Japanophobia: Economic Myths in the American Media

Oct 20, 2010Lynn Parramore

lynn-parramore-web-headshot-1If fiscal hawks have their way, we'll learn the wrong lessons from an ailing Godzilla.

lynn-parramore-web-headshot-1If fiscal hawks have their way, we'll learn the wrong lessons from an ailing Godzilla.

I'm turning Japanese
I think I'm turning Japanese
I really think so
~~The Vapors

The American obsession with the Japanese is nothing new. We marvel at their meteoric trains and mouth-watering cuisine. We once spoke of their economic prowess in hushed awe. But reading the New York Times last Sunday, I realized that our fixation was taking a new, dangerous turn. Japanophilia is morphing into Japanophobia --  a fear that the U.S. economic outlook will somehow mimic the Land of the Rising Sun if we don't heed the fiscal hawks. In truth, we are in danger of learning all the wrong lessons from the Japanese. A shame, because they have much of value to teach us.

Martin Fackler's "Japan Goes From Dynamic to Disheartened" presented a fear-inspiring narrative that does little more than perpetuate myths that benefit the rich. His story: the Japanese economy is in the shitter because of too much "wasteful spending" by the government. Fackler breezily suggests a consensus on this point among economists:

"Japanese leaders at first denied the severity of their nation's problems and then spent heavily on job-creating public works projects that only postponed painful but necessary structural changes, economists say."

Oh, really? Creating jobs that put people back to work is about denial? Funny, but I know some economists who say otherwise. My Roosevelt Institute colleague Thomas Ferguson dismisses the false choice implied by the author. "You don't have to choose between working to keep full employment and making structural changes," Ferguson wrote to me in an email. "The issue is whether you just let unemployment go up, which drives people to desperation and widens the gulf between the rich and the rest of us, or whether you keep people employed while you make the structural changes you think are needed. The latter way is much easier to do and far more productive for society."

Fackler draws his analogy between the U.S. and Japan beginning with the Japanese bubbles that burst in the 80s and 90s. According to him, the country "fell into a slow but relentless decline" that could not be reversed, alas, even by "enormous budget deficits" or "a flood of easy money". Then comes the ominous warning:

"Now as the United States and other Western nations struggle to recover from a debt and property bubble of their own, a growing number of economists are pointing to Japan as a dark vision of the future."

Memo to Fackler: If you look closely at the history of the Japanese economy, it provides precisely the opposite illustration. Government spending didn't cause the Japanese economy to stagnate. It was the fitful confusion of stop-start fiscal spending that seesawed the economy between hopeful improvement on the one hand, and wrenching cut-backs and consumption taxes urged by austerity-preaching deficit hawks on the other. Bipolar fiscal policy during a time when the private sector is trying to pay down debts and repair balance sheets is a recipe for disaster. The "flood of easy money" Fackler references, also known by the wonky term "quantitative easing", was the wrong approach by the Japanese government, which should have maintained the focus on jump-starting a weak economy by putting people back to work. That's the smart, productive way to get things moving. Unfortunately, a failure of nerve and political will crippled Godzilla. And the dismal vision Fackler outlines will emerge in the U.S. if we buy into his false narrative. Ironically, reports like Fackler's are creating the very reality they purport to warn against.

My colleague Marshall Auerback provides some facts that Fackler-the-Feckless would do well to master. In a mini-history of the Japanese response to economic crisis, he observes:

"In 1997, just as Japan was beginning to emerge from recession, the government introduced a 40% increase in the consumption tax, which promptly threw the country back into the throes of recession. Then you had the Asian financial crisis, which obliterated the export sector. Then you had the Koizumi Administration attempting "fiscal consolidation" throughout the early 2000s, which actually caused economic growth to slow and the budget deficit to rise. This, despite the fact that the Bank of Japan started to do "quantitative easing" in March 2001. It wasn't until September 2003, when the Koizumi government finally stopped the crazy fiscal austerity fetishism, when, lo and behold, the economy began to grow steadily again and the budget deficits began to go down. That's what was happening until the financial crisis of 2008."(Also see Auerback's "What Ever Happened to Japan?").

Contrary to Fackler's story, Japan's deficits show the dangers of what happens when you stop spending proactively and productively during a crisis: you get larger deficits as automatic stabilizers kick in and tax revenues decline. To avoid this fate, we have to deploy our fiscal resources to generate greater economic activity. Put plainly, we need to create jobs. It would be great if the private sector were creating all the jobs we need. But it isn't. And that's where government can step in.

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But meanwhile, we have to combat the Facklers who whip up Japanophobia and freeze our political will. As Rebecca Wilder points out at the News N Economics blog, cherry picking anecdotes about down-and-out Japanese people crushed by deflation as Fackler does is not a substitute for responsible analysis. Contrary to what he implies, the Japanese standard of living has actually grown over the last two decades. And as for the country's unemployment numbers, they ought to make Americans blush: They're around 5%. The Japanese may be wary of the future after the bubble-fueled economic euphoria of past decades. But most of them have jobs. And as to what they enjoy in the public sphere, well, let's just say that if you take a train out of Tokyo and compare that to a train ride from New York City, you will quickly discover just how well our fiscal austerity is working for us. Go ahead. Use the toilet if you dare.

But the big question is this: Why does America continue to put up with high unemployment when we can directly create jobs, just as FDR did through the Works Progress Administration? Is it because big corporate interests want to keep wages down by keeping large numbers of Americans out of work? Is it because the rich become more powerful when ordinary people have less? These are the dark visions we should be worried about. History shows that when times are tough, the government can create jobs and find plenty of useful things for laid-off folks to do. Like repairing roads and rebuilding decrepit schools. Where there's a will, there's a way. Political will is what stands between millions Americans and a more prosperous future. That, and reporters who don't do their homework.

Lynn Parramore is the editor of New Deal 2.0, Media Fellow at the Roosevelt Institute fellow, Co-founder of Recessionwire and the author of Reading the Sphinx.

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The Foreign Exchange Mystery

Oct 13, 2010Wallace Turbeville

money-question-150Why would such a large swaps market be a possible exemption from FinReg?

money-question-150Why would such a large swaps market be a possible exemption from FinReg?

The traded foreign exchange market is the big enchilada. It is the largest financial market in the world. The Bank for International Settlements estimates that the daily turnover in this market, including swaps, futures and spot purchases, is $4 trillion as of April 2010. This turnover increased more than 20% in the last 3 years. Trading is concentrated in London, accounting for 36.7%, while the New York share of the market is around 18%.

Since FX swaps and forwards are based on currency values, it is very easy to embed other financial transactions in a dealtransaction that involves exchange rates on its face. For instance, a loan can be the primary purpose for a swap of currency values. The danger in such obfuscation is illustrated by the foreign exchange transactions between the Greek government and Goldman Sachs, which disguised the debt burden of Greece and triggered a crisis.

In the Dodd-Frank Act, clearing (if available) is mandated for most derivatives, with "end user" hedging transactions carved out. But a second carve out, for FX swaps and forwards, is permitted if the Treasury orders it. There is significant concern among progressives monitoring the implementation of Dodd-Frank that the Secretary will soon exempt FX instruments from the clearing mandate. (See Mary Bottari, "Is Geithner Planning a Stealth Attack on the Wall Street Reform Bill" and David Wigan, "Traders Angered by Swaps Legislation.") Why did the Act envision this enormous exception? Why would Treasury implement the exemption? Why would it act now? These and other questions are shrouded in mystery, and that fact alone is of great concern.

Several knowledgeable individuals who were involved in the discussions of this provision during the drafting of Dodd-Frank report that Treasury never articulated a coherent rationale. It was clear that the New York Federal Reserve sought the exemption, but their motive was obscure. There was no structural impediment to mandating the clearing FX instruments: the Chicago Mercantile Exchange has a thriving FX futures business. It follows that Congress did not have the information to assess the proposed exemption, and the decision was delayed and delegated to Treasury.

According to Dodd-Frank, the Treasury Secretary must consider the following in deciding whether to grant the exemption:

1) "whether the required trading and clearing of foreign exchange swaps and foreign exchange forwards would create systemic risk, lower transparency, or threaten the financial stability of the United States;

2) whether foreign exchange swaps and foreign exchange forwards are already subject to a regulatory scheme that is materially comparable to that established by this Act for other classes of swaps;

3) the extent to which bank regulators of participants in the foreign exchange market provide adequate supervision, including capital and margin requirements;

4) the extent of adequate payment and settlement systems; and

5) the use of a potential exemption of foreign exchange swaps and foreign exchange forwards to evade otherwise applicable regulatory requirements."

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If the Secretary decides to grant the exemption, he is required to submit specific information to the relevant congressional committees, including:

1) "an explanation regarding why foreign exchange swaps and foreign exchange forwards are qualitatively different from other classes of swaps in a way that would make the foreign exchange swaps and foreign exchange forwards ill-suited for regulation as swaps; and

2) an identification of the objective differences of foreign exchange swaps and foreign exchange forwards with respect to standard swaps that warrant an exempted status."

It is hard to imagine that, in the months of discussion that preceded the enactment of Dodd-Frank, these issues were not thoroughly analyzed by the Treasury and the Fed. Certainly there is nothing that has emerged since enactment that is relevant to these issues. Granting the exemption now doesn't make sense with the flow of events. Congress could have been presented with all relevant facts and arguments so it could have decided instead of delegating the decision to Treasury.

The process suggests that this delay and the procedure were designed to appease opponents to the exemption and those who were concerned that the rationale was insufficiently presented. If this is true, the result is probably inevitable, at least in the minds of those in charge of the Treasury and the Fed. It is really maddening that the administration and the Fed were unwilling or unable to lay out the necessary factors to allow Congress to decide on such an important segment of the market.

We are left to guess at the reasons the FX market is to be treated so differently from other derivatives markets. There are several distinctions:

• As stated above, it is large. Worldwide, it is the largest of the financial markets.

• There is no meaningful distinction between a forward purchase and sale and a swap. Buying euros for future delivery at a fixed dollar price is not materially different from a euro/US dollar swap. In contrast, if someone sells a bushel of corn, he or she must deliver it.

• There has been much debate about the proportion of hedging and speculation in the FX market. However, it is clear that, compared with other markets, the amount of speculation is quite large.

• Relative currency values are directly related to central bank activities.

• The London market, being twice the size of the US market, plays a central role.

• The market presence of US financial institutions is significant, but the larger participants are European banks.

None of these distinctions compels a decision to exclude FX transactions from mandatory clearing, a process in which trade data is reported and a standard system for margining is imposed. Until the Treasury and Fed fill the public in on their thinking, it is pointless to speculate (unless you are a bank speculating on foreign exchange rates). It is ironic that, in implementing legislation designed to bring transparency to the financial markets, the Treasury and the Fed are so unconcerned about their own lack of transparency.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co. He is Visiting Scholar at the Roosevelt Institute.

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How War Debts, High Tariffs, and Competitive Devaluation Led to War

Oct 8, 2010David B. Woolner

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

Roosevelt historian David Woolner shines a light on today’s issues with lessons from the past.

Last week, in a little-noticed story, the German government announced that on October 3 -- the twentieth anniversary of German Unification -- Germany would make the final payment on the debts it acquired through the allied demand for reparations in the aftermath of World War I. The timing of this development is interesting. It brings to mind one more example of the misguided economic policies that came in the wake of the First World War, which contributed to the financial collapse that brought about the Great Depression. We now know that these polices -- which included the passage of the Hawley-Smoot Tariff that raised import duties to their highest level in American history, competitive devaluation of currencies among the leading industrialized nations, and other protectionist measures such as exchange controls -- were contributing factors to the onset and severity of the Depression. They also helped propel Adolf Hitler into power in Germany and hence had horrific consequences far beyond mere economics. How did the world get into this mess? And are we in danger of repeating some of the same mistakes today?

In the wake of the carnage wrought by the world's first truly "total war" -- the British alone lost over nineteen thousand men on the first day of the Battle of the Somme -- the desire for revenge against Germany was very strong, especially in France and Belgium, where large areas were devastated by the conflict. This sentiment, coupled with the fairly widespread belief among the allied powers that Germany was responsible for starting the war (Germany certainly bore a large share of the responsibility, but there were other forces at work as well), led to ever-increasing calls for Germany to pay for it. The allies had also taken on huge debts during the conflict, mostly owed to the United States, which emerged from the war as the world's leading creditor nation. Based on these determinations, the allies included the so-called "war guilt clause" in the Treaty of Versailles, which stated that Germany must accept responsibility for "causing all the loss and damage to which the Allied and Associated Governments and their nationals have been subjected as a consequence of the war..."

Having concluded that Germany was liable for the cost of the war, the allies imposed a reparations regime upon Germany that called for a payment of 269 billion gold marks. The treaty also stripped Germany of her overseas colonies and investments, drastically reduced the size of her military, eliminated her merchant marine, and split the country in two so as to provide a corridor to the sea for the newly reconstituted country of Poland.

Needless to say, these measures placed a significant economic (not to mention psychological) burden on the inchoate Weimar Republic. This was especially true with respect to the reparations, for as John Maynard Keynes observed in his landmark work The Economic Consequences of the Peace, the reparations not only involved payments of gold and/or foreign currency, they also transferred important coal, iron and steel properties from Germany to France and prohibited their utilization by German industry. The treaty as such struck at the very heart of the German economy and made it much more difficult for Germany -- even then the most important economic unit in Europe -- to fully recover from the war.

It was only a matter of time before the German government defaulted on its reparations payments. When it did so in 1922, the French responded by invading Germany's industrial heartland, the Ruhr. This in turn led to a campaign of passive resistance among German workers and the decision by the German government to continue to pay them, leading to hyper-inflation and the collapse of the German economy.

Even though the United States had rejected both reparations and the Treaty of Versailles, it was the US that ultimately came to Germany's and Europe's rescue in response to the 1923 "Ruhr crisis." Under the terms of the Dawes (1924) and later Young (1929) plans, the total reparations due was reduced to 112 billion gold marks, and millions of private American dollars were pumped into the German economy to stabilize its currency and make it possible for Germany to pay her reparations. This in turn made it possible for the British and the French to make their war debt payments to the United States.

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This inherently unstable system worked fine so long as American investors were willing to keep the flow of dollars moving into Germany. But when the bottom fell out of the US stock market in 1929 the flow stopped, the German economy once again collapse,; and with unemployment soaring, the popularity of the Nazi Party rose dramatically. In 1928, for example, the Nazis held only 12 seats in the Reichstag, but in 1930 they polled 107 seats and in 1932 they took 230, making Hitler's party the largest in the German Parliament. Within a matter of months, Hitler was appointed Chancellor of Germany and the fate of the world would never be the same.

None of this happened overnight. It took some time for these events to unfold, which is why in hindsight the actions of the governments involved look so disturbing. With Germany experiencing a rapid economic decline after the 1929 crash, for example, the allies offered to reduce the reparations demands, but only if the United States would be willing to do the same with respect to the war debts. The Hoover Administration, however, refused to do so, even going so far as to insist repeatedly that there was no link between the two issues. Hoover did offer -- and instigate -- a one year moratorium on all inter-governmental debt in 1931, but this was too little too late. Moreover, to make matters worse, the US by this point had instigated the Hawley-Smoot Tariff, making it even harder for the European nations to earn the dollars they needed to pay off their American debts. By 1931, the situation had reached crisis proportions, and in response the British and many other smaller nations abandoned the gold standard and depreciated their currencies in an attempt to promote their exports and revive their domestic economies. This in turn hurt American exports and placed further downward pressure on domestic American prices, deepening an already bleak economic picture.

When Franklin Roosevelt took office in 1933, there were great hopes in London and Paris that he would be much more sympathetic to the British and French desire to reduce or even eliminate the war debts. This may have been the case privately, but the US Congress was in no mood to compromise. So the matter was left unresolved, and as the Depression continued, eventually the payments ceased.

As for the German reparations payments, they were suspended in 1931 and were not recognized as legitimate under the Nazis. But in 1953, the West German government agreed at a conference in London to resume paying its foreign bond obligations from the inter-war years. By the early 1980s, the entire principal on these bonds had been repaid. Also included in the London agreement was an understanding that Germany would not have to pay the interest on this foreign debt until it had achieved unification. With this accomplished in 1990, Germany began paying off the interest in annual installments, making the final payment of 70 million Euros last Sunday.

The experience of the inter-war years -- including the determination that World War II was caused largely by economic forces -- helped inspire the creation of the American-led postwar multilateral economic system based on freer trade and the free movement of capital that for the most part served the world well. But the nationalistic "beggar-thy-neighbor" impulses of the interwar years have not disappeared and are clearly on the rise. Witness, for example, the tensions between China and the US over China's refusal to raise the value of its currency (what Treasury Secretary Geithner calls "competitive non-appreciation"); the response of the US House of Representatives, which just passed a bill targeting Chinese imports; the widespread speculation that these tensions and others among the world's emerging economies will lead to an all-out currency war; and the emerging anti-free trade stance among members the extreme right-wing of the Republican Party (61% of Tea Party members say they are opposed to free trade).

The experience of the 1920s and 30s taught our parents' generation that economic nationalism is a double-edged sword. Recent events seem to indicate this is one lesson this generation has either forgotten or is prepared to reject, with unknown consequences for the future.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.

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Is Japan Rolling into Recession? A Look at the Impact of China's Policies

Oct 7, 2010Marshall Auerback

How have China's policies affected Japan, and what to they mean for the U.S.?

The recently-released Tankan survey is consistent with the negative trends in Japan noted in yesterday's post.

marshallgraph106

How have China's policies affected Japan, and what to they mean for the U.S.?

The recently-released Tankan survey is consistent with the negative trends in Japan noted in yesterday's post.

marshallgraph106

Though the manufacturing sector index rose from +1 to +8, the forward looking measures deteriorated. Capital spending intentions of large corporations were +2.4%, down from +4.4% in the prior quarterly Tankan. The message is somewhat more negative because the September survey tends to seasonally show slightly higher capital spending intentions versus the June survey. More importantly, manufacturing optimism went from +3 in the June survey to -1 in the September survey.

The odds are that Japan may already be rolling into recession. Consumption has been buoyed by spending incentives; they expire this month. The Kan government is preparing a new round of such incentives, but the experience of other economies shows that a second round of such incentives has much less impact.

Most ominous is the trend in exports. Exports have led the Japanese economy over the last decade or so. It was almost a 50% decline in exports that took Japanese GDP down by a huge 8.9% from peak to trough in this latest recession. The rise in exports has accounted for 80% of the recovery since that trough which still has GDP 4.2% below the prior cyclical peak. The export data now shows a possibly significant outright downturn in exports already. This is striking because the world economy had still been recovering fairly strongly and Asia, led by 10% economic growth in China was still growing robustly.

Worse yet, the deterioration we are now seeing in Japanese exports do not reflect the strength in the yen this year. THE LAGS IN TRADE ARE LONG. The threat to Japan from the rising yen is that Japanese corporations are forced by the strong yen to move their production platforms to lower cost economies and thereby hollow out Japan. It takes a long time to make these business investment decisions and act on them. To the extent that "hollowing out" is now hurting Japanese exports, it reflects 95 to 100 yen to the dollar and not 83 yen to the dollar. A further adverse impact on Japanese exports and industrial production from recent yen strength could be huge. Already exports are weak and industrial production is rolling over even though Japanese firms report they can live with 95 yen to the dollar. The majority of Japanese industrial firms say they cannot live with 85 yen to the dollar. The deterioration in Japanese exports and industrial production we are seeing now could be much worse, all other things being equal, if the yen stays above 85 to the dollar.

Worse yet, the new China mega-investment boom is ongoing. Only the shortest lead time projects are in production, which are now competing with Japan. But, there is a huge surge in new Chinese production ahead which will compete with and substitute for Japanese exports. Exchange rate considerations aside, the secular trend whereby emerging Asia and especially China are competitively advancing on Japan will undermine Japan's exports and industrial production in the near to intermediate future.

This deterioration is all happening in an overall still-strong global economy. What will happen to Japan if there is considerable global weakness ahead and the yen remains strong? The odds are that Japan will have another severe recession.

Japan truly appears to be the canary in the coal mine in regard to China's overinvestment which, coupled with yen strength, is hollowing out the former. We now have the spectacle of half of all Japanese industrial corporations saying they will have to move their production platforms out of Japan to low cost economies at 85 yen, and yet we see commentaries from Bloomberg's William Pesek "How I Learned to Stop Worrying and Love the Yen", suggesting that an even stronger yen "can be a magnet for the foreign investment that tends to avoid Japan."

It was recently reported that the Band of Japan bought 2.12 trillion yen between August 28 and September 28. Apparently the BOJ continues to drag its feet. We have a market place that expects Helicopter Ben to engage in mega QE and believes a stubborn BOJ will resist intervening in the yen no matter how weak the Japanese economy has been and may be. This brilliant "expectations management" on the part of the BOJ now risks sending Japan into yet another recession while the rest of the world's economy is still growing. And China's ongoing purchases of yen bonds is both irresponsible and exacerbating this trend. This is the type of provocative behavior that could lead to real wars, let alone trade wars.

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The market with the biggest underexposure with the most bearish sentiment attached to it is the Japanese equity market. Eight months ago short the yen was the favorite macro trade of UBS and Goldman which means that all the macro funds were in that trade. Today, there is no bandwagon of yen bulls. So what explains yen strength? There is no manifestation of buying of yen in the balance of payments. Instead you see capital outflows. So who is taking the other side in the short term capital flow account? Have the "quant traders" taken over the market to such an extent that there is some obvious correlation their computers have all picked up and that is the nature of the buying? Or is there something of a more historical nature now enveloping this market?

Consider the recent fishing dispute between Japan and China: it is part of a longstanding rivalry between the two countries, predicated on a century of ill will. Perhaps the Chinese are buying far more yen than they have shown in their accounts. They only show the cash positions, not the forward positions. Could it be that they are buying huge quantities of yen in the forward market, which are then arbed to the short term capital account? The motive here would not just be to price a competitor out of the market, but to settle grievances from the Second World War, such as the Rape of Nanking. Most countries tend to bury these longstanding historical grievances in their diplomacy, but this fishing boat incident and Beijing's handling of it has to at least leave one with the impression that this newly emergent economy, now ranked number 2 in the world, is in a position to get revenge for the past. The best means of avenging the nation for historical slights and grievance, and making oneself the dominant power in Asia (whilst mitigating the influence of the US through its levers on Japan) is very simple: just buy yen and force the Japanese corporations to hollow out Japan.

Could this be the source of the mysterious strength of the yen? If so, then we have the makings of a real renegade nation on our hands. It is apparent that the post-bubble trauma in Japan has become so great that the body politic in Japan is near a breaking point. It appears to be only a matter of time before the Kan government, forced by the political tides, will simply steamroll the Bank of Japan and try to match the QE zeal of Helicopter Ben. However, if it does not act soon on a scale advocated by Ben Bernanke, Japan may already enter recession before the global economy approaches a double dip, and it may wind up with an economic and fiscal deficit and fiscal debt disaster if one or more major economies like the U.S. or Europe go into a double dip, even if it is a mild one.

More to the point, is Japan the lead indicator as to why could happen to the rest of the world, as a resurgent China continues on its current mercantilist course? The west coast port data for the US on outbound containers (exports) and inbound containers (imports) points to significant ongoing trade deterioration in the US in the months ahead. Because the second quarter reported U.S. trade deterioration was so great, it may have undershot a declining trend, so such trade deterioration may not surface in the next trade report. But it is there. Fiscal support to offset the declines in trade is non-existent (and likely to remain so given the likely future political configuration in Congress). We have gone from a very rapid pace of expansion in exports on a sequential and year on year basis to small declines in exports on a year on year basis and more severe declines on a sequential basis.

Why is U.S. trade deteriorating? In part because the rest of the world might be slowing. However, the more significant cause may well be China's over investment in industrial tradeables and consequent pressures for greater Chinese exports and a greater degree of Chinese import substitution. In that regard, Japan is proving to be the lead indicator.

There is a curiously perverse but symbiotic relationship that exists between China's mercantilists and America's finance capitalism. The whole "Bretton Woods II" process contributes to the financialization of our economy, as it continues to hollow out our manufacturing base. It represents an unholy alliance between Wall Street and China's military, which is driving much of the investment in China because they are reaping so many material benefits. The problem, however, is that at some point Chinese credit expansion has no place to put its money. All of the targets have been saturated, which means that there will be overinvestment in all industries and to an incredible degree. This may well kill industry after industry. It appears to be happening already in Japan.

How can there be an encore? To avoid recession you have to keep the investment ratio up. But capex as a percentage of GDP in China is already off the charts - it is in excess of 50% of GDP. So the Chinese can build an additional round of capacity, which may be equal to ten times annual demand by next year, and fifteen times by the year after, in Of course, this process has its limits. When the ratio is this high it is very hard to keep it this high. There is a tendency for it to fall and it will fall faster if there is a trade war. But if it falls there will be a recession in China, so perhaps China is far more recession prone than anyone thinks. It may ultimately be recreating Japanese-like bubble conditions in its own country.

And what does this mean for Japan, which is the canary in the coal mine? With this kind of investment going on in China, the Japanese firms haven't a chance to compete with the yen prevailing at this level. And China knows this so it continues to buy Japanese yen bonds, which keeps the currency high and basically destroys its main Asian competitor. It represents the ultimate revenge for Manchukuo and the Rape of Nanking. And this is a development that could move very fast because the excesses of investment in China are currently so great.

As Chris Dialynas and I have pointed out before, there is no question that China's mercantilism is a product of our ham-handed approach to Asia during the 1997/98 crisis, Less appreciated, however, is Beijing's role in creating that crisis via its cumulative 60% devaluation against the dollar from 1992-94. Very few people are looking at the direct impact of China's trade policies and how it is beginning to hollow out other countries' manufacturing bases. It's not just the US. The Japanese economy is now at the cutting edge of this threat.

Can the US be far behind?

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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How Much Will Currency Policies Really Affect Our Economy?

Oct 6, 2010J. W. Mason

downarrow-money-150Does the math really add up on these potential solutions to our economic problems?

downarrow-money-150Does the math really add up on these potential solutions to our economic problems?

A number of economists of the liberal Keynesian persuasion have been arguing recently that dollar devaluation is an important step in moving us back toward full employment. In principle, of course, a cheaper dollar should raise US exports and lower US imports. But what's missing from many of these arguments is a concrete, quantitative analysis of how much a lower dollar would raise demand for American goods.

In the interest of starting a discussion, here is a very rough first cut. There are four parameters to worry about, two each for imports and exports: how much a given change in the dollar moves prices in the destination country (the passthrough rate), and how much demand for traded goods responds to a change in price (the price elasticity). We can't observe these relationships directly, of course, so we have to estimate them based on historical data on trade flows and exchange rates. But once we assign values to them, it's straightforward how to calculate the effect of a given exchange rate change. And the values reported in published studies suggest that the level of the dollar is a relatively minor factor in US unemployment.

For passthrough, estimates are quite consistent that dollar changes are passed through more or less one for one to US export prices, but considerably less to US import prices. (In other words, US exporters set prices based solely on domestic costs, but exporters to the US "price to market".) The OECD's global macro model uses a value of 0.33 for import passthrough at a two-year horizon; a simple OLS regression of changes in import prices on the trade-weighted exchange rate yields basically the same value. Estimates of import price elasticity are almost always less than unity. Here are a few: Kwack et al (2007), -0.93; Crane, Crowley and Quayyum (2007), -0.47 to -0.63; Mann and Plück (2005), -0.28; Marquez (1990), -0.63 to -0.92. (Studies that use the real exchange rate rather than import prices generally find import elasticities between -0.1 and -0.25, which is consistent with a passthrough rate of about one-third.) So a reasonable assumption for import price elasticity would be about -0.75; there is no support for a value beyond -1. Estimated export elasticities vary more widely, but most fall between -0.5 and -1.

So let's use values near the midpoint of the published estimates. Let's assume import passthrough of 0.33, import price elasticity of -0.75, export passthrough of 1 and price elasticity of -1. And let's assume initial trade flows at their average levels of the 2000s -- imports of 15 percent of GDP and exports at 10.5 percent of GDP. Given those assumptions, what happens if the dollar falls by 20 percent? The answer is, the US trade deficit shrinks by 1.9 percent of GDP.

That might sound like a lot. But keep in mind, these are long-run elasticities -- in general, it takes as much as two years for price movements to have their full effect on trade. And the fall in the dollar also can't happen overnight, at least not without severe disruptions to financial markets. So we are talking about an annual boost to demand of somewhere between 0.5 and 1.0 percent of GDP for two to three years. And then, of course, the stimulus ends unless the dollar keeps falling. This is less than half the size of the stimulus passed last January. (Although to be fair, increased demand for tradables should have a higher multiplier than the mix of direct spending, transfers and tax cuts that made up the Obama stimulus.) The employment effect would probably be of the same magnitude -- a reduction of the unemployment rate by between 0.5 and 1.0 points.

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So it's not a trivial effect, but it's also not the main thing we should be worried about if we want to get back to broadly-shared prosperity. We should remember, too, that a policy of boosting US demand by increasing net exports has costs that a policy of boosting domestic demand does not.

And what about China? At least as often as we hear calls for a lower dollar, we hear calls for China to allow its currency to rise. How much could that help?

Unfortunately, there aren't as many good recent studies of bilateral trade elasticities between the US and China. And the BEA's published series for Chinese import prices only goes back to 2003, which isn't enough for reliable estimates. But common sense can get us quite a ways here. In recent years, US imports from China have run around 2 percent of GDP, and US exports to China a bit under 0.5 percent. So even if we assume that (1) a change in the nominal exchange rate is reflected one for one in the real exchange rate, i.e. that it doesn't affect Chinese prices or wages at all; (2) a change in the real exchange rate is passed one for one into prices of Chinese imports in the US; (3) Chinese goods compete only with American-made goods, and not with those of other exporters; and (4) the price elasticity of US imports from China is an implausibly high 1.5; then a 20 percent appreciation of the Chinese currency only provides a boost to US demand of less than one half of one percent of GDP in total, spread out over several years.

And of course, those are all wildly optimistic assumptions. A recent Deutsche Bank report uses an estimate of -0.6 for the exchange rate elasticity of Chinese exports. They don't give any estimates for US-China flows specifically, but given the well-established empirical fact that US imports are unusually exchange-rate inelastic, we have to assume that the number for Chinese exports to the US is substantially smaller than for Chinese exports overall. Consistent with that, my own simple error-correction model, using 1993-2010 data and the relative CPI-deflated bilateral exchange rate, gives an exchange rate elasticity of US imports from China of -0.17. If the real figure is in that range, then a Chinese appreciation of 20 percent will reduce our imports from China by just 0.03 percent of GDP -- and of course much of even that tiny demand shift will be to goods from other low-wage exporters. This last point makes a focus on the Chinese peg particularly problematic as an explanation of US unemployment. If you are talking about reducing the value of the dollar against our trading partners as a whole, any resulting shift away from imports has to be to domestic goods. But presumably the closest substitutes for Chinese imports are usually other imports, not stuff made in the USA.

These are rough calculations and only intended to start a conversation. But it's a conversation we very much need to have. Before we launch a trade war with China for the sake of American workers, we need more concrete answers on the size of the potential gains.

Historically-minded critics of China and other surplus countries often quote Keynes' writings from the 1930s and '40s, with their emphasis on the importance of "creditor adjustment". The implication is that it's China's responsibility to reduce its net exports. But this is a misleading reading of Keynes. In fact, his concern was only ever to ensure that no country was prevented from pursuing full employment by the need to earn foreign exchange. The US, as the supplier of the world reserve currency, cannot face a balance of payments constraint; if we fail to pursue full employment, we have no one to blame but ourselves. If Keynes were alive today, I suspect he would be telling American policymakers to forget about China and focus all their efforts on boosting US demand -- by public investment in infrastructure, by unconventional monetary stimulus, by paying people to dig holes and fill them up again if need be. Because he knew that the only reason to worry about the trade balance was to gain the freedom to pursue "a policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to the optimum level of domestic employment, which is twice blessed in the sense that it helps ourselves and our neighbors at the same time."

J. W. Mason is a graduate student in economics at the University of Massachusetts, Amherst. A version of this post previously appeared at The Slack Wire.

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Whatever Happened to Japan?

Oct 6, 2010Marshall Auerback

marshall-auerback-100Marshall Auerback explores Japan's poorly-performing economy and what it augurs for the rest of the world.

Something is very wrong with Japan.

marshall-auerback-100Marshall Auerback explores Japan's poorly-performing economy and what it augurs for the rest of the world.

Something is very wrong with Japan.

The Japanese economy has been much weaker than any other major economy for a while now: over the last business expansion, through the Great Recession, and in the recovery since the Great Recession trough. Japan's business cycle has been led by its exports for well over a decade. It has been my guess that overinvestment in industrial tradeables by Japan's Asian mercantilist competitors, especially China, along with yen strength has been seriously undermining the Japanese economy for some time. The recent all-time new highs in Chinese overinvestment and this year's crazy yen strength would only accelerate this process and might well presage what lies ahead for the rest of the world, especially the US.

Throughout the past month, the data coming out of Japan has been uniformly poor. This data -- especially a METI forecast for a coming 3% decline in industrial production in the next two months -- has been of a particularly gloomy and alarmist nature, especially from an organization such as METI, which has tended to be overly optimistic in its forecasts. But the data now says Japan may already be rolling over into a recession despite a growing global economy and a booming neighboring China. The markets right now with their yen "bid" seem as "out to lunch" regarding Japan as they were out to lunch regarding Europe last May/June, when the ECB contained an incipient currency/solvency crisis by backstopping the nations' respective bond markets.

What to do about Japan? Both Federal Reserve Chairman Ben Bernanke and economist Paul Krugman recommended to the Bank of Japan over a decade ago that it adopt a significantly positive inflation target and conduct monetary policy with that objective. Bernanke suggested that the Bank of Japan do this by buying foreign exchange and issuing monetary base until that target was reached. Similarly, in the recent Democratic Party of Japan (DPJ) leadership election campaign, challenger Ichiro Ozawa argued for such an inflation target for the Bank of Japan.

Although Naoto Kan retained his leadership position (and, hence, remains the country's Prime Minister), there are indications that he has begun to embrace much of the Ozawa platform. About a week ago, the Kan government moved to purchase significant quantities of foreign exchange through unsterilized issuance of yen in order to depreciate the yen. But it has not followed through after an initially promising start.

Unless the Bank of Japan follows Ozawa's recommendation and conducts foreign exchange intervention on a scale consistent with ending deflation and reestablishing inflation, it will probably fall short of the policy actions needed to weaken the yen. This cannot be done through quantitative easing per se. I have argued before that QE in terms of targeting reserve balances is ineffective. It is based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn't have adequate reserves, then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending. Right?

Wrong. Bank lending is not "reserve constrained". Banks lend to any credit-worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves, then they borrow from each other in the interbank market. Or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).

The point is that building bank reserves will not increase the bank's capacity to lend. Loans create deposits which generate reserves. But whereas a policy to target reserves might be in effective, this does not appear to be the objective right now in terms of what the Federal Reserve is currently doing in the US. In effect, it is trashing bonds as well as cash (getting bond yields lower through the promise of additional, but as yet undisclosed, measures) and inciting investors into risk assets, notably equities, on the premise that this will increase spending. In effect the Fed is targeting equity prices as a means of buttressing consumption.

Will it work? With the private non financial debt to GDP ratio still at 170% and only ten percentage points off its highs it appears that there are very high risks in the Fed's approach. The markets may well call "Helicopter Ben's" bluff and a failure to see some positive economic outcome from the embrace of outright QE could well cause a serious crisis of confidence in the US markets.

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But let us take Japan; clearly, a very different situation pertains. For one thing, Japan can buy foreign exchange and sell yen forever and get the exchange rate down. The BOJ has done so in the past and these interventions have for the most part been successful. The exchange rate matters far more for Japan, whose ratios of exports to GDP and industry to GDP are far higher than in the US. Furthermore, if Japan manages to reverse deflationary expectations, there may be a real financial and real response. Japan has reduced its ratio of private non financial debt to GDP by FIFTY percentage points, not ten. There is more scope for loan demand. More important, in addition to less private debt, the liquid assets held by the private sector in Japan is just huge. The ratio of M3 to GDP has gone from 105% to 164% in twenty years. The public holds huge quantities of government bonds and, if the Japanese public thought they might not earn anymore the real return generated by deflation, the BOJ could well "chase" the public into a different category of risk assets, such as equities.

Japan has been experiencing a post-bubble adjustment for twenty years. The adjustment process in the US, by contrast, has been going on for a mere two years. It makes a difference. An aggressive intervention by way of forex purchases might really work for Japan.

But what is the alternative? We have just experienced a hint of that: the country's largest consumer finance company, Takefuji, has just filed for bankruptcy. Deflationary pressures are intensifying again. There has generally been a high correlation between Japan's ratio of fixed investment to GDP and its ratio of exports to GDP. Both went up in the 2000s into 2008 when the economy began to grow again. However, by 2008 the export growth was slowing. Economist Andrew Smithers blamed it on economic growth in Japan's trading partners, which he argues was slowing.

Perhaps, but a more plausible thesis is that by that time China was starting to seriously compete with Japan's export machine. Consider what happened to the Japanese economy in 2008: exports fell by almost forty percent, and of course fixed investment fell in turn. Even more striking is that Japan's exports have recovered less than any other major economy post the Lehman induced catastrophe -- likewise with its GDP. In spite of 20 years of largely subpar growth (with the notable exception of 2003-2007), the Japanese economy's resilience in the face of ongoing external economic shocks has proven to be quite feeble, particularly in relation to its Asian competitors, especially China. It appears that a combination of Chinese technological advances and overinvestment, along with a super strong yen/dollar exchange rate has created the beginnings of a hollowing-out effect in Japan.

More economic data has come out in the latest Japanese tankan to confirm this abysmal picture. August industrial production fell -.3%. The consensus was looking for a rise of 1.1%. Industrial production is now below the level of January.

Worse yet is the METI forecast for industrial production in September and October. Companies who responded to the Meti survey expect a-0.1% decline in September and a -2.9% decline in October. These METI forecasts are often very wrong. So such a future decline is not set in stone. But my experience is when Japan's industrial production is moving towards weakness these forecasts are too optimistic. Throughout this year, as industrial production has flattened and began to fall, the METI forecasts, which were consistently predicting significant rises in future months, have proven to be too optimistic. Other data appears to confirm the prevailing gloomy picture. Earlier last September, Japan recorded a large monthly fall in export volumes. Over the previous two months of July and August, the average level of exports at 3.8% is below the average of May and June. The Japan manufacturing PMI is also falling and is now below 50.

Tomorrow, I'll examine the specific impact of China's policies: how it has adversely impacted Japan and what it might portend for the US in the future.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Main Street is Dying a Death by a Thousand Spending Cuts

Oct 5, 2010Marshall Auerback

marshall-auerback-100The evidence is everywhere that fiscal austerity only prolongs our misery.

marshall-auerback-100The evidence is everywhere that fiscal austerity only prolongs our misery.

According to the Telegraph.co.uk in an article entitled "Savers told to stop moaning and start spending," Charles Bean, deputy governor of the Bank of England, said, "Savers shouldn't necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit." Mr. Bean also said savers "might be suffering" from the low bank rate, but they had done well from higher rates in the past and would do so again. Encouraging Britons to spend was one reason why the Bank had cut interest rates, he added.

Spend what exactly, Mr. Bean? Why is it that central bankers find it easy to recall the following equation: C (consumption) + I (investment) + G (gov't spending) = GDP (gross domestic product), but they can't seem to learn this one: HU (high unemployment) + HD (high debt levels) + 0 (no interest income) = AZS (almost zero spending).

I know why: because the latter depends on fiscal policy, and central bankers consistently agitate against fiscal policy. This continues despite the fact that expansionary government spending by accounting identity helps to sustain the private sector desire to save. Unfortunately, Charles Bean of the Bank of England fails to understand that today's predisposition to save is a natural reaction to the credit binge that preceded the crisis. Had the increased private sector saving that occurred over the past few years not been accommodated by rising deficits, then the negative income adjustments would have been more severe and the private sector's plans to return some safety margin to their balance sheet positions would have been thwarted. But he and his fellow central bankers appear incapable of acknowledging this fact.

Each week new evidence emerges that categorically demonstrates that the fiscal austerity proponents are clueless about the functioning of real economies and monetary systems. So today in Britain we have a new government committed to significant budget cuts, despite mounting evidence that cuts already undertaken are drastically curtailing their economic activity. The recently released Markit/CIPS UK Manufacturing Purchasing Managers' Indices, which is calculated from data on new orders, output, employment, supplier performance and stocks of purchases, fell to a ten-month low of 53.4 in September, down from a revised figure of 53.7 in August. Similarly, Ireland finds itself in the midst of a major banking crisis -- Anglo-Irish Bank was recently nationalized, for example -- despite the fact that the Irish government has steadfastly continued to apply the fiscal austerian measures urged on it by the ECB. In reality, this is because of the austerity measures it is taking. The budget deficit, as a percentage of GDP, now stands at 32 percent! Those are wartime-type levels of expenditures.

Yet the conditions attached to the European Central Bank's ongoing financial support of Ireland and the rest of the euro zone is continued fiscal austerity. The so-called PIIGS nations remained trapped between Scylla and Charybdis as a consequence of this Faustian bargain with the European Central Bank. If the ECB stops buying national government debt on the secondary markets, those governments are likely to default, and the big French and German banks it is protecting will be in crisis. Alternatively, every day governments like Ireland or Portugal continue with this policy, the more their economies continue to implode. Ultimately there will be mayhem. The euro itself could once again be threatened.

Don't get us wrong: we think such deficits ultimately put a floor on demand and will help the economy recover. But policy makers need to let these economies breathe for a time, rather than crushing them with additional threats of fiscal austerity. Isn't it interesting that the very policy prescriptions designed to eliminate the so-called "scourge of public debt" are actually increasing it? Shouldn't that make our policy makers pause in their enthusiastic embrace of fiscal austerity? Even the high priests of austerianism, the International Monetary Fund, are now conceding in their latest report that these current policies will condemn Southern Europe to death by slow suffocation, as well as leaving northern Europe, the UK, and the US in a slump for a long time to come.

Policy makers here in the US continue to hint at accounting tricks such as quantitative easing on the premise that central banks swapping one financial asset for another will help incite more speculation. That seems to be doing the trick for the stock market. But this does nothing to boost underlying aggregate demand. How about a solution for Main Street?

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Even as the markets continue to make new post-2008 recovery highs, governments continue to construct policies around bailing out fundamentally insolvent financial institutions. These policies ensure that the bankers and others can continue to get their exorbitant and totally unjustifiable bonuses, thereby sustaining the very practices that created the crisis in the first place. Lloyd Blankfein of Goldman Sachs warned that the bank could shift its operations around the world if regulatory crackdown becomes too tough in certain jurisdictions. To which any politician with an ounce of backbone ought to say, "Good! Take your socially polluting activities elsewhere and leave our populations alone."

Of course, they don't do that. The more likely supine response (as we've already seen in Basel III and Dodd-Frank) is a further undermining of any kind of serious regulation. We tinker around the edges but make no fundamental, structural reforms. It's a national scandal that our most elite businessmen and professionals, who have destroyed the global economy through an unprecedented orgy of mortgage and accounting fraud, have to date gotten away with it scot-free and continue to have a major hand in policy making. Equally incredibly, our governments continue to trumpet the "success" of abominations such as TARP along with their enablers in the media.

As the risk of being called a whiner by Vice President Biden, it has to be pointed out that these very same governments hand out little in spending to underpin the real economy, even as unemployment remains in double digits around the globe. Government support for the real economy via fiscal policy is minimal compared to the trillions thrown at the financial sector. But before we see any kinds of real reductions in unemployment, the cries of "socialism" and "intergenerational theft" rise. The fiscal austerians launch counter-attacks to mobilize against further fiscal expenditures that support employment growth. The expansion of fiscal policy is stopped dead in its tracks.

Curiously, progressives have come to be seen as the enemy because they dare to point out the incoherence and incongruity in current government policy.

For all of the recent hoopla in the stock market recently, much of the latest economic data is consistent with a slow to stagnant economic environment. In the US, inventories are rising. ISM new orders are now just barely hovering above 50, which usually marks the onset of falling levels. The same thing can be said of the leading indicator (which has been falling since the second quarter), and the coincident to lagging indicator ratio. Weekly chains store sales continue to slip toward the April/May lows, while mortgage applications for refinancing are also tipping over, despite the recent drop in mortgage rates. Second quarter revisions of GDP were mild, although this probably marks peak profit margins

Overseas, Japan appears to be reverting back into a recession. Additionally, very few people are looking at the direct impact of China's trade policies and how Beijing's mercantilism is beginning to hollow out other countries' manufacturing bases -- not just in the US but also in other parts of Asia (which are also experiencing decelerations in their exports and purchasing manufacturing indices).

Consumer expectations are tipping over, and we are concerned with a relapse back to a low level of confidence, which never improved from the recession lows. Euro zone company and macro data flow are starting to reflect more fiscal retrenchment , and with the euro higher, exporters may find more competition in the quarters ahead.

Message to today's policy makers: the public debt ratio will fall again when growth resumes. Growth will not resume very strongly unless it is continued to be supported by discretionary fiscal stimulus. There is no magical alternative. Hacking away the last vestiges of fiscal support will simply ensure much more misery, unemployment and social turmoil in the years ahead.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Rob Johnson Blasts "Oligopoly-Style" Global Standoff

Sep 30, 2010

With unfailing energy, world-traveler Rob Johnson appeared on The Guardian's podcast "The Business" to discuss the (lacking) morality of large global corporations, how a stronger GOP will hamstring politics, and Obama's upended economic team. "There's an enormous breakdown... in morality that relates to globalization," Rob says.

With unfailing energy, world-traveler Rob Johnson appeared on The Guardian's podcast "The Business" to discuss the (lacking) morality of large global corporations, how a stronger GOP will hamstring politics, and Obama's upended economic team. "There's an enormous breakdown... in morality that relates to globalization," Rob says. The US CEO who has employees all over the world is no longer vested in the benefits for American workers, notes Rob, and the American people have wised up: "85% of Americans think the corporations have too much power".

But while banks have all the power, Congress is held up and likely to get even less done after any GOP midterm victories. Meanwhile, Obama's economic policies are "in tatters," as Rob puts it. "The analogy [of Obama] to Franklin Roosevelt did not materialize in this crisis. And now the public is quite upset with nearly 10 percent unemployment." The real political debate? It's all about the proper role of government in the economy. The GOP, it seems, wants to undo all of FDR's gains in using the government to aid its citizens.

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Rob then sat down with Reuters to explain just how bad the state of American economics really looks to those across the pond. "The administration is in real trouble right now," says Rob. There's high unemployment but no ability to either create more stimulus or see the Fed take more action.

Rather than the Fed considering more quantitative easing, which could heighten competitive currency devaluation, the world's nations need to work together to solve the problems facing the economy, Rob says. After all, if the current "oligopoly-style" standoff between nations continues, who's going to win?

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America's Big Fat Trade Problem

Sep 13, 2010Joe Costello

money-globe-150Don't worry about deficit spending. Worry about that money ending up in China and Brazil.

money-globe-150Don't worry about deficit spending. Worry about that money ending up in China and Brazil.

Come we go burn down Babylon one more time
Come we go chant down Babylon one more time
For them soft! Yes, them soft!
So come we go chant down Babylon one more time
-- Bob Marley

There's an interesting divide in economics: those who understand the importance of industry to industrial economies in an industrial age, and then the vast majority. The first group tend to be, though certainly not exclusively, old New Deal-types. Tom Geoghegan is one of them, and he has a piece in The Nation with some very excellent points on the matter. First, when you are in an industrial era and you have deficits of manufactured goods, then you're going to generate more and more government and private debt. Without addressing the first, you're not going to change the second. Tom addresses the problems this causes for those advocating more stimulus most excellently and succinctly:

When we have a big trade deficit, the feds can't run up a debt just to re-employ Americans. As long as we've so much trade debt, we have to figure that a distressing amount of any stimulus will go ultimately to re-employ the workers in China, Brazil, Japan and even Europe, who fill the gap between the "demand" we pump up and what we actually "supply." When we have a big trade deficit, it means that the more we prime the pump, the more we drain out this distressing amount of our national wealth.

Tom also throws in his hand trying to rescue poor old Mr. Keynes from his supposed disciples, writing:

Indeed, for every kind of debt -- government, consumer, trade -- the Democrats have to be the party that gets the country out of debt. That's the only way to bring back a fair and just economy that lifts the middle class. As debt piles up, even our base is freaking out. Deep down, people grasp that America got into this mess with too much private debt. "Hey, if we're all trying to get our own debt down, how does it make sense for the government to run it up?"

"Oh," some of us will say. "These poor unenlightened ones -- they don't understand Keynes." Maybe we don't understand Keynes. Keynes would never have happily urged a serious debtor country to go deeper into debt. This is not your great-grandfather's Great Depression. In 1936 Roosevelt could and should have gone into debt -- but didn't. We were the biggest creditor country in the world. In World War II we ran up a colossal debt -- but it was a debt to ourselves. We baby boomer kids never even noticed. That's why Keynes was so relaxed in 1936 about our going into debt. But otherwise Keynes spent much of his life trying to get debtor countries out of debt -- Germany, his own Britain after the war. If one looks at his career, it is clear that Keynes never told a debtor country to go deeper into debt.

As he would point out, much of the debt we pile up in Washington has little or nothing to do with putting people back to work. Much of it is just to balance the books. Because we buy more than we sell, we have a trade deficit. So the books have to balance, right? Someone has to make up the difference. Under Bush we had consumers go into debt to do it. But they're tapped out. So now Washington has to go into debt instead.

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He adds:

And why else did the stimulus run out of steam?

It was probably not big enough, but an even bigger one might have run out of steam. The bigger the trade debt, the less punch there is in running up a deficit. You can't just blame the GOP for cutting the stimulus down.

What's more, on this debt to pump up foreign "supply" we also have to pay out interest to foreigners. The deeper in debt we go, the more likely we are to end up in the clutches of foreign creditors. Don't believe me? The time may come on the left that we'll miss the days when we could rail at Goldman Sachs instead of the IMF.

Yes, in ten or so years the renminbi or even the euro (thanks to Germany) could replace the dollar as the world currency in which we denominate our debt, and our fate will be up to central bankers in foreign countries.

This is no joke: a Babylonian-type captivity for our country is but a presidential term or two away.

He calls for increasing exports, but I'd say at this point the US doesn't so much need to increase exports as to simply produce much more of what it consumes, just as the Chinese don't need to import more as much as they need to consume more of what they produce.

Chant down Babylon.

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.

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Viva La$ Vega$

Sep 2, 2010

Gonna set my soul on fire
Got a whole lot of money that's ready to burn
So get those stakes up higher
I'm gonna keep on the run
Gonna have me some fun
If it costs me my very last dime
If I wind up broke up, well
I'll always remember I had a swingin time
-- Viva Las Vegas

Gonna set my soul on fire
Got a whole lot of money that's ready to burn
So get those stakes up higher
I'm gonna keep on the run
Gonna have me some fun
If it costs me my very last dime
If I wind up broke up, well
I'll always remember I had a swingin time
-- Viva Las Vegas

The WSJ has a must read report from the currency table, which rolls 24/7. The Journal writes,

Currency trading volume around the world has hit $4 trillion a day,...the $4 trillion mark represents a 20% gain from $3.3 trillion in 2007, the last time the global foreign-exchange markets were surveyed, according to the Bank for International Settlements.

....the continued rise in trading reflects the increased globalization of investing. With the big developed economies of the U.S., Europe and Japan struggling, investors are turning toward other markets for returns and generating more foreign-exchange trading in the process.

Now small investors are increasing their foreign-currency exposure. They are piling into mutual funds which make bets on currencies as a core part of their strategy. More broadly, U.S. stock mutual funds that invest overseas have taken in $42 billion over the past year, according to Morningstar Inc.

In addition, exchange-traded mutual funds, whose shares trade like stocks, are making the currency markets more accessible to small investors. There are now 44 currency ETFs, up from 16 in April 2007, according to Morningstar. In 2004 there was only one.

But it gets better. Can you say leverage? Can you say bubble? Boy, just looking at how currency markets are operating, all you can say is thank god for Frank/Dodd, right?

Currency trading usually involves placing bets with borrowed money. That has regulators concerned about individual investors' ability to handle large amounts of leverage, though action has been limited so far.

On Monday, federal regulators backed off a plan to place stricter limits on how much individual investors who trade currencies can borrow.

Currently, investors can borrow $100 for every dollar they invest. The Commodity Futures Trading Commission, which regulates foreign-exchange trading in the U.S., tried to cut that amount to $10.

But after a wave of protests from brokers and individuals, it settled on $50 for every dollar invested, which is the amount of borrowing many large brokers currently allow.

No, no, baby! This place is hot! You can't cut 100 to 1 leverage down to 10 to 1, where's the fun in that? Hell! You can't make shit in this stock market, even with all Ben's pumping!

Kevin Rodgers, global head of foreign-exchange derivatives at Deutsche Bank in London, says funds of all stripes-hedge funds, mutual funds and sovereign-wealth funds -- are seeing the currency markets as a distinct asset class and not just a way to make an investment priced in another currency.

Trading among "nondealers," which includes hedge funds and mutual funds, grew 42% to $1.9 trillion per day...

So, here's the results when the Fed and other central banks started the last bubble by inflating/deflating currency with ZIRP policies, QE, and other methods of pumping money into deflating global assets markets. They are undermining the value of money itself, while the current structure of currency markets allows them much less control than they think. The question is what happens when this bubble pops? The general answer is economic carnage, what that looks like specifically is the real question, and a money maker, that is, if you can figure out how to keep it in a currency with any value.

Viva! Viva! Viva!

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