Geithner blows up the world
January 22nd, 2009By David Goldman
Geithner’s comment today that President Obama believes that China is “manipulating the yuan” takes us straight into Great Depression territory. With Paul Volcker at his side, I had hoped that Obama would be perspicacious enough not to touch the third rail of global economics, namely protectionism. Nothing, absolutely nothing that Obama might have done could be worse than this. If the US looks at the global jobs market as a zero-sum game in which the US has to claw back manufacturing jobs which China has taken away, we are back to beggar-thy-neighbor and the 1930s.
Notice that the 10-year Treasury has backed up from a low of 2.05% to 2.65% today, even while the stock market and the economic outlook have cratered. During the past several days, the market has sold off essentially everything: stocks, credit, and Treasuries. Only oil and gold are up. The cost of credit protection on the leading sovereigns, including the US, has jumped. What is happening?
As I observed yesterday, the immediate risk to sovereign credit, the risk of Icelandization of Ireland and perhaps even the UK, lies in the banking crisis. If governments take over banks on the premise that their asset books are worthless but their liabilities must be met, the weight of bank liabilities is sufficient to sink government finances. It is the threat of bank nationalization and the likelihood that the US government will have to assume massive amounts of additional debt that is crushing the long end of the Treasury curve and forcing up the price of credit protection on the US sovereign.
The alternative, hinted at by Paul Volcker after the presentation of the Group of 30 recommendations on the banking system, would eliminate mark to market accounting, stop the writedowns at banks, and run banks on a cash-flow plus recovery basis. There is a sufficient base of viable assets to keep the banks in positive cash flow if financed at zero interest by the Fed, and effectively zero capital cover (since the banks really don’t have any capital).
All this presumes that the major creditors of the US, notably China, will continue to support the Treasury market in a huge way. A cynic might think that Geithner’s statement is designed to unleash a wave of speculation that China will revalue, leading to enormous capital inflows into yuan and Chinese government intervention, which would balloon Chinese reserves, and increase Chinese purchases of Treasuries. No-one in this business, though, is that subtle or that smart.
It appears simply that Obama is playing to his labor constituency. Resorting to protectionism could have cataclysmic consequences in the midst of a 1930s-style contraction of world trade. If China were to shift even a fraction of its reserves into gold, the consequences for the dollar would be frightening. We already are seeing hairline fractures in the street cred of the US Treasury, in the form of a LIBOR+75 cost of default protection as well as the violent backup in the long end of the Treasury curve. That should flash a red danger signal at the Administration.
The way out of the recession (might as well say depression) lies through Beijing, Francesco Sisci and I wrote in November. This is the worst economic news I’ve heard all year.
January 22nd, 2009 at 11:57 am
There are a loto of sounds of protectionism world-wide, and thus it seems very important to me that the new administration keep a distance from those sounds. Otherwise these could objectively feed all kinds of speculations in a already very volatile market. To me these statements seem to show that the new administration has not yet a clear idea on how it should face the crisis. David Goldman says, correctly I think, that Obama is playing to his labor constituency. If it is just a tactical, short term move then there is no real harm in it. It could be a problem if this rhetoric is picked up by other countries later on.
January 22nd, 2009 at 1:58 pm
David,
What’s your take on Peter Schiff? Does he oversimplify things or miss anything in his view?
January 22nd, 2009 at 2:01 pm
Mr. Goldman,
I am a big fan. Sorry if my question is a bit simplistic. I did not see the Geithner interview and I certainly understand the dangers of protectionism. However, in the article that you co-wrote with Mr. Sisci that you cited in your post, you state that:
‘Recovery requires a great change in the direction of capital flows…one goal of the Chinese partnership should be to re-orient cash flows towards China and away from the U.S.’
If Obama’s team did succeed in pressuring China to raise the value of the Yuan, wouldn’t that help change the direction of capital flows towards China?
Thanks.
January 22nd, 2009 at 2:04 pm
To me it is not why anyone would want to buy protection against a US government default via a 5 year CDS at 75bp when the financial claim, represented by a CDS is (most likely) against a US bank? Any thoughts on this would be very helpful. Guenter Leitold http://www.highyieldblog.com
January 22nd, 2009 at 3:04 pm
Buying protection on the US is a bit like buying life insurance from a fellow passenger on the Titanic. European banks probably are the main buyers, with other EUropean banks (implicitly European central banks) as counterparties.
January 22nd, 2009 at 8:55 pm
Sir,
Somehow, the kind of massive financial inflows of savings from poorer countries like China to fund U.S. consumption must be stopped; that is what has gotten us into this mess. The markets don’t seem able to do it. And the goods flow imbalance is just the mirror image of the financial flows imbalance. The only alternative would seem direct restriction of financial flows, and it matters little whether the goods flow or the financial flow is the locus of the restriction. Ghosts of Smoot-Hawley notwithstanding, and scarcy as it may be in the short run, a judicious dose of protectionism may be entirely appropriate from a long-run perspective.
January 22nd, 2009 at 9:15 pm
Once you scramble the egg, it’s hard to….
David, why not just do what Robert Mundell advocates, which is to print a massive amount of money for consumers to spend in a given amount of time and watch the Chinese try to sterilize all that. In the short term, it would promote jobs in the retail industry, and in the long term the Chinese would at some point be unable to sterilize the dollar without incurring a very high borrowing rate.
January 23rd, 2009 at 8:37 am
> This is the worst economic news I’ve heard all year.
It’s only the 22nd.
I have a hard time believing that Obama would resort to protectionism with the array of economic advisors that have his ear. Is there anyone that doesn’t think this would be a stupid idea?
Jim
PS: What happened to Thain? I thought he was the next CEO of BOA.
January 23rd, 2009 at 12:26 pm
I was dead wrong about John Thain. I predicted he would oust Ken Lewis, and Lewis ousted him. Here’s an occasion on which I am delighted to have been wrong. I know Ken Lewis, and I’ve had my differences with him, but I think he’s an honest man and a straight-shooter. Whether he’s a good banker, the board and shareholders of B of A have to decide. Full disclosure: I sold every share I had of B of A common when I left the firm in 2005, although I still own a bit of preferred which I picked up at a very low dollar price.
Thain’s behavior as reported by the media sounds questionable.
Regarding China, let me put it this way: the trouble in China is that the Chinese are saving too much (around 50% of income) while Americans were saving too little (zero). The result was a flow of excess savings from China to the US. To reverse this, a couple of things have to happen. Chinese must feel more secure so that that the precautionary rate of savings falls. Fixing the dollar-yuan rate with a solemn commitment of both governments would tell the Chinese people that their savings are secure. If there were a small revaluation as part of the fixing, that would not necessarily be bad, but the important thing is stability.
WIth stability, the Chinese will save less and spend more, which is what America wants to happen.
If you simply force a revaluation upon the Chinese, exports fall further, there is more unemployment, and more fear, and more precautionary savings.
January 23rd, 2009 at 12:28 pm
As for Mundell’s idea of handing out spending coupons — I saw a brief report to the effect that he had said this at an American Economic Association panel at year-end. I’m not sure if he was joking or not. Mundell is a true genius, and has an eccentric sense of humor. I’ve had the privilege to speak to him on numerous occasions, and often came away puzzled.
January 23rd, 2009 at 4:59 pm
To use Andy Xie’s language: the reason why Chinese have such a lopsided high GDP distribution away from her citizens and why they are loathe to investing or spending lies in the ‘relationship between her government and her people’. It’s not an easy problem to solve, and that’s why the government resorted to central planning style infrastructure spending, over and over in just the recent weeks, to stimulate the economy, while at the same time noted domestic economists loudly recommend other reform based initiatives, such as tax reduction, SOE share vouchers, or ‘3-gong’ reduction (meaning the excesses in official banquet, travel, and auto expenditures), etc.
Actually average chinese citizens do not have much to save. The bulk of the massive savings are from either enterprises or a small minority of super riches. Therefore, the excessive savings is really a misnomer, the actual problem is an investment difficiency, by entities outside of the government. The money can not be invested in the economy to compete with the government’s own investment, while there is insufficient amount of assets, such as stocks and real estate, to sink the money in. Even the stocks and real estate are shaky lately as a result of incessant punitive policies by the government out of benevolent claims.
As much as the west is fighting for her economic life against speculative sins, China is doing the same against her own socialist demons.
The holly graile of China’s rapid economic development is indeed liquidity influx from the west, and after years of practices and watching other Asian countries on the sideline China now has a system well adapted to managing the torent of inbound liquidity with plenty of margin for error. Therefore expansive fiscal policies around the world will quickly rejuvenate China’s economy in the first half of 2009, and that’s the secret why China is so confident that it’d maintain above 8% GDP growth rate for the same year.
In other words, trade surplus, as a result of China’s best economic instrument in her still rapidly surging and upgrading manufacturing industries, will be a key phenomenon of the global economy for 2009. Obama, with his left leaning idiology, perhaps is running the same mistake as the two preceding presidents did in their early days in the office. At this stage there really isn’t much the US could do but to accomodate the Chinese juggernaut, while at the same time steer the US economy away from a direct confrontation by innovating toward a more suitable direction, such as defense and energy.
I’m not sure why Tim Geithner, with his exposure in Asian affairs and the Clinton government, would say what he said in his confirmation hearing. But I’m sure the reaction in the Chinese media and among the vast and attentive Chinese netizens would be swift, even though the government herself may tactically refrain from showing the hand at this early stage. Perhaps in his mind that China would singularly pose predative problems as the rest of the world fight to create demand for their respective economies, instead of the obvious debt for demand symbiotism so needed to maintain the stability of the two countries. No matter what the calculus, the US has nothing to gain from such a statement, whether Geithner believes the US has the upper hand.
The powerful Democratic Congress just may do something as many feared recently to the detriment of the country.
January 24th, 2009 at 10:33 pm
[...] http://blog.atimes.net/?p=494 [...]
January 26th, 2009 at 12:10 am
Xinglongite,
Thanks very much indeed for your thoughts. You make a persuasive case, but I am not convinced that China can step up its manufacturing exports sufficiently to achieve the kind of growth you anticipate. What I observe is a sudden shift in Americans’ desire to save, trying to make up for lost time as a wealth effect takes hold. The pullback in American expenditure is spectacular, really unlike anything we have ever seen. I doubt that the US government can create enough demand to reverse this behavior.
Your points regarding the deficiency in investment opportunities in China are well-taken. The reason I don’t expect this downturn to reverse any time soon is that we have to build the supertanker before we can turn it around. But again, your thoughtful post is appreciated.
January 26th, 2009 at 2:40 pm
America is down if we want to believe it or not.
China has the resource and chance to take over economical world leadership. But it has a price because of the connection to the US dollar. Chinas people learned to suffer for hundreds of years. If the Chinese leader starting to save there assets and are willing to loose a big portion of there finances because of the connection to the dollar they will be become the world economic leader and America will be down forever. The people with knowledge of technology and many other specialties will get great offers from China to move there, like ones after the world war people came to the united states. The only thing we do not know yet if China is willing to take over and take the loose for the gain of there future …
carsten-realty@gmx.net
January 26th, 2009 at 6:56 pm
Thank you very much indeed for your great work.
The key is not export by itself, but inbound liquidity. China isn’t going to help by proportional import than export, so the trade surplus will continue to play a key role in domestic money supply growth. Then there are the FDI and other money inflow streams.
Liquidity influx is indeed the holly graile of Chinese economy. Between October 2007 and April 2008, China accelerated RMB appreciation, and liquidity influx increased greatly between January and April 2008. I believe in April alone China received some $75 billion net inflow of liquidity, money anticipating rapid and perpetual RMB appreciation. But after June, when the smart money recognized that the RMB exchange rate may have overshot, a reversal of liquidity quickly took place between June and October. In October, sequential M2 growth decelerated to a screaching halt. M2 data and net influx was like mirror images of each other.
Economic activities during this period fell abruptly, and people quickly found explanations in the US financial crisis, the mass closure of Chinese coastal assembly factories, etc. But if you look at the export data closely, the truth you’ll find is rather astonishing strength, not just in competitiveness, but in its pace of technology and value added upgrading. As Lucent closed its Bell Labs in 2008, her competitor Huawei saw 60% revenue growth, mostly from outside of China, for example.
By end of November, M2 growth already saw sequential increase — the bottom of economic activities by then was already reached. A quick look at the A-share index told precisely the same story. It’s not like the multi-dimensional and flexible economy of the US, China’s ‘less transparent’ economy by comparison is quite easy to read. By end of December, many other economic indicators, such as power generation, transportation, loan growth, etc. began to show decided rebound. Just a few days before the release of December data, Wen Jiabao proclaimed that ‘China would rebound out of the current global economic crisis earlier than any other nation’ — that ought to be one of the greatest prophesy for 2009!
During November, the flow of liquidity began to reverse again was the key. Without FDI and other ‘hot’ money, trade surplus alone could not have generated the kind of upswing in M2 for November, and then December. Of course, a lot of these hot money, FDI, and trade surplus are not done by unconnected outsiders, and expansive monetary and fiscal policies outside of China do find their way ‘with laser precision’ and at ‘lightning speed’ to Beijing in this loop.
$2 trillion Federal deficit for 2009 and 2010 may not all trickle down to consumption or used for plugging the banking hole, and your article has done a great service to all of us in shining a light on where the money goes. I’m sure the powerful people in Washington may have another data table showing just how much of each dollar, saved or spent, would end up in China.
That I’m sure is a mega-issue for the economics people in Obama’s government. Tim Geithner’s remarks can not be as simple as a ‘mistake in judgement’ as many commented. Otherwise Wen’s prophesy would be too easy.
January 26th, 2009 at 9:56 pm
Xinglongite,
Again, thanks for a thoughtful post. China’s economic problems have been vastly exaggerated by people who do not understand the details of the situation.
At this point I am not sure who “the people in Washington” are. As I mentioned in earlier posts on this blog, I had the privilege in 2003 of attending a conference at the Italian home of Robert Mundell, co-chaired by Paul Volcker. Paul’s argument, as I reported, was that currency fluctuations create distortions (both inflationary and deflationary) for emerging markets that do not have the deep capital markets to hedge or diversify against them. The former Argentine economics minister Domingo Cavallo was at the conference, and his problems in 2000-2001 as well as the 1997 Asia crisis were the case histories under discussion. Mundell and Volcker argued for fixed parities just for this reason.
Regarding China’s trade position, I don’t think the issue is the trade surplus but rather the savings rate. Actually, the best thing China could do at the moment would be to suspend the one-child policy. In the absence of normal family formation, Chinese accumulate financial assets. As Sisci and I argued, what America has to tell to China is mainly technology, and the restrictions on high-tech exports should be eased.
January 26th, 2009 at 10:01 pm
Geithner still needs to learn that economics and politics are not the same. Even if it is true that China is manipulating the yuan, you don’t come out and say so. That’s called “diplomacy.” It’s also called “not blowing your own foot off,” because let’s face it, China is looking for any way to blame its problems on someone else (Isn’t everyone?), and Geithner just handed the Chinese government some heavy artillery to whip up the populace against the US. We didn’t need another obstacle to creating a new, sustainable, US-China relationship, but I guess we got one anyway.
January 27th, 2009 at 4:42 am
That 2001-2002 Argentina banking crisis was indeed mysterious. I wished I had enough information to understand the inner works back then. All I notices was that the fall of the currencies of Argentina and then a few other Latin America countries is accompanied with subtle rise of the US dollar, and every time the crisis deepened, the DOW seemed to get a mild boost. After all, I’m not an economist, I’m only an observing market participant, fascinated by the fact that every now and then, the world seemed to live through like moments.
Mundell’s fixed parities was often quoted by the Chinese in defence. And what Volker said was also found out by ex- Chinese Premier Zhu Rongji, one of the greatest reformist of all time. Chinese RMB for precisely that reason was pegged to the Dollar at 8.28 to 1 for more than a decade until July 2005. Today China is said to employs an opaque formula vs a basket of currencies of her major trading partners, but in reality the RMB has been effectively repegged to the dollar at 6.83 to 1 since mid April 2008.
That Chinese savings rate is not. And any notion that somehow improved human service policies would somehow give people the confidence to unzip their wallets, and blame the lack of consumption on the people’s propensity to save, in my view is dangerous. China’s lack of consumption is due to inadequate employment and wage, pure and simple. Enterprises in China, state, private or JV, hold the lion’s share of savings, while average citizens, sans a tiny elite, really don’t have much if anything. And consumption’s share in her GDP has fell to the low 40% if my memory is correct.
If China is to increase consumption, it’ll have to increase employment and wage. ‘The relationship between the government and the people’ in Andy Xie’s language means more of the of GDP must be unlocked for distribution to the private sector in the form of productive economic activites, instead of unproductive or counterproductive government functions. At current rate, China has been losing about 1 million private businesses each year for much of the last decade. The current global financial crisis serves to expose the truth about the harsh environment private Chinese enterprises must endure. Urbanization among coastal cities have gone backward since 2008. The influx of liquidity helped to heat up the limited investment vehicles in urban real estate and the A share market until 2007, and the exodus of the same during 3Q 2008 also helped to flatten bubbles. At the same time, consumption, as a share of the GDP, continued its decline.
Would China’s economic fundamentals be much different from 2007? I don’t think so, except only that any new bubbles would be bigger, since China’s economy is now bigger (reads more powerful). The same people in the same government would employ much the same tools to meticulously manage the liquidity, or to dress up benevolent ‘rescue’ or ‘bailout’ policies, while real reforms of the system at different levels may move at a glacier pace or may not move at all, given the short time.
The restrictions on technology transfer in their current form, would do more harm than good, and the W. Administration has made many adjustments. The Israeli Phalcon AWACS project was a case in point — when the project was canceled under US pressure, China moved to develop and then deploy her own AWACS within only a couple years. Another example is the TD-SCDMA: China has granted China Mobile, the largest telecom operator in the world by far, a TD-SCDMA license to help commercialize the Chinese standard. There are 6 times more college students in China than in US, and in the area of science and technology that ratio would be still more lopsided. China already caught up with the US in the number of patents created. The dilema is how much and for how long the Chinese will continue to buy, even if we began to sell to them.
Guess what American goods is selling well in China? Baby formula. Imports from the US has seen 60% price hike since last year.
Trade surplus, as a part of money influx, is a necessary evil in China’s economic management as they see it. The US has just recently won a case against Chinese export tax rebate at the WTO, if my memory is correct. To keep the economy growing at 10%, they have to keep M2 growth at 18%, and to keep M2 growth at 18%, there is no alternative to money influx, including trade surplus, since domestically generated money supply simply could not make it. — It’s the ‘relationship between the government and the people’ thing.
January 31st, 2009 at 3:03 am
[...] Inner Workings » Blog Archive » Geithner blows up the world (blog.atimes.net) - January 21, 2009David Goldman says, correctly I think, that Obama is playing to his labor constituency. If it is just a tactical, short term move then there is no real harm in it. It could be a problem if this rhetor… [...]
January 31st, 2009 at 7:04 am
[...] Inner Workings » Blog Archive » Geithner blows up the world (blog.atimes.net) - January 21, 2009David Goldman says, correctly I think, that Obama is playing to his labor constituency. If it is just a tactical, short term move then there is no real harm in it. It could be a problem if this rhetor… more David Goldman blog posts … [...]