Lack of Global Demand

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Major Global Imbalances

Not that I thoroughly agree with Stephen's solution to our problems, but he sure points out one band-aid alternative to our drastic problems of imbalance. I would sooner see a real reform of the entire international financial architecture as outlined by Paul Davidson, myself, and many others posted on the entirety of this blog. I believe our trade and financial problems are much more serious than Stephen paints. The global labor arbitrage is not going to go away by simple currency realignments while China maintains its peg. The ppp comparative disadvantages of OECD nations with the less developed world are truly beyond textbook realities of easy solution, and must be rectified by major monetary system reform. I see no other truly workable alternative. If others do, let me know.

Global Venting

Stephen Roach

The world economy, as I see it, remains very much in a state of fundamental disequilibrium. A US-centric global growth dynamic has given rise to extraordinary external imbalances around the world. America, the world's unquestioned growth engine, is facing unprecedented imbalances of its own; the national saving rate, current account, Federal budget deficit, and private sector debt ratios are all at historical extremes. And an increasingly powerful global labor arbitrage continues to keep high-wage developed economies mired in jobless recoveries. The result is a unique confluence of tensions that have left the global economy in a state of heightened instability. The venting of those tensions could well be the main event in world financial markets in 2004.

The case for global rebalancing has been an overarching theme of our macro call over the past year. The urgency of such a realignment in the mix of world economic growth has never been more compelling. Over the 1995-2002 period, the United States accounted for 96% of the cumulative increase in world GDP - basically three times its 32% share in the global economy. This was, by far, the most lopsided strain of global economic growth that has ever occurred in the modern-day post-World War II era. Two sets of forces have been at work in creating this unsustainable condition - a US economy that has been living beyond its means as those means are delineated by domestic income generation, and a non-US world that is either unwilling or unable to stimulate domestic demand. As a result, an unprecedented disparity has opened up between those nations with current-account deficits (the United States) and those with surpluses (Asia and, to a lesser extent, Europe). Such an unbalanced global growth paradigm is not sustainable, in my view. The debate is over the terms under which the coming rebalancing occurs. ...Continued

"China's Exchange Rate - U.S. Economy"

While searching for the relationship of exchange rates and tariffs, I came across this interesting article from the U.S. Treasury. It's a few months old but represents the clearest picture of our real trade dynamics with China, as well as others. It's well worth the read.

"China's Exchange Rate Regime and its Effects on the U.S. Economy"
by John B. Taylor Under Secretary

...The Economy of China

With this context, let me now address China’s economy and its exchange rate regime. Economic reforms in China have increased economic growth and have made China one of the largest economies in the world. China is now a major economy, and it is still growing rapidly. It is already an engine of global growth. With per capita income of only about $1,000 per year and with financial, legal and regulatory systems in need of reform, China still faces challenges in its effort to catch up with developed economies.

China’s Exchange Rate Regime

For nearly ten years now, the Chinese have maintained a fixed exchange rate for their currency, the yuan, relative to the dollar. The rate has been pegged at about 8.28 yuan/dollar for the entire period. Thus, as the dollar has appreciated or depreciated in value relative to other currencies, such as the Euro, the yuan has appreciated or depreciated by the same amount relative to these other countries.

To maintain this fixed exchange rate, the central bank of China has had to intervene in the foreign exchange market. It sells yuan in exchange for dollar denominated assets when the demand for the yuan increases and it buys yuan with dollar denominated assets when the demand for the yuan decreases. Recently the central bank has intervened very heavily in the markets to prevent the yuan from appreciating. Since the end of 2001, dollar buying has been so great that the foreign reserves held by the Chinese government have risen by $153 billion to over $360 billion. ...

....Impact on the United States

U.S. imports from China are equal to about 1 percent of U.S. GDP, or 11 percent of total U.S. imports. Although this share may seem small, China’s imports to the U.S. have been increasing rather rapidly, between 20 and 25 percent in recent years and months. In general, these imports result from China using low-skilled labor to assemble and process imported parts and materials originating in other countries-mostly from other Asian countries that have traditionally exported directly to the U.S. Consequently, the share of U.S. imports from these other countries has declined just as China’s share has increased. Asia’s share of U.S. imports has declined slightly. Much of the increase in U.S. imports from China has come at the expense of imports that once came directly from other Asian countries.

At the same time, growth of U.S. merchandise exports to China has been accelerating recently and grew 22 percent in the first 7 months of this year. Growth has been especially rapid in recent years for U.S. exports to China of transportation equipment (including aircraft engines), machinery, steel-making materials, chemicals, and semiconductors.

China has a large trade surplus with the United States. However, because China has a large deficit with the rest of the world, it does not have a large overall current account surplus. China’s bilateral trade surplus was $103 billion in 2002 with the U.S. while China’s deficit with the rest of the world was about $73 billion. Thus, China’s current account surplus was under 3 percent of GDP in 2002 and likely to decline to less than 2 percent in 2003. Many imports from China are goods from other Asian economies that are processed or finished off in China before shipping to the United States. Other East Asian economies increasingly send goods to China for final processing before they are shipped to the United States. China accounted for 11 percent of U.S. imports in 2002, up from 3 percent in 1990. Meanwhile, the combined share of Japan, Korea and Taiwan declined to 17 percent from 27 percent over the same period.

The overall trade deficit of the United States is spread across many countries of the world in addition to China. For instance, the overall trade deficit reached $468 billion last year with 1) the Americas accounting for $105 billion, 2) Western Europe $89 billion, 3) Japan $70 billion, and 4) China $103 billion. The U.S. overall trade and current account deficit is due to the excess of investment over saving in the United States. If this gap were reduced through an increment in savings, the overall deficit could shrink as would the size of the bilateral deficits. ...Continued

Debtor Nations - Financial System - Prosperity

Strong views from one of the modern world's greatest economists, and I don't say this lightly. We need many more economists of Paul's stature and understanding of the world's real systemic problems and solutions. He takes up where Gustav Cassel and John M. Keynes left off. We all need look at this type of understanding - time is running out - fast!

Debtor nations need a financial system that allows
them to work their way to prosperity

Paul Davidson

The global economy is at a crossroads. We can try to muddle through with the existing defective international financial system, while hoping that minor tinkering will quarantine the devastating depressionary forces experienced by developing nations and avoid contagion spilling over to developed nations. Or we can produce a new financial architecture that not only protects all nations from
experiencing the devastation of currency crises but also eliminates the persistent global depressionary pressures of the current system and therefore makes possible the potential of global full employment.

All prudent nations (except the United States) desire a surplus of exports over imports to obtain a net positive financial savings position on their internationally earned income. This surplus is added to the nation's foreign reserves. Since the global economy is on a dollar standard, additions to a nation's foreign reserves are held primarily in the form of US treasuries.

The effect of all nations attempting to accumulate foreign reserves is to create persistent high rates of unemployment, and liquidity problems for the global economy - and this is true whether the global economy is on either a fixed or a flexible exchange rate system. In essence, when any nation runs persistent export surpluses to accumulate foreign reserves, it is playing a game of Old Maid and passing the Black Queen of unemployment and indebtedness to its trading partners. ...Continued

Japan - MOF - Y140,000bn.

Is Japan handing BushCo the election, or just trying to survive? This is astounding news! Democrats better take notice.

The Ministry of Finance Has A Message For You

Harry Chernoff is an independent economist in Great Falls, VA

In Wall Street parlance, the heavyweight traders of the 1980s and 1990s were the Masters of the Universe. Well, Wall Street is going to have to come up with a new phrase to describe the universe the men at Japan’s Ministry of Finance are coming from. Forget about the little boys from Liar’s Poker and Long-Term Capital Management. It’s time to think in terms of a full-scale, Japanese-style Master of the Universe -- Godzilla.

On December, 19, 2003 the Financial Times reported that the Ministry of Finance (MOF) “said it would raise the ceiling on the amount it could borrow for intervention by Y21,000bn to Y100,000bn ($930bn) for the period until March, and by Y61,000bn to Y140,000bn for the year starting in April.”

Here’s the story in the Financial Times.

Let’s put 140,000 billion Yen ($1.3 trillion) in a U.S. perspective. In round numbers it is about equal to next year’s Federal budget deficit, next year’s state budget deficits (all 50 states), and next year’s current account deficit, combined -- with enough left over for the pension plans of every hard-pressed steel and automobile manufacturer in the country.

In practical terms, intervention at anything approaching this level means that the dollar / Yen exchange rate and the long-term Treasury bond rate will be whatever the MOF wants them to be. Assuming the MOF locks in the exchange rate and the bond rates at about current levels, it also means that the U.S. Presidential election next November was decided last week in Tokyo. As long as Japan is willing to monetize unlimited American profligacy next year, there is no possibility that the U.S. economy will run out of steam before the election. Even with China cutting back on domestic credit and apparently cutting back on its acquisition of dollar-denominated reserve assets, it won’t make a difference. Alan Greenspan can sit on his hands for all that it matters to Godzilla. When the largest creditor in the world with the largest current account surplus in the world calls the tune, you dance. ...Continued

Krugman - Wealth Inequality - Truth

Just as you think Paul has gone the wrong direction, back he comes. I love it.

The Death of Horatio Alger
by Paul Krugman

The other day I found myself reading a leftist rag that made outrageous claims about America. It said that we are becoming a society in which the poor tend to stay poor, no matter how hard they work; in which sons are much more likely to inherit the socioeconomic status of their father than they were a generation ago.

The name of the leftist rag? Business Week, which published an article titled "Waking Up From the American Dream." The article summarizes recent research showing that social mobility in the United States (which was never as high as legend had it) has declined considerably over the past few decades. If you put that research together with other research that shows a drastic increase in income and wealth inequality, you reach an uncomfortable conclusion: America looks more and more like a class-ridden society.

And guess what? Our political leaders are doing everything they can to fortify class inequality, while denouncing anyone who complains--or even points out what is happening--as a practitioner of "class warfare."

Let's talk first about the facts on income distribution. Thirty years ago we were a relatively middle-class nation. It had not always been thus: Gilded Age America was a highly unequal society, and it stayed that way through the 1920s. During the 1930s and '40s, however, America experienced what the economic historians Claudia Goldin and Robert Margo have dubbed the Great Compression: a drastic narrowing of income gaps, probably as a result of New Deal policies. And the new economic order persisted for more than a generation: Strong unions; taxes on inherited wealth, corporate profits and high incomes; close public scrutiny of corporate management--all helped to keep income gaps relatively small. The economy was hardly egalitarian, but a generation ago the gross inequalities of the 1920s seemed very distant.

Now they're back. According to estimates by the economists Thomas Piketty and Emmanuel Saez--confirmed by data from the Congressional Budget Office--between 1973 and 2000 the average real income of the bottom 90 percent of American taxpayers actually fell by 7 percent. Meanwhile, the income of the top 1 percent rose by 148 percent, the income of the top 0.1 percent rose by 343 percent and the income of the top 0.01 percent rose 599 percent. (Those numbers exclude capital gains, so they're not an artifact of the stock-market bubble.) The distribution of income in the United States has gone right back to Gilded Age levels of inequality. ...Continued

Speculation

Speculation

"'There's a wolf in the system... He was born of your laws. He roams from Maine to California - Alaska to Florida - Hawaii to D.C., and Chicago to New York... He is a hungry wolf. He tears into your hind quarters, clear to the bone, with a vicious set of teeth. He is simply after your wallet. He is the [international] speculation wolf, and he operates legally under your floating exchange law system, to rip the very soul from your nation. He will succeed unless you try to understand how he feeds............' "

World Economy Risks - 2004

The risks for the world economy in 2004

WASHINGTON, (AFP) - Lurking behind dream forecasts of a US-led global economic bounce in 2004 are nightmare scenarios of a frightful plunge in the dollar, trade war, disease, conflict and terror attack.

Menaces such as a damaging deflationary spiral, an impending financial collapse in Japan or a looming war, have subsided.

But "a variety of dramatic downside threats that were present in 2003 persist," said Citigroup economist Kermit Schoenholtz.

"These include the possibilities of new acts of terrorism, conflict on the Korean peninsula, a return of SARS (news - web sites) and oil supply disturbances," he wrote in an annual roundup of global prospects.

"In addition, new concerns including growing pressures for protectionism in the industrial world may become prominent over the coming year, especially in the runup to US elections (in November 2004)."

The dollar cast the darkest shadow over economists' 2004 forecasts for a self-sustaining US recovery and global growth of 4.0 percent or more, from about three percent in 2003.

Citigroup said it expected the dollar to retreat in the medium term against the euro and the yen, pressured by a huge and expanding American current account deficit.

The euro would advance to 1.37 dollars by 2008 from about 1.21 now, it said. In the same period, the dollar was slump to 88 yen from 108 yen.

But "a sharper-than projected dollar decline could undermine stablization efforts in the euro area and Japan, and may be associated with a larger risk premium on US assets than we forecast," said Schoenholtz.

"One possible trigger would be fear of protectionism." ...Continued

Great Expectations - Ought

Great Expectations
by Bill Bonner

..."Call it the overinvestment theory of recessions of 'liquidationism,' or just call it the 'hangover theory,'" Paul Krugman begins his critique of the 'Ought to' school. "It is the idea that slumps and the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion...

"The hangover theory is perversely seductive - not because it offers an easy way out, but because it doesn't," he continues in his December 1998 attack. "It turns the wiggles on our charts into a morality play, a tale of hubris and downfall...

"Powerful as these seductions may be, they must be resisted, for the hangover theory is disastrously wrongheaded..." he concludes.

In Krugman's mechanistic world, there is no room for Ought. If the monetary grease monkeys of the Great Depression of the '30s or of Japan of the '90s failed to get their machines working, it was not because there are any invisible hands at work or any nagging moral principles to be reckoned with...but because they failed to turn the right screws!

It is completely incomprehensible to him that there may be no screws left to turn...or that the mechanics might inevitably turn the wrong screws as they play out their roles in the morality spectacle.

Krugman is hardly alone. As the 20th century developed, mass democracy and mass markets gradually took the Ought out of both politics and markets. In the 19th century, a man would go bust and his friends and relatives would look upon it as a personal, moral failing. They would presume that he did something he oughtn't have. He gambled. He drank. He spent. He must have done something... .Continued

China - U.S. - GDP - PPP

Eddie Lee

...Now here's an excerpt from Martin Wolf...

China can make another great leap forward:
Today China's GDP per head, at purchasing power parity (PPP), is only about a sixth of that of the United States. But evidence from South Korea and Taiwan indicates it is easy for a catch-up country to sustain very rapid growth until its GDP per head is more than half the US level. Japan did even better than that. If the US economy continued to perform as it has done over the past half century, with a growth of GDP per head at just over 2 per cent a year, while China also managed to continue to grow at just over 6 per cent a year per head, the Asian giant would not achieve the magic halfway point until shortly before 2040. On this basis, therefore, another 2 1/2 decades of growth as fast as the last 25 years' is perfectly feasible. ...Article Continued

International Finance & Global Governance

MacroMouse

What Role For The IMF?
By Jane D'Arista*

Criticisms of the International Monetary Fund (IMF) by progressives and nongovernmental organizations (NGOs) currently focus on six issues: (I) the need for debt relief; (ii) the need to democratize the Fund's governance; (iii) the need to increase transparency; (iv) issues related to bailing-out and/or bailing-in private investors; (v) the Fund's future mission; and (vi) the need to reform the policy paradigm that countries must accept to qualify for borrowing. First I will provide a brief overview of progressive critiques on these issues. Then I will discuss other areas that also should be a focus of concern and criticism. I will conclude with some proposals for alternatives....

....Alternative Proposals

In addition to the reorientation of IMF and World Bank loans as a means to achieve social and environmental goals, progressives support a variety of ideas, both old and new, for reforming the international financial and monetary architecture. They argue for using capital controls to moderate pro-cyclical private flows seeking short-term profits.

Many support instituting some form of the securities transaction tax proposed by Tobin, that would discourage short-term turnover of investments in source countries (Pollin and Baker, 2000). Palley (2000) proposes extending asset-based reserve requirements to all financial sectors and assets, so as to reestablish monetary control over the supply of credit in national markets. Eatwell and Taylor (2000) propose the establishment of a World Financial Authority (WFA) to provide global oversight of international financial institutions, on the grounds that the monitoring of global markets via national regulation is inadequate. They argue that the IMF should not be involved in financial regulation, and that a WFA is needed both to reestablish the primacy of stability and soundness as regulatory objectives and to reverse the current push for deregulation.

Elsewhere (D'Arista, 1999), I have offered three proposals to reform the international financial and monetary systems. The first is a proposal for a closed-end international investment fund for emerging markets, with investment decisions based on development goals rather than short-term profit opportunities. The fund would be financed through private institutional investors' purchases of marketable World Bank securities. As a closed-end fund, investors could sell shares without triggering sales of underlying assets.

This structure would serve to insulate underdeveloped markets from volatile flows of foreign portfolio investment, while providing a highly-rated, guaranteed investment asset for institutional investors.

My second proposal is to issue new special drawing rights (SDRs) that would augment the international reserves of developing countries and reduce their debt burdens. SDRs were originally intended to become a primary reserve asset and to give the IMF limited powers to act as a lender-of-last resort (IMF, 1987). The most recent allocation, however, was in 1981, and only $28 billion in SDRs are currently outstanding, compared to $1.6 trillion of foreign exchange reserves. Moreover, as of yet, none have been issued to Russia and other new member countries. Yet, SDRs represent an existing mechanism for relieving the liquidity squeeze that has affected developing countries since the Mexican crisis in 1995. A new allocation, targeted to highly indebted and crisis-affected countries, could be even more effective than debt relief in re-igniting global growth.

My third proposal calls for the creation of an international clearing agency to address the basic problem in the global economy: the unraveling of the international monetary system. Failures of exchange-rate regimes and the push for dollarization and other currency blocs are symptoms of international monetary fragility. Under the privatized, post-Bretton Woods system, the volatility of changes in the valuation of currencies has widened their impact and deepened the economic damage they cause. The fact that only a few countries issue currencies that can be used in international transactions greatly exacerbates this instability. The primary objectives of the proposed clearing agency would be to allow all currencies to be used in international transactions and to shift control of international payments from private to public institutions.

This system would replace the current system of foreign exchange that is based on oligarchy. Resources would be valued in terms of the entire basket of currencies of member countries. All international reserves would be held by the international clearing agency. Changes in exchange rates would be tied to changes in the reserves of member countries and adjusted at two-week to four-week intervals. The clearing agency would also have the means and authority (on the basis of a majority vote of its member countries) to create reserves by conducting open market operations in national markets.

This power would create a true lender-of-last resort for the global economy, responsive not only to balance-of-payments problems stemming from trade and investment flows, but also to the often greater problems that can result from natural disasters and the devastation of war.

Creating an international clearing system that reestablishes public control over crossborder payments is necessary to end the pro-cyclical rule of market forces and to restore sovereign control over policy determination. It would allow national central banks to reintroduce the use of credit allocation and countercyclical policies; it would also allow governments to pursue development and growth as objectives of economic policy. Furthermore, since it would allow developing countries to pay their transactions and service their debts with wealth created in their own national economies, such a system would end the export-led growth imperative of the current system and reinstate demandled growth as an alternative policy paradigm for developing countries.

The reform of the international financial and monetary architecture requires a democratic basis for governance. The clearinghouse proposal envisions a rotating council composed of member countries that would represent half the world's population and half the world's wealth at all times. The EU has taken steps in a similar direction by weighing both population and monetary contributions to determine voting shares within the European Central Bank. Similar criteria must be applied to shaping the governing structures of international institutions, old and new. Whatever the specifics, the issue of democratic governance must be addressed. ...Complete Text

Fictitious Capitalism

Here's a completely new way of describing our new capital world. I have used the term fictitious wealth before, but fictitious capitalism is even new to me - I like it. It well fits the drastic imbalances we and others have piled to the moon. The article has a few numbers out, but not far enough out to throw the article. It's really worth the read. Mises also has a complementary article about Richard Duncan's book - worth a read.

Addison Wiggin

....Back to Wang: “In the era of fictitious capitalism, a fictitious capital transaction itself can increase the ‘book value’ of monetary capital; therefore monetary capital no longer has to go through material goods production before it returns to more monetary capital. Capitalists no longer need to do the 'painful' thing - material goods production.”

Real-life owners of stocks, bonds, foreign currency and real estate have increasingly taken advantage of historically low interest rates and applied for mortgages backed by the value of these financial assets. Especially since the rally began 8 months ago, they then turn around and trade the new capital on the markets. “During this process,” writes Wang, “the demand of money no longer comes from the expansion of material goods production, instead it comes from the inflation of capital price. The process repeats itself.”

Derivatives instruments, themselves a form of fictitious capital, help investors bet on the direction of capital prices. And central banks, unfettered by the tedious foundation set by the gold standard, can print as much money as is required by the demands of the fictitious economy.

But Wang sees a darker side to the equation. “Fictitious capital is no more than a piece of paper, or an electric signal in a computer disk. Theoretically, such capital cannot feed anyone no matter how much its value increases in the marketplace. So why is it so enthusiastically pursued by the major capitalist countries?”

The reason, at least until recently, is that the "major capitalist countries" have been using their fictitious capital to finance consumption of “other countries'” material goods. Thus far, the most major of the capitalist countries, the U.S., has been able to profit from the system because since the establishment of the Bretton Woods system, and increasingly since its demise, the world has balanced its accounts in dollars.

“Until now,” writes Wang, “U.S. dollars [have counted] for 60-70% in settlement transactions and currency reserves. However, before the ‘fictitious capital’ era, more exactly, before the fictitious economy began inflating insanely in the 1990s, America could not possibly capture surplus products from other countries on such a large scale simply by taking advantage of the dollar’s special status in the world...Lured by the concept of the ‘new economy’, international capital flew into the American securities market and purchased American capital, thus resulting in the great performance of U.S. dollar and abnormal exuberance in the American security market.”

And here we arrive at the crux of Wang’s argument that a war is brewing. “While [fictitious capital] has been bringing to America economic prosperity and hegemonic power over money,” he suggests, “it has its own inborn weakness. In order to sustain such prosperity and hegemonic power, America has to keep unilateral inflow of international capital to the American market...If America loses its hegemonic power over money, its domestic consumption level will plunge 30-40%. Such an outcome would be devastating for the U.S. economy. It could be more harmful to the economy than the Great Depression of 1929 to 1933.”

Japan’s example suggests, as your editors have oft reminded you, that a collapse in asset values in a fictitious economy can adversely affect the real economy for a long time.

In the era of fictitious capital, Wang surmises, America must keep its hegemonic power over money in order to keep feeding the enormous yaw in its consumerist belly. Hegemonic power over money requires that international capital keep flowing into the market from all participating economies. Should the financial market collapse, the economy would sink into depression.

America’s reigning financial monopolies, he believes, (whoever they may be), would not stand for it.

Wang writes that he was disturbed to draw these conclusions. And as noted above, he recommends that the Chinese government plan accordingly.

He could not be any more disturbed than we are. We’ve grown to like the perspective we’ve developed while enjoying carafes at the Paradis and watching passersby pass by. Trouble is, if Wang’s conclusions are correct, then the currency most suited to challenge the hegemony of the U.S. dollar has just this week closed at a historic high of $1.20. ....Complete Article

Speeding Growth & Falling Dollars

Of Accelerating Economic Growth and Falling U.S. Dollars

Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst, Mfwolff@aol.com

The data flow has been dizzying and confounding of late. The U.S. boasts China-like levels of GDP expansion without the accompanying structural shifts, let alone industrial revolution. All of this leaves the minority of commentators and investors who seek a meaningful answer to the out of style “why question” to crack wry smiles and wring hands. Here is my contribution to the frightened smirking and head-in-hands flow of information that confronts those of us silly enough to seek understanding from news and data streams.

The swelling U.S. economy is ever more “debtophilic” and few seem concerned about lending. Lady Liberty welcomes any and all foreign surplus savings to her warm and beckoning shores. As the world extends $2 billion per work day, the currency in which this debt piles up is quietly sinking against the monies of our major floating currency trade partners. Never mind that this is a very dirty and managed float-there is much central bank policy swirling in these “free markets.” The balance of this action acts to cushion and manage dollar decent. Our still trade over-weighted dollars are a faith-based initiative. So too, it would seem, is our recovery. ...Dollar Slide Continued

Plato & Exchange Clearing

Plato - The IFI Question?

"The citizen of the ideal state will require a currency for the purpose of every day expenses; This is practically indispensable for workers of all kinds and for such purposes as the payment of wages to wage earners. To meet these requirements, the citizen will possess a currency which will pass for value among themselves, but will not be accepted outside their own boundaries. But a stock of some currency common to the Hellenic world generally i.e., of international currency, will at all times be kept by the state for military expenditures or official missions abroad such as embassies and for any other necessary purposes of state. If a private citizen has occasion to go abroad, he will make his application to the government and go; and upon his return if he has any foreign currency left over in his possession, he will hand it over to the state receiving in exchange the equivalent in local currency." Plato

A Few IFA Proposals - Conventional - Unconventional

A Few IFA Proposals - Conventional - Unconventional
by Lloyd
Ah yes, Edward. Quite a problem we seem to be in. Since Edward asked this question, I thought I might stick my head out and see how many chop it off. Somehow, I feel they may not since we are all in such a quandry... "What this means is that the seesaw analogy fails: Europe cannot go up while the US goes down: both need to descend together. So the problem here is architectural (any suggestions Lloyd?):"

As I stated in one of my posts at: MacroMouse and in thorough agreement with you Edward, "We have never been here before." Due to the vast imbalances in global ppp's, wages, debts, trade, wealth, exchange rates, etc., which have evolved since the collapse of the Bretton Woods System in 1971-`73, we face the most serious challenge since, oh who knows when, forever. So what would I do with the international financial architecture? If enough serious minds are willing to admit something needs to be done, then there are definately several answers.

The goal, of course, is to rebalance the entire global system. How? Well, many forms of external exchange clearing have been put forth since Plato first advocated it, though none overly appeal to me or many others, as suggested - they reduce too much autonomy. Therefore, I suggest several different forms of conventional exchange clearing and several unconventional forms of internal exchange clearing - which allow a higher degree of local autonomy. I see no other way to otherwise rebalance the massively out of balance system. If we had originally, in 1971, rebuilt the then broken system by making balanced floating exchange the law of the land, we wouldn't be here, but we didn't. Just for the record, we could have made a 10% maximum balance band law the IMF would have been mandated to follow when nation's ppp's drifted out of balance, that they should have been mandated to rebalance, even though we had abandoned the pegged system. A rebalancing framework could have and should have been set up at that time, even if it meant loaning, or using a standby agreement until hostilities ended, the money needed by the U.S. to finish the war, etc. It would have been smarter than destroying the entire system as has nearly happened. There were many ways to rebuild a workable system at the time, it was just the acrimony over the war that prevented such a wise course. I mention this for background on what now must be done.

I have only recently come across enough information and empirical evolution to possibly offer a few new and different answers. I am no where near ready, but I can set the framework. At the outset, moral hazard must be guarded against most in the workings of any new system. As Alfred Marshall suggested, we could use his units of purchasing power as a solid standard of a new architecture. I suggest a very large basket[20% of GDP] of commodities, production, goods, and services as the new standard for all nations. This large 20% is required because I further suggest using many forms of derivatives contracts and bond contracts as insurance for the new system of clearing - to satisfy the large financial interests. I suggest this be a minimal financial computer controlled international clearing architecture - politics removed after implementation. To implement, all capital markets must be either closed[short term] or laws of gradual rebalance must be written into the architecture implementation and evolution. This way all nations can maintain their sovereignty and autonomy more than other already advocated systems. If the laws and computer programs are properly written, the world can evolve over a given timeframe to a new global balance of all thus mentioned markets. Rebalancing is a simple accounting trick if enough financing is forthcoming, to do so. It will take much new IMF financing, but the rebalancing will recreate so much new credit productivity, it will pay itself back over time just as the massive public financing of global WWII did.

There is also internal exchange clearing, a non-conventional system, that I have written George Monbiot about. There are several of these variations, also, but for now I will enter my e-mail to George:

Earlier today I came across an article of yours about a meeting, to come up with an alternative to capitalism other than the other failed system - totalitarianism. I'd like to make a suggestion that there is a way to build such an architecture. BTW, you are my favorite author. The system I am talking about is already here, almost but unrecognized, as yet. On the one side we have what I refer to as Minsky's Heinz `57 capitalisms. On the other we have the Heinz `57 totalitarianisms. None of these are satisfactory. Yet, the answer lies somewhere in the middle between the two. BushCo wants to implement an outrageously totally free [for the corporations that is] capitalism. China, on the other hand is moving from totalitarianism toward BushCo's totally free corporate capitalism. If it goes all the way this would be a big mistake, as the perfect mixed market capitalism lies in between.

What I'm talking about here is the world has a chance to help China develop the first perfectly balanced mixed economy of public and private enterprise. I use this example as the developed nations will not yet listen to common sense. Now, I know from reading your books and articles you can easily grasp this. If China were to naturally evolve to a state of 20% public enterprise markets and 80% private enterprise markets we would have a chance to witness something truly amazing in economic history, if properly organized at this % mix. As, at this total market mix the 20% public enterprise market could be used to keep inflation/deflation permanently in check throughout the 80% private enterprise market, thus allowing a fiat money system unlimited potential. I mention this about China as it is the only experiment in the world heading toward and most likely to reach this % threshold. It would be a great loss to the world if we do not recognize this once in earth's lifetime chance to grant the world a new path. E=1/5X is a formula for perfect competition capitalism.

The 20% public enterprise mix must be a total % market organization of all production, goods, and services in order to check inflation/deflation throughout the 80% totally free private enterprise side. A tripple entry banking system can be set up to finance. Alfred Marshall, at the turn of the century, mentioned such a similar mix with his units of purchasing power. This is the same thing, so to speak, at a much expanded macro level. If you can actually see this system, which I think you can, you must see the advantages a fiat system would possess when inflation/deflation can be market controlled, it frees the printing press to have free reign to build an unbelievably wealthy, healthy, strong, and viable moral capitalism.

If China were to discover this capitalism key, the rest of the world would be forced to emulate - gladly as debts and taxes would vanish or could be used productively. They most likely will cross the 1/5X threshold sometime in the near future as they are privatizing at a fast rate - almost 50% already. There is no need for them to cross it in disarray as is the case with many of Europe's social democracies and Russia's failed transition. They only need be shown the simple facts. Please dialogue with me to work out the details. The world needs us George.

I wrote three books about this system through the `80's and `90's. Trouble is they are very crude web published material - not enough free time. I am now retired and have the time to finish. My work will be rewritten and republished this winter. My first paper will be 20 to 30 pages long on global credit productivity - a totally new macroeconomic subject.

just a start, I have more,
everyone, dialogue with me,
Lloyd

The Washington Consensus?

No one I have ever come across argues a point as successfully as Dr. Paul Davidson, and this subject is certainly the one that requires the most clarity - Paul has more than accomplished the task. If this single message could reach the majority of serious minded people, we would be well on our way to improving our democracy. This is a thorough, deep paper and a very welcome addition to the body of existing knowledge. It is shining a very bright light on the fallacy of classical economic thought, and its related political lopsided and academic influences pushing the world in the wrong direction. Dr. Davidson also offers real solutions to our dire economic problems - I applaud him.

Paul Davidson

I. The Washington Consensus: Classical vs. Post Keynesian Views

John Williamson coined the term "Washington Consensus" in 1989. This Washington Consensus term, however, means different things to different people and apparently even different things to John Williamson at different times. Williamson [2002] states that this consensus requires ten reforms:
1. Fiscal Discipline. This was in the context of a region where almost all the countries had run large deficits that led to balance of payments crises and high inflation that hit mainly the poor because the rich could park their money abroad.
2. Reordering Public Expenditure Priorities.... from things like indiscriminate subsidies to basic health and education.
3. Tax reform. Constructing a tax system that would combine a broad tax base with moderate marginal tax rates.
4. Liberalizing Interest Rates. In retrospect I wish I had formulated this in a broader way as financial liberalization, and stressed that views differed on how fast it should be achieved.
5. A Competitive Exchange Rate. I fear I indulged in wishful thinking in asserting that there was a consensus in favor of ensuring that the exchange rate would be competitive, which implies an intermediate regime; in fact Washington was already beginning to subscribe to the two-corner doctrine. [William has championed the establishment of FEER (a Fundamental Equilibrium Exchange Rate) target zone for the exchange rate, i.e., a zone based on a fixed competitive rate plus or minus ten percent. Williamson has argued that FEER would simultaneously achieve internal and external balance]
6. Trade Liberalization...
7. Liberalization of Inward Foreign Direct Investment...
8. Privatization...
9. Deregulation....
10. Property Rights....
The three big ideas underlying these reforms are, according to Williamson, macroeconomic discipline, a market economy, and openness to the world. The first three reforms are, so far as I am aware, widely accepted among economists. ...

....Why have intelligent economists such as John Williamson gone so wrong on their demand for fiscal discipline, financial liberalization, and actively pursuing a competitive exchange rate policy? The fundamental analytical framework underlying Williamson's views is the same as the foundation of neoliberalist and market fundamentalists arguments (Davidson, 1992-3). For example, in an article co-authored with Marcus Miller (1989), Williamson accepts the classical belief that, in the long run, a free market economy will always revert to the optimum allocation of resources at full employment. Williamson and Marcus (1989, p. 50), however, are impatient with the length of time it takes for the market to achieve this long-run equilibrium, and therefore they argue that the economy, prodded by intelligent authorities will show a greater Aspeed of adjustment than the automatic pilot of a free market. In other words, the only analytical difference between Williamson and ideological Market Fundamentalists is the question of the length of time it requires for a free market to achieve a social optimum.

Those who profess a rational expectations approach can argue for immediate liberalization shock therapy. The common sense of mainstream economists such as Williamson suggests that such "shock and awe" medicine might severely debilitate if not kill the patient. Thus Williamson tries to direct the discussion towards the speed at which governments liberalize markets and reduce the size of government. Nevertheless, all ten reforms of the Washington Consensus are founded on classical economic theory that supports the laissez-faire doctrine as necessary to solve all our economic problems.

The evidence of the last 10-20 years, however, has demonstrated that attempting to implement the ten reforms of the Washington Consensus has ultimately proven to be a disaster for developing nations. If the empirical evidence of the failure of the Washington Consensus under the existing rules of the game is so clear, why does the G-7, the World Bank and the IMF seek to tie aid for Latin American nations' economic problems to a demand for the nation to move towards full adoption of the 10 consensus reforms? The answer to this question is nested in the classical theory belief in the beneficence of free markets. This beneficence, however, can only be aproved if one invokes three very restrictive classical axioms. If these classical axioms are not applicable to the real world, then the characteristics of the Washington Consensus market vision of the economic system happens not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience (Keynes, 1934, p. 3).

When put in the context of an open economy, Keynes' General Theory analytical framework demonstrates that the theoretical foundation for some of the reforms advocated by the Washington Consensus are not applicable to the economy in which we live. In a passage that is particularly a propos to the Washington Consensus, Keynes noted that "in a society where there is no question of direct investment under the aegis of public authority [due to the need for fiscal discipline per se], the economic objects, with which it is reasonable for the government to be preoccupied, are the domestic interest rate and the balance of foreign trade"[Keynes, 1936, p. 335].

If, however, the government institutes reform #4 of the Washington Consensus and permits capital funds to freely move across national boundaries, then "the authorities had no direct control over the domestic rate of interest or the other inducements to home investment, [and] measures to increase the favorable balance of trade [are]...the only direct means at their disposal for increasing foreign investment" [Keynes, 1936, p. 336] and domestic employment. ...Argument Continued

Paul Davidson - International Financial Architecture

This is a referenced article posted by Joerg over at Bonobo about reforming the international financial architecture. It is excellent as it covers the arguments between the two schools of thought concerning Keynesianism and Monetarism - LPT vs. EMT. It is a great addition to my work and posts of recent. Ph.D. Paul Davidson is the greatest Keynesian economist I have yet come across. Check out his Keynes', Washington Concensus', IFA, etc., high quality writings.

Paul Davidson

How one interprets volatility in the international financial markets and therefore chooses a policy stance regarding these markets depends on the underlying economic theory that one explicitly, or implicitly, utilizes to explain the role of financial markets in a market oriented entrepreneurial economy. There are two major alternative theories of financial markets: (1) the classical efficient market theory (hereafter EMT) and (2) Keynes's liquidity preference theory (hereafter LPT). Each produces a different set of policy prescriptions. EMT advocates call for a liquidity plumber to patch up some short-run stresses in today's efficient international financial flow system. LPT proponents believe that the current system is structurally flawed. Consequently, it will require an architect to build a new international financial structure on more solid foundations.

EMT is the backbone of conventional economic wisdom. The mantra of EMT is "the market knows best" how to optimally allocate scarce capital resources and promote maximum economic growth. This EMT view was succinctly epitomized in U.S. Treasury Secretary Summers's statement: "the ultimate social functions [of financial markets are] spreading risks, guiding the investment of scarce capital, and processing and disseminating the information possessed by diverse traders...prices will always reflect fundamental values .... The logic of efficient markets is compelling" (Summers and Summers, 1989 , p. 166).

In contrast, the logic of Keynes's LPT indicates that the primary function of financial markets is to provided liquidity not efficiency. (And a liquid market requires orderliness.) If Keynes's LPT of orderly financial markets is relevant, then the real world's international capital markets may never deliver, in either the short-run or the long-run, the results claimed by EMT.

Peter L. Bernstein is the author of the best-selling book entitled AGAINST THE GODS (1996), a treatise on risk management, probability theory and financial markets. Bernstein argues that the LPT and not the EMT is the relevant theory for the world in which we live. Bernstein states "The fatal flaw in the efficient market hypothesis is that there is no such thing as an [efficient] equilibrium price... a market can never be efficient unless equilibrium prices exist and are known" (1998b, emphasis in original; also Bernstein, 1998a). In other words, in Bernstein's view, EMT is not applicable to real world financial markets.

If EMT theory is not applicable to the real world then there is an important role for rebuilding the system to permit some degree of international capital flow regulation as a necessary but not sufficient condition for producing a golden age of economic development for the global economy of the twenty-first century. Since the 1970s, however, the compelling logic of EMT has provided the rationalization for nations to dismantle most of the ubiquitous regulations of post-war international financial markets. The justification for this "liberalization" of financial markets is that it will produce lower real costs of capital, greater growth rates of output and productivity, and more employment opportunities compared to the rates experienced between World War II and 1973 when international capital flow controls were practiced by most countries of the world, including the United States. ...Theory Continued

My IFA Post On Bonobo

The International Financial Architecture

U.S. Busy - China On The Move

The most interesting dynamic in the world is China as a capitalist power, a huge future economic powerhouse. How will America fair in the dynamics of this great competition? Will we awake and rise to the challenges posed, and reform the international financial architecture, as needed, so fair trade can finally start the long journey to rebalance the world's markets? Or, will we play Rip-Van-Winkle too long? I have no idea which choice we will make, but, I do know if nothing is done America Inc. will pass by perpetual economic suzerainty[just as England did to America] from our hegemonic power to the hegemonic power of China Inc. Some may say, here, that China has no chance of this, it will go the way of Russia. Well, maybe so, but again, in this case due to the massive amount of global derivative insurance contracts, foreign direct investment, and global treasury instruments invested in or held by China - a closed capital market, the rest of the world would trip over itself being first to either help or support China in any future serious financial market troubles, as such could bring down the entire house of cards. This would then leave her strong enough to become the example of the first scenario - global eco-political hegemon. I'd say we'd better soon awake from the Great Cold War Snooze.

U.S. Busy, China Is Romping With Neighbors

....Beyond the economics and the diplomacy, something else is going on. China has the allure of the new. A new affinity is developing between the once feared China and the rest of Asia.

Karim Raslan, a Malaysian lawyer and writer who traveled to Washington recently on a Fulbright scholarship, put it this way. The American "obsession" with terror seems tedious to Asians, he said. "We've all got to live, we've all got to make money," said Mr. Raslan. "The Chinese want to make money and so do we." ....

.....Most disturbing for the United States, China's surging economy has much to offer America's most important Asian allies. Japan's rebound is being driven by a surge in exports to China. Australia's healthy economy is being kept that way by Chinese investments in liquid natural gas projects. China is now South Korea's largest trading partner.

Among Southeast Asian countries with significant Muslim populations, places where the American concentration on terror is particularly unappealing, China is on a buying spree.

In Indonesia, Malaysia and the Philippines (and to a lesser extent Thailand), Washington's primary concern is the presence of Islamic militants. China's main interest is to scoop up what it can for its modernization. Indonesians have come to call this new relationship with Beijing as "feeding the dragon." ....

.....Not everyone is convinced that China's courtship of the region will last forever. "They're making progress because we're invisible and distracted; or bull-headed when we do show up," said Robert L. Suettinger, the author of the recent book "Beyond Tiananmen" and a member of the National Security Council during much of the Clinton administration. "There's no natural condominium for China in Southeast Asia. But I think it would behoove us to pay a bit more attention."

But the more provocative Mr. Przystup counters, "Today, China is East Asia's great power." ...Article Link

International Monetary Law - IMF - EU

Committee On International Monetary Law

Total Credit Market Debt (All Sectors) As % of U.S. GDP

Debt Chart - % GDP

Dollar "Problem" Watch

Interesting to take note of Soros and Buffett taking positions against the dollar. Suppose they know best?

Compounding the Problem
by Doug Noland

....These three anecdotes – “all they can do is limit the yen’s gains” BOJ dollar purchases; talk of speculative dollar sales by Soros and Buffett; and Welteke noting that German companies “have hedged” – go right to the heart of what I believe is an unfolding dollar “problem.” First of all, aggressive foreign central bank dollar purchases have clearly lost their forcefulness. Ballooning Asian central bank and U.S. “custody” holdings are today barely managing an orderly dollar decline. And with the ECB (as opposed to the BOJ) not aggressively accumulating dollars, euro sellers are finding it increasingly difficult to find buyers. This is precisely the type of environment that captivates the expansive global speculator community.

Speculative dynamics today find progressively emboldened sellers and discouraged buyers. Things have recently taken a turn for the worst, with this week’s strong data and today’s rising bond yields offering little in the way of dollar support. Such circumstances should have market participants contemplating the unprecedented derivative hedging positions that have and continue to accumulate. Recall the surge in derivative activity during the first half of the year. Dollar hedging has quite likely only escalated over the past few months. Surely, German, Japanese and other exposed manufactures have hedged dollar exposure. And, certainly, scores of global speculators and investors have incorporated more aggressive hedging strategies against their ballooning dollar holdings. But who is on the other side of these trades? Is the market to hedge dollar exposure tenable? I have serous reservations.

There is no doubt in my mind that dynamic hedging strategies play the dominant role in contemporary derivatives markets. Sellers of derivative protection incorporate “sophisticated” computer models that are basically trend-following systems “hedging” (buying rising and selling declining markets) exposure on market insurance written. Instead of learning from the 1987 portfolio insurance fiasco, the Greenspan Fed has been the staunchest supporter of the mushrooming derivative markets. But from analyzing the Mexican, SE Asian, Russian, and Argentina currency collapses, we have absolutely no doubt that the combination of runaway Credit excess, rampant global speculative financial flows, and aggressive (speculative) derivative hedging operations create over time acute currency and financial system fragility.

It would appear to me that we are now quickly approaching a critical point where heightened speculative and dynamic hedging-related selling could overwhelm apprehensive global central bankers. That the U.S. stock market at this time seemingly couldn’t care less about the unfolding dollar “problem” is curious. But, then again, the unfolding Mexican, Asian, and Russian meltdowns almost had to hit the U.S. market on its head before there was recognition.

I remember clearly how U.S. financial stocks rallied to new highs in late July 1998, with the Russian and LTCM collapses only weeks away. This, however, is only one of many curious examples of surging markets determined to ignore the inevitable. But, then again, excessive liquidity creation in the face of heightened systemic stress is a most-important dynamic of contemporary (unrestrained) finance. Looking at GSE and foreign central bank balance sheets, both domestic and international liquidity operations over the past four months have gone to new extremes. Accordingly, speculative excess, both domestic and international, has gone to new liquidity-driven extremes. Greater dollar liquidity is only Compounding The Problem. And when the next crisis does arrive, the old “fixes” won’t get the job done. ...Article Link