Hi, My Name's Uncle Sam, and I'm a Debtaholic

Does the IMF have the ability to reduce the risk of a hard-landing posed by global imbalances?:

Can the IMF avert a global meltdown?, by Ken Rogoff, Project Syndicate: When world financial leaders convene in Singapore on Sept 18 for the joint World Bank/International Monetary Fund meetings, they must confront one singularly important question. Is there any way to coax the IMF's largest members, especially the United States and China, to help reduce the risks posed by the world's massive trade imbalances? ... Incredibly, the US is now soaking up roughly two-thirds of all global net saving, a situation without historical precedent.

While this borrowing binge might end smoothly, ... most world financial leaders are rightly worried... Indeed, if policymakers continue to sit on their hands, it is not hard to imagine a sharp global slowdown or even a devastating financial crisis. ...

Though the comparison is unfair, it is hard not to recall the old quip about the IMF's relative, the United Nations: When there is a dispute between two small nations, the UN steps in and the dispute disappears. When there is a dispute between a small nation and a large nation, the UN steps in and the small nation disappears. When there is a dispute between two large nations, the UN disappears.

Fortunately, the IMF is not yet in hiding, even if some big players really don't like what it has to say. The IMF's head, Rodrigo Rato of Spain, rightly insists that China, the US, Japan, Europe and the major oil exporters (now the world's biggest source of new capital) all take concrete steps towards alleviating the risk of a crisis. ...

[S]uch steps might include more exchange-rate flexibility in China, and ... a promise from the US to show greater commitment to fiscal restraint. Oil exporters could, in turn, promise to increase domestic consumption expenditure, which would boost imports.

Likewise, post-deflation Japan could promise never again to resort to massive intervention to stop its currency from appreciating. Europe, for its part, could agree not to shoot its recovery in the foot with ill-timed new taxes such as those that Germany is currently contemplating.

Will the IMF be successful in brokering a deal? The recent catastrophic collapse of global trade talks is not an encouraging harbinger. ... Fortunately for Mr Rato, addressing the global imbalances can be a win-win situation. The same proposed policies for closing global trade imbalances also, by and large, help address each country's domestic economic concerns.

For example, China needs a stronger exchange rate to help curb manic investment in its export sector, and thereby reduce the odds of a 1990s-style collapse. As for the US, a sharp hike in energy taxes on gasoline and other fossil fuels would not only help improve the government's balance sheet, but it would also be a way to start addressing global warming. What better way for new US Treasury Secretary Hank Paulson, a card-carrying environmentalist, to make a dramatic entrance onto the world policy stage? ...

If today's epic US borrowing does end in tears _ and if world leaders fail to help the IMF get the job done _ history will not treat them kindly. Instead, they will be blamed for not seeing an impending catastrophe that was staring them in the face.

Let's hope that on this occasion in international diplomacy, the only thing that disappears are the massive global trade imbalances, and not the leaders and institutions that are supposed to deal with them.

Interventions don't usually work. Those with addictions don't usually seek help until they "hit bottom." You can give them advice, explain rationally why they must change, and they may even nod their head and agree with you at some level. But until a crisis forces them to reconsider their ways, they will not hear the message and they will not take actions to forestall the hard-landing they are likely to have.

The IMF can keep nagging, but it's up to the countries involved to become serious about reform. While I hope that countries can be more rational in their approach than addicted individuals and avoid hitting bottom before reforming, so far it's difficult to detect a serious effort to address the underlying problems.

Comments

[anne]

Should we panic now or later, for there is no implied proposal here that is going to seriously entertained? We are not going to induce a decline in imports by generating a recession, neither Europe nor Japan nor China will allow another dramatic loss in value of the dollar as with the Plaza Accord, oil producers are not about to be bullied at these oil prices. When should we panic, then?

[Robert]

Anne said:
"We are not going to induce a decline in imports by generating a recession"

Indeed not. The correct order of operations will be:

(a) a recession will induce a decline in imports;
or
(b) attempts to stave off the recession which will induce a decline in imports, will, against all best efforts of PBoC or BoJ or both, further erode the exchange value of the dollar, or further elevate US interest rates, or both;
or
(c) in the case of market driving rates higher, a credit cascade will ensue leading to unprecendented mortgae default rates, severely curtailed PCE, and a recession that will induce a decline in imports;
and
or
(d) a dramatic fall in the dollar (without ensuing rise in rates) will goose inflation as foreigners attempt to swap US obligations for real assets (shares real estate infrastructure, anything but paper).
and
(e) given all the above, despite peak oil; depiste asian demand growth; global growth will be discovered to be more correlated (as Roubini amongst others argue) whacking commodity & energy specs and [temporarily] take the wind out of OPECs windfall.

'a' through 'c' work through as they should for the choices taken; But 'd' ends badly for all (including US labour) unless authorities cooperate. Will the Fed - when faced with plunging USD - raise rates to stabilize or prevent further fall in the USD across the entire USD trade-weighted index? Will the PBoC & BoJ throw good money after bad to stop? Will Petrodollar holders front-run PBoC & BoJ? Since authorities seem to be leaning towards this path, I hope they are studying the board in preparation for their next moves...

[Emmanuel]

It's scary when even the ever-optimistic Anne becomes pessimistic. Unfortunately, she's also right.

My opinion of this whole matter (which I've also repeated elsewhere) is that both sides are spoiling for a fight. For a number of reasons, the US probably isn't budging and neither is China. The main reason is that this juncture provides an opportunity for both countries to see where they stand relative to each other geopolitically. The US likes to think that it's still king of the hill, while China wants to see how much inroads it has made in challenging the US for that position. I'm convinced that China will come off the better in the event of a genuine row even if badly hurt, but then again, Uncle Sam is too addled at this point to notice his wasted condition.

If no one blinks, then some pretty nasty stuff could ensue, like the passage of Graham-Schumer or China selling off its stash of Treasuries at fire-sale prices. Top it all off with the popping of the housing bubble and, as Metallica sang, we're off to Never-Neverland.

[dryfly]

It's scary when even the ever-optimistic Anne becomes pessimistic.

Ya anne - pessimism we got plenty. Show us some birds, birds & Vangard returns.

;)

[Tom Marney]

Mark,

My thoughts exactly.

[Winslow R.]

I still see Anne as optomistic as she sees an unlikely fall off in imports only after an unlikely recession. Funny how after reading so many of each other's post we still have different interpretations.

Mark wrote: "While I hope that countries can be more rational in their approach than addicted individuals and avoid hitting bottom before reforming, so far it's difficult to detect a serious effort to address the underlying problems."

Why is the 'underlying problem' something the IMF should even be able to solve? I guess it comes in the same package that allows some economists to see the Fed having the magical ability to negate any fiscal policy decision free of any political consequences by raising a simple interest rate.

Now some would have the IMF endowed with the magical ability to negate any international consequence of fiscal policy. The 'power' is based on the ability to negotiate outcomes free of any political consequences. The IMF would need the ability to be the true 'lender of last resort' to have any real power and the ability to enforce a framework like BASEL.

The 'underlying problem' seems to boil down to a so far 'friendly' dispute between national political leaders fought through their surrogate central banks. Until exchange rates more accurately reflect the decisions of a government and there is an ability to 'tax' internationally to pay for international concerns, the 'friendly' corrective mechanism is broken, leading to tariffs and possibly war.

[lonesome moderate]

It seems that many economists are worried by the fact that Americans are soaking up a huge proportion of the world's savings. But, isn't this largely the result of (1) the run-up in U.S. real estate prices, and (2) the lack of decent investments anywhere else? If these are indeed the causes, then the problem needs to be solved abroad, by the creation of more mature and better-regulated markets that would enable foreigners to keep more of their money at home.

[lonesome moderate]

"Oil exporters could, in turn, promise to increase domestic consumption expenditure, which would boost imports"

This is a terrible idea! Most oil states are already carrying the weight of millions of native-born welfare bums who are real good at consuming, while imported guest workers do the vast majority of the producing. Over time these people are more than up to the job of flushing away their country's "excess" income, although there will of course be a time lag. That time lag is the only thing that maintains the slightest bit of stability in these countries.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=4851&u=262|18|...

Eastern Bluebird
New York City--Central Park, Wildflower Meadow.

Now, I am forced to figure out whether I am optimistic or pessimistic. Not a simple problem.

[Richard]

Funny how the oracular anne is the first one consulted when the fear of a dawning economic crisis looms in the future. All scan the listing of Vanguard funds and photos of a finch or a bluebird, waiting to see what it tells them of the future.

For better or worse, anne, you have become this board's canary in a coal mine: all wait breathlessly on your optimism, waiting to see if their pessimism is justified . . . .

[anne]

Then came an answer. I understand the reasons for glumness among many economists, and worry about a fairly long decline in housing activity and prices is reasonable while what might substitute for housing to spur growth is not clear unless it is housing itself as the Federal Reserve reversed short term interest rate policy. However, there is promising commercial real estate activity and remarkably low long term interest rates for late in a Fed tightening cycle stemming from a rise in energy prices and there is a stable currency. Also, valuations in stocks are selectively excellent. Then, again, no developed economy has been recessed in the wake of a housing boom these 6 years, and only New Zealand is struggling with absurdly tight monetary policy. So, I am quite cautious and watching but hopeful.

[Emmanuel]

Three cheers for Anne, then, and an article supporting her point of view from the FT on how the UK and Australia avoided a real estate-led hard landing. I don't necessarily agree though (sorry), since I believe that the use of risky mortgages and the extent to which the economic recovery has been fueled by the housing boom are far greater stateside.

(There are some helpful charts from the print edition I read at the library that weren't included online):

Lex: The Comfort of Strangers

From coast to coast - especially on the coasts, in fact - Americans are worried about a decline in the value of their houses. For comfort, they might look out across either ocean. In the UK and Australia, recent housing sector slowdowns have not turned into routs, and have so far been short-lived...the average [US] home-owner's equity still amounts to about 56 per cent of the value of his property, according to Citigroup.

Flexible interest rates helped the UK and Australian housing markets recover. Likewise in the US, long-term rates have moved in favour of mortgage borrowers, falling about half a percentage point in two months. Other potential positives include an upward trend in incomes as other parts of the economy take up some slack, and a rising number of households. These factors could help offset the challenge of affording a home, which is more of a stretch than ever - although by some measures less so than in the UK.

Based on experience overseas, average Americans might find their property holding its value better than they fear. The risk is that the US economy, which boosted growth and sentiment in the UK and Australia, gets too weak to help itself.