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Musings on the savings-glut theory

by Migeru Thu Oct 16th, 2008 at 07:21:38 PM EST

For some reason I cannot quite put my finger on, I am dissatisfied about the exchange between Jerome and Martin Wolf on Bernanke's savings glut theory.

To paraphrase, Wolf takes a cue form a 2005 speech by Bernanke and blames East Asia's (and especially China's) mercantilist policies for the credit crunch. Jerome replies that wealth capture is not wealth creation. I guess part of my problem is that the two positions are not incompatible, and Jerome 1) doesn't refute that East Asia has been mercantilist; 2) doesn't refute the argument that this is the root cause of the asset bubble now deflating. Even if Wolf were to accept Jerome's contention that the bubble was a Western policy choice, Wolf's argument seems to be that there was no good policy path out of the situation created by China's dollar peg and that deflation and recession were inevitable and Jerome doesn't address that.

So I read Wolf's piece over a couple of times and then had some discussions with Metatone, Drew and Colman and here's the result.


Let's start by rereading Wolf's October 8 column Asia's Revenge for statements of fact, theory and opinion. Wolf starts with

What confronts the world can be seen as the latest in a succession of financial crises that have struck periodically over the last 30 years.
For me, mentions of "the last 30 years" in recent commentary are becoming synonymous with Friedmanomics, the Reagan/Thatcher revolution and the dominance of Market Fundamentalism as an ideology. The tone seems to be, universally, that Reagan's era is over, but depending of where in the ideological spectrum the writer comes from this is seen as either a good or a bad thing. Wolf is smart enough to not go into value judgements. However, what is clear from what he writes is that free movement of capital is a contributing factor to international financial crises. It has to stop.

Wolf's argument is that reserves accumulated through trade surpluses are lent to trade-deficit countries until they cause a default. The first example is the "recycling of petrodollars":

To trace the parallels - and help in understanding how the present pressing problems can be addressed - one needs to look back to the late 1970s. Petrodollars, the foreign exchange earned by oil exporting countries amid sharp jumps in the crude price, were recycled via western banks to less wealthy emerging economies, principally in Latin America.

This resulted in the first of the big crises of modern times, when Mexico's 1982 announcement of its inability to service its debt brought the money-centre banks of New York and London to their knees.

So far, so good. What makes the current crisis special is that the borrower is the US, and that the Western banks who used to be intermediaries between two sets of foreign countries are now involved not only as intermediares but as borrowers.
So a "large chunk of money has effectively been recycled to a developing economy that exists within the United States' own borders", they [Reinhart and Rogoff, in a paper from last year] point out.
Note the admission that the levels of inequality and lack of mobility within the US are such that it makes sense to say that the US contains a third-world economy within it. But here's where Wolf uses this to say "this is not our fault"
The links between the financial fragility in the US and previous emerging market crises mean that the current banking and economic traumas should not be seen as just the product of risky monetary policy, lax regulation and irresponsible finance, important though these were. They have roots in the way the global economy has worked in the era of financial deregulation. Any country that receives a huge and sustained inflow of foreign lending runs the risk of a subsequent financial crisis, because external and domestic financial fragility will grow.
So, the question which Wolf skirts is, without risky monetary policy, lax regulation and irresponsible finance (which, together with finance's oversized share of GDP, is what Jerome calls the Anglo Disease) would the global imbalances have led to a different outcome? Wolf is trying to argue that the Anglo Disease was incidental. Jerome, that it was fundamental.

Now, the fact is that Wolf arguably gets his economic history wrong here:

These latest crises are also related to those that preceded them - particularly the Asian crisis of 1997-98. Only after this shock did emerging economies become massive capital exporters. This pattern was reinforced by China's choice of an export-oriented development path, partly influenced by fear of what had happened to its neighbours during the Asian crisis. It was further entrenched by the recent jumps in the oil price and the consequent explosion in the current account surpluses of oil exporting countries.
According to Stiglitz in Globalization and its Discontents, not only had China been on its current development path for 20 years already but also the Asian Miracle pre-1997 was the result of high savings and investment: these countries did not become creditor countries only after 1997. Stiglitz actually argues that the crisis was caused by the adoption of IMF-inspired capital liberalisation which saw an influx of foreign capital to add to the high domestic savings, which was then quickly reversed crashing the Asian economies and currencies when the IMF voiced misgivings about these economies. Here's what Stiglitz has to say about the development model behind the Asian Miracle:
How, I wondered, if these countries' institutions were so rotten [as the IMF warned], had they done so well for so long? The difference in perspectives, between what I knew about the region and what the IMF and the [US] Treasury alleged, made little sense, until I recalled a debate that had raged over the East Asia Miracle itself. The IMF and the World Bank had almost consciously avoided studying the region, though presumably, because of its success, it would have seemed natural for them to turn to it for lessons for others. It was only under pressure from the Japanese that the World Bank had undertaken the study of economic growth in East Asia (the final report was titled The East Asian Miracle) and then only after the Japanese had offered to pay for it. The reason was obvious: the countries had been successful not only in spite of the fact that they had not followed most of the dictates of the Washington Consensus, but because they had not. Though the experts' findings were toned down in the final published report, the World Bank's Asian Miracle study laid out the important roles that the government had played. These were far from the minimalist roles beloved of the Washington Consensus.
To reiterate, a strong planning effort by the government, capital controls and high savings rates (hence no need to be a debtor country) were features of the East Asian Miracle before about 1994. And then, when Wolf claims that this pattern was reinforced by China's choice of an export-oriented development path, partly influenced by fear of what had happened to its neighbours during the Asian crisis, it is worh noting that china established its peg of the Yuan at 8 to the dollar in 1996, and did not change it in response to the Asian Crisis in fact keeping the peg at the same level until 2006.

This, then, means that Wolf is wrong on this
What lay behind the savings glut? The first development was the shift of emerging economies into a large surplus of savings over investment. Within the emerging economies, the big shifts were in Asia and in the oil exporting countries (see chart). By 2007, according to the International Monetary Fund, the aggregate savings surpluses of these two groups of countries had reached around 2 per cent of world output.
He implies that the emerging economies shifted into a large surplus of savings over investment after 1997. In fact these economies were saving heavily through the 1980's and early 90's.

Then, in a sleight of hand that would make The Economist proud, Wolf inserts three charts which have nothing to do with his argument. In fact, if you look at his third chart

you see that there's nothing peculiar about the "emerging Asia" current account balance until after 2004, that is, after the US had been running negative real interest rates for 18 months. Wolf continues:

Despite being a huge oil importer, China emerged as the world's biggest surplus country
and the interesting thing is that it appears from other data

that China had been using the dollar peg to manage its exposure to the price of oil, and that it only dropped the dollar peg in 2005 when the dollar started to come under real pressure from oil prices.

Wolf continues

That represented a vast shift of capital - but unlike in the 1970s and early 1980s, it went to some of the world's richest countries. Moreover, the emergence of the surpluses was the result of deliberate policies - shown in the accumulation of official foreign currency reserves and the expansion of the sovereign wealth funds over this period.

Quite reasonably, the energy exporters were transforming one asset - oil - into another - claims on foreigners. Others were recycling current account surpluses and private capital inflows into official capital outflows, keeping exchange rates down and competitiveness up. Some described this new system, of which China was the most important proponent, as "Bretton Woods II", after the pegged adjustable exchange rates set-up that collapsed in the early 1970s. Others called it "export-led growth" or depicted it as a system of self-insurance.

Yet the justification is less important than the consequences. Between January 2000 and April 2007, the stock of global foreign currency reserves rose by $5,200bn. Thus three-quarters of all the foreign currency reserves accumulated since the beginning of time have been piled up in this decade. Inevitably, a high proportion - probably close to two-thirds - of these sums were placed in dollars, thereby supporting the US currency and financing US external deficits.

There are two obvious questions about this. One is, aren't the deficit countries as responsible for the imbalances as the surplus countries? Isn't the emergence of a large US deficit also the result of deliberate US policies? And then the bit that I really don't understand: why do accumulated foreign reserves have to be lent by the surplus countries to the deficit countries, necessarily? Can't the reserves just sit in the Chinese Central Bank? And why does the US have to borrow from the Chinese? We then come to the key of Bernanke's savings glut argument:
In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.
In other words, to the best of my understanding, because China was hoarding US dollar reserves (and also as a result of the popping of the dot-com bubble), the US economy was in danger of monetary deflation and therefore the Fed had to run an expansionary monetary policy of real negative interest rates which kicked off the credit bubble. That is, because China was draining money out of the US economy the Fed had to keep printing more. And this would have depressed the US exchange rate with the Yuan until the trade balance became zero except that China had a dollar peg. So we have a situation in which the Chinese dollar peg causes runaway debasement of the dollar as China and the US run to stay in place relative to each other. My problem with this is that I don't find it intuitive at all, and Wolf assumes that it's either well known or bleedingly obvious. But on this hinges the whole argument.

So, once we manage to blame the Chinese for Greenspan's 18 months of negative real interest rates around 2003, we can say that

The big global macroeconomic story of this decade was, then, the offsetting emergence of the US and a number of other high-income countries as spenders and borrowers of last resort. Debt-fuelled US households went on an unparalleled spending binge - by dipping into their housing "piggy banks".
Except that the US households didn't go on an "unparalleled" "debt-fuelled" "spending binge". I would argue with Jerome that there was an "unparalleled debt binge" fuelled by the desire to maintain a standard of living in the face of declining real incomes. Low interest rates allowed people to tap their home equity (the only piggy bank they had left as household savings were minimal) for this purpose, leading to a housing bubble.

However, it is still unclear on Jerome's side whether there really was a deflation (and recession) threat from China's drain on the US money supply, and in case there was a threat whether different policies would have resolved it. This is again not intuitive to me, well-known or bleedingly obvious.

Interestingly, Wolf ends with a recommendation that we here might agree with:

So among the most important tasks ahead is to create a system of global finance that allows a more balanced world economy, with excess savings being turned into either high-return investment or consumption by the world's poor, including in capital- exporting countries such as China.
If only they had listened to Keynes at Bretton Woods we would already have an international system designed to attempt to dampen trade imbalances by imposing penalties both on deficit and surplus countries. My beef with Wolf is that he resorts to financialisation to achieve this, which may lead to a "more balanced" system but in my opinion not to a more stable system
A part of the answer will be the development of local-currency finance in emerging economies, which would make it easier for them to run current account deficits than proved to be the case in the past three decades.
And then comes the recognition that global capital market liberalization is a strong destabilising force and needs to be reined in
Yet there is a still bigger challenge ahead. The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.

Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.

This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.

Display:
Here's hoping to get an answer to my recent question to Bruce:
The economic rationale of the post WWII Military Industrial Complex was to avoid the global recessionary impact of a sustained US trade surplus at the same time as providing for a strong employment economy in the US without recourse to the New Deal mechanisms of the government fulfilling its obligations as Employer of Last Resort.

Does the Chinese trade surplus have a "global recessionary impact"? That is, does the savings glut theory have any merit?



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
by Migeru (migeru at eurotrib dot com) on Thu Oct 16th, 2008 at 07:24:06 PM EST
There is this question:
Does the Chinese trade surplus have a "global recessionary impact"?

And this question:

That is, does the savings glut theory have any merit?

However, the savings glut theory rests upon a distinctive understanding of the three balances that requires us to turn cause and effect on its head, and have what is largely a consequence take a leading role as a cause.

The three balances are, recall ...

Expenditure (breaking consumption down between income-financed consumption C_y and externally-financed consumption C_f) is Income-finance consumption, externally-financed consumption, gross domestic investment in productive capacities (including capacity to provide residential services), government spending, and exports.

Cy + Cf + Ig + G + EXP --> GDP

That expenditure provides national income, which is divided between taxes, income-financed consumption, saving in the period, and imports ...

GDP --> Y --> Cy + T + S + IMP

... where the system is in a stable state if the level of Cy that is helping to cause income is the same as the level of Cy that is caused by income.

As a matter of accounting, those injections and leakages can be organized by sector:

Cy + Cf + I + G + EXP = Cy + T + S + IMP =>

Cf + I + G + EXP = T + S + IMP =>

(Cf + I - S) + (G-T) + (EXP-IMP) = 0

or, in the internal/external breakdown:

(Cf + I - S) + (G-T) = (IMP-EXP)

Net new private creation of financial assets from debt-financed consumption and investment in productive capacity plus net new public creation of financial assets from government deficit spending can occur if there is a net finance of a trade deficit, as those financial assets are held overseas.

Now, is that financially sustainable? It very much depends on what is being purchased with the external finance.

Take the "crowding in" scenario: government is spending heavily on productive infrastructure that is acquiring a sustainable ability to harvest resources, plus increasing the efficiency of the economy through increasing the efficiency of resource use. That increase in availability and efficiency of domestic resources leads to private investment in productive capacity. Strong income growth combined with effective regulation of consumer finance to ensure the prudence of the lending means that there is strong saving than externally-finance consumption, and private investment is greater than the balance between the two:

(I - (S-Cf)) + (G-T) = (IMP-EXP)

Provided the average rate of growth of the economy over a business cycle that results is greater than the average trade deficit as a percentage of GDP that results, that could well be sustainable external finance (assuming appropriate terms on external finance, match in maturity of obligations and pace of income growth, etc.).

Now, by contrast assume that Income growth is sluggish, much increase in consumption spending is externally-financed, investment in productive capacity is sluggish, and the government deficit is a pure consumption expenditure, such as spending on aggressive and reckless overseas military adventures.

(Cf - (S-I)) + (G-T) = (IMP-EXP)

In this case, external finance of reckless military adventures and unsustainable debt-financed consumption seems less likely to be sustainable over the long term ... the external finance is not being invested in sustainable economic growth, and therefore an escalating amount of foreign finance may be required over time to sustain the same growth rates, eventually leading to a trade deficit that is a larger share of GDP than any projection of likely economic growth, even the optimistic ones.

OK, call the second case the "WJClinton/GWBush Economic Model". What would the role of the "savings glut" be?

If the US is engaged in the borrowing, clearly the role of the Chinese here is in accommodating, not in causing, the long term unsustainable GDP growth model. And that accommodating entails finding a mechanism for providing the external finance so that the US could continue to purchase Chinese exports, even though the US was on a growth path that is unsustainable in the long term.

Now, is this recessionary? Compared to what alternative? The Chinese have simply been in no position over the past two decades to dictate to the United States that is must adopt a sustainable GDP growth path. The only choices that it has had have been to either accommodate the growth path, putting off the day of reckoning, or refusing to accommodate the growth path, bringing forward the day of reckoning.

Given their own position of riding a massive demographic transition from the insanely unsustainable  pro-population-explosion policies of Mao to the population-control policies of Deng, instituted in 1979, the Chinese really had no choice but to accommodate.

The only side with actual freedom of action in the bilateral relationship was the United States, and our political elite choose to pursue a financially unsustainable GDP growth path.

Of course, under the savings glut model

Now, if you pretend that those accounting balances represent competitive markets, and that participants in those competitive markets are fully informed as to the long-term implications of their choices, and make all other manner of counter-factual suppositions, one can build a model in which the Chinese forced the US to import by manipulating the terms in the finance markets ... you can turn the driving flows of the income stream on their head and turn saving from a consequence into a cause.

But that would be silly. The aggregate amount of saving in the economy is the amount that is compatible with the equilibrium level of national income, and the injections, average tax incidence, and propensities to import and consume out of income that drive that equilibrium national income. People can "try" to save individually, but an increase in saving "effort" reduces consumption and results in the first instance in a reduction in income, rather than in an increase in aggregate savings.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 02:48:50 PM EST
[ Parent ]
So what you're saying is that even if the Savings Glut model were correct and Chinese forex policies forced the hand of the US economy (which you think is nonsense, but let's roll with it for the sake of the argument), Washington could have killed the vicious cycle dead by - say - enforcing margin requirements on all these funny derivatives instead of permitting banks to take them "off-balance-sheet?"

Because this would have limited the American consumer's ability to take on unreasonable debts, which in turn would have limited C_f in your model, which in turn would have limited Chinese saving by not having as big a current account deficit?

The algebra seems pretty simple, so I assume that Wolf knows this, right? Does he have a reason to assume that the US government didn't have the necessary tools to curtail C_f?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:09:53 PM EST
[ Parent ]
... glut model makes sense, then the people taking on risk exposure through complex derivatives already correctly know the risk of a financial system collapse, and interfering with their decision making is going to lead to a less good result.

And in the savings glut universe, if there were these things that the government could do to facilitate the sustainable harvesting of domestic resources, the private sector could do it too (and more efficiently), unless the government were to interfere with their ability to put deals together.

The fact that government can plan complex systems and implement strategic infrastructure permitting new activity to take place ... that fact is of no relevance in a universe where you assume that all complex systems of use are sitting somewhere in a book of blueprints and that innovation is simply a matter of copying the appropriate system out of the book.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:17:02 PM EST
[ Parent ]
So the Savings Glut model makes sense if and only if you assume that Markets Always Know Best?

Because then anything the government might do to regulate derivatives would already be anticipated by the market and priced into the derivatives?

Meaning that a form of derivatives that would pose a significant risk of systemic collapse (i.e. a risk that isn't thermodynamically small) would be priced prohibitively?

Meaning that what we're seeing right now before our very eyes Cannot Happen(TM), any more than all the air molecules in my living room can spontaneously gather under my table, thus choking me of air?

Now, if something actually happens that your model has assigned a thermodynamically small probability... Normally, you'd chuck that model out, right?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:45:00 PM EST
[ Parent ]
Its in the universe of a well-connected complete market system, including implicit valuations of what would be happening in the complete network of forward markets if they existed, that savings and investment as an equilibrium process makes sense.

In the real world, an equilibrium between aggregate saving and aggregate investment then proceeding to drive national income just doesn't make sense ... out here, investment is one of the drivers of income and income one of the drivers of saving.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:56:02 PM EST
[ Parent ]
For me, this comment by Wolf needs explaining in more detail:

European Tribune - Musings on the savings-glut theory

They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.

Why is this flow of capital into the US contractionary?

by Metatone (metatone [a|t] gmail (dot) com) on Thu Oct 16th, 2008 at 08:23:29 PM EST
The contractionary part is easy - when everyone wants to lend you money, there's no need to pay them high interest rates, so rates inevitably fall, just because they can. This is deflationary in the most basic sense of there being so much cash around that it's cheap, cheap, cheap.

This might or might not be contractionary from the point of view of GDP - which is the next part of the question.

What's strange to the point of being exotic is that apparently China was flooding the US economy with a savings glut, creating this danger of contraction, while simultaneously leaching money out of the US by way of its aggressive export strategy.

This only makes sense if you can accept that dollar reserves appear in at least two and possibly three places at the same time.

They're part of the US balance sheet, included in whatever it is that the Fed does when it tries to pretend to balance the monetarist books.

They're owned - or possibly borrowed, it's hard to be sure - by China and other US semi-colonial states, and considered savings.

And some proportion is also invested back in the US money markets as both sovereign funds and private investments, which not only hammer interest rates into the ground but simultaneously help drive a massively leveraged lending bubble.

This is not inflationary, as we all know, because asset inflation isn't counted in the same way as wage inflation or commodity inflation.

Finally - true quantum economics; the same capital, which only exists by fiat anyway, not only appears in many places at the same time, but has opposing effects depending how you count it.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Oct 16th, 2008 at 10:35:37 PM EST
[ Parent ]
Thanks, now what is really going on here? :-P

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
by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 03:27:05 AM EST
[ Parent ]
... process providing the finance to buy the goods that are being sold as a result of the discount.

Nobody in China ever prevented the US from focusing that finance on electrifying the strategic rail network and putting a national inter-regional HVDC grid in place, while establishing feed-in tariffs to encourage investment in domestic renewable energy production.

The decision to use the external finance for a consumption binge rather than an investment drive was entirely made within the US.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 05:23:01 PM EST
[ Parent ]
But the amount of finance that China provides in the process of depressing its FXR is correlated with the trade balance between the US and China. I other words, if the US doesn't buy the Chinese goods there is no upwards pressure on the dollar value of the yuan, and no need for China to accumulate reserves and provide finance to the US. So if the US decides to use the Chinese finance to build infrastructure, the Chinese finance dries up.

Correct me if I'm wrong.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 06:34:00 PM EST
[ Parent ]
The funds are not channeled. The US trade deficit includes manufactured goods trade deficits with Asia, Latin America, Europe, and a substantial trade deficit driven by energy imports.

If the US were to use Chinese finance to build infrastructure, that would attract foreign direct investment in the US, which would tend to push up the value of the US$, which would finance a manufactured goods trade deficit and, yes, the Chinese could shift their focus to maintaining a discount of the yuan/renminbi against the Euro, Yen, Pound Stirling, etc.

But its only perfect information in marginalist modeling that eliminate the impact of timing ... infrastructure construction is an increase in effective demand during the construction of infrastructure ... it is not a contribution to productive potential until it comes online.

Or, for a historical example, after the establishment of the Euro, with the creation of a Euro capital market with the same depth of liquidity as US$ capital markets, and without a foreign exchange risk, there was a substantial amount of acquisition of US-owned Eurozone operations by Eurozone domiciled corporations. As that acquisition wave was in place, it depressed Euro exchange rates against the dollar. Once the wave had passed, with the reduction in income account outflows from the Eurozone to the US, the long term impact was an increase in Euro exchange rates against the dollar.

Of course, with perfect foresight there is no such wave effect ... just as with an adequate wingspan and sufficiently strong flight muscles, pigs could fly and shares in the reinforced umbrella industry would be a growth stock.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 06:58:24 PM EST
[ Parent ]
I wrote again to Martin Wolf, after the initial exchange and after receiving Mig's initial comments on the fact that we did not need to borrow the Chinese surplus. Martin Wolf replied that there would then have been a nasty recession in the US.

I agree with him, but my point is that inflating a bigger bubble to avoid the effects of the previous one only pushes the problem a little further down the road (ie now) and makes it even worse wehn it hits (as we now see).

The problem was not the defict of the US - its was its growing deficit over the past few years. A stable deficit over the years is possible, especially when you own the world currency, but a growing one becomes a Pnzi scheme at some point.

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

by Jerome a Paris (etg@eurotrib.com) on Fri Oct 17th, 2008 at 06:32:55 AM EST
[ Parent ]
we did not need to borrow the Chinese surplus. Martin Wolf replied that there would then have been a nasty recession in the US.

I agree with him

So you don't dispute that the Chinese surplus had a recessionary impact on the US. And moreover

The problem was not the defict of the US

What makes no sense is the following: as a result of the .com bubble bursting there was excess capital in non-financial corporations, and underinvestment (claims Wolf)

The savings glut had another dimension, related to a second financial shock - the bursting of the dotcom bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.
In these conditions there's no need to borrow the Chinese surplus as there's already an excess of capital in the US economy. Why bring in more? And in fact excess capital depresses interest rates as The Economist points out (see quotes in a parallel thread) and low interest rates discourage borrowing from foreigners (such as China).

In addition there was a global shortage of capital due to the Chinese ability to absorb huge amounts of investment through its massive and cheap labour force. So we have excess capital in the US and scarce capital abroad even despite the huge Chinese reserves (though we had a debate here where the conclusion seemed to be that reserves are not really a pot of money that can be sent or invested). This again leads to US capital being lent abroad. This is a carry trade: borrow dollars to lend in other countries, and the Fed lowering interest rates just makes matters worse by making it even cheaper to borrow dollars.

So I am beginning to think that the key is the excess capital of non-financial corporations in the US. JK Galbraith would say that high retained earnings and reduced reliance on external borrowing are the signs of a healthy corporation. So, after the .com bubble the non-financial corporations that survived were in good shape (as apparently is notmally the case in the slow years after a crash). What was in bad shape was Wall Street, which couldn't lend to US corporations and so faced reduced turnover and lean times. So it then appears that the Fed's expansionary monetary policy was intended exclusively (since all the other alleged reasons don't hold water) to allow Wall Street to create a bubble to feed off. Also potentially to create a big pile of money to fund the Iraqi adventure. And then the whole China story is just smoke and mirrors to hide the fact that Fed policy was set for the exclusive benefit of Wall Street.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 07:12:47 AM EST
[ Parent ]
... engine for economic growth, then borrowing the trade surplus would have been an external finance of a portion of beneficial real investment, rather than external finance of private and public consumption.

External borrowing to consume in excess of existing rates of income growth is not a sustainable activity. External borrowing to invest in higher sustainable growth rates may be, depending on the terms and the realized benefit of the investment.

Clearly, the US has been borrowing to consume over the past 14 years.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 02:52:46 PM EST
[ Parent ]
I feel like I got more understanding about the 1997 Asian crisis by reading a chapter in Naomi Klein's "The Shock doctrine".

To start with, Stiglitz' conclusion on Asian tigers resonates:

the countries had been successful not only in spite of the fact that they had not followed most of the dictates of the Washington Consensus, but because they had not.
To strong planing effort, capital controls and high savings rates you may add some healthy old-fashioned protectionism.

The observation that free movement of capital is a contributing factor to international financial crises rings a bell as well. Prior to 1997, Friedmanists achieved little in Eastern Asia, except that they finally got they wish of free movement of capital. And the whole story of the 1997 Asian crisis is that: capital suddenly fled East Asia, and when the governments capitulated to IMF and accepted Washington consensus "medicines", the capital still did not return. Friedman himself called for more "necessary" pain there. (Could you imagine libertarians argue for more pain in Wall Street now?) At the end, "there was no alternative" (as the Iron lady would say) and Asia was picked apart for a bargain. The Asian crisis looks more like colonialism by financial means than a "natural" economic storm.

As for the topic question (the Asian saving glut versus unregulated Wall Street), one may ask: who could have behaved differently? After the crisis, Asia was saving dollars to protect their currencies against future (hegemonic) attacks. They may have overdone that, but on the other hand, they could not do much with excessive dollars, as domestic spending would cause inflation (or so they were told) and they had to keep their currencies low to be "competitive" exporters. On the other side, why did the US need to inflate its trade deficit?? That's where all the glut lies, I think. On balance, Asia was producing goods for America without much real gain and guarantees for its people. How different is that from "usual" colonialism?

by das monde on Fri Oct 17th, 2008 at 04:22:45 AM EST
Thanks, but this still doesn't answer the question of why/whether/how Asian mercantilism necessarily has a deflationary/recessionary impact on the US (or even globally).

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
by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 04:33:34 AM EST
[ Parent ]
What mercantilism? After the 1997 crisis, nothing was less of protectionism, or of selling goods high but buying low.

The earnesty to export is to be explained by behavioral macroeconomics. The developing world was told that the way to prosper is to export; what better could they know? Smart bulbs in world's financial centers must have liked this kind of stripped "mercantilism". They may have figured out unsustainability of it all, but the logic "by the time we'd suffer all the world would be in shatters" apparently kept them comfortable. Asia's savings may have became a contributing part of this doom machine in Wolf's way, but that contribution must be weighted against the fuel of follies from Wall Street. The problem is, no one knew (and still does not know) how to counter that much glut and financial intimidation from unregulated fools.  

by das monde on Fri Oct 17th, 2008 at 04:58:55 AM EST
[ Parent ]
I may need to talk to the spellchecker. In the first paragraph above, a sentence should continue

... nothing was left of protectionism...

by das monde on Fri Oct 17th, 2008 at 05:03:04 AM EST
[ Parent ]
The way I understand it, mercantilism means sustaining a trade surplus which, in a world of floating exchange rates, requires depressing the value of the currency which causes an accumulation of foreign reserves.

So I use mercantilism as equivalent to accumulation of foreign reserves.

I am open to correction since this is a learning exercise for me.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 05:08:54 AM EST
[ Parent ]
That's how adaptation of classical notions to the modern world looks like.

Indeed, mercantilism means sustaining trade surplus, but usually with a naked purpose to capturing more wealth.

Mercantilism as a whole cannot be considered a unified theory of economics because mercantilism has traditionally been driven more by the political and commercial interests of the State and security concerns than by abstract ideas. There were no mercantilist writers presenting an overarching scheme for the ideal economy... Rather, each mercantilist writer tended to focus on a single area of the economy... Smith saw the mercantile system as an enormous conspiracy by manufacturers and merchants against consumers, a view that has led some authors... to call mercantilism "a rent-seeking society"... Mercantilists viewed the economic system as a zero-sum game, in which any gain by one party required a loss by another. Thus... there was no possibility of economics being used to maximize the "commonwealth", or common good. Mercantilists' writings were also generally created to rationalize particular practices rather than as investigations into the best policies.

The modern Asian "mercantilism" is hardly grounded by self-interest analysis. The method is rather forced by the global system; the pressing question becomes "What does a country have to do (to appear nice)?" rather than "What does a country want?" The center of "rent-seeking" is somewhere completely else.

by das monde on Fri Oct 17th, 2008 at 05:38:52 AM EST
[ Parent ]
... the focus is not on the capture of the silver to use to buy into the carrying trade in East Asia, as in Europe in the 1700's, but rather on the finance of exports in order to generate employment.

A trade surplus is still being targeted, but the cause-effect has been inverted ... rather than pursuing a trade surplus in order to acquire foreign exchange (precious metals at the time), external exchange is acquired in order to depress exchange rates in order to achieve a trade surplus.

"Neo" often means "not exactly, but obliquely".


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 02:57:57 PM EST
[ Parent ]
See this diary by Jerome from 3 years ago. Which concerns the deflationary effect of  cheap Asian labour on American consumer prices and wages.

But no, it doesn't address the question of the necessity, by some macroeconomic mechanism, of foreign currency reserves accumulated in a country or countries leading to recession in the emitting country.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Oct 17th, 2008 at 05:45:12 AM EST
[ Parent ]
But deflation due to productivity increases is a good thing, whereas deflation due to monetary contraction is a very bad thing. Jerome says China's emergence into the world economy has made labour relatively abundant and capital relatively scarce, and so the relative return to capital has risen which is exactly the opposite of what Wolf claims, since he claims that there is excess savings and this leads to excess capital available in the US economy. He quotes The Economist saying
The entry of China's army of cheap labour into the global economy has increased the worldwide return on capital. That, in turn, should imply an increase in the equilibrium level of real interest rates. But, instead, central banks are holding real rates at historically low levels. The result is a misallocation of capital, most obviously displayed at present in the shape of excessive mortgage borrowing and housing investment. If this analysis is correct, central banks, not China, are to blame for the excesses, but China's emergence is the root cause of the problem.
Is Bernanke's savings glut theory not even wrong, then? And why does Wolf revive it now?

Thanks for the link in any case, that's a very good post by Jerome.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 06:05:39 AM EST
[ Parent ]
It doesn't make sense as long as you don't distinguish between financial and real economies.

In the Jerome economy labour is cheap and real investment capital is scarce. This is deflationary in terms of real earnings and likely future returns on practical investment.

In the Wolf economy labour is a footnote and financial investment capital is plentiful. This is apparently deflationary, but in fact it traps all of the productivity gains created by cheap labour which means it's pure distilled growth which is then releveraged.

The real economy deflates while the financial economy bubbles. Some of the financial economy trickles down to the real economy in the form of toxic cheap loans which disguise the deflation/recession, and which then bubble up again as fake collateral which makes the financial bubble even bigger.

In fact the argument is almost entirely political, and the aim is to blame China instead of accepting blame at home.

It would have been possible to grow the real economy - especially green and tech - with real investment.

Instead the money went elsewhere - and not just to China, but on corporate welfare projects, including the Iraq war.

Claiming that China is responsible is like blowing your legs off with a hand grenade and then blaming the company that made the pin.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Oct 17th, 2008 at 06:35:35 AM EST
[ Parent ]
Vital point: it traps all of the productivity gains created by cheap labour.

One of the main characteristics of the financialisation of the economy aka "Anglo Disease" is high and increasing return-on-capital requirements. In the bubble economy, it has been sink or swim on this criterion (little or nothing to do with useful competition in the real economy). Corporate survival itself was based on it (lose market cap, get swallowed by a bigger fish), hence the huge payouts to top corporate officers (keep the market cap high, the next quarter's expectations shiny, and you're the CEO who can name his price). And the results of this high profitability were not going to productive investment in the real economy, but sloshing around in the US and globally looking for yet higher (inc. speculative) returns. Labour (Asian or Western) and the real economy were/are/will be footing the bill for this froth.

Suggesting that all this was the mechanical result of a macroeconomic imbalance, while the Chinese were alone in making political decisions, is the usual conservative/marketista gambit: those who do politics are always on the other side.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Oct 17th, 2008 at 09:01:53 AM EST
[ Parent ]
In the Jerome economy labour is cheap and real investment capital is scarce. This is deflationary in terms of real earnings and likely future returns on practical investment.

In the Wolf economy labour is a footnote and financial investment capital is plentiful. This is apparently deflationary, but in fact it traps all of the productivity gains created by cheap labour which means it's pure distilled growth which is then releveraged.

Well, labour is cheap and capital is scarce globally but in the US you have relatively high labour costs and plentiful capital so the tendency is for US capital to seek investment opportunities abroad and that is deflationary/recessionary within the US. But the answer cannot be to reduce interest rates because that just makes the US less attractive for capital. One way or another the US government needs to stimulate investment in the US economy. Monetarists just lowered interest rates which created an asset bubble and no real investment, because they are mostly concerned with the putative effects of a monetary contraction which they try to fed off.  A fiscal solution would tax away the excess capital and reinvest it directly. But the reason there is a problem in the first place is that there is free cross-border movement of capital.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 09:15:25 AM EST
[ Parent ]
Well, as Afew says the reason there is a problem in the first place is because there's a caste which is willing to run a national economy into the ground for short term profit, and this caste has the resources to steer politics and the media narrative in its own favour.

It wasn't enough to try to globalise the rest of the world - the caste also decided to globalise the US itself.

Financially the US is now literally two different countries, joined nominally by a federal government which is contiuing to move cash from the real economy into the financial economy because what happens in the financial economy benefits everyone.

Supposedly.

Taxation, regulation, limitation of free capital movement, and reinvestment all have to be tied into a package - ideally with criminal charges for fraud.

But at the moment it's looking more likely that more bailouts will continue to be 'necessary' until bailouts stop being possible, real investment which will be decimated, and profit will be stripmined from the real economy and dumped into useless items like gold bullion.

Capping bonus culture, to the extent that it happens at all, doesn't even begin to address the real issues.

And we're losing the narrative battle again, because while people are angry about the bankers and idealistic about Obama, there's no practical or narrative push-back happening. A bit of sniping on TV from aggressive journalists doesn't count as a sea change - what counts is policy change, and there doesn't seem to be much likelihood of that yet.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Oct 17th, 2008 at 09:34:58 AM EST
[ Parent ]
And we're losing the narrative battle again, because while people are angry about the bankers and idealistic about Obama, there's no practical or narrative push-back happening. A bit of sniping on TV from aggressive journalists doesn't count as a sea change - what counts is policy change, and there doesn't seem to be much likelihood of that yet.

Maybe the most pertinent comment among the many analytical gems  here.

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears

by Gringo (stargazing camel at aoldotcom) on Fri Oct 17th, 2008 at 08:54:39 PM EST
[ Parent ]
... but steadily cheapening labor is the only way to describe median incomes, largely derived from wages and salary, being stagnant, while incomes of the top 1% and 0.1%, largely derived from corporate profits, rise.

And real capital has been by no means as plentiful in the US as financial capital ... real capital formation has been sluggish for the whole of the current decade.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 04:06:33 PM EST
[ Parent ]
Yes, exactly - the core mechanism here is a real economy recession/depression disguised under a faked-up financial bubble.

It's lipstick on a pig, and China bought the pig.

Bernanke is blaming China, but both he and Greenspan were the ones armed with the lipstick.

I don't entirely agree with Migeru that the bubble was exclusively for Wall St's financial benefit. I think there was an obvious political need after 9/11 to make it look as if Big Brother was raising the chocolate ration.

In fact what we got was a combination of PR spin and classic Keynesian deficit spending on a war. Unfortunately the war wasn't winnable and instead of retooling the economy for total war - which would have been impossible politically, but would have done the job economically - some of the cash was handed out as free money to the mil-ind people, and the rest was snorted as derivatives, et al.

Meanwhile the real economy was tanking, and this had to be disguised - or at least the inevitable outcome had to be postponed for as long as possible.

China was never the problem, because if China hadn't supplied cheap labour, it would have been some other country or mix of countries.

Aside from the corporate welfare angle, another major part of the problem was the US energy sector, which continues to be a massive drain on US capital. If there are 'savings' anywhere, that's a good place to look for them.

Enron died soon after 9/11, but privatised energy has been screwing consumers and businesses ever since, and generally acting like a very heavy boat anchor tied to the real economy.

A better way to avoid a recession would have been to regulate and redistribute wealth from energy profits, and to invest that money in retooling the economy for energy independence.

But that was never going to happen with 43 in the big white house. So - here we are.

Effectively Wall St is now a microstate of its own, and treats both the US and China - and the rest of the world - as its fiefdom. Where the real economy in the US has been entirely passive about its colonisation, China has been slightly - but only very slightly - more robust as a trading partner. This has attracted some minor disdain from the Barons, but not much more than that.

Nothing in the last few weeks has changed this in any way.

A useful question to ask now is - where are the savings which supposedly caused these problems?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Oct 17th, 2008 at 08:10:42 PM EST
[ Parent ]
... saving is the amount of income in a period that has been handed over by the recipients in return for financial promises. Savings is the total accumulated promises.

The saving evidently existed in the sense of income handed over from the recipients to be spent by someone else. Whether the savings exist depends on the ability of those who made promises to keep those promises ... since a person or people (often in the guise of a going concern) making a promise who is ready, willing, and able to keep the promise is what a financial asset consists of.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat Oct 18th, 2008 at 12:15:55 AM EST
[ Parent ]
Note that I have created a new index story with all the diaries and stories on the current crisis, plus the old Anglo Disease diaries. I should probably add to it the "Bubbles" Greenspan series.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Oct 17th, 2008 at 06:34:42 AM EST
A brilliant Diary, migeru: one of the most important recent Diaries.

the countries had been successful not only in spite of the fact that they had not followed most of the dictates of the Washington Consensus, but because they had not.

As anecdotal evidence, some people I know who inhabit the far out fringes of monetary reform got the ear of an adviser to Malaysia's Premier, Mahathir, who was convinced by their analysis and recommendations.

To wit, capital controls etc.

The result was that Malaysia came through the crisis relatively unscathed, and of course Mahathir was a pariah in the global financial system therafter....not that this bothered him...

It will take a little more time to assimilate this Diary, but migeru and I are in agreement that Keynes International Clearing Union proposal and Bancor were along the right lines.

I differ from Keynes in that I think the system can be architected on a Peer to Peer networked basis without a central financial institution creating the necessary globally acceptable currency - which IMHO should be "unitised" energy.

The greater proportion of value in circulation is the use value of land, and this is necessarily land-locked (ie with capital controls built in) since a Unit based on land rentalo values would only be redeemable on a geograhic basis.

It was John Law, 300 years ago, who first proposed monetising land rentals, but his proposal was for "securitisation". I advocate "unitisation" through new generatiions of quasi "REIT's and a "Debt - Equity Swap" on a massive scale.

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

by ChrisCook (cojockathotmaildotcom) on Fri Oct 17th, 2008 at 09:05:19 AM EST
More from Stiglitz:
Malaysia and China

By contrasting what heppened in malaysia and China, two nations that chose not to have IMF programs, with the rest of East Asia, which did, the negative effects of the IMF policies will show clearly. Malaysia was severely criticized during the crisis by the international financial community. Though Prime Minister Mahathir's rhetoric and human rights policies leave much to be desired, many of his economic policies were a success.

...

As the regional crisis grew into a global crisis, and international capital markets went into a seizure, Mahathir acted again. In September 1998, Malaysia pegged the riggit at 3.80 to the dollar, cut interest rates, and decreed that all offshore ringgit be repatriated by the end of the month. The government also imposed tight limits on transfers of capital abroad by residents in malaysia and froze the repatration of foreign portfolio capital for twelve months. These measures were announced as short term, and were carefully designed to make it clear that the country was not nostile to long-term foreign investment. Those who had invested money in Malaysia and had profits were allowed to take them out. On September 7, 1998, in a now-famous column in Fortune magazine, the noted economist Paul Krugman urged Mahathir to impose capital controls. But he was in the minority. Malaysia's Central Bank governor Ahmad Mohamed Don and his deputy, Fong Weng Phak, both resigned, reportedly because they disagreed with the imposition of the controls. Some economists—those from Wall Street joined by the IMF—predicted disaster when the controls were imposed, saying foreign investors would be scared off for years to come. They expected foreign investment to plummet, the stock market to fall, and a black market in the ringgit, with its accompanying distortions, to form. And, they warned, while the controls would lead to a drying up of capital inflows, they would be ineffective in stopping caital outflows. Capital flight would occur anyway. Pundits predicted that the economy would suffer, growth would be halted, the controls would never be lifted, and that Malaysia was postponing addressing the underlying problems. Even Treasury Secretary Robert Rubin, usually of such quiet demeanor, joined in the communal tongue-lashing.

In fact, the outcome was far different. My team at the World Bank worked with Malaysia to convert the capital controls into an exit tax. Since rapid capital flows into or out of a country cause large disturbances, they generate what economists call "large externalities"—effects on other, ordinary people not involved in these capital flows. Such flows lead to massive disturbances to the overall economy. Government has the right, even the obligation, to take measures to address such disturbances. In general, economists believe that market-based interventions such as taxes are more effective and have fewer adverse side effects than direct controls, so we at the World Bank encouraged Malaysiato drop direct controls and impose an exit tax. Moreover, the tax could be gradually lowered, so that there would be no large disturbance when the interventions were finally removed.

Things worked just as planned. malaysia removed the tax just as it had promised, one year after the imposition of controls. In fact, Malaysia had once before imposed temporary capital controls, and had removed them as soon as things stabilized. This historical experience was ignored by those who attacked the country so roundly in the one-year interim. Malaysia had restructured its banks and corporations, proving the critics, who had said that it was just with the discipline that comes from free capital markets that governments ever do anything serious, wrong once again. Indeed, it had made far more progress in that direction than Thailand, which followed the IMF prescriptions. In retrospect, it was clear that Malaysia's capital controls allowed it to recover more quickly, with a shallower downturn, and with a far smaller legacy of national debt burdening future growth. The controls allowed it to have lower interest rates than it could otherwise have had; the lower interest rates meant that fewer firms were put into bankruptcy, and so the magnitude of publicly funded corporate and financial bailout was smaller. The lower interest rates meant too that recovery culd occur with less reliance on fiscal policy; and consequently less government borrowing. Today [2002], Malaysia stands in a far better position than those countries that took IMF advice. There was little evidence that the capital controls discouraged foreign investors. Foreign investment actually increased. Because investors are concerned about economic instability, and because Malaysia had done a far better job in maintaining that stability than many of its neighbours, they were able to attract investment.

It comments itself, doesn't it? But to recap: the 1997 crisis was a direct result of IMF-inspired capital flow liberalization. Capital controls were the best route to recovery, but not by themselves. All that capital controls (or an exit tax) do is allw a low domestic interest rate in lean times which in the absence of capital controls would cause a capital flight out of the country. Also, when Wall Street says "foreign investors will be scared off for years" they really mean foreign speculators. Real investors "are concerned about economic stability" and were not scared off by capital controls.

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
by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 09:46:34 AM EST
[ Parent ]
Also, when Wall Street says "foreign investors will be scared off for years" they really mean foreign speculators. Real investors "are concerned about economic stability" and were not scared off by capital controls.

Investment needs to be added to our Newspeak dictionary, right alongside reform, flexibility and freedom.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 10:03:12 AM EST
[ Parent ]
"Investment" has always been understood as spending, where spending is transaction activity, between what value and the other is irrelevant. Spending is exchange and conveyance of ownership.

"Saving" on the other hand has always been understood to mean NOT transaction activity. One keeps capital. The safekeeper or custodian may lend one's capital as is permissable by law, in so far the custodian must remit one's capital ON DEMAND. Ownership of capital is not conveyed by any, none, zero, zip, exchange.

Currency is the final vestiges of productive asset ownership in western society is property (a) quantity of currency (b) quantity of labor.

"Neo-cons" --whose business model depends on intermediary calculation of exchange value (business value)-- promulgate the superiority of unearned income by capital usury, i.e. interest payments, "opportunity risk" as compared to earned income, i.e. labor payments. Neo-cons happen to own inordinate quantites of (a) currency and (b) labor, or surplus capacities to be rented to those who own none, by virtue of monopoly protections, vested in assets (inanimate or animate property), enforced by the state.

Amazing!

Burton K. Wheeler: I saw the Depression coming. Joe Kennedy [FDR SEC chair] came to see me. He said, "I'm afraid I'm gonna wake up with nine kides and three homes and no dough." I said, "Do you want to be safe? Buy gold." He came to me again. "They've take my gold." I said, "Buy silver buillon." He came down once more. "They're taking my silver buillon." I said, "Do you want to be perfectly safe? Go get a farm, wher you can raise a cow, a pig and some chickens, and put some of those kids of yours to work. But don't get too big, because we might take it from you." He said, "Is it as bad as that?" I said, "No, but it might get that bad."

He recounted his experiences as a visitor in Vienna in 1923, as the Depression there affected all classes. "I didn't think it would start as quickly as it did here in the United States."

Hoover was President when they passed the Reconstruction Finance bill. I opposed it. Its purpose was to bail out the bankers, the insurance companies and the railroads. I said, "The pressure's gonna be so great that anybody who's got a sick cow is gonna come to Washington to borrow money." Bob La Follette Junior said he's voting for it, because he's afraid there would be a crash. I said, "There would be, but the sooner it comes off, the better." This RFC would only prolong it. The greater our indebtedness, the greater the crash. [Terkel, 303: 1970]



Diversity is the key to economic and political evolution.
by Cat on Fri Oct 17th, 2008 at 05:29:05 PM EST
[ Parent ]
I think it's worthwhile to write the two models out explicitly and put them next to each other. As I understand it, the stories go something like this:

Jerome's StoryWolf's Story
US median real incomes have been declining since Reagan was elected.China runs a neo-merchantilist exchange rate policy - i.e. maintains an undervalued currency to boost exports [1].
Maintaining consumption patterns in the face of declining real income means reducing savings rate.Maintaining an undervalued currency requires accumulation of the currency you target [2].
If this trend goes on long enough, at some point, the median household will reach zero savings rate.The Chinese Central bank has to reinvest their surplus $ [Magic Asterisk 1], and the only place they can do that without crashing the $-everything-else-except-renmimbi rate is US Treasury bonds.
A negative savings rate eventually means that you run out of savings.Putting surplus $ into T-bonds drives up the price of bonds.
When you run out of savings, you have to either cut back on consumption, increase your income or start borrowing.Driving up the price of bonds is equivalent to driving down the interest rate [3].
Raising median real wage would shift the distribution of value-added in the economy back towards labour, so that's ideologically unpalatable for The Powers That Be. Telling people that they must cut back on their spending is tactically unacceptable to The Powers That Be, for much the same reason that suspending the bread and circus was tactically unacceptable to Roman plutocrats. So The Powers That Be had to make it easier to borrow money, which they did by lowering the interest rates.Lower interest rates make it easier to borrow money.
Making it easier to borrow money leads to higher leveraging (i.e. makes it easier to gamble with borrowed money).[Magic Asterisk 2]
Gambling on the exchange with borrowed money creates a bubble environment (or, if we are to be less kind, easy money facilitates Ponzi scams) in which asset prices inflate to untenable values.[Magic Asterisk 3]
Stuff Goes Boom.Stuff Goes Boom.

[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

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 09:31:55 AM EST
Now assuming that the two models I've sketched out are reasonably faithful representations of the arguments presented, I'd like to deduct some predictions (or rather, some postdictions) from them that can be used to compare them.

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)?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 09:45:07 AM EST
[ Parent ]
Extra asterisk [3] question:

Driving up the price of bonds is equivalent to driving down the interest rate [3].

And you note:

[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 %.

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.

by Metatone (metatone [a|t] gmail (dot) com) on Fri Oct 17th, 2008 at 02:59:55 PM EST
[ Parent ]
IANAE, but I think the short explanation can be summed up in the word arbitrage.

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.]

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:36:38 PM EST
[ Parent ]
... central bank is willing to lend at without frowning, or the interbank cash rate driven by the central bank injecting or draining reserves by buying and selling bonds, that is the commercial bank's floor cost of funds for ordinary banking operations.

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.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 05:14:45 PM EST
[ Parent ]
Still, as banks are receiving loan repayments without rolling the credit over, the quantity of credit-money will be declining

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 06:24:51 PM EST
[ Parent ]
Banks don't want to lend to those who need to borrow, in any event.

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.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 07:08:39 PM EST
[ Parent ]
What do you mean with 'domestic' vs. 'imported' value-added?

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
by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 07:15:14 PM EST
[ Parent ]
If 40% of the value added in a product came from imports components, and 60% from domestic factors (labor, equipment, natural resources), then that is 60% domestic value added.

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.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 07:47:27 PM EST
[ Parent ]
So to translate from econospeak into English, aggressive outsourcing during the 80s and early 90s - which led to the oh-so-admired increase in corporate profits (and "competitiveness") that caused Japan to be revered as a model country for corporate governance - killed off the economy and led to Japan being dumped like an apple with a worm in it by the very same people who'd been so enthusiastically praising it just years before?

And these bizniz pundits who recommend outsourcing are being taken seriously because?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Oct 18th, 2008 at 12:30:10 AM EST
[ Parent ]
... when Japan in the middle of the lost decade, slammed its cash rate down to 0.1% ... that of course pushed the Yen from an importer's to an exporter's exchange rate, and as a side-effect destroyed the presumption behind the easy money games in Southeast Asia that the Yen would always be strong against the US$, so it would always be possible to borrow short in US$ and roll it over and pay back long using Yen earnings, combining a foreign exchange gain with the lower cost of short term finance.

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.

by BruceMcF (agila61 at netscape dot net) on Sat Oct 18th, 2008 at 05:57:47 AM EST
[ Parent ]
... the dollars have to sit in dollar denominated assets, because moving them out of dollars neutralizes the exchange rate policy.

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.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:02:24 PM EST
[ Parent ]
So what you're saying is that sitting on a pile of T-bonds and sitting on a pile of cash is pretty much the same deal as long as you can't sell it and everybody knows that you can't sell it?

If so, that would indeed make [Magic Asterisk 1] go away.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:37:57 PM EST
[ Parent ]
Yes, certainly.

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.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 03:51:04 PM EST
[ Parent ]
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 ;-)

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 03:59:35 PM EST
[ Parent ]
Your expansion of the binge as an attempt to 'keep up' while suffering contracting income is spot on. This is driven of course by the consumer culture created over the last nearly 50 years by the profile of 'success in life' defined by the mainstream media and the marketing industry that supports it.

Surrounded by images and descriptions of how sexual satisfaction, power, status and 'happiness' can be achieved by possessions, and aided by marketing that negatively implies that you really are unhappy, but just buy or do 'this' to cure your unhappiness - it is little wonder that vast swathes of post-industrial societies were persuaded to buy the crap that empowered the industrializing societies into rapid growth while ignoring infrastructure and the limits to resources.

Up until now, there have been very few msm messages that have not supported this process of human destruction.

You can't be me, I'm taken

by Sven Triloqvist on Fri Oct 17th, 2008 at 02:12:31 PM EST
I think the savings glut hypothesis is very compelling - and not really in contradiction with the anglo disease.

The 'standard theory' is, that high inequality in a country leads to high savings, because the propensity of rich people to save is higher according to the 'standard theory' than for low income people. Lefties in Germany make always inequality responsible for the sluggish consumption, but perhaps this theory is indeed wrong and we should increase inequality to get more consumption.
Now, Jerome said, normal people borrowed to keep their standard of living with declining median incomes. But as the economy overall grew, this borrowing could be just a replacement for a different income distribution, e.g. the desire to keep the standard of living (note: to borrow for that is as well a choice, and an unusual one) would not require to borrow more than the extra savings of the rich. The negative savings rate in the US is only explainable, when rich people didn't save much, either. For the high trade deficit, the lack of huge savings from the better off maybe the most striking point.
But the historic crisis that is the example for the christianisation of the anglo-disease, describes a situation, in which one sector, that doesn't employ many people for its share of output, is over competitive on the international market and 'crowds out' other branches in the same country from the international market, by leading to a largely overvalued currency. But what was the product the US exported so successfully, that the dollar has become overvalued? IOUs! And who bought that paper, in a way, that the dollar went up? Emerging markets, with their surplus savings. Indeed European banks have as well lots of US debt, but they didn't really buy that paper with European savings. They borrowed dollars to purchase these papers, they were just dealers, no big net buyers. This actually makes sense, if you expect, that the US would inflate out of any debt crisis. Then US real estate would become more valuable in dollar terms, so no defaults on the now so toxic debt. And as the European banks were not net long in the dollar, the decline of the dollar wouldn't be a problem for them, either.
When a central bank keeps its interest down, then this should lead to long term inflation. Long term inflation  expectation should lead to high long term interest rates. The funny thing is, that this didn't happen. The emerging markets bought the $ IOUs despite the expectation, that they would lose money on them - the reasons maybe various or not, but that they bought this IOUs for low interest rates, is pretty clear. The expectation is, that this should lead to a losses mostly for the emerging markets, not the US.

What went wrong in the US then? I think the most important question is, if houses are counted as consumption or as investment. If they are investment, then there is no problem. The houses, that were bought with the borrowed money do still exist. If they are investment, they should generate enough wealth to pay for the debt, people have loaded on the houses.
If houses are consumption, their prices should be in the CPI and Greenspan should have raised rates. His argument for not raising rates is, that the long term rates - on which the central bank has no direct influence - were low, despite his low short term rates. Increasing the short term rates would have led to an inverse interest structure. He could have accompanied a rise in the rates with a clear statement, that he intends to keep rates high for a long term. But this would have required a brave decision. Greenspan is a coward, as obvious by his constant hedging of nearly all of his statements. He says about everything this and the opposite. As well the Fed has not even only the goal to keep inflation down, but as well to keep employment up (indeed many lefties in Germany cheered Greenspans low interest rates). So the Fed is very willing to create bubbles, when this helps to keep employment high. The lack of a social net, doesn't allow the US to have recessions with longer term unemployment as high as in many European countries. The normal gov't is paralyzed by the believe it is always and ever only the problem and never the solution. So the Fed is the only actor to perform a full range of gov't responsibilities (as not even Americans are libertarian enough to accept mass starving), that it simply cannot fulfill with its very limited tool box.

But while Greenspan's failure to act is important, the Fed wasn't the only institution that is responsible. One source of the trade deficit of the US in last years were already the high commodity prices of a more and more crowded earth. This strikes in a double way. Not only directly via higher import prices, but as well on the housing market, devaluing the worth of houses as investment, when they are huge, insufficiently insulated, and far away of other social infrastructure people need in their daily lives.
The channels through which the emerging markets financed the US was mostly by buying treasuries and somewhat by buying Fanny&Freddy guaranteed mortgages. So while the US could IMO do little to prevent to have a CA deficit against the mercantilistic emerging markets, she had the possibility to decide where to put the money. The money was funneled via F&F into the housing market, or used for consumption by the US gov't. If the national debt of the US would have been used to invest into something useful, e.g. energy independence, she would now easily be able to finance the interest on the debt. But instead tax reductions and wars were financed.

Now to some explicit points of your diary:


For me, mentions of "the last 30 years" in recent commentary are becoming synonymous with Friedmanomics, the Reagan/Thatcher revolution and the dominance of Market Fundamentalism as an ideology.

The last 30 years were pretty good years for humanity. Global inequality was reduced by free markets, technology and knowledge spread around the world, the increasing dependency of others made wars far more expensive and very rare, except in those countries that took harly part in the international division of labour. So Thatcher and Reagan were the greatest politicians - ever?


However, what is clear from what he writes is that free movement of capital is a contributing factor to international financial crises. It has to stop.

While totally free movement of capital - independent of international or national - boosts bubbles, relatively free movement provides huge benefits - especially for the capital poor countries. The US is a relatively isolated economy. The Eurozone e.g. is much more open (therefore I doubt that Thatcher and Reagan were really the driving forces). If the emerging markets would have bought directly mortgages, they would now suffer huge losses. The US state is only involved, because it funneled the money through gov't guaranteed IOUs to unproductive elements in the US, either via F&F, or war, or tax policy (deficit, tax deductability of mortgages and 'Laffer curve' believe, that lower taxes refinance themselves).


"spending binge"

Aggregatedly correct. One would have expected the better-off people to save in excess of the debt of the less well-off.


He implies that the emerging economies shifted into a large surplus of savings over investment after 1997. In fact these economies were saving heavily through the 1980's and early 90's.

Yes, but were they saving in excess over investment before 1997?

Re balance picture:
Note that this is savings relative to world GDP. Part of the increase may be due to the fact, that emerging Asia has increased its share of world GDP in that time. Perhaps the savings surplus became simply too big to absorb.


Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Fri Oct 17th, 2008 at 03:36:42 PM EST
But as far as I can tell, you don't actually disagree with Bruce that prudent US policy could have averted the crisis?

I don't think anybody disagrees with Wolf that the Chinese exchange rate policies helped inflate the bubble. But bubbles inflate with or without help from abroad - that's in the nature of almost all systems with limited information and delayed feedback. So the interesting question is not so much by which precise mechanism the bubble was inflated; rather, it is a question of who - if anyone - could have deflated it in time to minimise the fallout.

Wolf's (implicit) answer is that Chinese policy meant (at least partially) that the US government couldn't have deflated the bubble in time to avoid nasty fallout. Jerome's and Bruce's answer is that the US government could have deflated the bubble in time - but then they'd have had to deal with the fallout from the last bubble, which they deliberately did not deflate in time.

I.o.w., they made a conscious political choice to kick the can farther down the road rather than deal with the problems there and then. And if The Powers That Be are perfectly willing to make a bigger mess tomorrow in order to avoid dealing with the mess today... do you really believe that they wouldn't have found some other way to bubble up their economy if China hadn't played ball?

Also, I'll PN you on this:

The last 30 years were pretty good years for humanity. Global inequality was reduced by free markets, technology and knowledge spread around the world, the increasing dependency of others made wars far more expensive and very rare, except in those countries that took harly part in the international division of labour. So Thatcher and Reagan were the greatest politicians - ever?

I think that Grenada, Lebanon, El Salvador, Nicaragua, Libya, Iran, Panama, Iraq (twice - at least), Somalia, Sudan, Afghanistan (twice) and Serbia would disagree.

Not to mention East Timor, Palestine, Tchad, Liberia, Sierra Leone, Rwanda and a couple of other African countries whose names I can't recall off the top of my head.

One could, of course, argue that none of the above countries had joined the Washington Consensus (in fact, quite a lot of these wars were about forcing them (back) in line with the Washington Consensus. But I digress). But that would be akin to saying that the British Empire was a good thing for the colonies, because the colonies didn't fight wars against each other while under British rule.

And I take issue with your claim that global inequality declined. It is possible that global inequality between the countries within the Washington Consensus framework declined. But if so - and I am far from certain that it is so - this is more than offset by the explosive growth of truly destitute underclasses within Washington Consensus countries.

In fact, over this period, we saw slums and/or shantytowns springing up at an unprecedented rate in Palestine, South Africa, Indonesia, Russia and a couple of the countries on the above lists as well.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 04:36:17 PM EST
[ Parent ]
No, inequality declined on a basis person by person. I'm sure about that. I remember that I read this, because it has some funny aspects. The same statistic says, that in almost every country inequality increased. But the stronger growth of poorer countries more than offsets that.
I haven't a link to the study, but a graphical representation is in this presentation from Hans Rosling around minute 8.

Which single country of those you name, is part of the international division of labour? And which war was about the Washington consensus? For sure none of the Iraq or Afghanistan wars, for sure not the Iran-Irak war, not the war in Sudan,...
And rare is of course relative. We live for sure in peaceful times by historical standards. The overwhelming majority of people live in absence of war in their country.

But as far as I can tell, you don't actually disagree with Bruce that prudent US policy could have averted the crisis?
Of course I don't disagree. But that doesn't mean, that the savings glut didn't exist. It is important to mention this, as there are many Chinese officials, who blame the US for their most likely currency losses on their reserves. I don't see how any country in the context of the current financial crisis can blame any other country for its own problems. All problems are made by the countries themselves.
Does Wolf anywhere say explicitly, that the US couldn't do anything against that? As I see it, not in the exerpts presented by Migeru.
The point that comes closest:
the current banking and economic traumas should not be seen as just the product of risky monetary policy, lax regulation and irresponsible finance, important though these were.
You see, 'just'. Not 'not'. And I guess there are other things. E.g. the 'culture of debt', the unwillingness to react on the action of other people,... and the actions of other people.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Fri Oct 17th, 2008 at 05:23:19 PM EST
[ Parent ]
The stronger growth of the poorer countries wasn't necessarily shared by most of the population of those countries.

Also, GDP, as quoted in that Rosling presentation, is a self-serving measure which doesn't define well-being in any useful sense.

As an anecdotal data point I've known people who visit supposedly wretched and deprived third world locations and find that personally the people don't feel deprived at all - they have a strong culture and are more included and less alienated, not to mention happier, than Westerners are.

Imposing economic imperialism on the supposedly 'undeveloped' world doesn't necessarily count as a win just because the supposedly developed world can't imagine an alternative view.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Oct 17th, 2008 at 05:32:01 PM EST
[ Parent ]
Rosling doesn't quote only GDP, around minute 8 he speaks about personal income distributions.

Imposing economic imperialism on the supposedly 'undeveloped' world doesn't necessarily count as a win just because the supposedly developed world can't imagine an alternative view.
Who is doing that in which way?

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Fri Oct 17th, 2008 at 05:45:36 PM EST
[ Parent ]
Personal income distributions assume a model of economic activity which may not be appropriate or relevant in pre-existing cultures.

Economic imperialism is something the IMF has been doing for pretty much all of its existence, almost by definition.

Also, Rosling, by assuming that everyone wants to be like us - and if they don't, they should, because obviously we're better than they are.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Fri Oct 17th, 2008 at 05:48:47 PM EST
[ Parent ]
What this actually shows is China and India making great progress. I've seen the disaggregated data somewhere - can't remember where, though - and if you remove China (who very explicitly didn't follow Washington Consensus policies) and India (who did so only to a lesser degree), you don't see that big an improvement.

All the rest of Rosling's figures are aggregates or averages, which can easily mask worsening conditions for the majority of the population.

Which single country of those you name, is part of the international division of labour?

Which international division of labour? Niceragua and Serbia were certainly parts of an international division of labour.

And which war was about the Washington consensus?

Nicaragua, Iran, Grenada, El Salvador, arguably Palestine, East Timor and Lebanon (if propping up WC supporting states count - Israel, Indonesia and Israel, respectively), arguably Serbia (depending on which historians you ask).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Oct 17th, 2008 at 06:05:51 PM EST
[ Parent ]
... is how, by what seems to be almost pure happenstance, the same events that gave the US what it saw as an excuse to invade, were events that shifted the actual situation much closer to the propaganda picture of the NJM that the US Government was promulgating.

Two years after the invasion, there was no majority view of what the US action has been ... a Rescue Mission Ordained by God (the Gairy-ite position), a legal Intervention Sanctioned by the OECS (the position of anti-Gairy-ites who had fallen away from New Jewel), an Illegal Invasion overthrowing an Illegal coup d'état (the main New Jewel position) ... but an overwhelming majority of support for the action, whatever the action may have been.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 06:13:56 PM EST
[ Parent ]
This article was some years ago, but there is (imho) an important core.

Mike Bygrave: Where did all the protesters go? | World news | The Observer

Small armies of economists study these questions. In pursuit of the answers, I attended a lecture by Professor Robert Wade at the London School of Economics. He began with the usual depressing figures: 80 per cent of world income goes to the top 20 per cent of people while 60 per cent of the world's population have to make do with 6 per cent of the income. Then he moved on to 'the thunder and lightning of current debate': whether the situation has been getting better or worse over the past 20 years. His answer was twofold: we don't know for sure; but the balance of the evidence is, it's getting worse and inequality is increasing.

It turns out the statistics relied on by the pro-globalisers, led by the World Bank, are suspect. There are different methods for determining global poverty and inequality and the answers you get depend on the techniques you use. The World Bank, Wade implied, may have chosen the one that supports its own neo-liberal agenda. 'The Bank is a very political institution,' he said.

And Professor Rosling uses World Bank data for his neat graphical presentations. Of course you can argue that Professor Wade is political too (he very much appears to be).

I think poverty is hard to get good statistics on. Nobody measures it without having an agenda, and the poorest are the least likely to show up on routine measurements, the kind that Rosling loves. I would like to note that wealth has also turned out to be measured in fraudulent ways to serve political agendas.

I use my own poverty index, which is the number of apparently homeless I see in the streets. For example, by that measurement poverty has increased in Sweden the last twenty years. That average income and wealth also has increased (as Rosling would point out) only means that inequality has increased even more.

To be fair, if you should use Rosling to argue that there is less inequality between persons - not countries - you are better of picking when he looks at mortality rates for newly-borns. That is a measurement that is often connected to structural poverty.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Sat Oct 18th, 2008 at 09:23:10 AM EST
[ Parent ]
Does Wolf anywhere say explicitly, that the US couldn't do anything against that? As I see it, not in the exerpts presented by Migeru.

Well, it is implicit in

In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.
and the paragraphs around it in the original. Also, Jerome mentions upthread the e-mail exchange he had with Wolf in which Wolf claimed that, had the Fed not decreased interest rates and seeded the housing bubble, there would have been a nasty recession which he and Bernanke blame on the savings glut.

The Wolf/Bernanke argument is basically that China put the US in a no-win situation through its neomercantilist policies.

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

by Migeru (migeru at eurotrib dot com) on Fri Oct 17th, 2008 at 06:54:48 PM EST
[ Parent ]
Also, Jerome mentions upthread the e-mail exchange he had with Wolf in which Wolf claimed that, had the Fed not decreased interest rates and seeded the housing bubble, there would have been a nasty recession which he and Bernanke blame on the savings glut.
And, are you sure Wolf is wrong on that point? So he says the Fed initiated the bubble consciously to do the job of a dysfunctional regular gov't. Essentially Wolf says, the real gov't isn't the official administration, but the Fed. So according to Wolf the US isn't a democracy but more or less literally a plutocracy, in which the gov't is owned by banks.

The Wolf/Bernanke argument is basically that China put the US in a no-win situation through its neomercantilist policies.
Well, given his believe, that the only institution with a mandate to act is the Fed, he may be right. With the single policy tool of short term interest rates, there are not too much things the US could do. Of course the Fed has some regulative power, but given, that it was the goal to create a housing bubble, regulation would have been counterproductive.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Sun Oct 19th, 2008 at 01:35:43 PM EST
[ Parent ]
And, are you sure Wolf is wrong on that point?

Wolf isn't wrong to point out that there would have been a nasty recession. They had a very nasty bubble that burst around spring 2001. That bubble could have been deflated harmlessly, but a lot of people (Greenspan very prominently among them) decided that they'd rather make it bigger before it crashed. So if they hadn't inflated a new bubble, they'd have had to deal with the wreckage from the last one.

So he says the Fed initiated the bubble consciously to do the job of a dysfunctional regular gov't. Essentially Wolf says, the real gov't isn't the official administration, but the Fed.

That doesn't sound like an unreasonable political analysis. But the point is that whether or not the real government is powerless to fight a recession, inflating a bubble to obfuscate the wreckage from the popping of the last bubble is grossly irresponsible. Because it won't make the wreckage go away, it'll just hide it. So now they have to deal with both the wreckage from the tech stock bubble, and the wreckage from the Mother Of All Bubbles. Yeah, it bought them three to seven years - depending a bit on how you count. But at the cost of amplifying the problem greatly.

When a fuse blows in your house, you do not replace it with a string of copper wire - you find the faulty equipment and repair it. Unless, of course, you're Alan Greenspan.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Oct 20th, 2008 at 04:55:48 AM EST
[ Parent ]
They had a very nasty bubble that burst around spring 2001. That bubble could have been deflated harmlessly, but a lot of people (Greenspan very prominently among them) decided that they'd rather make it bigger before it crashed. So if they hadn't inflated a new bubble, they'd have had to deal with the wreckage from the last one.

And if you look at the timing it is clear that Bush wouldn't have been reelected if a nasty recession had hit in 2003. Real interest rates were negative in 2003-5, which resulted in a wave of remortgagings and home equity withdrawals.

And then in 2004 you have
USA Today: Greenspan says ARMs might be better deal (2/23/2004)

Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.
When nominal interest rates are at a historical low you don't get an adjustable rate mortgage - you try to lock in a (relatively) low fixed rate.

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
by Migeru (migeru at eurotrib dot com) on Mon Oct 20th, 2008 at 05:09:54 AM EST
[ Parent ]
The Wolf/Bernanke argument is basically that China put the US in a no-win situation through its neomercantilist policies.

Well, given his believe, that the only institution with a mandate to act is the Fed, he may be right.

Yes, but if their beliefs are wrong, neither Wolf nor Bernanke should be advising policy.

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
by Migeru (migeru at eurotrib dot com) on Mon Oct 20th, 2008 at 05:11:43 AM EST
[ Parent ]
... the establishment of Nigeria, the Democratic Republic of Congo (ex-Zaire) and South Africa as poles of instability played havoc with the opportunities for development across sub-Saharan Africa over the first part of the period, and the collapse of the apartheid regime in South Africa by itself is quite obviously insufficient to reverse this.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 06:17:05 PM EST
[ Parent ]
The income has to be generated, in order for anyone receiving the income to refrain from spending it so that it ends up being saving.

If the income level is above a short period equilibrium level, its the lack of injections or rate of leakage that can be blamed for it dropping back to a lower equilibrium than someone would like to see ... but if its low propensity to consume because income recipients are trying hard to save, that does not work through a big "surplus of saving" working through a saving/investment market, it works through a drop in consumption directly leading to a drop in income.

Different propensities to save do not determine the aggregate saving level, it determines the distribution of the aggregate saving that occurs.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 17th, 2008 at 07:58:26 PM EST
[ Parent ]
The dollar area was in a good equilibrium of all the time. The US has consumed for the Chinese and the Chinese have saved for the US.
Instead of formulating in abstract terms, one can simply ask the question, if emerging markets and the gulf would not have bought massively dollar assets, would there have been a housing bubble?
I think the answer is no.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers
by Martin (weiser.mensch(at)googlemail.com) on Sun Oct 19th, 2008 at 01:16:48 PM EST
[ Parent ]
Nobody disagrees with that. But you could just as easily ask the question, if the US hadn't been inflating a bubble, would it have sold so many dollars to these countries? And the answer is pretty obviously no.

Which is the chicken and which is the egg is largely irrelevant: The US could have stopped the process at any time by running a responsible economic policy that would have been in the best long-term interest of the US population. China and OPEC could have stopped the process at any time, but it is not obvious that it would have been in their interest to do so. If your chief rival is ruining his own economy through grossly irresponsible policies and paying you to aid him in the endeavour, why on Earth would you want to stop him?

It's kinda like building a navy full of big metal coffins battleships, going to war, getting your navy wiped out and then blaming China for selling you the steel to build the ships with in the first place.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Oct 20th, 2008 at 05:08:41 AM EST
[ Parent ]
... it is not a surplus of savings that is causing anything. The Chinese in manipulating exchange rates in pursuit of a trade surplus must be "saving" in the sense of having a outflows ex-trade exceeding inflows ex-trade ... because the overall inflows and outflows (including official balances) must be in balance.

But absent the willingness to hand goods over in exchange for dollars, the US could not have sustained its trade deficit ... while given a willingness to hand goods over in exchange for dollars, the Chinese cannot help but accumulate "external saving", and the only question is in what form.

The reason that cause and effect is important is that efforts to change the outcome by modifying effects rather than causes will be as successful as trying to suppress a fever by breaking the thermometer.

If the US pursues policy to return its trade deficit to below its long term average growth rate, or China adopts a policy of demanding a larger share of products in return for products, the "saving glut" subsides precisely in line with the reduction of the systemic current account imbalance.

By contrast, China or the US attempt to directly halt the "accumulating of external saving" by China without changing the system current account imbalance, and all that can change is the form of the accumulation of external saving.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Oct 22nd, 2008 at 04:03:51 PM EST
[ Parent ]
What went wrong in the US then? I think the most important question is, if houses are counted as consumption or as investment.

If they are investment, then there is no problem. The houses, that were bought with the borrowed money do still exist. If they are investment, they should generate enough wealth to pay for the debt, people have loaded on the houses.

If houses are consumption, their prices should be in the CPI and Greenspan should have raised rates.

I focus on this statement, because land is the basis of over 70% of "Anglo" money in circulation.

Land is a productive asset, as is the house built on it: the difference is that land does not depreciate, and it is also a Commons, but that is another story.

Now, if investment is about anything it is about acquiring ownership of a productive asset through a Property relationship.

The reason land is not consumption is that it has a "use value" that actually could be characterised as consumption. The purchase price of land is the net present value of future land rentals.

Yes, by all means include land/property rentals in an inflation index, but not the sale price of the productive asset: it's chalk and cheese.

The houses, that were bought with the borrowed money do still exist.

But to come back to the point of the Diary, Wolf's assumption is that in some way the "Savings Glut" is pre-existing money which has been lent to unwise property purchasers/ investors.

The chain of causality is the other way around.

Secured loans were made to by credit institutions to assist in property purchases, and due to the deficit nature of the money supply these interest-bearing loans created new money which inflated the bubble still further.

The direct cause of asset price inflation is the deficit basis of money created as debt

A very large part of this new money which was instantaneously deposited back into the system was thereupon used by American consumers to buy Chinese etc goods, and this was then saved, by being deposited in the banking system somewhere in the world.

The Bubble caused the Savings Glut: the Savings Glut did not cause the Bubble.

The whole point about the system now going to Hell in a Handbasket is that if pre-existing money were (as 99.999% of the population believe) lent out by banks to whoever, then there simply could not be any new money.

End of story.

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

by ChrisCook (cojockathotmaildotcom) on Sat Oct 18th, 2008 at 02:30:31 PM EST
[ Parent ]
The direct cause of asset price inflation is the deficit basis of money created as debt

A very large part of this new money which was instantaneously deposited back into the system was thereupon used by American consumers to buy Chinese etc goods, and this was then saved, by being deposited in the banking system somewhere in the world.

The Bubble caused the Savings Glut: the Savings Glut did not cause the Bubble.

And, indeed, as I point out in the diary,

Then, in a sleight of hand that would make The Economist proud, Wolf inserts three charts which have nothing to do with his argument. In fact, if you look at his third chart

you see that there's nothing peculiar about the "emerging Asia" current account balance until after 2004, that is, after the US had been running negative real interest rates for 18 months.
Note also the kink in 2007, when the bubble pops.
 

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
by Migeru (migeru at eurotrib dot com) on Sat Oct 18th, 2008 at 08:41:07 PM EST
[ Parent ]
(as 99.999% of the population believe)
Sure, because it is rarely explained properly.

But why didn't all this newly created money show up in the CPI and triggered the Fed to increase rates, or the banks to demand higher interest for mortgages?

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Sun Oct 19th, 2008 at 01:19:37 PM EST
[ Parent ]
Brilliant..

It reads like a physicist paper.... well more like a good referee report... I notice.

If I would be the referee I would say that they key question on whether China policies coul dalone produce deflationary and recession drive in the US economy aer to swallow...

it looks more like a chaotic system... without the main Greenspan bubble, the fix peg and the huge China savings would have produced, at most deflation... but together with low interet reates produced a fire.

In physcis terms, China peg was a recission drive force which can not cross the nonlinear instability threshold... when you add the coupling with US policies, you have a fully instable system in phase space.

Having said that, I must say I do not how any can proof if I am wrong or not.. it is actually not science.. more like a pure narrative...

that's my probblem with economics... and why I find somehting weird... there is soemthing which I can nto pinpoint which leads me to believe that predictions without previos trial and error is almost impossible in econmics...

but interesting wenough, we all here agree that how the US decided to use the bubble free ride was a US decission.. using it for a consuming spending binge was really his decision, and probably the worst decision of all..

here in Spain we decided to do houses.. now we have a million free!!! one million flats which at least provide some cover inc ase of rain.. unfortunately we decided not to invest in science and technology (why , if you could make thousands of bucks with a real state pelotazo?).

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Oct 17th, 2008 at 07:04:15 PM EST
Wolf's paper is not fit for publication :-)

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
by Migeru (migeru at eurotrib dot com) on Sat Oct 18th, 2008 at 03:57:09 AM EST
[ Parent ]
We do not only wathed the same TV but the same referee reports!!!! You read my mind... about me reading your diary... :)

Using the words of the now inmortal John (or George Parr, investment banker-financial advisort): "Precisely"

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Sat Oct 18th, 2008 at 05:34:53 AM EST
[ Parent ]
by Metatone (metatone [a|t] gmail (dot) com) on Sun Oct 19th, 2008 at 06:53:40 PM EST


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