Mark your calendars: BANKING COMMITTEE CHAIRMAN SETS JUNE 7 FOR DIMON TESTIMONY
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Systemic Risk Concerns: NY Fed vs. IMF. Is the Fund behind the Curve?
Tim Geithner – NY Fed President and formerly Under Secretary for International Affairs at the US Treasury and head of the IMF’s PDR department – has warned again this week about hedge funds and systemic risk. As his first speech as NY Fed Prez last March was on systemic risk, this is the third time since March that he has spoken on the subject (see also his October speech on systemic risk). Would that be a veiled suggestion that he, the NY Fed and the Fed Board are concerned about the issue? One may infer – from the frequency with which he has publicly spoken about the subject – that the issue of systemic risk may be on his mind. As he was at Treasury when LTCM blew up and as he is a leading expert – and crisis manager – of financial crises in emerging markets, his concerns are well justified.
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Social Security Privatization as as the Mother of All Con-Man Smoke-and-Mirrors Shell-Games
As widely reported by the press, a partial privatization of Social Security via the creation of private accounts is one of the top policy priorities of the Bush II administration.
But when you carefully look at the facts, it becomes clear that the proposed partial Social Security privatization is literally a Con Man Smoke-and-Mirrors Shell Game that – in the form it has been proposed – will not lead to any of the alleged benefits argued by its supporters. It is amazing the amount of misinformation that one reads about social security privatization; apologists argue that:- The current pay-as-you-go (PAYGO) Social Security system is bankrupt.
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Speculative Central Bank Reserve Diversification as the End Game Trigger for BWII?
The news today (see the FT story) that some central banks – India, Russia and “other petrodollar-rich Middle Eastern investors” – are starting to dump dollars to avoid the capital losses from further weakening of the U.S. dollar, may be the starting trigger – discussed in my paper with Brad – for the end of the so-called Bretton Woods Two (BWII)regime. As reported today by the Bloomberg columist Andy Mukherjee who cited my comments:
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The Upcoming Twin Financial Train Wrecks of the U.S.
With the election now over, the most essential question facing the U.S. and global economy is what will be the fiscal and financial policies of the Bush II administration? The simple answer is that no one has a clue, not even the economists close to the admnistration as reported by the FT yesterday. The President has spoken of tax reform and partial social security privatization but the most crucial issue ahead will be how to fix the fiscal deficit mess of the last four years and how to reduce the unsustainable current account deficit. On those basic issues, the stated objectives of the administration imply twin – fiscal and external debt – financial train wrecks down the line: serious financial distress from unsustainable fiscal and current account deficits cannot be ruled out at this point. Clearly, reducing the budget deficit will not be a priority of Bush II.
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New Global “Soft Patch” or the Beginning of a “Deep Murky Swamp”?
While markets are waiting for the third quarter US GDP figures, everyone’s attention is now concentrated on the fourth quarter and 2005 growth prospects for the US and the global economy. In Q3 the US recovered from the Q2 soft patch (as GDP growth is expected to end up in the 4% range for the past quarter); but now, with oil prices above $50, the concern is not any more that we are in a “soft patch” but rather falling in a deep murky swamp of global growth slowdown. The most alarmed are folks such as Steve Roach who is now predicting that the US , Europe and Japan will reach a stall speed of 1.5% growth by the beginning of 2005. And indeed the US flow of macro news has been poor: continued weak job numbers in september, falling consumer confidence while retail sales are holding, falling housing markets, weak industrial production, slow income/wage growth, increased inventory build-up, soft durable goods figures, large and growing trade deficit, mixed signals from inflation (with now core up more than expected).
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BW2: Are we back to a new stable Bretton Woods regime of global fixed exchange rates?
What is the hottest current policy debate among academic geeks, policy wonks and market gurus? The Bretton Woods 2 hypothesis: i.e. the view that the world is effectively back to a regime of global fixed exchange rates pegged to the US dollar like the original Bretton Woods regime that lasted from 1945 to 1973. Global fixed exchange rates? This BW2 hypothesis has been forcefully advanced by three economists affiliated with Deutsche Bank, namely David Folkerts-Landau (Global Head of Research at DB), Peter Garber (Global Strategist at DB) and Michael Dooley (formerly head of EM research at DB and now back to academia at UC Santa Cruz). David, Peter and Mike are three extremely smart folks and when they speak and write, people listen to them. They have recently written four papers (An Essay on the Revived Bretton Woods System; The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries; Direct Investment, Rising Real Wages and the Absorption of Excess Labor in the Periphery; and The US Current Account Deficit and Economic Development: Collateral for a Total Return Swap ) where they argue that the international financial system is experiencing today the reemergence of a new Bretton Woods regime of global fixed exchange rates (Bretton Woods 2 or BW2). In this view, this new BW2 regime will allow the U.S. to finance its large current account deficit at a low cost for a long time; consequently, the United States growing external indebtedness poses few immediate concerns. So, while everyone else is worrying about the US current account deficits and the global imbalances, the three DB gurus tell us not to worry about them and enjoy the US current account deficit.
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The employment report, the US $ and the US current account deficit
The dismal employment report today – a miser increase in jobs of 96K in September – led to the expected textbook asset markets reaction: stocks fell, bond prices rallied and long yields fell while the dollar sharply depreciated. In spite of the continued economic soft patch and the dollar weakening, the US current account deficit keeps on growing (with only a modest improvement in the trade balance in July) as the fiscal deficit is still out of control: we are on the way to record current account deficit of over $600 billion in 2004.
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Bush and Kerry Effects on the Stock Market and Bond Market
Recent conventional wisdom on the financial markets impacts of a second Bush administration or first Kerry administration is that Kerry would be good for the bond market (pushing yields down) while Bush will be good for the stock market.
This conventional wisdom is only partially correct. It is certainly the case that fiscal deficit reduction will be more significant during a Kerry administration as one of the key elements of deficit reduction will have to be an increase in taxes (something that Kerry plans to do while Bush would like to make his unsustainable tax cuts permanent). Deficit reduction will ensure, over time, that bond yields do not creep up excessively because of unsustainable fiscal deficits. Note that bond yields have remained low so far, in spite of growing deficits, because of low short rates (the Fed Funds rate is still only 1.75%), softness in the economy and the labor market, more stable inflation outlook and the massive purchases of Treasuries by Asian central banks.
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Steve Roach on the Global Imbalances…and China’s FX regime…
Steve Roach, chief economist at Morgan Stanley, correctly pointed out this week that the global current account imbalances are unsustainable and cited, in that context, my paper with Brad on the US current account deficit as providing the “best forecasts” of the future trends in the US current account. He also agrees with our view that the “Bretton Woods II” new regime of fixed exchange rates (the dollar axis between US and Asia) is not sustainable. In addition to the points in our paper, he stresses how this new regime is creating severe financial problems for China.
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The IMF on Global Financial Stability: Underestimating Systemic Risk?
The IMF published today its Global Financial Stability Report, its semi annual assessment of financial markets and vulnerabilities. It is a high quality document with lots of food for thought. Compared to previous times, the IMF seems to be less concerned about the risks of a “systemic financial crisis”. It argues:
“While it is obviously feasible that one or the other financial institution, such as a hedge fund or even a bank, might succum to serious mistakes in risk management or to outright fraud, such incidents should be isolated cases with limited, if any, contagion to the system as a whole.
Short of a major and devastating geopolitical incident or a terrorist attack undermining, in a significant and lasting way, consumer confidence, and hence financial asset valuations, it is hard to see where systemic threats could come from in the short run.”
