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January 26, 2005

Comments

Well, I can't really assuage your concerns Edward, but on re-reading your earlier post on Dr. V. I came across a comment Posted by: Moe Lane | April 19, 2004 09:03 PM.

Jeez, he's missed.

Edward: I can't assuage your concerns at all, since I share them. (I was actually going to write on a related point, and may still.) I haven't yet gone back to read about your conspiracy theorist friend, but you don't need conspiracy theories at all to be very, very worried about this. All you need to know is:

(a) we have put ourselves in a position in which we need constant and huge amounts of capital to pay for our budget deficit (and the trade deficit as well.)

(b) Financial Times: "In 2003, the most recent year with full international statistics, central banks financed 83 per cent of the US current account deficit, with Asian central banks accounting for 86 per cent of flows.

A similar picture is emerging for 2004. Despite a good start to the year, when the private sector was a large net purchaser of dollar assets, central banks came to the rescue again. The People's Bank of China has let it be known that China increased dollar reserves by $207bn (€159bn) in 2004, financing nearly a third of the US current account deficit, estimated at $650bn."

83% of our budget deficit was financed by central banks, not by private investors. Wow.

(c) With the dollar tanking, and no reason to believe that Bush is really going to get serious about deficits, there is every reason for these banks to stop buying treasury bonds and move to non-dollar assets.

(d) Part of the reason they haven't is that they have an interest in buying treasuries to prop up our currency -- but they can only do this for so long, and will not continue if things look as though they're going to get really bad.

(e) For the Chinese not just to do this, but to announce it publicly, makes it look as though things will, in fact get really bad.

Yikes.

Edward:

By any chance, does your Dr. "V" wear large wrap-around shades? If so, let me reassure you by saying that things will look scary right up until episode 18.

Then we'll prevail.

Hilzoy: For the Chinese not just to do this, but to announce it publicly, makes it look as though things will, in fact get really bad.

I wonder if Bush will continue to proclaim that the really serious financial problem facing the Bush administration is the "reform" (read: total wipe-out) of Social Security? It would be fairly parallel with his conduct of the Iraq war, or, come to that, his behavior with regard to al-Qaeda.

I don't see that there's really anything here to be worried about. China's been the party most insistent on keeping the yuan pegged to the dollar at an artificially low rate, not America, and a threat to do what American exporters have been demanding it do for years is hardly likely to have Treasury officials quaking in their boots.

As for the current-account deficit, I think people need to have a sense of historical proportion; Britain in its Empire days ran current-account deficits equivalent to up to 7% of its GDP, and the net consequence for the British economy was essentially zero. What bankrupted the British wasn't the deficits but a mixture of other things: the insistence on going back on the gold-standard at an unsustainably high valuation for sterling in the 1930s, the (inevitable) economic convergence of other European states, two globe-spanning wars, and finally a post-war commitment to Fabian socialism that ended up hampering British economic growth right up until the 1980s - at which point Thatcher came and saved the day.

I'm not saying that economic disaster couldn't yet unfold given terrible enough policies, just that it's easy to look at large nominal sums outside of historical context and see armaggedon approaching. America's economic fundamentals are superb, far better than those of either China or Europe, and it is simply alarmist to speak as if it were otherwise.

From my readings and postings on the foreign debt crisis, it appears to be a massive game of prisoner's dilemna. If all the Asian central banks co-operate and prop up US currency, then all benefit. After all, they all hold US debt that needs to be repaid in US currency, so if the dollar falls, they all lose. On top of that, a failure of the US economy will severely damgage the world economy.

However, if one significant Asian central bank sees the dollar's collapse as inevitable, then it would be in their best interest to get rid of their debt first. That way, they are hurt the least be the devaluation.

It's such an incredibly unstable situation that it can't continued indefinitely. Someone sooner or later will be the first to go, and then we'll see a frenzy of sellling, and the US dollar will plunge.

I'm going to argue the other side, just to be contrary :)

What happens, short and long term, if China does stop financing Bushenomics?

OK, here's the alarmist viewpoint - and, please note, just becuse I call it 'alarmist' doesn't mean I think it won't happen:

The dollar doesn't just fall, it sinks out of sight. Maybe out of control. Investors dump dollars for euros or some other currency. Prices of imported goods reach for the sky, and so do interest rates. Our credit-based economy goes into depression.

But: Isn't the US China's number one export market? Wouldn't China be cannonballing its own economy in the process of cannonballing ours? If so, maybe China is making a gesture, or will only 'allow' the dollar to fall enough to force Bush into fiscal responsibility.

Also: Wouldn't 'cheap overseas labor' stop being cheap? Wouldn't US jobs have to come back to the US, esp. in manufacturing?

Back in the 1980s, US lenders found themselves stuck with huge debts to second- and third-world countries those countries would never ever be able to repay. The US kept extending credit - because so much was tied up in those debts that, if the banks had foreclosed, they would have fallen like autumn leaves. It got to be an unfunny kind of joke, how US lenders were lending more money to debtor nations so the debtor nations could pay just the interest on the loans and avoid default.

Couldn't this be much the same situation? Aren't China and Japan are in the same situation US banks were in the '80s? Don't they 'have' to keep us afloat, even if by playing Creative Bookkeeping, in order to prevent their own financial institutions from collapsing?

Are these reasonable outcomes?

I think an important fact to recognize is that the wealth of our nation is really based on hard working and innovative Americans. The gov't has a role, but it really doesn't compare that.

But: Isn't the US China's number one export market? Wouldn't China be cannonballing its own economy in the process of cannonballing ours? If so, maybe China is making a gesture, or will only 'allow' the dollar to fall enough to force Bush into fiscal esponsibility.

Sure, that's one scenario. Here's another: supposing another central bank dumped its debt in order to increase its nation's economic fortunes at a cost to the Chinese? The Chinese would then be faced with losing trillions of dollars at a cost of transferring its own wealth to the US in the form of debt repayment in devalued US currency.

++UG: But only Japan, so far as I know, holds enough US debt to pull that off by dumping its debt before China can. And I think Japan is in the same position as China - ie, dependent on its trade with the US for its own financial stability.

You foolish barbarians are doomed, DOOMED I say!

d+u: Nouriel Roubini agrees. Abiola: I think the British situation in the 19th C. was really different from ours for all sorts of reasons.

ttl: "I think an important fact to recognize is that the wealth of our nation is really based on hard working and innovative Americans." This is true, but it doesn't change the fact that our government is running up enormous debts in the name of those same hardworking Americans, which they (we) are legally obligated to repay, and that the government elected by those hard-working Americans has put us on an absolutely unsustainable fiscal path, such that if CHina stopped buying our bonds, we would be plunged into, at best, a serious recession.

Drezner had a couple of interesting posts on this subject last month. Here:

What bothers me is the concern by Japan that others might be tempted to dump their dollars while they still hold so many of them. The Japanese and Chinese central banks own an enormous part of these dollar reserves, and if they don't move, a precipitous fall seems unlikely. However, both the Russians and the OPEC countries have started to diversify their holdings in favor of the Euro. If non-major Asian countries make the same move, the question for Japan and China is whether there is more to gain from moving first and getting a mediocre return on their dollar holdings or holding on and hoping the dollar slide won't last longer. The temptation to unilaterally defect here is quite powerful.
...and here:
In theory, a declining dollar should help the U.S. balance of trade by making imports relatively more expensive to Americans and exports relatively inexpensive to foreigners. However, the current macroeconomic imbalances cause this equilibrating mechanism to carriy some risks. Among the many fears about the current dollar depreciation are:

1) U.S. demand for imports is so inelastic that price increases won't have much of an effect;

2) A sizeable chunk of the U.S. deficit is bilateral trade with China, and the dollar's fall has not affected that exchange rate too much;

3) East Asian central banks will only tolerate so much of a fall before they decide to liquidate their dollar reserves, which would trigger a financial panic/run on the dollar/cats and dogs living together/mass hysteria (see Brad Setser for more on this -- as well as the Economist)

ttl: I think an important fact to recognize is that the wealth of our nation is really based on hard working and innovative Americans.

I think that's an important myth in the minds of many Americans, and will be very useful to your self-esteem in the long run.

d+u: "In theory, a declining dollar should help the U.S. balance of trade by making imports relatively more expensive to Americans and exports relatively inexpensive to foreigners." Add to Drezner's list of concerns about this statement the fact that much of the US economy is not in exportable goods, that we would therefore need to increase capacity if we wanted to export a lot more, and that it's hard to finance new construction of plants in an economic downturn.

"According to Dr. V., what comes next is a more overt land grab. The groundwork for it has been laid already...tax cuts for the wealthy, the path to the dismantling of the New Deal, private leases to all public lands, solidification of control over the government, religion, media, military, etc. Loosen up the nation's assets so the powerful can grab all they can get."

Duh.

Mr Lapite, are the account and fiscal deficits consequence free? If so, can we triple them this year without fear? If there are consequences, what are they, or is that a political decision that you believe the current regime will make in a way that benefits yourself?

I have asked on this blog before: we devalued in the seventies and late eighties. Was that cost free?

Jes:

"ttl: I think an important fact to recognize is that the wealth of our nation is really based on hard working and innovative Americans.

I think that's an important myth in the minds of many Americans, and will be very useful to your self-esteem in the long run."

No, it's definitely true, but you have to draw a distinction between 'based on' and 'owned by'.

sidereal: No, it's definitely true

No, it's really not true. Americans like to think it's true, but really: go read An Inquiry into the Nature and Causes of the Wealth of Nations. I don't (obviously) agree with Adam Smith politically, but as an economist, he's still a startlingly clear thinker.

Countries do not become or remain wealthy because they have a high number of "hard-working and innovative people". That's just not how the wealth of nations works.

From the NYT yesterday:

After a first term in which terrorism and war dominated President Bush's foreign policy agenda, his allies in Europe and Asia suspect that his next confrontation with the world could take on a very different cast: a potential currency crisis, in which a steep plunge in the value of the dollar touches off economic waves around the world.

Already, the tensions over the dollar are becoming a recurring source of friction, a conflict that does not reverberate as loudly as the differences over Iraq but may be as deeply felt. At a meeting in Paris on Monday, the finance ministers of Germany and France complained that Europe had unjustly borne the brunt of the dollar's decline, and called for coordinated action to stop it.

[...]

Administration officials, along with a number of like-minded economists, contend that the nation's record trade and current account deficits are not particularly worrisome, a reflection more of strong foreign interest in investing in the American economy than any sign of global weakness.

But across Asia and Europe, a wide range of officials and analysts worry that Mr. Bush's economic team may not be up to the challenge of grappling with the issue. They contend that Washington has retreated from efforts to marshal the biggest economies of the world into a mutual effort at more robust and balanced growth.

Not bad, covers both sides of the story. One thing for sure, though. China's getting ready to kick ass. Funny that Marxist-Leninism might actually win out in the global economy after all, innit?

Dude. What's 'Marxist-Leninist' about China's economy?

"Countries do not become or remain wealthy because they have a high number of "hard-working and innovative people"."

No, we're just in disagreement about whether 'based on' suggests necessary or sufficient. If there were no hard-working innovative people in America, there would be no wealth.

Dude. What's 'Marxist-Leninist' about China's economy?

Um. They sell a lot of posters of Marx, Engels, and Lenin? And there's a lot of red stuff on theirt web site?

Seriously, It's a socialist economy, but you're right, it's not Marxist-Leninist anymore by any economic definition.

re: Japan and China. The discussion of the prisoner's dilemma is interesting, but it is realy important to note that there is a lot more going on there, and it's not going to be mere money that causes (or fixes) the problem. Japan is currently plunged into a love/hate relationship that one usually only sees with the US. Politicians are increasingly trying to use nationalistic concerns to appeal to people (though North Korea is the obvious big bogeyman) but Japanese business is going in for closer and closer ties with China. The same things seems to be going on in China, but it is hard for me to tell if the politicians are controlling it, or if they are simply trying to manage it. This is one article that gives a good overview, I've read a few others, but can't seem to turn them up. Interesting times, for sure.

If there were no hard-working innovative people in America, there would be no wealth.

Given that there are hard-working innovative people in every country on earth, this is a kind of pointless statement. I mean, you're right, yes, but if your economy collapses underfoot into shards and rubble, and more powerful countries ensure that you never, ever get a chance to rebuild, all the hard-working innovative people will either leave for other countries, or spend their lives working hard, being innovative, and breaking their hearts because nothing they do makes a blind bit of difference.

Jes, I agree with you, but your turn of phrase is depressing.

The US has all sorts of economic & social problems, the vast majority of these can be traced back to the Deindustrialization that has been forced on the country by it's economic elites.

Even if the dollar dropped thru the floor the US would still have a negative balance of trade.

Dr. V's theories sound less like a conspiracy than old-fashioned class warfare--less Robert Ludlum and more Tom Friedman as read by Karl Marx.

I mean, whether or not the land grab was planned, it certainly makes sense for people with assets to take advantage of opportunities that present themselves.

I certainly hope that US foreign policy was not designed to destablize the mideast, wage preventive economic warfare with China, and help the wealthy seize devalued assets from the middle class in the US. ... The second, maybe.

Just wondering about the size of the PRC's GDP. What is the status of our relationship with India.

I have two, make that three, comments.

If there were no hard-working innovative people in America, there would be no wealth.

This is what'cha call hubris. As Jes pointed out, this does not make America very special. It's what you do with those hard-working people that counts.

Also, this is pretty plain evidence that the rest of the world has little faith in the ability of our economic policyverks. China takes great pride in planning (and they are still a command economy) for not just 5 or 10 years in the future but for the long, long road. Think 100 years. I think hilzoy's e comment is the most depressing. China thought long and hard before trashing our currency publicly. Unfortunately they have the leverage to cause some serious harm.

Finally, it disgusts me that we are being economically held hostage by creditors because I love America, dammit. Frankly, I blame Bush and his advisors. If he had been minding the store this wouldn't have happened.

. Frankly, I blame Bush and his advisors. If he had been minding the store this wouldn't have happened.

You shouldn't. He just one in a long line of politicians who have sold out their constituants (the US citizen)to the highest bidder (Corporate America).

It's easier for Corporate America to use Slave Labor in China or some third world rat hole to make money than to pay Americans a fair wage for an honest day's work. The US loses industry, tax payers and institutional know-how and get Mac jobs, unemployment, welfare and poverty!!!

And in case that there is some segment of the labor force that can't be exported, cheap labor can be imported either illegally (construction/farming/meat packing) or thru H1B visas (Nurses, Doctors, Progammers). Why buy the cow when you can get the milk for free?

Timmy T.W.D. - What is the status of our relationship with India.

A while back, Tim Dunlop of The Road to Surfodom posted a synopsis of a conversation with some Indian government figures that were visited by a mostly-Republican delegation from the US. Here's most of it:

We consider ourselves as in competition with China for leadership in the new century. That's our focus and frankly, you have made it very difficult for us to deal with you. We find your approach to international affairs ridiculous. The invasion of Iraq was insane. You've encouraged the very things you say you were trying to fix - terrorism and instability. Your attitude to Iran is ridiculous. You need to engage with Iran. We are. We are bemused by your hypocrisy. You lecture the world about dealing with dictators and you deal with Pakistan. We are very sorry for your losses from the 9/11 terror attacks. Welcome to our world. You threaten us with sanctions for not signing the non-proliferation treaty, but you continue to be nuclear armed and to investigate new weapons. You expect us to neglect our own security because you want us to. We don't care about sanctions.

They also spoke about economic development and the message here was that we're doing fine thanks. We can't address the poverty in our country wholesale--most of it is rural poverty anyway--but we find we have skills in the hi-tech area. We will continue to pursue that. We currently produce around 10,000 (I think, ed) science PhDs a year. We will build up a rich, well-educated strata.

I think the relationship has room for improvement.

You shouldn't. He just one in a long line of politicians who have sold out their constituants (the US citizen)to the highest bidder (Corporate America).

I don't doubt this for a second. I also have some faith in capital markets to bring about a fairly equitable exchange of wealth (YMMV). My problem is that Bush has made all the wrong choices and can't even keep the freaking status quo when it comes to American economic power.

Sorry, I also meant to point out the current Iran-Japan/China ties over oil. This article is interesting, and the following may be a fair prediction of the future.

For the moment, however, the Iran-Russia-China axis is more a tissue of think-tanks than full-fledged policy, and the mere trade interdependence of the US and China, as well as Russia's growing energy ties to the US, not to mention its concerns over Chinese "overstretch", militate against a grand alliance pitted against the Western superpower. In fact, Cold War-type alliances are highly unlikely to be replicated in the current milieu of globalization and complex interdependence; instead, what is likely to emerge in the future are issue-focused or, for the lack of a better word, issue-area alliances whereby, for example, the above-mentioned axis may be transcend purely economic considerations.

Also of interest is this article from the Taipei Times, which obviously has its own prejudices when it comes to viewing PRC initiatives.

Here's a view of US-Iran relations from a PRC viewpoint. And one has to consider that efforts like this are rooted in a desire to avoid the naval power of the United States in the future. This article details similar work by India. d+ug's Road to Surfdom link is one that I have already posted in response to the last time Timmy praised Bush's handling of our relationship with India, and I seem to remember that he got an answer about PRC's GDP here from hilzoy and others.

Of course, (though I think that a number of other people here have much better knowledge and understanding of this than I do) China has its own Islamic fundamentalist problem background and the most recent incident (though it is hard to know if it was an incident or an accident)


Here is what I think is the neo-con view of it, which I find rather cartoonish. However, I have to think that the inaugural speech was a neo-con biscuit to the dog, and the pushback on what the speech meant happened when people who actually have some notion of what foreign policy means heard it and said 'wtf?' (I should also add that it pains me more than I can say to now find myself in agreement with the realpolitik school of international relations)

The general movement of the Japan-Iran ties can be seen by comparing this VOA 2003 article, with this recent report

From the beginning, the Azadegan development has been a Japanese national project, thus it was not purely a matter of economics. Japanese politicians and bureaucrats still hope to see Japan commercially engage Iran, to diversify energy sources for greater supply security.

and the recent visit of the deputy foreign minister Isawa to Iran, which seems to have been un- (or perhaps under-, I haven't seen any mention) reported in the Japanese press.

This Japan Times interview mentions Japan-Iran, while providing some useful background on Japan-Iraq.

What worries me is that whipping up nationalism is viewed as an easy way to gain support, and the thought is that it is easy to contain. I'm trying to find an article about China's purchase of high speed rail equipment, quoting a Chinese official who said that it would have been a lot easier and made a lot more sense to buy everything from Japan, but the current popular attitudes towards Japan dictated that they only buy 50%, and that percentage was minimized. At any rate, it is a sad day when we have to rely on profit making businesses to act as a brake on these sorts of things.

In fact, Cold War-type alliances are highly unlikely to be replicated in the current milieu of globalization and complex interdependence

Has the writer of that article never heard of World War I?

Has the writer of that article never heard of World War I?

Well, that's certainly a frightening thought, and a lot of writers have brought up that precise scenario, comparing the international trade figures leading up to the war and such. Optimistically, I would hope that the ties between nations are much deeper than they were in that time, but I don't know if that is the case. To repeat, it really sucks to think that capitalism is going to be the engine that keeps us from another world conflagration.

LJ - What's 'cartoonish' about Stackelbeck's article? FrontPage might be a neocon journal (I'm not familiar with it, though seeing the name Horowitz on the masthead is a clear warning signal) but aside from the de rigeur reference to 'brutal regimes,' Stackelbeck's piece sounded like straightforward reportage. And interesting, too, since it suggests a (real) reason for the neocon push to go to war with Iran.

There's a good article in Asia Times, China, panacea for the world economy, which outlines how China's economic growth is actually benefiting the entire global economy, including America's.

The Chinese seem quite aware of the fact that they can only prosper within a prosperous global economy, and that if they destroy jobs in other countries then obviously those countries won't be able to buy their products.

oops! I don't mean 'real' reason as in 'good' reason; just one that sounds more actual than Bush's empty "freedom and democracy" rhetoric.

I share the concerns of Dr V. and our fair blogger. There is going to be hell to pay, and that right soon. I've read several places that over the last year, the US has soaked up 100% of the world's total savings -- that's clearly unsustainable.

The end result almost has to be hyperinflation, and the result of that will be a repudiation of that debt (not legally, but morally) as almost all of the debt is at an interest rate that will seem laughably low Real Soon Now. Perhaps Bush thinks that this is a good thing, and is how he sleeps at night -- I can't think of any other way.

The Treasury does sell inflation-protected bonds, but they have a number of chilling provisos -- "If, while an inflation-indexed security is outstanding, the CPI is (1) discontinued, (2) in the judgment of the Secretary, fundamentally altered in a manner materially adverse to the interests of an investor in the security, or (3) in the judgment of the Secretary, altered by legislation or Executive Order in a manner materially adverse to the interests of an investor in the security, Treasury, after consulting with the BLS, will substitute an appropriate alternative index." Think about it this way, would the US buy "inflation protected bonds" from Argentina, if they had that kind of get-out-of-jail-free clause? No, of course not. Note well that China and the US could well be taking the place of the US and Argentina in the above scenario.

Thad Beier

OK, two comments is probably two too many. But my previous comment focussed only on the Far East. Europe is equally interesting.

Europe has, amazingly, forced themselves into fiscal sanity in a kind of inverse prisoner's dilemma. The rules that govern the common currency require (and they really have to require) that each of the member governments maintain low deficits. Probably every country in Europe has bellyached over this requirement at some time or another over the last 10 years, but each time the rest of the member states held the line. The result has been dramatic, the Euro has soared against the dollar.

Unfortunately, in the US we have no checks and balances at all anymore, and the each branch of the government is doing their best to destroy the currency, and in the end, the country.

Perhaps we can join the EU. I mean, if Italy can find its way to fiscal sanity, then we can, too.

Thad Beier

LJ - What's 'cartoonish' about Stackelbeck's article?

Well, perhaps I'm being too harsh, but if it were straight reportage, he shouldn't be turning phrases like "these two brutal regimes", and when he goes to say

the alliance presents a united front in the face of what is perceived as a common threat posed by the U.S. Taken separately, China and Iran are formidable regional powers. However, when taken together, they become an unstoppable and influential force on many levels.

This is not to say that the two regimes are all sweetness and light, but when you start tossing those kinds of words in a piece, I think Wile E. Coyote.

Note how he gives himself an out at the end
Perhaps all of these agreements are designed merely to marginalize the U.S. and improve the negotiating position of both China and Iran -- no one knows for sure.

but the impression I get is that he imagines our way of life is going to be threatened, bizarrely enough, because "Iran’s need for consumer goods to satisfy its young, West-leaning population". I also note the "axis" in the title, which I presume is designed to echo the axis of evil. Furthermore, there is the invocation of the
“Shanghai Five,” the group now includes China, Russia, Tajikistan, Kazakhstan, Kyrgyzstan and Uzbekistan. Iran’s acceptance into the group would create an even more diverse and powerful alliance.

followed immediately by the

Unfortunately for the United States, a large part of the foreign investment in Iran’s energy infrastructure has come from the European Union and Southeast Asia. Signaling a possible fissure in U.S. efforts to further unite the world community against Iran’s Islamic regime, while at the same time dissuading energy development, France, Italy, Germany, Canada, Britain and Japan have all signed development and exploration contracts with Iran.

Yet again, we are the thin red line preventing the destruction of civilization as we know it, which seems a bit, well, cartoonish.

At least as far as Iran goes, "brutal regime" is pretty much a straight report on the facts.

I don't doubt this for a second. I also have some faith in capital markets to bring about a fairly equitable exchange of wealth (YMMV).

I don't! Capital doesn't care how many people it's screws over as long as it gets the highest possible return rate. Markets like Money make good servants & lousy masters.


My problem is that Bush has made all the wrong choices and can't even keep the freaking status quo when it comes to American economic power.

The last time someone that incompetant came to power, Millions died.

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