Month: December 2008

Yes, But WE’RE Above Average

My former employer has published a survey of business people around the world conducted in early November. It’s not particularly surprising, but I especially liked this chart (free registration required), according to which a plurality (39% to 38%) of North American companies think that their profits this fiscal year will be better than last fiscal year. (The “current” fiscal year ends sometime between November 2008 and October 2009, so in most cases it includes the steep part of the downturn.) The global numbers are 38% up and 43% down.

Maybe being an executive at a large company selects for unnaturally optimistic people. I’ve always suspected that there is a significant, quantifiable optimism bias to the statements of business people, even their private ones. (Their public ones, of course, are colored by the desire to positively influence their stock price, which can lead to some interesting results.) It’s something I’ve thought of studying but never had the time for. If anyone knows of any research, let me know.

The Importance of China

So, the global economy is falling apart, but not in the way people expected. Under the de facto arrangement sometimes known as “Bretton Woods II,” emerging market countries pegged (officially or unofficially) their currencies to developed world currencies at artificially low rates, having the effect of promoting exports and discouraging consumption by emerging market countries and promoting consumption and discouraging exports in developed countries. Of course, the classic example of this was China and the U.S. The U.S. trade deficit and Chinese trade surplus created a surplus of dollars in China, which were invested in U.S. Treasuries and agency bonds, keeping interest rates low and indirectly financing the U.S. housing bubble and consumption binge of the last decade (and, therefore, growth in Chinese exports).

The general fear was that U.S. indebtedness would lead China to diversify away from U.S. assets, causing the dollar to fall and U.S. interest rates to rise, hurting the U.S. economy and making it harder to finance the national debt. This may yet happen someday. But instead of demand for Treasuries collapsing, it’s been demand for every other type of asset that has fallen. Treasury yields have collapsed and the dollar has appreciated about 20%. Still, despite this increased purchasing power, the fall in U.S. (and global) consumption is having a severe impact on growth of the Chinese economy. Even though the Chinese government has signaled that it will do everything in its power to keep growth above 8% per year (down from 11-12% in the past few years), the slowdown has severely constrained the ability of the urban manufacturing sector to absorb internal migration from the countryside, and there are signs of a reverse migration that is aggravating the problem of rural poverty in China. Although China may seem to have all the cards – high economic growth, large foreign currency reserves – it could yet turn out to be a major loser of the global economic crisis.

This is of course just a brief introduction. For more I recommend Brad Setser, among others: some of his posts are here, here, and here.

The Lawsuits Begin …

OK, there are probably other lawsuits already. But now a hedge fund is suing Countrywide (Bank of America), claiming that its loan modification program violates contract law and that if Countrywide wants to modify any mortgages it must buy out the existing investors at face value.

This is one aspect of the “securitization problem” that got a lot of air time on this blog a few weeks ago.

More Signs of Monetary Expansion

With the Federal Reserve’s main policy tool, the Fed funds rate, past the point of diminishing returns (although the target rate is 1%, the actual rate has been well below that for weeks), there are more signs that the Fed is willing to use new tools to stimulate the economy. Fed Chairman Bernanke’s speech today spelled out quite clearly (no more Greenspan-speak here) what the plan is (emphasis added):

Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve’s quiver–the provision of liquidity–remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand. Indeed, last week the Fed announced plans to purchase up to $100 billion in GSE debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. . . .

Second, the Federal Reserve can provide backstop liquidity not only to financial institutions but also directly to certain financial markets, as we have recently done for the commercial paper market. Such programs are promising because they sidestep banks and primary dealers to provide liquidity directly to borrowers or investors in key credit markets. In this spirit, the Federal Reserve and the Treasury jointly announced last week a facility that will lend against asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. . . .

Expanding the provision of liquidity leads also to further expansion of the balance sheet of the Federal Reserve. To avoid inflation in the long run and to allow short-term interest rates ultimately to return to normal levels, the Fed’s balance sheet will eventually have to be brought back to a more sustainable level. The FOMC will ensure that that is done in a timely way. However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.

There have been a number of articles in the last week on the shift toward quantitative easing, and in particular the fact that the Fed is no longer sterilizing all of its liquidity injections (compensating for them by selling Treasuries to suck up cash). Here’s one from FT Alphaville with some nice graphs.

In their Real Time Economics post a week ago, Simon and Peter argued that this is precisely what we need. However, opinions differ – some fear that the increased long-term risk of inflation outweighs the benefits of monetary stimulus now.

Next MIT Class on Global Crisis: Tuesday, December 2nd

Tomorrow, Tuesday December 2, at 4:30pm (please note special start time for this week), we will webcast our next MIT class on the global crisis.  The session will run until 7pm, as usual, with a break around 5:30pm.

This is the last class on the crisis that we will broadcast & record, at least for now.  (There will also be a class on Tuesday, December 9, which will review the crisis to date; I’ll post summary materials but that session will not be recorded.)

On December 2nd, I plan for us to cover the following topics:

  1. The Citigroup Bailout, including whether this is or is not good value for the taxpayer (search this website for Citigroup to see readings).  Robert Rubin’s interview with the Wall Street Journal on Saturday is also essential reading (the WSJ article requires a subscription; the blog naked capitalism provides a free summary and some reactions worth discussing.
  2. The situation in Europe, which continues to worsen.  We’ll review the latest developments in the real economy and indications of various kinds of pressures (think: Italy, but the UK, Spain and other countries may well come up).
  3. Prospects for global financial system reform.  We can see fairly clearly the strategy of President-Elect Obama’s team with regard to fiscal policy, and we can infer some implications for monetary policy.  But what is their likely global strategy, with or without the IMF?  How does this fit with what the rest of the G7 or emerging markets or any other influential players want?  Can we see a full overhaul of the global system coming soon?  If not, why not?  (Search for Global Reform on this website for readings.)

Feel free to post questions here or email to us, through this website.  We’ll cover as many as possible in the classroom discussion.

Details on the webcast and some potentially useful background follow: Continue reading “Next MIT Class on Global Crisis: Tuesday, December 2nd” →