Cognitive Dissonance and Global Macroeconomics

One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.

There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:

“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.

“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”

People agree what the biggest imbalance is: it’s over-consumption in the United States and over-saving in China, thanks to an artificially low renminbi/yuan, which creates an artificially high dollar.

Yet in the same statement, “Trichet said U.S. policy makers’ commitment to a strong dollar was important in keeping currency markets and the global economy stable, repeating a long-held position.” Separately, French finance minister Christine Lagarde said, “Everyone needs a strong dollar.” Tim Geithner, like every senior government official for decades, has been repeating that we have a “strong dollar policy,” whatever that means.

But if no one wants the dollar to depreciate — which is the standard solution to a trade imbalance — what does it mean to be against global imbalances? No one will come out in favor of tariffs. Using fiscal policy to encourage domestic sourcing of goods and services did not go over well with the Europeans. I guess that leaves exhorting Americans to buy less and save more, which is a little like asking Goldman to pay smaller bonuses.

So the EU complains about our huge trade deficits and overconsumption, yet at the same time (along with China) seems to desperately want us to continue to play that role. This is a convenient position, since it allows them to blame us  for the financial crisis, while continuing to export to us. (Germany, the largest economy in Europe, is surprisingly export-dependent, compared to the U.S. and the U.K.) Unfortunately, it’s also logically inconsistent.

By James Kwak (with a major assist)

45 thoughts on “Cognitive Dissonance and Global Macroeconomics

  1. Don’t have a link offhand, but I last week I heard or read someone saying about the “strong dollar” policy that it’s diplo-speak for “the US will not initiate a competitive devaluation”. Maybe Simon could comment on this?

    If so, what Trichet and Lagarde are really saying is that it would not be good for anyone if the US were to announce a policy of competitive devaluation.

    Talk of “global imbalances” is code for China’s peg to the dollar. True Germany runs a large current-account surplus but the Euro-zone as a whole is pretty well in balance.

    I think what the Europeans want is for the Fed to raise rates to parity with the ECB (around 1.5% I think) and for the Chinese to revalue by a significant amount like 20% or more.

  2. I do not think there is any cognitive dissonance.

    The problem the Europeans have is not dollar devaluation per se… It’s dollar devaluation combined with the yuan currency peg. The two together are putting unrelenting pressure on the odd man out; i.e., the Euro.

    Willem Buiter wants the ECB to just start printing. Which is precisely what they may do if the Chinese do not relax their peg.

    Of course, the only way to fix the glaring “global imbalance” is for the dollar to fall versus the yuan. Thus far, the PBoC appears unwilling to let that happen. And hilarity ensues.

  3. All the world is aligning in new orders to counter American hegemony. When we were a kindler, gentler nation, – a long long time ago, – the world adored America, and dependent on our excellent products. Now we are the largest trash contributor on earth. Our primary exports are toxic financial products and weapons.

    America has fallen. We have lost our way, our principles have been mangled and blurred, our laws tossed to the heap like old cabbage. The world is very methodically exiting the goodship America. No one benefits by any rash behavior, – but the writing is clearly on the wall. The future reserve currency maybe a bucketlist of currencies, or a currency/commodity mix, – but the dollar will be replaced. America on the present trajectory is NOT a good bet.

  4. Minor nits:

    ” I guess that leaves exhorting Americans to buy less and save more, which is a little like asking Goldman to pay smaller bonuses.”

    Americans are buying less and saving more, but Goldman is not paying smaller bonuses.

    Also, please do not say “cognitive dissonance” when you mean “inconsistency”.

  5. Germany exports mainly to other EU countries, and I think (someone correct me if this is not the case) the rest of the exports fall mainly outside the U.S.
    Also, how does the RMB/$ cross effect the EUR/$ one?

  6. It’s not the result of a mix message, it’s clear talk if you’re used to reading between the lines. The authorities want a new international architecture but they don’t want the dollar being devalued too quickly.

    So a gradual depreciation in the dollar, yes. But a sharp devaluation in the dollar, no. The first allows other components of the economy to adjust in time whereas the second implies a sharp movement in the nominal exchange rate and a protracted and painful change in the real/underlying rates.

    Stability and gradual change.

  7. If the imbalance problem was caused by American consumers buying too much, long term real interest rates would not have decreased to record lows, they would’ve increased, as these consumers would by fighting for limited funds. Instead, funds were almost limitless.

    Looking at the worlds trade imbalances, the issue is China, if China were to run a zero trade balance, then those of America, Australia, UK, New Zealand and Ireland would all be dramatically reduced (the situations facing these countries is a huge risk going forward). There were other influences including big OPEC and other EME savings over the past decade but these trends should be reversed as these countries hold plenty of reserves now and have much lower receipts now with lower oil prices.

    Now china is the major contributor to world economic imbalances. America is suffering from the N-1 problem and the only way out is for China to revalue. It would be perfectly fair to punish them with tariffs if they refuse to float their currency or run a balanced current account.

    What do they gain from holding their currency down? Some jobs, assuming the US will keep borrowing and buying their goods, these jobs probably ensure social order. In the meantime, they’re holding down the purchasing power of their population (which no democracy would get away with for long), and effectively giving a massive subsidy to their exports.

  8. They’re in a box.

    In order to keep the zombie financialized globalization system going over even the mediun-run they need to find a new consumer base, since the Americans won’t be able to continue infinitely borrowing and spending.

    Their dream is that emergent Asia will bring forth these infinite consumers, and that America will export to them. This is allegedly how America will still be able to “grow” in the future.

    So from this point of view the dollar must be devalued.

    The trouble is, even as they express this plan they know it’s a fantasy. China is playing out this charade of stimulus where further infrastructure (but not social safety net) building, including such constructive exercises as literally tearing down a perfectly good bridge in order to rebuild it and book it as “growth”, is supposedly going to loft a vast consumer class.

    Meanwhile everybody knows America won’t be able to rebuild a real export economy. Even if it were physically and economically possible, it’s not possible in terms of domestic politics. The entire system is absolutely dead set on going all in on the new stock bubble (and whatever other bubbles will arise from it), because government has been completely captured by the bank rackets.

    The same is broadly true of Western financialization. All of it depends upon maintaining the stronger dollar so that for the short run they can keep borrowing while they try to figure something out. But endless short runs equals nothing changing, ever, until reality forces the change.

    So China, America, Europe, and the international bodies are all pretending. They’re all talking about theoretical solutions where they might as well say Mars colonies will spur the new growth and stability, for how practicable it is.

    Thus the contradiction.

  9. It’s very difficult to blow a bubble in China. If you get around the capital controls, then for every dollar that you lend to a Chinese firm or family, the People’s Bank of China will lend a dollar to the US government. (One tool for keeping the Remnimbi down)

    Quite an expensive policy, as Barack Obama pays less interest than Chinese private borrowers. This is how the US net debt position is lower than the cumulated current account deficits.
    (See figure 19 )

  10. This will not end well for a least a few countries and their political class. Nation states are preparing for ‘war’ now (trade or otherwise), not co-operation.

  11. There actually is a lot of morbid humor in James Kwak’s post from my point of view. Hats off to the “baseline” reader who assisted on this slam dunk.

    First thing that is really funny: Imagining a French official insisting the world needs a strong U.S. dollar. This brings visions of some Hollywood satire with Steve Martin or Robin Williams holding a press conference in a French style power suit and their best French accent. “We must keep zee American dollaw up or zee werld is dooooomed”

    I can also tell you from years of experience that the Chinese are not going to do ANYTHING that they don’t see as beneficial to themselves (that includes their laughable role as “good cop” with North Korea). The Chinese government would see the entire world starve to death before doing ANYTHING that they saw as weakening their position. So whatever prognostications are made on this should keep that pragmatic Chinese mind set as a large part of the equation.

    As usual the final solution is shirk and shove all responsibility and accountability on the Americans and if they don’t get the answer they want from America, label USA nosey and arrogant. Works every time.

  12. The problem is that with a deficit based economy – ie with money created as debt by credit intermediaries – whoever provides the money supply for a growing global economy necessarily has a growing debt to the rest of the world – this is Triffin’s Dilemma.

    So no national currency works in the long term, although it’s a pretty amazing interest-free loan for the issuer in the short and medium term.

    The problem for a global currency created as an IOU – in the absence of global institutions, government and taxation (from which may God preserve us) – is what backs it.

    I think that it is possible to distinguish between the monetary function of a “Value Standard” and that of a currency object – a Unit of value customarily accepted in exchange.

    As I said here

    I think it is possible to use a fixed unit of energy as a Value Standard, and to adopt, units redeemable in different forms of energy as a globally acceptable reserve currency.

    By way of example, Iran, Qatar and Russia could lead formation of a global natural gas clearing union, and issue a few billion Units redeemable in payment for natural gas supplied.

    I suspect that China and Japan would prefer to join such a Union and to hold such Units in preference to the dollar. If so. then most international trade participants would soon be prepared to accept such units in settlement for transactions.

    Regionally fungible Units redeemable in electricity would also develop, as well as other Units redeemable in carbon fuels -for as long as we have carbon fuels. All of these would be priced by reference to the Value Standard, whatever that absolute amount of energy is, and it would be an amount towhich the avaerage person can relate.

  13. Dollar has declined quite a bit in the past few days and currencies like AUD, are quite high right now. The dollar seems to be headed south and it is not so much a question of whether or not it should depreciate, but only of how much it would depreciate.

  14. “Americans to buy less and save more”

    but at the same time they are told that they must buy more if they want the economy to get in gear again

    so what are they to do? do those nudging people to do both at the same time have any inkling that in a real world one is not compatible with the other?

  15. Germany’s exporting business:
    France 9.7%, US 7.1%, UK 6.7%, Netherlands 6.6%, Italy 6.4%, Austria 5.4%, Belgium 5.2%, Spain 4.4%, Poland 4% (2008)
    this is from your CIA, showing just 55 %
    – that means 45 % are going to more “interesting” countries
    this makes the “mainly to other EU countries” look a rather mmmh? claim, don’t you think so?

  16. ???
    they’re holding down the purchasing power of their population (which no democracy would get away with for long)

    colleagues who had been deployed to Japan for years on end told me the Japanese got away with it quite well – but maybe for example keeping the price of rice astronomically high doesn’t count as limiting purchasing power?

  17. Russ,
    Matt Taibbi at Rolling Stone said “cap and trade” will create the next bubble – what about that and is it related to big companies leaving your Chamber of Commerce in protest over its handling of “cap and trade” as our media tell me they do?

  18. I am most “amused” by combining Lagarde’s wish for the strong dollar with the wish to replace London with Paris as the capital of islamic banking which I translate as oil money banking
    this makes me wonder: do those bankers Paris wants to attract by presumably any means insist on the dollar remaining strong?

  19. I haven’t heard that the exodus from the C of C is over the possibility of a carbon bubble. I suppose if someone like Goldman is looking forward to extracting high rents from such a bubble (which GS certainly is) then they’d oppose the C of C’s attempt to rain on the parade by preventing a cap&trade from being instituted.

    As for utilities like Exelon, or corporations having nothing directly to do with energy or financialization like Apple, looking toward the same opportunities, and breaking with the C of C over that, I don’t know.

    It’s sad to say that, given how badly things have been going on the public interest front, something ulterior like that sounds more plausible than that they’re really worried about losing business over such an unsavory association, let alone that they’re doing it because it’s the right thing to do.

    One thing’s for sure, the ACES bill has practically no protections versus the blowing of a carbon bubble, and I haven’t heard that Boxer-Kerry is much better on that score, though I haven’t looked into the details yet.

    Since this came up I’ll take the opportunity to link to my blog post from last April on “Subprime Carbon”.

  20. thanks, Russ

    that’s how German “BBC” explains the goings on to us

    I haven’t heard that the exodus from the C of C is over the possibility of a carbon bubble

    the longer I hang out here the more I wonder if they do anything besides fantasizing with their so-called analyses

  21. Japan got away with it because in Japan purchasing power is much more evenly spread through the population.

    Also because they exported lots, and foreign money filled the deflationary black hole they had created.

  22. The carbon market is deficit-based and fundametally unworkable. It consists of monetising by political fiat something inherently worthless. No surprise then to see that it’s brought to us by the same people who brought us the Credit Crunch.

    There IS a bubble in carbon – ie oil – as there was last year, and it’s orchestrated by the same people. The mechanism is not the futures market – that is the tail on the market dog.

    The problem lies in the Brent/BFOE complex, where Brent/BFOE is the global benchmark (and WTI just an appendage through the arb) and you have to be in the physical/OTC market to avoid being pillaged.

    That’s why GLG are getting into the physical market, and why Oxy bought Phibro.

    The funds are essentially lending money to producers, and producers are lending oil to the funds, via GS and the rest. It’s fine so long as the benchmark “dated” Brent/BFOE keeps going up, and is supported.

    It’s in producers’ interests to keep the BFOE benchmark up because they price physical against it. But as final demand for product falls eventually the loss they take on their BFOE transactions becomes unsupportable and they stop.

    Collapse of bubble. The tin crisis of 1985 is a perfect example of this sort of macro manipulation . Copper/Hamanaka is another. See Mike Riess re modern market manipulation. Brilliant.

  23. Hmm good point, ok Japan is a good counterexample, I have to admit I know little about Japan.

    You can also look at the wage bargaining power for workers in China, which seems to be very low. This is also due largely to Government policy.

    Chinese corporate profits in 2007 were 22% of GDP. Much higher than the 9% of GDP in the US in 2007. I don’t know the figure for Japan, but I would assume it closer to the US (please correct me if this is wrong, it’s hard to find figures!)

    When you couple this with holding down the Remnimbi, I would suggest that overall the worker has very little purchasing power in China.

    I would think that this low purchasing power compared with high corporate profits and government savings would be a tough political sell in most western countries with competitive democracies.

  24. If it’s not too rude to mention it here, I really appreciate your blog Nemo. Good information. I especially like your info. on interest rates. That commercial for Microsoft Windows 7 had me laughing for days man. Hope you continue.

  25. “Americans to buy less and save more”

    Therein lies the rub. The American economy (and the worlds, for that matter) is based on consumption, with the middle class being the largest consumer base. Unfortunately, that base has been losing ground economically for the past 30 years as the “trickle down” economics theory has dominated our government. As middle class incomes struggled to keep up with inflation, consumer credit became a big business and we were encouraged to spend, spend, spend way beyond our means. Savings kept declining until we hit this current crisis. This reliance on middle class spending is one of the reasons the threatened failure of the financial industry triggered a government bailout.

  26. The EU and ECB just don’t get it… unless they take positive action, they are going to experience what the US experienced over the last 30 years. Extreme hollowing out pressure due to an overvalued currency.

    Why? Simple. Demand for the Euro as a reserve currency is rising. Note the following chart from Hamilton:

    The dollar’s depreciation is partly due to the trade deficit, but is also largely due to the collective worldwide decision that it is not longer a stable reserve currency (due, largely, to the trade deficit, which occurred because of the overvalued Dollar which resulted from inherent demand for the Dollar as a reserve currency and for internal economic use – dollarization). The Euro, meanwhile, is rising partly because of inherent demand to HOLD the Euro in reserves. If you extend the lines through late 2009, I recall the Euro’s rise accelerates.

    In other words, the ECB is exporting Euros, and these Euros have (as in the US) made real exports more expensive. The EU, however, is opposed to unilateral mercantilism (unlike China), and so believes that the strong Euro is a good thing.

    May they wear that albatross proudly.

    As to arguments that a weak dollar is bad for the US, let me note that the ONE major bright spot in recent economic reports is the narrowing of the trade gap.

    The only question is whether the global economy can support a US recovery through “export led growth”.

    As my daughter’s first grade reading book says in a story, it’s the Boomerang Principle in action:

    “Whatever you cast, whatever you brew,
    sooner or later, comes back to you.”

  27. Nemo, why do you think that the Yuan peg is the issue? The EU is suffering from a massive drop in exports to the US – that is the primary source of complaints from EU businesses, including the german business federation. Are you arguing that the Chinese market would rapidly supplant the US market as an export target for EU goods?

    Even if the Dollar falls vs. the Yuan/Renmibi (I still don’t know what to call it), there remains the issue of the EU’s ascendance as a reserve currency (noted in comment below). Any currency that is in the process of expanding circulation to support reserve holdings by foreign banks is going to suffer upwards pressure (some, like Reagan’s advisors, thought this was a good thing since it allows us to support an unstable level of consumption, but it comes at the cost of unnaturally gutting US industry).

    China saw what happened to Japan and is not eager to follow suit. Even if it re-pegs, that does not mean it will remove currency controls (which it uses to direct resources away from consumption focused activities).

    It is all the fashion to start quoting Keynes, Hume, and Friedman these days.

    People actually should be re-reading Jacob Viner.

  28. “Whatever you cast, whatever you brew,
    sooner or later, comes back to you.”

    that is the morality tale they fed us all but on and off I have been interested in what happened to property “acquired” during our 3rd Reich and I have come to the conclusion that the equivalent German saying of
    “unrecht Gut gedeihet nicht” (wrong property doesn’t flourish)
    in real life is more to the point as
    “unrecht Gut gedeihet sehr” (wrong property flourishes very well)

  29. China’s payoff for a weak currency is internal development, increased economic (and hence political) power, and, most importantly, acquisition of western technology in exchange for cheap $*&^ that immediately falls apart. It is Japan with natural resources and lots more people.

    A weaker dollar benefits globalized American companies. So long as ANYBODY accepts dollars internationally, the Washington Wall Street power structure remains in place. What no one seems to notice is that we are now MONETIZING the Federal Debt. One year T bills pay nothing, they are essentially Federal Reserve Notes. America is now on a Greenback standard with the Greenbacks issued to enable Wall Street gamblers rather than production and exchange. How long can this continue? Imagine that the stock market is being held aloft by a Treasury support operation. Stranger things have happened.

    Trade flows are interesting but financially they are minor. In America it’s always about the money.

  30. I think Europe wants to export to Asia. I think Europe does not want a flood of cheap Asian imports.

    But most relevantly, I think it is easier to compete against one nation with a shrinking currency than with two, thanks to this wonderful global system of ours.

    What the world needs is an orderly devaluation of the dollar relative to everything else. By not playing ball, China risks setting off a competitive devaluation game and/or a disorderly dollar decline. I believe this is what our friends in Europe are politely trying to point out.

    Incidentally, have you noticed how many countries are issuing dollar-denominated bonds lately?

  31. Let’s be honest. Countries are not there to make gifts to each other. Trade always has two sides to it. And now in this downturn the natural consequence will be protectionism which is already going stronger and stronger each single day. Increasing the problems is the free speculation in currencies (as Soros just pointed out). Gerald Celente predicts major geopolitical fallout in the next 12-18 months. I think he is right. No one can intentionally shed jobs — neither the democratic west nor the Chinese (the latter are also increasing the production gap and ripping the consumer while at the same time trying to implement conflicting policies to reduce the production gap and starting to nationalize a lot of their economy). So, ultimately, we could start to see blocs of countries rising barriers of trade, surrounded by smaller countries having total fallouts (eastern Europe, the Baltics etc.).

  32. What puzzles me is that during the 90s Asian crisis there were gigantic currency fluctuations and all eyes were on China, as their exporters were being disadvantaged. China didn’t engage in competitive devaluation, and consequently gained considerable respect.

    Today we see the RMB firmly pegged against the dollar since last summer. China again has the opportunity to “do the right thing” but has declined to do so, putting pressure not only on the Euro-zone but on many small economies. This article, In Recession, China Solidifies Its Lead in Global Trade by David Barboza gives some hints of the stresses that are resulting.

    Having lived in Japan 80s-90s, I’ve always been pessimistic about integrating China smoothly into the world economy. Events since the turn of the century have been discouraging to say the least.

  33. imbalances between countries and their economic holdings in other economies is not as problematic as the conscious devaluation of a country’s currency. take a look at what is being done to the american dollar. it will double our national debt, if you can believe it, if inflation hits.

  34. The problem with inflation expectations is that US officials have been laughed at by Chinese students. The whole world is anxious of US$ inflation. How can a democratic elite work against that? I doubt it — at least. But I don’t rule out hyperinflation, too. It just all depends on politicians and their unpredictable actions.

    The U.S. has shown that its government is not as arrogant as it once has been. It duplicated policies from Germany (cash for clunkers) and shows a much more consiliatory behaviour in global issues. Brazil has just started to fight currency speculation. I expect the US to follow just because there is the problem of inflated prices while the economy is still way down. They are already trying to intervene in the commodity speculation arena. Let’s see what will become of all that in the end. Many say that the US government is addicted to the banks. In front of what I just said, my guess is that this is not the case (any more).

  35. Just a consideration or two.
    Those fostering a strong Dollar policy probably have in mind its value against major currencies, i.e. the British pound or the Euro, not the Remimbi. This makes a major difference since obviously the value of the RMB against the Dollar is only dependent on the Chinese government’s will to adjust it. As a matter of fact, far from being expensive the US dollar is fundamentally quite cheap now and continues to depreciate. One could generally argue that the issue lies on the RMB side as opposed to the Dollar, and a weakening Dollar /RMB cross (reducing imbalance) can be simultaneously achieved with the greenback appreciating against major currencies.

  36. “The race is not to the swift;
    nor victory to the strong;
    nor honor to the wise:
    but time and chance happeneth to them all.”

    quoted from my failing feline memory.

  37. Just a small correction to your final argument: most of Germany’s export most likely stays within EU and eurozone

  38. if you add up this summary there remain 45 % unaccounted for – don’t you think a wee bit of these 45 % may go to countries you try to embargo?
    Exports – partners:
    France 9.7%, US 7.1%, UK 6.7%, Netherlands 6.6%, Italy 6.4%, Austria 5.4%, Belgium 5.2%, Spain 4.4%, Poland 4% (2008)

    once upon a time I had a closer look at those statistics on German government sites and since then I guess that this constant mantra that we are doing “it” only within the EU might be a bit misleading

  39. The EU wants China to appreciate against the dollar. Now the euro is taking the brunt of the adjustment costs in terms of appreciation.

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