Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

Two economists, three opinions

by Jerome a Paris Wed Jan 9th, 2008 at 04:39:49 PM EST

Challenges for the world’s divided economy
By Martin Wolf

That there was a link between the savings glut and the financial fragility was evident. The former, I argued, generated the global imbalances and the monetary policy that drove household borrowing to the level required to absorb the capital inflow. Soaring house prices and rising household indebtedness were the vehicles through which policy worked.

America’s inflated asset prices must fall
By Stephen Roach

The US has been the main culprit behind the destabilising global imbalances of recent years. America’s massive current account deficit absorbs about 75 per cent of the world’s surplus saving. (...)America’s current account deficit is due more to bubbles in asset prices than to a misaligned dollar. A resolution will require more of a correction in asset prices than a further depreciation of the dollar.

As Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard note in a brilliant new paper [pdf!], this had similarities to the recycling of petrodollars to developing countries that preceded the debt crisis of the 1980s. This time, surplus savings were, in their words, “recycled to a developing country that exists within the US”: the subprime borrowers.America’s aversion toward saving did not appear out of thin air. Waves of asset appreciation – first equities and, more recently, residential property – convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way – out of income. Assets became the preferred vehicle of choice.

It is fascinating to see how these two economists look at the same phenomenon, see completely different things, and yet avoid the core underlying topic:

Wolf:
Roach
  • China and Russia earn dollars
  • China and Russia save dollars, creating "savings glut"
  • USA is "forced" to borrow dollars
  • Consumers spend all that easy money
  • Asset prices, among others, soar

For some (unexplained) reason, this is unsustainable and crashes. Financial crisis occurs, but only in the US. The Third-World-Within (a significant chunk of middle class Americans) can be blamed for it. And they'll support most of the consequences, so all is well.
  • Credit is too cheap (thank you Bubbles Greenspan)
  • Easy credit causes asset prices to inflate
  • More valuable houses can be used as piggy bank/ATM
  • Consumers spend all that easy money
  • US consumers live beyond their means
This is (more understandably) unsustainable. Spending cuts and housing crash will feed one another and drive a painful recession. China has very little to do with this whole process, other than to ride it.

As readers know, I'm very much on the Roach side of this fight about causality. At least everybody agrees now that there was too much debt, and that there will be a retrenchment of consumption in the US. Both move to different conclusions to their papers (Wolf to note that the emerging world will escape the crisis and continue to grow nicely, Roach to note that a dollar devaluation is not a solution to current problems), but both ignore the elephant in the room:

China's not spending its savings, and America's not building its savings are caused by the same thing: insufficient household income, due to stagnant (in the USA) or trailing (in China) wages.

In the US, workers faced with stagnant incomes resort to debt; in China, consumers don't get access to a fair share of the dollar surplus generated by US imports and their government recycles the resulting unspent dollars into international financial markets.

This is what profit-driven macroeconomic policies (supported and abetted by China's mercantilist urges, which form an integral part of the package) want: cheap "flexible" labor. And we're getting the logical consequence of that - not enough demand, after all artificial ways to prop it up have been exhausted. Workers are broke, and there is nothing left to squeeze out of them. But hey, it's their fault - and their problem.


Display:
with a catchy title: Blame the poor
Thanks for your support.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Jan 9th, 2008 at 04:58:04 PM EST
Nice one.

I only just picked up my FT from the local Tesco, so hadn't assimilated Wolf's piece when I postedSpending or Saving,.

But at first blush Wolf appears to be lining up with Michael Hudson's critique of Roach's article yesterday, albeit in more diplomatic language.

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

by ChrisCook (cojockathotmaildotcom) on Wed Jan 9th, 2008 at 05:12:34 PM EST
[ Parent ]
Ummm....

Memo to self: avoid comments based on perfunctory reading.

Wolf's talking bollocks as well, as you say.

Have a look at Hudson's account J, I'd be interested in your opinion.

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

by ChrisCook (cojockathotmaildotcom) on Wed Jan 9th, 2008 at 05:20:09 PM EST
[ Parent ]
Andrew Glyn (who died recently) had this to say in an interview about his book "Capitalism Unleashed":

Socialist Review

"A second major disruptive factor is the explosive growth in the financial sector, threatening serious instability. The Bank for International Settlements, which is supposed to regulate as well as monitor the international financial system, has produced a number of reports showing they are very worried. Those who would justify financial deregulation claim that risk is increasingly spread across the system and that this encourages real investment in the rest of the economy. In fact real investment has remained relatively stagnant throughout the industrialised world, with the temporary exception of the internet boom in the US at the end of the 1990s.

...

"Over the last 20 years there has been a very significant retreat for labour. Wages have stagnated and profits have been substantially restored. The pay-off from the point of view of orthodox economics should be an upsurge of investment and a restoration of rapid growth and higher employment. Yet this has not occurred to any significant extent. One reason for this must be fears of instability.

"There is a real paradox here, because in terms of economic growth, the 1990s were actually the most stable post-war decade in both the rich countries and in the world economy as a whole. Yet individual firms deciding when, where and how much to invest, seem to be faced with greater and greater uncertainties. Exchange rates have fluctuated wildly and long established industrial giants lost market share. Investing to expand production is not simply a question of current profits being at a high level, but of the capitalists' having confident expectations about the future. 'Animal spirits', in Keynes' vivid term, are currently at a low ebb."

I haven't had time to get hold of any figures around this issue, but it's well known that a lot of companies are holding cash rather than investing in productive capacity. I think there's a connection to be explored in there.

by Metatone (metatone [a|t] gmail (dot) com) on Wed Jan 9th, 2008 at 05:06:10 PM EST
Great. That's your so far most succint formulation of the Grand Unifying Theory of the current global imbalances.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Jan 9th, 2008 at 05:16:25 PM EST
I don't understand the theory of the "savings glut". Can someone outline it for me?

We have met the enemy, and he is us — Pogo
by Migeru (migeru at eurotrib dot com) on Wed Jan 9th, 2008 at 05:22:30 PM EST
Owners form more capital than what they could invest in their preferred investment markets. Or some idiocy like that.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Jan 9th, 2008 at 05:28:32 PM EST
[ Parent ]
Unreasonable speed of industrial development in slave-labor countries generates centrally administered monster piles of cash. These grow too fast (in the order of 1000 B$ per decade) to be invested in manageable infrastructure projects at home (so the industrialization goes on in an inefficient an environmentally sub-optimal way, but still very fast).

While these projects mature, cash is parked in the most "trustworthy" debt available: that of the very enslavors who buy the crap from the slave-labor. Ultimate fuck: they are not actually trustworth debtors, and when savers want to turn it into something real at home, it will be gone.

Pierre

by Pierre on Wed Jan 9th, 2008 at 05:39:58 PM EST
[ Parent ]
Or in other words - if you stop spending money and keep hoarding it, eventually it decays and ceases to exist.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jan 9th, 2008 at 05:49:43 PM EST
[ Parent ]
China focuses on exports, its economy generates surpluses, which are not spent on imports, but rather "sterilised" (ie the Central Bank buys the dollars at lowish rates via currency controls, and reinvests them in international financial markets rather than domestically).

Consumers cannot easily get their hands on dollars, because it's more expensive than it should be, or because it's regulated that way, and imports remain weak, relatively.

Thus the country on agreegate, saves more than it invests, and has to park the (forced) excess savings elsewhere.

what is true is that China abandoning the peg, and the cheap yuan policy, could trigger an increase in domestic spening and imports. But they worry about both inflation and about weakening the competitivity of the export sector, which fights mostly on price.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Jan 9th, 2008 at 05:53:45 PM EST
[ Parent ]
Jerome, I am curious about the transmission mechanisms you have used to deduce the following:
what is true is that China abandoning the peg, and the cheap yuan policy, could trigger an increase in domestic spending and imports. But they worry about both inflation and about weakening the competitivity of the export sector, which fights mostly on price.
What makes you think that the Chinese will suddenly change spending (and thus savings) patterns based on the exchange rates? I would think it has more to do with structural changes in their economy aside from some change in prices. And when the exchange changes to get more in line with its true value then how do you consider this is a cause to worry about inflation? Anyway, just asking for some clarification.

Rutherfordian ------------------------------ RDRutherford
by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Wed Jan 9th, 2008 at 07:57:08 PM EST
[ Parent ]
I suppose abandoning the peg will increase the value of the Renminbi, which will make it easier for the Chinese to afford products at international prices. It would reduce their exports and increase their imports or at least their internal consumption of the crap they produce for our markets.

But increased internal demand and increased purchasing power would lead to inflation down the line.

We have met the enemy, and he is us — Pogo

by Migeru (migeru at eurotrib dot com) on Thu Jan 10th, 2008 at 03:38:41 AM EST
[ Parent ]
I suppose abandoning the peg will increase the value of the Renminbi, which will make it easier for the Chinese to afford products at international prices.
Yes I think that is easy enough to understand that the Chinese will be 'able' to afford more internationally, but the question is whether they will change their spending/savings patterns and whether the government will allow more importation of goods and services. Also note that technically they do not have a 'peg'.
It would reduce their exports and increase their imports or at least their internal consumption of the crap they produce for our markets.
OK, yes we can see that there may be a change from export markets to domestic consumption but that does not indicate that total consumption will necessarily increase.
But increased internal demand and increased purchasing power would lead to inflation down the line.
And this is what I am questioning. Ron Paul says as the US Dollar loses its value that this will lead to inflation. I would think it would be hard to create a scenario where increased value in the currency will lead to inflation. Unless you are thinking that somehow a sectoral inflation phenomenon may develop.

Just wondering...

Rutherfordian ------------------------------ RDRutherford

by Ronald Rutherford (rdrradio1 -at- msn -dot- com) on Thu Jan 10th, 2008 at 02:25:55 PM EST
[ Parent ]
A good paper in Le Monde: Subprimes : la crise continue, par Daniel Cohen

Sorry,I don't have time to translate.

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet

by Melanchthon on Wed Jan 9th, 2008 at 06:44:04 PM EST
http://www.lemonde.fr/web/article/0,1-0@2-3232,36-997306,0.html

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Jan 10th, 2008 at 07:08:16 AM EST
[ Parent ]


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]