerging Asian countries, especially China, must play a big role.
“From the point of view of the United States, a decrease in China’s current account surplus would help increase demand and sustain the U.S. recovery,” he said. “That would result in more U.S. imports which would help sustain world recovery.”
But in order for China to boost domestic demand, it will need to provide a stronger social safety net and increase household access to credit, which will encourage its consumers to save less and spend more.
“Both higher Chinese import demand and a higher (yuan) will increase U.S. net exports,” he said.
http://www.nytimes.com/reuters/2009/08/18/business/business-uk-imf-outlook.html?_r=1
I can’t help but think of the irony in the fact that China’s mercantilist policies have created in the US an “opium” of debt. Although as Professor Pettis points out, these trade policies hurt China in the long-term, in the short term, the pegged exchange rates and the recycling of dollars into the US debt markets has created an opium like addiction to debt. (Make no mistake, no one forced the consumer to borrow heavily. That is “their bad”.) But the irony is there.
In the 19th Century, the British struggled to find a product that Chinese desired to offset the trade imbalance caused by huge western demand for Chinese goods. Opium was the product….a sordid tale in Occidental/Oriental relations, which led to gunboat diplomacy, the concessions to the west (Hong Kong, Macau, Tsingdao, etc).
Although there are many different things about the situation today, one thing is true, the US consumer will need to go through detox. Looks like right now it’s kind of a crash program, regardless of Mr. Ross’ arguments.
Just some thoughts on China: Although there may be studies showing that China’s investment efficiency is average or slightly above average, one need only be here to see the abundance of stupid projects. Assuming the definition of investment efficiency has something to do with productvity, I am reminded of the story of the Gods must be Crazy, wherein a discarded coke bottle becomes a magical tool improving productivity among African Bushmen. When over a third of your people are unproductive, sitting on farms with nothing to do, even a really bad investment increases productivity.
The Great Leap Forward caused the starvation of millions of people. That decision was made based on huge informational misreporting (about agricultural productivity and the level of food stocks) and a lack of healthy analytical skepticism among investment decision makers.
I worry about the same kind of misinformation practices happening today and an inability of analysts to critically question such investment information. While I certainly think some Chinese analysts have the skillset, they may not have the voice.
So, we continue to see boondoggle projects get financed. Do they add to productivity? Technically, yes… if you take somebody off the farm and put them in a job as a security guy at an empty building. Was it a good investment decision to use quasi-public funds to build yet another building? No.
The question is whether such suboptimal investments will ever come back to haunt. As one blogger said and I paraphrase, “No big deal…investment just becomes consumption”. Cities and Provinces are levering up to fund their portion of the 4 trillion stimulus package. If such stimulus is spent on unproductive (consumptive like) projects that fail to jumpstart economic activity or increase land values, then I fear there will be big problems.
[...] The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? (Pettis) [...]
Here some interesting read from the Economist. Many of the so-called expert on the so-called “Asian model” have been wrong in the past…
Please read more about!
http://www.economist.com/displayStory.cfm?story_id=14209825
Emerging Asian economies
On the rebound
Aug 13th 2009 | HONG KONG
From The Economist print edition
Asia’s emerging economies are recovering much more quickly than economies in other parts of the world. Can they keep it up?
Illustration by Bill Butcher
MORE green shoots have appeared in America in recent weeks, but they are nothing by comparison with the lush jungle sprouting in the East. Asia’s emerging economies probably grew at an average annualised rate of over 10% in the second quarter, while America’s GDP fell by 1%. In 2009 as a whole, recent forecasts suggest that emerging Asia could grow by at least 5%, while the G7 economies contract by 3.5%. The growth gap between the two has never been wider. How have these export-dependent economies managed to decouple from the developed world? And can their recovery last?
Average growth figures conceal big differences within Asia over the past year. China, India and Indonesia were among the few economies in the world that continued to expand throughout the global downturn (though China’s virtually stalled late last year). But the smaller, more open Asian economies were badly hit. Between September and March real GDP fell by an average annualised rate of 13% in Hong Kong, Malaysia, South Korea, Singapore, Taiwan and Thailand.
Yet the countries that have so far published second-quarter GDP figures show an impressive bounce. Comparing the second quarter with the first at an annualised rate, China’s GDP grew by 15%, South Korea’s by almost 10%, Singapore’s soared by 21% and Indonesia’s managed a respectable 5%. Other countries in the region are also likely to show a rebound. It is true that output in South Korea and Singapore was still lower than a year earlier, but quarterly changes are more useful for spotting turning points—and this is how growth rates are most commonly measured in America.
The revival in emerging Asia’s industrial production is even more impressive, jumping by an annualised rate of 36% in the second quarter. According to Barclays Capital, emerging Asia is the only region in the world where output has regained its level before the crisis (see chart 1). This is largely due to China, where industrial production rose by 11% in the 12 months to July, but all the Asian countries have seen a strong pick-up. In contrast, up to June, America’s production continued to fall.
The sharp “V” shape of this cycle, and the fact that GDP started the year well below the average level in 2008, means that growth rates for 2009 as a whole could give a misleading picture. Take Taiwan: JPMorgan predicts that its GDP in 2009 will be 3.8% lower than in 2008, implying another dismal year. But this forecast also implies that GDP will grow by a brisk 5.4% in the year to the fourth quarter. By this measure, Asia’s emerging economies are clearly leading the global recovery (see chart 2). Even if America’s economy grows during the second half of this year, it is still expected to end the year smaller than it was at the start.
Asia’s bounce has taken many forecasters by surprise. In May, for example, the IMF predicted that Asia’s recovery was likely to be “tepid” because the developed economies—and hence demand for Asian exports—would remain weak. Forecasters always seem to underestimate the ability of the Asian tigers to rebound from recessions. During East Asia’s financial crisis in 1997-98, for example, countries across the region were forced to devalue as a result of large current-account deficits and speculative attacks on their currencies. This caused firms’ foreign-currency debts to swell in local terms, resulting in widespread bankruptcies and bank failures. In 1998 the real GDP of Thailand, Indonesia and South Korea fell by an average of 10%.
Many foreigners concluded that Asia’s economic success had been a complete sham, based on governments pouring cheap money into favoured firms. Over-borrowing and over-investment had artificially boosted growth, it was argued; doomsayers predicted a decade of lost growth. Instead, the tigers came roaring back. At the end of 1998 The Economist’s poll of forecasters predicted that South Korea would shrink again slightly in 1999. Its actual growth turned out to be a stunning 9.5%. It was true that Asia’s strong growth had concealed wasteful investment, inadequate bank regulation and corruption, but the key ingredients of growth—rapid productivity growth, relatively open markets and a high saving rate to finance investment—remained in place. That helps explain why the East Asian economies recovered more quickly than many expected.
A case of Asia vu
Likewise, when the global information technology bust dragged Asia into recession in 2001, forecasters turned out to be much too gloomy about Asia’s prospects. Once again, emerging Asia bounced back fairly briskly. Westerners have always been too quick to pronounce the death of the Asian economic miracle. This may be wishful thinking, but it also reflects some misunderstandings about the ingredients of Asia’s success. This year it was widely predicted that Asia’s economies would not recover until after America and Europe had revived. Yet Asia’s supposedly export-dependent economies have resumed growth before the rest of the world. How can that be?
Sceptics argue that the pick-up simply reflects a temporary boost from rebuilding inventory, with no real increase in demand. Firms had cut production to below the level of sales in order to shed excess inventories, so now they need to reopen factories. This may be a factor in some countries, but in others firms are still running down their stocks.
In South Korea the decline in inventories accelerated in the second quarter, and the leanness of stocks bodes well for further gains in production over the rest of this year. Instead, the recovery has been led by investment and consumer spending. South Korea’s private consumption rose by an annualised 14% in the second quarter. In China fixed investment (on a GDP-consistent basis) is running more than 20% higher than a year ago, real consumer spending in urban areas is up by almost 11% and car sales have surged by 70%.
One reason why Asia’s emerging economies have been able to rebound well before those in the rich world is that their downturn was caused only partly by the slump in America. In 2008 domestic spending was squeezed by higher prices for oil and food (which account for a much higher share of household budgets than in other countries) and by tighter monetary policies, aimed at curbing inflation. China’s growth, for instance, began to slow well before global demand stumbled, as tight credit policies to prevent the economy overheating caused the property market and construction to collapse.
Across the region, aggressive fiscal and monetary stimulus has helped revive domestic demand. Asia has had the biggest fiscal stimulus of any region of the world. China’s package grabbed the headlines, but South Korea, Singapore, Malaysia, Taiwan and Thailand have all had a government boost this year of at least 4% of GDP. Most Asian countries, with the notable exception of India, entered this downturn with sounder budget finances than their Western counterparts, so they had more room to spend. Bank of America Merrill Lynch forecasts that the region’s public debt will rise to a modest 45% of GDP at the end of 2009, only half of the average in OECD countries.
Moreover, pump-priming has been more effective in Asia than in America or Europe, because Asian households are not burdened with huge debts, so tax cuts or cash handouts are more likely to be spent than saved. It is also easier in a poorer country to find worthwhile infrastructure projects—from railways to power grids—to spend money on.
In China the easing of credit has been even more important than its fiscal stimulus. Although lending slowed sharply in July, new lending by banks in the first seven months of this year was almost three times its level a year earlier. And across the whole of emerging Asia, cheaper money has been more potent in lifting spending than in the West. This is because, unlike in America and Europe, local financial systems are not crippled, so banks are able to lend more. And since Asian households and firms had not previously been on a borrowing binge (South Korea is an exception), they can afford to borrow more.
Growth rates will almost certainly moderate after the second quarter’s astonishing bounce. Even so, Mike Buchanan, an economist at Goldman Sachs, has raised his forecast for GDP growth in emerging Asia to 5.6% for 2009 as a whole and 8.6% in 2010. He expects China to grow by a breathtaking 9.4% this year and 11.9% next.
India’s GDP is forecast to grow by a more modest 5.8% in this fiscal year (ending March 2010). Exports accounted for only 15% of India’s GDP in 2008, compared with 33% in China, so India should have been much less affected by the global downturn. But because of its dire fiscal finances (a budget deficit of 10% of GDP last year), the government has had much less room to spur growth. The poor monsoon rains are also expected to reduce farm output this year. However, Mr Buchanan expects growth to increase to 7.8% next year.
Bubbling up
Even though these economies are only just starting to feel the upturn, policymakers now face a difficult problem: how to sustain a robust recovery without blowing up bubbles. There are growing concerns that a flood of liquidity is fuelling asset-price bubbles, which could destabilise economies when they burst. In China share prices have almost doubled since their trough last November, and most Asian countries have seen gains of around 50% or more since the start of the year (see chart 3). After falling last year, house prices are now rising rapidly in Hong Kong, Shanghai, Seoul and elsewhere. Home sales have surged by 70% in value in China over the past year. According to one estimate, one-fifth of all new lending this year in China has gone into the stockmarket or property.
Asset prices could rise much further. Despite the recent gains, average house prices in most countries are barely higher than a year ago. And although shares are starting to look pricey, China’s stockmarket is still 47% below its 2007 peak. But the lesson from America in recent years is surely that it is better to prevent bubbles forming. Asia’s monetary conditions are too loose now that economies are reviving; central banks need to raise interest rates. But with rates close to zero in the rich world, and likely to stay there for a while, this would lure in foreign capital, adding to domestic liquidity. Capital is already rushing in, attracted by the region’s growth, which is faster than the rest of the world’s.
The basic problem is that although the Asian economies have decoupled from America, their monetary policies have not. In a world of mobile capital, an economy cannot both manage its exchange rate and control domestic liquidity. By trying to hold their currencies down against the dollar Asian economies are, in effect, being forced to shadow the Fed’s monetary policy even though their economies are much stronger. Foreign-exchange intervention to hold down their currencies causes domestic liquidity to swell. Consumer-price inflation is not an imminent threat, because prices are falling in most Asian countries. Chinese consumer prices fell by 1.8% in the year to July. But asset prices look dangerously frothy. The obvious solution is to let exchange rates rise, but with exports still well below last year’s level, governments are reluctant to set their currencies free.
Making it stick
Several central banks in the region, including the People’s Bank of China, the Bank of Korea and the Hong Kong Monetary Authority, have given warnings about the risk of asset bubbles. But there is unlikely to be any significant policy tightening before next year, because boosting growth remains governments’ main priority. Indeed, the wealth effects of higher asset prices will help lift spending. Ample liquidity is therefore likely to continue to stoke asset prices. Andy Rothman, an economist at CLSA, a brokerage, predicts the “biggest round of asset-price inflation China has experienced since the command economy was dismantled”.
Its credit boom is clearly unsustainable, but China is unlikely to hit the monetary brakes until inflation turns positive and its year-on-year GDP growth tops 10%. Instead, policymakers will try to contain the bubble by tightening lending standards. For example, China’s banking regulator has warned banks to stick to rules on mortgages for second homes, which require a down-payment of at least 40% of a property’s value. It has also ordered banks to ensure that lending goes into the real economy, not shares.
Fiscal stimulus and the wealth effect of rising asset prices can provide only a temporary prop to domestic spending. Nor can Asia rely on a strong rebound in exports to America, where spending is likely to remain sluggish over the next few years as households are forced to save more in order to repay debt. In the longer term, Asia’s growth needs to come more from domestic demand rather than exports.
However, the standard policy prescribed by Westerners—Asian households must save less and spend more—is too simplistic. In China private consumption is indeed unhealthily low, at only 35% of GDP. But the average for the rest of Asia, at 58% of GDP, is not much lower than the OECD average of 61%. South Korean households, which have reduced their saving rate from 23% of disposable income in 1998 to only 3% last year, can hardly be accused of being overly thrifty.
In Indonesia, Malaysia, the Philippines, Taiwan and Thailand it is instead investment that looks too low. Investment as a percentage of GDP is little higher than in many rich economies, even though investment opportunities in a developing country should be far greater. For example, Malaysia’s investment has fallen from 43% of GDP in 1997 to only 19% last year, less than in the euro area or Japan and well below China’s 44%. Weaker investment is one reason why the trend growth-rates of some Asian economies have slowed over the past decade.
The appropriate measures needed to strengthen domestic demand therefore differ across the region. Although China’s goal should be to consume more, some of the other Asian economies need to invest more. That will require an improved regulatory environment, a crackdown on corruption, better infrastructure and—not least—greater political stability.
Even in countries like China, where low consumption is the main culprit, the necessary reforms are more complicated than the standard Western advice that the government needs to spend more on health care and welfare support to encourage households to save less. Companies, not households, have accounted for the bulk of the rise in saving across Asia over the past decade. Households’ spending has fallen as a share of GDP, not because they are saving a lot more, but because their share of national income has shrunk as that of corporate profits has grown.
To lift private consumption, governments therefore need to increase households’ share of national income by encouraging more labour-intensive services, rather than favouring capital-intensive manufacturing industries with subsidies and undervalued exchange rates. Recent estimates suggest that Asian currencies are among the most undervalued in the world. Stronger exchange rates would help shift growth away from exports and boost households’ real spending power.
Mind the gap
The gap between growth rates in emerging Asia and the G7 is forecast to rise to a record nine percentage points this year (see chart 4). But what of the future? Pessimists argue that Asia’s growth over the coming years will be much slower than before the global crisis because its main engine of growth, exporting to America, has broken down and it will take years to find a replacement. But this may overstate the importance of America to the Asian tigers. Between 2001 and 2006 (when America’s trade deficit peaked), the increase in emerging Asia’s trade surplus with America accounted for only 6% of the region’s GDP growth. If those exports cannot be replaced by domestic demand, growth will be slower, but not massively so.
Besides, long-term growth depends on supply factors, not just demand. A country’s long-term “potential” or “trend” rate of growth—the speed limit at which GDP can expand without igniting inflation—is determined by growth in its labour supply and productivity. The global financial crisis should not noticeably reduce productivity growth in emerging Asia. Indeed, recent increases in infrastructure spending across the region could boost productivity by reducing transport costs, especially in places such as inland China.
In America and many other rich countries, by contrast, potential growth rates are likely to fall over the next decade as soaring government debt and hence higher taxes blunt incentives to work and invest, the lingering credit crunch dampens investment, and increased government regulation deters innovation. All this could reduce productivity growth at a time when labour forces in these countries will be growing more slowly or even shrinking.
The tigers are unlikely to return to their breakneck growth rate, which averaged 9% during the three years to 2007. But this exceeded their safe speed-limit. Emerging Asia as a whole might enjoy annual growth of 7-8% over the next five years, at least three times the rate in the rich world. The sharp downturn in Asia late last year painfully proved that the region was not immune to America’s downfall. But the speed and strength of its rebound, if sustained, show that it is not chained to Uncle Sam either. If anything, the crisis has reinforced the shift of economic power from the West to the East.
The quality of economic analysis in The Economist has declined a lot in recent years, and this article is an especially bad example. There is so much in this article that is simply bad economics. To take one particularly egregious example:
“But this may overstate the importance of America to the Asian tigers. Between 2001 and 2006 (when America’s trade deficit peaked), the increase in emerging Asia’s trade surplus with America accounted for only 6% of the region’s GDP growth.”
As was pointed out by someone in an earlier comment, in a globalized world with multi-national trading chains, the use of bilateral trade balances to judge the importance of trade relationships is worse than useless. The Economist should know that.
yet more prominent economists who, according to the pompous john ross, have failed to understand what he, alone among all the world’s economists, knows to be true.
US, Asia needs to rebalance for global recovery: IMF
Agence France-Presse in Washington
1:32pm, Aug 19, 2009
The global recovery from recession depends on a delicate rebalancing of economies – notably between the United States and Asia – to sustain it, the chief IMF economist said.
“The recovery has started. Sustaining it will require delicate rebalancing acts, both within and across countries,” Olivier Blanchard said in an IMF article, released in advance of publication on Wednesday.
Mr Blanchard cautioned that predictable models based on past recoveries from recessions would not apply to the worst global slump since second world war.
“The world is not in a run-of-the mill recession. The turnaround will not be simple. The crisis has left deep scars, which will affect both supply and demand for many years to come,” he said.
In its latest economic forecasts, the IMF estimated in July a global contraction of 1.4 per cent this year, followed by sluggish growth of 2.5 per cent next year.
The United States, the epicentre of the crisis, “is central to any world recovery”, Mr Blanchard said in the article titled “Sustaining a Global Recovery”.
Mr Blanchard said two rebalancing acts will have to come into play to sustain the global recovery: a switch from public to private spending and the rebalancing of international trade flows.
The latter would require “a shift from domestic to foreign demand in the United States and a reverse shift from foreign to domestic demand in the rest of the world, particularly in Asia”, he said.
Pointing to a decline in American household consumption – which “represents 70 per cent of total US demand” – and a rise in the personal saving rate that is expected to persist for some time, Mr Blanchard estimated a 3.0 percentage point drop in the ratio of consumption to US gross domestic product, a broad measure of economic output.
With the 3.0 per cent drop unlikely to be made up by increased investment and the eventual phase-out of the massive fiscal stimulus, “US net exports must increase” for the US recovery to occur, he said.
Key to the rebalancing act will be an increase in foreign demand for US goods, particularly in countries with large current account surpluses, notably in China and other Asian countries.
“From the point of view of the United States, a decrease in China’s current account surplus would help increase demand, and sustain the US recovery. That would result in more US imports, which would help sustain world recovery,” the top economist at the 186-nation institution said.
China may be willing to pursue that “because it may well be in its own interest”, said the economist, but other emerging market Asian countries that run large current account surpluses have weaker incentives than China to boost internal demand.
Mr Blanchard said that Asia appeared the best-placed to tip the trade balance.
“If rebalancing is to come soon, it probably has to come largely from Asia, through a decrease in saving, and an appreciation of Asian currencies vis-a-vis the dollar,” he said.
In a typical recession model, he said, lower-than-normal growth gives way to higher-than-normal growth for some time, until the economy has returned to its normal growth path.
“The current global recession is far from normal,” he said, citing the breakdown in parts of the economic system.
“In advanced countries, the financial systems are partly dysfunctional, and will take a long time to find their new shape,” he said.
Emerging market countries may not see dwindled capital inflows return to pre-crisis levels for a few years.
The end result of the global crisis: possibly a permanently lower potential output, he said.
Mr Blanchard said the IMF’s upcoming edition of the twice-yearly World Economic Outlook will cover 88 banking crises over the past four decades in a wide range of countries.
“While there is large variation across countries, the conclusion is that, on average, output does not go back to its old trend path, but remains permanently below it.”
mr. ross, why you trotskyite devil you. now i understand your views. all this time it turns out you used to be part of the cloak-and-dagger little revolutionary groups that populated the wonderfully comic british loony left, and even headed a tiny little splinter group of your own called socialist action.
what marvelous fun! you probably had secret handshakes, right? i saw an intriguing reference to you in your oped article and when I googled you this is one of the two things about you that everyone seems to remember:
“John Ross, Livingstone’s economic adviser on £121,000, is typical. He is so lacking in economic knowledge that he decided that the Russian Communist party was a force for the future in 1991, two years after the fall of the Berlin Wall. His economic advice at the time was for the ruling class to learn ‘that they will be killed if they do not allow a takeover by the working class’.”
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the other thing everyone seems to remember is that when ken livingstone finally got thrown out, the whole lot of you managed to change the rules so as to get you all a huge, and scandalous, payout from the poor people of london.
so you’ve decided to come to china where no one knows you, eh? of course now i understand your economic theories – its all about evil amerika and the ultimate rise of trotskyites to world domination (are there trotskyites here?). here is an interesting link. it says:
“Last week I noted the presence in the entourage of left-wing London Mayor Ken Livingstone of a certain John Ross, who is also the brains behind a Marxist group known as Socialist Action. This group maintains a website on which can be found an anonymous screed entitled “Challenging the US Global Offensive”. This purports to provide a “Marxist” justification for supporting the autumn 2004 London European Social Forum, a rally of the broad anti-Zionist movement sponsored by Livingstone’s Greater London Authority, for which Ross now works. Written in Ross’ distinctive bullying style, the document sheds light on the world view underpinning Livingstone’s shameful alliance with Islamists bigots. Its guiding thread is the unsubstantiated assertion that the United States is responsible for everything that goes wrong in the world, from war to poverty, via terrorism and destruction of the environment. Notably, the US, because it is dependent on heavy borrowing from abroad, is accused of draining the world of capital which would otherwise be used for development. Typically, no explanation is given of why investors might choose to put their money in the United States rather than elsewhere. A complex economic phenomenon is simply assumed to be the result of the hidden hand of “US imperialism” exercising its occult power to shape the world to its sinister designs.”
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“distinctive bullying style”? ha ha i was wondering why you seemed so determined not to understand the points pettis was making, and now it seems obvious to me. conspiracy thinking requires a certain mind-set.
ha ha you devil you. you almost had me fooled.
PMJ,
Very, very funny comment but I think that Ross’s “bullying style” is starting to affect the quality of debate on this blog.
Armando,
You say the Economist article, which I agree with Angry is weak, although I don’t think the overall standard of the magazine is bad, indicates to you that “Many of the so-called expert on the so-called “Asian model” have been wrong in the past…” I am not sure how you came to that conclusion from the article.
Armando,
Your suggestion is possible but it will expose and end this con game. All social benefits have to be ‘invested’ in treasuries. This is money collected against promises for benefits. It has been and is still being spent on something else and is gone forever. Estimated at $50-60 trillion.
Of course the USD can be devalued and all borrowings easily repaid in nominal terms, of course the asians/arabs can be repaid at face value as well, but this is THE END of the con game. Once you devalue, you destroy confidence, then you create a run on the USD by the locals and all sleeping at the wheel foreigners, then you get exchange controls, confiscation of gold (1930 the last time), land and everything else the government can put its hand on and sell to import oil and other consumables. And of course you have no willing creditors, domestic or foreign.
And if you do not see such a radical scenario, think about the milder option: domestic savers HAVE TO keep pouring money into treasuries to finance the fiscal deficit. The gov’t cannot afford a bull equities market that will create a run on treasuries and will require monetization of a few trillion dollars. This will bring high inflation like in the late 70ties. Combined with 16.5% U-6 unemploymennt it does not bode well for any political party and social rest in general.
This is the stalemate brought by the great modation. If you know history, you know how all past social experiments have ended in Europe.
Sorry I haven’t been commenting much, but things are very busy and I have been working on another fairly long entry (sorry) which should come out tomorrow.
Baychev, you may or may not think it is a good idea for the USG to borrow from US households, but the point of the post is to suggest that there is too much concern about whether or not foreigners will fund the USG. First, they have no choice but to fund a current account deficit, and second, the less they fund, the easier it is for the US.
Glenn, yes Brad and I have been making a pretty similar argument for quite a while. I think it is because both of us approach things from the overall balance of payments.
Armando, as RodgerRafter points out, these numbers have huge holes in them and have to be adjusted. At any rate if seen from the macro level, the amount of foreign purchases of dollar assets is declining but still hugely positive. How do I know this? Because the US current account deficit is declining but still large. If there were a serious move by China to move out of dollars and into, for example, euros, we would almost certainly see a rise in the value of the euro against the dollar (unless Europeans simply intermediated the Chinese purchases into dollar purchases), along with a decline in the US trade deficit and a rise in Europe’s.
Yeswecan, Americans already work more than most other people, but it would certainly mean less consumption as a share of income.
Armando, just to avoid confusion to anyone else reading this, the “Michael” who responds to Brad’s post is not me. It is true that if there is a significant shortening of the UST maturities the US finds itself in a more difficult balance sheet position, but the flip side of this is that it makes the “inflation option” more difficult for the US. A recent report by UBS tries to debunk the idea that rising debt increases the pressure on a government to inflate its way out of the debt. You can read it all at
http://ftalphaville.ft.com/blog/2009/08/04/65156/the-debt-inflation-myth-debunked-by-ubs/
“The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future.”
PMJ, I agree with TR. I approved your last comment even though it is at best ony tenuously related to the topic at hand, but it is as far as I am willing to go. I have had to delete several other comments about Ross that were unnecessary. I have no idea if he is a Trotskyite and it is not really relevant to this discussion. I think most of his points have been addressed, and pretty much to my satisfaction, although reasonable people may disagree. At any rate I am not interested in having my site hijacked by a discussion on the pros and cons of the British loony left.
Kudos, PMJ! Great bit of detective work. Something has always smelled fishy there.
[...] On the other hand: http://mpettis.com/2009/08/the-usg-doesn%E2%80%99t-need-foreigners-to-finance-the-us-fiscal-deficit-… The storage figures on oil: [...]
So, USG is less dependent on foreign financing. I guess it’s one of those second derivative improvements. I don’t see how it changes anything. I liked better your previous observation that when confronted by mercantilist policy it is the productive sector of the holder of the reserve currency that must make adjustment. We’ve had at least 3 decades of that. Rebalancing would imply reversing that trend. I hope there is a second derivative improvement. That last I read US productivity is up even in the jaws of recession.
Dr Li.
You wrote: ‘I must disagree strongly with your supposition that the global crisis has finally ended and that China has emerged from it first. This may be true, but only if all the concerns about the fiscal stimulus package, expressed by both Mr. Pettis and many analysts in China and abroad, including me, are to be wholly dismissed. Perhaps they are wrong, but it is foolish to dismiss them so easily.’
The global crisis has certainly not ended. I prepared for Jiao Tong University earlier this year a bleak assessment of the prospects for international trade – therefore with unpleasant consequences for the recovery to previous peak levels of China’s exports in any short time frame. I know this shocked a number of people by its sharply negative assessment of export prospects – not due to wrong policies by the Chinese government but to the international trade situation. But time has only hardened my view, and I note that what I regard as more sober prospects for exports are now widespread. Because the international context is unfavourable it is still more important than the domestic stimulus package is right.
That the fundamentals of the approach of China’s stimulus package are correct, it goes without saying naturally not every detail will be right, can be shown clearly by contrasting it to the US as regards the reduction of ‘global imbalances’ – i.e. the US balance of payments deficit and China’s balance of payments surplus . The US is undergoing a ‘malign’ correction of this imbalance. The US’s already low total savings rate has fallen further (that is why it is not pedantic but very important to clearly distinguish between household savings and total savings – US household savings have risen but this has been more than offset by the increase in government dis-saving, and it is total>/i> saving that determines the balance of payments) and the US balance of payments deficit has declined because US investment has fallen even more rapidly than US saving. This further decline of US saving and investment will slow US GDP growth immediately and in the longer term and make serious emergence from the recession slower.
China, in contrast, is undergoing a ‘benevolent’ overall correction of its international balance. Its trade surplus is shrinking because its investment level is moving upwards towards its savings rate. This increasing investment is spurring economic growth.
The contrast between the ‘malign’ overall correction of the imbalance in the US and the ‘benevolent’ overall correction in China is why in the second quarter of 2009 the US economy contracted by 3.9% year on year and China’s economy expanded by 7.9%.
You also write: ‘Mr. Pettis is discussing about the evolution of US savings over the future and how it will affect Chinese savings.’ I have no wish to hold Professor Pettis to any position – nor am I ‘dismissing’ his views and others who hold similar positions. Professor Pettis has made a systematic presentation of a position but one which I consider is not in accord with the facts. I believe I was justified to argue he was stating a view that US savings had started rising, for example on 20 June he wrote: ‘we are now seeing a sharp rise in US household savings rates. This has been partly mitigated by a sharp rise in government dis-saving (borrowing), but nonetheless aggregate US savings rates are rising, and with them US consumption must decline.’ But if that was a loose formulation that is something we all do and if we can establish that so far US savings have fallen under the impact of the financial crisis, because the fiscal deficit has worsened by more than household saving has improved, which is the factual situation, that would be a step forward in clarity. If US savings do start to rise (which would move the US towards a more benign resolution of its international imbalances) then the impact of this must clearly be assessed when and if it takes place – but so far they have not done so.
So far, therefore, the correction of the global imbalances is taking place in the following way – rising investment and rapid growth in China, falling investment and recession in the US. That is why China is emerging from the financial crisis before the US.
Mike,
From my post, it is clear the USG is very dependant on foreign purchases: forcing people to put money into treasuries, thus forcing them to subsidize gov’t largesse is a game with guaranteed unhappy ending. It is like a family where everyone plays dirty tricks to the others, you cannot sustain it indefinitely, you cannot have a happy ending.
Another subject that you did not touch upon is the agency debt that the Fed has committed to purchase, $1.45 trillion. Those bonds were very popular with foreigners and after the collapse of Freddie/Fannie, now the Fed has to fund their operations. The money was shifted to treasuries and that temporarily increased demand in the past year from both foreigners and domestic institutional players. It is fair to combine both treasury and agency debt into one category and view it as the whole gov’t debt. Yes, agency debt is still not explicitly backed by the gov’t, but who believes that the government will leave the residential (and commercial?!?) real estate financing market??? That would totally freeze it given the shaky state of bank balance sheets, will tumble house prices by more than half again and will create a mess bigger than 2008′s. Semantics do not matter in this case.
So if the USG indeed does not need foreigners to finance its structural fiscal deficits, this is an implicit sign of currency devaluation commitment. The yuan is pegged to the USD, the question for you is: Is China committed to currency devaluation and reserves destruction to promote further (and unsustainable) growth? Or shall we rather call it to promote modern feudalism?
John Ross is correct that the crisis is not over yet! In the USA, the housing market crisis is not over yet since there is Alt-A, Option-ARM, Jumbo loan and combined that with the future increase in interest rate and high unemployment rate in the USA (U5=10.8%)I would expect more foreclosure and that would lead to more bad loan and more bail out.
The USA government has to either raise tax, interest rate or just print money. Look at the link below.
http://finance.yahoo.com/news/AP-source-Deficit-to-be-158-apf-4014883216.html?x=0&sec=topStories&pos=1&asset=&ccode=
“AP source: Deficit to be $1.58 trillion this year
AP source: Federal deficit to reach $1.58 trillion for fiscal year
* By Philip Elliott and Jim Kuhnhenn, Associated Press Writers
* On Thursday August 20, 2009, 1:29 am EDT
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Buzz up! 0
o Print
WASHINGTON (AP) — The White House plans to announce the federal deficit will be about $262 billion less than officials predicted earlier this year, but it still will total a massive $1.58 trillion and pose a tremendous obstacle for a president seeking policy overhauls in health care and the environment.
The decrease in the estimate comes in part because the administration has provided less aid than expected to Wall Street, but the revised figure still is three times last year’s deficit, a White House official said late Wednesday. The official spoke on the condition of anonymity to discuss the report before its release next Tuesday while President Barack Obama will be on vacation in Massachusetts.
The new deficit numbers are record shattering, but would give the Obama administration the opportunity to say that its policies have avoided a more extreme financial crisis and eliminated the need for further bank infusions.
The nonpartisan Congressional Budget Office also is expected to release its mid-session review on Tuesday. It estimated in June that it expected a deficit of $1.825 trillion.”
The USA is not out of the wood yet! Most of the initial pain was caused by mostly by subprime mortgage reset and wait with the increase interest rate hike to fight future inflation and that would affect all the option ARM and Alt-A and all the MBS based on option-ARM and Alt-A!
The reason why China stimulus is having a much better effect than that of the USA stimulus is due to the nature of the problem.
The USA is pretty much nationalizing the Financial bad loan caused by Wall Street crooks so the American tax payers will eventually have to pay it off through high tax or inflation! This is similar what Argentina did when it nationalized the private debt from their bank in early 2000!
While China being a poor country it need to develop its infrastructure and specially in the poorer region of China! It has a much better effect on the nation and on the people!
An interesting comment that I read recently was that for all of the bank that the credit explosion during H1 provided, in nominal terms – growth was only 3.8%. The real increase was a result of broad deflation. Does this indicate that China is out of the woods? Travel to second and third tier cities, and local governmens are building more industrial parks, etc. How beneficial is this kind of investment to productivity and income growth? Perhaps the US could do with some more investment, and needs another round of infrastructure building. But in the long-term, what the US Fed and other agencies have done to get the economy going appears far more beneficial to me than the quantitative building in China to keep heavy industrial producers afloat. 2010 will be a tougher year for China than the current one, methinks, partly becaue the policy options are pretty much limited to sending out another wave of credit. Contrary to its own rhetoric, and judged by its actions and spending levels, the Chinese government doesn’t have much of an interest in building a social safety net. Case in point, a recently announced boost of RMB 3 billion for retirement funding for farmers. Let’s assume that amount is intended for, say, 75 million farmers. That makes….40 RMB per head. That’s enough for a few bottles of erguotou to turn the lights out. Even during periods of macro controls there has been a lot of stimulus in the Chinese economy, so at this point it seems clear that the efficacy of traditional fiscal measures has entered into the territory of diminishing returns.
From 2/9/09 Financial Times : “Jong Wha-Lee of the Asian Development Bank says a sharp rise over recent years in intra-regional trade disguises the fact that 60 per cent of final demand for Asian goods comes from developed countries.”
—
Frankly, the 60 % number ‘feels’ much more accurate than the 6 % of GDP number quoted earlier ..
I agree, Purple, but this is based on such a common mistake that it seems pretty much impossible to kill off. I discuss the difference between bilateral trade and overall trade a little in my next blog entry, which I posted today.
“baychev | 19/08/09
So if the USG indeed does not need foreigners to finance its structural fiscal deficits, this is an implicit sign of currency devaluation commitment. The yuan is pegged to the USD, the question for you is: Is China committed to currency devaluation and reserves destruction to promote further (and unsustainable) growth? Or shall we rather call it to promote modern feudalism?”
I believe that China will keep its peg for time but I doubt that China will follow the same path as the USA in term of massive devaluation. No point in going down with a sinking currency!
People might argue that China is overpaying in Dollar but still it is better to use the Dollar to purchase real asset rather than keep buying treasury bill.
Besides, the USA might go into serious deficit expending in the coming years and that will lead to more money printing that would in turn lead to lead to Dollar devaluation better put the Dollar to use rather than watch it slowly destroyed.
China is actually using its dollar holding to buy natural resources around the world.
Here is link
http://www.businessweek.com/globalbiz/content/aug2009/gb20090813_124217.htm
China Eyes Repsol YPF’s Argentine Unit
The proposed $17 billion energy deal would be the largest-ever overseas acquisition for a Chinese company
By Manuel Baigorri
Related Items
* China Eases Rules on Outbound Investment
China’s state-owned enterprises have been on a quest to snap up natural resource companies around the globe for several years now, and their shopping list keeps getting longer. So far this year, outbound Chinese oil and gas acquisitions are at an all-time high of $13.4 billion, up 22% from a year ago, says British research firm Dealogic. State-owned giant China National Petroleum Corp. (CNPC) has reached a deal with BP to boost production in the Rumaila field located in Kuwait and southern Iraq, and China Petroleum & Chemical (Sinopec) has bought oil company Addax for $7 billion.
Now China Inc. appears to be making its biggest move yet. This time the Chinese energy companies are eying YPF, the Argentine unit of Spanish-based energy giant Repsol YPF. YPF is the leading oil exploration and refining company in Argentina, with a 60% market share. According to media reports in Argentina and the U.S., CNPC and China National Offshore Oil Corp. (CNOOC) are offering $17 billion for the acquisition of 84% of YPF. That would be the largest-ever overseas acquisition for a Chinese company.”
Here is another link of China going out in purchasing natural resource with the Dollar
http://www.abc.net.au/news/stories/2…18/2659831.htm
Australia signs $50b gas deal with China
Map: Barrow Island 6712
Related Story: Gorgon gas project a step closer
A deal has been signed in Beijing tonight for the biggest single investment ever made in Australia.
PetroChina has signed a deal to buy $50 billion worth of Australian liquefied natural gas over 20 years.
The Chinese resource company will buy natural gas from the Gorgon field off the coast of Western Australia.
It is yet to start production but the Chinese deal will be enough to virtually guarantee Gorgon’s development.
Australian Resources and Energy Minister, Martin Ferguson, is in Beijing to witness the signing ceremony.
“The ExxonMobile $50 billion LNG export contract to China represents the biggest export contract in the history of Australia,” he said.
“It also potentially underpins the biggest single construction project in the history of Australia, which could see 6,000 workers on the job at the peak construction period.”
More deal as well
http://online.wsj.com/article/SB125010557158826707.html
” Emerald Energy’s Directors Endorse Sinochem Takeover
LONDON — Shares in U.K. oil-and-gas explorer Emerald Energy PLC rose sharply Wednesday after its board recommended shareholders approve a takeover proposal from China’s state-owned Sinochem Corp., which values it at £532.1 million ($876.9 million).
Emerald said the tie-up offers Sinochem the opportunity to expand its exploration and production in the Middle East and Latin America by enhancing its reserve base in Syria and Colombia.
Chinese companies have been building up foreign energy and minerals holdings in recent years. The largest deal was Aluminum Corp. of China, or Chinalco, paying $14 billion for a 9% stake in Anglo-Australian mining-giant Rio Tinto PLC in 2008. Earlier this week, China National Petroleum Corp. and Cnooc Ltd. proposed paying at least $17 billion for all of Repsol YPF SA’s stake in its Argentine unit YPF SA.
Under the terms of the offer Wednesday, shareholders of Emerald will be entitled to 750 pence for each share — a 33.81 pence premium to the closing price on July 10, the last business day prior to an announcement from Emerald that it had received an approach.
Emerald didn’t reveal at that time that the proposal was from Beijing-based Sinochem, China’s fourth-biggest oil firm by assets. The Emerald board said it considered the terms of the proposal from Sinochem “to be fair and reasonable” and unanimously recommended shareholders vote in favor.
Emerald shares rose 9.2% to 737 pence Wednesday, more than double the previous 12-month low of about 300 pence seen in October and November.
Emerald’s chairman, Alastair Beardsall, said the offer represents fair value for shareholders, realistically reflecting its business and assets.
Sinochem’s president, Han Gensheng, said the acquisition is another step in building a global energy company.”
Armando,
In my opinion this currency beauty contest (or least ugly if you prefer to call it) is entirely pointless in nature and substance.
Just look at the hard facts:
- over the past few decades, the US has been exporting USD for all kinds of goods and raw materials. Most of this USD has ultimately endedn in the hands of China/Japan/Gulf States. Of all those, only Japan does not have a peg to the USD.
- the Eurozone more or less is running a very balanced trade policy. It has structural deficits only with Norway/Russia (energy imports), and of late with China. The EUR cannot be a world reserve currency, there is not much of it around, and the Eurozone countries will never swap their EUR for USD, since they run a trade surplus with the US and already have surplus USD.
Given the above we clearly have this situation: the USD is world reserve currency and the US provide these reserves in exchange for subsidized domestic consumption by net exporters. The mercantilist Asian states are savers and they naturally save in USD, 1st because they are pegged to the USD, and 2nd because no other country is running huge enough trade deficits to allow for reserve diversification in another currency. And another factor: there is no other keenly interested party besides China/Japan/Russia in the creation of a new world reserve currency, Russia’s argument is purely political though.
Letting the USD peg go (for China and the Gulf states) means triggering dollar devaluation and crippling their own ecconomies that have to downsize to the diminished purchasing power of the USD. Judge for yourself if the Chinese gov’t is going to take that risk anytime soon, and if the Gulf states are going to risk occupation like Iraq’s just to diversify out of savings that they still do not rely on. Getting off the USD peg does not seem to have less severe withdrawal effects than heroin.
Hi Baychev
The Chinese economy is not as dependent on export as other smaller Asia economy such Singapore or Taiwan.
Besides, using a money is just to keep record of business transaction for the involved party.
The most important thing is what can one buy with that particular money. If that particular money is losing value greatly then it would make business transaction less predictable. Imagine if one price the oil using Zimbabwe Dollar as opposed of using American Dollar, one would notice that the oil price would keep increase every minute on Zimbabwe Dollar denomination. Therefore, it is important to use a stable currency to international pricing and transaction like many natural resources e.g oil, iron ore, copper et al! However, now with the massive printing of Dollar to save Wall Street is damaging the Dollar value and eventually all that Dollar created by the Fed will start spreading throughout the world and that can lead to inflation. The Dollar was in serious problem in the early ’80 and the USA economy was in stagflation mode. So there is a precedence for the Dollar devaluation due to massive printing during LBJ time to fund his gun and butter program.
If the Dollar start losing value greatly, then countries might need to use another current to do transaction. Maybe instead of using a single currency for transaction, countries might start using several agreed currencies for transaction. The most important thing for a currency is what can one buy with it!
Armando,
Reserves are not meant to be spent, they primarily boost confidence in the local currency. Having a peg to the USD requires significant amounts of USD in the form of reserves. The purchasing power of those reserves is not even a second thought, if it is used as unit of account (other FX & gold reserves are denominated in USD for accounting purpose).
As I said before, if a country has balanced external trade account, it cares not what the world reserve currency is, becuase there is just enough of it at any given time (excluding the impact of daily FX fluctuations). But, if a country runs mercantilist trade policy, it wants as well to preserve the value of its accumulated currency reserves.
In the case of China, the CCP wants the USA to protect the value of the USD. Why not simply buy gold with all that USD China is accumulating? There is not much of it physically available, and they might trigger a USD selloff. China is by now a hostage of its own mercantilist policy, so is Japan, but with a slightly different twist. But both expect someone else to pull them out of their ‘awkward’ situation and make them whole!
And to give you an analogy: it seems alot like breaking the bank of a casino, you hold all the chips, feel really rich, but when you want to cash out, you realize that you will not collect your money in years and after plenty of additional efforts. You feel cheated, while you should feel stupid for your over-reliance on the good faith of others.
I hope you understand my not-so-altruistic position.
[...] Pettis posts infrequently but his latest happens to be on this subject. Please consider The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? [...]
[...] Pettis posts infrequently but his latest happens to be on this subject. Please consider The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? [...]
if that is the good news, how is the united states expected to finance all of this debt with rising unemployment, falling commercial values, and falling property values?
[...] The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew?. [...]
[...] Pettis posts infrequently but his latest happens to be on this subject. Please consider The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? [...]
[...] China held $801.5 billion in Treasury debt at the end of May. The Fed at that time held about $598 billion, although that has now risen to $704 billion. The latest figures for U.S. households, from the first quarter, showed holdings of $643.9 billion — more than double the $266.6 billion in the fourth quarter of 2008. [...]
[...] latest happens to be on this subject. Please consider The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew? [...]
Bravo, what the right words … great idea
Regarding the statement that the US doesn’t need foreigners to finance the US fiscal deficit…
Excuse me? If this is what you are saying, you need to explain your math.
Here is mine…
The federal fiscal deficit this year is projected to be $1.8 trillion (2009). The total government debt (the cumulative effect of annual deficits) is projected to hit $12.9 trillion this year (whitehouse.gov estimate). This means that it’s just not this year’s deficit that needs financing, its the whole debt.
This year’s estimated personal savings rate for the US = $403 billion (annualized Q109 – Source BEA). Clearly, even if all the personal savings of every American when towards financing this year’s deficit, there is a shortfall of more than $1.2 trillion. And what about the debt?
Total on deposit of all 8200+ FDIC-insured US Banks (Q1-09) = $13.4 trillion. In other words, just to finance US federal government debt would require nearly every dollar currently on deposit in US banks.
Then there is total credit market debt which including the total federal government budget deficit equaled $52.9 trillion in Q1-09. (This has grown 35% faster than the GDP since 2000 and now represents 375% of total annual US GDP).
Now add future unfunded liabilities to the equation which is another $59 trillion. (usdebtclock.org)
(Let’s put aside for a moment that future liabilities aren’t due today).. Here are the totals per US household (115 million). Oh, and there is also the interest on the debt (let’s assume 3.5% per year which is the approx. 10-year T bill yield which works out to an additional $450 billion/year)….
To put these numbers in perspective, this is what it works out per US household.
TCMD of $53 trillion = $461,000 per household.
Medicare, Social Security liabilities $59 T = $513,000/household.
Grand total per household = $974,000.
So please explain to me how the US can finance its own current debt and how will be finance our future liabilities without help from foreigners?
And while you’re at it could you also explain who will fill the $1 trillion gap that foreigners have invested in US Treasuries in the last 18 months as Net Treasury international capital flows reverse? (See Chart 2 at http://tradesystemguru.com/content/view/286/58/)
Matt Blackman
Host TradeSystemGuru.com
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Thanks,
Ron
You got to be kidding me when you say that US consumers can susbcribe to US debt issuances and save the country.
The saving rate in US is 5%. In India it is 32%. In China it is roughly 30%. Unfortunately the flip of savings in US will not happen tommorrow. I dont see it ever happening until there is some real pain to the consumers. Right now the US consumer has not felt the pain. They have only lost their jobs but govt continue to showe their benefits on the jobless instead of kicking them in the back and asking them work harder for their bread.
BRIC countries have life style of savings bred from centuries of difficulties. Even if there is some short term variations in savings rate US will always be less than 10%. Also US per capita Income is going to slide in teh coming few years which will further hit capital formation in banks. Already you are seeing teh failure of small FDIC banks. MARK MY WORDS. YOU WILL SEE A REPEAT OF THE SAVINGS AND LOANS CRISIS AT A MUCH LARGER LEVEL.
So if you are dreaming of US consumer pulling the country out of its spineless moronic policy of quantitative easing, let me clear that fog out for you.
You dont have to wait much longer anyways. Negotiations with the chinese are anyways not going well so we will see break down of the US currency system before year end. Then I want to see where spoilt US consumer will be to lend to the treasury.
1800 Banks to fail
FED going bankrupt
Fresbee
Investing Contrarian
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