Joseph E. Stiglitz, “Thanks to the Deficit, the Buck Stops Here”

Sunday, August 30, 2009

Beware of deficit fetishism.

Last week we learned that the national debt is likely to grow by more than $9 trillion. That’s not great news — no one likes a big deficit — but President Obama inherited an economic mess from the Bush administration, and the cleanup comes with an inevitably high price tag. We’re paying it now.

There are no easy options. When financial crises strike, economic growth declines and living standards drop, resulting in lower tax revenues and greater need for government assistance — all of which leads to higher fiscal imbalances.

What really matters is not the size of the deficit but how we’re spending our money. If we expand our debt in order to make high-return, productive investments, the economy can become stronger than if we slash expenditures.

There are other consequences, however, that we’re missing in the debate over all this red ink. Our budget deficit, as well as the Federal Reserve’s ballooning lending programs and other financial obligations, will accelerate a process already well underway — a changing role for the U.S. dollar in the global economy.

The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback’s role as a reliable store of value around the world. Right now, with so much unused capacity in the American economy and so much unemployment — likely to persist for at least another year or two — the more pressing worry is deflation (a general decrease in prices), not inflation. But as the economy eventually recovers, the possibility of inflation will loom, and with forward-looking markets, worries about the future often play out in the present. Anxieties about future inflation can lead to a weaker dollar today.

So, are these anxieties justifiable? And what do they portend for the global financial system?

The worries are justified, even though Fed Chairman Ben Bernanke, recently nominated for another four-year term, assures us that he will deftly manage monetary policy to keep the economy on an even kilter. This is a tough balancing act — move too quickly or too vigorously, and you plunge the economy into another downturn; too slowly or too weakly, and inflation can be unleashed. Anyone looking at the Fed’s record in recent years will be skeptical of its forecasting skills and its ability to get the balance right.

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America cannot resolve global imbalances on its own

America cannot resolve global imbalances on its own

By Fred Bergsten and Arvind Subramanian

Published: August 19 2009 22:29 | Last updated: August 19 2009 22:29

Warren Buffett, “The Greenback Effect”

The Greenback Effect, New York Times

August 18, 2009

Warren Buffett

IN nature, every action has consequences, a phenomenon called the butterfly effect. These consequences, moreover, are not necessarily proportional. For example, doubling the carbon dioxide we belch into the atmosphere may far more than double the subsequent problems for society. Realizing this, the world properly worries about greenhouse emissions.

The butterfly effect reaches into the financial world as well. Here, the United States is spewing a potentially damaging substance into our economy — greenback emissions.

To be sure, we’ve been doing this for a reason I resoundingly applaud. Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.

To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.

Because of this gigantic deficit, our country’s “net debt” (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.

An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

The current account deficit — dollars that we force-feed to the rest of the world and that must then be invested — will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients — China leads the list — to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased.

Then take the second element of the scenario — borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it is issuing. Washington’s printing presses will need to work overtime.

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Andrew Edgecliffe-Johnson, “Manufacturers feel ‘hardship’ of China currency”

Manufacturers feel ‘hardship’ of China currency, Financial Times

By Andrew Edgecliffe-Johnson in New York

Published: August 14 2009 21:52 | Last updated: August 14 2009 21:52

China is becoming a less attractive place for manufacturers, who are feeling the “hardship” of the country’s undervalued currency, according to the head of Samsung’s digital camera division.

Samsung Digital Imaging, which manufactures in China, had not enjoyed the benefits of Korea’s competitive currency, said Park Sang-Jin, its chief executive.

“The yuan is greatly devalued [so] we had a hardship from the currency,” he told the Financial Times in an interview in New York.

“China still makes sense, but any manufacturers who are keeping manufacturing facilities in China start pointing out the changes in Chinese government policy and the currency devaluation.”

Mr Park’s comments come amid an intense debate on the impact of China’s currency policies, a rising outsourcing trend and intensifying competition between low-cost manufacturing hubs.

AlixPartners, a consultancy, said in May that in the previous six months there had been “significant change” in China’s position in the low-cost country rankings, with Mexico now surpassing it for certain components and China’s “total, fully landed costs” just 6 per cent lower than the cost of manufacturing the same parts inside the US.

“The conditions are getting worse for maintaining our manufacturing facilities” in China, Mr Park said, noting that some Japanese manufacturers were now looking at Vietnam as an alternative location.

“As a global player, we always review our options. We will keep our competitiveness under whatever circumstances,” he said, noting that Samsung had already moved mobile phone production to Vietnam, where it has long produced televisions.

The digital imaging business had held no such talks with Vietnam, a Samsung spokesman said.

Mr Park’s comments came as he unveiled a new range of products that reflect the extent to which the growth of social networking sites is changing the camera business.

One, the TL225, features a second LCD display on the front of the camera, to meet what Mr Park called the “unmet need” of teenagers wanting to take pictures of themselves for their Facebook or MySpace pages.

“They take a lot of self-portraits shots, but they’re not so sure they’re in the frame and well-focused,” he said.

“Lifestyles are changing very quickly,” Mr Park said, highlighting the falling numbers of people who print out their photographs.

Mr Park predicted a “quick recovery” to 2008 revenue levels for the industry next year as consumers resumed travel plans put on hold by the economic slump.

Samsung would increase its global market share in digital imaging from GfK’s current estimate of 11.3 per cent, partly thanks to its largest marketing campaign yet, aimed at building up its brand in the camera business to the same level of recognition it enjoys in flat screen televisions and mobile phones.

Timothy F. Geithner, “The United States and China, Cooperating for Recovery and Growth”

The United States and China, Cooperating for Recovery and Growth
Treasury Secretary Timothy F. Geithner
Speech at Peking University – Beijing, China
June 1st, 2009

http://www.treas.gov/press/releases/tg152.htm

It is a pleasure to be back in China and to join you here today at this great university.

I first came to China, and to Peking University, in the summer of 1981 as a college student studying Mandarin. I was here with a small group of graduate and undergraduate students from across the United States. I returned the next summer to Beijing Normal University.

We studied reasonably hard, and had the privilege of working with many talented professors, some of whom are here today. As we explored this city and traveled through Eastern China, we had the chance not just to understand more about your history and your aspirations, but also to begin to see the United States through your eyes.

Over the decades since, we have seen the beginnings of one of the most extraordinary economic transformations in history. China is thriving. Economic reform has brought exceptionally rapid and sustained growth in incomes. China’s emergence as a major economic force more fully integrated into the world economy has brought substantial benefits to the United States and to economies around the world.

In recognition of our mutual interest in a positive, cooperative, and comprehensive relationship, President Hu Jintao and President Obama agreed in April to establish the Strategic and Economic Dialogue. Secretary Clinton and I will host Vice Premier Wang and State Councilor Dai in Washington this summer for our first meeting. I have the privilege of beginning the economic discussions with a series of meetings in Beijing today and tomorrow.

These meetings will give us a chance to discuss the risks and challenges on the economic front, to examine some of the longer term challenges we both face in laying the foundation for a more balanced and sustainable recovery, and to explore our common interest in international financial reform.

Current Challenges and Risks

The world economy is going through the most challenging economic and financial stress in generations.

The International Monetary Fund predicts that the world economy will shrink this year for the first time in more than six decades. The collapse of world trade is likely to be the worst since the end of World War II. The lost output, compared to the world economy’s potential growth in a normal year, could be between three and four trillion dollars.

In the face of this challenge, China and the United States are working together to help shape a strong global strategy to contain the crisis and to lay the foundation for recovery. And these efforts, the combined effect of forceful policy actions here in China, in the United States, and in other major economies, have helped slow the pace of deterioration in growth, repair the financial system, and improve confidence.

In fact, what distinguishes the current crisis is not just its global scale and its acute severity, but the size and speed of the global response.

At the G-20 Leaders meeting in London in April, we agreed on an unprecedented program of coordinated policy actions to support growth, to stabilize and repair the financial system, to restore the flow of credit essential for trade and investment, to mobilize financial resources for emerging market economies through the international financial institutions, and to keep markets open for trade and investment.

That historic accord on a strategy for recovery was made possible in part by the policy actions already begun in China and the United States.

China moved quickly as the crisis intensified with a very forceful program of investments and financial measures to strengthen domestic demand.

In the United States, in the first weeks of the new Administration, we put in place a comprehensive program of tax incentives and investments – the largest peace time recovery effort since World War II – to help arrest the sharp fall in private demand. Alongside these fiscal measures, we acted to ease the housing crisis. And we have put in place a series of initiatives to bring more capital into the banking system and to restart the credit markets.

These actions have been reinforced by similar actions in countries around the world.

In contrast to the global crisis of the 1930s and to the major economic crises of the postwar period, the leaders of the world acted together. They acted quickly. They took steps to provide assistance to the most vulnerable economies, even as they faced exceptional financial needs at home. They worked to keep their markets open, rather than retreating into self-defeating measures of discrimination and protection.

And they have committed to make sure this program of initiatives is sustained until the foundation for recovery is firmly established, a commitment the IMF will monitor closely, and that we will be able to evaluate together when the G-20 Leaders meet again in the United States this fall.

We are starting to see some initial signs of improvement. The global recession seems to be losing force. In the United States, the pace of decline in economic activity has slowed. Households are saving more, but consumer confidence has improved, and spending is starting to recover. House prices are falling at a slower pace and the inventory of unsold homes has come down significantly. Orders for goods and services are somewhat stronger. The pace of deterioration in the labor market has slowed, and new claims for unemployment insurance have started to come down a bit.

The financial system is starting to heal. The clarity and disclosure provided by our capital assessment of major U.S. banks has helped improve market confidence in them, making it possible for banks that needed capital to raise it from private investors and to borrow without guarantees. The securities markets, including the asset backed securities markets that essentially stopped functioning late last year, have started to come back. The cost of credit has fallen substantially for businesses and for families as spreads and risk premia have narrowed.

These are important signs of stability, and assurance that we will succeed in averting financial collapse and global deflation, but they represent only the first steps in laying the foundation for recovery. The process of repair and adjustment is going to take time.

China, despite your own manifest challenges as a developing country, you are in an enviably strong position. But in most economies, the recession is still powerful and dangerous. Business and households in the United States, as in many countries, are still experiencing the most challenging economic and financial pressures in decades.

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Peter Garnham, “Speculation grows over dollar’s turning point”

Speculation grows over dollar’s turning point, Financial Times

Peter Garnham

Published: August 11 2009 19:31 | Last updated: August 11 2009 19:31

Just a week after the dollar hit its lowest level for 10 months, the main talking point in FX markets is whether the US currency is about to strengthen.

The change of sentiment has been sparked by last week’s US payrolls report, which saw far fewer job losses in July than expected. This strengthened the view that the US is past the worst of its recession and that its economic recovery could precede that of Europe and Japan.

“Markets are in a flurry of debate about whether Friday’s US payrolls data marks an inflection point for FX, whereby good US economic news starts to benefit rather than hurt the dollar,” says Ray Farris at Credit Suisse.

Hans Redeker at BNP Paribas says there are signs that the US economy has responded positively to the massive US fiscal and monetary stimulus, thus reducing the risk premium for holding US assets.

“The introduction of quantitative easing in March has let the performance of the dollar diverge from the guidance of real interest rate differentials,” he says.

“Now, as the economic outlook has stabilised, the relative yield and interest rate differentials should regain their impact on currency markets.”

Others are hesitant to call an end to the trend of dollar weakness, given that the currency’s rebound has been based on its reaction to a single piece of economic data.

“If there is a shift, it’s at a very embryonic stage,” says Neil Mellor at Bank of New York Mellon.

But if the dollar does continue to rise, it would mark a very significant development given the pattern of trading that has tended to characterise the currency markets since the onset of the financial crisis.

This has seen the dollar benefit from haven demand when equities, and hence risk appetite, have fallen.

In contrast, the dollar has lost ground when stocks and investor confidence have risen as investors abandon the relative safety of the US currency in search of higher returns elsewhere.

Thus as equities hit their highest level of the year last week, the dollar index, which tracks its progress against a basket of six major currencies, fell to its lowest level since October.

This correlation has led to the perverse situation where the dollar has fallen on better US economic data and rallied when news from the US has disappointed.

This pattern seemed to break down last Friday after the US employment report. The positive surprise generated a predictable rise in equity markets and a surge in US Treasury yields. The dollar also strengthened.

Todd Elmer at Citigroup says this was a rare event indeed, since over the past 18 months, S&P gains of 1.7 per cent or more were associated with moves higher in the dollar index of 1 per cent or more on fewer than four occasions.

One key reason for the dollar rebound was that US interest rate expectations surged on the jobs data, moving to price in 130 basis points of monetary tightening over the next 12 months.

But the question for investors now is whether this is the start of a more concerted trend in which a rebound in US growth supports the dollar.

“We have argued for some time that higher US bond yields, as long as they are associated with stronger growth rather than increasing worries about the US fiscal position and potential for the monetisation of debt, were good for the dollar,” says Adarsh Sinha at Barclays Capital. Several factors will determine whether this happens, he says.

First, the dollar’s rise last week came at a time when oil prices were moving sideways. Mr Sinha says the dollar remains vulnerable to any rise in the price of oil.

Second, the outcome of Wednesday’s Federal Reserve meeting will be crucial to the dollar’s fate.

If the Fed remains dovish, the strength of the dollar may prove temporary, says Mr Sinha. Conversely, it might continue to strengthen if the central bank announces no extension to its asset purchase programme and sounds more upbeat on the US economy.

“This would likely be dollar positive and may herald a period where positive news for US yields continues to support the dollar as long as it is associated with stronger activity data and a muted response in commodity markets,” he says.

But not all analysts are convinced of the significance of Friday’s move, especially since it was not the first time in recent months that the dollar had rallied following a stronger-than-expected US jobs report. Indeed, it last occurred following the release of the US employment report for May, which was released on June 5.

On that occasion the dollar’s gains proved short-lived, partly because talk of an early increase in Fed interest rates quickly faded.

Callum Henderson at Standard Chartered believes the move this time is just a short-term phenomenon reflecting stretched positioning prior to the figures.

Bets on further dollar weakness – short dollar positions – were at their highest level since June 2008, according to positioning data from the Chicago Mercantile Exchange, going into the jobs report. Thus when the dollar pushed higher, the move was exaggerated as traders were forced to cover their losses and buy dollars.

“Clearly, the market was short of dollars going into the figures, but there is no case for the Federal Reserve to raise interest rates,” says Mr Henderson.

He says the fact that the present crisis started in the US means the US economy is likely to emerge last from the present downturn and the Fed the last to tighten monetary policy.

Mr Henderson believes US interest rates are likely to remain on hold until 2011, keeping the dollar under pressure in a repeat of the price action that followed aggressive Fed easing in 2001. “The dollar fell sharply from 2002 to 2004,” says Mr Henderson. “The dollar is going to grind painfully lower over the next couple of years.”

http://www.ft.com/cms/s/0/37a9a3de-869f-11de-9e8e-00144feabdc0.html

“Exchange rates threaten Asian exporters,” Financial Times

“Exchange rates threaten Asian exporters,” Financial Times

By FT reporters

Published: August 10 2009 17:37 | Last updated: August 10 2009 17:37

Unexpectedly upbeat economic data in recent weeks have boosted Asia-Pacific currencies against the dollar, causing governments to worry that rising exchange rates may hurt exporters.

Surging investment in stock markets in South Korea, Taiwan and Thailand has also strengthened currencies.

Anxieties are particularly high as the renminbi, which does not trade freely, has remained stable against the dollar, giving Chinese exporters an advantage over Asian rivals.

The won this month hit its strongest level since October, recovering to Won1,216, supported by statistics suggesting the South Korean economy was regaining its footing.

In March, the South Korean won hit an 11-year low of 1,574 to the dollar, capping months of decline even as Seoul put billions of dollars into the won’s defence, with foreign reserves dropping $27.4bn or 11 per cent in October.

However, much of this recovery in Asia’s fourth biggest economy is founded on large conglomerates and government pump-priming. Smaller enterprises, which account for 90 per cent of jobs, are still vulnerable to the won’s strength.

Kwon Goo-hoon, economist at Goldman Sachs, said the central bank could intervene by rebuilding foreign reserves, which dropped 11 per cent last October, and loosening regulations on Korean Investment Corp, National Pension Service and others seeking to invest abroad.

Overseas money has poured into shares in Taiwan on hopes of better relations with China, putting upward pressure on the Taiwan dollar. “The fact that Taiwan’s foreign exchange reserves hit another record high in July suggests that the central bank has been intervening in the foreign exchange market quite aggressively,” said one economist.

The rise in the New Zealand currency is more worrying given the small nation derives close to a quarter of its gross domestic product from exports.

The competitiveness of New Zealand’s dairy, lamb and wool exports has been undermined by a 28 per cent rise in the Kiwi against the US dollar in the last six months.

The New Zealand Manufacturers’ and Exporters’ Association this month warned the strength of the currency would cost jobs and called on the central bank to lower rates further. The central bank governor said further rate cuts could be on the cards if the NZ dollar kept rising.

The Bank of Thailand responded to the baht’s rise by last week saying it would allow Thai corporations with assets of at least Bt5bn ($149m, €105m, £89m) to invest overseas to a limit of $50m (€35m, £30m) without approval, and more with specific clearance.

Commenting on the currency’s rise, Thanyalak Vacharachaisurapol of the Kasikorn Research Centre in Bangkok said: “It is a combination of fundamental factors, particularly the current account surplus, and the funds flow into the stock market as hot money that was pulled out of the stock market earlier in the year starts to flow back in.”

Reporting by Christian Oliver in Seoul, Peter Smith in Sydney, Robin Kwong in Taipei and Tim Johnston in Bangkok

Rebalancing the world economy: China-The spend is nigh, The Economist

Rebalancing the world economy: China-The spend is nigh, The Economist

Jul 30th 2009 | HONG KONG

A REBALANCED global economy requires America to consume less and save more. That means the world’s three big surplus economies—China, Germany and Japan—will have to save less and spend more. None is under more scrutiny than China, whose vast current-account surplus has been fingered by some as the ultimate cause of the financial crisis. The case against China is exaggerated but a surplus of more than $400 billion in 2008, or 10% of GDP, was clearly too big. Can China right its trade imbalances, and if so, how will it achieve rapid growth in future?

The good news is that the surplus is already shrinking. The strong rebound in China’s economy in the second quarter—pushing GDP 7.9% higher than a year ago—came entirely from domestic demand. This sucked in more imports, while exports continued to slump. China’s merchandise trade surplus narrowed to $35 billion in the same quarter, 40% down on a year earlier. Yu Song and Helen Qiao of Goldman Sachs calculate that the decline is even more impressive in real terms (adjusting for changes in export and import prices), with the surplus shrinking to less than one-third of its level a year ago (see chart 1). They even suggest that a monthly trade deficit is possible within the next year.

Another way to look at the huge swing in China’s trade is that net exports (exports minus imports) contributed 2.6 percentage points of the country’s GDP growth in 2007, but shaved almost three points off its growth in the first half of this year.

Most economists think that China’s trade surplus will remain large. The jump in imports in the second quarter included heavy stockpiling of commodities, which will not last; copper imports, for example, were 150% higher than a year ago. Yet the underlying surplus is clearly shrinking. Paul Cavey of Macquarie Securities forecasts that China’s current-account surplus will fall to under 6% of GDP this year and 4% in 2010, down from a peak of 11% in 2007. Exports amounted to 35% of GDP in 2007; this year, reckons Mr Cavey, that ratio will drop to 24.5%.

On the surface, therefore, China is fulfilling the long-standing demand of Western governments that it shift its engine of growth from exports to domestic demand. Thanks to the biggest fiscal stimulus and loosening of credit of any large economy, China’s real domestic demand is likely to grow by at least 10% this year. In fact, the popular perception that China has always relied on export-led growth is rather misleading. Its current-account surplus did soar from 2005 onwards but until then was rather modest. And over the past ten years net exports accounted, on average, for only one-tenth of its growth.

The problem is more that the mix of domestic demand between consumption and investment is unbalanced, and becoming even more so. In 2008 private consumption accounted for only 35% of GDP, down from 49% in 1990 (see chart 2). By contrast, investment had risen from 35% to 44% of GDP. This year the bulk of the government’s stimulus is going into infrastructure, further swelling investment’s share. Chinese capital spending could exceed that in America for the first time, while its consumer spending will be only one-sixth as large. This is China’s most glaring economic imbalance.

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