Affordable Housing Institute : US

[Continued from yesterday’s Part 1.]

 

Yesterday’s post highlighted a deliberately provocative Washington Post Op Ed, What OPEC Teaches China, by Sebastian Mallaby, arguing that our pricing expansion – and now the painful contraction – were caused by deliberate currency manipulation from China.

 

I am offended that you question my motives

 

The second rival account of the crisis … blames the bubble on two mistakes at home rather than on the glut of capital from China.

 

Mallaby’s already exculpated us consumers; now he raises, only to knock over, the straw man of Federal Reserve policy:

 

 [2] And the Fed should have shut down the easy-money party by raising interest rates.

 

A lot of people have leveled this criticism, much of it landing at the doorstep of former Federal Reserve Chairman Alan Greenspan.  Mallaby says he’s innocent:

 

Don’t I look innocent?

 

If Americans’ insatiable appetite for loans explained the flood of Chinese capital into the United States, we would have seen the evidence in a rising price for those loans — that is, higher interest rates in the bond market.

 

This is a big assertion – is it true? 

 

 

Mallaby doesn’t prove it, so let me test out its logic sequence.

 

1.  The Fed sets rates.  The central bank can manipulate the money supply, and it can force sovereign interest rates (interbank Fed rates) down really low.  Or the Fed can push those sovereign rates up.

 

2.  The risk curve must be rational.  As previously posted at length, the risk curve presumes that investments can be ranked by the categories of risks their investors will take.  Since all business activity within a nation is denominated in that nation’s currency, the Treasury gnomes who print the money live in the basement of our national money store.  Toiling in obscurity down there, they take the sovereign risk.  Every other investment, denominated in those self-same dollars, takes those risks and more. 

 

Hence any rational risk curve is positive:

 

 

Or said in English, if lending is rational, any boost by the Fed should ripple through in higher interest rates for all. 

 

(We’ll ignore the yield curve, which tracks by maturity, and the potential yield restructuring efficiencies of securitization, both for simplicity and because right now nobody can see securitization’s benefits.)

 

3.  Foreign lenders/ investors would be rational.  Foreign investors wouldn’t necessarily have to limit their purchases to Treasuries; they could buy anything they wanted.  But as long as they were rational – with their hyper-appreciated or hyper-depreciated currency – their capital would be appropriately risk-priced.  So like the lead sled dog the Fed would, in fact, call the shots for sovereign finance.

 

I’m the Fed and I call the shots here!

 

Here I think Mallaby’s reasoning is rickety.

 

Entirely sound!

 

A nation that wanted to use its capital as a weapon would in fact accept lower risk spreads, in the sectors it wanted to over-stimulate.  If it had trillions at its disposal – which the Chinese government does – and could act in a coherent and coordinated fashion – which I think the Chinese government can and does – then for every Fed move, the Chinese could make a neutralizing countermove.

 

Fie, sirrah!  I block your interest rate hike!

 

I have no idea whether this could be demonstrated – international currency flows aren’t my bag.  Maybe somebody like Ken Rogoff will have studied it.

 

In any case, let’s return from our detour into speculation and grant Mallaby his (and by imputation, Geithner’s) thesis:

 

But bond rates were strikingly low at mid-decade. This strongly suggests that it was the supply of lending that went up, not the demand for it.

 

Or, as we previously suggested, starvation for yield.  Remember, if you’re a sovereign nation – or even a semi-sovereign plutocratic oligarchy of a wealth-producing nation – then you face the problem, where do I park all those billions?  And you examine your choices first and foremost in national terms.  If you move money into a country, you want:

 

* Safety from violence and insurrection.

* Its currency to be solid.

* A strong rule of law and property rights.

* Good assets to buy – good loans or good investments.

 

You want, in short, to have a positive vision of where that nation’ will be in a decade. 

 

If you were really rich, where would you feel most comfortable, geopolitically and geoeconomically? 

 

Personally, I like the USA.

 

We’re the global geo-economic boss!

 

Chinese money flooded into the United States because of the push factor from China, not the pull factor from Americans.

 

Yes, I buy that – but I don’t need to buy nefarious motivations to get there.

 

Suppose you were making double potfuls of money in your home country, which was experiencing unprecedented growth – unprecedented for itself and its history, unprecedented for its aggregate scale in the global arena.  Wouldn’t you want to diversify your national risks? 

 

Maybe I should diversify?

 

(Remember, Enron or Fannie Mae employees who put all their 401(k)’s into stock in their own company are now being derided for their credulity.)

 

Again, if you’re China, you want to balance your portfolio, and you’re grossly underweighted in US assets.  What better time to buy them than when your currency is strong?

 

Could the Fed have raised interest rates to avert the bubble? The Fed’s monetary policy was indeed too loose. But as Martin Wolf argues in his recent book, “Fixing Global Finance,” it’s not clear that higher interest rates could have prevented the trouble.

 

I posted at length on Wolf’s interesting hypothesis – which seemed really plausible to me.

 

Once China decides to export vast quantities of capital, that capital has to go somewhere.

 

The Law of Economic Pressure returns!

 

           

 

Now Mallaby’s argument starts to run into itself.

 

Higher interest rates in the United States might have encouraged the world’s savers to park even more of their capital in this country.

 

Exactly!  The Law of Economic Pressure is no more resistible than the forces of nature tearing up Saruman’s palace at Isengard. 

 

That for your currency restrictions

 

Nevertheless, Mallaby rallies in an interesting protectionist way:

 

So there is no getting around China’s culpability.

 

Huh?

 

I wouldn’t bet on that.

 

The country relies on the sort of export-focused growth strategy that other Asian Tigers have pursued, with the difference that China is too big to go this route without destabilizing the world economy.

 

As far as I can tell, this argument boils down to curse them for driving their economy to expand so much, and not consume what they’re generating, leaving them with scads of dollars that have to go somewhere.

 

Meanwhile, as we’ve seen in The clatter of breaking China and As the China breaks, the Chinese property markets are just plain crashing – not dropping like ours are, but crashing – so they’re going to pay their own price for our global problem.

 

The real question is whether it is diplomatically fruitful to push China to change.

 

The Bush administration tried and failed. Why would the new team fare better?

 

Change what?  Change how?

 

Clear enough?

 

The wrong answer is to say that Barack Obama’s guys will be tougher. However egregious China’s currency policy may be –

 

Again, probably this is just my ignorance, but I don’t know what’s egregious about China’s policy.

 

– it’s counterproductive to punish Beijing with sanctions. For one thing, a trade war is the last thing the world economy needs.

 

 

I’m genuinely baffled here.  Should China grow less?  Should it consume more domestically?

 

What should I do differently?

 

For another, as Geithner explained, the immediate priority is to get global growth going, so it’s more important to persuade China to extend its fiscal stimulus than to revalue its currency.

 

If they can.  China’s about to slow down big time.  Maybe not stop growing, but slow down.

 

Besides, reforming China’s exchange-rate policy is not the only way to wean the country off its high-savings, high-export model. The savings rate partly reflects China’s lack of social safety nets. If the Chinese spend some of their stimulus on pensions and health care, they will be heading in the right direction.

 

Undoubtedly such a move ought to be part of Chinese domestic policy.  The nation has a huge aging population and a low birth rate, plus a crush of urbanization without parallel (for sheer scale) anywhere in the world.

 

China’s leaders are not fools: They can see the effects of their policy not only in collapsing Wall Street banks but also in their own collapsing exports. The bubble that China inflated has brought China’s foreign customers to their knees. Because China pushed its export model too aggressively, its export markets have cratered.

 

And with them, its property markets.  The financial boomerang returns.

 

I couldn’t throw it away no matter how much I tried

 

Think of it this way: China’s position is akin to that of OPEC in the early 1980s. Two oil shocks taught oil producers the limits to their power: When they jammed prices up, the world economy sputtered and motorists bought smaller cars — and oil prices fell precipitously.

 

We’re seeing that now.  High oil prices allow despots to swagger.  Low oil prices may foment democratic revolution (or other revolutions less democratic, but let’s not worry about that just now).

 

OPEC learned to balance its lust for higher oil prices with the fear that customers might revolt.

 

OPEC’s leadership is also learning that gouging your customer is a bad strategy.  Symbiosis means the host gets healthier and stay healthy.

 

China’s leaders may be ready for the same lesson — and Geithner’s words may encourage them to learn it.

 

The Law of Economic Pressure says if there are very rich adjacent to very poor, no walls are high enough to prevent the very poor from scaling them.

 

The best world is one where we all get rich – or at least, less poor.

 

“I’ve had rich and I’ve had poor, and baby, rich is better.”

 

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