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Bubbles and Balances

by ChrisCook Sat Sep 8th, 2007 at 07:51:04 PM EST

With his permission I am publishing below the approved summary of a paper being written by Professor Michael Hudson for the Berlin heterodox economics meeting on "Finance and Capitalism" on Oct. 27.

Michael and I are both members of the "Gang 8" Yahoo Group, although I think we both believe the "Creditary Economics" central to the group is incomplete.

Michael wrote an absolutely first rate book:

Super Imperialism: The Origins and Fundamentals of U.S. World Dominance - Pluto Press

a review of which is here

Super Imperialism Review

I think that what follows is entirely relevant to much recent debate on ET, and I'm hoping Michael will have time to make a "Guest Appearance" to join any discussion.

The balance-of-payments dimension of today's bubble economy


Foreign savers have so much faith in the U.S. economy that they send their savings there - enough to finance the U.S. trade and payments deficit.


The U.S. Treasury-bill standard of international finance leaves foreign central banks with little choice but to accept dollars ad infinitum, now that they no longer have an alternative such as gold. Foreign "capital outflows" to the United States thus are not really voluntary. It exports IOUs, other countries export products and sell their assets to U.S. buyers.

Balance-of-payments constraints have been the limiting factor most responsible for bringing business expansions to an end in decades past. Typical booms create a demand for imports, while exports become less competitive as wages and prices rise. Outside of the United States, this obliges central banks to raise their interest rate to stabilize the currency, applying a "stop-go" policy that slows economic upswings. At least, this was the pattern before economies began to be swamped with dollars.

The United States has been uniquely free of the balance-of-payments constraint, thanks to its status as a key-currency nation since it stopped gold convertibility of the dollar in 1971. This immunity from the balance-of-payments constraint means that global financialization is inherently a U.S.-centered phenomenon. Not only has U.S. domestic demand expanded in the face of historically unparalleled trade deficits, but capital outflows from the U.S. economy have been a major force inflating financial bubbles abroad as its investors have bought up foreign assets.

This has shifted the international financial system away from financing trade (im)balances to financing "capital" transfers, increasingly short-term credit flows (including the "errors and omissions" line in balance-of-payments statistics). When U.S. officials depict these U.S. payments outflows as the "engine of world growth," they mean that U.S. import demand, capital outflows and overseas military spending is pumping dollars abroad. Surplus dollars end up in central banks, which have little alternative but to recycle them to the United States in the form of U.S. Treasury securities.

In effect, the U.S. payments deficit finances the domestic government budget deficit, thereby "freeing" Americans themselves from having to use their savings or credit to do this. As foreigners finance the deficit, the U.S. Treasury has been able to cut taxes on property and finance, thereby freeing yet more income to be pledged to banks as debt service, whose proceeds are lent out to inflate the bubble economy all the more. (What the tax collector relinquishes is available to be paid to bankers for loans - whose effect is to bid up property prices.)

The U.S. financial bubble thus becomes self-financing, in the form of a "Ponzi scheme" in which foreigners provide the money to pay interest on the rising foreign debt. The effect is rising U.S. asset price inflation. With regard to these central bank savings in the form of U.S. Treasury obligations in particular, the words "security" and "bond" have lost their literal meaning.

Nobody is able to create a plausible scenario for just how America's foreign official debt ever is to be repaid, or even serviced except by just adding the interest charge onto the principal each year in an eternally soaring compound-interest curve.

While the domestic economy shifts its focus from earning income (wages and profits) to economic rent-seeking and asset-price gains, the international balance of payments sees exchange rates respond to relative national asset prices, not commodity prices, churning in a pattern much like what a seismograph traces out during earthquakes.

By inflating the real estate bubble, "financialization" has made housing expenditure an increasingly dominant factor in international wage comparisons, and hence international commodity prices. Housing now plays the role that food did in Ricardo's day, accounting for as much as 40 percent of household expenditure for many U.S. wage-earners.

Today's Sunday Telegraph

China Crisis?

is right to the point.

A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable. Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of US Treasuries by $48bn since late July, with falls of $32bn in the last two weeks alone.

"This comes as a big surprise and it is definitely worrying," said Hans Redeker, currency chief at BNP Paribas.

"We won't know if China is behind this until the Treasury releases its TIC data in November, but what it does show is that world central banks are in a hurry to get out of the US. They don't seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance at 500 euros," he said.

While the greenback has been resilient over recent weeks - even regaining something of a 'safe-haven' role as banks scrambled to buy the currency to cover dollar debts - most experts believe that America's $850bn current account deficit will eventually cause the dollar to resume its relentless slide.

An imminent rate cut by the Fed is hardly likely to attract more overseas funding is it?

It seems to me that we have the long awaited "Perfect Storm" brewing here....

This is good meaty food for thought.

House ownership is not the same as having a home. Thus general US and European aspirations do differ. Is a house an asset or strange social attractor?

You can't be me, I'm taken

by Sven Triloqvist on Sat Sep 8th, 2007 at 08:28:08 PM EST
It's a social disease.  ;-)

Two years ago we were thinking of moving to Albuquerque.  I compared the costs of rent versus the cost-of-purchase and found a house would have to increase in value by 8%/yr to make-up the difference.  The new house prices in Albuquerque have increased over the last two years while the rental market has fallen thus today the contrast is even starker and yet people are still buying houses.  Apartment owners are so desperate for income they are offering first and last months free AND a move-in bonus for clean, substantial, 2 bedroom flats of 1,200 sq ft or 220 square meters with a monthly rent of $600.  For a for a two bedroom 1,200 home the monthly purchase payment is about $1,250.

It's madness.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sat Sep 8th, 2007 at 10:47:54 PM EST
[ Parent ]
House ownership statistics are misleading since they count in people who still have mortgage to pay (and in those case the real owner is the bank).
by Laurent GUERBY on Sun Sep 9th, 2007 at 07:34:15 AM EST
[ Parent ]
Holders of US funny-money will do what creditors have always done with defaulters: repossess.  There are plenty of US assets capable of being exchanged for their paper.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sat Sep 8th, 2007 at 10:58:55 PM EST
Compared to china's dollar holdings, $48b is a drop in the ocean. I still think that china regards it as a marker on America at some point, probably for good behaviour over Iran or, failing that, the return of Taiwan.

It will be more interesting if the withdawal continues at this rate cos at some point the value of the dollar will fall, threatening the value of the chinese holding. It will be interesting to see what the Chinese do then.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Sat Sep 15th, 2007 at 12:09:46 PM EST
[ Parent ]
I wonder what the US reaction would be if China Inc, Japan Inc, Korea Inc, started using their useless $ balances to hoover up sub prime, Alt A, and all the rest of the secured debt they could get, foreclosed and took ownership of swathes of US properties - becoming a landlord on a cosmic scale?

Somehow I think it might be - just a bit - politically unacceptable....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Sep 9th, 2007 at 07:46:10 AM EST
Who'd know? I expect that vulture funds are going to become the next big thing anyway. The creditor nations could simply wait until the funds are founded by Americans and then quietly take a position...

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman
by dvx (dvx.clt št gmail dotcom) on Sun Sep 9th, 2007 at 09:22:16 AM EST
[ Parent ]
Foreign states buy up West

... a number of trends are prompting concern among governments in Europe and America, and stirring up protectionist sentiments. For a start, new funds are being set up. China is creating a $300 billion fund that some believe could grow by a mind-boggling $250 billion to $300 billion a year.

Early next year, Russia, which already has a $24 billion vehicle, plans a $30 billion Future Generations fund, which many expect to grow by $40 billion a year. Japan is considering diverting $700 billion from its vast foreign reserves to set up a sovereign-wealth fund investing in overseas assets.

In a bid to boost returns, the funds' investments are being switched from low-yielding assets such as US treasury bonds to equity stakes and even outright takeovers. The targets: companies in America and western Europe, particularly in "strategic" areas such as technology, transport, oil, commodities and financial services.

No wonder governments are worried. "These funds are going to have the ability to buy any global company, to create panic in markets if they move too precipitously, even to dwarf the political clout of international financial institutions. They can no longer be ignored," wrote Jeffrey Garten, professor of Yale School of Management.

Many predict government bond prices will fall and yields rise as sovereign-wealth funds move their assets elsewhere.

"The idea of private, state-run funds buying public companies in developed countries can create fear - partly because the threat is from China. It is a fear of the unfamiliar," said one investment analyst.


Critics argue that sovereign-wealth funds lack transparency and are politically motivated. Others are alarmed at how state-owned firms could be used alongside the funds to grab strategic assets. The Kremlin has been accused of using the gas giant Gazprom as a tool for its foreign policy.

Not all funds are secretive. Norway's $320 billion Government Pension Fund, set up in 1990, is a model of openness and in a bid to not distort markets takes an average stake of less than 1% in a company.


Some funds are trying to face down the protectionist fears. Simon Israel, executive director of Temasek, which owns 16% of Standard Chartered and a stake in Bar-clays, has been on a charm offensive. Israel is at pains to point out the Singaporean fund is different because it is not "state-directed" and its corporate-governance standards mirror those of a listed company.

Critics say this stretches a point since five of the Temasek board are former or current members of the state apparatus and the chief executive, Ho Ching, is the wife of the prime minister.

Truth unfolds in time through a communal process.
by marco on Sun Sep 9th, 2007 at 10:20:10 AM EST
[ Parent ]
"These funds are going to have the ability to buy any global company, to create panic in markets if they move too precipitously, even to dwarf the political clout of international financial institutions. They can no longer be ignored,"

The final triumph of capitalism - sold wholesale to the communists.

I'm sure Marx would have been pleased.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Sep 9th, 2007 at 02:29:30 PM EST
[ Parent ]
I still think it's funny that america thinks that globalisation is fine when it's them doing the plundering of foreign assets, but they take a  remarkably different attitude when they are the ones being stuffed.

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Sat Sep 15th, 2007 at 12:13:04 PM EST
[ Parent ]

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