February 25, 2008
Elaine Meinel Supkis
A big snow storm approaches yet again, just after the last one melted. The cycle of storms is like the cycle of bad news we have been through lately. The latest attempt at preventing the inevitable storms has boosted Wall Street: the monoline insurance characters were saved! Deus ex machine was cranked down onto the stage and from it issued an angel from Standard and Poor. 'Arise, Ambac, arise, MBIA! With a wave of my magic wand, you shall live again!' And everyone clapped. Next: the Dragon enters from stage left, spitting flames of rage due to inflation from the US and Japan. We look at two US Congress reports about all this trade deficit/global savings glut business.
U.S. stocks staged their biggest rally this month after Standard & Poor's kept AAA debt ratings for the nation's largest bond insurers, easing concern credit losses will extend the worst earnings slump since 2001.
``People are breathing a sigh of relief and jumping back in again,'' said Peter Kovalski, who manages financial services stocks at Alpine Woods Capital Investors, which oversees $12 billion in Purchase, New York. ``All financials that would've been vulnerable to a meltdown in credit markets rebounded on this news.''
MBIA is no longer under review for a downgrade by Standard & Poor's, indicating the bond insurer is a step further away from losing its AAA insurance credit rating. Ambac, which ranks second to MBIA among bond insurers, is still being reviewed for a possible downgrade, S&P said.
``As long as the ratings are there, banks do not need to write down securities on their balance sheets that are guaranteed by Ambac and MBIA,'' said Anton Schutz, who manages $150 million at Mendon Capital Advisors in Rochester, New York.
OK, does anyone with half a brain think that ANY rating agency these days have ANY legitimacy? Maybe we should ask Kerviel and Kieber to tell us how to rate these guys. Indeed, it should occur to more than one person that this is a cover up. Just as fake as ratings last summer. Back then, everything was rated AAA. Even BBB was thought to be merely a slight variation on AAA that brought a better return!
Then the banking system collapsed. All aspects collapsed as it occurred to more then one investor, that something stank. The putrid smell is now quite obvious. So I suppose, putting a clothes pin on our noses, we can agree that Ambac and MBIA are now smelling sweet as roses growing up a wall in Liechtenstein. Everyone who has money invested within this bizarre and dysfunctional fiance/banking system wants desperately for Ambac and MBIA to be 'saved'. I noted the other day that the rescue operation is simply the entities being insured are the same ones who are guaranteeing these insurers. But this is kind of incestuous, I would venture to suggest. If these banks crash, they can't fund the insurers, can they?
Now that Tinkerbell is done with her tinkering, we can clap our hands and Ambacbell and MBIAbell will come alive. Isn't this cute?
Consumers have racked up more than $2.2 trillion in purchases and cash advances on major credit cards in just the last year. And it's become a habit for them to spend more than they have. The overall credit card debt grew by 315 percent from 1989 to 2006, according to public policy research firm Demos.
To compound the problem, fewer people are paying their credit cards bills on time. The percentage of people delinquent on their credit cards is the highest it's been in three years, according to CardTrack.com.
This habit of spending more than we have is called 'trying to cope with inflation'! People don't want to go in debt and pay 30% on the most expensive loans on earth. This isn't cheap money. Money is cheaper and cheaper, in our wallets. Accessing credit is very, very dear. And the fact that payments to these loan sharks is falling behind more and more is a very bad sign, indeed. One thinks perhaps filling the gas tanks of cars and paying heating bills is driving people to desperation. I know that the first half of winter in the North wasn't all that bad. The second half has been a trial. It has dropped below zero here a number of times.
Personally, I gave up on gas heat long ago. I go out into the woods with the chainsaw and axe and warm up by hauling wood around. Even when it is at zero, I get rather warm. But most Americans can't do this. They are stuck, paying increasing bills. Electric and food bills are up, too. And will continue rising due to global inflation. The cruel winter in China will force the government to buy grains and other foods and this is good news for farmers here but bad news for most Americans who can barely paddle along as it is. The rising use of credit cards is bad news, not good. They represent the Last Frontier in economic collapse.
The primary risk to China's economy is inflation and the government will stick to the tight monetary policy, said central bank vice governor Yi Gang here on Sunday.
However, the tightening measures would be "proper" and "moderate" to avoid recession, Yi said at a seminar on Chinese economy held in the Beijing University.
Last December, China decided to shift its monetary policy "from prudent to tight" in 2008 to prevent overheating and a surge in inflation.
China has changed the flow of money as well as global resources. If they return to internalizing their finances, the US will be in great trouble. On the other hand, if our farms don't get hit by any blights or droughts, we could make a lot of money selling our grains. But this will raise food prices here. And the US has a huge trade deficit with China. If China sucks out our food in return, this will balance things but it will increase inflation in the very things the working poor least can handle.
This is the backside of all those cheap goods from China. For a few years, it was marvelous. I couldn't believe how cheap everything was. But the party is now over.
Time to go back into the past to see what Congress and the White House though about the growing trade deficit. This report is from when we finally balanced the government spending. The debates about trade deficits have evolved over my lifetime. From 'this is very bad' to 'this is great'. Let's see how they did this.
10-Jan-2001; Craig Elwell
The size of the U.S. trade deficit is ultimately rooted in macroeconomic conditions at home and abroad. U.S. saving falls short of what is sought to finance U.S. investment. Many foreign economies are in the opposite circumstances with domestic saving exceeding domestic opportunities for investment. This difference of wants will tend to be reconciled by international capital flows. The shortfall in domestic saving relative to investment tends to draw an inflow of relatively abundant foreign savings seeking to maximize returns and, in turn, the saving inflow makes the higher level of investment possible. For the U.S., a net financial inflow also leads to a like-sized net inflow of foreign goods--a trade deficit. Absent the prospect of any major change in the underlying domestic and foreign macroeconomic determinants, most forecasts predict the continued widening of the U.S. trade deficit in 2000 and 2001.
Note how they are very clever here. The process is reversed. People are selling us stuff because we don't save money. They lend us money and we then have to discharge this new money being lent to us by refusing to buy US goods. Instead, we are so grateful we buy Toyotas. Alas, this isn't what happened. Starting in 1970, the US began to run trade deficits. Instantly, there was great alarm at this development. Many efforts were made to force Germany and Japan to stop flooding us with imports. The tools used were mostly monetary: the infamous Bretton Woods II Accords weakened the dollar to the point, we hoped, imports would balance. They didn't.
At first, we all imagined it was the fault of the price of oil imports for this coincided with the US importing increasing amounts of oil, the US hitting its own Hubbert Oil Peak at this point. Even as deep sea wells and Alaskan oil poured in more and more, the loss from the earlier wells meant diminishing returns versus the desire to use oil. We use more oil than ever before.
Several times, the US struggled to evade the trade deficit net and each time, monetarist manipulations were done but this didn't fix anything. Then a new course was set: to embrace deficits. To sell this to Americans as our birthright. To remove all our domestic non-military manufacturing and send it all to cheaper labor/cheaper environmental laws locations. Then the goods could return, cheaper, and thus, the dollar will be maintain relative value due to it not staying home but traveling overseas. The excess dollars created by excess debt would not inflate our prices but go away and return only as more goods.
So we had dollar stability, nay, everything got cheaper at home and to make up for this, we went into debt in the housing sector. Inflating the value of houses meant we could feel rich while declining into debt. The monthly payments on this new debt were cheaper than regular loans since it was against something a bank could seize. So we celebrated this new place to park our financial decline. By 2000, the outsourcing, offshoring process was bearing its poisonous fruits. But instead of doubting this process, the need to justify it all and to expand it was overwhelming. So if we read this report, it is the common thread: trade deficits are good, not bad. We can live with it. The benefits are our due. The world wants to lend money to us and we need the money and it balances things! So the unbalanced trade becomes a nifty way to create monetary balance.
All our troubles really took off at this point thanks to this childish belief system.
The benefit of the trade deficit is that it allows the United States to spend now beyond current production. In recent years that spending has largely been for investment in productive capital. The cost of the trade deficit is a deterioration of the U.S. investment-income balance as the payment on what we have borrowed from foreigners grows with our rising indebtedness. Borrowing from abroad allows the United States to live better today, but the payback must mean some decrement to the rate of advance of U.S. living standards in the future. U.S. trade deficits do not substantially raise the risk of economic instability, but they do impose burdens on trade sensitive sectors of the economy.
We were quite capable of producing what we consumed. If we transfer all our factories to other countries then yes, we need to spend beyond our production. The trick here is the same trick Standard & Poor fixed the monoline insurance mess: ignore the reality and use pure magic. I am also amazed at this report talking about 'productive capital'. What on earth was that? Were we producing more factories with exportable goods? Or were we using this to expand our military occupations?
Alas, history since 2000 shows where this was being used: mostly for military purposes. Some investment was, during 1999, in the Dot Com bubble. This report came along when that was fading fast. The money in that sector pretty much vanished for good. Also note here that they admit the wild spending in 2000 may lead to diminished living standards in the future! But this didn't really bother them since 8 years later is like eternity: will never come.
Policy action to reduce the trade deficit is problematic. Standard trade policy tools (e.g., tariffs, quotas, and subsidies) do not work. Macroeconomic policy tools can work, but have a limited scope for action in practice. It is most probable, however, that the trade deficit will correct itself, without crisis, under the pressures of normal market forces.
All things resolve themselves, willy-nilly. The problem with waiting until this happens is obvious. We may not like the way they decide to resolve. A total crash of our internal as well as external economies is not a good route to take. History shows us, this can be very painful as well as quite destructive. Letting things slide until the only choice is to threaten nuclear warfare is not recommended. Especially since some of our trade partners have nuclear arsenals. I often come back to this fact: the US leadership and many people deciding our course of action are dangerously foolish. This document is a classic example as to how impossible it is for them to imagine obvious outcomes that are a grave danger to all of us.
Right on the heels of this being launched, the US took the worst of all possible courses: tax cuts, allowing terrorist attacks in the center of our finances and trade as well as military complexes and then several disastrous wars. ALL WARS CAUSE INFLATION. The US dealt with this by dropping interest rates, not raising them as is usual in wartime. This dumped the excess money the Fed created with these wars and moved all of it into both real estate speculation and corporate debt accumulations. None of which created any export products. The flood of exports exploded along with all this new funding ground out by a host of places: Washington, DC, the Federal Reserve and the Bank of Japan.
The trade deficit widens as the economy expands, not because of trade barriers abroad, not because of foreign dumping of exports, and not because of any inherent inferiority of the United States goods on the world market, but primarily because of underlying macroeconomic conditions at home and abroad. In effect, the U.S. economy spends more than it produces, and this excess of demand is met by a net inflow of foreign goods and services leading to the U.S. trade deficit.
Talk about refusing to see what the macroeconomic conditions really were! War spending isn't mentioned, of course. Even when this report was made and we were in between major wars, the US spent, since 1963, as if we were continuously at war. This is why the specter of inflation always troubled our economy. So much so, we hardly notice it anymore. But we spend heavily on war factors and this is a huge financial burden which we refuse to carry. It is always been an overdraft in our budget. The heady joy about balancing the budget made people forget the dangers. For trade deficits simply grew even with this.
Now on to last summer. This is the most recent report about the general trade deficit and our financial future. Note how this is even more insane than the one at the beginning of the Bush regime:
Is the trade deficit caused by global savings glut?
In an often-cited speech in early 2005, Ben Bernanke, now the chairman of the Federal Reserve, argued that the underlying cause of the trade deficit was not insufficient domestic saving, but rather a “global saving glut.” He argued that there was too much saving worldwide and not enough investment demand, and that the United States was the natural destination for this excess saving. As a result of the global saving glut, the trade deficit increased, interest rates remained low, demand for capital and residential investment rose, and the incentive to save decreased in the United States. He argued that because the trade deficit was not “made in the U.S.A.,” policy steps to reduce the budget deficit or raise private saving were unlikely to significantly reduce the trade deficit until the global saving glut ended.
Just for that alone, Bernanke should have been rejected as capable of running the Federal Reserve! Even as it is obvious to anyone with a brain that savings in the US has collapsed and now is negative, he still clung to the notion of a savings glut which the US had to accept in order to function! Last June, as nearly a trillion dollars was being dumped onto every possible buy-out deal the offshore hell hounds could concoct, the idea that this was all savings was total insanity. Of all people, Bernanke should know about the carry trade from Japan which was at its height that month. The ¥ was only 124 to the dollar! It had been falling for a while even as the dollar fell against the euro. These developments should have alarmed everyone.
The conventional view and the global saving glut view are not necessarily mutually exclusive. To an extent, the difference between the two is tautological — the conventional view stresses that U.S. saving is too low relative to foreign saving, and the global saving glut view stresses that foreign saving is too high relative to U.S. saving. It is important to acknowledge foreign causes for international capital movements, but in doing so, changes in domestic conditions should not be neglected. Although neither view leads to any hard conclusions about whether the trade deficit is good or bad, the global saving glut implies that reducing it is largely out of American hands.
The world's most powerful empire, the ruler of the Seven Seas, the possessor of more nuclear bombs than anyone, is helpless??? This fatalism is a common thread throughout this last 35 years. We can't help ourselves. Like babies, we sit in our highchair and hope that the people who save money will feed us. Eh? This bizarre attitude is coupled with boasts that we are the world's most dynamic and biggest economy. We are #1. Yet we are also unable to set things to right? And note the uncertainty here. In 1974, we knew perfectly well, our trade deficit was deadly. But after years of it growing, it morphed into a good thing or at least, something we can live with. This is most bizarre.
Contrary to the global saving glut hypothesis, data show that world saving is close to its lowest level in decades. However, low interest rates (although not unusually low by historical standards) suggest that worldwide investment demand is probably low as well. Data also show that the rise in saving in the developing world (notably among oil producers and East Asian countries) over the past few years has gone hand-in-hand with the significant accumulation of official foreign exchange reserves. At the same time, there has been a decrease in government saving in the United States since the 1990s. In recent years, a large fraction of U.S. net capital inflows have been the result of foreign reserve accumulation by other countries rather than coming from private sources, which suggests that global imbalances are not primarily the result of decisions by private investors and that (because of the fall in U.S. government saving) the trade deficit to a great extent may indeed have been “made in the U.S.A.”
The policies that created the trade deficit certainly were hatched in the U.S.A. But everyone who surround us want a piece of this apple pie. They happily spoon fed us their exports while we sat there and drooled onto our bibs. The governments of Japan and China have been the top purchasers of our cheap government debts. But this was due them desiring control over our government's policies so the politicians in DC would not fight off their exports to the US. This put us in hock to them. And of course, savings in the realm of individuals saving money and then their banks investing it in US papers like our CDOs, etc, certainly happened but in the oddest of ways. Chinese and Japanese working people were saving money in GOLD or in other, stronger currencies. Their governments encouraged this because it weakened their own currencies and thus, increase trade with the US. On top of this, the money flow was via the Bank of Japan via the carry trade which was raging when this report came out. The collapse of this dynamic is why 'liquidity' suddenly vanished like a door slamming shut. The trade deficit continued. But the flow of money ceased. And I may add, with tremendous finality. Since mid-August, the central banks in Europe and America have struggled to make up for the vanished money flow from Asia.
But China, far from sending money here anymore is probably going to use it to buy more things they need to hoard since the US is now creating global inflation. The sea of red ink has now hit everyone right between the eyes.
Economic theory predicts that capital will flow to the country where it can earn the highest real rate of return. Although some economists are concerned by the scale of U.S. borrowing, most believe that international capital flows are generally mutually beneficial: they allow the borrowing country access to more capital than
domestic saving would allow, and they allow the lending country to earn a higher rate of return than could be earned at home. If rates of return (adjusted for risk)6 were higher in the United States than abroad, then capital would flow into the United States and a current account deficit would result. Rates of return might be higher in the United States than abroad for several reasons.
First, the United States has enjoyed an increase in productivity growth since the mid-1990s that has not been experienced widely abroad. As a result, U.S. economic growth has tended to consistently outpace growth in most other industrial countries in the past 10 years. At least in the short run, this productivity boom might be expected to raise U.S. rates of return above foreign rates.
Second, interest rates are determined by the intersection of the supply of national saving and the demand for investment spending. Because saving rates are so much lower in the United States than abroad, one would expect higher interest rates in the United States.
This section shows what happens when one goes insane. Up is down, in is out. We have NOT been 'more productive.' We have witnessed a dreadful collapse in pay for the working class. In China, for example, wages have been slowly rising. In Europe, they have riots if wages drop. But wages are falling there because factories are seeping out of Western Europe and into Eastern Europe or beyond. The US has grown mostly debts as everyone copes with this monstrous 'productivity growth' by borrowing more and more money. With interest rates at super-low levels while this was going on, it was pretty easy to live. But that is now over.
Note the bizarre last paragraph here. Interest rates were going up but not due to great productivity or rising savings. Even as rates rose, savings still fell! And we were hoping the higher interest rates would attract savings but it lasted hardly an eye blink before the dreaded collapse of world finances hit. Instantly, the Fed in desperation dropped rates and is still dropping rates. How can world excess savings be attracted to the US under these conditions? The trade deficit roars onwards, barely pausing. Only when we simply can't buy much of anything at all, will it end.
Third, demand for U.S. investment spending is being crowded out by budget deficits that are competing for the same pool of private saving, which increases interest rates.7 Because the budget deficit pushes up interest rates (which attract foreign capital inflows), the budget deficit and trade deficit are often referred to as
Fourth, economic theory suggests that additional investment is subject to diminishing returns. For example, adding a second machine at a factory would be expected to yield less additional output than the first machine for a given labor force. Many countries have higher investment rates than the United States; therefore, rates of return may be lower abroad because of diminishing returns. (This assumption would be less applicable to developing countries because their capital stocks are so much smaller than those of industrial countries.) For example, despite persistently low economic growth and low rates of return during the past decade, Japan’s investment rate was still roughly 4 percentage points of GDP higher than America’s in 2006. With investment rates so high, perhaps it is of little surprise that the Japanese would prefer to invest their remaining saving in foreign assets.
Japan is 'investing' in the US for one reason only: to insulate themselves from possible retaliation by the US for the trade deficits we run with Japan. If Japan assembles Toyotas here, they can also import even more from China and Japan and sell them, too. I witnessed the gigantic Toyota auto ships coming to port in Elizabeth, New Jersey. The ships are massive boxes! With no paintings on the side to show us whose ship this is or what they are carrying. They are painted taupe color to blend in, not stick out. This is how all these things are operating: via stealth. The 'investments' here are schemes to take over our systems and then force them to run in such a way that all the power and profits flow out of the US. Which is what is happening, of course! PROFITS MATTER. Where they flow matters! This is capitalism, after all.
In determining why international capital flows have changed, an important consideration is the form they have taken. Official foreign exchange reserves in developing countries more than doubled in dollar terms from 2003 to 2006, and more than tripled from 2001 to 2006, rising to $3 trillion in 2006.23 In many East Asian
countries, although overall saving has fallen, there have been large increases in foreign exchange reserves, as shown in Figure 3.24 When a country accumulates foreign reserves, its trade surplus increases (or trade deficit decreases) and its currency appreciates less than it would otherwise.
Many Asian countries, including China and Japan, have not seen their currencies significantly appreciate against the dollar in recent years.25 These countries presumably were attempting to maintain the attractiveness of their exports, but may also have been attempting to strengthen their fiscal position to stave off future financial crises (à la Bernanke’s war chest analogy). The accumulation of foreign reserves in oil-exporting countries stems from their higher oil revenues in recent years, which has not been completely offset by higher imports. Furthermore, not all state-controlled capital flows in oil-exporting countries are recorded as foreign reserves. The Economist recently estimated that $2.5 trillion may be held in various countries’ sovereign-wealth funds.
Far from offsetting imports of oil with exports, we are losing to Europe, Japan and China in sales to oil countries. We have trade deficits with ALL of the people we buy oil from! Even as we sell them weapon systems and jets, they still overwhelm us. This is a disaster.
Economic theory cannot predict how much a country should borrow abroad (at low levels), but if borrowing were becoming burdensome, one would expect net investment income payments abroad to be large. Despite being the world’s largest debtor country, the United States earns more abroad on its foreign assets than it pays out to foreign lenders. (Although its liabilities exceed its assets, the United States is earning more on its assets than it is paying on its liabilities.) As long as this is the case, it is difficult to see why the current account deficit is not sustainable — although it is implausible that the United States could borrow limitlessly without foreign debt payments becoming unsustainably large.
Bernanke points out that one potentially troubling feature of the current situation is that so much investment has been residential, which is unlikely to increase the nation’s productive capacity and reduce the burden of paying back foreign debt in the future. So far, global imbalances have not disrupted economic activity and have arguably been mutually beneficial, since they have allowed low saving economies like the United States to increase their investment rates and high saving economies like Japan to earn a higher rate of return. Thus, the mere existence of current account imbalances cannot be seen as problematic per se. If one were to argue that the current account deficit were harmful to the United States, it would have to be on the grounds of its future, rather than current, economic effects. The most widely cited worst-case scenario is if foreigners became unwilling to lend further to the United States, causing the current account deficit and the dollar to suddenly plummet. This event would presumably cause unrest in financial markets, leading to broader economic disruption. The gap between domestic saving and investment would suddenly need to be bridged through higher domestic saving and lower domestic investment, which would require a sharp rise in interest rates to occur.
Well, well, this came out mid-June. We learned exactly how messed up our 'limitless' debt accumulation really was soon afterwards. Parking most of this foreign investment in real estate was already a disaster when this report came out. I warned about this in 2005. This report is from 2 years later. Note again, how the 'worst case scenario' will lead to higher interest rates. Well, here it is and we see these rates... in our muni bond markets. And soon, elsewhere. The grab bag of goofy rescue schemes are all set to make our trade balance, our inflation and our red ink much, much worse. This is why a correct analysis has to include adult warnings of obvious dangers. And we can't then say, 'We are helpless.' Or, 'We don't have to worry since it will work itself out.'
Note how this report does mention some bad things which could happen. This 'sudden higher domestic savings' is code for 'Help! Volker! Save us!' The 'higher rates' are around 20% as we saw just this month in the muni bonds. This will cause mayhem at home and mayhem is around the corner if we don't figure out which way this street goes.
If, on the other hand, the current account deficit and dollar were to decline slowly, there would be little reason to expect it to cause economic disruption because the decline in investment spending would be offset by higher production in export- and import-competing industries. Domestic investment would have to fall and domestic saving would have to rise to restore equilibrium to financial markets. Higher interest rates would be the channel through which these changes would occur, and how much interest rates rose would depend on how sensitive saving and investment are to interest rate changes. This would be true in both the conventional view and the global saving glut view.
I looked for a more recent report but this is the latest one. Since we are NOT going the higher interest rate route, we are in serious trouble. What are the consequences of a super low, Japanese-level rate? Will world savings flow here under those circumstances? If the US is exporting to Asia, will Asia want to lend us money? According to these experts, the answer is, 'Nope.'
The risk that the record current account deficit could lead to economic disruption for the United States is still considered small by most economists, but potentially dangerous. Raising national saving through policy changes such as reducing the budget deficit remains the best defense against this risk. At worst, those measures would prove ineffective, as the global saving glut view predicts, but would still have a salutary effect on the U.S. economy in their own right.
When this report came out, the gold markets were beginning to really climb. This report has nothing to say about the various schemes to drop the value of gold such as a number of European banks dropping interest rates, for example. The need to mention gold is vital here since it is a good indication of a collapse of putting money into investments that are productive and parking it in a fairly inert and safe place until the inflation is recognized by the central banks and proper interest rates rise to deal with it. This was already quite obvious in June. I talked about this here.
The report ignores this because of the 'baby factor.' It is hard to think of three things at once when one is a helpless baby waiting for Mama Chinese dragon to feed some easy money at cheap interest rates or for Miss Toyota Japan to pass along more carry trade loans.