By Simon Johnson
The Greek government owes more than it can afford to pay, now or in the near future, at market interest rates. There are two options: reduce the payments through some form of restructuring, or move the debt into the hands of people who are willing to charge below market rates for the foreseeable future.
In this decision, the International Monetary Fund has relatively little say – this is really a political decision to be made by the European Union, with discrete backing from the US and China. Continue reading
By Simon Johnson
Most accounts of the ministerial meeting last weekend of the Group of 20 — 19 nations plus the European Union that represent the world’s wealthiest economies —implied that it continued to perform sterling service – heading off currency wars, keeping explicit protectionism under control and deftly managing the process of reforming governance at the International Monetary Fund.
Post-financial crisis, middle-income countries continue to rise in economic importance, and the recent shift in global leadership from the Group of 7 (the United States, Canada, Britain, Italy, France, Germany and Japan) to the G-20 is commonly supposed to accommodate the growing claims of “emerging markets” on the world stage.
This interpretation is correct as far as it goes, but it also misses the main story, which is that emerging markets have two primary goals that are increasingly at odds with each other. These goals – to hold large stocks of American dollars and to stave off a flow of capital from abroad – add up to wanting to retain the emerging markets’ recently achieved status of collective net creditors (i.e., being owed more than they owe). Unfortunately, this contributes to the serious vulnerability of the world economy as we head into the next credit cycle. Continue reading
By Simon Johnson
The G20 communiqué, released after the Toronto summit on Sunday, made it quite clear that most industrialized countries now have budget deficit reduction fever (see this version, with line-by-line comments by me, Marc Chandler and Arvind Subramanian). The US resisted the pressure to cut government spending and/or raise taxes in a precipitate manner, but the sense of the meeting was clear – cut now to some extent and cut more tomorrow.
This makes some sense if you think that the global economy is in robust health and likely to grow at a rapid clip – say close to 5 percent per annum – for the foreseeable future. With high global growth, it will matter less that governments are cutting back and unemployment will come down regardless. Taking this into account, the IMF is actually predicting (as cited prominently by the G20) that budget “consolidation” actually raise growth over a five-year horizon.
There is no question that some weaker European countries, such as Greece, Portugal, and Ireland, had budget deficits that were out of control. Particularly if they are to pay back all their foreign borrowing – a controversial idea that remains the conventional wisdom – these countries need some austerity. But what about those larger countries, which remain creditworthy, such as Germany, France, the UK, and the US? If these economies all decide to reduce their budget deficits, what will drive global growth? Continue reading
Posted in Commentary
Tagged China, g20
By Simon Johnson. This post is taken from testimony submitted to U.S.-China Economic & Security Review Commission hearing on “US Debt to China: Implications and Repercussions” – Panel I: China’s Lending Activities and the US Debt, Thursday, February 25, 2010. (Caution: this is a long post, around 1500 words; a summary of some key points will appear on the NYT’s Economix this morning.)
China is the largest holder of official foreign currency reserves in the world, currently estimated to be worth around $2.4 trillion – an increase of nearly $500 billion in the course of 2009 (on the back of a current account surplus of just under $300 billion, i.e., 5.8 percent of China’s GDP, and a capital account surplus of around $100 billion). These reserves are accumulated through arguably the largest ever sustained intervention in a foreign exchange market – i.e., through The People’s Bank of China buying dollars and selling renminbi, and thus keeping the renminbi-dollar exchange rate more depreciated than it would be otherwise.
China is also currently the second largest holder of US Treasury Securities – at the end of December 2009, it held $755.4 billion – just behind Japan (which had $768.8 billion).
The US Treasury data almost certainly understate Chinese holdings of our government debt because they do not reveal the ultimate country of ownership when instruments are held through an intermediary in another jurisdiction.
The week between Christmas and New Year’s is probably a good time to throw out half-baked ideas on topics I don’t know much about.
First, there’s been a lot of talk about the “lost decade” for stocks. The S&P 500 is below where it was a decade ago. Dividend yields bring you back up to break-even (the Vanguard Total Stock Market Index Fund had average annual returns of 0.18% for the ten years through the end of November, and that’s after about 0.1% in expenses), but inflation sets you back a couple of percentage points per year. (Vanguard’s S&P 500 index fund, however, was negative over those ten years.) James Hamilton, drawing on data from Robert Shiller, has some thoughts on why the stock market did badly; the fundamentals were so-so, but the big factor was that valuations were at their historical peak at the beginning of the decade.
“World Bank Chief Economist Justin Yifu Lin staked out a strong position against forcing China to let its currency appreciate as a way to rebalance the world economy.
“’Currency appreciation in China won’t help this imbalance and can deter the global recovery,’ he said in a lecture Monday at Hong Kong University.
“In an interview after the lecture, he said other countries shouldn’t intervene to keep their currencies cheap to boost their export sectors, calling it the ‘equivalent of protectionism.’”
You can read the rest at Real Time Economics. No, it doesn’t make more sense — except possibly as an expression of China’s policy.
By James Kwak
President Obama leaves next week for a high profile trip that includes meetings with other “Asia-Pacific” countries (in the APEC forum) and a visit to China. The President has had considerable diplomatic success on the economic front to date, including at the G20 summit in April and – to a lesser degree – at the follow-up September summit in Pittsburgh.
But the issues facing him now in Asia are particularly difficult, primarily because of China’s exchange rate policy. China essentially pegs its currency (known as the yuan or renminbi) against the US dollar, which means that it rises and – most recently – falls in tandem with the greenback.
Many countries operate de facto pegs of this nature, but China is problematic for three reasons: it is a large economy (10 percent of world GDP, if we adjust for purchasing power), it runs a big current account surplus (exporting more to the world than it buys from the world, in the range of 6-12 percent of the Chinese economy), and it consistently has a bilateral surplus with the US that is galling to many on both sides of the aisle on Capitol Hill (and their constituents). Continue reading
We’ve been at first amused but more recently alarmed at how “global imbalances” are becoming many people’s preferred explanation of the financial crisis. At first you could brush it off this way: “global imbalances (read: ‘blame China’) . . .” But this explanation is going mainstream, not least because it is always more convenient for policymakers and bad actors to blame someone far away. For example, Dealbook (New York Times) kicked off a roundtable on the causes of the financial crisis this way:
“There is a conventional view developing on the financial crisis. The Federal Reserve’s policy of historically low interest rates spurred a worldwide search for higher risk and return. Concurrently, the entrenched United States trade imbalance led to a huge transfer of dollar wealth to Asian and commodity-based countries. The unwillingness of Asian economies, particularly China, to stimulate their own domestic consumption led these countries to reinvest the proceeds into the United States. This further contributed to lower American interest rates and further fueled the search for return.”
(Mortgage securitization gets mentioned, but only in the fourth paragraph!)
Simon and I took this on in our Washington Post online column this week, but I thought it was interesting enough to repost here in full, below.
The time is here for our nation to actually do something about the recent financial crisis — that is, do something to prevent it from happening again. But instead, many people are finding it easier to pass the buck than to, say, regulate the financial sector effectively.
The recent Group of 20 conference in Pittsburgh was replete with talk about “global imbalances,” which means — in the spirit of the “South Park” movie — “blame China!”
This post was written by StatsGuy, a regular commenter here and very occasional guest contributor. We asked him to expand on the ideas he put forward in this comment on the relationships between monetary policy, international capital flows, and bank capital requirements.
Former Fed Chairman William McChesney Martin is most famous for his notorious quip that the job of the Fed is to “take away the punchbowl just as the party gets going.” It seems this has evolved into a full fledged theory of monetary management.
Unfortunately, structural problems – like trade imbalances, inadequate capital ratios, and weak financial regulation – severely constrain Fed monetary policy options by impacting currency flows and the value of the dollar. (Some specific mechanisms are listed in the previous comment.)
Why does this matter? Because it means the Fed cannot use monetary policy as effectively to keep the country going at full throttle and avoid a prolonged fall in utilization rates (unemployment and idle machines). How can it be that capacity utilization is still lower than at the bottom of the 81/82 recession and we’re ALREADY raising the bubble/inflation alarm? (Paul Krugman discusses this here, and the answer is that the output gap is itself defined against neutral inflation, not just capacity utilization.)
The usual concern about the US-China balance of economic and political power is couched in terms of our relative international payments positions. We’ve run a large current account deficit in recent years (imports above exports); they still have – by some measures – the largest current account surplus (exports above imports) even seen in a major country. They accumulate foreign assets, i.e., claims on other countries, such as the US. We issue a great deal of debt that is bought by foreigners, including China.
There are some legitimate concerns in this framing of the problem - no country can increase its net foreign debt (relative to GDP) indefinitely without facing consequences. And the Obama administration, ever since the Geithner-Clinton flipflop on China’s exchange rate policy early in 2009, seems quite captivated by this way of thinking: Will they buy our debt? Can we control our budget deficit? What happens if China dumps its dollars?.
The reason real to worry about China, however, has very little to do with external balances, China’s dollar holdings, or even capital flows. It’s about productivity and rent-seeking. Continue reading
On Monday and Tuesday of this week, Treasury Secretary Geithner – and Secretary of State Clinton - meet with a high-level Chinese delegation. (Could someone please update the Treasury’s schedule of events? At 7am on Monday it still shows last week’s agenda; update, 9am, this is now fixed – thanks).
According to official previews (i.e., the apparent contents of background briefings given to wire services), the economic topics are China’s concerns about the value of the dollar (i.e., their investments in the U.S.) and the amount of debt that the U.S. will issue this year.
This is absurd. Continue reading
On his China visit, Secretary Geithner is immediately on the defensive. The language he is using on the Chinese policy of exchange rate undervaluation-through-intervention is the mildest available. And the commitment he is making, in terms of bringing down the US deficit – which we all favor – is an extraordinary thing to put numbers on in a foreign capital. Such commitments are of course unenforceable, but still the wording indicates – and is understood by China – great US weakness.
Not surprisingly, China seems likely to push for more. Their main idea is that some part of their US dollar holdings be transfered to a claim on the International Monetary Fund, which would shift it from being in dollars to being in Special Drawing Rights – and therefore a claim against (a) the IMF’s whole membership, and (b) presumably, the IMF’s gold reserves.
This is a bad idea. Continue reading
At his confirmation hearing in January, Tim Geithner nailed the China Question. China prevents its exchange rate from appreciating through intervention (buying foreign currency), and this allows it to sustain a large current account surplus. Geithner said, as plainly as you can expect from a senior official: this is not in accordance with international rules and should stop.
Not only is this sensible economics and correct on the rules, it is also good politics. If you want to head off the considerable inclination towards protectionism in Congress, it would help greatly for the Chinese renminbi to rise in value (e.g., review the discussion at this House hearing).
But almost as soon as Geithner spoke on this issue, there was slippage. By late February, Hillary Clinton was asking the Chinese nicely to continue holding US Treasury securities and, it now seems, punting the exchange rate issue. Above all else, China wants to be left alone on the renminbi – variously arguing that any appreciation would jeopardize jobs, derail growth, and plunge the country into chaos.
So what should we expect from Geithner’s upcoming China trip? Continue reading
I’m warming up for a longish Beginners-style article on government debt, which will come out next week or so. In the meantime, the New York Times has an article today about China’s diminishing demand for U.S. dollar-denominated debt. Theoretically this could make it harder for the U.S. to borrow money and thereby push up the interest rates on our debt (now at extremely low levels).
China’s voracious demand for American bonds has helped keep interest rates low for borrowers ranging from the federal government to home buyers. Reduced Chinese enthusiasm for buying American bonds will reduce this dampening effect.
However, the article doesn’t mention one compensating factor. The fall in China’s buildup of its foreign currency reserves is linked to the rise in the U.S. savings rate, which is projected to rise to as much as 6-10% (it was over 10% in the 1980s). Some of that new savings will go to pay down debt, but a lot will go into savings accounts, CDs, money market funds, and mutual funds – which means that depresses interest rates across the board. On the back of the envelope, 6% of personal income is about $600 billion a year in new domestic savings to compensate for reduced overseas investment. Whether this will be enough to compensate entirely I don’t know. But if we were all one global economy in the boom, we’re still one global economy in the bust.
We’ve gotten some comments to the effect that, for all the discussion of the financial crisis and the various bailouts, we haven’t looked hard at the underlying causes of the financial crisis and accompanying recession. The problem, as I think I’ve hinted at various times, is that any macroeconomic event of this magnitude is overdetermined, on two dimensions. First, there are just too many factors at play to identify which are the most important: in this case, we have lax underwriting, lax bond rating, skewed incentives in the financial sector, under-saving in the U.S., over-saving in other parts of the world, insufficient regulation, and so on. How many of these did it take to create the crisis? There is no good way of knowing, because the sample size (one, maybe two if you add the Great Depression) is just not big enough. Second, there is still the conceptual problem of identfying the proximate cause(s). To simplify for a moment, we had high leverage which made a liquidity crisis possible, and then we had the downturn in subprime that made it plausible, and then we had the Lehman bankruptcy that made it a reality. Which of these is the cause? Leverage, subprime, or Lehman?
In any case, we’re not going to resolve these issues. But I want to start an occasional series of posts looking at one of the root causes at a time.
Today’s topic was inspired by this week’s meetings between U.S.-China meeting in Beijing, where, according to the FT, “the US was lectured about its economic fragilities.”
Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” he said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”