The Financial Times ran a very interesting article last week called “China: Turning away from the dollar”. It got a lot of attention, at least among China analysts, and I was asked several times by friends and clients for my response. The authors, James Kynge and Josh Noble, begin their article by noting that we are going through significant changes in the institutional structure of global finance:
An “age of Chinese capital”, as Deutsche Bank calls it, is dawning, raising the prospect of fundamental changes in the way the world of finance is wired. Not only is capital flowing more freely out of China, the channels and the destinations of that flow are shifting significantly in response to market forces and a master plan in Beijing, several analysts and a senior Chinese official say.
While this may be true, I am much more skeptical than the authors, in part because I am much more concerned than they seem to be about the speed with which different countries are adjusting, or not adjusting, to the deep structural imbalances that set the stage for the global crisis. My reading of financial history suggests that we tend to undervalue institutional flexibility, especially in the first few years after a major financial crisis, perhaps because in the beginning countries that adjust very quickly tend to underperform countries that adjust more slowly. As I have written many times before China’s high growth and very large capital outflows suggest to me how difficult it has been for China to shift from its current growth model.
Beijing has been trying since at least 2007 to bring down China’s high savings rate, for example, and yet today it remain much higher than it did seven years ago. Chinese capital outflows, in other words, which are driven by its excessively high savings rates, may have less to do with master planning than we think, and certainly when I think of the most dramatic periods of major capital outflows in the past 100 years, I think of the US in the 1920s, the OPEC countries in the 1970s, and Japan in the 1980s. In each case I think we misinterpreted the institutional strengths and the quality of policymaking.
Any discussion about China’s future role in global finance or about the reserve status of the dollar or the RMB is so highly politicized that you cannot approach the topic in the same way you might approach an article about the Mexican peso, or even the Russian ruble, but I figured that there are a lot of interesting points about which a discussion might anyway be illuminating. To begin with, there is much in the article with which I agree, but also some things with which I disagree. About the latter I have basically three different “sets” of disagreements:
- In some cases my interpretation of both the information and the implications provided by the authors is a lot more skeptical than theirs.
- The authors provide the views of several analysts concerning the impact on the US bond markets and US economy more generally of reduced PBoC purchases of US government bonds, and these views range from neutral to very negative. I would argue however that in fact these views fail to understand the systemic nature of the balance of payments, in which any country’s internal imbalances must necessarily be consistent with its external imbalances. They assume implicitly assume that PBoC purchases only affect the demand for US government bonds, whereas in fact the flow of capital from one country to another must automatically affect both demand and supply. In fact the impact of reduced PBoC purchases of US government bonds is likely to be net positive, and while this view is probably counterintuitive, and certainly controversial, in another part of the article the authors cite a Chinese official whose statement, had they explored the implications fully, would have explained why.
- There is one point that they make which I think is fundamentally wrong, although a lot of people, including surprisingly enough economists and central bankers, have made the same mistake. It is not fundamental to their argument overall, but I think this mistake does indicate the level of confusion that exists about the way reserve currencies work and it is worth drawing out.
The first set of disagreements concern issues on which reasonable people can disagree, and while I have always been on the skeptical side, I also recognize that only time can resolve the disagreements. For example in discussing some of Beijing’s recent activity in driving the internationalization of the RMB the authors say:
What is clear is that Beijing’s intention to diversify the deployment of its foreign exchange reserves is strengthening. Over the past six months, it has driven the creation of three international institutions dedicated to development finance: the Shanghai-based New Development Bank along with Brazil, Russia, India and South Africa; the Asian Infrastructure Investment Bank and the Silk Road Fund.
There certainly have been many announcements in the past few years, not just about new global institutions that are being planned, but also about currency swap agreements and other actions taken by foreign central banks related to RMB reserves, and each of these has created a great sense of excitement and momentum. I have often thought the amount of attention they received significantly exceeded their importance, and while I won’t mention specific cases because that may come across as a little rude, some of the countries whose central banks negotiated currency swap lines with the PBoC are either credit-impaired enough that any implicit extension of credit would be welcome, or are primarily making a political statement. In at least one case the currency swap is denominated in both RMB and the counterpart’s national currency, but is actually settled in US dollars, and so is little more than a dollar loan indexed to RMB.
How certain are today’s predictions?
I am also very skeptical about the long-term importance of the various development banks that are in the works. It is not clear to me that the incentives of the various proposed members are sufficiently aligned for there to be much agreement on their loan policies, nor is it clear to me that all the members agree about their relative status and how policy-making will occur. It is easy enough to agree in principle that there is a lot of room to improve the existing infrastructure of global financial institutions – mainly the Bretton Woods institutions – but that may well be because the needs of different countries are either impractical or so heterogeneous that no institution is likely to resolve them.
We do have some useful history on this topic. The Bretton Woods institutions were established when one country, the US, was powerful enough to ride roughshod over competing needs, and so the misalignment of interests was resolved under very special and hard-to-replicate conditions, but since then it is hard to think of many examples of similar institutions that have played the kind of transformative role that is expected of the institutions referred to in the article. It is not as if proposals to change the global financial system have not been made before – I remember that burgeoning reserves among Arab OPEC members in the 1970s, or Japan in the 1980s, also generated waves of activity – but change is always easier to announce than to implement. This doesn’t mean that the new institutions being proposed will not have a very different fate, of course, but I would be pretty cautious and would wait a lot longer before I began to expect much from them.
There is anyway a more fundamental reason for long-term skepticism. As the authors note the creation of these institutions is driven largely by China and is based on current perceptions about longer-term trends in China’s growth. Historical precedents suggest however that it may be hard to maintain the current momentum. Rapid growth is always unbalanced growth, as Albert Hirschman reminded us, and what many perceive as the greatest economic strengths of rapidly growing economies are based on imbalances that also turn out to be their greatest vulnerabilities. The fact that the US in the 1920s, Germany in the 1930s, Brazil in the 1960s and 1970s, Japan in the 1980s, China during this century, and many other rapidly growing economies generated deep imbalances during their most spectacular growth phases should not be surprising at all, but it is important to remember that all of them subsequently suffered very difficult adjustments during which, over a decade or more, these imbalances were reversed (Germany after the 1930s of course “adjusted” in a different way, but it was already clear by 1939-40 that the German economy was over-indebted and substantially unbalanced).
The reversal of these imbalances involved adjustment processes that turned out very different from the predictions. While the periods of spectacular growth always get most of the attention from economists and journalists, and always create outsized expectations, the real test over the longer term is how well the economy adjusts during the rebalancing period. We can learn much more about long-term growth, in other words, by studying Japan post-1990, or the US post-1930, for example, than we can from studying Japan pre-1990 or the US pre-1930. Until we understand how adjustment takes place, and the role of debt in the adjustment process, the only safe prediction we can make, I suspect, is that the momentum that drives Beijing’s current activity will not be easy to maintain.
A second area in which reasonable people can disagree is on the quality and meaning of recent data. “The renminbi’s progress has been more rapid than many expected,” according to the authors. This may be true by some measures, but there has been a great deal of discussion on how meaningful some of the trade and capital flow numbers are, especially when compared to other developing countries much smaller than China. It is true that the use of the RMB has grown rapidly in recent years according to a number of measures, but so has that of currencies of other developing countries – Mexican pesos, for example – and at least part of this growth may have been a consequence of uncertainty surrounding the euro. We have to be careful how we interpret the reasons for this growth.
What is more, when you compare the share of foreign exchange activity – whether trade flows, reserves, or capital flows – that is denominated in RMB with the share in the currencies of other countries, including other developing countries, what is striking is how remarkably small it still is relative to the Chinese share of global GDP or of global trade. There are obvious reasons for this, of course, but it will be a long time before we can even say that the RMB share is not disproportionately small, and it has a long way to go just to catch up to several developing countries in Latin America or Asia. It is too early, in other words, to decide on the informational content of the growing RMB share of currency trading.
There has also been a lot of debate and discussion about how much of this data represents fundamental shifts in activity anyway. It is clear that a lot of trade is denominated in RMB for window-dressing purposes only – a mainland exporter that used to bill its client in yen, for example, will reroute the trade through its HK subsidiary, and bill the HK sub in RMB before then selling it on to the final buyer in yen. This shows up as an increase in the RMB denominated share of exports, but in fact nothing really changed. There has also been currency activity driven by speculation, or by political signaling, or by the need to disguise transactions, and so on. So much has already been said over the past few years on these issues that I don’t have much to add, but it is worth keeping in my mind as we try to assess the informational content of this data that there may be strong systemic biases in the numbers
How does the RMB affect US interest rates?
I think there is a small but growing awareness of why Keynes was right and Harry Dexter White wrong in 1944 about the use of bancor versus dollars as the global reserve currency. There is a cost to reserve currency status, even though a global trading currency creates an enormous benefit to the world.
When any single currency dominates as the reserve currency, however, the cost can be overwhelming unless the reserve currency country intervenes in trade. The UK paid that cost heavily in the 1920s and less so in the 1930s after it began to raise tariffs (people forget that sterling reserves exceeded dollar reserves during this period), which is why Keynes was so adamant that the world needed something like bancor. It is in light of the debate over the value of reserve currency status that I find the discussion about the impact a shift in the status of the RMB might have on US interest rates the more interesting part of the article. According to the authors:
Not only is China’s desire to buy US debt diminishing, so is its ability to do so. The banner years of Treasury bond purchases, during which holdings rose 21-fold over a 13-year period to hit $1.27tn by the end of 2013, were driven by an imperative to recycle China’s soaring US dollar current account surpluses. But these surpluses are narrowing sharply — from the equivalent of 10.3 per cent of gross domestic product at the peak in 2007 to 2.0 per cent in 2013. In fact, if financial flows are taken into account, China ceased over the most recent four quarters to be a net exporter of capital at all.
Actually if financial flows are taken into account, China has not ceased over the most recent four quarters to be a net exporter of capital. I think the authors are confusing capital exports through the PBoC (increases in central bank reserves) and capital exports more generally. China’s net capital export, by definition, is exactly equal to its current account surplus, and while it is true that China’s current account surplus has narrowed from its peak in 2007 to its trough in 2013, it has risen very rapidly during 2014. In fact I think November’s current account surplus may be the largest it has ever posted.
It is true that PBoC reserves have not increased in 2014, and have actually declined, although this may be mainly because the non-dollar portion of the reserves dropped dramatically in value, so that in dollar terms they have declined, but this was not because net exports have declined and it is not even a policy choice. Because the PBoC intervenes in the currency, it cannot choose whether to increase or reduce its accumulation of reserves. All it can do is buy the net inflow or sell the net outflow on its current and capital account, so the fact that we have seen massive capital outflows from China in 2014 means that it is exporting more capital than ever, but not in the form of PBoC purchases of foreign government bonds.
The trend, in other words, is no longer narrowing current account surpluses and less capital export but rather the opposite. An investor they cite thinks we will see a reversal of this trend: “I absolutely think we are going to see smaller Chinese current account surpluses in the future”, he says, “because of greater Chinese spending overseas on tourism and services and greater spending power at home may lead to more imports.”
I think we have to be cautious here. In order to protect itself from a rapidly rising debt burden, China is trying to reduce the growth in investment as fast as it can. It is also trying to reduce the growth in savings as fast as it can, but there are only two ways to reduce savings. One is to increase the consumption share of GDP, but this is politically very hard to do because it depends on the speed with which China directly or indirectly transfers wealth from the state sector to the household sector. The other is to accept higher unemployment.
Because the current account surplus is by definition equal to the excess of savings over investment, an expanding current account surplus allows China to reduce investment growth at a faster rate than can be absorbed by rising consumption – without rising unemployment. But with Europe competing with China in generating world-record current account surpluses, and with weak consumption in Japan, it isn’t easy get the rest of the world to absorb large current account surpluses.
Put differently, the biggest constraint on China’s export of its savings is not domestic. It is the huge amount of savings that everyone wants to export to everyone else, but which neither China nor any developing country wants to import. Still, I suppose in principle we could see a huge shift in capital flows, with less going to the US and to hard commodity exporters (as commodity prices drop) and more going to India, Africa, and other developing countries. At any rate over the long term the authors are concerned about the impact China will have on capital flows to the US:
All of this leads to a burning question: how convulsive an impact on US debt financing — and therefore on global interest rates — will the changes under way in China have? Analysts hold views across a spectrum that ranges from those who see an imminent bonfire of US financial complacency to those who see little change and no cause for concern.
The great concern, the authors correctly note, is the idea that the US has come to depend on China to finance its fiscal deficit. If China stops buying US government bonds, the worry is that the US economy may be adversely affected, and even that US government bond market will collapse and US interest rates soar:
A decade ago Alan Greenspan, the then chairman of the US Federal Reserve, found his attempts to coax US interest rates upwards negated by Beijing parking its surplus savings into Treasuries. Arguably, says Mr Power, a bond bubble has existed ever since. “If China is now set to redeploy those deposits into capital investment the world over, does this mean the [Greenspan] conundrum will be at last ‘solved’ but at the cost of an imploding Treasury market?” Mr Power asks. “If so, this will raise the corporate cost of capital in the west and put yet another brake on already tepid western GDP growth.”
Because PBoC purchases of US government bonds are so large, it seems intuitively obvious to most people that if the PBoC were to stop buying, the huge reduction in demand must force up interest rates. But this argument may be based on a fundamental misunderstanding of how the balance of payments works. First of all, greater use of the RMB as a reserve currency does not mean that the PBoC will buy fewer US government bonds. On the contrary, higher levels of RMB reserves in foreign central banks will by definition increase capital inflows into China. In that case either it will force the PBoC to purchase even more foreign government bonds, if the PBoC continues to intervene in the currency, or it will cause some combination of an increase in Chinese capital outflows and a reduction in China’s current account surplus. This is an arithmetical necessity.
If the RMB becomes more widely used as a reserve currency, it could certainly result in lower foreign demand for US government bonds, but not lower Chinese demand. This, however, would not be bad for the US economy or the US government bond market any more than it would be if the PBoC were to reduce its demand for US government bonds. China, and this is true of any foreign country, does not fund the US fiscal deficit. It funds the US current account deficit, and it has no choice but to do so because China’s current accounts surpluses are simply the obverse of China’s capital account deficits. This may not seem like an important distinction in considering how lower demand will affect prices, but in fact it is extremely important because any change in a country’s capital flow can only come about as part of a twin set of changes in both the capital account and the current account.
This is true for both countries involved. There is no way, in other words, to separate the net purchase of US dollar assets by foreigners with the US current account deficit. One must always exactly equal the other, and a reduction in the former can only come about with a reduction in the latter. So what would happen if the PBoC were sharply to reduce its purchase of US government bonds? There are only four possible ways this can happen:
- The reduction in PBoC purchases of US government bonds was matched by an increase in purchases by other Chinese institutions or individuals of US dollar assets. This is mostly what seems to have happened in 2014, and because the PBoC intervenes in the currency, fewer purchases of government bonds by the PBoC was not a choice, but rather the automatic consequence of increased foreign investment by other Chinese institutions or individuals. The impact on the US economy would depend on what assets the other Chinese institutions or individuals purchased. If they purchased risk-free US assets there would be no net impact. If they purchased risky US assets there would be a small, barely noticeable increase in the riskless US interest rate, matched by an equivalent reduction in the US risk premium.
- The reduction in PBoC purchases of US government bonds was matched by an increase in purchases by other foreigners of US dollar assets. The impact on the US economy would depend, again, on what assets the other foreigners purchased. If they purchased risk-free US assets there would be no net impact. If they purchased risky US assets there would be a small, barely noticeable increase in the riskless US interest rate, matched by an equivalent reduction in the US risk premium.
- The reduction in PBoC purchases of US government bonds was not matched by an increase in purchases by other Chinese or foreigners, so that there was a commensurate decline in the US current account deficit. Because the US current account deficit is equal by definition to the excess of investment over savings, there are only two ways the US current account deficit can decline. If there is no change in US investment, US savings must rise, and in an economy with underutilized capacity and unemployment, this will happen as unemployed workers and underutilized capacity are put to work, either to replace imports or to increase exports. Workers with jobs save more than workers without, and companies with less underutilized capacity save more than companies with more because they are more profitable. More profitable businesses and fewer unemployed workers results in higher fiscal revenues and lower fiscal expenses, so that fewer foreign purchases of US government bonds is accompanied by a lower supply of government bonds.
- Finally, because the US current account deficit is equal by definition to the excess of investment over savings, the only other way the US current account deficit can decline is if there is no change in US savings, in which case, US investment must decline. Businesses close down American factories and otherwise reduce business and government investment. This causes GDP growth to drop and unemployment to rise.
What determines US savings?
These four, or some combination, are the only possible ways in which the PBoC can reduce its purchases of US government bonds. It is pretty obvious that the best outcome, the third scenario, requires fewer foreign purchases of US assets, as does the worst, the fourth scenario. It is also pretty obvious that what the PBoC does in largely irrelevant. What matters is whether the US current account declines. Because not only are Chinese institutions and other foreigners eager to purchase US assets, and because demand abroad is so weak, the US current account deficit is in fact likely to increase, as foreigners purchase even more US assets. The US current account deficit will only decline if growth abroad picks up or if the US takes actions to reduce its current account deficit – perhaps by making it more difficult for foreigners to invest their excess savings in the US.
If the US were to force down its current account deficit, would US savings rise or would US investment drop – put another way, is a lower current account deficit good, or bad, for the US economy? For most people the answer is obvious. A lower US current account deficit is good for growth. In fact much of the world is engaged in currency war precisely in order to lower current account deficits, or increase current account surpluses, by exporting their savings abroad.
For some analysts, however, a reduction in foreign purchases of US assets would be bad for US growth because, they argue, the US is stuck with excessively low savings rates. Because there is no way to increase US savings, a reduction in foreign purchases of US assets must cause US investment to decline.
These analysts – trained economists, for the most part – are almost completely mistaken. First of all, it does not require an increase in the savings rate for American savings to rise. Put differently, if unemployed American workers are given jobs, US savings will automatically rise even if the savings rate among employed workers and businesses is impossible to change. Secondly, these economists mistakenly argue that the reason the US runs a current account deficit is because US savings are wholly a function of US savings preferences, which are culturally determined and impossible to change. Because these are clearly lower than US investment, it is the unbridgeable gap between the two that “causes” the US current account deficit.
But while the gap between the two is equal to the current account deficit by definition, these economists have the causality backwards. As I show in the May 8 entry on my blog, excess savings in one part of the world must result either in higher productive investment or in lower savings in the part of the world into which those excess savings flow. This is an arithmetical necessity. Because China’s excess savings flow into the US – mostly in the form of PBoC purchases of US government bonds – the consequence must be either more productive investment in the US or lower savings.
If productive investment in the US had been constrained by the lack of domestic savings, as it was in the 19th Century, foreign capital inflows would have indeed kept interest rates lower, and because these foreign savings were needed if productive investment were to be funded, the result in the 19th Century was higher growth. But while it is true that in the US today there are many productive projects that have not been financed – the US would clearly benefit from more infrastructure investment for example – the constraint has not been the lack of savings. No investment project in the US has been turned down because capital is too scarce to fund it. In fact more generally it is very unlikely that any advanced economy has been forced to reject productive investment because of the savings constraint. It is usually poor planning, dysfunctional politics, legal constraints, or any of a variety of other reasons that are to blame.
This means that if China’s excess savings flow into the US, there must be a decline in US savings, and the only way this can happen is either through a debt-fueled consumption boom or through higher unemployment. The analysts interviewed in the Financial Times article argue that if there were an interruption to PBoC purchases of US government bonds, the adverse consequences could range from fairly minor to the extreme – a collapse in the US government bond market – but in fact the only necessary consequence would be a contraction in the US current account deficit. While there are scenarios under which this could be disruptive to the US economy, in fact it is far more likely to be positive for US growth.
As counterintuitive as this may at first seem, several economists besides me have made the same argument, and I provide the full explanation of why fewer foreign purchases of US assets will actually increase both American savings and America growth in Chapter 8 of my book, The Great Rebalancing. What is more, the fact that the US government has put pressure on Beijing to revalue the RMB in order to reduce the US current account deficit is simply another way of saying that Washington is pressuring Beijing to reduce the amount of US government bonds the PBoC is purchasing. After all, if large foreign purchases of US government bonds were good for the US, Europe, China, or anyone else, it must follow automatically that large current account deficits are good for growth and help keep interest rates low.
And this cannot be true. Remember that by definition, the larger a country’s current account deficit, the more foreign funding is “available” to purchase domestic assets, including government bonds. And yet instead of welcoming foreign funds and the associated current account deficits, countries around the world are eager to export as much of their savings as they can, which is another way of saying that they are eager to run as large current account surpluses as they can.
The arithmetic of the balance of payments
In fact there is evidence even within the article that Chinese purchases of US government bonds, far from boosting US growth, either by keeping interest rates low or otherwise, actually causes a reduction in demand for US-produced goods and services. This becomes obvious by recognizing the inconsistency between Chinese behavior and Chinese claims that they are seeking to diversify reserve accumulation away from the dollar. The inconsistency is made explicit when the article cites a famous incident in 2009.
“We hate you guys”, was how Luo Ping, an official at the China Banking Regulatory Commission vented his frustration in 2009. He and others in China believed that, as the US Federal Reserve printed more money to resuscitate American demand, the value of China’s foreign reserves would plunge. “Once you start issuing $1tn-$2tn . . . we know the dollar is going to depreciate so we hate you guys — but there is nothing much we can do,” Mr Luo told a New York audience.
Mr. Luo, of course, turned out to be wrong, and the value of China’s dollar-denominated foreign reserves did not plunge. On the contrary, if the PBoC had purchased more dollars instead of fewer dollars, it would have avoided some of the currency losses it has taken since 2009. But while it might have been useful to explain why Luo was wrong about the plunging dollar, what really needed explaining is why “there is nothing much we can do”.
Actually China did have a choice as to whether to buy dollars or not. Luo was right about China’s lack of choice only in the sense that as long as Beijing was determined to run a large current account surplus, and as long as purchasing other currencies would have been too risky, or too strongly resisted by their governments, the PBoC did not have much of a choice. In China the savings rate is extremely high for structural reasons that are very hard to reverse. This means that the investment rate must be just as high, or else the gap between the two must be exported. Put differently, if China cannot export excess savings and run a current account surplus, either it must increase domestic investment or it must reduce domestic savings. This is just simple arithmetic, and is true by definition.
With investment rates among the highest in the world, and with much of it being misallocated, China wants to reduce investment, not increase it. Rising investment is likely to cause the country’s already high debt burden to rise. But as in the case of the US, the only way it can reduce its savings is with an increase in consumer debt or with an increase in unemployment.
Because none of the options are desirable, China can only resolve its imbalance between supply and demand if it exports the excess of savings over investment, or, put another way, it must run a current account surplus equal to the difference between savings and investment. But because China is such a large economy, and the gap between investment and savings is so large, this is an enormous amount of savings that must be exported, and China must run an enormous current account surplus that must be matched by the current account deficit of the country to whom these savings are exported. The US financial market, it turns out, is the only one that is deep and flexible enough to absorb China’s huge trade surpluses, and, perhaps much more importantly, it is also the only one whose government would not oppose being forced to run the countervailing deficits.
Had the PBoC tried to switch out of dollars and into Japanese yen, or Swiss francs, or Korean won, or euros, or anything else, it would have met tremendous resistance. In fact it did try to purchase some of those currencies and it did meet tremendous resistance, which is why its only option was to buy US government bonds. I explain why in my book as well as in another one of my blog posts.
Luo’s statement implies very directly that the only meaningful way to protect the PBoC from being forced to buy dollars is not by increasing the use of the RMB in international trade but rather for China to run smaller surpluses. It certainly did have a choice, but because the alternative was so unpalatable, Beijing felt as if it had no choice. China bought US government bonds not because it wanted to help finance the US fiscal deficit but very specifically because if it didn’t it would be forced either to increase domestic debt or to suffer higher unemployment.
This point is a logical necessity arising from the functioning of the balance of payments. Both Lenin and John Hobson explained this more than 100 years ago: countries export capital in order to keep unemployment low. If the RMB becomes a reserve currency, Beijing will have to choose whether, like the US, it will allow unrestricted access to its government bonds, or whether, like Korea, it resist large foreign purchases.
If it chooses the latter, the RMB cannot be a major reserve currency. If it chooses the former, the RMB might indeed become a major reserve currency, but this will force China to choose between higher debt and higher unemployment any time the rest of the world wants more growth. The result of a rising share of reserves denominated in RMB at the expense of a declining share denominated in dollars is really Washington’s goal, in other words, and not Beijing’s.
Can China invest its current account surplus at home?
At the beginning of this entry I said that the authors made one assertion that is fundamentally wrong, although so many economists get this wrong that it would be unfair to blame the authors for failing to do their homework. The mistake isn’t necessary to their argument, but I bring it up not just because it is a mistake commonly made but also because it shows just how confused the discussion of the balance of payments can get.
Early in the article the authors cite Li Keqiang’s “10-point plan for financial reform” which includes the following
Better use should be made of China’s foreign exchange reserves to support the domestic economy and the development of an overseas market for Chinese high-end equipment and goods.
They then go on to make the following argument:
As a mechanism towards this end, China is earning a greater proportion of its trade and financial receipts in renminbi. Because these earnings do not have to be recycled into dollar-denominated assets, they can be ploughed back into the domestic economy, thus benefiting Chinese rather than US capital markets.
This is incorrect. The amount that China invests at home and the amount of foreign government bonds the PBoC must purchase are wholly unaffected by whether China’s trade is denominated in dollars, RMB, or any other currency.
There are two ways of thinking about this. One way is to focus on the trade itself. If a Chinese exporter sells shoes to an Italian importer and gets paid in dollars, the exporter must sell those dollars to his bank to receive the RMB that he needs. Because the PBoC intervenes in the currency, it effectively has no choice ultimately but to buy the dollars, and the result is an increase in FX reserves. This is pretty easy to understand.
But what happens if the next time the Chinese exporter sells shoes to the Italian importer, he gets paid in RMB? In that case it is the responsibility of the Italian importer, and not the Chinese exporter, to buy RMB in exchange for dollars. This is the only difference. The Italian importer must obtain RMB, and she does so by going to her bank and buying the RMB in exchange for the dollars. Her bank must sell the dollars in China to obtain RMB, and once again because the PBoC intervenes in the currency, it effectively has no choice ultimately but to buy the dollars. The result once again is an increase in FX reserves.
The other way to think about this is to remember that the change in FX reserves is exactly equal, by definition, to the sum of the current account and the capital account. This is because the balance of payments must always balance. China’s current account surplus is wholly unaffected by whether the trade is done in dollars (the Chinese exporter is responsible for changing dollars into RMB) or in RMB (the Italian importer is responsible for changing dollars into RMB). In either case, in other words, PBoC reserves must rise by exactly the same amount.
What about Chinese investment? It too is wholly unaffected. The current account surplus, remember, is equal to the excess of Chinese savings over Chinese investment. If the current account surplus does not change, and savings of course will not have been affected by the currency denomination of the trade, then domestic investment must be exactly the same.
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china suffered sharp collapse in GDP growth leading up to the Tienanmen square protest of 1989, were those caused by successful economic reforms?
Maybe. Radical reforms always increase volatility, and in fact China suffered high inflation in the 1985-87 period, one of the reasons why Beijing has always been worried about inflation.
I’m a little perplexed why we’re fretting the possible departure of China as a buyer from the Treasurys market. China hasn’t been a buyer for a year already: http://www.treasury.gov/ticdata/Publish/mfh.txt
Not necessarily, Tom, although it is true that all of this “fretting” misses the point. In the entry I say: “It is true that PBoC reserves have not increased in 2014, and have actually declined, although this may be mainly because the non-dollar portion of the reserves dropped dramatically in value, so that in dollar terms they have declined, but this was not because net exports have declined and it is not even a policy choice. Because the PBoC intervenes in the currency, it cannot choose whether to increase or reduce its accumulation of reserves. All it can do is buy the net inflow or sell the net outflow on its current and capital account, so the fact that we have seen massive capital outflows from China in 2014 means that it is exporting more capital than ever, but not in the form of PBoC purchases of foreign government bonds.”
In 2014 the PBoC barely added to reserves, but this doesn’t mean that the Chinese stopped exporting capital, of course, because they ran a very rapidly growing current account surplus. Like every country with a CAS, China must recycle the inflows by exporting capital. Normally it is the PBoC that does this, by buying foreign government bonds, and this shows up as higher reserves. In 2014, however, capital exports by other Chinese institutions and individuals were so much greater than imports (normally it is the reverse) that the net amount of capital exports was roughly equal to the CAS. The PBoC doesn’t choose whether or not it will increases reserves. It just balances whatever the net amount on the capital and current accounts. This, by the way, is what intervening in the currency means — the central bank sets the exchange rate and then buys or sells whatever is needed to balance supply and demand at that level.
Dear Prof. Pettis,
Love your intellectual insights and deep-thoughts on China.
I’ve been doing some research on China for a while and found it strange how China’s export data grow so robustly.
According to trading economies, China’s exports peaked in 2008 at $1.3trn and subsequently fell to $600bn in 2009. Afterwards, it has grown by 250% as exports jumped to $2.2trn.
However, I am skeptical how Chinese exports is 50% higher than in 2008, whilst 70% of its import’s partners have barely recovered to its 2008 peak in imports.
My questions are:
A. Is China export data since 2009 seem fabricated?
It is not uncommon for China to loan money to African countries so they could buy chinese goods, and over a number of years later write it off as ‘debt forgiveness’. But this is spreading to Latin America and even to some European countries.
B. Could rich Chinese be funnelling money out of China through the use of exports? Is it even possible?
There are various articles of wealthy chinese going aboard, buying up passport, in case things in China are not what they seem.
C. If the rich Chinese leave China, in fear of a crackdown (I believe the richest 1%, or 10m Chinese control 40% of China’s wealth, not accounting for corrupt officials), how is the government going to ‘re-balance’ its economy?
I know the above questions are tedious, and somewhat ‘taboo’ in China, but I appreciate it if you could share your insights and thoughts on the matter.
Moving Money Out, but then Moving it In…….and we worry about this when the government moves to set-up more finance zones, where 300 million USD can be brought in without any hiccups. This is the real issue, they are now proposing more sites like Shanghai, to enable more external capital to continue to flow in to fund the excessive capital-debt driven model they now have, minimal revenues of firms, all making money on the bubble, with everything access to capital, so that there are more ways to bring in outside money, with little oversight, which will likely increase or sustain reserves (until the crisis or through the transition), even as the wealthy exit. (enabling a sustaining of more stable conditions, while drawing the world more tightly into any potential crisis that occurs, while people still have the illusion that the RMB must rise)
But, there are many ways. that this (over under) can be done, has been done, and continues to be done, right now, many believe that the most recent data on exports, of rising exports, are actually related to this.
This is done both to bring money into the country and to move money out of the country.
I call it the over under…..over-invoicing and under-invoicing as a way to move money on and off-shore
Some believe that exports are ways to move money in and imports to move money out, but I am not so sure that the relationship need be so firm. Both underinvoicing and overinvoicing could, theoretically, be used to move money in and out.
exports of under-priced goods (rather than over-priced) goods, could be used as a way to move money out as well, or the inverse for Imports.
Company A can Export to Company B when the two are based on familial or other relations and this is a way to get the money in (not just out).
This is why the over-under, is difficult to account for….although typically people discuss it when considering import and export spikes that don’t seem to gel with other data.
Thanks, Walter. Actually these are questions we are all poring over.
A. There are always problems in the data, and in the past few years one that seems most to have most concerned the PBoC is the over- and under-invoicing of both exports and imports to hide capital flows.
As for lending money to developing countries to purchase goods and services and then “forgiving” the loan, this happens a lot, but it isn’t really a strategy, and usually the forgiveness is part of a negotiation that follows debt default or restructuring. There is a long history of developing countries that borrow money and then when conditions turn adverse cannot repay — as I mentioned in a recent entry, for example, between 1837 and 1841 nearly two thirds of the US states defaulted on their mostly-English loans.
This isn’t really an economic “strategy” because it is the same as simply giving the goods and services for free. China has just begun the process of investing abroad, and so it probably has suffered few defaults as of yet, but with commodity prices plummeting and global growth slowing, I suspect we are going to see a lot of this in the next decade or so.
B. Yes, Chinese institutions and wealthy individuals have been funneling money out (flight capital) and funneling money in (speculative inflows).
C. Capital outflows of any kind can have a complex relationship on the rebalancing process, and not always negative. For example if China runs a net deficit on the capital account, it must run a current account surplus, and a large current account surplus driven by higher exports, as opposed to lower imports, extends the rebalancing period for Beijing. In that case instead of China’s recycling the CAS via PBoC purchases of foreign government bonds, wealthy individuals do it via purchases of hard assets.
Walter
See below
http://www.gfintegrity.org/issue/trade-misinvoicing/
and
http://www.gfintegrity.org/wp-content/uploads/2014/12/Illicit-Financial-Flows-from-Developing-Countries-2003-2012.pdf
Excellent post Prof. Pettis, as usual.
I had a quick question related to the possible scenarios of reduced PBoC purchases of US Treasuries. Your 3rd, and most preferable, scenario states that: “If there is no change in US investment, US savings must rise, and in an economy with underutilized capacity and unemployment, this will happen as unemployed workers and underutilized capacity are put to work, either to replace imports or to increase exports.”
Could another possibility be increased savings from rising income inequality? As you’ve discussed, the wealthy have a lower marginal propensity to consume out of income, and thus savings rise. Is this scenario possible and if so, what would be the implications?
Of course rising income inequality does increase the savings rate, Dylan, but it would not be an obvious consequence of fewer foreign purchases of US assets. It could happen, of course, but as I see it foreign purchases tend to push up asset prices, which disproportionately benefit the rich. In fact there seems to be a positive correlation between increased global trade and capital flows and rising income inequality. This should not imply any obvious direction of causality, but I don’t really think of reduced net inflows as benefitting the rich.
Was surprised to see China savings rate 0.32 whereas Aust about 10% and US amd UK about 5%
http://www.tradingeconomics.com/australia/personal-savings
Dear Professor Pettis,
Excellent analysis as usual. I definitely go by what you write to assess what is really going on in the Chinese economy and world trade. I was wondering if you read this study that came out today and if you have any comment about it. Certainly I think these actions would help the U.S. economy, although they would harm China’s, so as a U.S. citizen, from that perspective it is confusing and even alarming that the U.S. continues to do nothing and allows itself to suffer for China’s artificial growth, although doing these things might spark an ever more damaging trade war reminiscent of the 1930s. If you cannot comment for political reasons because you live in China, I understand.
“Gagnon recommends that the rules of the WTO be changed to allow countries to impose tariffs on imports from currency manipulators. Since changing the rules of the WTO requires unanimous consent of all members, Gagnon observes that “the main targets of currency manipulation—the United States and euro area—may have to play tough. One strategy would be to tax or otherwise restrict purchases of U.S. and euro area financial assets by currency manipulators” (Gagnon 2012a, 1). Such financial taxes would be “consistent with international law” (Gagnon 2011).
In addition, Congress can help end currency manipulation by passing pending legislation (H.R. 1276 and S. 1114) that would allow the Commerce Department to treat currency manipulation as a subsidy in countervailing duty trade cases (OpenCongress.org 2014a and 2014b). In addition, the president and federal agencies possess the tools needed to end currency manipulation with the stroke of a pen (Scott 2013b). The Treasury and Federal Reserve have the authority needed to offset purchases of foreign assets by foreign governments by engaging in countervailing currency intervention (Bergsten and Gagnon 2012). By taking these steps, the U.S. government could make efforts by foreign governments to manipulate their currencies costly and/or ineffective.” http://www.epi.org/publication/china-trade-outsourcing-and-jobs/
This is what Brazil did, after it announced that there was a currency war in the aftermath of the GFC, as it saw its currency rising. I believe they are called Tobin taxes.
Anther thing that is interesting about your suggestions of policy responses is that it is Fred Bergsten of Peterson; now that does hit toward both respected and watched by many. El Erian even just was honered and spoke there, so mainstreaming those options, if Murdoch’s Wall street (oh what a shame for it of the owner) journal, and Bloomberg is still huffing and puffing, and not quite up to where the pack is moving.
I suspect, Sulla, that we, by which I mean the whole world, and not just the US, are going to be debating the costs and benefits of trade a little more seriously over the rest of this decade.
I also regularly read Alan Tonelson’s blog here: https://alantonelson.wordpress.com/. He cuts through all the misinformation, platitudes and dare I say vapid reporting from the press regarding U.S. trade and the current account deficit.
According to information from the Solaris.com website, during the ten years between China’s WTO entry in 2001 and 2011, US companies transferred/invested over $17 trillion into China. Corporate influence over the US political class will strive to maintain the status quo.
Here’s an article in Foreign Affairs by Nassim Taleb and Gregory Treverton. It’s an article about the stability and pseudo-stability of political and economic systems.
Taleb and Treverton touch on China, but it’s not deeply discussed. In the end, they come to the same conclusions that I do about China. This is what they say about China.
“China’s stunning economic growth makes its future hard to assess. The country has recuperated remarkably well from the major shocks of the Maoist period. That era, however, ended nearly four decades ago, and so the recovery is hardly a recent comeback and thus less certain to protect against future shocks. What’s more, China’s political system is highly centralized, its economy is dependent on exports to the West, and its government has been on a borrowing binge as of late, making the country more vulnerable to slowdowns in both domestic and foreign growth. Are the gains from past turmoil big enough to offset the weakness from debt and centralization? The most likely answer is no—that what gains China has accrued by learning from trauma are dwarfed by its burdens. With each passing year, those lessons recede further into the past, and the prospects of a Black Swan of Beijing loom larger. But the sooner that event happens, the better China will emerge in the long run.”
My reason for posting this isn’t about China per se. It’s about how we can look at these types of systems with a different lens.
http://www.foreignaffairs.com/articles/142494/nassim-nicholas-taleb-and-gregory-f-treverton%E2%80%A8/the-calm-before-the-storm
I find Talebs writings far more useful than his videos, I tend to be disappointed, and am far less convinced in person of the utility of his perspectives as I see him express them, live, then when he writes them in his caustic view. He comes off playing the simple blue collar trader, that is tired of all the big talk, words, and thoughts, and we all know that this is just that and that, or this and that, and so forth, so easily, while totally taking a very parochial, option trader perspective on the matter, as he extols longer term horizons, but acts as if global forces, and other forces, outside of what a trader would view, hold no importance. A shame really.
“He comes off playing the simple blue collar trader, that is tired of all the big talk, words, and thoughts, and we all know that this is just that and that, or this and that, and so forth, so easily, while totally taking a very parochial, option trader perspective on the matter, as he extols longer term horizons, but acts as if global forces, and other forces, outside of what a trader would view, hold no importance.”
He talks about these two competing views in his books. He writes about two alter-egos: Fat Tony vs Nero Tulip. He’s basically a mix of both.
He does come off as crankish in his videos, but he’s not wrong. If you do look at his papers, they’re about as rigorous as can be. They’re all 100% dead on and there’s not really a flaw. He’s extremely rigorous. He’s about as fundamentally sound as it gets.
I think a lot of people find Taleb’s personality tics annoying at times, but he has written some useful things and helped spread an extremely useful way of thinking about the world that is intuitively obvious to some people but highly counterintuitive to most. I think his first book, “Fooled by Randomness”, is one of the absolutely best books on the system of probability that governs trading. It would have been better if the roughly one-third to one-quarter aimed mainly, it seems, at expressing and avenging personal insecurities, was edited out.
Who cares, after all, that he makes less money than the most profitable trader on the floor, even when it is obvious to anyone who understands basic probability theory that on any large trading floor both the biggest winners and the biggest losers in any given year are likely to be the most foolish about risk? But because it is the most intelligent book I have ever read on how to think systemically about trading, I have made most of my favorite students read it.
The Black Swan book interested me much less, as I suspect it would for anyone with a strong historical background and basic intuition about probability theory. I didn’t read Anti-Fragility, but from the many reviews again I think what he writes there is intuitively obvious for certain people and extremely counterintuitive for most, and so useful mainly for the latter. If you read Hyman Minsky, for example, you will see that his idea of a well regulated financial system is one in which government balances sheets are effectively long volatility explicitly to counterbalance the destabilization in the financial services industry.
But for those who haven’t read “Fooled…”, do read it. It is really brilliant.
Taleb may be the only person I have read with whom I never see things differently than. He simply speaks like a guy who has realized, through P+L, what it feels like to always have risk at different points on a surface. Then to watch the wildest and previously unimaginable points on that surface become realized. After that, what you once perceived as obviously intuitive, becomes more deeply and somewhat differently understood. And yes ‘EXTREMELY’ counterintuitive for most…but he says that also…
“but from the many reviews again I think what he writes there is intuitively obvious for certain people and and so useful mainly for the latter.”
I like the way Taleb carries himself. He always hangs out with math professors in real life, which is actually a blessing. He doesn’t get caught up in the bullshit that economists keep thinking of.
You think Fooled by Randomness has got personal attacks towards various people? Damn, you outta read Antifragile. In that book, he pulls absolutely no punches. I like his honest, blunt nature. I’d much rater deal with an honest asshole than a pretentious douche any day of the week.
Unfortunately, such has become a familiar aspect of recent evolution’s in the popular culture. Often, it is but a cheap technique of rhetoricians, sophists, and those who would heighten a value based ideology beyond its logical and rationale position in the discourse. Such, is a method that seeks, because it can not be done otherwise, to stymie points that the proponent can not otherwise address. They do a good old, guy from the neighborhood, down on the farm, none of that highfalutin, blah blah blah, thus my blah blah blah is rather more supported, no.
This has been further extended, and I believe become a briefly entrenched practice aided by the rather expansive explosion in information and digital media, that wanes, as more balanced, thoughtful, and useful perspectives get shared, as I might say of Michael s way of discussing, and modeling.
Do not take this to mean that I do not think that Taleb has a lot of very useful things to say, or that I think he is a purposive driver of the above techniques devoid of a true sentiment toward such, just that an apple is apple even if sold by a Rolex dealer.
These quick jump from A to Z, leaves a whole slew of numbers outside of the alphabet of many other factors of importance, not settled by both A and Z being addressed and occupied by the thinker.
BTW, Taleb also has a derivatives textbook, in case you didn’t know. He wrote his derivatives textbook well before any of his works for laymen.
He also holds a PhD in math/probability theory.
CSteven.. It’s a cultural issue. Whether you graduated a year early from MIT or #1 out of Wharton, the language of a derivative trader is expected to approximate the language of a degenerate ‘street fighting’ gambler. Nathan Detroit (Fat Tony – the trader) instead of Stephen Hawkins (the ‘quant’).
I don’t know how much of it is necessarily a cultural issue. When I walk around on the street, I’d like for people to look at me and think I’m a thug. I don’t want the first thing that comes to their mind to think of me as a math nerd, even though I’m a total math nerd and not a thug.
I’m with family for the break and me and my cousin went out. Before we left, my mom looked at me and said something like, “You look like that?! You look like a gangster!” That comment made my day.
I’d rather hang out with honest assholes than pretentious douchebags because I hate spineless cowards who don’t stand for anything. Simply put, you can’t trust them. When push comes to shove, they’ll throw you to the wolves in order to cover their ass. I don’t know why anyone would wanna be around people like that.
Yes, and one of the implicit if unstated implications from this piece, Suvy, is that in rigid systems, imbalances can persist, giving the perception of strength rather than weakness, so that their reversal is all the more surprising. I think among people who naturally tend to think in terms of systems, as opposed to components of a system (and I think Taleb may be such a person), there is a tendency to see linear progression not as the norm but in fact as pretty rare. In that sense I find this article quite useful.
Brilliant lucid article. I think. And yes CAD can defines itself, by definition. And this does seem to be forgotten by most journalists.
I had a similar revelation when I finally got around to doing double entry accounting.
But are there not cultural issues that cannot be dismissed? The “free market raises all ships” was stubbornly adhered to by the US even when it was met with currency pegging by China. Try getting the US to impose tariffs for example.
I tend to be less impressed than most by cultural conditions, BBotM, but yes, it is shocking how just an understanding of double-entry book-keeping would prevent so much nonsense from being written.
People who argue from accounting identities are often criticized for doing so because they seem trivial, but the critic almost always fails to understand that while accounting identities are certainly not proof of anything, and indeed are “trivial”, in the sense that they can be understood quite easily, all attempts to understand the economy as a system requires rigid adherence to these identities, and that is where the vast majority of economists seem to fail, at least judging from all the mistakes nearly everyone makes when discussing something as simple as the balance of payments.
I recently discovered that Ralph Hawtrey criticized Keynes for just this reason. He thought Keynes’s insistence on arguing from accounting identities was a limitation, whereas in fact it allowed Keynes to work logically towards his astonishing breakthroughs in understanding macroeconomics as a system. Here is David Glasner on the subject:
As in his criticism of the fundamental equations of the Treatise, Hawtrey was again sharply critical of Keynes’s tendency to argue from definitions rather than from causal relationships.
“[A]n essential step in [Keynes’s] train of reasoning is the proposition that investment an saving are necessarily equal. That proposition Mr. Keynes never really establishes; he evades the necessity doing so by defining investment and saving as different names for the same thing. He so defines income to be the same thing as output, and therefore, if investment is the excess of output over consumption, and saving is the excess of income over consumption, the two are identical. Identity so established cannot prove anything. The idea that a tendency for investment and saving to become different has to be counteracted by an expansion or contraction of the total of incomes is an absurdity; such a tendency cannot strain the economic system, it can only strain Mr. Keynes’s vocabulary.”
Hawtrey is wrong that “Identity so established cannot prove anything.” By itself it cannot prove anything, but it forces everything that follows to conform systemically, or, put differently, it forces you to understand why a change in consumption in Country A, for example, cannot help but cause a change in the relationship between consumption and investment in Country B, and until you have worked through all the changes, you haven;t explained anything. At any rate it seems to me that an intuitive understanding of accounting identities, which is probably no different that an intuitive understanding of systems, allowed Keynes to prove something that to Hawtrey was impossible, that long-term unemployment could exist as a consequence of weak demand.
But for all their obviousness, not many economists get them. How many people, for example, “refuted” Bernanke’s “global savings glut” hypothesis by pointing out smugly that there had been no increase in global savings? As I show in an entry a few months back, it is a matter of very simple logic to show that a global savings glut is unlikely to cause global savings to rise, and you only need two accounting identities to prove it. Anyone who understands accounting identities could not have possibly made such an obviously irrelevant “refutation”.
But now I digress.
Not a digression. Its really the nub of the issue.
“If investment is the excess of output over consumption, and saving is the excess of income over consumption, the two are identical.”
Identity so established cannot prove anything. The idea that a tendency for investment and saving to become different has to be counteracted by an expansion or contraction of the total of incomes is an absurdity; such a tendency cannot strain the economic system, it can only strain Mr. Keynes’s vocabulary.”
Brilliant article, thank you for sharing…I cannot understand why U.S. analysts and policy makers seem so slow to learn and understand more about the balance of payments. Also, why do U.S. policy makers allow for such large foreign capital inflows? Other countries resist the capital inflows, as mentioned in the article. I would’ve thought that U.S. politicians/policy makers would be grateful for your insights so that they could intervene to reduce the capital account surplus- so that we could lower the U.S. current account deficit…? I like free markets, etc. but couldn’t they at least tax foreign capital coming into the U.S.? -perhaps by taxing foreign purchases of Treasury bonds or similar, etc.?
Ps. thank you for the great explanations
A word is missing in the sentence, probably “aloof”. While this may be true, I am much more skeptical than the authors, in part because I am much more concerned than they seem to be “aloof???) about the speed with which different countries are adjusting, or not adjusting, to the deep structural imbalances that set the stage for the global crisis.
It may be a clumsily constructed sentence, Jon, but I don’t think any word is missing.
Sorry Michael, you are right. I see what you mean.
It took me a while to see it, though. Smile.
– China can only “turn away from the USD” with countries it runs a Current Account Deficit with. Only with those countries the currency of trade can become the yuan.
– If China wants the yuan to become the world’s reserve currency then China should start running an overall Current Account Deficit. That’s a good start. But it takes more to enable China to be able to turn away from the USD.
GOOD TO HAVE SOMETHING WISE TO READ. THANK YOU, KP
By what definition is the US treasuries debt is “safe” if it is a well known fact that the principal is too high to EVER be paid back?
Jon
This might help you…..
https://mediacentral.princeton.edu/media/1_tykmsgp9
Soverigin Debt Analysis
Speaker:
Mark Aguiar
Department:
Bendheim Center for Finance
Jon
This might help you as well….
it is an economy, list of countries, with sectoral components, to GDP, 2011:
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_sector_composition
If you can multiply quickly, or do back of the envelope calculations, this should help you to understand away many of your assumptions.
Csteven,
looked at GDP sectoral components chart. And, you point is?
Just another confirmation that the USA has overdeveloped financial sector which is smoke and mirrors based on irredeemable US dollar.
It is basically very simple. USA consumes more than it produces. Period. And US dollar is a mechanism for that to happen. This system must collapse in a spectacular way. I am sure Michael agrees with that, he is just to polite to say it. The USA financial structure will collapse in a spectacular way. That is what this blog is all about, the way I see it. Only Csteven is too naive to think otherwise.
No comments on other sectors, notions of growth elsewhere on the US consumption component, just on and on with dying memes, of lessor well processed, economic thought.
Dollar is a mechanism, blah, blah, blah, what a bunch of over-assumptive, say nothing, noise.
With the sectoral components you can see.
For example the US exports more to China than Germany UK, Italy and Spain Combined, near as much as the entire EU. Both Eu and US, export more than Japan and Korea and Aus, far more than India and Brazil and Russia.
But US produces nothing. Make a statement, say it over and over, and one day it will come true, right Jon.
Csteven,
what about how much USA CONSUMES comparing to other countries? Would you like to run statistics on that?
dear Mr Pettis,
it occured to me yesterday night as I was looking at oil price related material that you might get something wrong with regards to rebalacing (or I might get something wrong from your posts).
To me it seems like you are eagerly waiting for rebalancing to start and basically what you see here is a race between orderly rebalancing and an internal debt crisis/hard landing. One of those must happen but whichever happens first, you dont know.
However when I looked at the chinese oil consumption, I saw a change of gear at around 2009. Chinese oil consumption started accelerating in 2009 strangely coinciding whith the onset of the credit binge .
To me oil consumption is a very good proxy for consumption.
In 2014 oil consumption growth broke and it may well be a fundamental reason behind the oil price collapse.
Also taking a historic look at current account balance, the surplus started shrinking in 2009 and started regrowing in 2014.
All this leads me that whatever Chinese official statistics tell, the 2009 credit binge in fact spilled into consumption and some rebalancing happened. I can think of it as a Clepto-Keynesian intervention, a redistribution of wealth from the exporting elite to the domestic elite.
To me it seems like Chinese economic policy has two mode of operation
#1 export oriented
#2 increasing internal demand through a corporate credit binge, which is cleptocratic, unjust, inefficient, etc but good for the elite
By default, policy #1 is the preferred one, but in case of weak external demand, #2 comes to the forefront. And thats all you can expect from current elite. There has been rebalancing since 2009 but external demand is strong again, so lets go back to export driven growth again.
How about it?
I am not sure why you would use oil consumption, Lemmiwinks, as a better indicator of the rebalancing towards consumption than just looking at the household share of consumption. Certainly consumption growth would increase demand for oil, but investment growth would too, and may be even more energy dependent.
I have heard anecdotal evidence that some of the “investment share” of GDP is actually consumption, for example company cars. And also, I am looking at the current account balance, too.
and please take a look at china passenger car sales. Up 200% from 5 million units in 2008 to 15 million units in 2014. Are these all concrete mixers? I doubt it,
sorry 500k /month in 2008 to 150k/month in 2014
http://www.tradingeconomics.com/china/car-registrations
from 500k to 1500k /month in the last 6 years. I ‘d rather give it up…
another piece of the puzzle: China’s oil consumptions shifts away from diesel to gasoline and jet fuel.
actually China is now an exporter of diesel (because you cant get gasoline only from crude oil)
http://www.reuters.com/article/2014/09/24/us-china-oil-exports-idUSKCN0HJ0YV20140924
“Most refiners are currently running at 35 to 37 percent of their capacity in diesel, compared with about 45 percent a few years ago, analysts said.”
and even the reduced share of diesel is exported.
Very strong indication of rebalancing in oil consumption from industry towards consumption.
I would give more credit to these natural measures than official statistics.
I think what has fundamentally changed are
1. The neat the Ying/Yang Surplus/Deficit, China/US relationship. WhenChina’s recycling the CAS via PBoC purchases of foreign government bonds” these were to a large part US government bonds and if instead “now wealthy individuals do it via purchases of hard assets” they are, as far as I can are are to a lesser extent in the US.
2. An increase in risk. These global “hard asset” purchases (aka money laundering if you happen to be a rival of whoever currently most powerful ), if not actually made with credit are made by people who have credit. And there is serious deleveraging back in China and asset markets in the west are at bubble levels also. The next asset bubble popping will happen in sync. No ying/yang – but now you see it, and now you still see it but its worth half as much!
From 1985 to 1993, Japan made some $77 billion in direct real estate investments in the US. By 1995 Japanese companies’ total market value losses on US real estate holdings were ”at least $25 billion”Kenneth Leventhal
I would argue that a rising chinese Current Account Surplus is a sign the chinese are succesfull in reducing investment spending. Reduced investment spending would mean reducing commodity imports while at the same time exports remain flat. Hence the growing Current Account Surplus.
Keynes was right at Bretton Woods about having an international reserve currency which is not also the domestic currency of a participating country (be it the largest economy in the world) so as to avoid current account imbalances, as proposed in the Havana Charter of 1948. Avoiding current account imbalances is an essential condition for international trade to be mutually wealth-enhancing. The Havana Charter was rejected by the US.
Triffin was right in the early 1960’s in stating the incompatibility between the US$ as international reserve currency and balanced trade for the US, which meant that the US would be forced into debt as soon as it was no longer growing faster than the rest of the world, which was likely if for no other reason than because it was the most advanced. His advice was ignored and Nixon simply ended the gold convertibility of the $ for the official sector in 1971 to remove this obstacle to permanent current account deficit and permanent accumulation of now inconvertible $ balances by the rest of the world. (As an aside, it is not sufficiently stated and reflected upon that since Nixon’s decision, the $ devalued by a shocking -97% versus gold…).
Rueff was right in the 1960’s when he explained that the accumulation of external $ balances led to a global duplication of credit as these $ balances were on-lent back to the US while at the same time entering the monetary base of creditor countries where they would multiply through their domestic fractional reserve credit system. This realisation led to proposals by France to reform the world monetary system in the mid-1960’s. They were rejected by the US which caricatured them as inamicable to the US (France was at the same time asking for conversion of its official $ balances into gold to exert some pressure), even though these proposals were in the best interests of the US (and the rest of the world too) as it would have avoided it to sink into debt from 140% of GDP then to 350% today. The dual credit spiral described by Rueff has since been the engine behind the staggering growth of world debt from ~ 100% of world GDP 40 years ago to over 300% now.
Now, this FT article is a reminder that, while having a functional world trade and monetary system is absolutely not a priority for opinion leaders (not even after the series of crises each time more severe of the past 30 years), what is really an essential priority is that someone – anyone – keeps financing our collective debt addiction at record low interest rates, ie. by grossly mispricing the likelyhood that this debt will ever be repaid. In other words, this FT article is one among many and frequent reminders that the current crisis is – even before being a severe economic, financial and social crisis – first and foremost a deep intellectual crisis.
In that context of deep intellectual crisis, clear thinkers like Michael Pettis are rare exceptions who keep the argument sharp until enough evidence has accumulated – typically over decades if not centuries – that their views finally become accepted and replace the old ideas that typically maintained their dominance long after they have been proven wrong multiple times. In that sense, the evolution of economic thinking is not different than the evolution of sciences as described by Karl Popper.
“As an aside, it is not sufficiently stated and reflected upon that since Nixon’s decision, the $ devalued by a shocking -97% versus gold”
Price of gold in 1971 – $35
price of gold 2014 – $1200.
Still about 30%. Where did you get shocking 97% from?
35 / 1200 = 2.9%, which we round to 3%.
The $ has lost 97% – ie. almost all value – against gold in the 43 years since Nixon decision.
In all fairness. To correctly calculate that, one should add in storage costs of maintaining gold, and the other side of the equation should be rewarded with something along the lines of a 3mo rolling note rate on the cash. Then you would be modeling reality.
The ruble has lost 5/59 (or about 91.5%) against the dollar since 1995, should that trend continue for the next 20 years it would be worth less than 1/10 of a percentage point against Gold.
Interestingly, the USD has only lost 68% on Gold since that time, therefore it seems that the Ruble is indeed a stronger case for concern than the USD, but let us look at this further.
Even more interesting was that in 1993 the Ruble was slightly stronger than the USD, and it has lost 98.4% of its value against the USD since that time. During the 2000’s when Russia gained its vast store of foreign reserves, it had lost 97% of its value against the USD (from 7 to 16 years before).
If things continue as such, the Ruble will be worth less than 1/10 of 1% of its value in 20 years (@ the same time since 1973).
Now do you see how ridiculous these Gold Bug assertions are, especially versus the USD (or Gold), when almost universally there are similar if not so excessive (as per ruble) a case of relations with most of the other currencies in the world, but for very few exceptions.
Yes and no. At the individual level, you would indeed be modeling what seems to be the reality. But at a system level, you would be modeling an illusion. This is because of this illusion that most people don’t grasp the full meaning of the -97% devaluation of the current international reserve instrument (the US$) relative to its predecessor (gold).
First, your remark. You are correct for storage cost of gold but incorrect in assuming no storage cost for your $ account. There is a “storage fee” for (safe)keeping paper money (which historically was just a receipt for the metallic species in your account down in the vault, so that this storage fee for gold or silver and paper money was initially one and the same). Typically, you can find this “storage fee” on the annual statement of the bank or financial intermediary which “keeps” your $ account. Now that money is even more immaterial in electronic form, you can still find this “storage fee” in your annual bank statement. As for the interest, you have to be more precise to avoid confusing reality and illusion of reality. To simplify, let’s imagine an economy with 1 once of gold and $100 of paper money in circulation. Let’s first assume that there is no money creation in this economy (either in gold form or in paper money) but positive interest rate (reflecting for instance liquidity and / or risk premium, say 2% annual). The persons who are creditors in $ have 2% more at the end of the year and the persons who are debtors in $ have 2% less so that, at the end of the year, the money supply is unchanged at $100. The 2% annual interest rate corresponds in this case to a real transfer of value between debtors and creditors in the economy. Since there is still exactly 1 once of gold and $100 of paper money in circulation, and assuming storage fees are proportional for gold and paper (which is plausible as they historically were one and the same), the relative price of gold in $ is unchanged at 1 once = $100 in our example. Let us now assume that in this exact same economy there is now 2% annual money creation, all in paper form given that it is by far cheaper to produce than gold (as Bernanke famously explained in its November 2002 speech, the marginal production cost of paper money is 0). At the end of the year, there is still 1 once of gold but there is now $102 of paper money in circulation. Instead of transferring 2% of real value to creditors, the debtor has instead issued 2% more money or, in other words, increased the volume of means of payment by 2%. The 2% interest owed by the debtor to the creditor has not been paid by anything of real value but simply by the issuance of extra paper money. And here lies the secret of “deficit without tears which allows to buy without paying”. In this second example, gold appreciates relative to the $ to $102 per once. This is due to the faster increase in paper money in circulation (to pay “interest” on paper money) versus gold in circulation. In fact, the two points you mention would have been two good reasons for foreign central banks not to ask for conversion of their $ reserves into gold in the mid-1960’s. Yet, they did. They did because they were not getting any real value for their $ balances, just more $ fresh from the printing press at 0 marginal cost of production.
This secret of the “deficit without tears” when your currency enjoys international prestige so that you can just issue it in more quantity instead of transferring anything of real value to creditors which would force the adjustment of your economy from a deficit back to a balanced situation is also referred to as the “exorbitant privilege”. It is THE reason why the US rejected and blocked a return to an independent international monetary standard preventing current account imbalances on at least 3 occasions in the past 93 years.
But, as Michael Pettis has shown, there is another side to the “exorbitant privilege”, it is the “exorbitant burden”. If the rest of the world starts growing faster than the issuer of the world reserve currency (if for no other reason than being less advanced), the issuer of the world reserve currency will have to experience bigger and bigger current account deficit to supply monetary reserves to the rest of the world. Reciprocally, and perhaps more realistic this way around, the rest of the world would find it irresistible to “game the system” and try to grow its own domestic production at the expense of the US by running a growing current account surplus vis a vis the US and exporting its surplus savings to the US in the form of $-denominated assets. The US being “forced” to accept either an increase in debt (which some people even welcome apparently since it comes with the “blessing” of lower and lower interest rate) or an increase in unemployment, or more realistically an increase in debt first followed by an increase in unemployment later.
This has of course happened almost constantly after Nixon’s decision, compounded by parallel efforts to liberalize global trade. First, OPEC replicated to the sharply falling $ following Nixon’s decision by the oil shock of 1973 (prior to that, oil prices had been remarkably stable in $ terms for the past 100 years…), which was very directly a way to increase their terms of trade and current account surplus vis a vis the US, the Kippur war providing the political occasion. Then Japan in the 1980’s, then the Asian Tigers and China during the 1990’s, then China on a much bigger scale following its entry in the WTO in 2001. All trying to move the terms of trade in their favor and to generate growing account surpluses vis a vis the US to accelerate their economic development.
So, the US has experienced large and persistent deficits, meaning it had to go deeper and deeper into debt (from 147% of GDP end 1971 where it had been stable since 1947 to 356% of GDP now). Meaning the required adjustment was becoming more and more costly. Meaning the alternative of simply issuing more and more $ was becoming more and more irresistible. And so on so forth. This is how the $ lost -97% of its value against gold in the space of 43 years (and yes, part of it has been catch up for gold price remaining fixed at $35 from 1934 to 1971 despite war-time inflation). Gold appreciation has indeed greatly accelerated from 2002 as US current account deficit was widening relative to GDP and monetary expansion was accelerating under Greenspan chairmanship. What it means: US economic prosperity since Nixon’s decision has been to some extent a monetary illusion. This has become plainly visible since 2008-2009 thanks to the $3.6Tr liquidity injection from the Fed coupled with a policy of 0% interest rate forever. Yet, while the symptoms give rise to such fascinating linguistic debate between 0% interest rate for “an extended period of time” versus for “a considerable period of time” or any variation thereof, the causes of this precarious situation – the same for the past 43 years – are still very much taboo. And here lies the great intellectual crisis behind this totally unnecessary economic and social crisis.
Of course, in defense of the $, many people are quick to point out (Csteven has just done it below) that versus other paper currencies, the $ devaluation has not been so spectacular as versus gold. Since August 1971, the $ has only lost -25% versus major world currencies as measured by the Dollar Index. And that’s with the rest of the world gaming the system to keep the $ overvalued versus their own currency in order to gain a trade advantage versus the US. It is even possible to find currencies against which the US$ has dramatically appreciated (for instance the Ruble as per Csteven below) but of course we are very far from currencies having any international prestige at all or that could remotely be considered for reserve instrument. However, this observation that the $ has been more stable versus other major paper currencies misses the most important point: most other paper currencies have also resorted to rapid money expansion. At the first slowdown, ie. at the first attempt at rebalancing, their accumulated FX reserves have been used to unleash a strong domestic credit expansion. See Japan or Sweden in the late 1980’s, see China since 2009. Far from being an attenuating factor, the generalization of accelerated paper money creation to a growing proportion of the world economy and the increasing unanchoring of the world monetary system as every country or region manipulates its own exchange rate in a desperate effort to avoid having to bear its share of the rebalancing of global current account imbalances is an aggravating factor (see warning from former BIS chief economist in the link provided by Ultron below). It pushes the global debt pyramid of inter-related claims higher and higher to level impossible to service with cashflows from productive activities in an ever more fragile edifice made all the more unstable by the breakdown in international cooperation.
The debate between “gold bugs” and believers in the practicality of fiat money or the debate about whether gold is overvalued or undervalued versus US$ is really not the important issue here. Gold is far from perfect as an anchor to the world monetary system. Storage is just one issue among several. But replace “gold” by “bancor” or whatever independent standard you like and the issue is still the same: how to reform the world trade and monetary system so as to avoid large and persistent desequilibrium of current account balances and the related duplication of credit on a global basis forcing many countries – and the US in particular as issuer of the world reserve currency – towards insolvency.
The exact same mechanism was at play in the late 1920’s, by the way, after the US rejected the revaluation of gold during the negotiations of the 1922 Genoa conference, when the gold-$-exchange standard allowed capital and credit to flow back to Europe without being taken away from the US market, thereby greatly facilitating the speculative push by duplicating the global availability of credit. Jacques Rueff has shown that it is the collapse of the European credit structure based on US and to a lower extent British loans in 1931 (mainly in Germany and Austria) and the resulting rush to ask conversion of £ and $ reserves into gold and the resulting credit crunch that collapsed the US credit structure that ended up transforming the financial crash and recession into the Great Depression, forcing England to stop the £ convertibility into gold in 1931, forcing Germany to resort to capital controls in 1931 and forcing the US to stop the $ convertibility into gold for the general public in 1934 (see “The monetary sin of the West”). Taking as the reason of the Great Depression the fact that central banks didn’t backstop the credit structure is confusing the symptoms for the causes and is an incredible mistake from Friedman and Bernanke. As an aside: is Russia now playing the role of Germany in 1931? Is the US now playing the role of the US in 1929 with global capital rushing there? The similarities are at least intriguing.
The US has blocked the solution to an independent world monetary system designed to prevent the development of large and persistent current account imbalances at least three times already in the past 93 years: a first time in the preparation of the 1922 Genoa conference after WWI, a second time at Bretton Woods in 1944, a third time in the mid-1960’s when Triffin in the US and France called for a reform of the world monetary system (see De Gaulle press conference on 4th February 1965). Perhaps, now that the US stand at 356% total debt to GDP and the world at 300%, would be a good time to wake up.
The debate about the gold standard, to me, completely misses the point. Does anyone really think it’s a good idea to tie the value of money to one commodity that’s dug out of the ground and has more volatile prices than anything else? I can’t see how someone would think that’s a good idea.
However, the advantages in a gold standard lie, not in gold being international money, but in the fact that the price level becomes reflated when the economy enters a debt deflation. Of course, that mechanism doesn’t work when everyone demands more gold all at the same time, which is why the gold standard collapsed in the 30’s.
DvD
Bravo….very well discussed.
As to currencies, nearly every currency as stated, not some, every, just go to trading economics, and do a comparison, and just as I stated, almost all less then half their value over a period of time (1995, 2000), whatever.
Then, and unfortunately, impossible to really compare to the European countries (is it 1.9 DM, 1.4…is it 3, or 1.7 that it came in when the Euro was formed, similarly and so forth). What is the DM’s value now? Are there other reasons for the Euro’s strength, the strength nature and character of EU banking and GDP dynamics. Do we count the height of the euro vis a vis USD, and count the USD weaking, or where it was slated to come in at, expected, or where it actually came in at, because if actually came in at, upon inception, because it was slated to come in at 1.06 to 1.16, came in at 1.18, and is now only 1.22, so…..(certainly not 25%, not even 5%). So we can say trade weighted, inflation adjusted, etc….etc….etc… on PPP, etc….But then was its rise, and USD weakening, only because of investor demand, and foreign central bank acquisitions, etc….
Then the Japanese, the long term value, was that cheapened, when, at what point, why, did it stay weak too long, why, is it even meaningful to make this question at all.
Rather than century long analysis, perhaps only to 1973.
But, the 1 ounce of Gold = 100 (used to make proportional calculations useful)
Why should the ounce of gold be stable, in a world that sees everything else moving, why should the monopoly game, have a limited amount of currency in it?
If population is increasing, if lifespans are increasing, if use of natural resources is increasing, if knowledge is increasing, if caloric intake is increasing, if products are enabling the material capabilities of men to advance, if there is movement and progress all along the frontier of all the capitals, where the movement from serfdom, saw the greater rule of man over his private affairs (or the word “economy”), why should we expect, even desire for 1 oz of Gold to stay 100, or only be limited by some being able to pull more of it out of the ground.
“At the end of the year, there is still 1 once of gold but there is now $102 of paper money in circulation.”
No there isn’t. I used $43.57 of my $100.00 and I bought some gold panning equipment, then I went went prospecting. I pulled down about 10 oz of nuggets.
If you could eliminate the current account imbalances by changing the monetary system, it’d do this country a lot of good. That being said, one of the strengths of the US is that most of the private sector’s source of funding comes from equity with bonds being a (relatively far away) and banks (loans) being the third. In Europe, almost all of the funding sources comes from the banks (>80%). Also in Europe (and in China), banks aren’t really a profit making sector–they’re used as a tool for national policy (IMO). This creates problems and really misaligns the incentives.
Here in the US, we seem to be moving towards more of an equity based system. This transition would be complete if we change the monetary system. In other words, the libertarian leaning guys actually have the right solutions. We’re tired of this bullshit where we use our domestic industries as geopolitical tools rather than letting them develop naturally. It’s so difficult for people to understand that developing a strong economy requires (almost) the exact opposite kind of thinking as developing military strength. Military strength comes primarily through strong command and control. Economic strength comes through the ability to shift and adjust immediately to shocks with bottom-up self-organization. We’ve gone way too far towards the former.
Yes, gold is a cumbersome standard and not one that is necessary. But it’s important to get the terms of the debate right and to not confuse the gold standard, the gold-exchange-standard and the role played by the fixed gold price as these are in fact features not specific to gold but of a generic nature that will be important to have in mind when designing a better world monetary system than the current US$ standard.
The gold standard is a monetary system where international deficits are settled by transfer of gold to the surplus countries. It collapsed in 1914 with WWI. In this system, there is international transfer of purchasing power from one country to another, which is precisely the balancing mechanism to keep current accounts in balance.
The gold-exchange standard is a system where deficits are settled by issuance of paper claims denominated in the currency of the deficit country (to the extent its currency has international prestige and acceptance) to the surplus countries, such paper currency being convertible to gold at the discretion of the surplus countries, subject to possible pressure by the deficit country not to convert. It is this system – not the gold standard – that collapsed in the early 1930’s and again in 1971 for the very simple reason that issued paper claims where far in excess of the amount of gold by which they were supposedly backed. In this system, there is no international transfer but rather international duplication of purchasing power: the foreign central bank which ends up receiving $ has no use for it except to immediately replace them on the US market where they remain available as if there was no deficit. But at the same time, the foreign central bank has them as part of its reserve and it is therefore also available to extend credit domestically. Thus, there is duplication of credit and therefore no balancing mechanism anymore. To the extent neither the deficit nor the surplus countries voluntarily take coordinated steps to rebalance their current account transactions, imbalances can balloon and be perpetually settled by more and more paper claims. In other words, the system becomes unanchored. Debt becomes the dominant part of the capital structure of the overall economy, whereas equity was the dominant part of the capital structure pre-1914 (incidentally, the Fed was created in December 1913). The economic trajectory becomes a deeply sub-optimal series of booms and busts driven by credit expansion and contraction. As we get closer to the debt / income limit, the trend around these boom-bust fluctuations deteriorate.
As for the price of gold being “more volatile than anything else”, the price of gold was actually fixed at $20.7 per once from 1800 (don’t have data before) up to 1934 (except during the civil war) and fixed at $35 per once from 1934 to 1971. That is, it has had hardly any volatility at all during 171 years. And that was precisely a big part of the problem. This fixed price for “a considerable period of time” is the main reason why there was a permanent gold shortage. Because gold price was never revalued in line with the general price level despite substantial war-time inflation of WWI and WWII, the price fell long ago below production cost, hence ensuring permanent gold shortage (that’s why not many people did, as Derivs suggests, buy gold panning equipment and went prospecting, at least not in the 20th century: it was a lousy investment). If you go back to my previous example of the simplified economy and we now assume +2.5% real growth (say +0.75% population growth and +1.75% productivity), and we agree that it is not desirable to have -2.5% annual price deflation as it greatly complicates the adjustment of whichever industries need to adjust at any particular point in the continuous creative destruction process, then we need +2.5% money expansion to keep price stable overall (now, this is pushed further with price stability being interpreted as +2% inflation by the same guys who allowed labor cost arbitrage to go global thereby ensuring deflation, but that’s another part of the story). Of course, you can’t have +2.5% expansion of the stock of gold if the price of gold is permanently maintained below production cost. Note that there was absolutely no good reason why the gold price was fixed (Csteven, this answers your question “why should the once of gold be stable?). The only reason (which is not a good reason) was that the US always refused the revaluation of gold price both at the 1922 Genoa conference after WWI (only to have it in 1934), refused it again at the 1944 Bretton Woods conference after WWII and again in 1965 when France proposed to reform the world monetary system based on a revalued gold price (only for the US to unilaterally revalue gold in 1971). The official reason for keeping gold price fixed was the concern that revaluing gold would be too inflationary. The real reason was of course to impose the $ as reserve instrument, which was presented as a convenient way to save precious metals which was not available in sufficient quantities (precisely because price was artificially maintained below production cost…). Of course, the unrestricted issuance of paper $ proved much more inflationary at the end than a revaluation of gold to the general price level would have been in that it precisely allowed the development of large and persistent current account imbalances financed by duplication of credit on a larger an larger scale, said inflation materializing first in CPI and then gradually shifting to asset price inflation as trade globalization and the shift of production to low cost countries spread. As an aside, taking the price of gold at $20.7 per once in 1800 and assuming +2% annual growth for 214 years to the current day gives a price of $1434 per once, not far from the current price. So, in fact, after long time repression, expansion in gold price eventually happened, but only when it no longer risked to challenge the US$ standard. These days, it is interest rate that are repressed. Eventually, this will also change. But the example of gold shows that things can remain artificially repressed for “a considerable period of time” indeed. Eventually, “what must happen, happens” (Jacques Rueff). It might just take a very long time to do so.
All that to say that the debate about the gold standard and the gold-exchange-standard is not besides the point. It is to the point, not because gold is the indispensable standard (it is not) but because the essential difference in nature between the two systems, their balancing features or lack thereof, and the desired pace of expansion of whatever standard anchoring the system is important to understand and keep in mind in designing whichever new world monetary system will sooner or later emerge as a result of the repeated crisis and tensions brought about by the large and persistent current account imbalances within the present US$-based system.
“As for the price of gold being “more volatile than anything else”, the price of gold was actually fixed at $20.7 per once from 1800 (don’t have data before) up to 1934 (except during the civil war) and fixed at $35 per once from 1934 to 1971. That is, it has had hardly any volatility at all during 171 years.”
If we fix the gold price, but inflation varies from -10% to >50% over that period, I don’t know how you can say that there was no volatility in the price. The volatility needs to be determined from the shift of the price relative to real assets, not the shift in the dollar value of gold.
Suvy,
Yes, if you want to say that a “fixed” gold price vs. $ is in fact “volatile” vs. a basket of consumer goods or other real assets, that’s of course true and only a matter of perspective.
Of course, in the normal course, a fixed gold price in $ was precisely intended to keep overall price stable. That’s what happened pre-1914. Using Robert Schiller and Angus Maddison data since 1871, pre-1900, inflation was volatile on a short term basis but the trend is low to mid single digit deflation while real GDP per capita was growing on a +1.8% annual pace in the 1870-1899 period. In the 1900-1913 period, inflation was still volatile but the trend was low single digit inflation while real GDP per capita was growing on a +2% annual pace. Overall, under a gold exchange standard, in the 43 years from 1870 to 1913, prices and indebtedness were overall stable while real GDP per capita was growing +1.8% p.a.
The issue is when it is not a normal course anymore. Like WWI, which left the general price level (CPI) in 1920 more than double its 1914 level, home price +27% higher and oil price 2.8x higher. At the same $ price than in 1914, gold was no longer in the adequate place in the overall scale of prices, leading to gold price falling below production cost and therefore to shortage. In this situation, refusing – as the US did in preparation to the 1922 Genoa conference – to revalue gold to its relative place in the overall price hierarchy for the purpose of pushing the $ as convertible international reserve instrument was of course hugely deflationary. The inflation trend was low single digit deflation in the 1920’s but this was largely mitigated by the great private debt build-up allowed by the gold-$-exchange standard (credit flows were restored from the US to Europe after the monetary stabilizations of late 1923 in Germany and 1926 in France while US domestic credit expansion was simultaneously very strong, in other words global debt was skyrocketing far in excess of the gold inventory which was ultimately backing it all). Once debt (which is an instant amplification of purchasing power) could no longer grow faster than production, this duplicated credit structure collapsed in 1930-1931 and the full deflationary impact of a pre-1914 gold price was fully revealed during the brutal 1931-1933 depression. It is important to understand that this deflationary bias was not at all inherent to the gold standard but was entirely due to the policy decision to not revalue gold in line with the dramatically altered price level post WWI and to instead use the elasticity of the gold-$-exchange standard to expand credit far in excess of gold inventory, thus ensuring the speculative excesses of the late 1920’s. In your words, gold price was very “volatile” vs. consumer goods and other real assets in the sense that it collapsed during and in the aftermath of WWI. Combined with the deflation of 1931-1933, Roosevelt $ devaluation / gold revaluation took gold back to its relative price of 1904. Gold was suddenly very “volatile”, catching up in one go with 30 years of slippage in the overall hierarchy of prices after a largely unnecessary great depression.
The exact same mistake was repeated after WWII. US consumer price went up by +71% from end 1940 to end 1948. In the same period, home prices more than doubled and oil price doubled. Gold, still at the $34 pre-war level, was again completely misplaced (“volatile” on the way down) in the overall price scale. Keynes’s Bancor proposal at Bretton Woods was to get rid of gold as the standard but others proposed a revaluation of gold price back to its relative pre-war position. This was rejected by the US and the issuance of $ started again post WWII to palliate gold “shortage”. France proposal in 1965 was explicitly based on a revalued gold price to be used to pay down accumulated $ balances. At that time, gold was getting as low relative to CPI as it was post WWI and lower than post WWII. This proposal was deemed unfriendly to the US, which however went on to implement it 6 years later when Nixon revalued gold / devalued the $ (well, not quite, the US in fact suspended convertibility so that the higher gold price could not be used to redeem accumulated $ balances, thereby unleashing during peace time inflation comparable in scale to WWI and WWII). Gold skyrocketed against consumer goods (as CPI inflation was itself accelerating strongly) and against other real assets and commodities, being very “volatile” again as it was catching up in one go with 37 years of slippage in the overall hierarchy of prices.
In the 41 year period of 1972-2013, under a pure $ standard, real GDP per capita grew at a +1.7% annual pace, just a tad slower than the +1.8% annual pace achieved in the 43 year period of 1870-1913 under the gold standard. However, this similar real growth per capita was achieved with significantly more inflation and debt build-up, hence is of lower quality and less sustainable. Much more based on a monetary illusion.
Again, the important lesson here is not to go back to gold. The important lesson is to have a system which combines the built-in current account discipline (which the gold standard allows and the gold-exchange standard to a much lower extent) together with steady growth in money supply, in line with real growth potential and price stability (something which the gold standard is actually not best suited to deliver, which is i think the real sense of your remark).
The US more than many other countries has shown that it possesses many aspects of the economic organization of society best suited to deliver sustained wealth creation and rising living standards. However, it has not yet shown that it possesses the complementary monetary organization that could allow such economic organization to deliver its full potential. On the contrary, the extent to which US apparent prosperity since 1971 relies on monetary illusion is greater than during the 1920’s.
Agreed for the most part. Why not just eliminate the Fed and allow states to deal with currency issuance? Why not just remove the government’s ability to fix the price of the currency AND the money market rate of interest? Clearly, these guys can’t do anything well, so why give them the right to do anything like monetary policy wrong in the first place?
Suvy,
We can indeed easily reformulate your earlier remark as follows:
“Does anyone really think it’s a good idea to tie the value of money to one standard whose quantity can fluctuate at will based on central bank and / or commercial banks decisions and has more volatile real prices – both internally and internationally – than anything else? I can’t see how someone would think it’s a good idea.”
We are obviously referring here to the USD.
Indeed, nobody thinks it’s a good idea. So much so that nobody ever asked for it. US President Nixon just imposed it unilaterally one day in 1971. The USD standard has since caused debt problems on every continent: in Africa, in Latin America, in Japan, in South-East Asia, in the US itself, now in China, etc. Nobody has any reasons to keep it and everybody – including the US – has good reasons to get rid of it. Except a bunch of guys in Washington who thus capture the benefit of money creation on a worldwide basis for themselves and their associates (“the exorbitant privilege”, literarily hundreds of billions of $ p.a.) at the cost of huge and damaging fluctuations and distortions in production, employment, price, income and wealth distribution for the rest of the population (“the exorbitant burden”).
It’s not that these guys don’t understand the issues discussed by Michael Pettis and many others before him – for a very long time now – about the deficiencies of the current global trade, monetary and financial system. They understand it perfectly well and for a very long time too. It is just that they benefit so handsomely from money creation that that they will never change it. Even an extraordinary event like 2008-2009 didn’t change anything: Greenspan’s disastrous “wealth effect” policy has simply become permanent. That’s it. Nothing has changed because the decision makers are directly benefiting from the exorbitant privilege and are thus actively opposed to changing anything. That’s the only reason why Michael Pettis and others have not been heard so far, are not being heard now and will not be heard in the future.
Of course, “what must happen, eventually happens”. So it is a certainty that, sooner or later, the USD standard will disappear. It’s just a matter of how much pain can be tolerated in terms of economic inefficiencies and income and wealth inequalities, such pain ultimately expressing itself in social unrest and conflicts, including potentially wars. There should be no doubt by now that the beneficiaries of money creation will go to extreme lengths to preserve their exorbitant privilege. There should also be no doubt that they will eventually lose because they are such a tiny fraction.
So, the time will eventually come – potentially at very short notice – to design a monetary and credit system best suited to support the full efficiency of the decentralised and competitive economic organisation together with a equitable income and wealth distribution within society. I believe the aspects to consider then would be:
– At the national level, the pace at which it is desirable that money and credit supply expand steadily to achieve sustainable real economic growth with overall price stability in light of ongoing productivity improvements,
– At the national level, the public appropriation of the benefits arising from money creation and the corresponding ability by the public sector to reduce inefficiency-generating taxes on the private sector, meaning essentially that only the central bank will be able to create money, the ability by commercial banks to create money by extending credit being taken away and being mandated to cover all sight deposits with base money issued by the central bank,
– At the national level, the duration matching of term savings mobilised with loans / financings extended so as to make the banking / credit system fundamentally more stable,
– At the national level, the ways to make the unit of account stable over time in real terms to achieve an equitable distribution of income and wealth and avoid undue transfers of income and wealth (as is the case in the current system),
– At the international level, the setting of cross exchange rate between participating countries at fixed but potentially adjustable levels consistent with cross current account balances being at equilibrium.
What if Gold was previously undervalued?
What if it is currently overvalued?
What if Gold is actually value-less?
If gold were to drop to $32 tomorrow, would that change conditions that you perceive to obtain to the dollar, the state of the dollar, or your perspectives as to these?
Csteven,
$ has a cost of production of 0, so its value is purely abstract or conventional if you prefer, subject to change in collective psychology, either in the US and / or abroad.
Gold, on the other hand, has a value which is inextricably linked to an economic reality called its cost of production.
Instead of engaging in a futile battle of words, the best therefore is to check the P&L of gold producing companies (several are listed so the information is readily available) to see what is their cost base relative to their gold output. I haven’t done the exercise but i would suspect the cost of the most efficient gold mine in the world is higher than $32 per once. So, subject to confirmation about production cost, if gold price goes to $32, it means all gold producers go bust, which means gold production goes to 0, which means there is gold shortage, which means gold price goes up. It is that simple. Note i’m not a gold bug: i could have said the same of, say, a heat exchanger.
DvD
Yes, and of course, and I similarly frame.
And the use of the 35, which, funnily enough is a rahter early figure, not 50 or 55 later, I believe, but it doesn’t add for the purpose of dramatization, where it lessons the seeming extent hoped to be envisioned, of an argument progression, rather than topic elucidation approach to discussing these matters, but more importantly it is toward meaningless in my estimation.
There is more than economic capital (there is Political, Legal, Social, Technical, Environmental otherwise; then within so many forms, Human, Cultural, etc). Paper is just a medium of exchange, that sees progress along these, as structural dynamics and forces obtain, that can inhibit or aid this progress.
US Total Debt Summary
Last Value: 329.4%
Latest Period: Sep 2014
Updated: Dec 23, 2014, 8:45 AM EST
Next Release:
Frequency: Quarterly
Unit: Percent of GDP
Adjustment: Not Seasonally Adjusted
Long Term Average: 204.6%
Value Previously: 332.2%
Change From Previous: -0.83%
Value One Year Ago: 331.5%
Change From One Year Ago: -0.63%
First Period: Dec 1949
First Value: 146.7%
Notes: Total US Debt as a percent of GDP
As of end September 2014:
Total credit outstanding $58.0Tr + Central bank liabilities $4.5Tr = $62.5Tr Total Debt = 355% of nominal GDP (revised few days ago, hence was 356% before revision). Adding central bank liabilities gives the underlying picture in absence of monetization.
Then, there is the still unanswered question of the $2.4Tr of corporate bonds that the Fed simply erased from the debt statistics in their second quarter release of the Financial Accounts of the United States, precisely in the year where corporate bonds issuance broke all records, which makes no sense. That would be another 13.6pts of GDP at constant “accounting” methods or 368% of GDP.
Again, we are not surprised to find that much more ingenuity is employed in presenting appalling numbers in the best possible light than in having a well functioning system where such appalling number would simply not be possible. This remark is true for many countries, not just the US.
Ok, and this is a serious question, but why is this appalling, why would a lessor number be considered better, why would previous levels be better, more natural, and similar, with different dynamics, technologies, per capita measures and similar; these would I suspect relate to structural limits, etc….
If you were to merely propose notions of efficiency, then you must be able to illustrate how these process, your surmising, was exhibited in efficiency, previously. So, see this as an opportunity to elaborate, if you would, because it might lead to assumptions that are more useful to review.
Further where is your info from, I see a Fed site with similar data, but it includes Central Bank liabilities I believe, and doesn’t discount money owed to gov trust funds or debt held by the Fed, which rather than go north of your number, should be going south, and then netting out money owed to itself.
Csteven,
With regards to your first question (“why is this appalling, why would a lessor number be considered better, why would previous levels be better, more natural”?), i refer you to virtually all articles on this blog as to what causes debt to grow faster than income and why does debt matter. And i return you the question: in what sense exactly do you think it is better to have 350% debt to income than 150%?
With regards to you questioning the data, no the $58Tr debt does not include the central bank and yes the government debt owed to other government agencies is netted out. The source is the Financial Accounts of the United States by the Fed, which means, as i said, that more ingenuity has been employed in presenting these appalling numbers in the best possible light than in having a well functioning system. And since you are – rightly so – focused on data integrity, please let us know why $2.4Tr of US corporate bonds vanished between the first and the second quarter of this year.
Why is it appalling that debt levels (either federal or private/state/local) are this high? The problem is that debt represents a transfer of real resources. If the transfer isn’t productive, it’ll drag on future growth. It’s that simple. Debt induces fragility into the system. Debt is great if you know what’s gonna happen and can forecast everything. I don’t have that ability, I don’t know everything, and I can’t forecast everything, so I don’t make such reckless decisions. If you trust bankers or bureaucrats/politicians to make such decisions, then it might not be appalling. That being said, I don’t think relying on people who have no skin in the game and “trust” them is the brightest decision in the world.
I also don’t think it’s fair to use the comparison against the Post-war period because of several reasons:
1. Demographics
2. The war left Europe devastated while the US was the only source of capital. The end result was the US being the world’s largest creditor.
OK, looked at the Fed accounts, will look again.
Am interested in the structural dynamics.
Particularly important, in the case of the Chinese example, and all articles published here on this blog, is not merely that debt is growing so fast, but also construction of GDP, movements in components of GDP, that GDP itself, and components as investment are growing so fast, the relations between such growth in debt, and the creation of debt to service this FAI, the percentage of the economy that is investment, consumption, the percentage of the economy that is export driven, the percentage of trade that is in what type of good (final, raw material, intermediate good), etc….
This then has a timing function…..trading economics starts their data in 1948($) 147%
2013 325%
So there is the path taveled and the velocity of this
And the path traveled otherwise and the velocity
While a sickness is bad, ultimately heart disease generally evolves over a longer period of time and is more treatable than a rapidly spreading cancer, so we might want to ensure our distaste for a matter doesn’t weight our view of a processes that might be very dissimilar.
Of course different velocities to this matter, different acceleration dynamics, lower verticality in so far as rises, lessor abrupt alteration, and different physical impact (can use a mechanical and computational framing mechanism if you prefer). So not so quickly.
The 2.5 trillion you tell me.
I suspect in many things, more continuity, larger rises, and less abrupt increases is generally a fairly stable thing, in coordination with the inter-relations that obtain; multi-points of attachment in an economy largely consistent of many points (70% consumers, 17% or so investment, as the investment inevitability need be rationalized in relation to consumers {somewhere, in the case of fast industrializers that use external demand as well in their calculations of what is sustainable investment, which of course is why a lessor external demand environments, in a condition of expanding ability to supply, places breaks on growth in Chinese Investment and Chinese debt growth, where increasing investment of this expanding debt drives down returns.
Whether you agree or don’t agree with what I said, do not forget, that the pace of all this matter, both for sustainability and unsustainability, for example, this assertion would not be refuted in the Irish, Spanish, Greek or Portuguese case either.
The pace not only has systemic impacts as far as rapidly altering the set of forces and inter-relations within the micro-system, at the state level, but at individual participant level, which when aggregated, comes to comprise the system, and these movements have impacts, individually and societal. So it is not a mere number that matters, but movements, pace and structure.
For example I can travel 90 mph in many vehicles.
But doing so in a 1950 Cadillac, a 1990 Ferraro, a 1915 bicycle or a (A-Z) have very different impacts when hitting a speed bump, pothole or wall (while all remain a vehicle for transportation).
SO,
“And yet instead of welcoming foreign funds and the associated current account deficits, countries around the world are eager to export as much of their savings as they can…”
Which countries are those? Is Greece, Italy, Spain and Russia are among them?
It is may be a philosophical question, may be not.
For me, if I double my US checking account, it is a tangible proof I became richer because I intend on spending the money in the nearest future.
For China, if they increase their reserve north of $1.8 trillion, does the government feel richer, if most of is invested in US Treasuries? Should they not be worried that their “investment” is a liability of another country? Unless they hedge it somehow. I just do not get it.
Csteven, please do not reply to that, I already know what you are going to write. The question to answer is only for open minded readers who are not stuck in US dollar groove.
Jon:
Do you even read what has been written here?
Not sure how many posts Michael has written, but just about each time he addresses matters that show the systemic nature of the forces that drive foreign reserve accumulation. These matters are structural. If (S) is greater than (I), if (S) is driven to great heights so that (I) can be driven to great heights, but (S) is still above, then
Surplus, if not then Deficit.
For example, oil and commodities decline while S is high, and I is slightly declining, this will mean growing surpluses and you see this as become richer, and that the resultant figure as savings that are investment.
Wow, that takes a whole lot of imagination.
CS
Does not mean you must invest it in US Treasuries, though.
I also think it is somewhat retarded for a country to say: well, it is just an end result of arithmetic, we are stuck with US dollars. And there is nothing we can do about it. It is our fate to pile up irremediable pieces of papers getting nothing in return for years to come. ” And I do not think Chinese government is stupid.
What people like Csteven do not understand, (even though he pretends he knows how to read ), is that US dollar absolutely must hyperinflate to bring world economic system back in order.
It will not happen for a while, but it must happen. The euro, in spite of all its problems was designed to replace US dollar and it will. Euro reserves are indexed to gold and are updated by ECB quarterly, so everyone knows how much real reserves it has.
Csteven, I just hope both of us will be alive to see it happening and this blog is still around.
Just so I could tell you “see, told you so”.
According to Csteven, Chinese government accumulates US reserves and just accepts its fate of getting stuck with it.
Yes, Csteven, I am sure they would not mind waking up one day to find out their trillions of US dollars are worthless.
And I have a bridge to sell you.
No like Michael has said for years, China will not see a loss on their reserves in the future, they book, a compounding loss, each time they pruchase a reserve. The case for this notion was strong, when appreciation of the RMB was assumed, now with debts growing faster than the ability of revenues to service debts, as they have aligned this, of raising investment share of the economy, it is not assured that the RMB will appreciate. Where your gold noise is garbage of the 1960’s, recycled repeatedly, and was popular 20 years ago, 10 years ago, has waned, especially with the retrenchment of gold valuations, it seems that the Web brigades, might be out trying to re-hash it, as their rodgen miesto suffers and sits on a precipice. An attempt to deflect there issue, never have quite understood the purpose, as to outcome, which I have always known to be counter to their assumptions.
Csteve,
You think you are smarter then all the CB in the world which accumulate gold in their vaults and all the Rothschilds of the world, Saudis, Russia and China who drastically increased their gold reserve lately? Keep thinking that, Cstevey boy. like I said before, you still going to be around to see your US paper denominated “assets” going in smoke one day, as the monetary plane adjusts to a physical plane.
By the way, the Stanford presentation the link you referenced to the subject of Sovereign debt is a complete garbage. 1:30 minutes of noise, which did not even start answering the main question, when the US dollar collapses in hyper inflationary waterfall.
Can not wait to see you what you post on this blog when gold gets to $55000 an once and you will be cartwheeling your US dollars around.
Actually, the US and Indian women would hold the most reserves on Earth at such a time, were such to occur. Rather quickly the Marianna’s trench would be emptied, as would vents and flutes elsewhere on the floor of the seas, conflict outside of the territory delimited by Law of the Sea would occur, and environmental degradation, on a rather more wide basis, and nothing would alter globally, but the entrenchment of poverty in the worlds undeveloped spaces.
As to Rothchilds, you are joking, no my delusional friend…..
I have written a piece of prose on the subject of this, it is astounding just how deluded some may be, and is largely a subject relevant to the insignificance of some in relation to the whole, and their need to control their environment, or assume to criticize others they would have doing so, born of the greater control we have of it, while not actually to the extent that some would imagine, of some great delusion from the mangled philosophical fragments of the past, distorted to fit the social, political and value based criticisms of far too many lessors thinkers in the present, or merely an assumption by those of no sure noble pursuit, in merely attempting to manipulate the minds of others, while they would hope the other to be surmised.
Repeatedly I have stated, it is the success of the system that has led to this point.
Further, while I do not believe there is much desire for the SDR, more people have to sit alongside the US, in roughly the same position of the US, insofar as the structure of the system, inevitably as higher levels of growth external to the US, in the world sees the US shrink as a percentage of global GDP, inevitably of the structure, if that shrinkage occurs under increasing standards of living otherwise, which it does.
The structure of interactions, as at present, will put a break on others industrialization, as it stresses those who created the system that has enabled some to industrialize in the system. This is a peer developer, rather than developed developing dichotomy. China’s excess, not due to success of the state led model, but its underlying weakness, aggravates conditions for the stable development of the world, creating impediments for some, and stressing others (not merely of their own impetus, and likely certainly less of their desire).
Again, and again……and then there are the inflation, hyper-inflation, the US will have it, when others bloat assets, artificially structure their economies to engineer whatver growth is necessary, and print at multiples of the US.
As someone who has long roots in my own country, i culdn’t care if we had the dollar, the taller, thaler or guilder. We will have a currency that we use as a medium of exchange. More importantly, while we have supported the system that has enabled many to rise, against the flow of trends that are limiting of such a movement, this benefit, will inevitably reverse, both of structural limitations re demand provision, but inevitably, to service domestic relations, along structural necessities, eventually. If we need, which I don’t believe, to rename a currency, this would be of little concern to me, or anyone else buying milk bread, r reinvesting in industries from highpoint north carolina to detroit michigan. In fact, 13 state already allow crowfunded equity, and this, along with any trends, that sees not only the rise of the material capabilities of states, also enables this of free men and women in free societies, so…you can still worry, me, not at all.
So Rotschild of the world in your opinion Csteven, have less gold that Indian women? And you call me delusional?
it is people like you are delusional thinking that restoring a monetary order must happen via wars and starvation. It will not happen. Read about Triffin dilemma. What will happen is following: US dollar holders will loose conservatively 99% of their savings within days, while gold will appreciate to its true price of $55000. It will happen sudden, so people like you will not have time to react. Too busy listening to bullshit presentations from “economists” with smart formula on the board.
Where you are right, there are a lot of promoters of paper gold which is dishonest. But physical gold holders will be rewarded.
No, it is not the “Indian women” who will be rewarded. What they have is peanuts. As far as USA, we will see. For now, they are loosing its gold, while others are accumulating.
Csteven is correct with regards to who owns the gold. There’s still many stores of precious metals that’re still being discovered in Hindu temples. They’re still finding these rooms.
I don’t necessarily know about “Hindu women” per se, but if not taken literally, he is quite right with Hindus hoarding gold and such. Hinduism encourages the transfer of wealth across generations by accumulating such assets.
Yes this is indeed the fact, when I seriously studied the matter, about 2006, around the time of the Gulf CC Gold Dinari, report in which the indicated a Gold backed Dinari was not feasible, Indian women had 13% of all the Gold ever mined (in the history of gold mining from antiquity):
in their ears, noses, around their feet, across their bellies, on their fingers, around their necks, upper arms and in their dowry boxes.
Of course this is 24k, 22k or 18k….otherwise the US in bullion, and a fair amount in 14k or 18k jewelry, sitting crinkled up in jewelry boxes, and similar to Indian women, but in far less proportions.
As to Rothchild’s, please, you realize this excludes you from serious discussion, no?
99% of their savings within days, I thought that we didn’t have any? Is that the normal argument. No they are not loosing Gold, if they did consent to institutional selling, which was technically gold that had been committed, needed their, and other sovereigns to accept the distribution, and similar, and then many, during high prices have been digging as much as they can, and selling the old crinkled 14k gold chains, etc…
Bring on Carnegie, the Rothchild’s and the New World Order,
Jack Van Impe is prophesying a slaughter,
the world is spinning on an axis
Likely you’d see Hitler and all his Nazi’s
Lyndon LaRouche, Ron Paul and Lew Rockwell
Bring a stench that makes the rot swell
Linking some thoughts all that drive us to hell
Gold is rising
the dollar is falling
Banksters Fraudsters and Enron
Etc, Etc, Etc,…..child minded non-sense that boggles the mind of many of those who might be interested in these serious matters….
A shame really.
“What we see now, is a cruel battle with time. On the one hand, Russia and China, together with the rest of the BRICS, are trying to get rid of the dollar and form their own currency system to gain complete independence, on the other, the neocon banking-corporate puppets in the US are in panic and seek desperately a pretext to come to war with Russia and put an end to this threat for their plans. This explains their agony to drag Russia into a warm conflict.”
http://goo.gl/9pIL4N
Is that why each of the BRICS countries have been printing money, since 2005 each of the BRICS has grown M2 by 300% or more, with the US under 100%, even with QE, and some have seen their currencies halve, South Africa, Russia even less than halve, India has seen its currency drop from 38 to 64 to USD.
Is that what they are doing, printing enough money, in a really short period of time so they can have the money to challenge, if that is the case, they needn’t have bothered, because China replicated the entire US commercial banking system in but 4 of the last 6 years, to mention nothing of the last decade nor all of the other BRICS who have been printing at rates more than three times the US rate, some even 4 times. So, all told they have printed so much money in the last 10 years that they should have more than enough fiat currency to fit the bill, no.
Csteven,
does referencing any currency to USD even make sense?
How about if I print out some of my currency and tell you it is strong? Would you reference anything to it as well?
How about starting to make sense, for a change, and noticing what other CB are doing, which is accumulating gold.
I can not believe that after reading this blog for so long Csteven does not understand that US dollar is ultimately worthless, which is what Michael has been implying all along. .
Well, one can merely reference the percentages as listed, and then reference worthless to even more worthless, and if such is the case, then the first assertion holds, thus my point has been carried as to the non-sense of that which you continue.
So, exactly, then moving (on) (back) to the relevant.
So we are agreed, there are plenty of gold-bug sites to fill up with the hyper-inflation, exorbitant privilege non-sense, where the Web brigades, 50 centers and similar can ply their wares to those far more interested.
You should start converting everything into gold, even sell your old lothes, extra blankets, you don’t need more than a plate, a dish a fork and a glass, etc….quickly, onto another medium.
Csteven,
no, I will put ALL my savings in US Treasuries. Sit on my fat old ass and pretend I am rich. Thank you for that great advice. I appreciate it.
Way to go, do not address the issues presented, merely restate, and defer to the artificial that pervades this discussion, oh yeah, that is the only thing that is ever done by those who support the notion.
Again, am happy for you to jettison, what haven’t you heard, only remind that what will happen, and what will happen without more understanding of trends, free of post-modern critic, more broadly. I am fine with that experiment, to see the course, as I have been with the last few decades of experimentation to run its, but the impact will not be as you suspect, I assure you that.
No, you are confused as aver, Csteven. Stop reading this Stanford garbage about sovereign debt and start making sense.
China and Russia are PRODUCING, while they are printing. USA is CONSUMING while it is printing. That is what makes the difference.
As far as gold, it has been a reserve to be used among the countries to naturally control the money flow between exporter and importer. As producing-exporting country was accumulating more and more gold, their products were more and more expansive to the importer.
We NEVER had a STRUCTURAL deficit conditions until gold was FORCEFULLY taken out as reserve by the governments. Once the current financial experiment is over, US dollar must revalue drastically against gold.
But it is OK, Csteven It is after all your money. You can waist them any way you like. In some ways I am glad people like you do not compete with the ones who understand.
Gold is relatively precious and has tendency to hide in strong hands as the price will go up.
Russia produces natural resources in a world of collapsing global supply. Also, Russia is certainly not “printing”; they’re doing the opposite. They just hiked rates to 17% (which means they sharply contracted the base money supply).
BTW, US production is increasing faster than US consumption. The advantage of the US is that the US economy doesn’t depend on world trade. There’re only a handful of countries less dependent on the rest of the world to consume their goods and most of those are for geographical reasons (ex. Rwanda, South Sudan).
I don’t know where you’re getting your facts, but they’re not correct. Csteven is correct in this regard.
Suvy:
Whatever it might doing now, Russia has printed at great extents, all emerging economies have printed at ratio’s of 3 to 1 or more to the US over the last decade. And further, similarly into the past, many of them, the vast majority of them. This is why the Marxian Libertarian “US just prints money” is fallacious, where others print at multiples of the US.
The more cognizant then state, yes but they have grow at a faster rate, which is true for some of the economies, but, upon such a statement, what is the problem with printing, if faster growth justifies printing much more quickly, just the US money supply static why everyone else’s can grow at multiples. Which is an important point for those who make policy demands on US economic policies, or criticisms toward the libertarian strain, that the US should just do this, while the rest of them do that, place philosophical perspective above systemic forces, impacts, inter-relations and similar.
Far too many have a mechanical and control {focus} (heuristic, cognitive lens/framing device) {focus} on politics and economics.
This frame tends to end to paranoia and discontentment, and make things far to sure for the purveyor, I believe.
Suvy,
you made me laugh today so much!!!!!! HAHAHA
“The US economy doesn’t depend on world trade”
Just look around your house. EVERYTHING just about is made in China.
Russia has a vibrant economy, which does not depend on the rest of the world. once Russia implosed reversed sanctions, every country involved started screaming like crazy: our businesses are hurting, we are losing money, please help us.
Suvy,
did you start smoking something funny recently? You stopped making sense, buddy.
Next thing you will be telling me that in the US there is no deficit.
USA is still consuming WAY more than it is producing. And it is the rest of the world that pays the difference. This is just a fact. Please stop arguing against it and embarrassing yourself.
Csteven, is full of crap and makes number as he goes along.
He fooled a lot of people already with his US propaganda garbage.
Would not be surprised if he gets paid to post his pro US garbage on this blog and confuse people.
Look at the numbers John. The only countries less integrated into the global economy are Rwanda, Brazil, and a few other countries.
You realize that the US was the largest manufacturer in the world until a few years ago, and might very well be the largest in a couple of years from now (this is less dependent on dynamics in China, but whether and what you are calling Europe; OECD Europe, EU-7, EU14, EU-27, all european countries, of course that does change the largest dynamic).
Russia, producing what? Have you been to Russia? Seen what exists there?
The old Unimog copied trucks? What? Steel, yes…oil, Us not far off, Gas, US probably exceeds, manufacturing, Russia not even close, China more, a process where is currently blowing up inventories, sitting on 20 years of clothing alone, same across all industries, not if they are sitting on inventories that would bankrupt companies in all other economies in the world, at historical highs, but whether it is 1.5 years, 20 years of production, 8 years, and this is what they are printing against, plus real property in a system, not where the developer drives a hard bargain to get a good price on land to be developed (X) but is happy if he pays 2X, because he gets not Y, but 2Y from the bank. And this is what they are printing money against, anyway, watch more Stanford, Peterson, CSIS, Yale, MIT, Harvard, SIM, ANU, Lee Kuan Yew school, and another two dozen or so that I forget….quickly
Csteven,
Yes, I have been to Russia recently. A lovely country with fully developed independent economy.
And what is the USA producing, inflation and useless Facebook? and making other countries miserable?
Truth must be told that the USA financially enslaved other countries for many years, just like GB did it before. It is not politically correct to talk about it, but it is the truth. And that is the reason it is using its military to “project its power” or in other words to continue enslavement.
Csteven,
you are completely clueless about Russia and yet you think you are knowledgeable. OK, I give you a couple of examples just to bring you down a notch and to expose your ignorance.
Look here, http://www.voltairenet.org/article185860.html
Russian SU-24 disable Aegis Combat System making D. Cook destroyer COMPLETELY BLIND and at mercy of Russian jets. Where do you think they found technology to do it? Stole it from China?
Csteven,
please stop embarrassing yourself talking about Russia. You think you did not do enough damage to yourself posting to this blog in your broken English?
I had to take two Advils just to finish reading One of your posts. Should have known better reading junk.
Russia lives within its means. Moreover, it is supporting the life style of people like you who live in the USA and are leaching on the rest of hardworking people in other countries.
It is OK, Stevey boy enjoy it while it lasts. Soon enough you will be sitting on a toilet in our house staring on a wall plastered with your useless US dollars. The time will come when you have to work yourself for all these privileges your government created for you while bombing other countries.
Csteven, so what do you think Rotschield has in his vaults? US treasuries? Stack of US dollars?
Those who buy gold in big numbers do not normally talk about it for you stevey boy to find on your useless Stanford presentations. They keep it to themselves of course.
I hope to see you all sad and financially ruined one day. Just do not ask me for money, Ctevey boy.
Csteven, and what did US produce lately?
Facebook and inflation?
Everything they say they make is made in China or Russia.
Could not even go to space without Russian help. Bunch of sore losers.
Csteven, and how did US even got into space?
Had to rely on ex German scientists for that, could not even invent anything themselves.
http://en.wikipedia.org/wiki/Wernher_von_Braun
Bunch of losers. Can not argue with facts.
Csteven, they even rewarded Wernher von Braun a NASA medal.
Bunch of hypocrite losers. Now they are telling others what democracy and Nürnberg tribunal is all about.
How about stop stealing technology and scientists from other countires and try to develop something of value themselves? Other than Facebook. Or I forget, Twitter, another worthless product of a country who supposedly prides itself on invention.
Bunch of potato couch fat losers.
Jon
Printing Money (M2 growth)
US…………..(2000) 4600 to 11.562 (2015) 2.4 x’s
http://www.tradingeconomics.com/united-states/money-supply-m2
Russia…….(2000) 1100 to 30,000 (2015) 27 x’s (http://www.tradingeconomics.com/russia/money-supply-m2
China …..(2000) 12,000 to 120000 (2015) 10x’s
http://www.tradingeconomics.com/china/money-supply-m2
Germany (2000) 1300 to 2400 (2015) .7 x’s
http://www.tradingeconomics.com/germany/money-supply-m2
Brazil (2000) 270000 to 2100000 (2015) 8x’s.
http://www.tradingeconomics.com/brazil/money-supply-m2
“There is no automatic adjustment of current account deficits and surpluses, they can get totally out of hand. There are effects from big countries to little ones, like Switzerland. The system is dangerously unanchored. It is every man for himself. And we do not know what the long-term consequences of this will be. And if countries get in serious trouble, think of the Russians at the moment, there is nobody at the center of the system who has the responsibility of providing liquidity to people who desperately need it. If we have a number of small countries or one big country which run into trouble, the resources of the International Monetary Fund to deal with this are very limited. The idea that all countries act in their own individual interest, that you just let the exchange rate float and the whole system will be fine: This all is a dangerous illusion.” – Former BIS Chief Economist
http://www.zerohedge.com/news/2014-12-19/former-bis-chief-economist-system-dangerously-unanchored-it-every-man-himself
Ultorn,
until we get away from using USD as a means of savings, the problem will never be solved. It should be obvious to everyone right now. Except may be Csteven.
Yikes!! What is going on with Chinese interest rates? http://www.shibor.org/shibor/web/ShiborJPG_e.jsp
I dont know how accurate these tables are as I got them off the net and was surprised to see Australia rate at about 10% uk and usa 5% but
China .35 ??????
Aus==
Australia 9.30 Aug/14 9.50 20.60 -0.20 percent [+]
Canada 43800.00 Aug/14 43332.00 69512.00 1200.00 CAD Million [+]
China 0.35 Dec/14 0.35 3.15 0.35 percent [+]
Euro Area 12.90 May/14 13.10 15.58 12.80 percent [+]
France 53628.00 May/14 53198.00 55320.00 430.00 EUR Million [+]
Germany 9.30 Aug/14 9.20 17.30 7.80 percent [+]
India 22124.14 Jun/13 20547.37 22124.14 6.34 INR Billion [+]
Italy 1.32 Oct/14 1.42 8.57 0.94 percent [+]
Japan 16.60 Oct/14 3.10 48.30 -9.90 percent [+]
Mexico 19.90 Dec/13 23.90 25.70 19.90 percent [+]
Netherlands -1010.00 Oct/14 -49.00 4293.00 -3048.00 EUR Million [+]
South Korea 494415.30 Jun/13 473507.20 494415.30 494.00 KRW Billion [+]
Spain 51257.00 May/14 34227.00 64635.00 22254.00 EUR Million [+]
Switzerland 95684.77 Jun/12 96029.41 96029.41 39871.15 CHF Million [+]
United Kingdom 6.70 May/14 5.70 14.00 -0.90 percent [+]
United States 5.00
Here is Andy Xie
http://www.bbc.com/news/30490554
This is certainly an interesting read. I think, as you pointed out, this article is thought provoking because of the serious polarization that intuitively happens when we compare these two countries.
Michael, how do we measure the maturity mismatch within the balance of payments? We can certainly see how and when debt is rolled over to fund over investment, but how do we measure this amount as compared to the maturity of the investment itself, particularly fixed asset investment?
One can see a need for housing in China. One can also measure how this need is paid for. However, I doubt anyone who has seen the quality of new apartment buildings in China can think this is a long term investment. If China is rolling over debt and attempting to change its growth model, how can we best examine the maturity of its investments versus the maturity of its loans, especially since they differ so greatly? Surely this must be quantifiable.
Sorry for another basic question, but although it may undesirable (and unlikely, IMO), can the savings simply be reduced by inflating the away? In other words, is inflation a variable that must be considered in your analysis?
Savings is DEFINED as income not consumed. You can increase income by increasing savings or increasing consumption. Inflation can increase consumption of increase savings, but it usually increases consumption (or the consumption rate).
“a month of borrowing costs soaring on speculation that some local government financing vehicles (LGFVs) will lose government support, Bloomberg reported.” A possible explanation for recent spike in interest rates.
Prof. Pettis,
These are interesting times and you surely have many interesting thoughts. We hunger for your wisdom.
For those who like to discuss long-term social security and health care unfunded mandates, from the liars that perpetuate that non-sense, and you realize you can evaluate previous reports to see how they faired going back to the 1960’s, correct, so no evil maniacal hidden group lying to the ignorant, when the ignorant are thos who merely read the highly propagandized noise of those with an agenda, often an agenda, directly opposed to the interests of those who hyperventilate, so here is the
“THE 2014 ANNUAL REPORT OF THE BOARD OF
TRUSTEES OF THE FEDERAL OLD-AGE AND SURVIVORS
INSURANCE AND FEDERAL DISABILITY INSURANCE
TRUST FUNDS” available at http://www.ssa.gov/oact/tr/2014/tr2014.pdf
and a summary of 75 year dynamics, and 25, 50, etc….with historical estimates and actual from the past throughout to be able to benchmark their progress and process, and alteration of assumptions.
So no need to have these stupid fantastical numbers, and false ones at that bandied about, and also to understand how the issue will evolve. The past didn’t pay as much, and the future will pay slightly more than they receive. Low, Intermediate and High cost assumptions, show that there are assumptions that can change (retirement age, cola freezes, and tax rates) that alter whether the eventual is a moderate negative, positive, or high negative. So stop spreading lies (and yes you can check their past estimates to check for accuracy, so no need to assume they are the ones lying, rather than you paranoid ideological masters)
“By 2088, the combined OASDI and HI annual balances as percentages of
GDP range from a positive balance of 0.85 percent for the low-cost assumptions
to a deficit of 7.01 percent for the high-cost assumptions. Balances differ
by a much smaller amount for the tenth year, 2023, ranging from a
positive balance of 0.11 percent for the low-cost assumptions to a deficit of
1.82 percent for the high-cost assumptions.
The summarized long-range (75-year) balance as a percentage of GDP for
the combined OASDI and HI programs varies among the three alternatives
by a relatively large amount, from a positive balance of 0.53 percent under
the low-cost assumptions to a deficit of 4.20 percent under the high-cost
assumptions.”