Category Archive: Uncategorized
US-China “Balance of Financial Terror” Game. A Prisoners Dilemma Game: hard landing MAD or Chinese pre-emption as the likely solution?
Can we think of Bretton Woods 2 as a Prisoners Dilemma Nash Game between the US and China? Certainly Larry Summers referred to it as a “balance of financial terror” game. So, will the outcome be cooperation for global rebalancing or hard landing mutually assured financial destruction, i.e. MAD or MAFD?
The cooperative solution – beneficial both to the US and to the world at large is for the US to agree on a serious fiscal adjustment (reverse some tax cuts for the rich and and give up on social security privatization and/or fix social security without financially reckless privatization) and for China to agree on adjusting its peg, say by 20% plus. Then, the other Asian will follow China in cooperative appreciation step as China is the large Stackelberg leader whose currency value affects the currency policies of the rest of Asia. Then you get cooperative orderly global rebalancing of current accounts with sustained global growth.
Housing Market Bubbles and the Fed: The Higher They Blow, The Harder They Crash…or Why We May Need Houdini after Greenspan…
While Greg Ip wrote a very fine front page analysis of the risks of a dollar crash in the WSJ today (and thanks for the citations of my work with Brad Setser on financial crises), an even finer article by him on the risks of a bursting of housing bubbles made it only to page 2 of the paper (I guess the informal rule is that you cannot have more than one article per journalist in the front page). And his timely analysis was matched by another good WSJ piece by Agnes Crane in the Credit Market section on how the risk of a bursting of the housing bubble may affect US monetary policy (i.e. whether Greenspan & Co. may not tighten as much as is needed if there are risks to the housing markets from higher interest rates).
As Argentina is on the verge of launching its debt restructuring deal, the two questions on the mind of everyone are:
1. Will the deal succeed (i.e. will at least 75-80% of creditors accept it)?
2. Should creditors accept this deal (or should they instead hold out)?
My quick answers to both questions are Yes: the deal will be succesful with a limited number of holdouts; and all classes of creditors should accept the current deal as they will not get a better one if they decide to hold out.
So, since investors are rational (most of the time), the deal will get done and Argentina will succesfully close this sad chapter of crisis and default.
As the entire Argentina default saga is filled with some silly views and arguments that do not make much sense, I will use this blog to review some of these misperceptions and myths to get some clarity on the most important issues in this debt restructuring episode.
As reported by the newswires Bush has decided to name a major fundraiser, and former HBS buddy, as the new director of his National Economic Council (NEC). Can we sink any lower than this?
To get a sense of what this means consider the following two points:
1. The director of the NEC is the main economic advisor of the president – in most cases, even closer to the Prez than the Head of the Council of Economic Advisors (CEA) – as he gets an office in the most precious real estate in DC, the West Wing, and as he sees the President daily, often many times a day.
2. In the past, regardless of whether the White House was Republican or Democrat, some heavy-weight individuals had the job of NEC Head. Bob Rubin was the first Clinton NEC head followed – when he moved to head Treas – by Laura Tyson who had been the first Clinton CEA head (previously a renown professor at US Berkeley and currently Dean of the London Busines School after being Dean of UC Berkeley’s B-School). Next, NEC was headed by Gene Sperling who was one of the most savvy and influential economic advisors of the president even while not having previous high profile financial or academic credentials. At that time, brilliant minds and scholars such as Dan Tarullo and Lael Brainard were the deputies of the NEC.
Israel got very lucky to have Stan Fischer accept the offer to become the Governor of the Bank of Israel. He is the ideal candidate for the job, a brilliant mind with amazing wisdom and deep policy experience.
Of course, in a more fair world, Stan would have been chosen to run the IMF (where he was the #2 for years) or run the World Bank (where he served as the Chief Economist before moving to the Fund) or even the US Fed (where he would be as good and even better than many other candidates for the job).
While our own Fed is in the strong hands of Alan Greenspan and has a first rate group of governors and staff, come January 1st 2006 we will need a new Fed Chairman. And the Fed looks like the only institution of US economic policy with a strong head and a bunch of competent senior managers (deputies, undersecretaries). The NEC is headless with Steve Friedman leaving, the CEA will be soon headless once smart Greg Mankiw goes back to Harvard, Treasury is led by lame duck Snow and has just lost its incoming assistant secretary for tax affairs. So, as the conservative WSJ editorial page put it, US economic policy is run from the “hip pocket” of Karl Rove.
In my previous blog item, I argued that 2005 is likely to be the YOTGBMR (Year Of The Great Bond Market Rout)…As strongly argued by the bond market guru Bill Gross, in 2005 Cash will be Prince and King too…and I would argue Cash will be Emperor too as the Treasury Emperor has no clothes at all (and little foreign assets or reserves left) and is digging to himself an even bigger multi-trillion funeral hole (or immolation funerary pire?) with its wretched Social Security privatization plan…
Biggest Bond Manager in the world recommends to avoid US long bonds in 2005 as if they were pestilence: Cash is Prince…and Emperor too…
As Brad Setser and I have been repeatedly warning about the risks of a bond market rout in 2005 (more details in our forthcoming papers but your can read our preliminary views here and here and here and here), it is refreshing to read that the bond guru Bill Gross, Managing Director at Pimco, the one of largest bond (fixed income) asset management firms in the world (over $400 billion assets under management), is recommending to stay away from US long term bond in 2005 and keep as much as possible in cash. Having the Managing Director of an institution specialized in selling to investors the widest variety of bonds and bond funds telling you to avoid bonds and hold cash is quite an irony: as if the largest world food multinational company were to start a global ad campaign to warn you to avoid its products as if they were poisonous or pestilence-inducing. Of course, the menu offered by these most respected bond managers includes a variety of poison-avoiding foods (inflation indexed bonds, foreign bonds that will gain from the dollar weakness, very short-duration bonds and, best of all, zero interest rate short-term bonds, i.e. Cash). As he Gross rightly and honesty puts it: in 2005 Cash will be King or Prince… This is indeed the most authoritative indirect endorsement of the view that the US government is on its way to bankruptcy. And you gotta give great credit and respect to the intellectual honesty of the biggest bond salesman around warning you about his wares with the loudest Caveat Emptor of all! Kudos to Gross for his honesty: truth above narrow self-interest!
As reported yesterday by the Washington Post, the Bush administration will put tax reform on the back burner for a year – and consider a more modest attempt to reform the tax system rather than radically change it – to concentrate on social security privatization and “spending” controls. To figure out the administration’s new tax reform plans:
“tax policy analysts and business lobbyists have been looking for clues in a 2002 study done by the Treasury Department. Its author, former assistant Treasury secretary for tax policy Pamela F. Olson, said she has been fielding a steady stream of calls about the report, especially about its fifth, most incremental tax option.”
Liquidity/Rollover Risk on US Assets? A Nightmare Hard Landing Scenario for the US $ and the US Bond Market..
One of the most typical and common features of currency and financial crises in emerging market economies is “liquidity” or “rollover” risk. If a country has a large amount of short term debt that is coming to maturity and investors are unwilling to roll over (refinance) such debt, then a liquidity or debt rollover crisis may occur. The debt coming to maturity is usually the foreign currency (or foreign currency-linked) debt of the government (as the infamous Mexican Tesobonos in 1994) or the short-term foreign currency liabilities of the banking system (as the $20 billion plus of short-term cross-border inter-bank lines in Korea in 1997). Similar liquidity or rollover crises (also referred to as roll-off crises as investors roll off rather than roll over their claims) have been observed in every emerging market economy crisis in the last decade (see Chapter two of my new book with Brad Setser).
On selling your reserves, babies and other Banana Republic schemes…a follow-up on my Swiftian “Modest Proposal”…
Somehow, based on email feedback from many, the sarcasm and ironic nature of my recent blog’s “Modest Proposal” for the US Treasury to sell US reserves and government foreign assets as a way to finance our budget deficit – given the shrinking willingness of the world to do that – was missed by many, even otherwise sophisticated, observers; all this in spite of the obvious Swiftian allusions of my blog’s item title.
Many took seriously what I thought was obvious irony and asked me: “But we do not have so many reserves, right?” or “For how long could we play this treasures’ fire sale game?” or “The whole problem is attributable to a loss of confidence in the dollar. The only possible solution is to restore that confidence.That would not happen if the US starts selling its foreign assets. On the contrary, such acts could further undermine the dollar.”