naked capitalism

Richard Kline says:

What I see in your comment, Anon of 7:46, is the problem of self-reference. You look at present conditions, they look much like conditions of a month ago, and not seriously unlike conditions of a year ago, and the determination is “All systemes go!” When the present circumstance is compared with other historical instances, the resulting perspectie is sharply divergent.

Here is the money paragraph to me from elsewhere in Das’ piece: “Sovereign debt crisis, especially in emerging markets, are characterised by high levels of debt, especially foreign borrowings, poor fiscal policies, persistent trade deficits, a fragile financial system, over-investment in unproductive assets and a sclerotic political system. Arturo Porzecanski (in Sovereign Debt at the Crossroads (2006)) noted that: “Governments tend to default specifically when they must increase spending quickly (for instance, to prosecute a war), experience a sudden shortfall in revenues (because of a severe economic contraction), or face an abrupt curtailment of access to bond and loan financing (e.g. because of political instability). He further observed that: “governments with large exposures to currency mismatches and interest rate or maturity risks are, of course, particularly vulnerable.” ” _That_ picture by and summary well describes the US of A as of 2008. Other comparable contexts ended in major social and political whackage. Well, my fellow citizens, if the ass fits, wear it.

It is not ‘different this time’ even if the same good times are what those in the midst of them mostly, selectively see. The best inference is that for the US and it’s currency, it is exactly the same this time as for others other times, only moreso. Das makes another very relevant point also elsewhere in his article, that debt service may be managed initially, but eventually reaches a level where it is politically unsustainable even before it becomes economically unsustainable. This is perhaps the most likely scenario for the US, we spin the hampster wheels of debt service on our $10T, $12T, $15T owed, while foreign currency holding shares for the $ drop to 50% and then below . . . and then we skip on a bond, and the world is made new and strange. This all may change not with a bang but a simper. What’ll we do when our creditors fail to applaud?

Anonymous says:

“Many global currencies are pegged to the dollar. The link is sometimes at an artificially low rate. At a minimum, the US will at some stage have to pay higher rates to finance its borrowing requirements.”

The inverse of the first statement is that the dollar is valued at an artificially high rate. International demand for dollar reserves holds the dollar’s external value higher, and U.S. interest rates lower, than they would be if the dollar were only a minor component of forex reserves.

In Richard Kline’s insightful comments, I would differ with the “bang but a simper” formulation. It’s more likely to be a ‘chaos theory’ scenario, such as determining when one last grain of sand on a sandpile will cause an avalanche.

Political arrangements can have tremendous inertia. The Ottoman empire was widely considered to be decadent on the eve of World War I, but it had soldiered on for decades in that condition. Similarly, the U.S. dollar was made the central reserve currency in Bretton Woods I because the U.S. constituted 50% of global GDP in the war-torn world of 1946. Six decades later, U.S. troops remain in Europe and the dollar remains the principal reserve currency, despite a transformation of Europe’s security situation for the better, and of the U.S. dollar’s fundamentals (both the closing of the gold window in 1971, and the chronic current account deficit now) for the worse.

Predicting when the dollar’s “unclothed emperor” plight will suddenly attract unfavorable comment is as tough as forecasting the top tick for crude oil. It could go on for decades, or end at 3 a.m. tomorrow. Both presidential candidates are saying that they will escalate the war in Afghanistan. This surely implies continued inflation (in the 5 to 10% range) and continued dollar weakness for the foreseeable future. It also implies rising current account deficits which will need to be financed.

Dollar crisis is a wild card. But the dollar’s postwar crises have occurred in wartime — the demolition of Bretton Woods I (1968-1973) during the Vietnam War; the recent bout of weakness during the Iraq War. Continuing the foreign imperial wars is like playing Russian roulette with several bullets in the chamber. One day, something goes bang, and it’s “Goodbye, Uncle Buck.” The wheels of economic justice grind slowly, but the result is certain.

Bob_in_MA says:

I don’t think anyone really has any idea how exactly this will play out, but the first poster’s sanguine attitude echoes those predicting as recently as 18 months ago “a leveling off to sustainable levels” of the housing market in the US, or those making the same prediction about the UK just a month or two ago.

I think Soros had it right when he characterized the last 20 years or so as a giant credit bubble. And there are a lot of silly truisms that have seemed to be repeatedly confirmed over that period. One of my favorites is, “never underestimate the American consumer’s willingness to spend.” As if income and access to credit had nothing at all to do with it, it was simply a matter of attitude.

The sanctity of the dollar and US debt is a sure thing–up until the point when it isn’t any longer…

Michael McKinlay says:

The current unwinding of leveraged debt positions will continue unabated as our monetary system of fractional reserve banking will shrink by the multiples by which the money was created.

Today the rules are being bent backwards to float these insolvent financial institutions.

But, at some point when new debt can no longer be created the system crashes rendering almost all debt uncollectable.

The only hope is a Public Central Bank that is the arbiter and guarantor of all credit and that creates such credit from future revenue streams of taxation so as to create money without debt.

The bankers will crash the financial system or cry for war before they allow this to happen.

Anonymous says:

If foreigners dump their dollars, the effect will be to devalue the dollar and push up inflation accordingly. Inflation is good for borrowers and bad for lenders. Most of the US debt is not inflation-indexed, so the value debt will decline in real terms. If the fed does not stem the inflation, the effect will be to bail out the US govt on the backs of its debt holders. It’s happened before. Meanwhile US goods will become cheaper on the world market and imports will become more expensive, leading to a significant shift in the trade deficit.

On the other hand, as Buffett points out, foreigners may choose to buy Rockefeller Center and land in Hawaii and US companies at ridiculous prices. That’s happened before, too. Purchases of US companies are particularly good news for the US since often the assets are intangible. Let China buy Nike and Disney, say. They can have ‘em, we’ll make more.

Anonymous says:

Max -

Good grief. The point is that the US is short its own currency. It’s international position improves if the dollar weakens. And the balance on investment income is a subset of the current account. It is the net servicing requirement for the US external position. It is roughly in balance. That is a good thing. It is because the US earns more on foreign investment than foreigner investors earn in the US. You won’t find that in Wikipedia.

Shawn H says:

Anon 8:23p -

“the US is short its own currency…that is a good thing”

From the perspective of freezing the economy at some point in time, and screwing our creditors, yes, it’s a good thing for the USA. We tell China and OPEC to pound dirt and devalue/print.

Now what?

Read about life in Russia in the early 80s, when citizens were burning their currency in the winter because it was cheaper than wood. That should give you a pretty good idea of what comes next.

Anon 7:46 a.m. / 8:40 a.m. / 8:23 p.m. says:

Richard Kline:

A very interesting point re NIIP and nationalization.

First, let me be clearer on the two points I should have made about NIIP:

a) The NIIP as you know is the international component of the US balance sheet. TO THE DEGREE that the external position of the US represents an exposure, there is some correlation with the degree to which this international component represents a net liability position. It is a net liability position. But it is a smaller net liability position than one would infer by simply adding up the cumulative current account deficits of the US. Essentially, the long term investment performance of assets is better than that of liabilities. There are a number of reasons. E.g. the foreign investment performance of US multinationals; the fact that assets are weighted more toward US risk taking abroad whereas liabilities are weighted to “risk-free” (note quotes) treasuries and agencies; the fact that assets tend to be denominated in appreciating currencies such as the Euro and that liabilities tend to be denominated in dollars.

b) The income associated with NIIP (receipts and payments) is a component of the current account. TO THE DEGREE that this component is well behaved compared to the core current account exposure (the trade deficit), it is very important in determining the sustainability economics of the current account deficit. This component is well behaved. Even though the NIIP is a net liability, the net investment income is close to being in balance and in fact for a number of years was actually in surplus. The main reason is that the US earns more on its foreign assets than foreigners earn on their US assets, and this difference dominates the disadvantage of servicing a net liability position.

All of this represents a marginal advantage, other things equal, in the ability of the US to have sustained its current account deficit so far. For example, in response to an earlier anonymous comment, I never said that the depreciation of the US dollar was a good thing for the US dollar. What I did say was that, for a given or assumed depreciation in the US dollar, it is a good thing rather than a bad thing that one result is a favourable valuation effect on NIIP.

(Brad Setser wrote extensively about these technical aspects about a year ago.)

Now, you make a very interesting point re nationalization. You correctly assume I did not mean to infer this. But I must admit I’d need to think more about the point you’ve made. In the interim:

I posted this yesterday on Setser’s very interesting post (to which you referred and where you’ve made a comment as well):

1. anon Says:
July 24th, 2008 at 8:46 pm

Central banks finance the deficit at the exact point they buy the dollars that the US exports via the deficit. They buy treasuries and agencies because, essentially, they have nothing better to do with the money, and they must do something with it. The exchange rate policy is the preeminent one. It is the critical risk, more so than the funding pattern corresponding to the assets that are purchased with the dollars.

Brad responded:

bsetser Says:
July 25th, 2008 at 2:23 am

anon — technically, you are right. central banks buys dollars ( a us asset) when they intervene. after that they just shuffle between dollar assets. I don’t want to discount that reshuffling — a world where the official sector buys $1 trillion of us equity is different than a world where the official sector buys $1 trillion of us debt. and, of course, just ’cause you buy a dollar doesn’t mean that you hold a dollar — dollars can be sold for euros, if there is a buyer. but I agree that the key decision is the decision to step into the market to begin with and to purchase dollars.

Anon here: Unfortunately, this only brings me to the point of reiteration and technical convergence with your comment, which is more fundamentally geared. Sorry I have no more time to respond here. But I think the balance sheet dimensions in totality are very important to the issue of the likely path of resolution of all of this. It is important to know for example that the NIIP liability is about $ 1.5 trillion, that Gross’s latest estimate of mortgage losses is $ 1 trillion, that US household wealth is about $ 55 trillion (and declining), etc. etc. etc. The US is not a small country, and the foreign account is arguably the one with the greatest degrees of freedom as to how it will get resolved. This is not a small country that will suddenly fall off a cliff, although pricing action in FX and bonds may at points become abrupt (not the same thing as falling off a cliff). Finally, it is very important to know that foreign central banks have also brought this on themselves, to a very great degree.