Toxic US Treasuries?
Posted: March 13, 2009 Filed under: Equity Markets, Global Financial Crisis, Team Obama, U.S. Economy, Uncategorized | Tags: China Debt, Current Account deficit, U.S. Treasuries 15 Comments
You know things are changing in the world when a country expresses “concern about the outlook for the U.S. and the safety of its Treasury bonds”. This would especially be true when that country is China and they are your biggest creditor. This is not the sort of thing one hears about industrialized nations, let alone the world’s largest single country economy. But there it is. The US is now considered a credit risk.
Analysts who watch the interest rates that the US must pay on its debt should have felt a little shiver yesterday. The Chinese government, the largest holder of Treasuries, expressed some doubt about the turnaround of the American economy and came a bit too close to stating that US paper might be becoming less attractive as the government borrowing to stimulate the economy and save financial institutions makes American debt a more risky investment.
According to the FT, the Chinese premier said, “We have lent a huge amount of money to the United States. Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried. I request the US to maintain its good credit, to honour its promises and to guarantee the safety of China’s assets.”
I posted at the end of January about the touch and go trade relationship between the US and China. We stimulate their economy by buying Chinese stuff. They enable us to do so by buying our debt. We don’t yell at them for restricting their capital flows, pegging their currency, or violating human rights and we get to spend a lot of money without raising taxes. Well, that was so last month. Today, China’s decided to publicly assert its ‘interests’. We have yet to respond. Is China expressing similar concerns already voiced by economists and the markets over the current handling of the US Economy by the Obama team? Quite possibly. This, from the previously cited WSJ article.
Mr. Wen said that China is also closely watching to see the effects of the policies taken by U.S. President Barack Obama aimed at returning the world’s largest economy to health. Chinese foreign minister Yang Jiechi was also in Washington this week to discuss how the two countries can cooperate on economic policy, among other issues.
A test of that cooperation is quickly approaching. U.S. Treasury Secretary Timothy Geithner this week called on the Group of 20 – a gathering of the world’s largest developed and developing economies – to increase funding for the International Monetary Fund by up to $500 billion to help combat the financial crisis. Achieving that sum likely will depend on getting agreement from countries that hold large foreign exchange reserves, such as China and Saudi Arabia.
Ahead of a preparatory meeting of G-20 financial officials this weekend near London, Mr. Wen said pointedly that “increased funding for the IMF is not a question for just one country” but for all member nations. He also repeated China’s desire to see reforms to the IMF that give more clout to developing nations.
They’re ‘inkling’ that China deserves more international status and bargaining power. They also would like the international community–especially the US– to lay off any notion of a more free and open Tibet. I still find it intolerable that we’ve basically decided cheap Chinese manufactured goods are worth more than the religious and political freedom of native Tibetans. That is, however, the bargain that is on the table.
Mr. Wen used harsh language against the Dalai Lama, Tibet’s spiritual leader, who accused the Chinese government this week of turning the Himalayan region into a “hell on earth.” He said talks between
Beijing and the Dalai Lama, which took place last year without making any progress, could only resume if the Dalai Lama is “sincere.”
Indeed, China does have a big stake in the U.S. economy and is the nation’s biggest creditor. It is always disconcerting when that creditor calls you at work and reminds you about the bill. Here’s the size of the problem reported by the NYT.
China should seek to “fend off risks” as it diversifies its $1.95 trillion in foreign-exchange reserves and will safeguard its own interests, Mr. Wen said. He said that the Chinese had invested $696 billion in United States Treasury bonds as of Dec. 31, an increase of 46 percent from a year ago.
The United States Treasury Master index from Merrill Lynch shows that the securities declined 0.5 percent last month, after falling 3.1 percent in January, the worst since April 2004, as President Barack Obama sells record amounts of debt to finance his $787 billion bailout. The dollar has dropped 17 percent against the yuan since China ended a fixed exchange rate in July 2005.
This definitely presents a challenge to the Obama administration. In order to forward the aggressive spending packages and tax cuts required for their agenda, the Chinese must continue buying US Treasuries. It was rumored that one of the messages brought to China by newly appointed SOS Hillary Clinton was the hope that China would continue its huge investment in Treasuries. The Chinese have now publicly stated that there will be a cost to those funds above and beyond the current interest rate.
Every time my students ask my what would happen if the Chinese suddenly dumped their supply of US Treasuries on the market, I say absolute chaos. Chaos here in the US and chaos throughout the world markets. I’ve also thought that an infinitesimally likely event. I’m not so sure about that now that we’ve had such a public announcement of our bad risk status. I’m also not sure if we’re being threatened with kneecapping, higher fees, or a mortgage on our soul.
Potus and Team Flunk Economics
Posted: March 11, 2009 Filed under: Equity Markets, Global Financial Crisis, No Obama, Team Obama, U.S. Economy | Tags: AEA, economists forecasts worsen, obama team flunks economics, WSJ survey of economists 6 Comments
The Wall Street Journal’s Phil Izzo reports that a majority of economists participating in its forecasting survey believe the Obama economics team is failing to make the grade. The ratings for Obama and Geithner trail the grade for Bernanke who is chair of the Fed and show a lack of confidence in current economic policy. You may remember that Martin Wolf assigned Obama an “English B” or “D” in an interview with Zakaria posted earlier. It appears Wolf’s peers agree.
A majority of the 49 economists polled said they were dissatisfied with the administration’s economic policies. On average, they gave the president a grade of 59 out of 100, and although there was a broad range of marks, 42% of respondents rated Mr. Obama below 60. Mr. Geithner received an average grade of 51. Federal Reserve Chairman Ben Bernanke scored better, with an average 71.
They are completely unimpressed with the stimulus package and most are now forecasting the recession to be both deeper and longer than previously anticipated. Previous forecasts predicted the trough to come in August. The consensus has now shifted the bottoming to occur sometime in October. Many believe a second stimulus package will be required, however, this was not a majority opinion. The worst grades were assigned to the handling of the banking crisis.
Economists were divided over whether the $787 billion economic-stimulus package passed last month is enough. Some 43% said the U.S. will need another stimulus package on the order of nearly $500 billion. Others were skeptical of the need for stimulus at all.
However, economists’ main criticism of the Obama team centered on delays in enacting key parts of plans to rescue banks. “They overpromised and underdelivered,” said Stephen Stanley of RBS Greenwich Capital. “Secretary Geithner scheduled a big speech and came out with just a vague blueprint. The uncertainty is hanging over everyone’s head.”
The primary professional association is the AEA (American Economic Association) which frequently surveys its members for both political affiliations as well as opinion on economic outlook. Surveys have consistently shown that the majority of members lean democratic. In the cited study of its surveys, the author McEachern (2006) finds that the ratio of contributions of AEA economists that contribute to democrats v. republicans is about 5.1 to 1. A survey by the Economists in the fall (not a scientific poll so results are subject to question) found overwhelming support for Obama over McCain in the general election. Given that, this pattern appeared responsible for this interesting finding from the WSJ’s December Survey.
The economists’ negative ratings mark a turnaround in opinion. In December, before Mr. Obama took office, three-quarters of respondents said the incoming administration’s economic team was better than the departing Bush team. However, Mr. Geithner’s latest marks are lower than the average grade of 57 that former Treasury Secretary Henry Paulson received in January.
Clearly, economists are not amused if their ratings and outlook have changed so quickly. The surveyed economists are now expecting worse numbers in the employment sector. They have also upped the probability of having a depression in the US.
Meanwhile, the economists surveyed this month predict that the economy will shed another 2.8 million jobs over the next 12 months as the unemployment rate climbs to 9.3% by December, up from the 8.1% rate recorded in February. Economists also see nearly a one-in-six chance that the U.S. will fall into a depression, defined as a decline in per-person GDP or consumption by 10% or more.
“We just keep moving the date [when the recession will end] out, hoping at some point in time we will be able to move the date back in,” said Diane Swonk of Mesirow Financial.
The economists were also glum about the international response. There were two more positive findings. Again, Bernanke achieved the highest approval and most felt the Fed was performing its functions well. There was also some consensus around the idea of putting money in the stock market for the long run.
Despite the growing criticism elsewhere, the respondents were broadly supportive of the Fed. More than 85% of the economists agreed that the central bank’s proliferating lending programs are well-designed, well-executed and helping the economy. And while grades for Mr. Bernanke remain off of their 2007 highs, the average has stabilized after falling as low as 69 in the November survey.
Amid all the gloom, there is a bright spot: Four-fifths of the economists said now is a good time to buy equities, especially if the investor has a long-term view.
Given most economists are registered democrats. these ratings suggest a rather large vote of no confidence.
Kabuki Financial Regulation
Posted: March 10, 2009 Filed under: Equity Markets, Global Financial Crisis, No Obama, U.S. Economy | Tags: AIG, bernanke, CDOs, Fannie, Freddie, Japan's lost decade, Swaps, zombie banks 3 Comments
Much speculation has been made recently about the possible similarities between Japan’s lost decade and financial crisis during the 1990s and the current US Financial crisis. It’s impossible to get through any graduate program in either finance or economics without spending time with the mounds of research the decade ignited. Since many folks are talking and writing about this period in the popular business press and speculating on the chance of an L-shaped recovery similar to the one experienced by Japan, I thought I’d focus some on Japan’s Lost Decade. There are some similarities but some important differences too.
About a month ago, The Economist asked if America’s crisis could rival Japan’s. Their answer was yes. This article examines something we’ve looked at twice before. That would the IMF study of banking crises. Both the Nordic banking crisis and the Japanese banking crisis are including in the database and highlighted by the study. The experience of these rich country crashes have both been bandied about as possible road maps to financial system recovery. Sweden nationalized its banks. There was also the lesson from South Korea. This country recovered after two years. The there was Japan. It let its banks languish. Japan became infamous for its decade of economic stagnation. Are we turning Japanese?
Japan’s property bubble burst in the 1980s and its run up prior to the bubble was smaller than ours. Additionally, Japan has a high domestic savings rate. America is the world’s largest debtor.
Judged by standard measures of banking distress, such as the amount of non-performing loans, America’s troubles are probably worse than those in any developed-country crash bar Japan’s. According to the IMF, non-performing loans in Sweden reached 13% of GDP at the peak of the crisis. In Japan they hit 35% of GDP. A recent estimate by Goldman Sachs suggests that American banks held some $5.7 trillion-worth of loans in “troubled” categories, such as subprime mortgages and commercial property. That is equivalent to almost 40% of GDP.
The authors of The Economist articles see both other differences too.
Japan’s central bank took too long to fight deflation; its fiscal stimulus was cut off too quickly with an ill-judged tax increase in 1997; and it did not begin to clean up and recapitalise its banks until 1998, almost a decade after the bubble had burst. But the history of bank failures suggests that Japan’s slump was not only the result of policy errors. Its problems were deeper-rooted than those in countries that recovered more quickly. Today’s mess in America is as big as Japan’s—and in some ways harder to fix.
Let’s look at the first statement about deflation. We’re not experiencing deflation in all sectors. The latest numbers from the BLS still show slight inflation. However, we are looking at some tax increases in the near future. Both Japan and the Roosevelt administration in 1937 instituted tax increases before both of these major financial crisis had be solved. In 1937, it led to a second economic and financial market down turn. In 1997 Japan, it slowed down recovery.
Our dollar is strengthening as the financial crisis impacts the global economy. Japan’s yen is similarly a strong world currency. The dollar is still seen as a 
safe-haven asset. However, Japan is a net exporter while the US is a net importer. Japan is not a debtor nation, but a creditor nation. Japan could still rely on exports to deliver some economic stimulus. The US does not have that luxury. However, while South Korea and Sweden’s currencies weakened and helped make their exports look cheap, Japan’s yen stayed somewhat strong. This crippled Japan’s ability to fully use exports as stimulus making its recovery much longer than either those of South Korea or Sweden. The dollar continues to strengthen which also makes any exports we send to the rest of the world relatively expensive. It also continues our reliance on imports as they stay relatively cheap.
In some ways America’s macroeconomic environment is even trickier than Japan’s. America may have a big current-account deficit, but the dollar has strengthened in recent months. America’s reliance on foreign funding means the risk of a currency crash cannot be ruled out, however. That, in turn, places constraints on the pace at which policymakers can pile up public debt. And even if the dollar were to tumble, the global nature of the recession might mean it would yield few benefits.
I already mentioned that Japan’s households were historically good savers. This meant only the Japanese corporations had to ‘deleverage’ or get rid of debt during the Japanese crisis. I remember watching Japanese commercials at the time from the government extolling patriotic Japanese households to go spend like crazy at the same time the US government was telling Americans to consider saving. Well, that trend is reversing. Japanese households are beginning to decrease their savings rates, while Americans have rediscovered thrift. This is also something we’ve talked about. Here’s how that played in Japan and could play out differently here.
Six Sigma Probabilities
Posted: March 9, 2009 Filed under: Equity Markets, Global Financial Crisis, president teleprompter jesus, U.S. Economy | Tags: Financial Times., global economic downturn, Obama financial disaster, Wolrd Bank 2 Comments
“The black swan for me would be for us to emerge out of this unscathed and return to normalcy,” Taleb said. Compared with the Great Depression, this crisis is “very different, and it requires much more drastic action.”
Today’s market close set more new records. We’ve had a bear market that’s just run itself long enough to become the worst bear market on record with one exception. That one exception is the one that started on Black Friday, 1929. The second one, until today, was the bear market in 1937. There’s only been one trend recently in all of the capital markets and that is down. No one knows at this point where the bottom is and how long we’ll stay there.
These kinds of losses and numbers usually bring about what is called a Bear Rally. A Bear Rally occurs about the time investors expect the negative momentum to end. Technical traders would expect this any day now. Well, actually they’ve been expecting it any week now and any month now. They’re still looking for it. First we heard that the market was ‘oversold’ and now we’re hearing that there’s a lot of money (estimates of like $3 trillion) just waiting for the good news to get back in. The deal is that recently we’re not even seeing the hint of bounce. It’s now a black swan market.
I have a suspicion that is why our President seems to want to replace Mad Money Cramer as the tipster-in-chief. Cramer just criticizes him (which POTUS hates) and at the moment Cramer is at a loss for any technical explanation. So first, POTUS told us that there were a lot of bargains at there because of the “profits and earnings ratios” (sic). Now, in a NY Times interview, he tells us to not put our money in the mattress.
What I don’t think people should do is suddenly stuff money in their mattresses and pull back completely from spending. I don’t think that people should be fearful about our future. I don’t think that people should suddenly mistrust all of our financial institutions because the overwhelming majority of them actually have managed things reasonably well. But I think that coming out of this crisis what you’re going to see is, you know, a return to the fundamentals – hard work, investing for reasonable returns over time, saving steadily for your kids’ college education and for your retirement. All of us, thinking about our purchases and making sure that we’re taking care of the necessities before we go after the luxuries. And I think that’s true not only for individual families but I think that’s going to be true for government as well. And if we take those steps, if we return to the fundamentals, if we go back to that ad that used to run, where they say, you know, ‘we earn money the old fashioned way’ — or what is it?
So, now we have a lecture on budgeting and spending our money on fundamentals and not luxuries while the omnibus spending bill will just get signed without any significant review and revision. Evidently, what is good for the people, is not what they should expect from their government. I’m clearly on record supporting a huge stimulus bill. In fact, I’ve said that the last stimulus bill was not big enough in TERMS of stimulus and size. The President would be well-advised to review that last paragraph and consider what he’s due to sign shortly. The forecast of job creation in the stimulus bill was based on an average 8% unemployment rate. We just achieved a higher rate than that last month and the increasing downward trend is not expected to stop. The current budget bill would provide an opportunity to transfer funds for earmarks into spending that could possibly address the shortcomings in the stimulus bill.
In FDIC We Trust
Posted: March 7, 2009 Filed under: Equity Markets, Global Financial Crisis, Main Stream Media, president teleprompter jesus, Team Obama, U.S. Economy | Tags: banking regulation, joseph stiglitz 6 Comments
I continue to read current economic thought on the state of the economy and the state of the Obama administration’s response. I don’t’ know if you’ve ever made a trip to Project Syndicate, but it’s an interesting site where you can read contributions by brilliant people to newspapers around the world. It’s another one of those places that I’ve found since I’ve completely given up on the US MSM’s ability to provide real news, insight, or criticism of the world today.
Joseph Stiglitz is a frequent contributor. He’s a 2001 Nobel Laureate Economist. This is a contribution of his to The Guatemala Times from March 6, 2009. It’s called How to Fail to Recover. I’ve talked a lot about how the stimulus package isn’t big enough, that it contains too many tax cuts and that it is a bandage approach to a systemic problem that started in the financial system with bad lending practices egged on by Washington and greedy megainvestors. I feel vindicated because that is Stiglitz take too.
The stimulus package appears big – more than 2% of GDP per year – but one-third of it goes to tax cuts. And, with Americans facing a debt overhang, rapidly increasing unemployment (and the worst unemployment compensation system among major industrial countries), and falling asset prices, they are likely to save much of the tax cut.
Almost half of the stimulus simply offsets the contractionary effect of cutbacks at the state level. America’s 50 states must maintain balanced budgets. The total shortfalls were estimated at $150 billion a few months ago; now the number must be much larger – indeed, California alone faces a shortfall of $40 billion.Household savings are finally beginning to rise, which is good for the long-run health of household finances, but disastrous for economic growth. Meanwhile, investment and exports are plummeting as well. America’s automatic stabilizers the progressivity of our tax systems, the strength of our welfare system – have been greatly weakened, but they will provide some stimulus, as the expected fiscal deficit soars to 10% of GDP.
In short, the stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.
The real failings in the Obama recovery program, however, lie not in the stimulus package but in its efforts to revive financial markets. America’s failures provide important lessons to countries around the world, which are or will be facing increasing problems which are or will be facing increasing problems with their banks.
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