House Testimony Today

This morning I testified before the House Committee on Foreign Affairs’ Subcommittee on Terrorism, Nonproliferation, and Trade, chaired by Brad Sherman.

My written testimony is available through the Peterson Institute for International Economics’ website.   I was asked to provide a perspective on the global economic outlook, so my testimony previews our next Baseline – we’ll release that when we see the G20 outcomes (i.e., from ministers of finance and central bank governors) this weekend.

In my interactions with the committee members, I stressed three points that connect our view of the outlook with the upcoming G20 discussions this weekend.

1. The financial sector should be thought of at this stage as a type of undefused bomb. We might be able to live with it for years or it could be a more immediate issue. There is nothing I see in anyone’s G20 agenda that even begins to address this; the “regulation” pieces proposed by Europe will make essentially no productive progress in the right direction.

2. The financial problem is much worse in Europe than in the United States, because (a) banks are larger relative to GDP in Europe, and (b) they have major problems with bad loans (from US property, European property, East European property and more). We have banks that can claim to be Too Big To Fail. Europe has banks that may be Too Big To Rescue. Sadly, therefore, most European countries don’t have room for further fiscal stimulus – they need to prepare to help out their own bank depositors, as well as weaker EU and eurozone member countries; putting all available resources into a European Emergency Stabilization Fund should be the priority.

3. In this context, I support Secretary Geithner’s call yesterday for $500bn in additional resources for the IMF (i.e., they would go from being able to lend $250bn currently to potentially lending $750bn; I called for $1trn in the fall, so we are getting there). But this should be seen as the backstop in case the Europeans drop the ball, particularly for smaller eurozone countries. I don’t know how likely that is (ask me again after the weekend), but more money for the IMF is smart contingency planning – what else are you going to do?

In the broader discussion before the committee, what really struck me is how angry people are about our trading partners’ behavior (including China, but also Europe, Latin America, and other parts of Asia were mentioned).  There may be some good specific reasons to be unhappy, but I worry about the fragility of global trading relationships under the pressure we face today.

Update: typo in name of committee corrected, and name of chairman added.

20 thoughts on “House Testimony Today

  1. For 40 years, Friedmanomics has told us that when foreign countries subsidize exports, our rational response is to say “thank you”. When they impose tariffs, our best response is to do nothing.

    This has always seemed dumb to most people, especially those losing jobs.

    Now we find ourselves in a rather horrid situation. The immediate issue (immediate being last 15 years) is lax financial regulation.

    But many people point to deeper issues. Part of the housing problem is due to bad underwriting, but part is due to the fact that while house price increases have exceeded long term trends, real median incomes have been below long term trends. People are taking on too much debt, but is this because they’ve become lazy and frivolous or because they have no choice as living costs rise and salaries stay flat?

    And many people lay the blame at unregulated globalization – unfair trade practices, and unfair labor practices within trading partners.

    Within the US, those people who want lower wages think globalization is a grand thing; “free trade” becomes a lever to take down domestic wages. Those who see their jobs being offshored? Not so much…

    As with subsidies and tariffs, Friedmanomicons argue viciously against a linkage between “free” trade and anything bad. They can easily construct a model that shows how free trade is always good – and all of these models are frail little things that easily fall apart.

    So in short, a lot of Congressmen – and a LOT of their constituents – think we’ve been duped by 40 years of Friedmanomics into letting our trading partners kill us.

    Still others (far right) think we’ve been duped by economists into believing we can artifically control the money supply when the only true money is a gold standard. (ugh, don’t get me started)

    Maybe they’re just looking to displace blame on others… Or maybe they’re right.

    But now we have this awful spectacle… the people who’ve been brutalized by the free market mantra – who lost their jobs and houses along the way – see this the curtain pulled back:

    All the people who BENEFITED from the free market mantra – financiers, hedge funds, bankers – when it’s their turn to face up to the rules of their own game… what happens?

    For decades, when blue collar workers lose jobs, the banks scream “free markets!”, but when the bankers are threatened?

    They get bailed out.

    So think about it: Why shouldn’t they be mad? Really mad! They just saw 10 years of their life savings – thousands of hours they spent away from their kids and families so they could save for a house or retirement or college – vaporized. And their kids are being indebted to pay off bankers who stashed billions in the good times.

    Why should they listen to anything that economists have to say, when economists have been so dead wrong on so many things? A lot of America is deeply, deeply suspicious of professional economists, yet they are also scared because they know they don’t understand what is going on around them – so they feel they have no choice but to listen to people they don’t like.

    I suspect that many Americans are going along with this bank plan only because Obama has put his personal credibility on the line.

    The anger does not shock me at all, though it may shock the other residents of building E52.

    It’s bad out there Professor Johnson. People are really, really angry. And scared. And, to borrow an often-abused phrase: It’s going to get worse before it gets better.

  2. A quick note (plea?) regarding policy discussion in the new baseline:

    There is little discussion of velocity of money as it relates to perceived risk, which seems to be emerging as a key theme. Krugman has taken up this theme in his repeated discussion of the Zero Bound and “stashing money in the mattress”.

    Fed is increasing base money, but overall credit (and asset values) may still be declining, resulting in decreased wealth and spending power.

    The increase of base money (which can be leveraged) with a lag in credit supply creates the _potential_ for inflation, without actual inflation.

    At the same time, further increases in the money supply cause more _potential_ for inflation without actual inflation. If the Fed keeps pumping in money which stays on the sidelines, we become increasingly vulnerable to a rapid inflationary response when events reach a tipping point.

    In the short term, the (apparent) inability of the Fed to exert leverage over this dynamic creates enhanced risk of falling asset values, along with concomitant bankruptcies that are driving increased losses among financial institutions.

    In the long term, it creates enhanced risk of serious inflation.

    The Fed is trying to control multiple things (inflation, asset values, credit) with one instrument. Money supply is a blunt instrument, however, and so we see Bernanke begging for fiscal stimulus (which is not internationally contagious as you note).

    It seems as if the Fed would benefit from some sort of policy instrument that provides more direct control over the velocity of money.

    The Fed has managed without this for many years during which the “Maestro” (Greenspan) carefully manipulated expectations of inflation. Indeed, the ability to manipulate expectations served as the needed policy instrument. (It worked because everyone believed it would work.)

    The Fed has lost that ability. It needs a new direct instrument to exert more precise control over the velocity of money (and hence expectations for inflation, which vary wildly depending on who one talks to).

  3. I had an interesting discussion with my barber today about interest rates. Our general conclusion was that no sane person would invest at less than 1% for 1 year (better cash in the mattress) or not borrow at the rates offered over the last decade or so. While not quantitatively precise, our conversation nevertheless reflects the so called wisdom of a decade of monetary policy.

  4. I read your testimony and found it sobering, not surprisingly. Looking ahead: if the results of the financial stress tests are not credible, and pressure on the banks’ stocks intensifies, will Treasury continue the policy of dribbling in the money to feed the zombies? It seems like that’s the “solution” the politics dictates.

  5. I want to make it crystal clear. We in the US cause this global crisis.

    We in the US made all the mistakes. Starting with excessively low interest rate under Greenspan. This cause the housing bubble. Our citizen got greedy and gladly participated. Some are navie and some tried to make a quick bucks. Of course let’s not forget our mortgage brokers pushing this stuff to fellow countrymen. We than spread the problem all around the world using financial tools such as CDS, CDO, etc.

    Now this whole thing blows up. The whole world suffers. The people in the emerging market suffers the most because they have a lot less to start with. Furthermore, they work hard and they saved too! For god sake, their society don’t even have decent social safety net such as unemployment insurance!

    I think a more positive attitude would be to take responsibility for our mistakes and help the world out of the trouble we’ve created.

    We collectively have no right to complain; unless you only want to be a fair weather American.

  6. one difference being that a much larger portion of europe’s population is unbanked – and even if they are banked, tend to have maintain unbanked deposits of wealth – if they may be better prepared to ride out a banking crisis given their experience with them:

    “…In China and India, only about a third of the population participates in the formal banking sector. In Africa, the number is just 25 percent. India has the second-highest number of financially excluded households in the world – 135 million – after China’s 263 million. Africa as a whole has 230 million unbanked households. Central and Eastern Europe and Latin America have 19 million and 42 million respectively…”

    it would seem the swiss are doing their bit – providing some relief by devaluing the franc

    but with all due respect, how on earth does giving the imf more money and power help? if you can better explain this

    undefused bomb can be used to describe an airplane…

  7. Many Americans would rather disagree with this. Some notable points:

    1) The Fed alone does not drive interest rates in the US. For instance, throughout the late 1990s, Japan has ridiculously low interest rates vs. the Fed. International banks were thus able to borrow Yen cheaply, convert to dollars (helping to prop up the dollar) and extend cheap credit in the US. Since the US controls neither the Japanese rates nor the cap/asset ratio requirements for Japanese banks, it was hard to stop this, and it magnified the financial crisis.

    Read up on: dollar yen carry trade

    2) The persistent US trade deficit (unlike the federal deficit) cannot be laid at the feet of greedy US consumers. Much of it was because of artifically low foreign currencies. Certainly the Yuan (China), and some may argue the Yen. The argument is that US trading partners use mercantilist mechanisms to boost exports to support domestic growth, while the US ignorantly sees its stock of wealth depleted.

    While the US bears the blame for many of the world’s problems, Europeans and others are excessively self-righteous to claim that this is an American crisis. Their banks are at least as poorly regulated (and highly leveraged) as US banks, and some of them are downright criminal – knowingly and deliberately aiding and abetting US criminals in hiding assets and evading taxes.

  8. StatsGuy, you mean in other words, someone put a gun to the US consumers’ head to spend and to buy houses they can’t afford and just be generally irresponsible?! It is always someone else to blame isn’t it? Us poor Americans, woe is me.

    I think many more reasonable Americans have a different take. Low interest rate helped US recover from the tech bubble (another problem cause by American) and 9/11. Low import kept inflation in the US in check for the last decade and general raise the entire society’s standard of living.

    To put bluntly, you are being a whinny, ungrateful and irresponsible.

    StatsGuy, it is your kind of attitude that defines the term “ugly American” and as an American I find it exceedingly insulting.

  9. No – what I actually mean is the dollar is going to be devalued. Period. It’s coming, one way or another. It could be sooner, and less painful, or later, and a lot more painful.


    And when it does, our lnders will discover that “bad loans” come in many forms, and that maybe it wasn’t in their interest either to keep lending to the US to maintain their export-subsidizing policies. Right now, our neighbors are lobbying very heavily against dollar devaluation.

    Particularly with the spectacle of Senator Clinton begging China to keep buying T-bills, and beggaring human rights in the process, one must wonder who is wielding power in D.C. Even so, China is in a quandary…

    If they sell their T-Bills now, they might see the prices they can get drop. And even then, what do they choose to own instead?

    If they keep buying to keep the price of T-bills up (and interest rates low), they see even more exposure.

    It’s the old saying – if you owe the bank a million dollars, it’s your problem. If you owe the bank a billion dollars, it’s the banks problem. Our debt is so big that it’s becoming China’s problem too.

    As to your rant against American consumerism:

    I am trying to explain why people are mad. You can choose to be sympathetic or unsympathetic. The perceptions I described are widely held.

    Many people share blame for this crisis – US voters and consumers among them. And certainly economists as well.

    But if you wish to blame the US for all the world’s ills – as if no other countries are jointly at fault – then you clearly are missing half the picture and/or you have an agenda.

  10. No, you are still wrong.

    Let me be crystal clear on what I have a problem with. I have a problem with people like yourself that blames others for our failures. In fact, not just blame others but twist past history where we’ve clearly disproportionally benefited into somehow others deeply wrong us!

    Your response is just unbelievable. China is now financing the recovery of our economy. The nicest response you got “what do they choose to own instead”?! Wow, gracious you are not! At least you didn’t again complain that they kept interest rate low to hurt us!

    I don’t blame the US for all the world’s ill. The US has done many great things and we live by great ideals. We are confident in ourselves and when we’ve err, we admit it and we fix it.

    Honestly, don’t try to spin. My reply is directed precise toward the attitude you take in your write up. Bush has already greatly damaged our image in the world.

    The attitude in your write up will only make it worse. No, your attitude is NOT widely held.

  11. With all due respect, I would rather China stop financing the US. I see no reason whatsoever to be grateful for this. Let the dollar devalue to its natural state vs. the Yuan (instead of being artificially supported for over a decade); the Fed can finance the stimulus through QE. Resulting inflation would reflate asset prices and reduce net indebtedness that are bankrupting the finance system, households, and the government – and destroying spending power. The only risk is current account deficits due to energy (oil); this can be mitigated through demand management and bilateral negotiations with OPEC to set a long-term price target ($70 per barrel) would would benefit both the US _and_ OPEC.

    Nor do I fault China for anything other than foolishly agreeing to finance the US to support its mercantilist export policies. Yet China is blaming the entire crisis on the US:

    China accepts none of the blame itself. Its stance is “It’s the fault of the US for accepting our loans and letting us keep the Yuan devalued.” No one obligated China to buy US treasuries, or keep the Yuan undervalued.

    China is trying to pursue its own national interests, as it should. The US, likewise, should pursue its national interests (for a change) – which does not include allowing its children to become further indebted.

    It’s the same question regarding mortgages…

    Who’s at fault, the lender who shouldn’t have borrowed, or the underwriter who should not have lent?

    Letting the economy crumble to prevent T-Bills from losing value is protecting lenders at the expense of future US generations. It is that simple.

    The ostensible reason for continuing to borrow money to finance the fiscal stimulus is to “keep interest rates low”.

    Uh… keeping interest rates low does not appear to be helping the world economy.

    China is doing the US no favor by continuing to buy debt. In the long run, it is doing itself no favor. I see no reason why US citizens should thank China for creating these severe distortions.

    Having said that, China is only one piece of the crisis – the US bears a lot of responsibility as well, as does the world financial system, and European banks, etc… If you participated, you’re at fault.

    Yet you seem to insist that it’s those dumb, stupid, lazy, greedy Americans who are _entirely_ at fault.

    As to my assertion that many people in the US blame China, well…

    Frankly, I am a moderate on this issue. But I do understand the anger being expressed throughout the country. If we do not take rational measures to fix the currency/trade imbalances, we may yet see rising protectionism.

  12. You seem eager to assert that I am mis-representing US public opinion…

    NBC News/Wall Street Journal Poll conducted by the polling organizations of Peter Hart (D) and Bill McInturff (R). April 21-24, 2006. N=approx. 500 adults nationwide.


    “When it comes to China, is the United States too tough, about right, or not tough enough in our business and economic negotiations with China?”


    Too Tough About Right Not Tough
    Enough Unsure
    % % % %
    4 18 57 21

    CNN/Opinion Research Corporation Poll. July 27-29, 2008. N=1,041 adults nationwide. MoE ± 3 (for all adults).

    “Do you consider China to be an economic threat to the United States, or not?” N=527, MoE ± 4.5 (Form A)


    Yes, a
    Threat No, Not a
    % %
    7/27-29/08 70 30

  13. “Having said that, China is only one piece of the crisis – the US bears a lot of responsibility as well, as does the world financial system, and European banks, etc… ” – StatsGuy

    Still cannot admit us Americans are MAINLY at fault for this crisis? Damn it, us poor Americans are always the victim!

    You never took a economics course did you? Have you ever travel outside of your town, city, state? You sure are full of shit on matters of economics.

    OK, just so you are not confuse on what I am insisting on. I insist you are an irresponsible, ungracious, fact twisting, dumb and ugly shit bag.

  14. StatsGuy, do you have adult attention-deficit disorder too?

    The issue I have is your attitude that us Americans are not PRIMARY responsible for this crisis. Furthermore twist history to suit your argument. It is this kind of weaselly, whinny attitude that is a disgrace to all Americans.

    I’ve point this out in every post you’ve made on this thread. Yet, I suspect you do have AADD! So far, all you’ve done is twist and spin!

  15. Hey, StatsGuy, you are right. Your devalue the dollar idea is simply marvelous!! I should have read it more carefully!!

    Let’s devalue the dollar and inflat our problems away! Let’s screw every country that traded with us. Screw anyone who use the US dollar for trade. Screw anyone who lend us money. Never mind the credit worthness of of good old US of A. Cause we’ll never borrow a dime again! We are so tire of the foreigners getting their dirty paws on our pretty dollar bills anyway!! Screw them!

    While we are at it, let’s screw our freeloading seniors that live on fix income. They are useless anyway. Let’s also decimate the real value of everyone’s bank account. The stock market and the housing market clearly didn’t do a complete job!!

    hey, forget all the high ideal like honor and trust. We didn’t ask people to trust us, did we?! Anyhoo, it is their fault for being nice.

    Hey, what can I say. Time is tough. Let’s have a depression party to celebrate the renaming of our country to USZ, the United State of Zimbabwe! Yeah!! USZ , number 1, screw everyone!!

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