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The most important news of the month. Perhaps the year.

29 September 2008

Summary:  The warnings continue from our foreign creditors, as they see the deeper significance of America’s financial crisis.  The post-WWII geopolitical regime is ending, and they are thinking about the future.  Through one of those peculiar episodes of blindness that shapes history, the more warnings America receives — the more indifferent we become to them.  China in particular has given a stream of warnings over the past few years.  The first were by obscure academics, very low key in nature.  Slowly they have grown more explicit, but we remain oblivious. 

Now our allies — also our creditors — are speaking out.  This post gives two of the lastest reports.  Whatever happens, we cannot say that we were not warned. 

  1. Asia Needs Deal to Prevent Panic Selling of U.S. Debt, Yu Says“, Bloomberg, 25 September 2008
  2. US ‘will lose financial superpower status’“, Financial Times, 25 September 2008
  3. Dollar Intervention Risk `Meaningful’ on Volatility“, Bloomberg, 29 September 2008

Excerpts from these articles

1.  “Asia Needs Deal to Prevent Panic Selling of U.S. Debt, Yu Says“, Bloomberg, 25 September 2008 — This advocates similar measures to those I said were necessary in my post on the same day as this article:  A solution to our financial crisis.  Yu Yongding is a member of the Monetary Policy Committee (MPC) of the People’s Bank of China, and has long warned that the US-China economic relationship is becoming disfunctional.  Excerpt:

Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank.

“We are in the same boat, we must cooperate,” Yu said in an interview in Beijing on Sept. 23.  “If there’s no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.”  An agreement is needed so that no nation rushes to sell, “causing a collapse,” Yu said.  

Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations.

China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank’s monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said.

… China’s huge holdings of U.S. debt means it must bear a large proportion of the “burden of sorting things out” in the U.S., Yu said. China is not in a hurry to dump its U.S. holdings and communication between the two nations every “couple of days” is keeping Chinese leaders informed and helping to avoid a potential panic, he added.  “China is very worried about the safety of its assets,” he said. “If you want China to keep calm, you must ensure China that its assets are safe.”

Yu said China is helping the U.S. “in a very big way” and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said.   “It is not fair that we are doing this in good faith and are prepared to bear serious consequences and you are still labeling China this and that, accusing China of this and that,” he said. “China knows what to do. We don’t need your intervention.”

The U.S. financial crisis had taught China a lesson and that was: “Why are we piling up these IOUs if they may default?” China’s economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu.

“Our export-growth strategy has run its natural course,” he said. “We should change course.”   China should stop intervening in the foreign currency markets and thus allow rapid appreciation of the yuan, he said. While this would cause pain for exporters, China could ease the transition by using its strong fiscal position to aid those who lose their jobs. It also should stimulate domestic demand to offset lower income from overseas sales.

Without yuan appreciation, China will continue to accumulate foreign reserves, which means further accumulating “IOUs from the U.S.,” said Yu. “This is paper and it may default and it will not increase China’s national welfare.”  If China doesn’t allow the yuan to appreciate and continues to promote export-led growth it will lead to confrontation with the U.S. and Europe, Yu said.

2.  “US ‘will lose financial superpower status’“, Financial Times, 25 September 2008 — Excerpt:

The US will lose its role as a global financial “superpower” in the wake of the financial crisis, Peer Steinbrück, the German finance minister, said on Thursday, blaming Washington for failing to take the regulatory steps that might have averted the crisis.  “The US will lose its status as the superpower of the world financial system. This world will become multi­polar” with the emergence of stronger, better capitalised centres in Asia and Europe, Mr Steinbrück told the German parliament. “The world will never be the same again.”

His were the most out­spoken comments by a senior European government figure since Wall Street fell into chaos two weeks ago.  He later told journalists: “When we look back 10 years from now, we will see 2008 as a fundamental rupture. I am not saying the dollar will lose its reserve currency status, but it will become relative.”

The minister, who has spearheaded German efforts to rein in financial markets in the past two years, attacked the US government for opposing stricter regulations even after the subprime crisis had broken out last summer.  The US notion that markets should remain as free as possible from regulatory shackles “was as simplistic as it was dangerous”, he said.

His comments followed calls this week by Nicolas Sarkozy, the French president and current holder of the European Union presidency, for an emergency G8 meeting on the crisis.

3.  “Dollar Intervention Risk `Meaningful’ on Volatility“, Bloomberg, 29 September 2008 — Excerpt:

A growing number of currency traders and strategists are starting to speculate that finance ministers from the world’s biggest economies will join to support the dollar.  Volatility in currencies is the highest since 2000, when the so-called Group of Seven nations last intervened in the foreign-exchange market.

… While the dollar strengthened 9% from its record low against the euro on July 15, wider price swings threaten to undermine confidence in the U.S. currency just as government borrowing rises and U.S. lawmakers prepare to vote on Treasury Secretary Henry Paulson’s plan to bail out the nation’s banks. The greenback is still down 23% since 2005.   “We’re getting closer to the right conditions for authorities to step in and prop up the dollar,” said Maxime Tessier, who manages $151 billion as head of foreign exchange in Montreal at Caisse de Depot et Placement. “The nightmare scenario will be a wholesale loss of confidence in the dollar.”

… “The central banks of the world have embarked on all sorts of extraordinary interventions,” said Stephen Jen, the global head of currency research at Morgan Stanley in London. “Currency joint intervention would be the least surprising. And it would probably be the cheapest.”

… Finance ministers from the G-7 are more concerned about rapid swings in exchange rates than the absolute level of currencies because volatility complicates the assessment of economies, interferes with monetary policy and gives companies little time to adjust by cutting costs.

… The G-7, which includes the U.S., Japan, Germany, Britain, France, Italy and Canada, warned in April against the implications of “sharp fluctuations in major currencies,” the first time since 2004 that the group used such language. Shoichi Nakagawa, Japan’s new finance minister, reiterated that view on Sept. 26, saying “sharp fluctuations in the foreign exchange market aren’t good.”

… Weakness in the dollar hasn’t become so disruptive to suggest imminent intervention, said Ken Jakubzak, who manages the KML Currency Program in Chicago for KMJ Capital LLC, which has $100 million under management.  The currency is 3% stronger than its record low in March on a trade-weighted basis. Some investors say the currency may rally as the economies outside the U.S. slow.

“Authorities don’t want excessive dollar weakness to feed the sell-America mentality,” said Chris Turner, head of foreign exchange strategies in London at ING Groep NV, the largest Dutch financial-services company. “We are not there yet, but the risk is there. People I speak to are worried about a budget explosion.”

The government depends on foreign money to finance the budget deficit because investors outside the U.S. own 56%of the $4.8 trillion in marketable Treasuries outstanding, up from 42% five years ago, according to data compiled by the government.

While the G-7 decided against intervening in April when the dollar fell below $1.60 per euro for the first time, tolerance for a weaker currency may be limited because of the turmoil sweeping the financial system. The next meeting is scheduled for Oct. 10 in Washington.

Updates

The media has begun reporting concerns by experts about the willingness of our credtors to support us. 

A default by the US government is no longer unthinkable“, The Telegraph, 20 September 2008 — “So, here we are – the start of a new world order. After the tumultuous events of the last fortnight, the global economic landscape will never look the same again.”

Foreign Investors and a Dollar Plunge“, BusinessWeek, 24 September 2008 — “Foreign central banks worry about U.S. debt load after a bailout. Could the dollar get hammered if the $700 billion bailout goes through?”

As usual, Brad Setser provides a clear look at the situation (hat tip to him for the above links):

It is (almost) official: the quiet bailout is roughly equal in size to the US current account deficit“, Brad Setser, Council on Foreign Relations, 28 September 2008.

What should we do?

That is a complex question.  For a simple answer see A solution to our financial crisis.

Afterword

If you are new to this site, please glance at the archives below.  You may find answers to your questions in these.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling). 

Some FM posts about the current crisis

For a full listing see the FM reference page about the Financial crisis – what’s happening? how will this end?.

A few of the most important posts warning about this crisis

This crisis has long been forecast by many, including in articles on this site.  Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results.  To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime.  Here are some of those posts.

  1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
  2. The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  3. We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
  4. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  5. Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end?  With re-balancing of the global economy, so that the US goods and services are again competitive.  No more trade deficit, and we can pay out debts.
  6. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
  7. What will America look like after this recession?, 18 March 208  — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
  8. The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
  9. The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
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6 Comments leave one →
  1. 29 September 2008 2:17 pm

    There’s a comprehensive lead article in the newest Spiegel issue (not yet on the English website) that’s all about the consequences of the crisis.

    The basic tune is that the prosperity was too much built on cheap money and deregulation since early Reagan day that collapsed. Furthermore, they insisted that the time of ambitious and somewhat arrogant foreign policy were over simply because the economic power to support it is gone.

    It began with an analysis of the behind-the-scenes and in-the-audience reactions to Bush’s UN speech. They recollect it as a demonstration of wide-spread disrespect for a man of yesterday who spoke about terrorism when all others think about the economy. They mention that there was always political opposition in such meetings, but never such a degree of disrespect.

    They’re quite late, though. I mentioned the loss of respect almost a year ago: “‘Leader of the free world’“, Sven Ortmann at Defense and Freedom, 14 October 2007.

    Like

  2. plato's cave permalink
    29 September 2008 3:19 pm

    I sense a certain satisfaction at the perceived coming shift in America’s global status. I feel it too. I hope it includes a waning of our current military adventurism, although one of history’s oldest lessons is that warfare is a wonderful way of distracting a population from its internal social discontents.

    Sarkozy’s call for a new global economic order is very interesting to me. He says it doesn’t mean the end of capitalism, but it does mean the end of “free market” ideology. The German minister quoted above is clearly opposed to the deregulated financial practices of the hedge fund era. Does any of us think that capitalism can be thus reformed, and will go quietly into that good night of state-regulated behavior?

    Like

  3. 29 September 2008 3:34 pm

    German magazines and newspapers are telling us all the time how the German government tried to push international financial market regulation and oversight since years, especially in the past twelve months.
    Interviews and recounts of their present attitude reflect a kind of bitter satisfaction. They were apparently opposed by US and UK politicians on this issue on the G8 summit and on other occasions. Now they feel a bit like Cassandra.

    That’s a strikingly similar situation as with the Iraq war, where the voices of friendly and allied nations that opposed the invasion weren’t heard as well.

    Like

  4. pluto permalink
    29 September 2008 5:31 pm

    The Brad Setzer article was most enlightening, thank you for sharing it with us.

    Like

  5. 30 September 2008 1:52 am

    Certainly the US has lost ‘financial super power’ status. Plus a huge amount of paper-value in home prices. But that debt-based overvaluing meant the US didn’t really have superpower assets the last 10 years anyway.

    There will be no default — that’s silly. Unlike Argentina or Zimbabwe, the US debt is in US dollars. Obviously, the US Treasury can print money, just like Zimbabwe’s printers. That devalues the currency, but it’s not default.

    From that Telegraph article:
    And by the way, the Fed has also just offered another $125bn of liquidity to banks outside the US that are desperate for dollars and can’t access America’s frozen credit markets – a move co-ordinated with central banks in Japan, the Eurozone, Switzerland, Canada and here in the UK.

    I wonder if these banks are ‘desperate for dollars’ or racing for dollar exit? I don’t know why foreign banks would need dollars so much — what are they buying? Or do they have private USD deposits whose owners now want out? (my guess)

    When will China move to increase its Euro reserves, and freeze its USD holdings?
    .
    .
    Fabius Maximus replies: I enjoy reading the folks with psychic powers who comment here! In this case, precognition — the gift of prophecy.

    “There will be no default — that’s silly. Unlike Argentina or Zimbabwe, the US debt is in US dollars.”

    This asserts that printing dollars to meet debt is in all cases superior to default. After all, it worked for Weimer (except for crippling it, leading eventually to that guy with the funny mustache and total devastation)!

    In the real world a negotiated default can be less destructive than hyperinflation. Nor is it certain that the US debt will always be in US dollars. We issued yen and D-mark bonds during President Carter’s term, and might have to do so again if we are forced to a general debt restructuring (which I consider likely during the next 5 years).

    Like

  6. 30 September 2008 1:56 am

    Data question Fab — don’t currency interventions by central banks usually fail? Even joint ones? I’m wondering what the data says.
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    .
    Fabius Maximus replies: Define “fail.” Currency interventions can buy time for other measures to work or slow a movement in the markets. No expert believes they can do much else.

    Like

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