http://news.ft.com/cms/s/881eb29e-6e78-11d9-b058-00000e2511c8.html  Editorial comment: Dollar dilemma  Could a country with a de facto dollar peg diversify its reserves without appreciating against the dollar? Many assume not. In fact the answer, as so often in international economics, depends on whether the country in question is “small” or “large” in this context. A “small country” with medium-sized reserves, such as Thailand, Malaysia or even India, could continue to absorb surplus dollars on the bilateral currency market, but sell its stock of dollars for euros. The effect would mainly be to push the euro up against the dollar. The central bank’s own currency could remain pegged.  A “large country” – Japan or China – could also embark on the same strategy. But the scale of the dollar sales would probably cause a generalised dollar collapse, with private buying disappearing altogether, demanding still greater central bank purchases. The central bank would lose control over domestic money supply, resulting in soaring inflation that would in turn push up the real exchange rate. In practical terms, Japan and China probably cannot diversify to a meaningful extent without letting their currencies rise. So keep an eye on the other Asians. Who will break ranks first?

 we are going to need those repatriated profits. if consumer confidence stays high, imports stay high. if oil is above 41 (average) in 05, our oil import bill also rises. the US could easily need MORE than $800 b in financing. I would be very interested if any one has a clear breakdown of where this financing will come from — something like $400 b = central bank dollar reserve accumulation, $100 b (too high i suspect) profit repatriation, $100 b middle east petro dollars, $100 b Japanese insurance and pension funds (+ other asian private investors), and $100 b europeans buy us bonds … (all this assumes net FDI and net equity flows are zero, so there is no net outflow nor a net inflow)

yardeni sez $200-$500bn in repat, but i can also see it at the low end and below; like it’s not like it’s just sitting there…  http://www.yardeni.com/pub/a_050124.pdf  The data suggest that corporations have kept roughly 50% of their overseas profits overseas since 1980 (Figures 13-16). The Federal Reserve actually reports quarterly foreign earnings retained abroad by nonfinancial corporations in the Flow of Funds Accounts.3 Since 1980, the accumulated total is $1435 billion. Most observers expect $200 billion to $500 billion to come home this year.  3 See “Flow of Funds Accounts,” Table F102, Line 6, at http://www.FederalReserve.gov/releases/Z1/current/Z1.pdf

In my most recent post I meant to say “there is a strong tendency for change to revert to the trend” rather than “there is a strong tendency for change to revert to the mean.”

I enjoyed and agree with Nouriel’s Prisoner’s Dillema analysis (1/25) but think it misses one point:   How does China weigh the costs of the status quo (risk of loss of value of its dollar-denominated reserves, some inflation etc.) against the costs of RMB appreciation: possible bank collapse, increased unemployment, etc. A decline in the value of China’s reserves seems like an issue with little political impact (few outside the intelligentsia understand it) and unclear economic impact (with a strong economy, China’s need for reserves to, e.g., stave off a speculative attack is low). Yet a bank collapse and rising unemployment would presumably have a big political impact in China, which is far from a stable political system. To me this implies that even if the long-run equilibrium is RMB appreciation, the long-run could be long.

there is a palpable sense of currency ‘ endgame ‘ in the air -and everyone blithely assumes that the accident waiting tohappen is the dollar collapse.  here is a tentative different collapse scenario emphasis on tentative. a conversation stimulant. it is never quite like you think it will be. . .  0000000000000000000000000000000000000000000  1 confidence cracks. we all wake up to the realisation that the endgame of the 1945 to – ? – period has begun in earnest.  2 something – whatever it is – has moved in a direction not anticipated by the speculators. perhaps peaking property prices have tipped the american public from re-mortgaging to madly paying off their debts and reducing consumption in order to do so. paying off debts is a form of saving – climbing the mountain from a starting point down a deep coal mine. america begins to save . . .  3 greenspan, or successor houdini, lowers interest rates in a desperate attempt to stimulate house prices and general irrational consumption. . .  4 but the rush to savings and safety has gathered momentum. instead of the dollar it is property and shares which take the dive – suddenly bad debts, saving, a rush to cash, are actually stacking money away from circulation. people freeze like rabbits in the headlights.  5 greenspan / houdini wildly promises that the dollar printing presses are to roll, but the punters – like japanese – happily save any extra and wait as the deflation cuts the price of everything that has ‘ bubbled ‘ for years past, as if a global january sales has begun. gordon brown retires to run a b and b in the lothians.  6 although the interest rate is close to zero – with deflating asset bubbles – the real interest rate is still good. inflation is at minus five.  7 so the dollar strengthens. people are looking to real assets, and the united states is still a big country with grain, land, forests, mines, illegal mexican wage slaves, ships, and every other kind of stuff in quantity.  8 countries with less real estate per capita suffer in comparison. the renminbi and yen fall against the dollar and thousands of speculators are caught facing the wrong way. more billions are wiped off hedge funds. buffet takes up gardening and golf. soros cancels book signings and gets a job. the speculative billions leave china for home. china holds on tight to her dollars as the renminbi is falling against the dollar.  9 price of oil crashes. o p e c breaks up in discord.  10 global unemployment leads to competing demands for protectionism, and trading nations suffer badly in comparison with less developed but more self sufficient countries.  11 everywhere people, in surplus, are willing to do anything for cashflow, which is scarce. money seems unable to circulate, however great the volume printed / given away. people hoard as in wartime. people who have cash, hold it. people who have no cash seek to sell assets even as values dive. van goghs unsaleable. sadlers wells colts sold to belgian butchers. second homes in connemara sold to farmers for conversion into sheds.  12 finally gold, which has run up to a peak, crashes. the reason is the search for income – which gold does not provide. the world begins a new phase – nothing glitters.  13 bush says no policy changes envisaged.  everything is going well. – but no one is listening.  gillies          

Relatively new reader,  excellent blog!  However, I have a question that I figured you all should be able to answer:  Assume for a moment that we get a hard landing to this game, how does the Fed react?   Could they at all feasibly loosen to ameleorate the effects? If they did, what precisely would the be effect? (In my limited knowledge of macro-economics it seems that a Fed loosening would provoke a futher rout in the USD and U.S. bonds, rinse and repeat)

 gillies –  interesting thesis. and not unreasonable — though i suspect that the fed can avoid a japanese style liquidity trap where newly minted dollar are saved rather than spent, limiting the more extreme outcome.  but the low-interest rate adjustment scenario is certainly a plausible alternative to the high-interest rate adjustment scenario (goldman looked at both, by the way). in the high interest rates scenario, the US demand for financing grows (fallin savings, rising consumption, rising investment) beyond the available sources of cheap external financing (central bank $ reserve accumulation), leading to upward pressure on int. rates to slow the pace of growth in US private consumption/ private investment (since the government does not seem like it will adjust, the private sector has to do more). In the low-interest rates scenario, the US consumer finally slows down, higher oil prices start to bite, and the us consumer grows leery of new debt and tries to rebuilt its balance sheet with more savings. consumption falls. If that triggers a fall in the price of risky assets, then you get a reverse wealth effect. the uS economy slows, the trade deficit falls and b/c national savings is rising rapidly, there is plenty of room to finance us fiscal deficits domestically and for the fed to keep rates low. I think the first scenario is more likely, but the second is not out of the question (note high yield bonds do badly in both scenarios, but treasuries do very differently).     

“1 confidence cracks. we all wake up to the realisation that the endgame of the 1945 to period has begun in earnest.   2 something – whatever it is – has moved in a direction not anticipated by the speculators.”  What are candidates for an exogeneous trigger? Mr Roubini has cited here the emerging conflict with Iran and a subsequent energy shock that rapidly lifts prices forcing the Fed’s hand. A domestic guerilla attack against infrastructure may be another. [See jrobb.mindplex.org] Is there evidence that those contingencies are priced?

glory — alas, from what i have gathered, most of the $ abroad that get repatriated are just that, $ — and to get the fx inflow you need firms to convert euro and yen and pound assets into $. Otherwise, they take a $ held offshore for tax reasons, which no doubt is invested in an onshore US asset (see caribbean islands). They move the offshore dollar onshore, but it stays invested in a US asset. I need to sit down and do all the BOP transactions, but to really use offshore $ to finance a current account deficit, you basically need to trade an offshore $ (an existing one) to say china in return for chinese goods. China ends up with an external asset (a caribbean bank account). the uS ends up with one less asset (the caribbean bank account) and the same liabilities. Net debt goes up, as it must …   keith — $500 b in reserve financing? or total financing? There is a big difference …

Current debt/gdp ratio is up to 300 % in the USA, it has gone up in all OECD throughout the last 15 years. Households are especially heavily indebted.   That debt has to be cleared. That ratio has to fall.   Could it fall inside an inflationist environnment ?  CAn it fall without creating a deflationnist environment ?   Let’s look at different scenarios…  imagine there’s 100 GDp 300 debt.  1 Imagine a general strike, wages go up, so do prices. Inflation increases without any additions to the monetary supply. In fact money from asset markets (financieal sphere) flows into the real economy sector.   Result, this wipes out X% of the debt around in real terms.  So you may say, well, inflation can happen in the same time as the debt/GDP ratio falls.  Well yes, but only as long as there is no money creation. What happens is that the asset prices deflation is so great that it matches good price inflation. In fact in the process, some cash has probably disappeared.  2 The central bank starts to try to get out of the crisis by creating more money.  The only way it can create money is through lending more. If the lending activity is higher than the GDP growth, then the debt /GDP ratio increases. Therefore the crisis is only postponed  One thing is clear, the money available is related to the debt level. If the debt level is to go down, some cash has to be destroyed.  May be some inflation in good price is possible in the short term (if wages rise), but the money stock will fall and the prices of (goods and assets) will fall too.  

I’ll go watch the site, but you must know of course that fiat money is way below the two other types of money. THe ratio is around 1/10. So you can’t match a 10% decline of bank created money and other type created money without a doubling of fiat money.  I believe the debt ratio has to go down by 4 or 5 to bring us back to a new start. And I mean worlwide. THe world is too leveradged. THe ony way to do that is through deflation first (and bankrupcies) and inflation then (when the fiat money to other type money ratio has made higher, then the inflationist effect can happen, the other point being, inflation in goods can only happen when wages increase faster than productivity, when labor is strong, which is not the case now, if you add 100 now to the money base, 90 goes to asset prices, and not enough to inflate prices, when labor was strong, the other relation was true, when labor will be strong, monetary creation will have a stronger impact on inflation in good prices).  

And I just thought of this.  If K can move and not labor.  Let’s say productivity ratio is 10/1 US vs China.  But wages are 15/1, because remnibi is undervalued and labor is so week in China.  Then US companies invest in China and make higher profits. THis is a wise bet for CHina as productivity and wages rise along the way.  In the mean time, wages in the USA are under pressure and do not follow productivity.  Even inside the USA there’s a widening gap, as the minimum wage does not grow, nothing forces overall productivity up, there’s a widening productivity gap and it is equally profitable to invest in low productivity sectors. In those sectors were productivity growth is high, wages do not follow.   Anyway you explain it, wages do not keep up with productivity world wide, demand is increasingly relying on debt.

DF,  It’s not my site but  http://www.mosler.org/wwwboard/wwwboard.html  and  http://www.mosler.org/index_docs.htm  has many interesting papers. I do agree with much that you have written, though it seems that PKE’s seem to think the whole thing is sustainable as long as “saving desires” are met with sufficient deficit spending. The main problem with the current system, is the ability to fluctuate “fiat money” creation quickly enough to accomodate fluctuating “saving desires”. This is why some PKE’s promote a flexible “labor pool” to create flexible deficit spending rather than government directed programs which tend to become fixed. The “labor pool” BTW is being tested in Argentina.

I’ve long said, things will really get nasty once CHina gets out of ADPIC and refuses to pay for intellectual rights. After all, it’s not in their interests. Once Asia will have most of the world industrial base, I think they should declare patents an obstacle to world growth, some capitalist scheme and so on, and refuse to pay them.    In response to winslow, I don’t see how ever growing debt levels are sustainable.  May be I did not understand you. I think you imply that if private agents (households and companies)want to save more, then the government should stop saving.   But what if the country itself is in debt externally ? And what if the government is really overindebted in relation to its tax base ?  What if wages lag too far behind productivity ?  This is not some small conjonctural crisis we’re facing. It’s not another 1971, 1973 1979 (end of gold standard, oil shocks). We’re talking about something big. And scary.  Something like 1991, but not the little recession in the USA, no, something like the collapse of the sovietic system. In 10 years, they lost 50% of their GDP, life expectancy minus ten years.   From where I stand, this should be the scale of the crisis we’re heading in, given the size of the imbalances.  I just pray so we’ll escape a war.

I don’t follow you.  You’re basically saying, bubbles can never burst, as long as the government is willing to fuel them with liquidity.   I think this has been proven false by history. And it brings us back to the discussion of relative levels. Given the small size of fiat money and government deficits, relative to the overall money creation and debt level, the government sooner or later loses control of the bubble.    I believe concentration of financial assets and debt can be a real problem. Once too few own the assets and are creditors to too few over indebted people, THEN the creditors with non financial assets refuse to trade them for a debt coming from those overindebted, they refuse to trade them for any financial asset.    On an aside not, the ability of governments to tax is precisely what is coming under question in the globalisation era.  Tax reduction moves have been initiated also in a competition for access to (freely moving) capital.   Political choices, do not have a political solution, as if it was a matter of reasonning.  That would be too simple. Political choicies are also the result of balance of power and cultural impregnation. Try to explain to the business community that wages are too low, try to enforce a raise in wages. You’ll have trouble to pass any legislation.  That is another reason why crisis happen. Crisis happen so people realise that they NEED to do something, fix something that they knew or could have known was necessary before.  Crisis solve freeriding problems.   On an aside note again, countries have been overindebted in relation to their tax base historically. It was often because their debt was labeled in another currency.  Labeling the debt in another currency is the next step for USA if they go on with deficits in this way.   I think you’re saying states do not default internally. In fact they don’t need to, it is enough that investors think they could. The problem here is that internal debt is owned by foreigners, and has said very often around here, they could stop investing in the US government, that US government would face a currency crisis and a need for cash, it would raise rates, and so doing would create the deflation-depression circle. Or it could try to finance all of its deficit with fiat money, but it would destroy in this case the dollar and lose the priviledge of it being the international currency.  London 29 or US 05 look very much the same. Gold standard or not.  

Seems we agree on most.  1  You’re basically saying, bubbles can never burst, as long as the government is willing to fuel them with liquidity.   *Isn’t this self-evident?  No. Not if liquidity is itself backed on credit. My point is fiat money creation can not match bank money destruction.   Examples in history :  Japan central bank has provided lots of liquidity with 0 interest rates. But so far deflation has been going on. Wages fall faster than prices so I don’t see it ending.  US federal bank provided lots of liquidity back in the 30′s. That was not enough.  I doubt any number would have been enough. Liquidity injection can only postpone a deflation crisis. In fact it can be efficient only if there are severe control on credit expansion. If you can inflate prices faster than debt load, then you escape the debt crisis, but so far the liquidity injection policies have achieved exactly the opposite, they have increased the debt load and had little effect on inflation (and this has been seen as a victory !!)   On an aside not, the ability of governments to tax is precisely what is coming under question in the globalisation era.   *True, though foreign CB’s and offshore entities can be ‘taxed’ through inflation.  what you mean ?   *If the U.S. wants some nonfinancial asset (oil), and another country won’t sell it for our financial assets (fiat money), the U.S. would roll over? I see inflation as an “international tax” for the ‘services’ the U.S. currently provides. The last time we collected was in the 70′s (excluding Gulf War) though Iraq may be a start.  I Don’t understand. May be my english is not good enough. Oh OK.  I believe you’re saying the dollar being the world currency, inflation is equivalent of a tax for the USA government. Granted.  But then deflation is tax refunds ? Ough. Pray it won’t happen.  I think you’re too focused on good prices. Inflation in asset prices has had exactly the same effect as inflation of good prices. The development of world trade is also a positive factor as it props up the use of dollars (the tax base widens).  I see all these falling and tax refunds very high…  The reasons for deflation have been pointed out : wages lag productivity, fiat money expansion has lagged credit money, low interest rates have led to deficits and dollar devaluation in nominal terms more than rising inflation and dollar devaluation in real terms. The USA are exporting deflation not inflation.     3 London 29 or US 05 look very much the same. Gold standard or not.    *I’d give the U.S. at least 10 more years before they start sharing power. No other country is currently ‘willing or able’ to share the responsiblity of being the “reserve” currency.  Nobody was willing or able either back in 1929 if you remember.  Well the US had a huge share of gold stocks, bigger than the chinese share of world reserves … But they had not the power to take over.   That’s precisely why a crisis happened.   My bet is that this time around, the next reserve currency will be world backed. No country ought to own the reserve currency.          

US federal bank provided lots of liquidity back in the 30′s. That was not enough.  I doubt any number would have been enough. Liquidity injection can only postpone a deflation crisis.   *Banks cannot ‘inject’ liquidity because they do not directly purchase nonfinancial assets, though the gov can. Japanese banks can only lower rates to zero to move spending forward.   1 of course global inflation is good for the country issuing the reserve currency   *Good, or justified? Few economists seem to think the U.S. should be ‘paid’ to be the world’s policeman.  2 could asymetric inflation be even better ?  *To maximize taxation of foreign entities through inflation, the U.S. would maximize the amount of financial U.S. savings (tsy secs) held by foreigners, and discourage nonfinancial U.S. savings by foreigners possibly through tax policy. The devaluation could then come from SS reform which benefits wall street, or raising the minimum wage which benefits main street.

I think we agree that deflation inflation is mostly a real phenomenon. When wages are higher than productivity, there is inflation (in consumption goods), asset prices fall. ANd vice versa.   *I agree they cause micro wealth effects. Inflation/Deflation of basket of goods? Increase/decrease in prices are temporary and only made permanent with increased monetary base. Long-term trend is if deficit spending grows faster than savings we have inflation, if deficit spending grows slower than savings we have deflation. The intermediate trend may fluctuate due to many micro factors.  The central bank mostly has an influence on the amount of money created but not where it goes.   *CB has ability to move spending forward or backward but with little or no net gain by flucuating interest rates. Moving spending forward can keep the economy going during a time of restricted borrowing due to low tech development.  That’s the basic. ANd that’s why inflation is not possible, not with Bush in power, not with the unions and the labor laws as they are, not with asymetric mobility in favor in capital etc.   *We don’t have inflation because of current large saving desires of foreign CB’s. Mosler believes we are headed towards deflation.   2 American politicians may think it be good or not that the US get paid to be the world policeman.   From a rest of the world point of view this is absolutely not the correct phrasing. The USA are extracting a tax by force, and looking for their best interest. the question was is it good for the USA if there is inflation ?   *You sound like a libertarian. What about paying for a functioning WORLD SOCIETY?   Conversely, if other countries all engage in monetary policies with severe control of their monetary base, is it for them a way to reduce the taxation coming from the USA ?   *Yes but what a waste unless all their peoples are employed. Maximizing labor resource potential has distinguished the U.S. from most countries, though this is changing.  3 I was mentionning asymetric inflation between inflation in the USA and inflation outside the USA.  I m saying that if the one dollar the government sent abroad is still worth one dollar at home 10 years later, it has taxed the world for one dollar. It’s pretty cool.   *This has allowed the world to save one dollar, no tax.  If ten years later it’s worth 10 cents, then it has only won 10 cents. The correct phrasing, is then ten years later, you need to send 10 dollars abroad to tax the world for the same amount.   *Disagree, rethink.  I’m saying the best situation is a situation in which the rest of the world’s inflation is infinite, and inflation in the USA is zero, so that the central bank can create infinite numbers of dolars sent abroad and make lots of things with the cash it makes (lend it to the government)  *You promote allowing foreigners to save U.S. financial assets and not pay for the privilege. Most economists agree with you.  You’re pointing at asymetric inflation between different goods, consumption goods (wages) stocks and bonds.  You’re saying that it is possible to rip off foreign investors by having them to invest in uninteresting assets.   *I’m saying tax foreign investors for investing in uninteresting assets through inflation, or if you like, match interest rates on tsy secs to inflation so their return is ZERO. Reduce the incentive to save fiat money.

It seems like a blind spot to dwell exclusively on the exchange between China and the U.S. As Eric asks, “What are candidates for an exogeneous trigger?”  As a non-economist, I don’t start with models full of variables and exponents and derivatives. I start with a checklist of every major trading power. I look at each one and ask, does this country have the capacity to destabilize the dollar? And would that be in its interest?  To fulfill the first, a country needs substantial holdings of dollars, T-bills, CMBSs, or other debt-backed securities, denominated in dollars. Basically, oil states and countries that export a lot to the USA.  To fulfill the second, countries can’t rely on exports to the USA in order to survive (like China). Best would be a country that imports more from the USA than it exports.   Maybe Russia? I don’t know about their dollar reserves, but they have already stated that they want more Euros. If they start auctioning their oil and gas in Euros and ditching their dollars, could that be enough to destabilize the dollar (and give Russia some cheap wheat flour)?  I honestly don’t understand this stuff, I’m self-taught and I appreciate all of you having patience for neophytes like me. I hope this post isn’t too close to kindergarten; if so just reply off-list.

what do you call deficit spending ? Is it deficit from the government ?  are you saying that if deficits grow faster than savings, then you have inflation ?  Look around, in the 70′s inflation was high, savings were high, deficits low. That’s for history.  And then logically, I see absolutely no link. May be you can explain me.   *The “deficit” is gov spending in excess of taxation. C/A surplus is “saving” by foreign entities. If you remember the 70′s the French and German CB’s were not inclined to “save” the U.S. dollar. If you look at U.S. gov debt growth in 1975 it was growing at 23.9% compared to 8 or 9% today. See Fed’s Z1.  *I also agree with what you write, though you are seeing the effects (wealth effects) as the cause. If you look at the effects (micro economic) rather than the cause (savings exceeding deficit spending), you will miss the solution (macro economic).

Not being an economist myself, I am suggesting we keep the conversation somehow close to Nouriel’s layout: a prisoner trilemma. In addition to the US and China we also have Europe. Then, I suggest we make a step forward and include in our conversation the need for security of the various entities. It is only then that we make the conversation less technical and closer to reality.  Cooperation may be the name of the game given the skeletons in each of the above entities’ closets. The EU is probably the closest to a position in which to challenge the status qvo. Yet, in many respects, EU is still a dream. Do you recall Timothy Garton Ash’s recent story in which President Bush asked him if it was in the US interest for EU to succeed? Probably, President Bush asked him so for he has something on the Europeans.  To return to cooperation, the US has to adjust the way it conducts itself internally and externally, monetary and fiscal policies included. Just because it’s been like this, and we seem to enjoy buying on credit while others seem to like to sell for credit, is no guarantee in and of itself things will stay put no matter how much everybody likes to cooperate.   So, cooperation doesn’t mean status qvo. It only means the large (3) entities of the world need to come together and reshape most everything we know, from Breton Woods to NATO and to the way we keep each other honest. It is foolish to think we can keep it uni-polar with props in NYC and Wash. DC…  fCh http://chircu.com 

China will want to be cautious. They can repeg their currency to a weighted average of dollars, yen, and euros, and slowly over time adjust the proportions in the weighting and the exchange rate. That way they avoid sudden disruptions that could be detrimental for their economy.