There are growing signs that the United States is losing its financial clout. One of these signs is the growing talk about adding other currencies to the list of currencies used as international reserves. The Premier of China has been raising this issue for quite a few months now. French President Nicolas Sarkozy gained attention last week by not only supporting discussions on the issue but also suggesting that France and China work together in developing such a change. The proposed venue: the upcoming G-20 talks in Seoul, South Korea.
There has also been talk within the International Monetary Fund about the need for change, both in terms of representation (the governing body of the IMF is heavily weighted toward the Europeans) and the makeup of international reserves.
The fact is that these initiatives are becoming more and more credible. A change is not imminent, but it is expected that discussions will grow about more co-ordination between countries or the inclusion of other currencies as international reserves.
The United States continues to attack the foreign-exchange policies of the Chinese, but Chinese leaders have worked hard behind the scenes to build relationships and to act in a way that is supportive rather than divisive. A recent example is the announcement that China will buy Greek government bonds to show support of the effort being made in Greece to restore confidence in the economic policies of that government.
“The U. S. plans to use IMF meetings and sessions of the Group of 20 in October and November as venues to coordinate international pressure on Beijing, rather than press its views unilaterally.” (See “IMF Talks on Currency Restraints,” http://online.wsj.com/public/page/news-business-us.html.)
Yet those that seemingly support a broader base for international reserves are getting most of the press and any real publicity condemning the actions of the Chinese appear to be mostly coming from the United States. The support the United States does get seems half-hearted, at best.
The United States seems to be losing its relative position in the financial world. Yes, it is still “Number One” but the fifty years of credit inflation that has weakened its economic base (http://seekingalpha.com/article/227990-monetary-warfare-can-nations-have-independent-economic-policies) coupled with growing strength in the emerging nations has resulted in changes in the relative position of countries in the world. The United States continues to act as if it were still the “sole act” on the stage, while many of the emerging nations, especially the BRIC nations, are finding their relative strength and their voice. (France’s Sarkozy, with no place else to go, seems to be leaning to the BRICs to show he still has some clout in the world.)
The growing conflict comes from the fact that the financial world has become increasingly interconnected. Capital mobility is greater now than many believed possible forty years ago. But, the existence of this mobility limits the choices available to countries: they can either have fixed exchange rates or they can have independent governmental economic policies.
Many, like the United States, have opted for independent governmental economic policies. This has resulted in the internal economic problems in the United States mentioned in the Seeking Alpha post cited above. The consequence of this has been a decline in the value of the United States dollar. Other countries have had to follow various paths in order to protect themselves from what they consider to be a “competitive devaluation” on the part of the United States.
These other countries are not particularly happy.
The call has gone out for nations to join in greater co-ordination: “the Institute of International Finance, the global top bankers’ club, is calling for renewed global co-ordination to address the trend towards unilateralism on macroeconomic, trade, and currency issues. Likewise, Chinese Premier Wen Jiabao has also been calling for global policy co-ordination.” (See the opinion piece by John Plender, http://www.ft.com/cms/s/0/295e207a-d09a-11df-8667-00144feabdc0.html.)
The likelihood of achieving some form of greater co-operation and co-ordination in the economic policies of member nations seems to be slim and none. This is especially true given the leanings of a majority portion of the voting body of the Federal Reserve System and the Chairman of the Bank of England concerning the use of “quantitative easy” to spur on their economies. In fact, the calls for greater “quantitative easy” at central banks has grown over the past several weeks which, of course, has had a negative impact on currencies.
In my view, we are in this conflict for the long haul. To me, the stage is set for the emerging nations to continue to press their point. There seems to be a growing sense their time is coming and that the United States is only going to become relatively weaker…although still Number One.
The model broke in the European sovereign debt crisis earlier this year and the European Union pulled together for a long enough period of time to keep things from totally falling apart. Some people had suggested that this European model of “coming together” be used in the G-20 and in the IMF.
I don’t think this is going to happen.
Greater global co-operation and co-ordination is going to have to come about someday. It is just not going to happen any time soon.
Wednesday, October 6, 2010
Tuesday, October 5, 2010
Ominous Clouds over State and Local and Federal Government Financing
The dark clouds seem to be spreading over government financing throughout the western world. These clouds have been observed in Europe during the debt crisis that occurred there earlier this year. Now the clouds are becoming darker and darker in the United States.
We get a picture of this in the article by Mary Williams Walsh in the New York Times this morning, “Cities in Debt Turn to States, Adding Strain,”
“Harrisburg, the capital of Pennsylvania, dodged financial disaster last month by getting money from the state to make a payment to its bondholders.
Now Harrisburg is calling on the state again. On Friday, the city said it could not meet its next payroll without money from the state’s distressed cities program.”
But, we learn that there are 19 more cities in Pennsylvania that are in the distressed-cities program. Michigan has 37 in its program; New Jersey has seven; Illinois, Rhode Island and California have at least one. And, this is on top of the troubled housing programs (see Philadelphia), power efforts, and hospital authorities.
And, this doesn’t include anything about the problems that states are having. Let’s highlight California, Illinois, Nevada, and New Jersey as a beginning. And, this is on top of the underfunded state pension programs that exist throughout the country.
Let’s see…if the states pick up the financial shortfalls in the municipalities…and the federal government picks up the financial shortfalls in the states…who picks up the financial shortfalls in the federal government?
Like I said earlier, the dark clouds seem to be spreading over government financing throughout the western world.
We get a picture of this in the article by Mary Williams Walsh in the New York Times this morning, “Cities in Debt Turn to States, Adding Strain,”
“Harrisburg, the capital of Pennsylvania, dodged financial disaster last month by getting money from the state to make a payment to its bondholders.
Now Harrisburg is calling on the state again. On Friday, the city said it could not meet its next payroll without money from the state’s distressed cities program.”
But, we learn that there are 19 more cities in Pennsylvania that are in the distressed-cities program. Michigan has 37 in its program; New Jersey has seven; Illinois, Rhode Island and California have at least one. And, this is on top of the troubled housing programs (see Philadelphia), power efforts, and hospital authorities.
And, this doesn’t include anything about the problems that states are having. Let’s highlight California, Illinois, Nevada, and New Jersey as a beginning. And, this is on top of the underfunded state pension programs that exist throughout the country.
Let’s see…if the states pick up the financial shortfalls in the municipalities…and the federal government picks up the financial shortfalls in the states…who picks up the financial shortfalls in the federal government?
Like I said earlier, the dark clouds seem to be spreading over government financing throughout the western world.
Corporations are Hoarding Cash and Keeping Their Powder Dry
There is a great deal of discussion these days about all the cash that corporations are holding. This issue made the lead article in the Wall Street Journal on Monday, October 4. This issue is also connected with the move by many corporations to issue new debt with interest rates so low. This made the front page of the New York Times on Monday, October 4. (See Graham Bowley, “Cheap Debt for Corporations Fails to Spur Economy,” http://www.nytimes.com/2010/10/04/business/04borrow.html?_r=1&scp=4&sq=graham%20bowley&st=cse.)
People continue to believe that the issuance of more debt and the hoarding of more cash will eventually lead to more corporate investment which will spur on the economy and help achieve the recovery everyone wants so badly.
A recent commentator to this blog is skeptical of such occurrence because the amount of debt still outstanding in the corporate sector far exceeds the cash that is being held.
First, let me say that, like the commercial banking sector, there are some corporations that are piling up cash and issuing debt to pile up cash, and there are many more corporations that are facing solvency problems and have way too much debt for them to handle.
That is, there is a huge separation at this time between those banks and corporation that have and those that are drowning.
The macro issue of the relationship between debt and cash is not as relevant as is the micro issue of who has the cash to play with and who is still way over-leveraged.
The United States economy is at the point where a major re-structuring of the manufacturing and financial base is taking place. I have written about this over and over again and I have emphasized that the economic policy of the federal government has created a credit inflation over the past 50 years that has resulted in the need for this massive re-structuring.
Who would have ever imagined twenty years ago, for example that General Motors would ever need to be bailed out as it was last year? Who would have ever imagined the need for the major pharmaceuticals and other industries to re-structure as they have been doing, consolidating, and scrambling for their lives?
And, as for the smaller companies? They seem to be stuck. They cannot raise funds from either commercial banks or from the bond markets. As Bowley emphasizes in his New York Times article, “Smaller companies continue to have trouble borrowing, and most of the new financing is limited to bigger corporations.”
The same thing is happening in the banking industry. The bigger commercial banks (the largest 25) prosper; many of the smaller commercial banks (about 7,800) are just holding on.
So we have this huge bifurcation of both the manufacturing sector and the financial sector. One part of each is piling up cash while the other part is just trying to keep its nose above water.
It is my bet that the companies that are building up their cash hoards are just waiting for the opportunity to sweep in and acquire firm after firm that are extremely weak. It is my guess that these companies are waiting for the right time to pick up their exposed brothers and sisters for a song.
They see the opportunity to participate in a complete re-structuring of the economic framework in the United States. The move depends upon two things. First, it depends upon the realization on the part of the weaker companies that they have little or no future without being acquired. Second, it depends upon some of the uncertainty surrounding the economic policy and regulatory philosophy that the federal government is going to finally decide upon.
The debt issuing and cash hoarding that is going on in both the banking sector and the manufacturing sector is not in preparation for hiring more people and buying more equipment. The corporations issuing debt and hoarding cash are preparing to build themselves by acquiring the assets and intellectual property of those companies that are not going to be able to make it on their own into the future.
Note, that this strategy WILL NOT increase jobs and investment in the near future. The strategy, like most mergers and acquisitions will result in cutting down and stream-lining the merged or acquired organizations. This strategy will result in more layoffs and the elimination of the excess capacity in the merged or acquired firms.
These activities will take several years to complete and, consequently, will not produce much economic growth over this time period.
Also, in both the manufacturing industry, as well as in the financial industry, this strategy will result in the big getting bigger. It seems as if the economic policy of the Obama administration is just exacerbating the distance between the small and the large. But, there is little that can be done now except attempt to create a “stifling” regulatory structure that clamps down on all mergers and acquisitions and creates an environment that is very unfavorable to business.
So, my conclusion is that the corporations that are issuing debt and building up their cash holdings are just increasing their ammunition for the up-coming economic re-structuring.
And, until that time occurs, they will just hold on to their ammunition and keep their powder dry
People continue to believe that the issuance of more debt and the hoarding of more cash will eventually lead to more corporate investment which will spur on the economy and help achieve the recovery everyone wants so badly.
A recent commentator to this blog is skeptical of such occurrence because the amount of debt still outstanding in the corporate sector far exceeds the cash that is being held.
First, let me say that, like the commercial banking sector, there are some corporations that are piling up cash and issuing debt to pile up cash, and there are many more corporations that are facing solvency problems and have way too much debt for them to handle.
That is, there is a huge separation at this time between those banks and corporation that have and those that are drowning.
The macro issue of the relationship between debt and cash is not as relevant as is the micro issue of who has the cash to play with and who is still way over-leveraged.
The United States economy is at the point where a major re-structuring of the manufacturing and financial base is taking place. I have written about this over and over again and I have emphasized that the economic policy of the federal government has created a credit inflation over the past 50 years that has resulted in the need for this massive re-structuring.
Who would have ever imagined twenty years ago, for example that General Motors would ever need to be bailed out as it was last year? Who would have ever imagined the need for the major pharmaceuticals and other industries to re-structure as they have been doing, consolidating, and scrambling for their lives?
And, as for the smaller companies? They seem to be stuck. They cannot raise funds from either commercial banks or from the bond markets. As Bowley emphasizes in his New York Times article, “Smaller companies continue to have trouble borrowing, and most of the new financing is limited to bigger corporations.”
The same thing is happening in the banking industry. The bigger commercial banks (the largest 25) prosper; many of the smaller commercial banks (about 7,800) are just holding on.
So we have this huge bifurcation of both the manufacturing sector and the financial sector. One part of each is piling up cash while the other part is just trying to keep its nose above water.
It is my bet that the companies that are building up their cash hoards are just waiting for the opportunity to sweep in and acquire firm after firm that are extremely weak. It is my guess that these companies are waiting for the right time to pick up their exposed brothers and sisters for a song.
They see the opportunity to participate in a complete re-structuring of the economic framework in the United States. The move depends upon two things. First, it depends upon the realization on the part of the weaker companies that they have little or no future without being acquired. Second, it depends upon some of the uncertainty surrounding the economic policy and regulatory philosophy that the federal government is going to finally decide upon.
The debt issuing and cash hoarding that is going on in both the banking sector and the manufacturing sector is not in preparation for hiring more people and buying more equipment. The corporations issuing debt and hoarding cash are preparing to build themselves by acquiring the assets and intellectual property of those companies that are not going to be able to make it on their own into the future.
Note, that this strategy WILL NOT increase jobs and investment in the near future. The strategy, like most mergers and acquisitions will result in cutting down and stream-lining the merged or acquired organizations. This strategy will result in more layoffs and the elimination of the excess capacity in the merged or acquired firms.
These activities will take several years to complete and, consequently, will not produce much economic growth over this time period.
Also, in both the manufacturing industry, as well as in the financial industry, this strategy will result in the big getting bigger. It seems as if the economic policy of the Obama administration is just exacerbating the distance between the small and the large. But, there is little that can be done now except attempt to create a “stifling” regulatory structure that clamps down on all mergers and acquisitions and creates an environment that is very unfavorable to business.
So, my conclusion is that the corporations that are issuing debt and building up their cash holdings are just increasing their ammunition for the up-coming economic re-structuring.
And, until that time occurs, they will just hold on to their ammunition and keep their powder dry
Monday, October 4, 2010
Federal Reserve Non-Exit Watch: Part 2
During the Federal Reserve’s Exit Watch, the excess reserves in the banking system rose by $400 billion or so. Thus, as the Federal Reserve attempted to exit it put more reserves into the banking system.
Remember that in August 2008, the assets on the Federal Reserve balance sheet was no more than $900 billion…total!
Now we are told that the Federal Reserve, still concerned that the economy is not growing fast enough, has entered into a phase of not exiting the banking system, even expanding its stance of monetary ease by the tool affectionately referred to as “Quantitative Easing.”
Well, excess reserves in the banking system fell below the $1.0 trillion level in September for the first time since late October 2009. The decline in excess reserves in the banking system has reached almost $200 billion since the peak in this total was achieved.
Does anyone understand what the Federal Reserve is trying to do? Does the Federal Reserve understand what the Federal Reserve is trying to do?
I have argued many times in recent months that I have never seen such a lack of leadership at the Federal Reserve in my lifetime.
People claim that there is so much uncertainty in the economic and financial world right now that businesses and individuals don’t know what to do!
Well, you can look at the leadership of the Federal Reserve and get a prime example of why there is so much uncertainty around in the world.
The Fed looks positively leaderless!
In looking at the numbers from the Federal Reserve release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” one could argue that over the past four weeks and over the past thirteen weeks the Fed has been facing some “operational” factors that have affected reserve balances and this has clouded the picture.
“Operational” factors are things like seasonal movements in currency outstanding due to cash needs during the summer months or during the Thanksgiving to New Year’s time period or in the management and payment of tax receipts on the part of the United States Treasury.
These factors usually appear of the side of the Fed’s balance sheet that “absorbs” bank reserves. For example, if the Treasury draws funds from commercial banks into its General Account in order to “write checks” this removes (absorbs) reserves from the banking system.
In the last four months, Total Factors Absorbing Reserves rose by almost $26 billion. This increase was centered in three areas. First, currency came out of circulation ($4 billion) as the summer came to an end. Second, the United States Treasury brought about $12 billion into its General Account at the Federal Reserve. And, the Federal Reserve engaged in more Reverse Repurchase Agreements with “Foreign Official and International Accounts” which rose by $9 billion.
The Federal Reserve did not offset these absorbing factors. In fact, Total Factors Supplying Reserves also fell, but only by a little more than $3 billion. This decline seems to have occurred as line items connected with the government’s financial bailout ran off.
So, “operational” factors seem to have accounted for the $29 billion decline in Reserve Balances with Federal Reserve Banks, (part of bank’s excess reserves) over the past four weeks. This is “not exiting”? At one time this amount of decline was about 3.5% of the Fed’s balance sheet!
At the same time the Federal Reserve replaced declines in its’ portfolio of Mortgage Backed Securities and Federal Agency securities by purchases of Treasury Securities. During the four week period ending September 30, 2010, the Mortgage Backed Securities portfolio declined by about $25 billion; the Federal Agency Securities portfolio dropped by about $2 billion.
The Fed upped its portfolio of Treasury Securities by a little more than $25 billion.
So the Fed appears to be replacing maturing mortgage-backed securities and federal agency securities with Treasury securities so that the overall portfolio does not decline by much. This is one thing the Fed said it “might” do.
One should note, however, that in the last 13-week period, the Fed’s portfolio of securities declined by almost $16 billion as the Fed did not replace all of the $40 billion in mortgage-backed securities that left the portfolio and the $11 billion decline in the portfolio of federal agency securities.
One should also note that during this last 13-week period $18 billion in accounts associated with the government’s financial bailout also ran off.
I don’t know what the Federal Reserve is doing. A lot of people don’t know what the Federal Reserve is doing.
All I can add to this is that the value of the United States dollar versus the Euro declined by about 8.3% since Chairman Bernanke spoke at the Fed conference at Jackson Hole, Wyoming in August and the Wall Street Journal index of the value of the United States dollar has fallen by over 6.6% since then.
A real vote of confidence.
Remember that in August 2008, the assets on the Federal Reserve balance sheet was no more than $900 billion…total!
Now we are told that the Federal Reserve, still concerned that the economy is not growing fast enough, has entered into a phase of not exiting the banking system, even expanding its stance of monetary ease by the tool affectionately referred to as “Quantitative Easing.”
Well, excess reserves in the banking system fell below the $1.0 trillion level in September for the first time since late October 2009. The decline in excess reserves in the banking system has reached almost $200 billion since the peak in this total was achieved.
Does anyone understand what the Federal Reserve is trying to do? Does the Federal Reserve understand what the Federal Reserve is trying to do?
I have argued many times in recent months that I have never seen such a lack of leadership at the Federal Reserve in my lifetime.
People claim that there is so much uncertainty in the economic and financial world right now that businesses and individuals don’t know what to do!
Well, you can look at the leadership of the Federal Reserve and get a prime example of why there is so much uncertainty around in the world.
The Fed looks positively leaderless!
In looking at the numbers from the Federal Reserve release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” one could argue that over the past four weeks and over the past thirteen weeks the Fed has been facing some “operational” factors that have affected reserve balances and this has clouded the picture.
“Operational” factors are things like seasonal movements in currency outstanding due to cash needs during the summer months or during the Thanksgiving to New Year’s time period or in the management and payment of tax receipts on the part of the United States Treasury.
These factors usually appear of the side of the Fed’s balance sheet that “absorbs” bank reserves. For example, if the Treasury draws funds from commercial banks into its General Account in order to “write checks” this removes (absorbs) reserves from the banking system.
In the last four months, Total Factors Absorbing Reserves rose by almost $26 billion. This increase was centered in three areas. First, currency came out of circulation ($4 billion) as the summer came to an end. Second, the United States Treasury brought about $12 billion into its General Account at the Federal Reserve. And, the Federal Reserve engaged in more Reverse Repurchase Agreements with “Foreign Official and International Accounts” which rose by $9 billion.
The Federal Reserve did not offset these absorbing factors. In fact, Total Factors Supplying Reserves also fell, but only by a little more than $3 billion. This decline seems to have occurred as line items connected with the government’s financial bailout ran off.
So, “operational” factors seem to have accounted for the $29 billion decline in Reserve Balances with Federal Reserve Banks, (part of bank’s excess reserves) over the past four weeks. This is “not exiting”? At one time this amount of decline was about 3.5% of the Fed’s balance sheet!
At the same time the Federal Reserve replaced declines in its’ portfolio of Mortgage Backed Securities and Federal Agency securities by purchases of Treasury Securities. During the four week period ending September 30, 2010, the Mortgage Backed Securities portfolio declined by about $25 billion; the Federal Agency Securities portfolio dropped by about $2 billion.
The Fed upped its portfolio of Treasury Securities by a little more than $25 billion.
So the Fed appears to be replacing maturing mortgage-backed securities and federal agency securities with Treasury securities so that the overall portfolio does not decline by much. This is one thing the Fed said it “might” do.
One should note, however, that in the last 13-week period, the Fed’s portfolio of securities declined by almost $16 billion as the Fed did not replace all of the $40 billion in mortgage-backed securities that left the portfolio and the $11 billion decline in the portfolio of federal agency securities.
One should also note that during this last 13-week period $18 billion in accounts associated with the government’s financial bailout also ran off.
I don’t know what the Federal Reserve is doing. A lot of people don’t know what the Federal Reserve is doing.
All I can add to this is that the value of the United States dollar versus the Euro declined by about 8.3% since Chairman Bernanke spoke at the Fed conference at Jackson Hole, Wyoming in August and the Wall Street Journal index of the value of the United States dollar has fallen by over 6.6% since then.
A real vote of confidence.
Friday, October 1, 2010
Monetary Warfare: Is An Independent Economic Policy Possible for a Nation?
John Maynard Keynes, after 1917, wanted to achieve full employment for England, but also for other major countries in Europe and the western world. The reason for this goal was that he was afraid of the Bolshevik menace threatening his civilized world.
Thus, beginning with the time that he returned to England from the Paris Peace Conference following World War I, Keynes sought ways that would allow a country to follow an independent economic policy that would primarily focus on full employment for the nation. Before the First World War, Keynes was, like most of his liberal counterparts, a free-trader who believed in capital mobility and flexible exchange rates
Keynes, in essence, developed a policy prescription that is consistent with what is now called the “Trilemma” problem as it is applied to economics. The “Trilemma” problem is that a nation can only achieve two out of the following three policies: fixed exchange rate, independent economic policy, and capital mobility.
Keynes opted for an independent economic policy for a government in order to achieve high levels of employment. He also believed, in his later years, that exchange rates should be fixed. This was ultimately achieved in the Bretton Woods agreement in 1944. This agreement set up the current system of international financial organizations and created a foreign exchange system that stayed in place until August 15, 1971.
The third component of this, international capital mobility, was severely restricted at the time.
What occurred in the 1960s was that inflation increased in the United States due to the fiscal and monetary policies of the government and capital began flowing throughout the world. Thus, the value of the dollar had to float in world markets. Thus, President Richard Nixon set free the dollar on August 15, 1971 and we entered a new age.
Full employment remained a policy goal of the United States government written into law by the Congress. So, the monetary and fiscal policy of the government had to remain independent of what other nations did.
Capital mobility increased as the world became more and more globalized in the latter part of
the 20th century.
And, the consequence of this combination of events left the value of the dollar on its own. And, since the early 1970s, the value of the dollar has declined by about 40% against other major currencies.
The fundamental reason for the decline in the value of the dollar was the credit inflation created by the United States government. The gross federal debt of the United States has risen at an annual compound rate of about 9.5% in the fifty years from 1961. Financial innovation on the part of the United States government has been huge.
The private sector has emulated this governmental behavior as incentives all pointed to increasing amounts of leverage on family and company balance sheets. Again, following the government, financial innovation was everywhere, especially in the area of housing finance.
World financial markets reacted by sinking the value of the dollar…except in a crisis when there was a so-called “flight to quality”. The dollar continues to remain weak and will continue to be weak as long as the United States government follows its policy of underwriting the credit inflation which is undermining the strength of the economy.
But, given conditions of the Trilemma, the dollar must continue to sink as long as international capital mobility continues and the deficit of the United States government is expected to add $15 trillion or more to federal debt over the next ten years. The United States can inflate credit all it wants, but it will have to pay in terms of a falling dollar. The two parts of the Trilemma, flexible exchange rates and the independent economic policy of the government are not really compatible at this time.
For one, this seems to play right into the hands of the Chinese. They are building up enormous international reserves. These reserves are being used to buy productive resources around the world, acquire commodities which they badly need, and increase their political power and influence throughout the nations. (See my post “Monetary Warfare: U. S. vs. China?”: http://seekingalpha.com/article/227632-monetary-warfare-u-s-vs-china.) Yes, we have a major case of mercantilism, here.
And, how does the United States respond? In terms of the policy of the government, it continues to pump things up, just what the Chinese want. And, then the United States government points its finger at China as if it is the bad guy. Well, China is the “bad guy” because it is growing stronger as the United States weakens itself.
The other piece of the picture has to do with what the economic policy of the United States government is doing to its own economy. Well, the results are not good: one in four workers of employment age are under-employed; in industry, capital utilization is between 75% and 80%; and income inequality has increased dramatically over the past 50 years as the wealthy have taken advantage of the credit inflation and the less-wealthy have suffered dramatically from the massive increase in debt leverage. (See my post “Does Fiscal Policy Really Work?”: http://seekingalpha.com/article/227210-does-fiscal-policy-really-work.)
The United States must either get its monetary and fiscal policy in order or it must seek to reduce or prohibit capital mobility. The United States cannot continue to pursue a policy of credit inflation in this era of almost totally free capital mobility without serious ramifications to the strength of its economy. The evidence of this is the current status of the American economy.
The weakness in the economy is what is driving the decline in the value of the dollar. The first conclusion one draws from a declining currency is that the decline is related just to monetary factors, to inflation. However, what we are seeing in the case of the United States is that the U. S. has exported inflation to the emerging nations through the freely flowing capital in the world. The inflation has not shown up explicitly in U. S. prices. But, the inflation has shown up implicitly in terms of the dislocation of economic resources within the United States economy.
That is why I argue that either the United States must change its philosophy about what governmental policy can do or it must seek to reduce or prohibit capital mobility. It cannot continue to support both.
In this mobile global world we live in, we cannot achieve the Keynesian requirement that the monetary and fiscal policies of a country can conducted independently of the rest of the world. Economists have to move on from the Keynesian prescription. The funny thing is, I believe that Keynes would have changed his mind many years ago.
Thus, beginning with the time that he returned to England from the Paris Peace Conference following World War I, Keynes sought ways that would allow a country to follow an independent economic policy that would primarily focus on full employment for the nation. Before the First World War, Keynes was, like most of his liberal counterparts, a free-trader who believed in capital mobility and flexible exchange rates
Keynes, in essence, developed a policy prescription that is consistent with what is now called the “Trilemma” problem as it is applied to economics. The “Trilemma” problem is that a nation can only achieve two out of the following three policies: fixed exchange rate, independent economic policy, and capital mobility.
Keynes opted for an independent economic policy for a government in order to achieve high levels of employment. He also believed, in his later years, that exchange rates should be fixed. This was ultimately achieved in the Bretton Woods agreement in 1944. This agreement set up the current system of international financial organizations and created a foreign exchange system that stayed in place until August 15, 1971.
The third component of this, international capital mobility, was severely restricted at the time.
What occurred in the 1960s was that inflation increased in the United States due to the fiscal and monetary policies of the government and capital began flowing throughout the world. Thus, the value of the dollar had to float in world markets. Thus, President Richard Nixon set free the dollar on August 15, 1971 and we entered a new age.
Full employment remained a policy goal of the United States government written into law by the Congress. So, the monetary and fiscal policy of the government had to remain independent of what other nations did.
Capital mobility increased as the world became more and more globalized in the latter part of
the 20th century.
And, the consequence of this combination of events left the value of the dollar on its own. And, since the early 1970s, the value of the dollar has declined by about 40% against other major currencies.
The fundamental reason for the decline in the value of the dollar was the credit inflation created by the United States government. The gross federal debt of the United States has risen at an annual compound rate of about 9.5% in the fifty years from 1961. Financial innovation on the part of the United States government has been huge.
The private sector has emulated this governmental behavior as incentives all pointed to increasing amounts of leverage on family and company balance sheets. Again, following the government, financial innovation was everywhere, especially in the area of housing finance.
World financial markets reacted by sinking the value of the dollar…except in a crisis when there was a so-called “flight to quality”. The dollar continues to remain weak and will continue to be weak as long as the United States government follows its policy of underwriting the credit inflation which is undermining the strength of the economy.
But, given conditions of the Trilemma, the dollar must continue to sink as long as international capital mobility continues and the deficit of the United States government is expected to add $15 trillion or more to federal debt over the next ten years. The United States can inflate credit all it wants, but it will have to pay in terms of a falling dollar. The two parts of the Trilemma, flexible exchange rates and the independent economic policy of the government are not really compatible at this time.
For one, this seems to play right into the hands of the Chinese. They are building up enormous international reserves. These reserves are being used to buy productive resources around the world, acquire commodities which they badly need, and increase their political power and influence throughout the nations. (See my post “Monetary Warfare: U. S. vs. China?”: http://seekingalpha.com/article/227632-monetary-warfare-u-s-vs-china.) Yes, we have a major case of mercantilism, here.
And, how does the United States respond? In terms of the policy of the government, it continues to pump things up, just what the Chinese want. And, then the United States government points its finger at China as if it is the bad guy. Well, China is the “bad guy” because it is growing stronger as the United States weakens itself.
The other piece of the picture has to do with what the economic policy of the United States government is doing to its own economy. Well, the results are not good: one in four workers of employment age are under-employed; in industry, capital utilization is between 75% and 80%; and income inequality has increased dramatically over the past 50 years as the wealthy have taken advantage of the credit inflation and the less-wealthy have suffered dramatically from the massive increase in debt leverage. (See my post “Does Fiscal Policy Really Work?”: http://seekingalpha.com/article/227210-does-fiscal-policy-really-work.)
The United States must either get its monetary and fiscal policy in order or it must seek to reduce or prohibit capital mobility. The United States cannot continue to pursue a policy of credit inflation in this era of almost totally free capital mobility without serious ramifications to the strength of its economy. The evidence of this is the current status of the American economy.
The weakness in the economy is what is driving the decline in the value of the dollar. The first conclusion one draws from a declining currency is that the decline is related just to monetary factors, to inflation. However, what we are seeing in the case of the United States is that the U. S. has exported inflation to the emerging nations through the freely flowing capital in the world. The inflation has not shown up explicitly in U. S. prices. But, the inflation has shown up implicitly in terms of the dislocation of economic resources within the United States economy.
That is why I argue that either the United States must change its philosophy about what governmental policy can do or it must seek to reduce or prohibit capital mobility. It cannot continue to support both.
In this mobile global world we live in, we cannot achieve the Keynesian requirement that the monetary and fiscal policies of a country can conducted independently of the rest of the world. Economists have to move on from the Keynesian prescription. The funny thing is, I believe that Keynes would have changed his mind many years ago.
Wednesday, September 29, 2010
Monetary Warfare: the United States versus China?
Martin Wolf, in his latest column writes (http://www.ft.com/cms/s/0/9fa5bd4a-cb2e-11df-95c0-00144feab49a.html):
“In the absence of currency adjustments, we are seeing a form of monetary warfare: in effect, the US is seeking to inflate China, and China to deflate the US. Both sides are convinced they are right; neither is succeeding; and the rest of the world suffers.”
“It is not hard to see China’s point of view: it is desperate to avoid what it views as the dire fate of Japan after the Plaza accord.”
The basic argument in favor of China’s efforts is the Japanese experience in the 1990s. It seems as if everything goes back to this Japanese experience these days.
Maybe there is another explanation. Maybe this is what China’s leaders would like us to think.
The figures behind this discussion are those related to the world’s official reserves. From January 1999 and July 2008, these rose “from $1,615 billion to $7,534 billion—a staggering increase of $5,918 billion.” Between July 2008 and February 2009 reserves shrank by $472 billion, but rose again by $1,324 billion between February 2009 and May 2010 to reach $8385 billion.
“China is overwhelmingly the dominant intervener, accounting for 40 per cent of the accumulation since February 2009. By June 2010, its reserves had reached $2,450 billion, 30 per cent of the world total and a staggering 50 per cent of its own GDP. This accumulation must be viewed as a huge export subsidy.”
“Never in human history can the government of one superpower have lent so much to that of another.”
And, this, to me, is the key point. The key point is not what happened to Japan.
It is like the large United States corporations who have accumulated a huge amount of cash and they are, for the time being, just keeping their cash on their balance sheets. The question analysts are asking is “when will the corporations begin to invest again and get the economy moving?”
I don’t believe this is the issue for the United States corporations with lots of cash on hand. I believe that these corporations sense that a major re-structuring is in the process of taking place in the United States economy. They want to play a role in this re-structuring. Thus, the game plan is not to expand production by investment in physical plant and capital. Their plan is to merge and acquire other organizations and help re-define the landscape of American industry. I believe that this consolidation is just beginning.
I believe that this also applies to the some of the cash buildup in the banking industry and one of the reasons for the accumulation of so much cash in many of America’s larger financial institutions. These institutions want to be players in the consolidation of the banking industry.
China is observing the changes taking place in the world. It needs commodity resources. It needs production capacity. It needs world presence. In needs to extend its power into the world.
China is buying commodities or assuring commodity channels throughout the world. China is buying companies throughout the world. China is seeking and paying off new political relationships throughout the world. China is helping the world re-structure.
It would seem to me that a lot of international reserves would help it achieve these goals.
And, what is the United States doing?
It is underwriting the Chinese “re-structure” machine. Quoting Wolf, “the US is seeking to inflate China.” But, one could argue, China is not trying “to deflate the US.” China is playing a game of chess with the rest of the world. It is trying to re-position itself to be in a relatively greater position of power. It is trying to reduce the relative strength of the United States in the world and build up its own place.
And, the United States government is providing China with the means to accomplish this goal!
As with Mr. Wolf, many advisors in the United States government have been mesmerized by the events that took place in Japan in the 1990s. They couch almost every discussion about current international economic conditions in terms of Japan in the 1990s. Again, they are fighting the last war.
Japan was not trying to take on the United States. China is. And, that is the difference.
And, the President and the United States government, in their myopia, are doing all that the can to help China achieve its goal.
I would disagree with Mr. Wolf. We are not in “monetary warfare.” We are in a situation where the United States is giving China exactly what it needs to challenge America in the world!
“In the absence of currency adjustments, we are seeing a form of monetary warfare: in effect, the US is seeking to inflate China, and China to deflate the US. Both sides are convinced they are right; neither is succeeding; and the rest of the world suffers.”
“It is not hard to see China’s point of view: it is desperate to avoid what it views as the dire fate of Japan after the Plaza accord.”
The basic argument in favor of China’s efforts is the Japanese experience in the 1990s. It seems as if everything goes back to this Japanese experience these days.
Maybe there is another explanation. Maybe this is what China’s leaders would like us to think.
The figures behind this discussion are those related to the world’s official reserves. From January 1999 and July 2008, these rose “from $1,615 billion to $7,534 billion—a staggering increase of $5,918 billion.” Between July 2008 and February 2009 reserves shrank by $472 billion, but rose again by $1,324 billion between February 2009 and May 2010 to reach $8385 billion.
“China is overwhelmingly the dominant intervener, accounting for 40 per cent of the accumulation since February 2009. By June 2010, its reserves had reached $2,450 billion, 30 per cent of the world total and a staggering 50 per cent of its own GDP. This accumulation must be viewed as a huge export subsidy.”
“Never in human history can the government of one superpower have lent so much to that of another.”
And, this, to me, is the key point. The key point is not what happened to Japan.
It is like the large United States corporations who have accumulated a huge amount of cash and they are, for the time being, just keeping their cash on their balance sheets. The question analysts are asking is “when will the corporations begin to invest again and get the economy moving?”
I don’t believe this is the issue for the United States corporations with lots of cash on hand. I believe that these corporations sense that a major re-structuring is in the process of taking place in the United States economy. They want to play a role in this re-structuring. Thus, the game plan is not to expand production by investment in physical plant and capital. Their plan is to merge and acquire other organizations and help re-define the landscape of American industry. I believe that this consolidation is just beginning.
I believe that this also applies to the some of the cash buildup in the banking industry and one of the reasons for the accumulation of so much cash in many of America’s larger financial institutions. These institutions want to be players in the consolidation of the banking industry.
China is observing the changes taking place in the world. It needs commodity resources. It needs production capacity. It needs world presence. In needs to extend its power into the world.
China is buying commodities or assuring commodity channels throughout the world. China is buying companies throughout the world. China is seeking and paying off new political relationships throughout the world. China is helping the world re-structure.
It would seem to me that a lot of international reserves would help it achieve these goals.
And, what is the United States doing?
It is underwriting the Chinese “re-structure” machine. Quoting Wolf, “the US is seeking to inflate China.” But, one could argue, China is not trying “to deflate the US.” China is playing a game of chess with the rest of the world. It is trying to re-position itself to be in a relatively greater position of power. It is trying to reduce the relative strength of the United States in the world and build up its own place.
And, the United States government is providing China with the means to accomplish this goal!
As with Mr. Wolf, many advisors in the United States government have been mesmerized by the events that took place in Japan in the 1990s. They couch almost every discussion about current international economic conditions in terms of Japan in the 1990s. Again, they are fighting the last war.
Japan was not trying to take on the United States. China is. And, that is the difference.
And, the President and the United States government, in their myopia, are doing all that the can to help China achieve its goal.
I would disagree with Mr. Wolf. We are not in “monetary warfare.” We are in a situation where the United States is giving China exactly what it needs to challenge America in the world!
Tuesday, September 28, 2010
The Shadow of Lula
It is remarkable to see the accolades being heaped on retiring Brazilian President Luiz Inácio Lula da Silva. Who would have believed this would be the case eight years ago.
Even the Financial Times has as its lead editorial “Brazil Dazzles Global Finance” (See http://www.ft.com/cms/s/0/9de004be-ca68-11df-a860-00144feab49a.html). “Brazilian finance will be felt increasingly in international centers.” Brazil’s development bank, with a balance sheet larger than the World Bank, has chosen London as its main foreign office.
Brazil is a player. Statements like this cannot be put in a future tense any more like “Brazil wants to be a player in the world.”
And, the Brazilian Finance Minister Guido Mantega gained global headlines this morning with his comments about “a trade war and an exchange rate war.” Brazil has one of the stronger currencies in the world right now. The value of the dollar has fallen by about 25% relative to the
Brazilian real since the beginning of last year.
Brazil is now listened to around the world.
This is just one more indication of how the world has changed.
Every day, we, particularly in the United States, must remember that things are different now. Although the United States is still a very powerful nation, quite a few other countries have increased significantly in power so that the relative position of the United States is not the same as it once was.
And, there are other hints. JPMorgan Chase has reorganized so that it can become more of an international force. Economically, it cannot just rely on its position in the slow growing United States economy anymore.
We also see the changes in leadership in the United States. For example, the bank that formerly was the largest bank in the United States has someone born in India as its CEO, Vikram Pandit, who was brought into this position to save Citigroup and turn it around.
And what about the biggest, most aggressive investment bank (now a bank holding company) in the United States, Goldman Sachs. There are rumors that a Canadian by birth, someone who has been Goldman’s Asian chief, Michael Evans, is playing a larger part in the management of the company and might even be a successor to Lloyd Blankfein, the current chief executive. Also, Mr. Evans does not have a back ground in Goldman’s trading unit, a place many other Goldman Sachs’ leaders have come from.
The world is open. People and products and services are flowing more easily from country to country.
We still see individuals that resist this fact.
It is hard to believe that this growing global integration can be ignored by investors, governments, and financial institutions, manufacturing concerns, and others who want to perform well in these times.
Well done Mr. Lula!
Even the Financial Times has as its lead editorial “Brazil Dazzles Global Finance” (See http://www.ft.com/cms/s/0/9de004be-ca68-11df-a860-00144feab49a.html). “Brazilian finance will be felt increasingly in international centers.” Brazil’s development bank, with a balance sheet larger than the World Bank, has chosen London as its main foreign office.
Brazil is a player. Statements like this cannot be put in a future tense any more like “Brazil wants to be a player in the world.”
And, the Brazilian Finance Minister Guido Mantega gained global headlines this morning with his comments about “a trade war and an exchange rate war.” Brazil has one of the stronger currencies in the world right now. The value of the dollar has fallen by about 25% relative to the
Brazilian real since the beginning of last year.
Brazil is now listened to around the world.
This is just one more indication of how the world has changed.
Every day, we, particularly in the United States, must remember that things are different now. Although the United States is still a very powerful nation, quite a few other countries have increased significantly in power so that the relative position of the United States is not the same as it once was.
And, there are other hints. JPMorgan Chase has reorganized so that it can become more of an international force. Economically, it cannot just rely on its position in the slow growing United States economy anymore.
We also see the changes in leadership in the United States. For example, the bank that formerly was the largest bank in the United States has someone born in India as its CEO, Vikram Pandit, who was brought into this position to save Citigroup and turn it around.
And what about the biggest, most aggressive investment bank (now a bank holding company) in the United States, Goldman Sachs. There are rumors that a Canadian by birth, someone who has been Goldman’s Asian chief, Michael Evans, is playing a larger part in the management of the company and might even be a successor to Lloyd Blankfein, the current chief executive. Also, Mr. Evans does not have a back ground in Goldman’s trading unit, a place many other Goldman Sachs’ leaders have come from.
The world is open. People and products and services are flowing more easily from country to country.
We still see individuals that resist this fact.
It is hard to believe that this growing global integration can be ignored by investors, governments, and financial institutions, manufacturing concerns, and others who want to perform well in these times.
Well done Mr. Lula!
Subscribe to:
Posts (Atom)
