[1] If 1 $ has the same purchasing power in the US as 4 yuan have in China, and it costs 6 yuan (1.5 $PPP) to make a teddy bear in China and 1.1 $ to make it in the US, the Chinese factory can be made competitive by maintaining a $-yuan exchange rate of - say - 1:8.
[2] If the $-renmimbi exchange rate is 1:8, but the 4 yuan can buy 1 $ worth of rice, I could take 1000 $, buy 8000 yuan and use them to buy 2000 $ worth of rice, which I could then sell for 2000 $. But this increases demand for yuan, while increasing supply of $, pushing the price of yuan up and the price of $ down. If China wants to maintain a $-renmimbi rate of 1:8, the Chinese central bank must then be willing to buy the 1000 $ with 8000 yuan (which it can issue by fiat) to maintain balance between supply and demand.
And it has to accumulate $, because if it sold the $ for, say, €, it would crash the $-€ exchange rate, which would mean that if China wanted to maintain its $-renmimbi exchange rate, it would have to massively devalue against the €, which it may not want to do for a variety of mostly excellent reasons.
[Magic Asterisk 1] I don't understand why the Chinese central bank has to reinvest their surplus $. If the surplus $ is the tail rather than the dog, why not just let them sit there?
[3] If the Treasury issues a one-year 100 $ bond at an interest rate of 5 % and the market value of the bond is 102 $, then the interest rate that the buyer gets on his payment is only a bit under 3 %.
[Magic Asterisk 2 & 3] I don't think Wolf spells these steps out explicitly. But given that it was asset prices that collapsed, given that asset prices only collapse like that when they are systematically overvalued and given that systematically overvalued assets is the very definition of a bubble, I think it's reasonable to infer agreement on these steps.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
If the primary driver was cheap debt being used to cover up declining real wages, what other effects would we expect? Ditto for the primary driver being neo-merchantilist policies? If the primary driver was cheap debt, could anybody outside the perpetrators in the US have stopped the buildup to disaster (and if yes, why would it be in their interest to do so)? If the driver was Chinese neo-merchantilist policies, could the US government have done something about it (and if yes, then why didn't they)?
Driving up the price of bonds is equivalent to driving down the interest rate [3].
And you note:
Your example is about the interest that the "buyer" recieves from the Treasury. By what mechanism does this affect the interest that a bank has to pay TO the Treasury in order to borrow money from it?
Low interest rates for borrowing leads to leverage leads to "stuff goes boom."
I think the causal chain is important in understanding what is going on.
As I understand it, banks don't borrow money from the Treasury (unless they're pulling an All Your Shitpile Are Belong To Paulson on the taxpayer).
So if a bank wants to borrow money from the central bank, surely it must pay at least as much as the Treasury would have to (otherwise, it could borrow money and lend it to the Treasury until the price of a bond rose to the level where Treasury and borrowing rate were perfectly matched).
I think banks usually have to pay a bit more (as Jerome frequently notes in respect to energy policy, the Treasury gets financing cheaper than everybody else) to represent the greater risk that a bank defaults over the risk that the Treasury defaults.
If that's right, the central bank cannot lend money to the other bank at a rate higher than the bond rate plus the risk premium.
If it tried to do so, the bank would just borrow money directly from some of the people who would otherwise go into bond, since it would be able to pay its risk premium plus the bond rate plus a bit and still come out ahead. Which in turn would depress bond prices (i.e. raise bond rates), until bond rates matched the central bank rate minus the risk premium.
So that means that the central bank can lend money to banks at rates between the bond rate and the bond rate plus the bank's risk premium.
In normal times, you'd not lend money to the banks at rates below the bond rate plus their risk premium, because doing that would in effect be printing money and giving it to the banks (or rather, take some of the bank's default risk away from the bank's shareholders and other creditors and dump it on the full faith and credit of your currency, but in a statistically large sample of banks, that's the same thing).
Which, as far as I can tell, is precisely what is being done under the various and sundry All Your Shitpile Are Belong To Us plans that're being implemented by various central banks.
I hope this makes some kind of sense. Somebody who isn't winging it could probably put it in a more easily understandable structure, but as I noted, IANAE.
[Disclaimer: All of the above examples of arbitrage makes a number of assumptions about frictionless markets, etc. that may or may not hold in the real world.]
What the money and debt markets set are the premiums over the cash rate.
What has been startling over the last year is the shift from a primary emphasis on cash rate manipulation through buying and selling Treasury securities to reliance on the discount window. Still, as banks are receiving loan repayments without rolling the credit over, the quantity of credit-money will be declining, and if the Fed tries to make that good by injecting Reserves into the system by purchasing Treasury securities ... that would press up the price of Treasury securities and depress their market rate of return. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
How is this similar/different from the situation in Japan in the 1990s where (if I am not mistaken) the credit also wasn't being rolled over, but it was because people there were so many savings that nobody needed to borrow? A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
In Japan in the 1980's, corporate investment in domestic productive capacity was strong, until there was a decision to shift the imported value added in Japanese production and corporate investment in domestic productive capacity substantially dried up.
I don't understand the Japanese political economy well enough to know who exactly reached that decision and how, but the transition was very dramatic, from roughly 90% domestic value added to roughly 60%.
"Magic force field of savings" people would ascribe all sorts of causal effect to Japanese saving rates, but with strong exports, weak imports because of the sluggish GDP growth, and massive government deficits to keep the economy ticking over in the face of the corporate investment drought ...
(I-S)+(EXP-IMP)+(G-T) so
S = I + (EXP-IMP)+(G-T)
... even with I in the doldrums, with a trade surplus and a massive government deficit, there has to be substantial savings. The only question is who ends up holding it. Given the system of big corporate networks having their own pet banks and high downpayments required for consumer purchases, it seems unsurprising for the saving to be acquired by households rather than as retained earnings. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
The big increase in outsourcing of various stages of production by Japanese firms in the late 1980's and 1990's led to a corresponding reduction in the share of the value of Japanese production that originated within Japan. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
And these bizniz pundits who recommend outsourcing are being taken seriously because?
How deliberate that timing was, or whether it just took the Japanese that long to decide upon such a dramatic monetary policy ... like I said, I don't understand Japanese political economy to really have any idea.
A little while after the outsourcing wave was over, the Japanese economy showed a return of stronger economic growth ... it was the shift from one level to another level so dramatically that led to the domestic investment drought in Japan ... at least, compared to prior levels of investment. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
Holding the liquid balances in the money market that everyone knows that you cannot sell out of without undermining your FXR policy would not get them out of way of influencing the finance sector.
Indeed, it would seem that holding Treasury securities is the most neutral thing that a foreign central bank can do with its foreign exchange reserves. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
If so, that would indeed make [Magic Asterisk 1] go away.
Indeed, assume it was cash. That is, assume that the Chinese sold yuan/renminbi for US dollars and then withdrew Federal Reserve notes that it shipped back to hold in vaults in Beijing.
That withdrawal of Reserve notes would drain reserves from the system, and if the Fed is maintaining a target cash rate, it has to buy Treasury bonds to re-inject the reserves back into the system to maintain the rate. The same amount of bonds that the Chinese would be buying and holding if they were holding the FXR in bonds.
That means that the big change was not in the 1990's, but in the middle of the current decade, when the Chinese went from a US$ peg to a hidden basket peg, putting a composite foreign exchange rate, that they don't declare, on a basket of foreign currency, including US$, where they don't declare the make-up of the basket.
Of course, it is necessary to distinguish between what the Chinese monetary authority it doing and what the balance of the Chinese finance sector is doing. In the past year, stories in the finance press suggest that Chinese commercial banks have been whittling down their holdings of US$ denominated assets. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
Indeed, assume it was cash. That is, assume that the Chinese sold yuan/renminbi for US dollars and then withdrew Federal Reserve notes that it shipped back to hold in vaults in Beijing. That withdrawal of Reserve notes would drain reserves from the system, and if the Fed is maintaining a target cash rate, it has to buy Treasury bonds to re-inject the reserves back into the system to maintain the rate. The same amount of bonds that the Chinese would be buying and holding if they were holding the FXR in bonds.
facepalm
Well, I guess my excuse is that IANAE ;-)
