Kenneth Rogoff: Why Hasn't the Dollar Crashed Yet?

Ken Rogoff looks at "the world's largest foreign aid program," foreign loans to the U.S., why the dollar hasn't collapsed under increasing pressure from the trade deficit, and the risks ahead:

Betting with the house's money, by Kenneth Rogoff, Project Syndicate: Many people have been asking why the dollar hasn't crashed yet. Will the United States ever face a bill for the string of massive trade deficits...? ...[S]taggeringly, US borrowing now soaks up more than two-thirds of the combined excess savings of all the surplus countries in the world...

Foreigners are hardly reaping great returns on investing in the US. On the contrary, they typically get significantly lower returns than Americans get on their investments abroad. ...[T]he central banks of Japan and China are holding almost two trillion dollars worth of low-interest bonds. A very large share of these are US treasury bonds and mortgages. This enormous subsidy to American taxpayers is, in many ways, the world's largest foreign aid program. ...

Most sober analysts have long been projecting a steady trend decline in the dollar... So why hasn't more adjustment taken place already? The first answer, of course, is that the trade-weighted dollar has fallen - by more than 15% in real terms since its peak in early 2002. Yet the US deficits have persisted, and even risen, since then.

The real driving force has been two-fold. First and foremost, America's government and consumers have been engaged in a never-ending consumption binge. On the consumer side, this is quite understandable. ...

Overall, after almost 25 years of stunning prosperity, punctuated by only two mild recessions, most Americans feel pretty confident about their economic situation. ... So it is not surprising that private consumption continues to hold up... People have enjoyed such huge capital gains over the past decade that most feel like gamblers on a long winning streak. By now, they see themselves as playing with the house's (or their houses') money.

It is less easy to rationalise why the US government is continuing to run budget deficits despite a cyclical boom. When a fiscally responsible government launches a war, it typically cuts back on other domestic expenditures and raises taxes. The Bush administration did the opposite. It may not be good economics, but the strategy proved to be good politics, for a time. Unfortunately, it is unlikely the new Democratic majority in Congress will do much about it.

Of course, it takes two to tango. In order for the US economy to run deficits with the world, other countries must be willing to ... supply ... savings. Ben Bernanke ... once famously pinned the whole US current account deficit on a "global savings glut". But it would be more accurate to say that there is global investment shortfall, with investment trending downwards despite the upward trend in global growth.

This investment shortfall is due to many factors, but perhaps the main one is ... substantial medium-term institutional roadblocks to investment in many developing countries, where long-term returns now seem to be by far the highest. The net result is that money is being parked temporarily in low-yield investments in the US, although this cannot be the long-run trend.

What then is future of the dollar? As long as the status quo persists, with strong global growth and stunning macroeconomic stability, the US can continue to borrow and run trade deficits without immediate consequence. Over time, the dollar will still decline, but perhaps by no more than a couple of percent a year. Nevertheless, it is not hard to imagine scenarios in which the dollar collapses. Nuclear terrorism, a slowdown in China, or a sharp escalation of violence in the Middle East could all blow the lid off the current economic dynamic. ...

In sum, the fact that the US trade balance has defied gravity for so many years has made it possible for the dollar to do so, too. But some day, the US may well have to pay the bill for its spendthrift ways. When that day arrives, Americans had better pray that their creditors will be as happy to accept dollars as they are now.

Update: Kenneth Rogoff continues to worry about the stability of the global financial system. This is from the Financial Times:

No grand plans, but the financial system needs fixing, by Kenneth Rogoff, Commentary, Financial Times: What ever happened to all the grandiose plans for improving the global financial architecture? Up until a few years back, leading policy economists seemed to be tripping over themselves to come up with blueprints for radical change. Particularly popular were plans for new global institutions... More modest plans (such as mine) merely called for a sweeping restructuring of the major existing multilateral financial institutions, the International Monetary Fund and the World Bank.

Over the past couple of years, however, all introspection appears to have vanished. Instead, the policy community has developed a smug belief that enhanced macroeconomic stability at the national level combined with continuing financial innovation at the international level have obviated any need to tinker with the system. ... There is no problem that markets cannot solve.

Really? How well would markets handle the fallout from a sharp slowdown in India or China? How would they react to a dirty nuclear bomb in a US city..., and a sudden reluctance on the part of global investors to keep financing America’s 800-plus billion dollar current account deficit? Or a rapid escalation of conflict in the Middle East that encompassed Iran and Saudi Arabia? ...[C]ontrary to market perceptions, global central banks have only very limited instruments for dealing with a genuinely sharp rise in global volatility, particularly one that is geo-politically induced.

True, it is not clear that any of the grand plans of the past couple of decades would better equip the world economy to deal with such catastrophic shifts. The typical grand plan was far too simplistic and heavy-handed... But just because most grand plans were far too simplistic does not mean we should dismiss the deeper problems that they aimed to address. ...

The real shame with the disappearance of grand plans is that they had provided a valuable reservoir of ideas to spur major improvements in the world’s existing multilateral financial institutions. ...

We should bemoan the world’s lack of interest in grand plans to improve the financial architecture, but not because any of them was necessarily perfect. The problem, rather, is a lack of the purpose and energy needed to sustain even more modest, and unambiguously positive, reforms. Which means, of course, that after the next round of crises, we shall be deluged with even more and even grander plans.

Comments

[anne]

The reason the dollar hasn't crashed yet, is that American goods, services, and investments are valuable enough to limit the possibility of a crash or to make a crash the sort of possibility that has apparently become less likely in deveoped economies these last 25 years. Possible, but less likely.

The dollar has lost 9.4% against the Euro these last 10 years, and could easily give up relative value from here, but why should there be a crash as opposed to a now and then tempered loss?

There is something I am not understanding, because investment in developing countries is ample while America absorbs much of international saving. Why then is this not making for stability? I am missing something.

[Bupa]

How about this interpretation Anne: the reason the dollar hasn't crashed yet is the central banks of China, Japan, and the Oil Exporters have built up enormous dollar reserves. I

Larry Summers has been asking for a few months -- is it possible they could find better things to do with their money than park it in low yielding U.S. Treasuries? Of course the returns will be especially low in their local currencies if the dollar falls...not to mention the capital loss. But their reserves continue to grow making the potential losses larger and larger.

[anne]

No; I have not found the argument convincing, but rather a tautology. Dollars are accumulated from China to Sweden to Brazil to Australia, with little concern. Were I handling a portfolio in Australia I would be as inclined to hold dollar assets as Euro assets. Similarly for a portfolio in Japan, as was shown to me a few days ago. I have preferred Euro assets for a while, but always have had American holdings. Still, I am thinking carefully and cautiously.

[maria]

The present situation is a symbiotic relationship into which China and the Oil States are locked along with the USA. We pour out dollars to purchase their products and they return the dollars to us in exchange for our IOUs. It seems to work well enough so that neither side wants to take drastic steps to change it. Although the longer it goes on the more dangerous it becomes. I tend toward the view that some extraneous shock,---a cut off of the oil flow from the Gulf, a nasty little war with China, or a nuke where one is not expected,---will be the only thing that disrupts it. China has a trillion dollars in reserves; that seems immense, although probably only 70-80% are in dollar instruments. Still PFE and GE together have a market value of around half a trillion, so China's hoard could be wiped out simply by purchasing two among hundreds(?) of major US corporations.

[Bupa]

A trillion dollars in reserves and growing every day. What is the average return on those reserves? The Chinese central bank does not have Anne as a financial advisor. They are not investing in high return assets. The developing world is lending at very low (or potentially even negative) real interest rates to the most developed country in the world so that it can consume Chinese goods and Middle East oil happily. Not exactly what Keynes had in mind in the middle of the last century.

Still, the Ken Rogoff's and Larry Summers of the world don't know how long it will go on. I'm sure they both would have lost a bet to Anne long ago. Just because Anne has been right for a long time doesn't mean she always will be. As Maria says, the longer the dance goes on the bigger the potential crash.

[anne]

No; the Chinese financial authorities are investing in the development of China. Indian central bankers are investing in the development of India. There is no reason not to hold low return international assets when the country can grow at 10% a year. Curiously, I take almost no satisfaction in being right because I am simply following the logic of relative value and noticing but not really understanding a remarkable stability. With China and India growing so remarkably, I do not know why a crash should come.

[Bupa]

Anne, their one trillion dollars in reserves are not being invested in the development of China. One trillion dollars are sitting idle.

[anne]

No; the reserves have been gained precisely in the course of developing China. What is happening in China appears to me the equal to the development of America after 1870-1875. I am thoroughly impressed and hopeful.

[dissent]

Anne do you mean to say that the trajectory of increasing American indebtedness is of no concern? Do you think this can go on, in economic terms, 'forever'? If not, what would be, for you, a flashing yellow light?

[anne]

Domestic debt is the concern, and right now domestic debt is moderate relative to the size of the economy. The concern will come in time however with domestic debt growing faster than the economy can grow. We have time however. I would guess the dollar will lose relative value but moderately for several years. The question will be in the coming several years, can we limit the growth in domestic debt below or at economic growth? [I am stealing here from Warren Buffett.]

[touche]

A crash is inevitable. Its not possible to create a soft landing scenario. US consumers will soon exhaust their ability to service more debt, and then there will be a stampede to offload our bonds.

[anne]

Will there be enough control over the defense budget, a stopping of additional tax cuts, with support of social benefit programs in a mix that can allow more moderate domestic debt growth? With growth of 3%, I will be cautiously hopeful.

[anne]

No; personal debt is easily serviceable and controllable. Personal debt is little worrisome for me or for the bond market. Simply look at long term interest rates. Always look to the bond market.

[anne]

Remember, we have just completed the finest international 5 year growth period since 1945. The international economy is remarkably healthy, and has been remarkably resilient.

[David E..]

Anne- "No; the reserves have been gained precisely in the course of developing China. What is happening in China appears to me the equal to the development of America after 1870-1875. I am thoroughly impressed and hopeful."

That is not the way I got it in history class. The situation to me looks completely the opposite - not the equal. The United States was a debtor company in the 1870's. Foreigners were financing the development of our country. It is very strange that a developing country like China is financing consumption in a developed country.

[anne]

Yes; China is financing consumption and investment in a developed country in buying bonds, helping keep long term interest rates low, while financing infrastructure development in China and bargaining for international investment in turn, especially bargaining for international investment that involves technology transfer.

[anne]

Brad DeLong several years ago noted the despair of development economists from 1945 to possibly as late as 1995 in finding the development that China appears to have generated. Brad noticed China, then India. There may be development involving 2.3 billion people as a generator. Brazil? South Africa?

[mrrunangun]

Fortunately for us, the US and China have complementary political problems. The US public has been told by its government for the past 40 years that it will make sure we are able to have our cake and eat it too and we believe it. We are happy to borrow Chinese money and buy Chinese stuff with it. The Chinese government is willing to pop for the party because its sole remaining source of legitimacy is its ability to produce export-led prosperity for its people. There is no place else but the US big enough to absorb the necessary output. Immense political problems would follow an economic downturn there, so the Chicoms can't risk one. Gorging themselves on dollars keeps the party going for us all. The end of this game won't be pretty for anybody, but in the short run it serves the interests of both governments and we the public are happy to believe assurances from experts that the reckoning will never arrive. I mean after all, they may be right, neh?

[vorpal]

I am not sure if there will be a crash, or a protracted arduous decline.

China and Japan are buying our Treasuries because they have an export-driven economic model. They are trading wealth for growth.

Will the US hit a brick wall and have a sudden rapid decline in imports from Asia? This could be a result rapidly rising oil prices and recession. Once the US stops buying from Asia, then Asia will have nothing to lose by weakening the dollar. In fact, they would gain because it would give them a leg up on purchasing that pricey oil. Once strategic way of doing this would be to buy US agricultural companies. This would help alleviate north chinas water woes and spur inflation in the US.

Or perhaps, China could buy a British investment firm and use the firm as a proxy for purchasing oil...because Americans won't allow us to sell our oil companies to China directly.

If I were a Chinese leader, that's what I would be thinking about.

[vorpal]

Another important issue for the Chinese is getting the wealth of the new economy into all areas of the nation. Somehow, they need to take that wealth in US dollars and leverage it into growth in their more neglected regions. This may spur them to use their dollars before they otherwise would.

My guess is that the Chinese themselves don't know when they will change policy or how drastic a change it will be. Domestic politics, the US economy and other factors will determine these parameters. A drastic change in the econo-political environment may result in a commensurate change in monetary policy.

[John Booke]

I day trade spot foreign exchange. Spot foreign exchange trading envolves trading "currency pairs. For instance EUR/USD or USD/JPY. If I want to buy Euros then I can sell Dollars to buy the Euros. Or if I want to buy dollars I can sell yen and buy the dollars. The point is there are two currencies traded at the same time. Just like there are two sides to every story.

The main economic story for the global economy is about "consumption." After you've read the story you come away believing that this economic planet spins around an axis of American personal consumers. Thats the overiding benefit of holding dollars - we use dollars to buy stuff. Not Euros, Yen, Yuan ect. Its a very one-sided story.

[jm]

"Foreigners are hardly reaping great returns on investing in the US."

Not so. The foreigners who really matter -- the well-connected elites who decide the policies -- are accumulating enormous wealth. Contemplate for a moment the fortunes Detroit auto executives could make if they could take the MidWest out of The Union and set the exchange rate of MidWest Dollars in the neighborhood of 25 yen and 1.5 yuan.

[garhaneg]

The American anti imperialist Ambrose Bierce had a great description of an international alliance as a union of two thieves who have their hands so deep in each other's pockets that they cannot separately plunder a third. Sort of fits, does it not. Now I realize there is some one in charge in China, not quite the hard nosed generation of the old street fighters but still very hard. What I wonder is, is there anyone in charge in the USA? Never mind all the slobbering over the wonders of the system and all that, what about those "ruling circles". Are their restricted memberships too busy gathering in truckloads of loot to notice that a gang of bandits is trying to hijack the whole show?

[Tina]

The Dollar is leading currency in which to buy oil and still the leading international reserve currency. As long as a currency has such privilegdes, people will trust in its value not to slump.

[johnchx]

anne wrote: The dollar has lost 9.4% against the Euro these last 10 years, and could easily give up relative value from here, but why should there be a crash as opposed to a now and then tempered loss?

and: Simply look at long term interest rates. Always look to the bond market.

Bingo: the problem is the bond market. You're correct that the bond market appears to be quite optimistic about the future of the dollar. And that's precisely what has economists like Krugman worried. Because that optimism seems unjustified, and unjustified optimism tends to evaporate overnight, not gradually.

Here's the issue: most U.S. international debt is paid in dollars, so if the value of the dollar should fall in the future, that will reduce the value of those payment. Foreign lenders, being non-fools, therefore price in some degree of currency risk when they decide to buy our bonds. Now, you can ascertain how much currency risk is priced in by comparing the interest rates of more or less equally credit-worthy debt denominated in other currencies (e.g. government bonds of the U.K., Japan, and E.U. countries). If bondholders expect the dollar to decline gradually over the next few years or decades, we'd expect an interest rate premium over comparable debt payable in other currencies.

It turns out that the international bond market is exacting no premium at all -- that is, that current interest rates indicate an expectation that the dollar simply will not fall.

There are two possible outcomes. First, it may turn out that the markets are right, and that the dollar may never fall. Economists aren't sure how that could happen, since it basically implies that the U.S. will be able to borrow unlimited resources from the rest of the world and never repay the debt. A nifty outcome, but puzzling. Second, the bond market may someday realize that the dollar really does have to fall eventually, that the U.S. external debt cannot go to infinity, and that, therfore, bond prices are way too high (and interest rates too low)...at which point a stampede for the exits occurs.

A consensus seems to be forming around this "stampede sooner or later" scenario. The real controversy is over whether the stampede will have serious negative effects on the real economy.

[anne]

John Chx:

"It turns out that the international bond market is exacting no premium at all -- that is, that current interest rates indicate an expectation that the dollar simply will not fall."

Nice argument; I am thinking.

[fiskhus jim]

Cribbed from Chalmers Johnson at Harper's:

Military Keynesianism

The ongoing U.S. militarization of its foreign affairs has spiked precipitously in recent years, with increasingly expensive commitments in Afghanistan and Iraq. These commitments grew from many specific political factors, including the ideological predilections of the current regime, the growing need for material access to the oil-rich regions of the Middle East, and a long-term bipartisan emphasis on hegemony as a basis for national security. The domestic economic basis for these commitments, however, is consistently overlooked. Indeed, America's hegemonic policy is in many ways most accurately understood as the inevitable result of its decades-long policy of military Keynesianism.

During the Depression that preceded World War II, the English economist John Maynard Keynes, a liberal capitalist, proposed a form of governance that would mitigate the boom-and-bust cycles inherent in capitalist economies. To prevent the economy from contracting, a development typically accompanied by social unrest, Keynes thought the government should take on debt in order to put people back to work. Some of these deficit-financed government jobs might be socially useful, but Keynes was not averse to creating make-work tasks if necessary. During periods of prosperity, the government would cut spending and rebuild the treasury. Such countercyclical planning was called “pump-priming.”

Upon taking office in 1933, U.S. President Franklin Roosevelt, with the assistance of Congress, put several Keynesian measures into effect, including socialized retirement plans, minimum wages for all workers, and government-financed jobs on massive projects, including the Triborough Bridge in New York City, the Grand Coulee Dam in Washington, and the Tennessee Valley Authority, a flood-control and electric-power-generation complex covering seven states. Conservative capitalists feared that this degree of government intervention would delegitimate capitalism—which they understood as an economic system of quasi-natural laws—and shift the balance of power from the capitalist class to the working class and its unions. For these reasons, establishment figures tried to hold back countercyclical spending.

The onset of World War II, however, made possible a significantly modified form of state socialism. The exiled Polish economist Michal Kalecki attributed Germany's success in overcoming the global Depression to a phenomenon that has come to be known as “military Keynesianism.” Government spending on arms increased manufacturing and also had a multiplier effect on general consumer spending by raising worker incomes. Both of these points are in accordance with general Keynesian doctrine. In addition, the enlargement of standing armies absorbed many workers, often young males with few skills and less education. The military thus becomes an employer of last resort, like Roosevelt's Civilian Conservation Corps, but on a much larger scale.

Rather than make bridges and dams, however, workers would make bullets, tanks, and fighter planes. This made all the difference. Although Adolf Hitler did not undertake rearmament for purely economic reasons, the fact that he advocated governmental support for arms production made him acceptable not only to the German industrialists, who might otherwise have opposed his destabilizing expansionist policies, but also to many around the world who celebrated his achievement of a “German economic miracle.”

In the United States, Keynesian policies continued to benefit workers, but, as in Germany, they also increasingly benefited wealthy manufacturers and other capitalists. By the end of the war, the United States had seen a massive shift. Dwight Eisenhower, who helped win that war and later became president, described this shift in his 1961 presidential farewell address:

Our military organization today bears little relation to that known by any of my predecessors in peacetime, or indeed by the fighting men of World War II or Korea.

Until the latest of our world conflicts, the United States had no armaments industry. American makers of plowshares could, with time and as required, make swords as well. But we can no longer risk emergency improvisation of national defense; we have been compelled to create a permanent armaments industry of vast proportions. Added to this, three and a half million men and women are directly engaged in the defense establishment. We annually spend on military security alone more than the net income of all United States corporations.

This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence—economic, political, even spiritual—is felt in every city, every statehouse, every office of the federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.

Eisenhower went on to suggest that such an arrangement, which he called the “military-industrial complex,” could be perilous to American ideals. The short-term economic benefits were clear, but the very nature of those benefits—which were all too carefully distributed among workers and owners in “every city, every statehouse, every office of the federal government”—tended to short-circuit Keynes's insistence that government spending be cut back in good times. The prosperity of the United States came increasingly to depend upon the construction and continual maintenance of a vast war machine, and so military supremacy and economic security became increasingly intertwined in the minds of voters. No one wanted to turn off the pump.

Between 1940 and 1996, for instance, the United States spent nearly $4.5 trillion on the development, testing, and construction of nuclear weapons alone. By 1967, the peak year of its nuclear stockpile, the United States possessed some 32,000 deliverable bombs. None of them was ever used, which illustrates perfectly Keynes's observation that, in order to create jobs, the government might as well decide to bury money in old mines and “leave them to private enterprise on the well-tried principles of laissez faire to dig them up again.” Nuclear bombs were not just America's secret weapon; they were also a secret economic weapon.

Such spending helped create economic growth that lasted until the 1973 oil crisis. In the 1980s, President Ronald Reagan once again brought the tools of military Keynesianism to bear, with a policy of significant tax cuts and massive deficit spending on military projects, allegedly to combat a new threat from Communism. Reagan's military expenditures accounted for 5.9 percent of the gross domestic product in 1984, which in turn fueled a 7 percent growth rate for the economy as a whole and helped reelect Reagan by a landslide.

During the Clinton years military spending fell to about 3 percent of GDP, but the economy rallied strongly in Clinton's second term due to the boom in information technologies, weakness in the previously competitive Japanese economy, and—paradoxically—serious efforts to reduce the national debt.[3] With the coming to power of George W. Bush, however, military Keynesianism returned once again. Indeed, after he began his war with Iraq, the once-erratic relationship between defense spending and economic growth became nearly parallel. A spike in defense spending in one quarter would see a spike in GDP, and a drop in defense spending would likewise see a drop in GDP.

To understand the real weight of military Keynesianism in the American economy today, however, one must approach official defense statistics with great care. The “defense” budget of the United States—that is, the reported budget of the Department of Defense—does not include: the Department of Energy's spending on nuclear weapons ($16.4 billion slated for fiscal 2006), the Department of Homeland Security's outlays for the actual “defense” of the United States ($41 billion), or the Department of Veterans Affairs' responsibilities for the lifetime care of the seriously wounded ($68 billion). Nor does it include the billions of dollars the Department of State spends each year to finance foreign arms sales and militarily related development or the Treasury Department's payments of pensions to military retirees and widows and their families (an amount not fully disclosed by official statistics). Still to be added are interest payments by the Treasury to cover past debt-financed defense outlays. The economist Robert Higgs estimates that in 2002 such interest payments amounted to $138.7 billion.

Even when all these things are included, Enron-style accounting makes it hard to obtain an accurate understanding of U.S. dependency on military spending. In 2005, the Government Accountability Office reported to Congress that “neither DOD nor Congress can reliably know how much the war is costing” or “details on how the appropriated funds are being spent.” Indeed, the GAO found that, lacking a reliable method for tracking military costs, the Army had taken to simply inserting into its accounts figures that matched the available budget. Such actions seem absurd in terms of military logic. But they are perfectly logical responses to the requirements of military Keynesianism, which places its emphasis not on the demand for defense but rather on the available supply of money.

[js paine]

i got ADHD ants in my pants
and did a skip
so if i'm repeating folks

dang me !!!!

let me suggest this

uncle's trade gap is not growing
especially if you throw out oil's hoopla
in fact its shrinking
a fact

our exports are about three years behind imports

--about the size of the oil price bulge based surge---

seems a far guess this indicates
--if current trens continue --
the ability to pay our wayis a okay
we're
not falling behind on the real level

the deval et al so far
has put us in a holding pattern

of course we're in a very large deficit mode now
but dynamically its closeable

hence i suspect this may account
for
at least part of the non freak out

pending a price drop in oil to 30 bucks
we'd be in clover ..real gap wise

since looking at trends while looking ahead
factoring in further anne like dollar adjustments
vis a vis the other old trade power's currencies ..

well
we might expect the trade gap to shrink away slowly
to nada

but here's the brad setser trap

in the mean time
will we build up too much foreign debt

on the road to trade balance will we over burden ourselves

forcing a serious period of trade surplus on ourselves

or
can we expect to cover our future balanced trade financial net outflow
by borrowing

this isn't impossible of course

if we get to more or less pay as we go
on the real level

( if we don't ???
well that obviously is beyond the smile version of our future and not what i'm looking at here )

but
if we can close the trade gap
but not go into surplus
to cover the net financial flow deficit
we then migght indeed face
a dollar correction of non anne like proportions

a deval of the value of our foreign owned domestic assets
and a reval of our domestic owned foreign assets
which would throw us into trade surplus

nice how these two levels interact eh ??

a side bar on that day of reckoning
it might mean a rebuild of our industrial base
albeit at cool-ee wages

and yet
none of this looks like the norse
three winters in a row signal that end time for empire is upon us

what looks like that to me

is the coded message in this passage

"( recent global) investment shortfall is due to many factors, but perhaps the main one is ..."

start your thinkers mates :

" substantial medium-term institutional roadblocks to investment in many developing countries, where long-term returns now seem to be by far the highest"

as your home work assignment
de cypher and report back here

hint

for us jobbled masses
the problem may get way worse

and intentionally so

[dissent]

A consensus seems to be forming around this "stampede sooner or later" scenario. The real controversy is over whether the stampede will have serious negative effects on the real economy.

Yeah what he said. In addition I think there will be negative effects because our housing bubble is supported by low interest rates. The real reason for the slow deflation of the housing bubble is that high prices are still supported by low interest rates. The deflation we see reflects the exhaustion of the American home buyer in a climate of low interest rates. If interest rates surge, I would expect a radical drop.

[Alex]

The Chinese, Japanese, and other central banks hold large US dollar reserves so that they can keep their currencies down relative to the dollar and thus keep up their exports. Additionally, what is actually a trade deficit or surplus? All it means is that a country is either importing or exporting more. People are not becoming more indebted by this. The only way you get debt is if people are taking cash out of houses, assets in general and using that for a consumption binge. If this is the case, then the problem is not the trade deficit, but whether US assets are larger than US debt. Currently, this is the case. US debt, including all governmental, corporate, and consumer debt is about thirty to forty trillion dollars. US assets in the mean time are at least sixty trillion dollars. As such, there is no problem right now, although if all the obligations were called in, then that could case an economic collapse. But that issue stems from leverage of asstes and use of sophisticated derivatives and financial isntruments, not upon debt buildup.

[Cassandra]

Slink said:
a deval of the value of our foreign owned domestic assets and a reval of our domestic owned foreign assets which would throw us into trade surplus

Not to quibble but are not the former primarily public obligations and the latter primarily private assets? In any equation (convergence towards some MT equilibrium), doesn't the public sector need to, at some point, in some manner, acquire a greater share from the private sector to square the proverbial circle??!

Re: The Big Question
It seems that when capital stops flowing uphill, there will be errr "adjustment", but need we be that pessimistic about its form? Such adjustment merely means consuming less producing/working more, to make good on previously incurred (by then, somewhat devalued) obligations?? But the market first must be allowed to send some signals that such adjustment is deterministically in the offing. This is where the foreign official intervention in the "bond market" is most insidious: no one has been informed and the vigilante is in a straitjacket... Anne??

[anne]

Bond investors ask after inflation prospects, and evidently long term inflation prospects are considered quite moderate. Now, the argument is often heard that with central banks as bond investors the concern is not with inflation but with currency stability. That has never struck me as true, but even if true private bond investors would still influence rates enough to warn against rising inflation prospects.

[anne]

What then of a relative loss in value of the dollar? After the Plaza Accord in September 1985, long term interest rates were remarkably stable though dollar value losses ranged from 40% to 50%. Interest rates began to rise in 1987 only after the Federal Reserve began a tightening sequence in a rapidly growing economy, echoing rapid growth in Europe and Japan.

The Plaza Accord, by the way, was accompanied by a wild bull market in stocks and commercial real estate in Europe, Japan and America. A dollar value decline of 40% to 50%, simply because of the long term Japanese experience in the wake of the Plaza Accord may be rather unlikely. Besides, European currency values reversed against the dollar from 1992 on.

Heck, I am just not worried about the value of the dollar.

[anne]

"We should bemoan the world’s lack of interest in grand plans to improve the financial architecture...."

Why? We have passed through 5 splendid years of growth internationally, with all sorts of stability. China and India with 2.3 billion people are growing in ways thought impossible not long ago. Brazil is increasingly hopeful; Argentina, South Africa. Europe is fine. Why?

[anne]

"We should bemoan the world’s lack of interest in grand plans to improve the financial architecture...."

Why? We have passed through 5 splendid years of growth internationally, with all sorts of stability. China and India with 2.3 billion people are growing in ways thought impossible not long ago. Brazil is increasingly hopeful; Argentina, South Africa. Europe is fine. Why?

[js paine]

c sorry i short circuited my line there

the dollar deval would accomplish two things
improve our balance sheet and allow us to generate
a trade surplus to balance our payments

[Cassandra]

Slink
I was just pointing out that you are taking liberties with the word "our" insofar as the assets are private and liabilitie are public. Tax receipts will not go up on mark-to-market gains, nor will interest payments be reduced by foreign holders' mark-to-market losses.

[js paine]

but guys my real point

look at that line about institutional barriers
to investment
in emerging states

that means trans nats are piling up cash
cause they can't take over
the financial markets of india and china
quite yet

this means the cross pacific tilt and super profit slurry has a long robust future if hi fi dreams become reality

i hasten to add ...needlessly ....
a dollar dropping against all emerging
asian currencies could blow this dream to pieces

but such a rad deval
is not in the cards even mid term apparently

the de industrialization of amerika willl continue apace

"we control the horizontal
we control the vertical "

-------------------------

anne seems content with collision matts
and the setting up
ofever larger
pub funded or subsidized
human capital building sites

i suspect she assumes
this will come overwhelming
out of taxes on job incomes
preferably thru curtailing their consumption

surely the sager elements
among
the trans nats and their knights
as personified by say
those two wonders
summers and rubin
will have little problem with all this
make america safe for complete de industrializationb
so long as the job class funds
their own safety net

ps
the hu cap boom
btw will have this bonus
skill cost reduction
even without skill migration
from eastern europe and asia

kind of a insurance plan against
possible anti immigration yahooery

recall
my conjecture
if we gotta have re action among the jobblers

better it be against immigration
then against trade
and the imperial dollar's over valuation

recall build more human capital you prolly reduce its cost and return

[js paine]

c good point

the refi of uncle's debt
ultimately thru private markets
even if forCBs are doin the buying
mediates all this
to cut the detail
the net surplus earned by our firms
works its way around till it
buys the rolled over excess forCB debt

[dissent]

Policy choices are constrained in practice by social factors: ideology, national identity & 'core competencies', custom. The US is not capable in my opinion of

make america safe for complete de industrialization
so long as the job class funds
their own safety net

We do a lousy job of educating anyone who is not middle class, a lousy job with health care for the same population, ditto with housing.

This didn't used to matter. Now it does, because, as Carly Fiorinna said, there is no such thing as an American job.

On the other hand, a 'core competency' of America is social abandonment. We have a vast and lazy tolerance for impoverishment and decline. We have a corporate and financial elite that flatters itself mirrored in Chinese industrialization even as it abandons the American rust belt. The Republican ruling elite has also embraced governmental incompetence as a political methodology with the goal of undermining trust in government and destroying any appetite for funding 'waste' via tax increases.

No, I think the most likely prospect is increased divisiveness and conflict. There will be no improved social safety net. The foundation of American social peace is the American job market, and it is no longer working.

[Real Person from the Real World]

Someone up top said: China and Japan are buying our Treasuries because they have an export-driven economic model. They are trading wealth for growth.

Makes sense to me. My immigrant employer is stuck astride two continents, and sees himself as a pipeline between the two.

If you've got cheap labor you export it or the results of it, to get wealth. If you are making too much money, and some in the US certainly are, you buy. If you are poor and can only afford cheap imports, you buy.

The question is, will the world stop selling. It takes time to change behavior. So that is unlikely in the near term, without some shock. Furthermore, markets outside the US in developing countries are risky, aren't they? Most investors want a sure thing or something close to a sure thing. Conservative investors trade high rewards for safety.

My employer, like most immigrants hangs onto every dollar and eases his risk by paying me poorly, and other games, not by risking and paying me a fair income. Meanwhile, he will prevaricate or do whatever to hit his jackpot. While all these fancy US economists agonize over whether he and those in other countries will pull his money out of the "US." Unlikely, in the near term.... and maybe unlikely for a much longer term!

[RR]

Anne makes the classic mistake of looking backwards instead of forwards.

She is of course dead wrong. The trade and current account deficits must stabilize at some point or the currency must falter. There's almost no more simple function in economics.

[Rob Lazarus]

China, Japan and the oil exporting countries are accumulating enormous amounts of dollars and must do something with them. They certainly are not going to just hide them under their mattresses. As a result they are buying US treasuries, US equities and US real estate and they are making large capital investments in the US, building new foreign owned factories with new high tech equipment. These loans and asset accumulations are almost entirely responsible for keeping the dollar high against the yen, renminbi, and petro-currencies and keeping US interest rates low. At the same time these countries are beginning to diversify more of their foreign reserves into Euros, pushing the Euro higher against the dollar.

These countries well understand that their low currencies are subsidizing America’s current standard of living, that they are loaning us enormous sums at ridiculously low interest rates and that they will be paid back in devalued and probably inflated dollars. They also recognize that they are (or will be) overpaying for US real estate, equities and other assets. So why then are they doing it?

There are many reasons behind the strength of the dollar against the currencies of the oil producing countries. They involve security considerations, global financing and other factors. They can be addressed in another forum. The probability, however, is that these countries will increasingly diversify their foreign reserves out of dollars and may well begin to price petroleum in other currencies, most likely the Euro. This will significantly weaken the dollar and will have impact throughout the US and world economies.

The US has its largest growing trade deficit with China, and China has very good reasons for subsidizing US consumption. The Chinese government must continue to create new jobs for an enormous population or face real social and political instability from a public (especially in the interior rural areas) that is no longer willing to accept such poor living conditions. The Chinese do not now have enough broad based consumer wealth to purchase enough goods and services themselves to internally drive the growth necessary to satisfy their required employment needs. They must rely on US consumers. If the Chinese were to stop buying low interest treasuries and stop purchasing US assets, they would cause the dollar to fall, US interest rates to rise, US housing prices to fall and a substantial US recession. This, in turn would significantly decrease US imports from China, significantly slowing down China’s economic growth.

Chinese companies, many of which are partnered with the Chinese government, find it necessary to sacrifice higher profit margins to achieve more overall employment. China is therefore willing to lend us money extremely cheaply and purchase expensive assets in the US, thus subsidizing the current high US living standards. Unfortunately for the US, the day of reckoning will come when the Chinese consumer market matures enough to drive growth internally and exporting to the US becomes less and less important.

At that same time Chinese citizens, corporations and the Chinese government are accumulating more productive capacity in the US ensuring against the probability of US imposed protectionist tariffs and restrictions. Soon, more and more Americans will be working in the US for foreign owned firms, sending the profits and thus sending more and more dollars abroad even if the purchases are made from companies operating in the US. Then, even if we stop buying as much from companies located in China when their products are no longer as cheap, we will still be purchasing goods and services from foreign owned companies, ensuring a structurally weak dollar.

When the US was the world’s largest creditor nation, the American public enjoyed a structurally strong dollar, great purchasing power and an increasing standard of living largely provided by the hard work of cheap labor around the world. In the future, it will be American workers who will be working cheaply, over-paying for goods, services and assets and subsidizing the Chinese living standards.

Much of the previous discussion about China also applies to Japan. Although Japan has a mature consumer base and near full employment, they also rely on exports to the US to drive their economy. The large US market, relative to the size of Japan necessitated reliance on an export driven economy. As a result, Japan is also willing to accept a weak yen, low interest rate loans and expensive asset purchases, sacrificing today’s profits to promote more stable employment. The Japanese are also positioning themselves to move away from reliance on America’s consumers toward more export opportunities to the growing Chinese market.

For years now, the US has been insisting that the Japanese start liberalizing their economy and enact policies which discourage saving and promote more consumption. The Japanese have taken steps to liberalize their economy, which they recognize will strengthen their long term economic competitiveness. These steps include beginning to address the incestual relationship between government and private industry, removing some employment guarantees, and discontinuing government subsidies of poor performing loans. They are, however, reluctant to open up much of the economy to US competition. Japanese companies are unwilling to give up market share to US companies now while the dollar is strong and the US has a competitive advantage in certain service related sectors, when the US will be in such a fiscal and competitive disadvantage in the future, when everyone is competing for the Chinese market. Again, they are willing to sacrifice purchasing power today for more employment and competitive advantage in the future.

Even with a weak yen, competition with China and other emerging economies, especially in Asia, has kept Japanese growth and wage increases stagnant. To encourage more growth, the Bank of Japan has kept real interest rates near zero percent, only recently raising them slightly. With zero interest rates, large global investors borrowed lots of yen and converted it to other currencies, investing it around the world, rather than in Japan, where they could get better returns. This was known as the “carry trade” and provided tremendous liquidity spurring faster growth around the world. This led to boom in worldwide real estate and equities, especially in the emerging markets.

Japan’s economy did grow, albeit slowly as low interest rates spurred much more worldwide investment but less internal consumption. Even so, Japan’s economy does seem to be growing and the Bank of Japan will probably soon raise interest rates again.

The future economic prospects for Japan and the US however are very different. Just as workers must save and invest during their working years so as to provide enough income to maintain their living standards during retirement, countries must do the same thing. Both Japan and the US are literally and figuratively entering their retirement years. In the literal sense, both countries face dramatic demographic changes which will leave each of them with far more retirees and far few workers. And, figuratively, both countries will lose their competitive advantages to the younger emerging markets and will either have to rely on the investments they have made during their prime years or be able to add enough additional value to what they produce (or provide), to keep on working and competing with “emerging” cheaper labor. Otherwise their standard of living has got to fall.

Japan has very high personal savings rates and is starting to address their structural budget deficits. Rather than consuming today they are educating their population and investing heavily in China and emerging markets. They hope to stay competitive enough to maintain higher wages and supplement slower growth at home with investment income from abroad.

Personal savings in the US, however, are very low, maybe even negative because of our flagrant borrowing and consumption, and we seem incapable of addressing the unsustainable growth in entitlement spending which will become unaffordable as the baby boomers retire. We have gone from the world’s largest creditor nation (investor) to the world’s largest debtor. The economy is in large part driven by consumption financed by borrowing on our houses. When interest rates rise and housing values fall, economic growth has got to slow. In addition we are falling further and further behind in educating our children relative to the rest of the world. Most Americans will neither be able to stay competitive enough to keep their wages from falling nor have the necessary personal investments to offset the decrease. For the majority of Americans, the standard of living will fall dramatically. Political pressure for global isolation and protectionism is the most likely consequence.

[anne]

Interesting comment, the point seeming to be that we can no longer afford to have grandparents or parents and we had better hope they know we can no longer afford them. I am puzzled though, no matter how massive the Social Security surplus the cry is that we can no longer afford Social Security. No matter the growth of the economy, we are always bound for no growth. No matter how low long term interest rates are, we are always heading for higher and for a housing collapse.

Debt, debt, debt; but we seem to be handling debt well. Investment markets are booming and we are part of the boom. Where are the harbingers of economic doom? The dollar goes up, the dollar goes down; but the stability is what strikes me. What am I missing (even looking backward)?

[anne]

There is a curious thing about education, which I always wish challenged and improved. We have remarkable schools through the country at every level, and universities that are or should be the envy of all. Are we all that poor in education? Now, I would like to have a dramatic program to reduce tuition at public colleges-universities and broaden facilities. But, we can manage this with political will. Why do we find ourselves so threatened?

[anne]

When we are told, as we are continually told, about not being able to care for our grandparents and parents, forgetting about being able to afford caring for race horses (I adore horses), why are we not being told by the same tellers of not being able to afford a $622 billion military budget for 2008?

[meno]

"We have remarkable schools through the country at every level, and universities that are or should be the envy of all. Are we all that poor in education? "

Having taught at universities here in NZ and in the US I've gotta say: your best 10% of education providers are fantastic. Your average is pretty average. Your worst 25% are utterly terrible beyond what any western nation should put up with. For odd historic reasons your nation has local funding and control of education, and the result is a bloody disaster.

Your problem is not the quality of your PhD programmes.

[Yellow Submariner]

Not to sound too conspiracy theoretical (?) but the only reason the dollar hasnb't crashed is the same as the reason certain businesses and instituions are being bailed out by taxpayers worldwide. It is in the best interests of those who engineered the current financial situation.