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Saturday, December 27, 2008

Monetary implosion: looking for the floor

Peak uncertainty. No positive information. Indeed, the only positive economic information is coming from the economists who predict it can't be negative forever. When will we receive the first positive information that will most likely form the floor to the economic spiral el muerté and thus will be the measure of how deep it goes? I haven't seen anything yet and am not expecting to soon (I have discounted the Alexopoulos-Cohen postulation concerning "uncertainty" key words in the press) - but even after we receive the first solid positive information the question becomes how long before we return to positive GDP growth and how long will it take to return to where we were at the peak (2007). That is another thing entirely.

On the NZ scene I note that the exchange rate situation is just coming off another scrape with the psychological barriers of 40c Euro, 54c US and 50¥. Our historic lows with these currencies is something beneath these mental barriers but the fact they have not fallen far beyond them supports their existence. There seems no reason to believe that the long term trends will not continue: for the Euro is to strengthen and the long term trend for the USD is to weaken (I believe it to be more vulnerable now than at any other time). The longer NZ bounces along at these rates the more it may seem that we have bottomed out as far as overseas confidence goes.

After the banking collapses and failures in larger countries our economic weakness is not nearly so bad compared with the rest of the world, and our low unemployment and trade deals would suggest a more robust economy than many of our peers - and even more resilient than our structural and massive balance of payments legacy would otherwise indicate.

Despite all the dramatic movements in monetary operation (not to mention monetary theory!) - including an historic 1.5% point cut in the RBNZ's main interest rate earlier in the month, NZ still has relatively high interest rates and that is most likely helping to keep it up our exchange rates.


China's low-key announcement it will move to make its Yuan a reserve and settlement currency must translate into some sort of currency movements. The Chinese will want to exit their $1 Trillion + US-denominated monopoly money on terms beneficial to it, which would mean they would have little to gain by decapitating the greenback by pulling out all their holdings. Like Australia (or was it Switzerland?) did with their gold reserves when they sold it down they may only announce that it has happened at the very end of the process. Then it will tank, and they won't particularly care. [* see below] By that stage the Yuan would have replaced most Asian transactions, the Euro the rest, leaving the US and Ecuador using Mickey Mouse greenbacks.

There has been much talk that the total figure of $750 billion (TARP package and other measures by the US government) comes out of thin air. I've heard people say they have no idea why it is that sum. I suspect that the figure is very close to the dollars in circulation outside of America. That's their confetti in circulation beyond their borders that they use to buy people off. What will happen when everyone stops using it? Bye, bye America.

NY Times today:

Chinese Savings Helped Inflate American Bubble
The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.

This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “we probably have little choice except to be patient.”

Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.

In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States.
The inaction was because of a range of factors, political and economic. By the yardsticks that appeared to matter most — prosperity and growth — the relationship between China and the United States also seemed to be paying off for both countries. Neither had a strong incentive to break an addiction: China to strong export growth and financial stability; the United States to cheap imports and low-cost foreign loans.

In Washington, China was treated as a threat by some people, but mostly because it lured away manufacturing jobs. Others argued that China’s heavy lending to this country was risky because Chinese leaders could decide to withdraw money at a moment’s notice, creating a panicky run on the dollar.
Mr. Greenspan and the Bush administration treated the record American trade deficit and heavy foreign borrowing as an abstract threat, not an urgent problem.
In the 19th century, the United States built its railroads with capital borrowed from the British.

In the past decade, China arguably enabled an American boom. Low-cost Chinese goods helped keep a lid on inflation, while the flood of Chinese investment helped the government finance mortgages and a public debt of close to $11 trillion.

But Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes. Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations.
China tied itself even more tightly to the United States than did Japan. In 1995, it devalued its currency and set a firm exchange rate of roughly 8.3 to the dollar, a level that remained fixed for a decade.

During the Asian financial crisis of 1997-98, China clung firmly to its currency policy, earning praise from the Clinton administration for helping check the spiral of devaluation sweeping Asia. Its low wages attracted hundreds of billions of dollars in foreign investment.

By the early part of this decade, the United States was importing huge amounts of Chinese-made goods — toys, shoes, flat-screen televisions and auto parts — while selling much less to China in return.

“For consumers, this was a net benefit because of the availability of cheaper goods,” said Laurence H. Meyer, a former Fed governor. “There’s no question that China put downward pressure on inflation rates.”

But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States.

It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency — primarily dollars — that they earned from foreign trade and investment.

As foreign trade surged, this hoard of dollars became enormous. In 2000, the reserves were less than $200 billion; today they are about $2 trillion.

Chinese leaders chose to park the bulk of that in safe securities backed by the American government, including Treasury bonds and the debt of Fannie Mae and Freddie Mac, which had implicit government backing.
By 2003, China’s trade surplus with the United States was ballooning, and lawmakers in Congress were restive. Senator Graham and Senator Charles E. Schumer, Democrat of New York, introduced a bill threatening to impose a 27 percent duty on Chinese goods.
At the People’s Bank of China, the central bank, a consensus was also emerging in late 2004: China should break its tight link to the dollar, which would make its exports more expensive. Yu Yongding, a leading economic adviser, pressed the case. The American trade and budget deficits were not sustainable, he warned. China was wrong to keep its currency artificially depressed and depend too much on selling cheap goods.

Proponents of revaluation in China argued that the country’s currency policies denied the fruits of prosperity to Chinese consumers. Beijing was investing their savings in low-yielding American government securities. And with a weak currency, they said, Chinese could not afford many imported goods.

The central bank’s English-speaking governor, Zhou Xiaochuan, was among those who favored a sizable revaluation.
in 2005, under heavy pressure from Congress and the White House, it moved cautiously. The renminbi was allowed to climb only 2 percent.
But Chinese save with the same zeal that, until recently, Americans spent. Shorn of the social safety net of the old Communist state, they squirrel away money to pay for hospital visits, housing or retirement. This accounts for the savings glut identified by Mr. Bernanke.
In Washington, some critics say too little was done. A former Treasury official, Timothy D. Adams, tried to get the I.M.F. to act as a watchdog for currency manipulation by China, which would have subjected Beijing to more global pressure.

Yet when Mr. Snow was succeeded as Treasury secretary by Henry M. Paulson Jr. in 2006, the I.M.F. was sidelined, according to several officials, and Mr. Paulson took command of China policy.

He was not shy about his credentials. As an investment banker with Goldman Sachs, Mr. Paulson made 70 trips to China. In his office hangs a watercolor depicting the hometown of Zhu Rongji, a forceful former prime minister.

“I pushed very hard on currency because I believed it was important for China to get to a market-determined currency,” Mr. Paulson said in an interview. But he conceded he did not get what he wanted.

In late 2006, Mr. Paulson invited Mr. Bernanke to accompany him to Beijing. Mr. Bernanke used the occasion to deliver a blunt speech to the Chinese Academy of Social Sciences, in which he advised the Chinese to reorient their economy and revalue their currency.

At the last minute, however, Mr. Bernanke deleted a reference to the exchange rate being an “effective subsidy” for Chinese exports, out of fear that it could be used as a pretext for a trade lawsuit against China.

Unselfconscious arrogance? It's the Yanks who have been given an "effective subsidy" FFS. They have been given store credit - store credit to Uncle Sam from China Trading Co. The Chinese shopkeeper has been taking Uncle Sam's drunkenly scribbled IOU's along with the rest of the world and now they say the terms were manipulated? The hypocrisy. The market indeed - the US goes to war and invades countries just to manipulate markets and secure trade on their terms and they go off to lecture the Chinese - these people are un-fucking-believable. Imagine having to listen to that lecture. Their President is a baboon FFS, the last neo-con war-mongering crony they sent in to run the World Bank was as corrupt as all fuck and had to resign and their top financial officials deign to lecture the Chinese about how to successfully run an economy while they rack up deficits to pay for their imperialism. The Chinese will revalue at a time when it suits them, and perhaps even deliberately at a time to hurt the Americans.

Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true.
Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds.[...] For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt.

The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American habit.

* If the Chinese have used that debt (US IOUs) to float other securities, or re-packaged as junk bonds like Wall Street was doing so furiously these last few years - if they have (I don't know if it's possible, but why not?) then converted those funds into say Euros or other denominated securities (rather than re-investing in US denominated instruments) then they would really have the Americans by the balls. Not only would they have less incentive to care about US economic health, they may gain from hurting it - they could start buying real assets in the US rather than the federal government's junk bonds. Real estate, factories, infrastructure. Solid assets returning constant revenue. They will buy them for a song if they revalue their currency steeply. They will be the only ones in a position to buy right now and with a stronger, revalued Yuan they would have more spending power. Just like in NZ the US run the risk of being cleaned out. And then, after their investments are made when the currency is at its weakest, and they've bought everything they can, they could float.

The Chinese have the ability to do things in their own way, and haver done so without having really been retaliated against on the trade front. Investment (as in the US) can prove political and big deals can fall into "national/strategic/sensitive" and be vetoed, but what of goods and services - trade?

What we now risk is the re-imposition of punitive tariffs. It is the most logical thing in the world for Obama to say to America: the only way the taxpayer can get any money back from (insert failing American industry/sector here), eg. Detroit, is for the firms we are backing to compete successfully in the domestic market and the only way we can do that quickly and with any certainty is to make all the overseas products more expensive by putting on a tariff. There is a logic to it once the government gets involved particularly as nationalism always plays better when times are tough. Protectionism is just as much of an American classic as "the free market" ever was. The political temptation is to go there even if Bernanke's depression history tells him he cannot.


At 28/12/08 8:25 am, Anonymous Anonymous said...

Nobody wants a world war.
But it is the perfect solution to this market driven crisis.

The US would have a pretext to just tear up their Chinese debt.

And if the war seemed to be getting out of hand, using their overwhelming military might, the US could turn China into a radioactive wasteland.

US policy makers are probably, even now, contemplating tolerating one, or even two Chinese nuclear strikes in return, as the necessary price for re-building the new American century.


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