With the IMF annual meeting taking place this weekend in Washington, D. C., it is hard to pick on any other topic than what is happening in economics and finance in the world.
The underlying story: the United States has not been challenged, financially as well as economically, in many years and has grown comfortable with its position as the Number One Player (NOP) in the World.
Plot line: the United States will not fall from its position as NOP but other countries are becoming relatively stronger, especially China.
Scenario: China smells weakness in the United States position. When an “opponent” smells weakness, that “opponent” steps up its game. Most experts expected China to “step up its game” at some time in the future, but they did not expect this behavior to happen so soon.
Response: the NOP calls “foul”! The first reaction of the NOP is to claim that the “opponent” is cheating or playing dirty. The NOP tries to get those on the sideline into the game in order to overcome the pressure that the “opponent” is applying to the NOP. China bashing has become de rigueur in the United States, especially for those running for office in this fall’s elections. (“China-Bashing Gains Bipartisan Support,” http://professional.wsj.com/article/SB10001424052748704689804575536283175049718.html?mod=ITP_pageone_2&mg=reno-wsj.)
Script: the battle goes on. This conflict is not going to be resolved this weekend. Nor is the conflict going to be resolved at the G-20 meetings in November. The conflict, for the time being, is going to be played out on the playing fields. The “opponent” is going to push the NOP and is going to hit the NOP on many different fronts.
For example, another move by the “opponent’ is the effort by the Chinese to make its currency, the yuan, more global. Last week, electronic trading of the yuan began. Further efforts are underway to expand this trading to banks in the United States and in Europe. (“Yuan Goes Electronic in Global Market Bid,” http://professional.wsj.com/article/SB10001424052748704011904575537754269611906.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)
“China’s government has made a series of moves in the past year to encourage the yuan’s use outside China, an effort to become less dependent on the dollar for trade and investment. The moves are allowing pools of yuan to accumulate in bank accounts outside of China, particularly in Hong Kong.
Hong Kong banks have been trading the currency among themselves, but through over-the-counter trades where the banks contact each other directly or through brokers.”
This new move will mean that prices and trading amounts will be posted for all to see.
The effort to improve its relative position in the world is not going to stop. China is making efforts on many fronts to strengthen its position in the world. The contest is on.
Leaders in the Obama administration, from the President to the Secretary of the Treasury on down, are speaking out more forcefully against the actions of the Chinese.
World leaders are observing this conflict and are trying to keep the discussions civil and “in bounds”. This is why someone like the managing director of the IMF, Dominique Strauss-Kahn, as well as others, are attempting to temper the rhetoric and bring things into the existing organizations that deal with trade and international finance. (“IMF Chief Steps into Dispute over China’s Currency Policy,” http://www.nytimes.com/2010/10/08/business/global/08currency.html?ref=business.)
Players crying “foul” can only achieve so much. Sooner or later the NOP will have to modify its game plan and raise its play to another level. The “opponent” is not going to lessen its pressure as long as weakness in perceived in the NOP.
And, where does this weakness show? One very prominent place this weakness shows is in the value of the dollar. Since the early 1970s when the dollar was taken off the gold standard, the value of the dollar has declined by about 40%. Except for the “flight to quality” periods experienced during the financial unpleasantness of the 2008-2009 period, the dollar has continued to be in decline from the level it reached during the Clinton years. The international investment community is not “in love” with the fiscal and monetary policy of the United States government.
This contest between China and the United States is for real. The pressure from the Chinese is not going to abate anytime soon. The “rest-of-the-world” is not in any position to contain this conflict unless it shuts down world trade, something it will not do.
This means that the United States must get its act in order. The United States cannot compete with 20% to 25% of its industrial capacity not being used. The United States cannot compete with 20% to 25% of its labor force under-employed and not trained sufficiently to work in the modern economy. The United States cannot compete when its government creates incentives for people to protect themselves from credit inflation rather than engage in productive pursuits.
And, fiscal stimulus by the government and quantitative easing on the part of the monetary authorities will not correct these problems. They will only indicate to the Chinese how weak the United States has become.
This contest between China and the United States is for real. The only way the United States can “raise its game” is by focusing on what can make it more competitive. I don’t believe that the United States will ever again get the “free ride” it benefitted from over the past thirty years or so. So, the United States government must change the way it does business.
The Chinese are only the first in line to “take us on”. Right behind them are the Brazilians, the Indians, and, of course, the Russians, again. And, right behind them is a whole host of other nations.
Showing posts with label Russia. Show all posts
Showing posts with label Russia. Show all posts
Friday, October 8, 2010
Monday, June 21, 2010
China Is In The Game
China wants to play in the game. Yes, it would like to dominate the game, but that is for another time. For the present, China wants to be a player. I have written this constantly throughout my blogging career and I see no reason to change my opinion at this point.
China wants to play in the game and to do so its leaders realize that it must be a part of the game and not absent from it. But, remember two things: first, China will not do anything that it thinks might be harmful to itself in the long run; and second, China will always move in a way that “saves face.” Given these two conditions, China will be “in the game.”
The weekend news about China’s move on its currency is a case in point. The move was taken at China’s initiative. It seemed to catch the rest of the world by surprise. The move followed weeks of discussion about the possibility that China would not change the value of its currency in the near term.
China timed its move according to its dictates and not those of other nations.
Furthermore, the move pre-empts any discussion or actions by members of the G-20 at its June 26-27 meeting to highlight China’s unwillingness to play ball with the other major nations that will be in attendance. Now, the rest of the G-20 must re-boot their strategies relative to the agenda of the upcoming meeting.
China must see this as beneficial to itself and believe that moving at this time “saves face” because the news was done on its terms and not those of other countries in the world. It is keeping itself in the game.
However, China does not want events to get ahead of its plans. Although the announcement came on Saturday, when the market opened on Monday the value of the yuan was approximately 6.83 yuan to the dollar, roughly the same as it closed on Friday. By Monday afternoon, however, the yuan was trading around 6.8015 to the dollar, the highest level it has been in the modern era.
The point here is that China wants any appreciation in the value of the yuan to be incremental and not discrete. That is, movements in the yuan will tend to be more like a slow crawl and not like a discrete jump or leap. The leaders in China do not want to encourage speculators or huge currency inflows.
The signal to investors is that the value of the yuan may change but don’t expect wide swings. This is just not the way the Chinese do business.
But, I think, there is a bigger story going on here. The bigger story includes Russia and India…so we have three of the four BRIC nations as a part of what is going on. President Obama and his administration are making a concerted effort to be a part of the trajectory taking these countries into a prominent position in the world. All three of these countries are engaging each other, and talking with each other, visiting each other, and doing things with each other.
Chinese leaders have come to America and American leaders have gone to China.
New contacts with Russia show promise. Last year, President Obama called for a reset in relations with Russia. The countries have now signed a nuclear arms reduction treaty, agreed to increase cooperation in Afghanistan, and Russia has supported United States sanctions against Iran. This week President Medvedev comes to Washington to discuss business and then will visit Silicon Valley to meet with leaders in the technology field. Medvedev would like to encourage technology areas similar to Silicon Valley in Russia.
Leaders in India also are responding to invitations from the Obama administration to engage in dialogue and improved communications between India and the United States. Of these three BRIC nations, India has the longest solid ties with the United States and the greatest personal bond to see that these ties become stronger.
Not only are these three countries becoming relatively stronger in the world pecking order, but are the important reason why discussions about world business and foreign trade need to work in the larger Group of 20 nations rather than in the smaller groups that have been so prominent in the past.
Add on top of this the economic weaknesses experienced in the United States and Europe which have allowed these three, China, Russia, and India, to gain relative to “the West” faster than they would have if the financial collapse in these former areas had not occurred. These three nations are not going to back off their ascent in the world power scramble just because the United States and Europe are facing some “uncomfortable” economic weaknesses.
Furthermore, Europe has its own internal contradictions to deal with. Leadership in Europe is close to zero and the political problems that must be resolved there are almost overwhelming. And, while Europe attempts to get its house in order…the rest of the world moves on.
Brazil, the other BRIC, seems to be laying bricks lately. The current president, Luiz Inảcio Lula da Silva seems more interested in playing around with the leaders of countries at odds with the United States rather than entering into more mature relationships with the rest of the emerging world. Enough said.
What is vitally important for world trade and finance is to have these major countries talking with one another and learning about how they can work together to create a world in which all can prosper. World trade will not exist if it just benefits one or two countries.
The emerging nations are doing just that…emerging. These countries must be an important part of the world of the future. Keeping these nations down and causing resentments in a world where there are no channels for communication is not the way to build a richer and more vibrant world to live in.
The crucial thing is learning how to deal with each other. As I mentioned above, the Chinese will not make moves that will harm themselves in the long run and when they move they will do so in a way that does not make them look bad. Can we in the United States accept these two behavioral traits that seem so important to the Chinese or will we become so impatient and try and impose our self-importance on them?
Certainly, leaders in the United States cannot become “doormats” that others can just walk over. But, the time seems right for talking, for keeping channels open, for cooperation within the competitive framework, and for learning how to work with each other, accepting the quirks and psychological needs of others.
China will not always internally do the things we in the United States think that they should do…especially in some areas like human rights. We should not be silent on these things. But, I believe the world still has more to gain by building cooperation over the longer run than it does by breaking off ties. I believe that the recent economic moves by China confirm this. I believe that the leaders of China truly want to be in the game and will act accordingly.
China wants to play in the game and to do so its leaders realize that it must be a part of the game and not absent from it. But, remember two things: first, China will not do anything that it thinks might be harmful to itself in the long run; and second, China will always move in a way that “saves face.” Given these two conditions, China will be “in the game.”
The weekend news about China’s move on its currency is a case in point. The move was taken at China’s initiative. It seemed to catch the rest of the world by surprise. The move followed weeks of discussion about the possibility that China would not change the value of its currency in the near term.
China timed its move according to its dictates and not those of other nations.
Furthermore, the move pre-empts any discussion or actions by members of the G-20 at its June 26-27 meeting to highlight China’s unwillingness to play ball with the other major nations that will be in attendance. Now, the rest of the G-20 must re-boot their strategies relative to the agenda of the upcoming meeting.
China must see this as beneficial to itself and believe that moving at this time “saves face” because the news was done on its terms and not those of other countries in the world. It is keeping itself in the game.
However, China does not want events to get ahead of its plans. Although the announcement came on Saturday, when the market opened on Monday the value of the yuan was approximately 6.83 yuan to the dollar, roughly the same as it closed on Friday. By Monday afternoon, however, the yuan was trading around 6.8015 to the dollar, the highest level it has been in the modern era.
The point here is that China wants any appreciation in the value of the yuan to be incremental and not discrete. That is, movements in the yuan will tend to be more like a slow crawl and not like a discrete jump or leap. The leaders in China do not want to encourage speculators or huge currency inflows.
The signal to investors is that the value of the yuan may change but don’t expect wide swings. This is just not the way the Chinese do business.
But, I think, there is a bigger story going on here. The bigger story includes Russia and India…so we have three of the four BRIC nations as a part of what is going on. President Obama and his administration are making a concerted effort to be a part of the trajectory taking these countries into a prominent position in the world. All three of these countries are engaging each other, and talking with each other, visiting each other, and doing things with each other.
Chinese leaders have come to America and American leaders have gone to China.
New contacts with Russia show promise. Last year, President Obama called for a reset in relations with Russia. The countries have now signed a nuclear arms reduction treaty, agreed to increase cooperation in Afghanistan, and Russia has supported United States sanctions against Iran. This week President Medvedev comes to Washington to discuss business and then will visit Silicon Valley to meet with leaders in the technology field. Medvedev would like to encourage technology areas similar to Silicon Valley in Russia.
Leaders in India also are responding to invitations from the Obama administration to engage in dialogue and improved communications between India and the United States. Of these three BRIC nations, India has the longest solid ties with the United States and the greatest personal bond to see that these ties become stronger.
Not only are these three countries becoming relatively stronger in the world pecking order, but are the important reason why discussions about world business and foreign trade need to work in the larger Group of 20 nations rather than in the smaller groups that have been so prominent in the past.
Add on top of this the economic weaknesses experienced in the United States and Europe which have allowed these three, China, Russia, and India, to gain relative to “the West” faster than they would have if the financial collapse in these former areas had not occurred. These three nations are not going to back off their ascent in the world power scramble just because the United States and Europe are facing some “uncomfortable” economic weaknesses.
Furthermore, Europe has its own internal contradictions to deal with. Leadership in Europe is close to zero and the political problems that must be resolved there are almost overwhelming. And, while Europe attempts to get its house in order…the rest of the world moves on.
Brazil, the other BRIC, seems to be laying bricks lately. The current president, Luiz Inảcio Lula da Silva seems more interested in playing around with the leaders of countries at odds with the United States rather than entering into more mature relationships with the rest of the emerging world. Enough said.
What is vitally important for world trade and finance is to have these major countries talking with one another and learning about how they can work together to create a world in which all can prosper. World trade will not exist if it just benefits one or two countries.
The emerging nations are doing just that…emerging. These countries must be an important part of the world of the future. Keeping these nations down and causing resentments in a world where there are no channels for communication is not the way to build a richer and more vibrant world to live in.
The crucial thing is learning how to deal with each other. As I mentioned above, the Chinese will not make moves that will harm themselves in the long run and when they move they will do so in a way that does not make them look bad. Can we in the United States accept these two behavioral traits that seem so important to the Chinese or will we become so impatient and try and impose our self-importance on them?
Certainly, leaders in the United States cannot become “doormats” that others can just walk over. But, the time seems right for talking, for keeping channels open, for cooperation within the competitive framework, and for learning how to work with each other, accepting the quirks and psychological needs of others.
China will not always internally do the things we in the United States think that they should do…especially in some areas like human rights. We should not be silent on these things. But, I believe the world still has more to gain by building cooperation over the longer run than it does by breaking off ties. I believe that the recent economic moves by China confirm this. I believe that the leaders of China truly want to be in the game and will act accordingly.
Thursday, July 2, 2009
Is Treasury's TARP Debt Already Monetized? Part III
The discussion continues for one more post. I ended the last post with these words:
“The hope is that as the banking system works through its problems, TARP funds will be returned and the mortgage-backed securities will mature or be sold back into the market allowing the balance sheet of the Federal Reserve to contract back to where it was in the summer of 2008. The banking system is apparently holding onto reserves to protect itself and that is why they are really not lending. The idea is that if they don’t need these excess reserves they will return them. This is what the Federal Reserve is planning to happen. Let’s hope that they are correct!”
On this issue, let me point out the post by Jonathan Weil on Bloomberg this morning, “Crisis Won’t End Until Balance Sheets Get Real” (http://www.bloomberg.com/apps/news?pid=20601039&sid=azsX7o.atu7U). After presenting interesting data on the state of commercial bank balance sheets he argues the following:
“Banks and insurers got Congress to browbeat the Financial Accounting Standards Board into making rule changes that will let them plump earnings and regulatory capital. There also was Fed Chairman Ben Bernanke’s line in March about “green shoots,” which sparked a media epidemic of alleged sightings.
For all this, we still have hundreds of financial companies trading as though the worst of their losses are still to come. Just imagine what their prognosis might be if the government hadn’t pulled out all the stops.”
And, then Weil closes:
“Truth is, there’s no way to know if the economy has turned the corner, or if last quarter’s market rally will prove sustainable. Yet when this many banks still have balance sheets that defy belief, it means the industry probably hasn’t re- established trust with the investing public.
Trust, you may recall, is the financial system’s most precious asset. On that score, we still have a long way to go before we can say this banking crisis is over.”
This is the short run problem and it is the one that is going to determine whether or not the Federal Reserve is going to be able to shrink its balance sheet. This has been the point of my last two posts. And why are we facing such uncertainty at this point? Because the Mark-to-Market rule was pulled and because there is not enough openness and transparency in the public financial reporting of financial institutions. If there are going to be regulatory changes in the future, a lot is going to have to be changed as far as the reporting requirements for financial institutions is concerned.
But, this is just the short run problem.
The longer run problem is the projected budget deficits of the Federal government. Even if things work out as the Federal Reserve has planned as far as bank reserves are concerned and Federal Reserve credit retreats back to where it was in August 2008, there is the massive problem facing the country about how prospective government deficits are going to be financed. The bet is that the Fed will finance a substantial portion of the deficits to come. Let the printing presses roll!
The fear? Inflation.
But many say, we are in a severe economic contraction now. The fear should be deflation and not inflation.
The only response to this counter argument is that in the latter half of the 20th century, any nation that has run substantial deficits has, sooner or later, run into problems related to inflation. Monetary authorities are never so independent of their central governments that imprudent fiscal policies are not in one way or another underwritten through some form of monetization. And, since this happens time after time, how can the international investing community sit on the sidelines and do nothing? Yes, the United States is in a severe recession right now, but what are your odds for the monetization of a lot of the Federal debt over the next three years? Over the next five years? Over the next ten years?
Where do you look for such for an indication of market sentiment on this? Look at the value of the United States dollar. The dollar fell by about 15% against major currencies in the latter part of the 1970s as the Carter budget deficits seemed to get out-of-hand. As we know, Paul Volker played the savior there by conducting a very restrictive monetary policy to bring the value of the dollar back in line. However, the Reagan budgets became so severe by 1985 that the value of the dollar began to plummet. In the face of continuing deficits and the realization that this would continue to result in a weak dollar, Volker gave up the reins of the Federal Reserve in August 1987. The dollar did not pick up strength again until fiscal restraint was returned to Washington with the Clinton administration as the value of the dollar rose over 25% from April 1995 until the end of 2000. The massive budget deficits of Bush 43 were translated into another precipitous decline in the value of the dollar which fell by almost 40% between the middle of 2002 to March 2008.
The fiscal policy of a nation does matter to the international investment community!
But, you say, look at all the other major countries having economic problems and their budgets are out of balance as well. Look at England, Germany, Italy, France, and others.
The response to this? This is not the case for many of the major emerging countries of the world, specifically the BRIC countries. Perhaps one leaves Russia out of this, but China, India, and Brazil are going to emerge from this period much stronger relative to the United States than could have been thought even a year ago or so. So is Canada and several other important countries. This world crisis is going to shift world economic power in a way that has not been seen since the shifts in world power that took place in the 1920s and 1930s. And, international investors are realizing this!
Yes, the dollar will still be used as the reserve currency of the world…for a while longer. The Chinese, and the Russians, and the Brazilians, and the Indians all realize this. And, even though they keep talking about establishing a new reserve currency, they seem to back off and say that the dollar cannot be replaced right now. Yet, the Chinese have called for the Group of 8 to talk about a new reserve currency at its upcoming meeting. The issue IS on the table and my guess is that it is not going to go away.
Which brings me back to the deficits. In my mind, the budget deficits of the United States government are out-of-control right now and there is great concern that this administration will not be able to regain control of them in the near future. There is no “reversal” mechanism that is built into these budgets as the Fed has attempted to build in a “reversal” mechanism in its efforts. As a consequence, great pressure will be put on the monetary authorities over the next several years to monetize a substantial portion of the debt that will be created. The history of the past fifty years or so is that the Fed will not be able to avoid the pressure. This is perception that the international investing community will be bringing to the market when it place its bets. This can be translated into higher long term interest rates in the United States and a continuation in the decline in the value of the United States dollar.
“The hope is that as the banking system works through its problems, TARP funds will be returned and the mortgage-backed securities will mature or be sold back into the market allowing the balance sheet of the Federal Reserve to contract back to where it was in the summer of 2008. The banking system is apparently holding onto reserves to protect itself and that is why they are really not lending. The idea is that if they don’t need these excess reserves they will return them. This is what the Federal Reserve is planning to happen. Let’s hope that they are correct!”
On this issue, let me point out the post by Jonathan Weil on Bloomberg this morning, “Crisis Won’t End Until Balance Sheets Get Real” (http://www.bloomberg.com/apps/news?pid=20601039&sid=azsX7o.atu7U). After presenting interesting data on the state of commercial bank balance sheets he argues the following:
“Banks and insurers got Congress to browbeat the Financial Accounting Standards Board into making rule changes that will let them plump earnings and regulatory capital. There also was Fed Chairman Ben Bernanke’s line in March about “green shoots,” which sparked a media epidemic of alleged sightings.
For all this, we still have hundreds of financial companies trading as though the worst of their losses are still to come. Just imagine what their prognosis might be if the government hadn’t pulled out all the stops.”
And, then Weil closes:
“Truth is, there’s no way to know if the economy has turned the corner, or if last quarter’s market rally will prove sustainable. Yet when this many banks still have balance sheets that defy belief, it means the industry probably hasn’t re- established trust with the investing public.
Trust, you may recall, is the financial system’s most precious asset. On that score, we still have a long way to go before we can say this banking crisis is over.”
This is the short run problem and it is the one that is going to determine whether or not the Federal Reserve is going to be able to shrink its balance sheet. This has been the point of my last two posts. And why are we facing such uncertainty at this point? Because the Mark-to-Market rule was pulled and because there is not enough openness and transparency in the public financial reporting of financial institutions. If there are going to be regulatory changes in the future, a lot is going to have to be changed as far as the reporting requirements for financial institutions is concerned.
But, this is just the short run problem.
The longer run problem is the projected budget deficits of the Federal government. Even if things work out as the Federal Reserve has planned as far as bank reserves are concerned and Federal Reserve credit retreats back to where it was in August 2008, there is the massive problem facing the country about how prospective government deficits are going to be financed. The bet is that the Fed will finance a substantial portion of the deficits to come. Let the printing presses roll!
The fear? Inflation.
But many say, we are in a severe economic contraction now. The fear should be deflation and not inflation.
The only response to this counter argument is that in the latter half of the 20th century, any nation that has run substantial deficits has, sooner or later, run into problems related to inflation. Monetary authorities are never so independent of their central governments that imprudent fiscal policies are not in one way or another underwritten through some form of monetization. And, since this happens time after time, how can the international investing community sit on the sidelines and do nothing? Yes, the United States is in a severe recession right now, but what are your odds for the monetization of a lot of the Federal debt over the next three years? Over the next five years? Over the next ten years?
Where do you look for such for an indication of market sentiment on this? Look at the value of the United States dollar. The dollar fell by about 15% against major currencies in the latter part of the 1970s as the Carter budget deficits seemed to get out-of-hand. As we know, Paul Volker played the savior there by conducting a very restrictive monetary policy to bring the value of the dollar back in line. However, the Reagan budgets became so severe by 1985 that the value of the dollar began to plummet. In the face of continuing deficits and the realization that this would continue to result in a weak dollar, Volker gave up the reins of the Federal Reserve in August 1987. The dollar did not pick up strength again until fiscal restraint was returned to Washington with the Clinton administration as the value of the dollar rose over 25% from April 1995 until the end of 2000. The massive budget deficits of Bush 43 were translated into another precipitous decline in the value of the dollar which fell by almost 40% between the middle of 2002 to March 2008.
The fiscal policy of a nation does matter to the international investment community!
But, you say, look at all the other major countries having economic problems and their budgets are out of balance as well. Look at England, Germany, Italy, France, and others.
The response to this? This is not the case for many of the major emerging countries of the world, specifically the BRIC countries. Perhaps one leaves Russia out of this, but China, India, and Brazil are going to emerge from this period much stronger relative to the United States than could have been thought even a year ago or so. So is Canada and several other important countries. This world crisis is going to shift world economic power in a way that has not been seen since the shifts in world power that took place in the 1920s and 1930s. And, international investors are realizing this!
Yes, the dollar will still be used as the reserve currency of the world…for a while longer. The Chinese, and the Russians, and the Brazilians, and the Indians all realize this. And, even though they keep talking about establishing a new reserve currency, they seem to back off and say that the dollar cannot be replaced right now. Yet, the Chinese have called for the Group of 8 to talk about a new reserve currency at its upcoming meeting. The issue IS on the table and my guess is that it is not going to go away.
Which brings me back to the deficits. In my mind, the budget deficits of the United States government are out-of-control right now and there is great concern that this administration will not be able to regain control of them in the near future. There is no “reversal” mechanism that is built into these budgets as the Fed has attempted to build in a “reversal” mechanism in its efforts. As a consequence, great pressure will be put on the monetary authorities over the next several years to monetize a substantial portion of the debt that will be created. The history of the past fifty years or so is that the Fed will not be able to avoid the pressure. This is perception that the international investing community will be bringing to the market when it place its bets. This can be translated into higher long term interest rates in the United States and a continuation in the decline in the value of the United States dollar.
Thursday, June 11, 2009
The BRICs Are On The Move!
In the midst of the current economic and financial crisis the world is radically changing. Comparisons are constantly being made between the collapse of the global economy that is now being experienced and the collapse the world went through in the 1930s. Whereas most of the discussion has limited itself to the extent of the downturn and the methods being used by policymakers to avoid a repeat of the severity of the earlier depression, I would like to focus on another area in which comparisons can be made. The specific area I would like to focus upon is the relative shifts that are taking place in economic and financial power in the world.
At the start of World War I there was no question that Great Britain was the number one economic and financial power in the world. The 1920s and the 1930s represented a turning point in the economic structure of the world and a change in the location of the center of financial power. The change in economic structure related to the final triumph of the industrial sector over the agricultural sector in the most advanced countries in the world. This movement favored the United States over Europe. The center of financial power in the world shifted from London to the United States. The changes in industrial structure helped to explain parts of the economic dislocations of the Great Depression that were not fully absorbed until World War II. The shift in financial power was not really recognized until after the war.
An important and interesting history of this period can be found in the book “Lords of Finance” by Liaquat Ahamed. I have written a review of this book for Seeking Alpha and this can be found at http://seekingalpha.com/article/121616-financial-collapse-a-lesson-from-the-20s.
I am bringing up this history because I believe there is a similar shift in economic structure and financial power that is going on in the world at the present time. It is important to understand these changes because they are going to influence what is going on in the world for a long time.
Like the 1920s and 1930s there is an economic restructuring going on. To me, the emerging dislocations in the world are related to advances in information technology and the global changes in energy needs. I have no idea how these dislocations are going to work themselves out but there are huge changes coming. The innovation in financial instruments markets over the past forty years or so are the result of the new information technology and the intense study of what are now called “Information Markets” is going to lead to transactions and trading opportunities that have not fully been realized yet. I believe that the collapse of the auto industry is just one part of the mammoth changes that are coming in the area of energy sources and uses.
The other shift that is taking place is in the location of financial power within the global marketplace. Yesterday it was announced that Russia and Brazil will each acquire $10 billion of bonds from the International Monetary Fund (See Brazil, Russia Trade T-Bills for IMF Clout, http://online.wsj.com/article/SB124463884266502011.html). China is planning to purchase $50 billion in IMF bonds and it is said that India will also make a similar purchase. The BRIC countries are on the move!
The reason given for the purchase of the IMF bonds is to increase the clout that these emerging nations have on world economic and financial affairs. The BRIC nations believe that they have earned and therefore deserve to play a bigger role in what is going on globally. Hence, the movements of these countries are not surprising and are not uncoordinated. The leaders of the BRIC nations have been meeting regularly and communicating frequently. Their next group meeting begins June 16 in Russia.
The important thing for the leadership in the United States to realize is that they must take the world into consideration when making decisions relating to U. S. fiscal and monetary policy. I have gotten comments on my recent posts about the dollar that question the need for policy makers to be concerned about the value of the dollar in their decision making. I agree with Paul Volcker that the most important price in a country is the price of its currency. The United States, even more than in the past, will not be able to afford to ignore what the rest of the world is saying about the direction its budget policy and monetary policy are going. All too often in the past, and especially in the past eight years, American leadership has thumbed its nose at world opinion. The rise of the BRICs indicates that this time is over and real attention needs to be paid to what others are saying and doing. Although the United States will continue, in the near term to be the major financial power in the world, the times are changing and will continue to move in the current direction over the next ten to twenty years.
There are two reasons for saying this. First, Brazil, Russia, India, and China are going to continue to become more powerful economically and financially. Whereas there may not be an absolute shift in world power in these areas, there will be a relative shift with the BRIC nations becoming relatively more powerful. This, in my mind, is not going to stop.
Second, some form of international organization is going to evolve that will oversee global financial institutions and financial markets. The IMF is a natural place to look for such leadership. In the past it has not quite lived up to its possibilities. Now, however, it looks as if there is a new focus on the possibilities it presents. The BRIC nations seem to be eying the IMF as a place where they might be able to exert their growing economic and financial clout to attain the recognition and influence they want and believe they deserve. The IMF is certainly not an unwilling recipient of such attention and is actively seeking more funding.
What does all this mean for investors? I would like to focus on just two points related to the financial issues. First, the United States seems headed for a clash with the rest of the world in terms of monetary and fiscal policy. The current and future budget deficits appear to be unsustainable and the Obama administration has not yet presented any credible plans to reduce the amount of debt the government will be creating. In addition, the Federal Reserve has already put so much liquidity into the financial system that Bernanke’s statements about removing the liquidity as the crisis retreats seem less than serious. The added concern is what role the Fed will play in helping the Treasury place all the debt that it must issue. As I have stated before, history has repeatedly shown that this is not a good combination either for keeping interest rates low or for keeping the value of the currency up. Such movements over time will be brought on by the international markets. The only response that will avoid this is to bring the budget under control and take the pressure off the central bank to support the placing of the debt.
The second point refers to the shift in world economic power. If the BRIC countries find that they can work with the IMF, a new power structure will emerge in global finance. Financial and non-financial companies in emerging markets will become much more relevant. Important financial centers will be distributed throughout the world rather than being concentrated in just one or two cities. As with the evolution of the financial power in the 1920s and 1930s, these changes will not take place overnight. What I am suggesting, however, is that we are seeing the beginning of a shift in financial power in the world that will continue to evolve over the next ten to twenty years.
This has important ramifications for the regulation or re-regulation of the United States financial system. As usual, Congress and the Administration are fighting the last war. Right now the policy makers in charge in Washington D. C. are responding to the populist discontent being expressed in the country. Get rid of greed! Regulate salaries and bonuses! Emasculate the role of derivatives! This is not the way to prepare the economic and financial system for the future.
Yes, the world is changing. The economic base of the global economy is shifting and the resulting need to restructure is the reason for the severity of the current recession. Financial power in the world is being re-distributed and this trend is just beginning to show itself. These movements are going to define the conditions for investment in the coming years. It will require new and creative thinking.
At the start of World War I there was no question that Great Britain was the number one economic and financial power in the world. The 1920s and the 1930s represented a turning point in the economic structure of the world and a change in the location of the center of financial power. The change in economic structure related to the final triumph of the industrial sector over the agricultural sector in the most advanced countries in the world. This movement favored the United States over Europe. The center of financial power in the world shifted from London to the United States. The changes in industrial structure helped to explain parts of the economic dislocations of the Great Depression that were not fully absorbed until World War II. The shift in financial power was not really recognized until after the war.
An important and interesting history of this period can be found in the book “Lords of Finance” by Liaquat Ahamed. I have written a review of this book for Seeking Alpha and this can be found at http://seekingalpha.com/article/121616-financial-collapse-a-lesson-from-the-20s.
I am bringing up this history because I believe there is a similar shift in economic structure and financial power that is going on in the world at the present time. It is important to understand these changes because they are going to influence what is going on in the world for a long time.
Like the 1920s and 1930s there is an economic restructuring going on. To me, the emerging dislocations in the world are related to advances in information technology and the global changes in energy needs. I have no idea how these dislocations are going to work themselves out but there are huge changes coming. The innovation in financial instruments markets over the past forty years or so are the result of the new information technology and the intense study of what are now called “Information Markets” is going to lead to transactions and trading opportunities that have not fully been realized yet. I believe that the collapse of the auto industry is just one part of the mammoth changes that are coming in the area of energy sources and uses.
The other shift that is taking place is in the location of financial power within the global marketplace. Yesterday it was announced that Russia and Brazil will each acquire $10 billion of bonds from the International Monetary Fund (See Brazil, Russia Trade T-Bills for IMF Clout, http://online.wsj.com/article/SB124463884266502011.html). China is planning to purchase $50 billion in IMF bonds and it is said that India will also make a similar purchase. The BRIC countries are on the move!
The reason given for the purchase of the IMF bonds is to increase the clout that these emerging nations have on world economic and financial affairs. The BRIC nations believe that they have earned and therefore deserve to play a bigger role in what is going on globally. Hence, the movements of these countries are not surprising and are not uncoordinated. The leaders of the BRIC nations have been meeting regularly and communicating frequently. Their next group meeting begins June 16 in Russia.
The important thing for the leadership in the United States to realize is that they must take the world into consideration when making decisions relating to U. S. fiscal and monetary policy. I have gotten comments on my recent posts about the dollar that question the need for policy makers to be concerned about the value of the dollar in their decision making. I agree with Paul Volcker that the most important price in a country is the price of its currency. The United States, even more than in the past, will not be able to afford to ignore what the rest of the world is saying about the direction its budget policy and monetary policy are going. All too often in the past, and especially in the past eight years, American leadership has thumbed its nose at world opinion. The rise of the BRICs indicates that this time is over and real attention needs to be paid to what others are saying and doing. Although the United States will continue, in the near term to be the major financial power in the world, the times are changing and will continue to move in the current direction over the next ten to twenty years.
There are two reasons for saying this. First, Brazil, Russia, India, and China are going to continue to become more powerful economically and financially. Whereas there may not be an absolute shift in world power in these areas, there will be a relative shift with the BRIC nations becoming relatively more powerful. This, in my mind, is not going to stop.
Second, some form of international organization is going to evolve that will oversee global financial institutions and financial markets. The IMF is a natural place to look for such leadership. In the past it has not quite lived up to its possibilities. Now, however, it looks as if there is a new focus on the possibilities it presents. The BRIC nations seem to be eying the IMF as a place where they might be able to exert their growing economic and financial clout to attain the recognition and influence they want and believe they deserve. The IMF is certainly not an unwilling recipient of such attention and is actively seeking more funding.
What does all this mean for investors? I would like to focus on just two points related to the financial issues. First, the United States seems headed for a clash with the rest of the world in terms of monetary and fiscal policy. The current and future budget deficits appear to be unsustainable and the Obama administration has not yet presented any credible plans to reduce the amount of debt the government will be creating. In addition, the Federal Reserve has already put so much liquidity into the financial system that Bernanke’s statements about removing the liquidity as the crisis retreats seem less than serious. The added concern is what role the Fed will play in helping the Treasury place all the debt that it must issue. As I have stated before, history has repeatedly shown that this is not a good combination either for keeping interest rates low or for keeping the value of the currency up. Such movements over time will be brought on by the international markets. The only response that will avoid this is to bring the budget under control and take the pressure off the central bank to support the placing of the debt.
The second point refers to the shift in world economic power. If the BRIC countries find that they can work with the IMF, a new power structure will emerge in global finance. Financial and non-financial companies in emerging markets will become much more relevant. Important financial centers will be distributed throughout the world rather than being concentrated in just one or two cities. As with the evolution of the financial power in the 1920s and 1930s, these changes will not take place overnight. What I am suggesting, however, is that we are seeing the beginning of a shift in financial power in the world that will continue to evolve over the next ten to twenty years.
This has important ramifications for the regulation or re-regulation of the United States financial system. As usual, Congress and the Administration are fighting the last war. Right now the policy makers in charge in Washington D. C. are responding to the populist discontent being expressed in the country. Get rid of greed! Regulate salaries and bonuses! Emasculate the role of derivatives! This is not the way to prepare the economic and financial system for the future.
Yes, the world is changing. The economic base of the global economy is shifting and the resulting need to restructure is the reason for the severity of the current recession. Financial power in the world is being re-distributed and this trend is just beginning to show itself. These movements are going to define the conditions for investment in the coming years. It will require new and creative thinking.
Monday, June 8, 2009
BRIC, the Dollar, and U. S. Monetary Policy
Over the past several months I have written regularly that the value of the United States dollar will decline over an extended period of time. The basic argument for this is that over the past forty years or so, any country that has run excessive governmental budget deficits and has not had an independent central bank has seen the value of its currency come under pressure in international financial markets. During this time, country after country has had to regain discipline over its fiscal affairs and see to it that its central bank acted more independently of the government’s budgetary affairs.
The United States has not been immune to this pressure throughout this time period. Of recent note, reference has often been made of the pressure the Clinton administration faced early on that resulted in a fiscal discipline that brought about a surplus in the government’s budget in the latter years of the administration. Of course, that discipline completely disappeared in the Bush 43 years supported by a compliant Federal Reserve System. As a consequence the value of the United States dollar decline in a relatively steady fashion from late 2001 through August 2008.
The rebound in the value of the dollar only came about as the world wide financial crisis created a movement toward United States Treasury securities and credit quality. As this movement has subsided, the dollar has shown some weakness once again.
The bet right now is that given the massive budget deficits projected for the next several years the Obama administration will find itself in the same fiscal stance that the Bush 43 administration was. But, even worse, the Federal Reserve has already liquefied the financial system and now seems to be in a position where it has to provide even more liquidity to banks in order to assist the placement of all the new governmental debt coming to market.
As almost everyone knows the Federal Reserve has more than doubled the size of its balance sheet since the first week in September last year going from about $880 billion in assets to around $2,060 billion on June 3, 2009. Total reserves in the banking system have increased by roughly 1,900% since then and excess reserve in the banking system recently have averaged slightly below the size of the whole Federal Reserve balance sheet in that first week of September last year (up from just $2 billion then). The ominous change, however, is that recently the Fed’s holdings of U. S. Treasury securities has begun to rise once again as the Fed has given more support for the bond market. The increase in the Fed’s portfolio of Treasury securities was almost $46 billion from Wednesday May 6 to Wednesday June 3.
So, the Fed has supplied a tremendous amount of liquidity to the banking system that is just sitting out there waiting to see what further solvency shocks it will have to face. (See my post of June 4, 2009, http://maseportfolio.blogspot.com/.) Even though Chairman Bernanke has promised that the liquidity will be removed from the financial system once the need for it goes away, it is hard to see how all these funds will be taken away in a reasonable period of time. Furthermore, if the Federal Reserve is under pressure to support the forthcoming supply of new Treasury issues it is hard to see how it can both reduce its balance sheet while at the same time provide support to the bond market: especially if it has already started with this support.
It, therefore, seems as if there is some justification for participants in international financial markets to be concerned about a further decline in the value of the United States dollar. The scenario unfolding in the United States has all the components to it that international markets reacted against in the past forty years or so. And, the promises of the Obama administration to bring the federal budget under control with savings resulting from the, as-yet, unknown health care program appear to be grossly optimistic, at best.
There is another factor looming on the horizon that has not been present in earlier discussions about the value of the dollar. Over the past forty years or so there never has been a question raised about the role that the United States dollar plays in the international financial system. Over the past six months this topic, something that was unthinkable before, has been raised by the leaders of several countries.
In my estimation we are a long way from de-throning the United States dollar from its lofty position. However, one must take into consideration the fact that this idea is even being seriously floated in the world today. This points up the fact that the fiscal and monetary position of the United States government is being questioned and this only provides additional evidence of the weakness of the dollar in world markets.
The primary concern is being expressed by the BRIC countries, Brazil, Russia, India, and China. These are the countries that are closing the economic gap between themselves and the United States. Not that the United States will lose its Number One position as an economic power: just that these countries are coming on fast to reduce the difference. And, as these nations become more powerful relative to the United States, more and more attention is going to have to be paid to their economic and financial issues and concerns.
The BRIC countries are in a bind right now and the tension is only going to grow. These countries tend to be exporting countries and therefore must accumulate foreign exchange. The United States dollar has been the currency of choice in the past. Now, however, their large dollar holdings are “at risk” because a decline in the value of the dollar will only hurt them. As a consequence they have kept the dollar from falling further than it would have otherwise by buying large amounts of U. S. dollars. In May, the BRIC countries increased foreign reserves by more that $60 billion in an effort keep the dollar from falling further than it did. In fact, these nations are adding to their dollar reserves at their fasted pace ever.
Yet, at present, there is no alternative for them to chose. One analyst has stated that discontent with the dollar is increasing, yet nobody knows what needs to be done. Hence, the frustration with the situation has been expressed by leaders from Russia, China, and Brazil. This feeling has risen to the surface in Germany where last week German Chancellor Angela Merkel verbally took on the central banks of the United States and England for their loose monetary policies.
This is a situation that is only going to get worse before it gets any better. One can talk all they want to about the possibility of inflation and when or if inflation is actually a fear that should be present in the United States at this time. The problem is that the correlation between excessively large governmental budget deficits and loose monetary policy is too high for participants in international financial markets to ignore. Furthermore, the power of the BRIC countries is growing and their needs and desires are going to have to be accounted for. And, within these latter countries there is the stunning rise of China. Given all the economic and financial turmoil in the world, China is probably going to achieve a more prominent world role even faster than anyone expected.
The world has indeed changed. Whereas the United States has not given enough attention over the last forty years to the value of the dollar in international financial markets, it is going to have to do so going forward. The Obama administration cannot afford to casually claim to want a strong dollar and then ignore the fact that it continually declined in value the way Bush 43 did. The rest of the world will not allow this to happen.
The United States has not been immune to this pressure throughout this time period. Of recent note, reference has often been made of the pressure the Clinton administration faced early on that resulted in a fiscal discipline that brought about a surplus in the government’s budget in the latter years of the administration. Of course, that discipline completely disappeared in the Bush 43 years supported by a compliant Federal Reserve System. As a consequence the value of the United States dollar decline in a relatively steady fashion from late 2001 through August 2008.
The rebound in the value of the dollar only came about as the world wide financial crisis created a movement toward United States Treasury securities and credit quality. As this movement has subsided, the dollar has shown some weakness once again.
The bet right now is that given the massive budget deficits projected for the next several years the Obama administration will find itself in the same fiscal stance that the Bush 43 administration was. But, even worse, the Federal Reserve has already liquefied the financial system and now seems to be in a position where it has to provide even more liquidity to banks in order to assist the placement of all the new governmental debt coming to market.
As almost everyone knows the Federal Reserve has more than doubled the size of its balance sheet since the first week in September last year going from about $880 billion in assets to around $2,060 billion on June 3, 2009. Total reserves in the banking system have increased by roughly 1,900% since then and excess reserve in the banking system recently have averaged slightly below the size of the whole Federal Reserve balance sheet in that first week of September last year (up from just $2 billion then). The ominous change, however, is that recently the Fed’s holdings of U. S. Treasury securities has begun to rise once again as the Fed has given more support for the bond market. The increase in the Fed’s portfolio of Treasury securities was almost $46 billion from Wednesday May 6 to Wednesday June 3.
So, the Fed has supplied a tremendous amount of liquidity to the banking system that is just sitting out there waiting to see what further solvency shocks it will have to face. (See my post of June 4, 2009, http://maseportfolio.blogspot.com/.) Even though Chairman Bernanke has promised that the liquidity will be removed from the financial system once the need for it goes away, it is hard to see how all these funds will be taken away in a reasonable period of time. Furthermore, if the Federal Reserve is under pressure to support the forthcoming supply of new Treasury issues it is hard to see how it can both reduce its balance sheet while at the same time provide support to the bond market: especially if it has already started with this support.
It, therefore, seems as if there is some justification for participants in international financial markets to be concerned about a further decline in the value of the United States dollar. The scenario unfolding in the United States has all the components to it that international markets reacted against in the past forty years or so. And, the promises of the Obama administration to bring the federal budget under control with savings resulting from the, as-yet, unknown health care program appear to be grossly optimistic, at best.
There is another factor looming on the horizon that has not been present in earlier discussions about the value of the dollar. Over the past forty years or so there never has been a question raised about the role that the United States dollar plays in the international financial system. Over the past six months this topic, something that was unthinkable before, has been raised by the leaders of several countries.
In my estimation we are a long way from de-throning the United States dollar from its lofty position. However, one must take into consideration the fact that this idea is even being seriously floated in the world today. This points up the fact that the fiscal and monetary position of the United States government is being questioned and this only provides additional evidence of the weakness of the dollar in world markets.
The primary concern is being expressed by the BRIC countries, Brazil, Russia, India, and China. These are the countries that are closing the economic gap between themselves and the United States. Not that the United States will lose its Number One position as an economic power: just that these countries are coming on fast to reduce the difference. And, as these nations become more powerful relative to the United States, more and more attention is going to have to be paid to their economic and financial issues and concerns.
The BRIC countries are in a bind right now and the tension is only going to grow. These countries tend to be exporting countries and therefore must accumulate foreign exchange. The United States dollar has been the currency of choice in the past. Now, however, their large dollar holdings are “at risk” because a decline in the value of the dollar will only hurt them. As a consequence they have kept the dollar from falling further than it would have otherwise by buying large amounts of U. S. dollars. In May, the BRIC countries increased foreign reserves by more that $60 billion in an effort keep the dollar from falling further than it did. In fact, these nations are adding to their dollar reserves at their fasted pace ever.
Yet, at present, there is no alternative for them to chose. One analyst has stated that discontent with the dollar is increasing, yet nobody knows what needs to be done. Hence, the frustration with the situation has been expressed by leaders from Russia, China, and Brazil. This feeling has risen to the surface in Germany where last week German Chancellor Angela Merkel verbally took on the central banks of the United States and England for their loose monetary policies.
This is a situation that is only going to get worse before it gets any better. One can talk all they want to about the possibility of inflation and when or if inflation is actually a fear that should be present in the United States at this time. The problem is that the correlation between excessively large governmental budget deficits and loose monetary policy is too high for participants in international financial markets to ignore. Furthermore, the power of the BRIC countries is growing and their needs and desires are going to have to be accounted for. And, within these latter countries there is the stunning rise of China. Given all the economic and financial turmoil in the world, China is probably going to achieve a more prominent world role even faster than anyone expected.
The world has indeed changed. Whereas the United States has not given enough attention over the last forty years to the value of the dollar in international financial markets, it is going to have to do so going forward. The Obama administration cannot afford to casually claim to want a strong dollar and then ignore the fact that it continually declined in value the way Bush 43 did. The rest of the world will not allow this to happen.
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