Friday, February 27, 2004

BonoboLand - On Currency Adjustment, Part III

On Currency Adjustment, Part III

Ok, the story so far, we have seen that there is a problem, and that the two principle candidates to take the strain (the euro and the yen) simply aren't up to the task. So what are the alternatives? (And BTW this article is going to be a disappointment for those who are looking for a solution: I don't have one, at least not knocking around in my back pocket I don't. But I guess this means that there will have to be a part IV next week). Anyway, to resume the thread, what major currencies are there knocking around in the global economy, just waiting to take the mantle. Well no prizes for guessing that two principal candidates are being extensively canvassed: China and India. But are they up to it? Let's take them one at a time.

Firstly China. Now of course the Rimban revaluation has been topic of the moment in the currency debate for quite a while now, and normally I've taken the view that the Chinese economy isn't in a position to stand this kind of strain, and that what is really needed first is a move back to the Bretton Woods drawing board to try and find an architectural solution to the problem of the retreating dollar, a solution which would increase the probability of a soft, and so logically enough reduce the probability of a hard, landing. What is needed in a way is precisely that 'dollar version of the Washington agreement' which Paul was suggesting last week would be so 'whacky'. ...Link

Thursday, February 26, 2004

China's Urban Workforce Fuels Rural Economy

Ah... finally a little economic information on what's happening in inland China. Whether she is planning this or not it is going to make China a powerful force in the future. Just imagine the new roads and infrastructure she will need. What a dynamo coming.

China's urban workforce fuels rural economy
By James Kynge

Remittances from China's fast-growing urban labour force are on track to overtake agriculture as the biggest income generator in the rural areas they left to find work, a new survey shows.

Research by the agriculture ministry's think-tank found an estimated 98m rural residents who worked away from their villages sent or carried home a total of Rmb370bn (about $45bn) in 2003, an increase of 8.5 per cent over the previous year.

China has made raising rural incomes a priority because without a consumer society in the vast rural sector, the nation could not hope to sustain its rapid economic growth, said Chen Xiwen, a leading Beijing policymaker.

But the greater reliance of China's rural population on industrial incomes could be a cause of concern should anything interrupt China's economic growth.

The contribution of migrant workers to the rural economy reflects the wider dependence on foreign direct investment and exports.

Of an average peasant income of Rmb2,618 last year, the contribution from agriculture fell below 60 per cent, while the contribution from migrant workers' earnings rose eight percentage points to more than 40 per cent.

Worker remittances do more than any other single infusion of funds from the central or local governments to promote the rural economy. Average spending on consumer durables such as televisions, air-conditioning and washing machines rose last year by 17 per cent to an average Rmb92.4 per rural household, the survey said.

The average net annual income of migrant workers, after living and travel expenses, came to Rmb3,768 last year, according to the survey, which was based on interviews in 20,089 rural households in China's 31 provinces.

The rural sector is generally considered a drag on China's growth, but signs of increasing spending are emerging in villages and towns. In Shanxi, the coal producing heartland, former peasants earning about Rmb1,400 a month in the mines have generated considerable demand for products such as motorcycles costing between Rmb3,000 and Rmb4,000, shopkeepers in the town of Jiexiu said.

An executive at Jialing, one of China's largest motorcycle manufacturers, said demand from such quarters had created a market that grew at 20 per cent last year. "The rural areas have become our major battlefield. We should stake our claim there as the peasants are getting richer after working in towns." ...Link

Wednesday, February 25, 2004

Japan's Recovery?

Stephen Kirchner

Japan’s Recovery. This blog has often been critical of The Economist’s coverage of Japanese monetary policy. Its latest leader on the subject argues that ‘the best case for optimism that this time the recovery will last is that the Bank of Japan’s monetary policy has now become steadily and credibly expansionary.’ This is nonsense. The Economist confuses a change in style, associated with the change in the Governorship of the BoJ a year ago, with a change in substance. The Economist credits Governor Fukui with having ‘printed a lot more money,’ failing to sterilise the proceeds from foreign exchange market intervention and with rhetoric more strongly geared to promoting positive inflation expectations. In fact, all of these initiatives were well established features of monetary policy under former Governor Hayami, whom The Economist calls ‘quite possibly the world’s worst central banker.’

It is certainly true that Governor Fukui has made greater use of some of these policy tools, but almost no one apart from The Economist believes that these amount to a substantive change in policy. As even orthodox monetarists like Robert Hetzel and base money growth-rule advocates like Bennett McCallum would argue, there is no reason to expect increased monetary expansion to translate into stronger growth in nominal income or broader money and credit aggregates given the current monetary policy framework and zero interest rate environment in Japan. The BoJ’s switch to a quantitative approach to monetary policy in March 2001 under Governor Hayami was undertaken precisely so that the BoJ could appear to be taking policy action, knowing full well that these measures did not amount to much in substance.

The fact that Japan is now enjoying another cyclical upswing, with no substantive change in monetary policy since March 2001, is itself a strong argument against the view that monetary policy has been a decisive factor in holding back Japan. Japan has likely seen a permanent reduction in its trend growth rate associated with real factors. Monetary policy is largely irrelevant to this process. Most of the domestic pressure on the BoJ to adopt a more aggressive approach to monetary easing over the years has come from old-line LDP politicians and bureaucrats, the so-called ‘techno-rivalists,’ who see macroeconomic stimulus as a way of avoiding the demands of structural reform. They have a firm friend in The Economist. ...Link

Paul Krugman Videos/Audio

Paul Krugman

Tuesday, February 24, 2004

Japan And The U.S. - Historical Revisionism Run Amok

This is an amazing piece of currency wisdom by Marshall. He paints a very clear picture of the globe's structural future and "it ain't pretty." Anyone for architectural reform, yet?

Marshall Auerback

Japan And The Us: Historical Revisionism Run Amok

Since December 2000, the dollar has depreciated by 56 percent against the euro. For all of the fuss of last week’s “strong dollar rally”, that’s probably the best gauge of the greenback’s true underlying weakness. European Central Bank authorities (most recently, ECB chief economist, Otmar Issing) have made it abundantly clear that, unlike their Asian counterparts, they do not buy into the monetary snake oil currently being peddled by the Greenspan Fed and have accordingly refused to play the currency intervention game. But for the support of the neo-mercantilist Asians, the magnitude of the dollar’s fall against the euro would likely have been replicated against a broader basket of currencies.

Still, over the past year the dollar has slipped some 13 per cent against the yen, notwithstanding the fact that the Bank of Japan spent 187 billion dollars in 2003 buying all the dollars it could. With Japan and China serving as the United States' largest financiers of its current account deficit, now running at an annual rate of over 5 percent of gross domestic product, the U.S. Treasury bills and bonds held by these foreign governments are sinking in value while at the same time American exporters are attempting to reap the benefits of a huge currency-driven advantage in world markets.

And yet the Japanese, at least, remain adamant that they are likely to perpetuate this state of affairs. Merrill Lynch economist Jesper Koll tells us that for this year Prime Minister Junichiro Koizumi's national budget has raised potential intervention firepower by 61 trillion yen or about $580 billion: “Put another way: After spending $15 billion on average every month in 2003, Japan now has the budget to spend $48 billion per month to protect its corporations from a falling dollar, and $48 billion is more than three times Japan's monthly current account surplus.”

Japan has in effect acted as America’s leading sub-underwriter. It seems to have bought into the Ameri-centric view of its past policy failings, to the extent that it did not “do enough” during its own post bubble decline. To wit, Japanese policymakers at that time acted too late and with too little in the way of monetary and fiscal policy to counter the underlying deflationary undertow present once the bubble had definitively burst...

...In contrast to Japan, the U.S. economy cannot finance its economic expansion with its own internal resources, as has been exemplified by the ballooning current account deficit. The cumulative surpluses in Japan help to explain why there is persistent upward bias in the yen/dollar exchange rate, only alleviated to a limited extent by Japan’s extraordinary currency interventions, which the markets continue to perversely applaud even as it becomes more and more destabilizing.

And now that Tokyo appears to be playing ball with Washington, both seem to be locked into some mutual economic suicide pact (whilst the ECB stands on the sidelines, watching the whole scenario unfold with growing unease). Tokyo’s finances are beginning to resemble that of a Latin American country, with Washington rapidly catching up.

In the interim, the trans-Pacific trade imbalance has tipped further, resulting in the buildup of massive countervailing forces which will likely be unleashed later in the form of a further precipitous fall in the dollar. Furthermore, counting on the seemingly insatiable appetite of the American customer, the allocation of economic resources in the Japanese and other Asian economies appears to have been distorted to a larger extent than before.

By playing along like an American colony, Japan and the other Asian nations appear to be behaving like innocent merchants willing to sell on credit as much as their customers want. But at some point, either the creditors insist on proper payment for their large and growing I.O.U.’s, or the debtor simply declares, “No mas”, as Argentina has done, and the creditors are left with the prospect of huge write-downs. In such circumstances, credit will be harder to come by in the future, which bodes ominously for dollar assets.

At that point, the real consequences of this unhealthy symbiotic relationship will come home to roost. After all, when market commentators discuss the problems of the American twin deficits, what they really mean is that the sheer size of these deficits prevents any future short run policy stimulus-induced strength in US domestic demand from being sustainable over the medium to longer term. But if that is the case, logically it follows that one cannot be optimistic about the prospects for economies, like Japan, which remain dependent on exports to sustain growth, notably to the US. Which means less credit for the world’s largest debtor. How, then, does one resolve these awkward questions about exit strategies? Persisting in self-serving historical revisionism is clearly not an answer. ...Link

BonoboLand ? Japan Riding the China Wave

Japan Riding the China Wave
by Edward Hugh

Japan’s trade surplus leapt almost 400 per cent in January as surging exports to Asia continued to support the domestic economic recovery there while shipments to the US actually declined. Japan's trade surplus jumped to Y507bn (this should be compared with the Y103bn of January 2003) with overall exports up 11.3 per cent, according to government data released on Monday.

News of the sharp rise came hot on the tail of an abrupt fall in the yen against the dollar. In fact exports have been the main engine of the Japanese economic recovery and are the main component in that widely quoted 7 per cent annual GDP number (domestic consumption was virtually flat) for the past quarter.

The Financial Times quotes Peter Morgan, economist at HSBC in Tokyo, as cautioning that exports were unlikely to keep growing at such a fast pace. "Monthly export growth has generally peaked at around 15 per cent in previous cycles and we’re getting close to that," he said. For the April-to-June quarter he predicts growth to fall back to the 5-10 per cent range. This observation may help understand why the Yen is in fact falling against the dollar: the central bank is intervening to try and soften the landing by making exports cheaper.

The principal engine of export growth so far has been Asia and especially China. The value of goods sent to China rose 33.8 per cent last month while shipments to the US actually fell 5.4 per cent.

A recent New York Times article, gives some indication of the scale of the Japanese relocation to China, and indicates the extent to while the major global players have all gotten hooked onto the Chinese economy. Which means if there is any faltering here........ ...Link

Monday, February 23, 2004

Debt vs. Income: At the Point of No Return

At the Point of No Return

...Income and job growth are so low that we have certainly passed “The Point of No Return”. There cannot be an easy resolution to the debt bubble and resolution will only come when a crisis forces change. Perhaps, for this election year, crisis can be postponed by continuing to facilitate an increase in borrowing so that debts can be rolled over, but increased. By 2005, the ultimate outcome to resolve the debt problem looks like it will be a combination of inflation, rising interest rates and debt default.

The reason we do not believe that job and income growth will save the day for the American worker is we have never before seen in history such increases in government spending, tax cuts, federal budget deficits, consumer spending and borrowing, with so little job growth. The massive fiscal and monetary stimulus has mostly been spent. There will be some nice tax refunds this spring, and that’s it! The peak of mortgage refinancing is already past. Construction spending is at a peak and the percentage of people who own their homes is at a record 69%. Mortgage underwriting shows that 5% of homebuyers in 2003 really couldn’t afford to buy a home, and another 5% could lose their home if one spouse becomes unemployed.

While the industrial sector is recovering, employment in the manufacturing sector has not increased since the start of the recession - there has been job loss in manufacturing for the past 42 months in a row. The United States has been in an economic recovery for over a year and a half and continues to lose manufacturing jobs every month! This is unprecedented!

Capacity utilization in the US remains about 76%, while massive new investments in production capacity are being made in Asia. The drop in the dollar has primarily affected trade with Europe, and Europe isn’t stealing our jobs. As long as Asia buys our dollar debt and continues to hold their currencies down against the dollar, job growth will happen there, but not here. Even when China and the rest of Asia “finally float” their currencies, few jobs will come back to America. In the United States, we only produce 45% of the manufactured goods we consume and much of that production is in electricity, petroleum refining, chemicals etc., that are capital intensive, with few workers required. Critically, many of the workers listed as employed in manufacturing are not engaged in manufacturing at all but in design, marketing, and distribution. Even if the Chinese currency doubled in value, the labor cost for a worker in China would still only be a fraction of the cost for an American in America. The sad fact remains that Personal Income growth will not happen because of job growth. Personal Income remains under pressure as higher “valued added” manufacturing jobs are exchanged for lower paying part-time and service jobs. America is losing manufacturing jobs paying $45,000 - $60,000 a year so it needs three new service jobs paying $15,000 - $20,000 a year just to replace the one manufacturing job that was lost.

So, where are Americans and their mountain of debt headed? If the days of borrowing more - courtesy of both the Federal Reserve and Asia’s Central Banks - are winding down later this year when Asia revalues its currency, it looks like there will only be two ways out: increased inflation and debt default. Both are likely. When those Chinese goods at Wal-Mart go up 30% in price, Americans will see inflation. The Fed will accommodate most of the inflation, but there will be a rise in interest rates. Inflation, if allowed and encouraged, will save the wage earner so he can continue to service his consumer debts. Rising interest rates will smash into housing prices like a tornado in Kansas. Homeowners who have a 30-year fixed rate mortgage will come out in the end, if they don’t have to sell their home for at least 10 years. Anyone who wants to sell their home will see some “asset deflation”, and financial institutions will experience substantial “debt default”. The Federal Reserve will “print money like crazy” to fight asset deflation and encourage inflation. Sometime before or after the Presidential election, the financial markets will be interesting, but painful to many. ...Link

Sunday, February 22, 2004

Cartoon - Recent 'speculation'

Guardian Unlimited | Cartoons | Recent 'speculation'

Derivatives Instruments Causing Concern?

Otoh... a little trouble showing up in the global derivatives markets? This $169trillion global market walks on shakier ground every day due to massive global imbalances and its associated ever increasing outright speculation. If Keynes were alive today he'd have a field day with our modern pseudo-classical economists over their blind speculation theories based upon abstract beliefs in the neutrality of money. According to these eminent pretenders of knowledge global speculative transactions balance in a state of equilibrium - how quaint. Then tell me just what happens when all wise investor/speculators book all their long positions in strong currency nations and all their short positions in weak currency nations under a confiscating floating exchange monetary system?

Institutional Investor

Correlation Trades Causing Concern

Dealers are issuing huge volumes of single tranche collateralized debt obligations based on untested correlation assumptions and this could mean everything from the pricing of the deals to the hedge is wrong, according to several investors. Frederick Horton, managing director at Trust Company of the West, said CDO dealers' trading books "look like an accident waiting to happen." Risk management of bespoke CDO tranches is an opaque process and no-one really knows how to manage correlation, he added. Horton made the comments in a speech at the ABS West conference earlier this month but declined to elaborate when contacted afterward.

The investors and managers are concerned that models used for managing risk and pricing deals are based on a paucity of historical data. It is difficult for managers to bring value to single tranche deals because the pricing of aspects such as substituting credits is not transparent. When credits in bespoke tranches are substituted, dealers also need to adjust their delta-hedge of the portfolio, which they factor into the price, explained an analyst. When determining the costs of the trade a dealer will take into account its entire credit portfolio, including whether it wishes to take more exposure to the particular credit being pitched. Not only is this a process that dealers will not wish to share with CDO managers, it is one that will create greatly divergent prices between firms depending on whether the new credit is attractive for their trading book, explained the analyst.

Brian Colgan, fixed-income manager with a portfolio of some USD40 billion at WestLB in New York, is also uncomfortable with correlation assumptions saying it is one factor delaying him from purchasing single tranche synthetic deals.

CDO dealers, not surprisingly, think the correlation assumptions are accurate. Alex Reyfman, global head of credit derivatives research at Bear Stearns in New York, said there is a liquid and transparent market for correlation and the risk profile of correlation books that are marked-to-market is pretty clear. Large market moves should not bring any surprise profit and loss changes, he added.

Another strategist explained that most dealers are long correlation so if spreads all move in the same direction, banks will make money. In the worst case scenario, a credit default does not lead to a general widening of spreads. This is because the dealer will have to pay out on the default, but will not gain from spreads on the other positions widening. This happened when Parmalat defaulted because the market decided it was an isolated case. The banker, however, estimated that around 10% of the dealers' portfolios would have to default without spreads on the remainder of the portfolio being affected for there to be a serious risk to the CDO houses. ...Link

Friday, February 20, 2004

BonoboLand ? On Currency Adjustment Part II

BonoboLand ? On Currency Adjustment Part II
by Edward Hugh

You can find Part I of this further down the page in the Global Finance section. So the dollar is destined to fall. So if one thing goes down, something else has to go up, right. Enter the first candidates, the euro and the yen. Now the Japanese economy has, as everyone knows, been the sick man of the planet for the last decade, mired in an apparently inexplicable bout of slow-burn deflation, a deflation which, if anything, has been accelerating during recent months. (And if you want a quick reality check on what is actually happening in Japan you could try this William Pesek piece). And what is the main proposed remedy for deflation once interest rates hit zero, and increasing the money supply reveals itself to be totally ineffective: why devaluing your currency, of course.

Now the Japanese have been in no postition to enforce an outright devaluation (which they probably need), but they are in a position to try and reduce the rate of its rise. So they print money and buy dollars: " ...Link

Wednesday, February 18, 2004

Analysts Warn China On Verge of Economic Crisis

Not that I totally agree with this socialist web site article, but it has many interesting and informative features, making it well worth a read.

Analysts warn China on verge of economic crisis
By John Chan

The year has opened with warnings that China is lurching toward a major economic crisis that will inevitably have far-reaching global ramifications. While the Chinese regime is hailing the country’s 9.1 percent economic growth last year, analysts are noting that the growth itself has produced the type of overcapacity and rampant speculation that has characterised other economies before they experienced a severe slump.

The New York Times, for example, warned on January 18: “As 2004 begins, China’s economy looks as invincible as the Japanese, South East Asian and American economies of those earlier times. But recent excess—from the frenzy of factory construction to speculative inflows of cash to soaring growth in bank loans—suggest that China may be in a bubble now, especially on the investment side of the economy.”

Over the last decade, China’s combination of plentiful low-cost labour and a currency pegged to the US dollar has kept commodities manufactured in China cheap and competitive. This has enabled the country to become world’s primary destination for foreign direct investment, attracting $US53 billion last year. Driven by a desire to maximise profit and corporate dividends, the feverish trend to invest in China has spawned a number of serious problems.

The explosive growth of China’s export and industrial capacity has far outstripped market demands. According to a study in the December issue of the US-based Foreign Affairs magazine, China’s fixed asset investment grew 31 percent in the first half of 2003, almost triple the growth rate in 2000, but household consumption grew only by 8.8 percent to 10.1 percent in the same period.

China’s huge export sector, which is largely run by foreign-invested firms, increased 35 percent to $430 billion last year, with total foreign trade soaring to $840 billion—the fourth largest in the world. Industrial production increased 17 percent, the highest since 1995. Last year China produced 35 percent of the world’s cellular phones, 40 percent of its colour TVs and 55 percent of the world’s computer monitors. ...Link

Mercantilist Stirrings in the Land of Laissez Faire

I have posted articles by Max befor. He has an excellent perspective about our real economic world. He is right on, check him out.

Mercantilist Stirrings

Mercantilist Stirrings in the Land of Laissez Faire
Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst.

We are known throughout the world as the second and more aggressive generation of free traders. Starting after World War II and following the oil shocks and global downturn of the 1970’s, America began a global crusade to liberalize markets and financial flows. The changing role of Bretton Woods Institutions and our trade policy announced and supported an international return to deregulated late nineteenth and early twentieth century style capitalism. Academics and analysts called upon to discuss and debate these processes termed them “globalization.”

The history of the rise and fall of earlier waves of globalization was lost in the rush to celebrate or condemn a new world economy. Underpinning this has been the meteoric rise of free marketeering, of rhetoric and reality. Neo-classical economics and its policy prescription have swept into dominance in boardrooms and the halls of state power. The fall of the Eastern Block and the great equity boom of the last two decades heaved fuel on the blaze.

A global economy with the US as ideological, military and economic leader took shape. Leadership was based on free trade credentials and general openness to imports- particularly from friends and strategic allies. Our dominating ivory towers, corporations and state apparatus blared Adam Smith’s wisdom utilizing power bestowed by wealth, position and the latest innovations in transport and communication. Mercantilist tendencies toward state meddling, preferential access to contracts and granted domain were to be relegated to history’s dustbin. Alongside the banishing of such discredited and inefficient tendencies, America would topple those who would obstruct the market’s light from penetrating the darkest corners of a shrinking world. I would argue we have lost this momentum and are slipping toward just those mercantilist tendencies that inspired Smith’s epoch making critique.

It is about belief in a set of rules, when they work for you and when they cause pain. As the stern physician administering painful doses of austerity medicine around the globe, we are assumed to be willing to submit to our own intellectual commitments- regardless of immediate impact. Across the last few years we have begun to ignore our own rules at home- while pushing them increasingly selectively around an unstable world. In so doing we have begun to set in motion the impulses and musing that may well end the recent era of US led globalization. The Smithian torch risks being snuffed out by its guardians in a panicked rush to safeguard privileges and gain advantage. So it was that past eras of globalization degenerated into chaos, trade and military conflict. If this last comment strikes you as ludicrous, you might try a brief look back at the period leading up to WWI. ...Link

Tuesday, February 17, 2004

Dollar Drinking In The Last Chance Saloon

Last Chance Saloon
Stephen King

The weather's looking rather unsettled outside, but the policy cowboy doesn't mind too much as he ambles into the Last Chance Saloon. Going up to the bar, he orders his favourite tipples. Low interest rates. A big budget deficit. And, to make sure there's no disappointment, he also orders a bottle of "Mr Snow's weak dollar elixir". The barman slides this depreciation bottle down the bar. The cowboy grabs it eagerly, and takes a deep swig. The dollar heads to lower levels and the cowboy begins to feel a whole lot more relaxed.

But relaxation under the influence is unlikely to be sustainable, particularly when the cowboy finds himself in the Last Chance Saloon. He strides over to the roulette wheel, hoping that his new-found confidence - helped by his depreciation inebriation - will lead to big winnings. In particular, he needs to win a few jobs because, so far, despite all his spending, all his borrowing and all his drinking, he hasn't quite got to the point where his gamble has really paid off.

The cowboy slaps his last few remaining dollars on the table, the wheel spins and... and...

And oh dear. His numbers don't come up. What does he do? He can't cut interest rates any more, because they're already close to zero. He can't really borrow very much more, because his creditors are becoming uneasy about the debts he's built up. And he can't keep swigging from the dollar depreciation bottle. A couple of gulps might not do too much damage, but a whole bottle? That's another matter altogether. ...Link

The 7 Stages of A Dollar Crisis

The 7 stages of a dollar crisis

'Experts' simplistically tout a weak dollar as good news. No wonder many regular folks are unaware that its dramatic decline could spell real trouble.
By Bill Fleckenstein

Along the way to a full-blown crisis, the steps leading up to it may either pass unnoticed or prompt insufficient concern. That is the story of the dollar. Its decline continues to strike many folks as good news. It is only a matter of time before that perception changes. The inevitable crisis will inflict damage, but those who see where we are headed can protect themselves beforehand. To this end, I'll explain where I believe we are in that process.

G7's 'lingo limbo:' How low can the dollar go?
Recently, the Group of Seven finance ministers met in Boca Raton, Fla., to hammer out a much-parsed currencies communiqué. Why folks take this exercise in semantics seriously beats me. The fact is, even the seven ministers, who are capable of speaking five languages, can't tell you what the heck they mean. Of course, one reason they can't tell you is that their differing agendas make it hard to pretend like they're all on the same page.

That said, the foreign ministers probably agree on one point: The dollar is becoming a problem, which is why the gist of their communiqué stated that too much volatility (read: dollar weakness) is not a good thing.Your money, fast.

What we are witnessing is the unfolding of a dollar crisis. Though its external value seems to be a nebulous concept for many folks, as the dollar's ongoing decline builds to a crisis, it will have a significant impact on the workings of financial markets -- and affect everyone's financial well-being. (For review, please see my past columns: "The dollar's dramatic decline comes out of your wallet”; "The dollar: linchpin to stocks and the economy"; "Face up to the falling dollar"; “Fantasy, the Fed and the falling dollar: Oh my!"; and "The dollar is on borrowed time.")

7 small steps to crisis
Here, then, is my outline of a 7-step process of creating a full-blown crisis.
Step 1. Nobody notices or pays attention that the dollar is falling.

Step 2. Folks wake up, but they either don't care or rationalize dollar weakness as a good thing.

Step 3. The central banks now know they have a problem, but the bankers think the market will obey them. It will, for a while. (This is the step we have now reached and what emerged at the G7 meeting.)

Step 4. The dollar now tests everyone's resolve by resuming its decline. The currency markets will not respond to jawboning by finance ministers.

Step 5. In this step, the finance ministers are forced to take action. (Think about it. Even if they'd stated that they wanted the dollar to go up, nothing either explicit or implied indicates they'll do anything about what's happening. That will come next.) When they do take action, the market will do what they want -- but only for a while.

Step 6. The ministers take some additional action, but it won't be enough, and the currency markets won't do what the ministers want.

Step 7. Finally, we'll have a full-blown crisis, and that will be the end game. ...Link

Friday, February 13, 2004

Offshoring Backlash

If you read my posts over the last couple of days, you will see it just isn't America with a jobless recovery. Europe is being hit just as hard by the massive structural problems capitalism is exhibiting in recent years. In my opinion, these structural problems have been ever increasing since the `73 breakdown of the Bretton Woods System. I don't know how we can ever get people to listen and take seriously, the true Keynesian economists like Paul Davidson who actually offer real solutions, instead of most being seduced by the abstract rhetoric of the classical schools of wrongheadedness. Even Stephen Roach, who I admire below, is ill influenced by the free trade dreamland of such a monetary system's end-game wasteland. With the massive ppp and curency imbalances in the world, it is glaringly obvious to me that we have a serious structural problem - one that can not be solved by classical model tools and solutions. The Bretton Woods System has been ever more in conflict with our constitutional democracy since Nixon dismantled its more proper workings in `71 and `73. The Bretton Woods System has actually taken on the dire semi-reality of becoming, through international corporate legal intrigue and national inattention, our 2nd quasi-constitution - dereging and annulling our national and state laws - through the related secretly negotiated GATT, NAFTA, WTO, FTAA, CAFTA and GATS agreements, etc. Thus, since `73 we have been suffering ever increasing consequences. Something must change.

I am well aware of the shortcomings of the then Bretton Woods System, but there was still no excuse for not updating its workability at that time. Many people, myself included, are offering much updated Keynesian systems, or actually the full Keynes' system that never was instituted in 1946, yet updated to today's financial realities. These systems are listed a couple posts below. Please, let us all consider Keynes' seminal work to solve the world's massive problems.

Stephen Roach

It’s economics versus politics. The free-trade theory of globalization embraces the cross-border transfer of jobs. Political systems do not — especially as election cycles heat up. That heat is now being turned up in Washington, as incumbent politicians in both parties come face to face with the angst of America’s jobless recovery. Jobs could well be the “hot button” in Campaign 2004. And offshoring — the transfer of high-wage US jobs to the low-wage developing world — could quite conceivably be the most contentious aspect of this debate and one of greatest risk factors for ever-complacent financial markets.

Like most economists, I worship at the high altar of free-market competition and the trade liberalization that drives it. But that doesn’t mean putting a positive spin on the painful dislocations that trade competition can spawn. Unfortunately, that was the mistake made recently by the Bush administration’s chief economist, Gregory Mankiw, in his dismissive assessment of white-collar job losses due to offshoring. Like most economic theories, the optimal outcomes cited by Mankiw pertain to that ever-elusive long run. Over that timeframe, the basic conclusion of the theory of free trade is inarguable: International competition lowers costs and prices, thereby boosting the purchasing power and standard of living of consumers around the world. The practical problem in this case — as it is with most theories — is the concept of the long run. Sure, over a long enough timeframe, things will eventually work out according to this theoretical script. But the key word here is “eventually” — the stumbling block in presuming that academic theories map neatly into the shorter time horizons of financial markets and politics. Lord Keynes put it best in his 1923 Tract on Monetary Reform, cautioning, “In the long run, we’re all dead.” ...Link

Wednesday, February 11, 2004

Paul Davidson - International Financial Architecture

I have been asked to repost Paul Davidson's international financial architecture proposal. I will also repost a link to my own international financial architecture ideas.

Paul Davidson Article

Elsewhere (Davidson) I have developed in detail a proposal for reforming the entire international payments system via an international clearing union that provides for capital controls and other necessary and sufficient conditions to permit the establishment of a golden age in the 21st century. The main proviso of my proposal are:

1. The unit of account and ultimate reserve asset for international liquidity is the International Money Clearing Unit (IMCU). All IMCU's are held only by central banks, not by the public.

2. Each nation's central bank is committed to guarantee one way convertibility from IMCU deposits at the clearing union to its domestic money. Each central bank will set its own rules regarding making available foreign monies (through IMCU clearing transactions) to its own bankers and private sector residents(21). Ultimately, all major private international transactions clear between central banks' accounts in the books of the international clearing institution.

3. The exchange rate between the domestic currency and the IMCU is set initially by each nation -- just as it would be if one instituted an international gold standard.

4. Contracts between private individuals will continue to be denominated into what ever domestic currency permitted by local laws and agreed upon by the contracting parties.

5. An overdraft system to make available short-term unused creditor balances at the Clearing House to finance the productive international transactions of others who need short-term credit. The terms will be determined by the pro bono clearing managers.

6. A trigger mechanism to encourage a creditor nation to spend what is deemed (in advance) by agreement of the international community to be "excessive" credit balances accumulated by running current account surpluses. These excessive credits can be spent in three ways: (1) on the products of any other member of the clearing union, (2) on new direct foreign investment projects, and/or (3) to provide unilateral transfers (foreign aid) to deficit members.

7. A system to stabilize the long-term purchasing power of the IMCU (in terms of each member nation's domestically produced market basket of goods) can be developed. This requires a system of fixed exchange rates between the local currency and the IMCU that changes only to reflect permanent increases in efficiency wages.(22) This assures each central bank that its holdings of IMCUs as the nation's foreign reserves will never lose purchasing power in terms of foreign produced goods, even if a foreign government permits wage-price inflation to occur within its borders.

8. If a country is at full employment and still has a tendency towards persistent international deficits on its current account, then this is prima facie evidence that it does not possess the productive capacity to maintain its current standard of living. If the deficit nation is a poor one, then surely there is a case for the richer nations who are in surplus to transfer some of their excess credit balances to support the poor nation.(23) If it is a relatively rich country, then the deficit nation must alter its standard of living by reducing the relative terms of trade with major trading partners. If the payment deficit persists despite a continuous positive balance of trade in goods and services, then there is evidence that the deficit nation might be carrying too heavy an international debt service obligation. The pro bono officials of the clearing union should bring the debtor and creditors into negotiations to reduce annual debt service payments by [1] lengthening the payments period, [2] reducing the interest charges, and/or [3] debt forgiveness.(24) ...Link

China May Allow Yuan To Appreciate

China May Allow Yuan To Appreciate

Currency Policy Causes Tension With U.S.
By Peter S. Goodman

Chinese Premier Wen Jiabao said Tuesday that his country's fixed currency-exchange rate would remain "basically stable," state media reported, in an apparent sign that Beijing might allow its currency to appreciate slightly this year to ease trade tensions with the United States.

The premier made the comment in an opening speech to a closed-door gathering of senior government officials and financial regulators in Beijing, according to the state-run China Central Television network. The conference came two days after the Group of Seven industrial nations called for greater flexibility in currency values worldwide -- a message widely construed as being aimed primarily at China.

Hong Kong continued to bid up the price of futures contracts to purchase China's currency, a key indicator that markets are betting that China will allow at least a slight increase in the value of its currency, the yuan.

The gathering of economic policymakers in Beijing focused on discussion of China's fixed currency regime along with plans to revamp the country's state-owned banks, which are holding up to $500 billion in bad loans, state television reported. The agendas of such meetings are rarely disclosed publicly, underscoring the sense that China may be attempting to signal a slight change, or at least is attempting to mollify those assailing the country for holding the line on its currency policy. ...Link

Tuesday, February 10, 2004

Printing A Global Bubble

Is it just me or are there more and more people chiming in on this very same story? You know this isn't just the direct currency intervention money involved, it is the inter-nation banking and market multiplycation mechanics of this currency addition through the reserve requirements' laws of each nation's banking system. And, if you do a check around the world, you may find many nations big banks running reserves of less than the very dangerous levels of 1%!

Printing a global bubble
By Ian Campbell

Globalization is a misunderstood concept. It is a target for demonstrators, seen as a way in which the rich world and big companies exploit the poor world. But globalization is an old phenomenon, even if the term is new. Merchants have been traveling for thousands of years and bringing new products, new services, new ideas to countries that are unfamiliar with them and building fresh industries as they do.

In one particular regard, however, the world probably is much more globalized than ever before: in the flow of capital around the globe. This is by no means a new phenomenon either but improved communications have caused it to grow. One clear and very important example at present is that about half the huge fiscal deficit being run by U.S. President George W. Bush is being financed by Asian countries, in particular Japan, but also China.

These flows of capital have consequences, important ones, and, given the current behavior of the U.S. government and U.S. Federal Reserve and that of other governments and central banks around the world, extremely dangerous ones.

To illustrate what is going on, let us begin with a news headline that took your correspondent's eye this week: "Treasuries Barely Blink at Refunding Bill." The U.S. government had announced its intention to borrow $56 billion as part of its quarterly refunding plan. That is a lot of new debt to put into the market. It ought to make investors, the government's creditors, wary. But the news did not drive down Treasury prices. Why? ...Link

PIMCO Bonds - The Last Vigilante

This is a very important and informative article from the perspective of a bond trader. Bill has a keen insight into the finer workings of the U.S. economy. Especially check out the historical graph on total credit market debt. The comparison between `29 and today is ominous. As we march toward the edge of globalisation's end game, we need all the serious information possible to assess our position. Then, can we even know?

PIMCO Bonds - Vigilante
By Bill Gross

You don’t hear much about the bond market vigilantes anymore. They sort of rode off into the sunset a few years back, either having forgotten their role or perhaps having grown accustomed to their impotence in an era where deflation instead of inflation was public enemy number one. Their glory days were probably a little overrated anyway. Vigilantes are essentially lenders and decades ago when they first gained their reputation there were no inflation protected TIPS or real return commodity funds for a bond investor to send a message with. It was either bonds or cash, and the price of cash was set by the Lone Ranger at the Fed who was heading up the posse. All the rest of us sort of rode along, whoopin’ and a hollerin’, shootin’ our guns in the air like we were gonna lasso and hogtie those inflationary varmints. But we were kind of acting. Paul Volcker was the man, the Vigilante, and later I suppose it was Alan Greenspan, although to me he now seems more like Barney Fife than the Lone Ranger. I write this in half jest if only to introduce the notion that Volcker’s Wild West was a lot different than that of Greenspan’s today. While both marshals were entrusted with the dual responsibility of controlling inflation and maintaining a sound economy, Greenspan’s economy is a completely different one than the one Volcker rode his white horse into in 1979 and out of in 1987. Greenspan’s economy is a globalized economy, filled with negative vibrations revolving around substitution of cheap Asian and Latin American labor for workers here at home. It is an economy full of technological wonders such as the Net, cell phones, high-speed data transmission, and the like. We may not be able to go to the moon anymore, but things down here on mother Earth are certainly movin’ and shakin’. These changes have completely altered the perspective of our High Sheriff and Chief Vigilante. Now there are legitimate questions as to the natural rate of domestic unemployment in a globalized world, the sustainable level of productivity in a technology tinted economy and the resultant effects they have on inflation and economic growth – the Fed’s two primary responsibilities. It is not an easy assignment, this job of Chief Vigilante in the year of 2004. ...Continued
America's shrinking job market

Friday, February 06, 2004

Reload The Cannon

Steven Roach

"Economic policy-making requires a touch of art as well as science. But it also needs a good deal of common sense. Like war, one of the basic principles of stabilization policy is never to run out of ammunition. Policy stimulus is to be used in bad times, but when circumstances improve, it is critical to "reload the cannon." Otherwise, there will be no ammo for the inevitable next battle.

As simple as this basic rule is, it has all but been forgotten in the current climate. The Bank of Japan's zero interest rate policy is the most obvious case in point - a central bank that has completely run out of basis points. But it's not as if the monetary authorities in America and Europe have vast stockpiles of arms either; their policy rates are only 1% and 2%, respectively. The same rule, of course, applies to fiscal policy - deficit spending in bad times should be followed by fiscal restraint in good times. The recent globalization of fiscal profligacy is not exactly comforting in that regard either. "

....Lacking in the traditional fuel of income support, consumers have had little choice but to extract purchasing power from yet another asset — this time, property. But such asset-driven growth spawns the lethal combination of debt and reduced saving. And America has willingly complied. Household debt outstanding has soared to a record 82% of GDP, while the net national saving rate plunged to a record low of less than 1% in 2003. Unfortunately, the shortfall of domestic saving has given rise to America’s massive current-account deficit — leaving the US economy with the worst confluence of macro imbalances in its modern history. All this and more is an outgrowth of the Fed’s asymmetrical strategy of coping with asset bubbles — holding its fire on the upside but then deploying maximum defenses on the downside.

Meanwhile, this approach has another worrisome by-product: It has become a breeding ground for a string of additional asset bubbles that have come on the scene in the aftermath of the burst equity bubble. That’s not just true of property but also of bonds, credit instruments, emerging market debt, and tech stocks (again). This multiple-bubble syndrome is strikingly reminiscent of the moral hazard play that became central to the Great Bubble of the late 1990s — the recognition on the part of investors and speculators that Fed accommodation was here to stay. As long as the Fed takes interest-rate risk out of the equation, one bubble begets another. ...Continued

Thursday, February 05, 2004

Group of 7 - Europe - Outsider

As Group of 7 Gathers, Europe Looks Like an Outsider

When finance ministers of the Group of 7 leading industrial countries convene on Friday in Boca Raton, Fla., the European delegation may find itself stranded on the sidelines.

The fall of the dollar against the euro has frustrated exporters and political leaders in Europe, and there is little hope that they can reverse the policies of either the Bush administration, which seems content to let the market push the dollar downward, or Asia's central banks, which have intervened heavily to curb the rise of their currencies against the dollar.

"The U.S. and Asia have entered a symbiosis, in which Asia is financing the American recovery," said Thomas Mayer, the chief European economist for Deutsche Bank in London. "For Asia, that's fine, and for the U.S., that's also fine. The problem is for the bystander."

European officials seem resigned to their currency's bearing the brunt of the dollar's downward adjustment. Exchange rates are likely to be Topic A among the United States, Japan, Germany, France and other countries, but few here expect the Boca Raton meeting to yield more than a general statement, carefully worded to avoid roiling the markets.

Similarly, the European Central Bank is not expected to lower interest rates when its policy board meets here in Frankfurt on Thursday, even though many analysts worry that the surging euro could derail Europe's fledgling recovery by dampening exports. The consensus forecast is that the bank will keep its benchmark short-term interest rate at 2 percent.

So far, the bank's president, Jean-Claude Trichet, has limited himself to speaking out against "brutal" movements in exchange rates - a strategy known as verbal intervention, which analysts said had been effective in slowing the euro's rise in recent weeks. ...Continued

Wednesday, February 04, 2004

Why War? Op-Ed: The Currency War

I do not entirely endorse the views in this story, however it holds forth an overall vision which can not be ignored, especially since it was written a year ago and many items mentioned have come true. I advise caution when reading, yet the story offers merit.

A Macroeconomic and Geostrategic Analysis of the Unspoken Truth
by W. Clark

"I hypothesize that President Bush intends to topple Saddam in 2003 in a pre-emptive attempt to initiate massive Iraqi oil production in far excess of OPEC quotas, to reduce global oil prices, and thereby dismantle OPEC's price controls. The end-goal of the neo-conservatives is incredibly bold yet simple in purpose, to use the 'war on terror' as the premise to finally dissolve OPEC's decision-making process, thus ultimately preventing the cartel's inevitable switch to pricing oil in euros."

...The most likely end to US hegemony may come about through a combination of high oil prices (brought about by US foreign policies toward the Middle East) and deeper devaluation of the US dollar (expected by many economists). Some elements of this scenario:

1) US global over-reach in the "war on terrorism" already leading to deficits as far as the eye can see — combined with historically-high US trade deficits — lead to a further run on the dollar. This and the stock market doldrums make the US less attractive to the world's capital.

2) More developing countries follow the lead of Venezuela and China in diversifying their currency reserves away from dollars and balanced with euros. Such a shift in dollar-euro holdings in Latin America and Asia could keep the dollar and euro close to parity.

3) OPEC could act on some of its internal discussions and decide (after concerted buying of euros in the open market) to announce at a future meeting in Vienna that OPEC's oil will be re-denominated in euros, or even a new oil-backed currency of their own. A US attack on Iraq sends oil to $40 per barrel.

4) The Bush Administration's efforts to control the domestic political agenda backfires. Damage over the intelligence failures prior to 9/11 and warnings of imminent new terrorist attacks precipitate a further stock market slide.

5) All efforts by Democrats and the 57% of the US public to shift energy policy toward renewables, efficiency, standards, higher gas taxes, etc. are blocked by the Bush Administration and its fossil fuel industry supporters. Thus, the USA remains vulnerable to energy supply and price shocks.

6) The EU recognizes its own economic and political power as the euro rises further and becomes the world's other reserve currency. The G-8 pegs the euro and dollar into a trading band — removing these two powerful currencies from speculators trading screens (a "win-win" for everyone!). Tony Blair persuades Brits of this larger reason for the UK to join the euro.

7) Developing countries lacking dollars or "hard" currencies follow Venezuela's lead and begin bartering their undervalued commodities directly with each other in computerized swaps and counter trade deals. President Chávez has inked 13 such country barter deals on its oil, e.g., with Cuba in exchange for Cuban health paramedics who are setting up clinics in rural Venezuelan villages.

The result of this scenario? The USA could no longer run its huge current account trade deficits or continue to wage open-ended global war on terrorism or evil. The USA ceases pursuing unilateralist policies. A new US administration begins to return to its multilateralist tradition, ceases its obstruction and rejoins the UN and pursues more realistic international cooperation. ...Link