Very interesting, and long, article examining the political dysfunction across the western democracies under rapid globalization. Published by City Journal.
But it’s not just the French, we’re all fried.
Very interesting, and long, article examining the political dysfunction across the western democracies under rapid globalization. Published by City Journal.
But it’s not just the French, we’re all fried.
What concerns me most from the following article is the misguided notion that pan-nationalism and global citizenship has displaced the sovereign nation-state international system. The sovereign nation-state is all we have to manage global affairs in a representative democratic, people-centered global society. Without it we are all vulnerable to constellations of power among political elites and authoritarians of all stripes.
Reprinted from The American Interest:
The Deconstruction of the West
April 12, 2017
The greatest threat to the liberal international order comes not from Russia, China, or jihadist terror but from the self-induced deconstruction of Western culture.
My how we live in interesting times. I’m sure they said that at the turn of the 20th century too. Let’s hope our leaders can manage this phase of national sovereignty a bit more successfully.
It’s a mistake to ignore or turn away from this reassertion of national sovereignty with horror. It is a natural communal reaction to rapid change not properly managed. The intention should be to slow down the social impact of those technological and economic changes in order to maintain a stable path to progress. This requires the establishment center to hold, but not by dismissing the real problems faced by significant portions of their populations. Because mismanagement of this complex challenge carries risks for nation-state conflict through trade wars or even hot wars with imperialist intentions.
We should keep in mind that nationalism, patriotism, and national identity are not necessarily expressions of ill-will toward others, but they can be turned into that.
From The New Yorker:
EUROPE’S POPULISTS PREPARE FOR A NATIONALIST SPRING
By Elisabeth Zerofsky January 25, 2017
A gathering of European far-right leaders in Koblenz, Germany, on the day of Donald Trump’s Inauguration expressed growing confidence in its agenda following his victory and that of Brexit.
On January 20th, as Donald Trump was taking the oath of office, in Washington, populist leaders from across Europe were arriving in a quiet city on the Rhine. Early the next morning, French, German, Italian, Austrian, and Dutch nationalists stood together on a stage in Koblenz, a central German town that has been associated with political countercurrents since it harbored aristocrats during the French Revolution. Their national flags flew behind them as they greeted what they called the “birth of a new world.” “Yesterday, a new America,” Geert Wilders, the leader of the Dutch Party for Freedom, proclaimed to a hall filled with about a thousand attendees, most of them sturdy men in dark suits. “Tomorrow, a new Europe.”
The momentum of the Brexit vote, followed by Trump’s election, has provided European populists with a ready-made argument for their own inevitability. “People thought Trump wouldn’t win and he won; they thought during the two months preceding his Inauguration he would backpedal on all his promises, but he didn’t do it,” Thibaud Gibelin, a parliamentary aide to France’s National Front, told me. “It shows it is possible to achieve victory over the establishment, and for us that’s the most beautiful symbol.” The parties gathered in Koblenz have gained voters over the past few years, as Europeans across the political spectrum have lost confidence in mainstream politicians’ ability to manage the refugee crisis, the threat of terrorism, and, in some cases, high unemployment. Both Wilders and Marine Le Pen, of France’s National Front, will face elections this spring, and both lead in the polls. Le Pen, who could become President of France in May, has called for a Brexit-style referendum, which she claims is the only way to regain control over national borders and put an end to immigration. France and Germany are the nucleus of the European Union, and a “Frexit” would in all likelihood mean its end.
The Koblenz conference was organized by Germany’s Alternative für Deutschland, a four-year-old party that is trying to gain a foothold in a country that is still loath to tolerate the far right. In the fall, the AfD will likely obtain seats in the German parliament for the first time. Much of the French and German press expressed surprise that Frauke Petry, the party’s forty-one-year-old chair, would appear with Le Pen; the National Front presents a particular taboo in Germany because of some of its founders’ ties to the Vichy regime. But of Europe’s populists, Le Pen has the most serious ambitions to become head of state, and she is the clear kingpin of the group.
Le Pen took the stage like the instructor at a populists’ master class, radiating a warm familiarity. She hailed the domino effect that June’s Brexit vote had set in motion. “We have felt it coming, the rebellion of the people of Europe against a non-elected power that has pretended to be based on democracy,” she said. “What a blow to the old order!” The applause at the end was so rapturous that she returned to the stage for a curtain call.
There is something contradictory about a confederation of nationalist parties, but in addition to their shared opposition to the E.U. the parties have a common patron in Moscow. “It’s pretty clear that one of the geopolitical elements bringing these different forces together today is proximity to the Kremlin,” Joël Gombin, a political scientist who studies the National Front, told me. Le Pen’s party has been taking money from Russian banks for years, most recently a nine-million-euro loan, in 2014, from a bank that has since been dissolved. Over the past four years, Le Pen and members of her inner circle have made several trips to Moscow, where they’ve met with officials including the Deputy Prime Minister and the speaker of the Duma; her contacts reportedly include politicians who have been sanctioned by the E.U. in response to the Ukraine crisis. Leaders from the AfD have been guests at Russian government forums, and Austria’s Freedom Party has signed a coöperation agreement with President Vladimir Putin’s party. These connections have coalesced into an informal network connecting Putin’s inner circle and the European far right.
Le Pen presents an alliance between nationalist parties as a source not of bellicosity but of harmony. In Koblenz, she laid out a vision of a flowering of European cultures, and argued that a “diversity” of strong national identities would bring not war but mutual respect. Far-right supporters also believe that new European and American alliances with Russia will bring about a broader détente. In Koblenz, I had coffee with a fifty-four-year-old German attendee who politely refused to tell me his name or profession. “I don’t know what American troops are doing six thousand kilometres away from their country at the Russian border,” he complained. I suggested that they might be responding to Russian provocation. “No, the Americans provoked first, by orchestrating Ukraine,” he said. “The Americans are very big in regime change, very bad in solving problems. Trump will solve Ukraine and concentrate on American interests. Then it’s O.K.”
At the Koblenz conference, the populists made their claims of “rebirth” before an audience of mostly older white men. But the “identitarian” movement, while small—the French chapter claims two thousand paying members—is growing among the young. Gibelin, the National Front aide, is twenty-seven years old and was dressed in a gray wool suit, his hair slicked back in the manner of Donald Trump’s elder sons. As we stood in the café outside the conference hall, the babel of languages thickening around us, I asked whether he agreed with the vision put forth by older party members. His response came in the form of a seamless narrative. “The reality today that European countries are interdependent is clear to everyone,” he told me. “Coöperation is obvious, but it’s a question of what kind of coöperation. The one we have now, which benefits the economic empire and denies identity in submission to globalized interests?” Europeans, he said, share a cultural heritage. “We have our Roman roots, our language, our culture; the cathedrals you see, whether in Cologne or Paris, that are Gothic, that’s transnational; the Renaissance was a European phenomenon; and the great religious moments that marked Europe, the spread of Christianity, the Reformation, those were never isolated to one nation.” The refugee question was simple. Global corporations sought cheap labor, and politicians enabled them. He didn’t mind European governments providing financial aid to refugees, as long as that aid was used to help them stay in their own countries. “We think the dignity of these people can be expressed in their own homeland. Not here.” He shrugged confidently. “We are attacked by the media as being extremist, but for me it’s exactly the opposite,” he said. “It’s global capitalism that is extreme. We are simply defending the interests of the people.”
The refugee question was simple. Global corporations sought cheap labor, and politicians enabled them. He didn’t mind European governments providing financial aid to refugees, as long as that aid was used to help them stay in their own countries. “We think the dignity of these people can be expressed in their own homeland. Not here.” He shrugged confidently. “We are attacked by the media as being extremist, but for me it’s exactly the opposite,” he said. “It’s global capitalism that is extreme. We are simply defending the interests of the people.”
The Fed’s core policies of 2% inflation and 0% interest rates are kicking the economic stuffings out of Flyover America. They are based on the specious academic theory that financial gambling fuels economic growth and that all economic classes prosper from inflation and march in lockstep together as prices and wages ascend on the Fed’s appointed path.
Crown Business; 1st edition (May 17, 2016)
Ms. Foroohar does a fine job of journalistic reporting here. She identifies many of the failures of the current economic policy regime that has led to the dominance of the financial industry. She follows the logical progression of central bank credit policy to inflate the banking system, that in turn captures democratic politics and policymaking in a vicious cycle of anti-democratic cronyism.
However, her ability to follow the money and power is not matched by an ability to analyze the true cause and effect and thus misguides her proposed solutions. Typical of a journalistic narrative, she identifies certain “culprits” in this story: the bankers and policymakers who favor them. But the true cause of this failed paradigm of easy credit and debt is found in the central bank and monetary policy.
Since 1971 the Western democracies have operated under a global fiat currency regime, where the value of the currencies are based solely on the full faith and credit of the various governments. In the case of the US$, that represents the taxing power of our Federal government in D.C.
The unfortunate reality, based on polling the American people (and Europeans) on trust in government, is that trust in our governmental institutions has plunged from almost 80% in 1964 to less than 20% today. Our 2016 POTUS campaign reflects this deep mistrust in the status quo and the political direction of the country. For good reason. So, what is the value of a dollar if nobody trusts the government to defend it? How does one invest under that uncertainty? You don’t.
One would hope Ms. Foroohar would ask, how did we get here? The essential cause is cheap excess credit, as has been experienced in financial crises all through history. The collapse of Bretton Woods in 1971, when the US repudiated the dollar gold conversion, called the gold peg, has allowed central banks to fund excessive government spending on cheap credit – exploding our debt obligations to the tune of $19 trillion. There seems to be no end in sight as the Federal Reserve promises to write checks without end.
Why has this caused the complete financialization of the economy? Because real economic growth depends on technology and demographics and cannot keep up with 4-6% per year. So the excess credit goes into asset speculation, mostly currency, commodity, and securities trading. This explosion of trading has amped incentives to develop new financial technologies and instruments to trade. Thus, we have the explosion of derivatives trading, which essentially is trading on trading, ad infinitum. Thus, Wall Street finance has come to be dominated by trading and socialized risk-taking rather than investing and private risk management.
After 2001 the central bank decided housing as an asset class was ripe for a boom, and that’s what we got: a debt-fueled bubble that we’ve merely re-inflated since 2008. There is a fundamental value to a house, and in most regions we have far departed from it.
So much money floating through so few hands naturally ends up in the political arena to influence policy going forward. Thus, not only is democratic politics corrupted, but so are any legal regulatory restraints on banking and finance. The simplistic cure of “More regulation!” is belied by the ease with which the bureaucratic regulatory system is captured by powerful interests.
The true problem is the policy paradigm pushed by the consortium of central banks in Europe, Japan, China, and the US. (The Swiss have resisted, but not out of altruism for the poor savers of the world.) Until monetary/credit policy in the free world becomes tethered and disciplined by something more than the promises of politicians and central bankers, we will continue full-speed off the eventual cliff. But our financial masters see this eventuality as a great buying opportunity.
Financial markets exhibit centripetal forces, sucking in all the capital from the periphery to the center. That’s why our financial centers have become the repository of capital wealth. As NYC is to Peori or Decatur; the US$ economy is to the rest of the world. As the FED screws up the world’s monetary system, dollar holders will be the least hurt. A very unneighborly result that usually leads to military conflicts.
From the WSJ:
The Dollar—and the Fed—Still Rule
Americans may think the U.S. is in hock to China, but Beijing’s economic fate lies in Washington’s hands.
By Ruchir Sharma
July 28, 2016 7:20 p.m. ET
When Donald Trump recently declared that “Americanism, not globalism, will be our credo,” he was expressing the kind of sentiment that animates not only his new Republican coalition, but nationalists everywhere. From the leaders of Russia and China to the rising European parties hostile to an open Europe, these nationalists are linked by a belief that in all matters of policy, their nation should come first.
This world-wide turning inward, however, comes in a period when countries are more beholden than ever to one institution, the U.S. Federal Reserve. Every hint of a shift in Washington’s monetary policy is met with a sharp response by global markets, which in turn affect the U.S. economy more dramatically than ever.
The Fed has been forced to recognize that it can no longer focus on America alone. When the Federal Open Market Committee voted in January 2015 to hold interest rates steady, its official statement explicitly noted, for the first time, that it was factoring “international developments” into its decisions. Since then the Fed, including this week, has frequently cited international threats, from Brexit to China, as reason to continue with hyper-accommodative monetary policy.
Though Mr. Trump argues that America must tend to its own affairs because it is weak, the Fed’s evolving role shows the limits of this argument. The U.S. may have slipped as an economic superpower, falling to 23% of global GDP from 40% in 1960. But as a financial superpower Washington has never been more influential. Forecasts of the dollar’s downfall have completely missed the mark.
Since the 15th century the world has had six unofficial reserve currencies, starting with the Portuguese real. On average they have maintained their leading position for 94 years. The dollar succeeded the British pound 96 years ago, and it has no serious rival in sight.
In the past 15 years, total foreign currency reserves world-wide rose from under $3 trillion to $11 trillion. Nearly two thirds of those reserves are held in dollars, a share that has barely changed in decades. Nearly 90% of global trade transactions involve dollars, even in deals without an American party. A Korean company selling TVs in Brazil, for instance, will generally ask for payment in dollars.
Because the Fed controls the supply of dollars, it reigns supreme. Its influence has only grown since the financial crisis of 2008. As the Fed began experimenting with quantitative easing to inject dollars into the system, tens of billions flowed out of the country every month. The amount of dollar loans extended to borrowers outside the U.S. has doubled since 2009 to $9 trillion—a record 75% of global nonresidential lending. Many of those are in the form of bonds, and bond investors are highly sensitive to U.S. interest rates.
That helps explain why any sign of Fed tightening, which reduces the supply of dollars, sends global markets into a tizzy. Earlier this year, for example, Chinese investors were shipping billions abroad every month, searching for higher yields. The Fed had been expected to raise short-term interest rates later this year, but it backed off that commitment in February, when China appeared headed toward a financial crisis.
Had the Fed tightened, China’s central bank would have been pressured to follow, crippling the flow of credit that is keeping the Chinese economy afloat. So instead the Fed held steady, effectively bailing out Beijing. Though many Americans still see the U.S. as deeply in hock to China, the fact is that China is even more reliant on easy money to fuel growth—putting the country’s economic fate in Washington’s hands.
The Fed is thus caught in a trap. Every time the U.S. economy starts to perk up, the Fed signals its intent to start returning interest rates to normal. But that signal sends shock waves through a heavily indebted global economy and back to American shores. So the Fed delays rate increases, as it did in June and again this week.
The rest of the world recognizes the Fed’s power as well. As soon as quantitative easing began, finance ministers from Brazil to Taiwan warned about the risks of unleashing torrents of dollars. They said it would drive up the value of currencies in the emerging world, destabilize local financial markets, undermine exports and economic growth.
The Fed was initially skeptical. Its then-chief Ben Bernanke argued that the central bank’s policies were a boost for every country. Other officials stated bluntly that the rest of the world wasn’t their problem. “We only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, said in 2013. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”
The Fed has since discovered the world, which matters more than ever to the American economy. In the past 15 years the share of U.S. corporate revenues that come from foreign markets has risen from a quarter to a third. The more interconnected global markets become, the more rapidly financial instability in the rest of the world ricochets to hurt the U.S.
In the immediate aftermath of the financial crisis, the Fed’s loose policies may have temporarily stimulated growth world-wide. But those policies have come back to haunt it. Fed officials ignored the resulting excesses, including the credit and asset bubbles building around the world. Now every time the Fed tries to tighten, the dollar starts to strengthen and global markets seize up, forcing the Fed to retreat. It’s unclear how to end this cycle, but this much is apparent: The financial hegemony of the U.S. has never been greater, making the Fed the central bank of the world.
Blog Note: the world is screwed and we’re part of it.
Martin Feldstein is nowhere near as excitable as David Stockman on Fed manipulations (link to D.S.’s commentary), but they both end up at the same place: the enormous risks we are sowing with abnormal monetary policies. The economy is not nearly as healthy as the Fed would like, but pockets of the economy are bubbling up while other pockets are still deflating. There is a correlation relationship, probably causal.
The problem with “inflation targeting” is that bubble economics warps relative prices and so the correction must drive some prices down and others up. In other words, massive relative price corrections are called for. But inflation targeting targets the general price level as measured by biased sample statistics – so if the Fed is trying to prop up prices that previously bubbled up and need to decline, such as housing and stocks, they are pushing against a correction. The obvious problem has been these debt-driven asset prices, like stocks, government bonds, and real estate. In the meantime, we get no new investment that would increase labor demand.
The global economy needs to absorb the negative in order to spread the positive consequences of these easy central bank policies. The time is now because who knows what happens after the turmoil of the US POTUS election?
The focus is misplaced—and because it delays an overdue interest-rate rise, it is also dangerous.
By MARTIN FELDSTEIN
The Wall Street Journal, May 17, 2016 7:02 p.m. ET
The primary role of the Federal Reserve and other central banks should be to prevent high rates of inflation. The double-digit inflation rates of the late 1970s and early ’80s were a destructive and frightening experience that could have been avoided by better monetary policy in the previous decade. Fortunately, the Fed’s tighter monetary policy under Paul Volcker brought the inflation rate down and set the stage for a strong economic recovery during the Reagan years.
The Federal Reserve has two congressionally mandated policy goals: “full employment” and “price stability.” The current unemployment rate of 5% means that the economy is essentially at full employment, very close to the 4.8% unemployment rate that the members of the Fed’s Open Market Committee say is the lowest sustainable rate of unemployment.
For price stability, the Fed since 2012 has interpreted its mandate as a long-term inflation rate of 2%. Although it has achieved full employment, the Fed continues to maintain excessively low interest rates in order to move toward its inflation target. This has created substantial risks that could lead to another financial crisis and economic downturn.
The Fed did raise the federal-funds rate by 0.25 percentage points in December, but interest rates remain excessively low and are still driving investors and lenders to take unsound risks to reach for yield, leading to a serious mispricing of assets. The S&P 500 price-earnings ratio is more than 50% above its historic average. Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.
When interest rates return to normal there will be substantial losses to investors, lenders and borrowers. The adverse impact on the overall economy could be very serious.
A fundamental problem with an explicit inflation target is the difficulty of knowing if it has been hit. The index of consumer prices that the Fed targets should in principle measure how much more it costs to buy goods and services that create the same value for consumers as the goods and services that they bought the year before. Estimating that cost would be an easy task for the national income statisticians if consumers bought the same things year after year. But the things that we buy are continually evolving, with improvements in quality and with the introduction of new goods and services. These changes imply that our dollars buy goods and services with greater value year after year.
Adjusting the price index for these changes is an impossibly difficult task. The methods used by the Bureau of Labor Statistics fail to capture the extent of quality improvements and don’t even try to capture the value created by new goods and services.
The true value of the national income is therefore rising faster than the official estimates of real gross domestic product and real incomes imply. For the same reason, the official measure of inflation overstates the increase in the true cost of the goods and services that consumers buy. If the official measure of inflation were 1%, the true cost of buying goods and services that create the same value to consumers may have actually declined. The true rate of inflation could be minus 1% or minus 3% or minus 5%. There is simply no way to know.
With a margin of error that large, it makes no sense to focus monetary policy on trying to hit a precise inflation target. The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980.
Although we cannot know the true rate of inflation at any time, we can see if the measured inflation rate starts rising rapidly. If that happens, it would be a sign that true inflation is also rising because of excess demand in product and labor markets. That would be an indication that the Fed should be tightening monetary policy.
The situation today in which the official inflation rate is close to zero implies that the true inflation rate is now less than zero. Fortunately this doesn’t create the kind of deflation problem that would occur if households’ money incomes were falling. If that occurred, households would cut back on spending, leading to declines in overall demand and a possible downward spiral in prices and economic activity.
Not only are nominal wages and incomes not falling in the U.S. now, they are rising at about 2% a year. The negative true inflation rate means that true real incomes are rising more rapidly than the official statistics imply. [Sounds good, huh? Not quite. Read Stockman’s analysis.]
The Federal Reserve should now eliminate the explicit inflation target policy that it adopted less than five years ago. The Fed should instead emphasize its commitment to avoiding both high inflation and declining nominal wages. That would permit it to raise interest rates more rapidly today and to pursue a sounder monetary policy in the years ahead.
Somehow we cling to the hope that debt on our side of the world works differently than debt on the other side of the world. And then we wonder why GDP constantly falters and consumer spending is so reticent.
Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP…eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent…
by Gordon G. Chang
After a near-disastrous start to the year and a one-month recovery in March, the Chinese economy looks like it’s now headed in the wrong direction again. The first indications from April show the country was unable to sustain upward momentum.
Even before the first dreadful numbers for last month were released, Anne Stevenson-Yang of J Capital Research termed the uptick the “Dead Panda Bounce.”
The economy is essentially moribund as there is not much that can stop the ongoing slide. A contraction is certain, and a severe adjustment downward—in common parlance, a crash—looks likely.
At the moment, China appears healthy. The official National Bureau of Statistics reported that growth in the first calendar quarter of this year was 6.7 percent. That is just a smidgen off 6.9 percent, the figure for all of last year. Moreover, the quarterly result cleared the bottom of the range of Premier Li Keqiang’s growth target for this year, 6.5 percent.
The first-quarter 6.7 percent was too good to be true, however. And there are two reasons why we should be particularly alarmed.
First, China’s statisticians appear to be just making the numbers up. For the first time since 2010, when it began providing quarter-on-quarter data, NBS did not release a quarter-on-quarter figure alongside the year-on-year one. And when NBS got around to releasing the quarter-on-quarter number, it did not match the year-on-year figure it had previously reported.
NBS’s 1.1 percent quarter-on-quarter figure for Q1, when annualized, produces only 4.5 percent growth for the year. That’s a long distance from the 6.7 percent year-on-year growth that NBS reported for the quarter.
Even China’s own technocrats do not believe their own numbers. Fraser Howie, the coauthor of the acclaimed Red Capitalism, notes that the chief of a large European insurance company, who had just been in meetings with the People’s Bank of China, said that even the Chinese officials were joking and laughing in derision when they talked about official reports showing 6 percent growth.
Second, the central government simply turned on the money taps, flooding the economy with “gobs of new debt,” as the Wall Street Journal labeled the deluge.
The surge in lending was one for the record books. Credit growth in Q1 was more than twice that in the previous quarter. China created almost $1 trillion in new credit during the quarter, the largest quarterly increase in history. [The Fed has created $3.5+ trillion and counting during our non-recovery.]
Of course, Chinese banks tend to splurge in Q1 when they get new annual quotas, but this year’s lending exceeded all expectations.
The Ministry of Finance also did its part to refloat the economy. Its figures show that in March, the central government’s revenue increased 7.1 percent while spending soared 20.1 percent.
All that money produced good results—for one month. In April, the downturn continued. Exports, in dollar terms, fell 1.8 percent from the same month last year, and imports tumbled 10.9 percent. Both underperformed consensus estimates. A Reuters poll, for instance, predicted that exports would decline only 0.1 percent, while imports would fall 5 percent.
Exports have now dropped in nine of the last ten months, and imports, considered a vital sign of domestic demand, have fallen for eighteen straight months.
Both figures show a marked deterioration from March, when exports jumped 11.5 percent and imports fell 7.6 percent.
The trade figures followed extremely disappointing surveys of the manufacturing sector. The official Purchasing Managers’ Index came in at 50.1, down from March’s 50.2, barely above the 50.0 that divides expansion from contraction.
The widely followed Caixin survey registered at 49.4, down from March’s 49.7. April was the fourteenth straight month of contraction in this more representative—and far more reliable—survey.
Beijing will release additional numbers in the next two weeks, but its reported figures—especially those showing consumer prices, retail sales and industrial output—have obviously become less accurate in recent months. By now, with the first indications for April, it’s clear the economy did not turn the March spike into a recovery.
That has grave implications for Beijing, as Chinese technocrats have evidently lost control of the economy. For one thing, they are no longer helped by strong external demand, and there is little prospect of relief in coming months. As Zhou Hao of Commerzbank told the Wall Street Journal, “China is on its own.”
And alone, Beijing can rely only on stimulus. Extraordinary spending in March produced only a one-month bump—and that blip came at a high price. The government in March piled up debt at least four times faster than it created nominal GDP.
Although debt does not work the same way in China’s state-directed economy as it does in freer ones, eventually rapid credit creation must produce a disaster. Already, the country’s debt-to-GDP ratio is well north of 300 percent, as Barron’s, referring to Victor Shih’s calculations, notes. Soros in January said the ratio could be as high as 350 percent, and Orient Capital Research in Hong Kong suggests 400 percent.
Whatever it is, China is just about at the limits of the debt it can bear, as growing defaults—and a stark warning from the Communist Party itself on Monday—indicate.
There are many problems, but state firms, backed by Beijing’s spend-like-there’s-no-tomorrow approach, are investing capital, and private ones are not. Leland Miller and Derek Scissors note that their China Beige Book survey of 2,200 Chinese businesses shows that in the first quarter, capital expenditure by lumbering state firms was “stable from a year ago” while private companies “cut back substantially.”
That is an issue because virtually no one thinks an even bigger state sector is a good idea. Yet Chinese leaders have opted for one because, as a practical matter, they have no choice. Structural economic reform, which everyone knows is necessary, would lower growth rates too far, well below zero. That’s politically unacceptable, so they continue with a strategy that must result in a crash, simply because it buys time.
It is no coincidence that Chinese leaders are now pressuring analysts and others to brighten their forecasts and not report dour news, to show zhengnengliang—“positive energy”—a sure indication Beijing has run out of real options.
China, therefore, has passed not only an inflection point but also the point of no return. There are no longer off ramps on the road leading over the cliff.
And that thud you just heard when the first April numbers were issued? That was the big black-and-white bear hitting the floor.
This article explains in greater detail a subject I addressed in a recent comment in the Wall St. Journal:
“…our macroeconomic models are wholly incapable of incorporating operational measures of uncertainty and risk as variables that affect human decision-making under loss aversion. We’ve created this unmeasurable sense of uncertainty by allowing exchange rates to float, leading to price volatility in asset markets because credit policy is unrestrained.
The idea of floating exchange rates was that currency markets would discipline fiscal policy across trading partners. But exchange rates don’t directly signal domestic voters in favor of policy reform and instead permit fiscal irresponsibility to flourish. Lax credit policy merely accommodates this fiscal fecklessness. The euro and ECB were tasked with reining in fiscal policy in the EU, but that has also failed with the fudging of budget deficits and the lack of a fiscal federalism mechanism.
The bottom line is that we do NOT have a rebalancing mechanism for the global economy beyond the historic business cycles of frequent corrections that are politically painful. The danger is we now may be amplifying those cycles.”
Currency Wars: Central Banks Play a Dangerous Game
As nations race to reduce the value of their money, the global economy takes a hit.”
Almost three generations after the Great Depression, that lesson has been unlearned. In the years leading up to the Depression, and even after the contraction began, the Victorian and Edwardian propriety of the gold standard was maintained until the painful steps needed to deflate wages and prices to maintain exchange rates became politically untenable, as the eminent economic historian Barry Eichengreen of the University of California, Berkeley, has written. The countries that were the earliest to throw off what he dubbed “golden fetters” recovered the fastest, starting with Britain, which terminated sterling’s link to gold in 1931.
This, however, is the lesson being relearned. The last vestiges of fixed exchange rates died when the Nixon administration ended the dollar’s convertibility into gold at $35 an ounce in August 1971. Since then, the world has essentially had floating exchange rates. That means they have risen and fallen like a floating dock with the tides. But unlike tides that are determined by nature, the rise and fall of currencies has been driven largely by human policy makers.
Central banks have used flexible exchange rates, rather than more politically problematic structural, supply-side reforms, as the expedient means to stimulate their debt-burdened economies. In an insightful report last week, Morgan Stanley global strategists Manoj Pradhan, Chetan Ahya, and Patryk Drozdzik counted 12 central banks around the globe that recently eased policy, including the European Central Bank and its counterparts in Switzerland, Denmark, Canada, Australia, Russia, India, and Singapore. These were joined by Sweden after the note went to press.
In total, there have been some 514 monetary easing moves by central banks over the past three years, by Evercore ISI’s count. And that easy money has been supporting global stock markets (more of which later).
As for the real economy, the Morgan Stanley analysts write that while currency devaluation is a zero-sum game in a world that isn’t growing, the early movers are the biggest beneficiaries at the expense of the late movers.
The U.S. was the first mover with the Federal Reserve’s quantitative-easing program. Indeed, it was the initiation of QE2 in 2010 that provoked Brazil’s finance minister to make the first accusation that the U.S. was starting a currency war by driving down the value of the dollar—and by necessary extension, driving up exchange rates of other currencies, such as the real, thus hurting the competitiveness of export-dependent economies, such as Brazil.
Since then, the Morgan Stanley team continues, there has been a torrent of easings (as tallied by Evercore ISI) to pass the proverbial hot potato by exporting deflation. That has left just two importers of deflation—the U.S. and China.
The Fed ended QE last year and, according to conventional wisdom, is set to raise its federal-funds target from nearly nil (0% to 0.25%) some time this year. That has sent the dollar sharply higher, resulting in imported deflation. U.S. import prices plunged 2.8% in January, albeit largely because of petroleum. But over the past 12 months, overall import prices slid 8%, with nonpetroleum imports down 1.2%.
China is the other importer of deflation, they continue, owing to the renminbi’s relatively tight peg to the dollar. The RMB’s appreciation has been among the highest since 2005 and since the second quarter of last year. As a result, China has lagged the Bank of Japan, the ECB, and much of the developed and emerging-market economies in using currency depreciation to ease domestic deflation.
The bad news, according to the Morgan Stanley trio, is that not everyone can depreciate their currency at once. “Of particular concern is China, which has done less than others and hence stands to import deflation exactly when it doesn’t need to add to domestic deflationary pressures,” they write.
But they see central bankers around the globe being “fully engaged” in the battle against “lowflation,” generating monetary expansion at home and ultralow or even negative interest rates to generate growth.
The question is: When? Bank of America Merrill Lynch global economists Ethan Harris and Gustavo Reis estimate that global gross domestic product will shrink this year by some $2.3 trillion, which is a result of the dollar’s rise. To put that into perspective, they write, that’s equivalent to an economy somewhere between the size of Brazil’s and the United Kingdom’s having disappeared.
Real growth will actually increase to 3.5% in 2015 from 3.3% in 2014, the BofA ML economists project; but the nominal total will decline in terms of higher-valued dollars. The rub is that we live in a nominal world, with debts and expenses fixed in nominal terms. So, the world needs nominal dollars to meet these nominal obligations.
A drop in global nominal GDP is quite unusual by historical standards, they continue. Only the U.S. and emerging Asia are forecast to see growth in nominal-dollar terms.
The BofA ML economists also don’t expect China to devalue meaningfully, although that poses a major “tail” risk (that is, at the thin ends of the normal, bell-shaped distribution of possible outcomes). But, with China importing deflation, as the Morgan Stanley team notes, the chance remains that the country could join in the currency wars that it has thus far avoided.
WHILE ALL OF THE central bank efforts at lowering currencies and exchange rates won’t likely increase the world economy in dollar terms this year, they have been successful in boosting asset prices. The Standard & Poor’s 500 headed into the three-day Presidents’ Day holiday weekend at a record 2096.99, finally topping the high set just before the turn of the year.
The Wilshire 5000, the broadest measure of the U.S. stock market, surpassed its previous mark on Thursday and also ended at a record on Friday. By Wilshire Associates’ reckoning, the Wilshire 5000 has added some $8 trillion in value since the Fed announced plans for QE3 on Sept. 12, 2012. And since Aug. 26, 2010, when plans for QE2 were revealed, the index has doubled, an increase of $12.8 trillion in the value of U.S. stocks.
This is a good, succinct explanation of the significance of the Swiss National Bank action to cease printing money and what’s in store for the central bank policies of the world.
Quote from asset manager Axel Merk:
Ultimately, central banks are just sipping from a straw in the ocean. I did not invent that term. Our senior economic advisor, Bill Poole, who is the former president of the St. Louis Federal Reserve taught us this: that central banks are effective as long as there is credibility.
What central banks have done is to try to make risky assets appear less risky, so that investors are encouraged or coerced into taking more risks. Because you get no interest or you are penalized for holding cash, you’ve got to go out and buy risky assets. You’ve got to go out and buy junk bonds. You have to go out and go out and buy equities.
The equity market volatility, until not long ago, has been very low. When volatility is low, investors are encouraged to buy something that is historically risky because it is no longer risky, right?
But as the Swiss National Bank has shown, risk can come back with a vengeance. The same thing can happen of course, in any other market. If the Federal Reserve wants to pursue an “exit” to its intervention, if it wants to go down this path, well, volatility is going to come back.
Everything else equal, it means asset prices have to be priced lower. That is the problem if you base an economic recovery exclusively on asset price inflation. We are going to have our hands full trying to kind of move on from here. In that context, what the Swiss National Bank has done is it is just a canary in the coal mine that there will be more trouble ahead.