The end of Bretton Woods II?

The following is related to my most recent essay at The Economist.

I suppose it’s presumptuous for me to pontificate on Bretton Woods II, given I found out the meaning of the term only a few weeks ago.  But heh, that’s never stopped me before.  Here’s Wikipedia:

Bretton Woods II was an informal designation for the system of currency relations which developed during the 2000s. As described by political economist Daniel Drezner, “Under this system, the U.S. is running massive current account deficits to be the source of export-led growth for other countries. To fund this deficit, central banks, particularly those on the Pacific Rim, are buying up dollars and dollar-denominated assets.”

Well at least I was aware of the phenomenon.

There’s been a lot of recent discussion of whether Bretton Woods II is about to fall apart, with this post by Tim Duy being perhaps the most authoritative:

The inability of global leaders to address global current account imbalances now truly threatens global financial stability.  Perhaps this was inevitable – the dollar has not depreciated to a degree commensurate with the financial crisis.  Moreover, as the global economy stabilized the old imbalances made a comeback, sucking stimulus from the US economy and leaving US labor markets crippled.  The latter prompts the US Federal Reserve to initiate a policy stance that will undoubtedly resonate throughout the  globe.  As a result we could now be standing witness to the final end of Bretton Woods 2.  And a bloody end it may be.

I don’t know whether Bretton Woods II is about to collapse or not.  But I am skeptical of much of the discussion of global imbalances, which in my view focuses far too much on currency/trade questions, and far too little on savings/investment imbalances.  Before considering Duy’s views, I’d first like to address an argument recently made by Michael Pettis:

For that reason I am always puzzled by people who say that devaluing the dollar will have no impact on the US trade deficit because the problem is low savings relative to investment.  No, that is not the problem.  That is simply one of the definitions of a current account deficit.  But if the dollar devalues, and consumer prices rise, US consumption is likely to decline.  In addition, to the extent that any of the stuff Americans used to import before the devaluation is now produced domestically (not all, but any), then US production must rise.  Since savings is equal to production minus consumption, the US savings rate must automatically rise.

As you may know, I’ve never liked arguments that “reason from a price change”:

1.  Next year the price of oil will be higher, therefore we can expect consumers to . . .

2.  Interest rates will fall therefore we can expect investment to . . .

3.  The dollar will fall therefore we can expect exports to . . .

This is often a misuse of basic supply and demand theory.  There is no necessary correlation between a price change and a quantity change; it entirely depends on why the price changed.  Was it more supply, or more demand?  Now that doesn’t mean Pettis is wrong here, he probably assumed a particular cause of the price change in the back of his mind.  But we need to start with that fundamental cause.

Often when people talk about the need for the US to devalue the dollar, they imagine it occurring through an expansionary monetary policy.  But monetary policy doesn’t have real effects in the long run, so it can’t solve secular problems.  There is no particular reason to expect that having the Fed devalue the dollar would “improve” the US trade balance:

1.  In the long run money is neutral; hence the real exchange rate is unaffected.

2.  In the short run the trade balance might get worse due to the J-curve effect.

3.  If monetary stimulus has a business cycle effect, then the trade balance might get worse if the stimulus creates a boom in the US.

So while Pettis might be right, I don’t have much confidence that the sort of dollar depreciation people are currently discussing would materially affect the US trade balance.  The most “beggar-thy-neighbor” policy in American history was probably the massive devaluation of 1933, and the trade deficit initially got worse.

Of course it may be the case that a country adjusts its currency value by altering the savings/investment equation.  For instance, many people are calling on China to revalue it’s yuan by purchasing fewer foreign bonds.  That doesn’t necessarily reduce Chinese saving (it depends what else the Chinese government does) but there are certainly scenarios where it might.

On the other hand I don’t have much confidence that a laissez-faire attitude in China would materially affect the US trade balance in the long run.  Remember that if China removed all currency controls, it would also be much easier for Chinese citizens to invest overseas.  I think we need to see China in a broader East Asian context.  One reason I could foresee Bretton Woods II being around for a long time is that East Asia is very different from the West, and those differences will become much more important over time, as East Asian wealth skyrockets.  (The term “skyrocket” is not hyperbole, Chinese wealth is set to rise dramatically.)  All of East Asia seems to be moving toward ultra-low birth rates and economies that are structured to produce high saving rates.  I don’t know if Singapore intervenes to weaken their currency, but given the extraordinary high savings rates there you’d expect a big CA surplus even if the government wasn’t accumulating foreign reserves.  The exact same thing occurs if the Singapore public buys the assets, and puts them in retirement accounts.

Over the next few decades China will get much richer.  As it does so, I’d expect its economy to resemble other East Asian countries more than the US.  And that will be true even if their government ends its weak yuan policy.  To take just one trivial example, I’d expect far more Chinese citizens to be speculating in property in LA, Vancouver and Sydney, than Westerners buying vacation homes in Shanghai or Hainan.

The East Asian economy is set to become extremely large in 20 or 30 years.  Given the enormous structural differences from our economy, I think it quite likely that the imbalances will become even larger in absolute terms.  When I lived in Australia in 1991, many Aussies were worried that their huge CA deficits were unsustainable, and also the cause of their recession.  They haven’t had a recession since, and they have continued to run very large deficits.  I see no reason why this “unsustainable” trend cannot continue for many more decades.

This is not to suggest that I disagree with Pettis’ policy recommendations, indeed I think his views on restructuring the Chinese economy make a lot of sense.  He also seems to share my view that while moderate yuan appreciation would be desirable, a sudden and sharp appreciation might be counterproductive:

This is why I worry that we are putting too much pressure on the renminbi.  There are many ways for China to rebalance, and they all involve the same process of transferring income from producers to households.  Raising the value of the renminbi, for example, increases the real value of household income in China by reducing the cost of imports.

It balances this by lowering the profitability of exporters.  The net result is that if it is done carefully, the household income share of China’s GDP rises when the renminbi is revalued, and with it consumption rises too.  Since China must export the difference between what it produces and what it consumes or invests, raising the value of the currency also reduces China’s trade surplus.

But what would happen if China were to raise the currency too quickly?  In that case the profitability of the export sector would decline so quickly that exporters would be forced either into bankruptcy or into moving their facilities abroad to lower-wage countries.  Either way, they would have to fire local workers.

Tim Duy also seems skeptical of those who put all the focus on Chinese surpluses:

But I don’t want to make this piece about China.  It is more than China at this point.  It became more than China the instant US Federal Reserve policymakers woke up one morning and decided they needed to take the dual mandate seriously.  And seriously means quantitative easing.  Brad DeLong suggests that when the Fed actually acts on November 3, it will be too little too late.  But if it is too little, more will be forthcoming.

Put simply, the Federal Reserve is positioned to declare war on Bretton Woods 2.  November 3, 2010.  Mark it on your calendars.

So perhaps Bretton Woods does not end because foreign governments are unwilling to bear ever increasing levels of currency and interest rate risk or due to the collapse of private intermediaries in the US, but because it has delivered the threat of deflation to the US, and that provokes a substantial response from the Federal Reserve.  A side effect of the next round of quantitative easing is an attack on the strong dollar policy.

Even if we could boost US demand by bashing China (and I doubt we could) there is a much better way; boost NGDP with a more expansionary monetary policy.  Where I differ with Duy is that I don’t think it will permanently end Bretton Woods II.  Yes, there may be some short term reduction in imbalances, but once the US recovers I have trouble seeing why we would not revert to running large deficits.  In my view there are only two permanent ways to address the US CA deficit; raise the US saving rate through fiscal reforms, or depress investment by adopting demand and supply-side policies that impoverish the country.  I think you know which approach I prefer.

BTW, David Beckworth posted on this earlier, and he shares my skepticism about the end of BWII.  Bill Woolsey also has a good post on exchange rates.

HT:  Marcus Nunes



43 Responses to “The end of Bretton Woods II?”

  1. Gravatar of mlb mlb
    19. October 2010 at 12:38

    Some very interesting comments from Richard Fisher. It is especially helpful that he actually talked to businesses that create jobs rather than simply theorize what it takes to create jobs…

    The vexing question is: Why isn’t this liquidity being utilized to hire new workers and reduce unemployment? Why is it that, as pointed out in Alan Greenspan’s op-ed in the Oct. 7 edition of the Financial Times, the share of liquid cash flow allocated to long-term fixed asset investment has fallen to its lowest level in the 58 years for which data are available?[4] If current dramatically high levels of liquidity and low interest rates are not being harnessed to add to payrolls or expand capital expenditures, would driving interest rates further down and adding more liquidity to the system through Fed purchases of Treasury securities induce U.S. businesses and consumers to get on with spending it?

    The intrepid theoretical economist would argue in the affirmative, the logic being that there is a tipping point at which the market becomes convinced that money held in reserve earning negligible returns is at risk of being debased through some inflation and, thus, should be spent rather than hoarded. Hence, the appeal of the Fed’s showing a little leg of inflationary permissiveness.

    There is some valid theory behind this approach. Yet, my soundings among those who actually do the work of creating sustainable jobs and making productive capital investments?private businesses, big and small?indicate that few are willing to commit to expanding U.S. payrolls or to undertaking significant commitments to expand capital expenditures in the U.S. other than in areas that enhance the productivity of the current workforce. Without exception, all the business leaders I interview cite nonmonetary issues?fiscal policy and regulatory constraints or, worse, uncertainty going forward?and better opportunities for earning a return on investment elsewhere as factors inhibiting their willingness to commit to expansion in the U.S. As the CEO of one medium-size business put it to me shortly before the last FOMC, “Part of it is uncertainty: We just don’t know what the new regulations [sic] like health care are going to cost and what the new rules will be. Part of it is certainty: We know that taxes are eventually going to have to increase to get us out of the fiscal hole Republicans and Democrats alike have dug for us, and we know that regulatory intervention will be getting more intense.” Small wonder that most business leaders I survey, including those at small businesses, remain fixated on driving productivity and lowering costs, budgeting to “get fewer people to wear more hats.” Tax and regulatory uncertainty?combined with a now well-inculcated culture of driving all resources, including labor, to their most productive use at least cost?does not bode well for a rapid diminution of unemployment and the concomitant expansion of demand.

  2. Gravatar of Rebecca Burlingame Rebecca Burlingame
    19. October 2010 at 12:50

    Bringing it back to China, apparently trade of rare earths is being blocked to Japan and the U.S., and it remains to be seen how strong a reaction comes from that.

  3. Gravatar of Benjamin Cole Benjamin Cole
    19. October 2010 at 13:21

    Can you name any real business people that Richard Fisher talked to? Do he informally walk an industrial district in Dallas?

    Or did he clink glasses with Texas Chamber of Commerce types and then talk about the need for tax cuts before QE2?

    Give to me the names of five real business people in Texas Richard Fisher talked with.

    I work in an industrial district in Los Angeles. I talk with small contractors and manufacturers every day (nearly). These guys will hire when they get orders.

  4. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 13:42

    An industrial district in Dallas? HUH? Energy – thats’s Texas. Would you please stop imagining that US manufacturing is going to increase if we print money?

    If you want to increase manufacturing – throw out the minimum wage, and provide people whose labor is not enough to care for themselves AID.

    We can keep the cheap jobs here – the textile industry, the call centers – light manufacturing – we just have to be able to pay $4 a hour.

    Of course if we’re going to provide that kind of Safety Net – we have to toss Birth Right Citizenship – MF says we can’t have both.

  5. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 14:33

    Also: it is very nice to see GOLDLINE ads at Scott’s site.

    Be sure everyone clicks on them routinely!

    Now if only Scott would adopt DISQUS like MATTY at Think Progress has…

  6. Gravatar of Richard W Richard W
    19. October 2010 at 15:27

    I agree with you that focusing only on the exchange rate is wrong. However, the problem I have with explaining away reserve accumulation as primarily a savings/investment imbalance in the US, is why did reserve accumulation suddenly rocket only after the Asian Financial Crisis? Three quarters of all reserve accumulation from the beginning of time was accumulated between 1999-2007.

    One can see the massive increase here table 1, p8, p13.

    This is good post pointing out that the household savings ratio in China has been constant. What increased was corporate savings. Moreover, the labour share of national income fell. Therefore, Chinese internal reforms to give workers a higher share of national income must go hand in hand with currency appreciation for re-balancing to be effective. Moreover, there is evidence (EMH) that Chinese stock values are adjusting towards a more consumption paradigm.

  7. Gravatar of Benjamin Cole Benjamin Cole
    19. October 2010 at 15:50

    OT, but current, from Reuters.

    “Atlanta Federal Reserve Bank President Dennis Lockhart put forth his proposal for a new round of quantitative easing, dubbed QE2. He sees the Fed purchasing $100 billion in treasuries per month. Lockhart made his statement in an interview on CNBC and is reported by Reuters.

    Lockhart is the third Fed official to come forth in favor of easing. Last week we heard from Charles Evans and William Dudley who both favor QE2.

    Lockhart was more specific by giving an estimate of how much money is involved. He said: “As a monthly number $100 billion is fairly consistent with what we did before, and so I think it would certainly be in the range of numbers one might consider …but if you were talking about $100 billion as simply the overall program, I think that’s too small. He further stated: “I think the risks associated with it are acceptable. Quantitative easing will help improve a recovery that is going very slowly and improve the trajectory of the economy overall.”


    Gee, $100 billion a month? Where did that number come from? I realize it is a round number, but still…Did this number emerge when Benjamin Cole asked Scott Sumner to lay out a plan? Is that Twilight Zone music I hear?

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 17:00

    BW II will end when good public policy brings the US CAD into balance for reasons other than decreased AD. Progressive Consumption Tax (PCT) anyone?

  9. Gravatar of marcus nunes marcus nunes
    19. October 2010 at 18:22

    Bad manifestations:
    “The real threat is a world broken into two competing financial blocs, one centred on the dollar, the other on the Bric nations of Brazil, Russia, India and China. Tentative steps in this direction occurred last year when China, India and Russia, along with Iran and members of the Shanghai Co-operation Organisation took early steps to use their own currencies for trade, rather than the dollar. China took a simpler path last month when it supported a Russian proposal to start direct trading using the renminbi and the rouble. It negotiated similar deals with Brazil and Turkey.

    To deter this the US and Japan should refrain from QE2, even at the cost of lower US growth. An even better response, however, would be new regulations stopping western banks from speculating in foreign currencies, by using heavier reserve requirements or a short-term tax on foreign currency trades and options. Without such steps other countries will soon move to protect their currencies. If they do it will have been US policy short-sightedness, conducted without concern for its effect on developing economies, that will ultimately have isolated the dollar and its users.”

  10. Gravatar of marcus nunes marcus nunes
    19. October 2010 at 18:36

    As the “demand” for “tinkering” with exchange rates goes up, “supply” of tinkering” proposals accomodate.

  11. Gravatar of scott sumner scott sumner
    19. October 2010 at 19:06

    mlb, Yes, it is “interesting” that a top Fed official thinks money is easy because rates are low and there is lots of liquidity (like 1933.)

    And also that talking to a few businesses is more informative that polls that show lack of sales to be the biggest problem facing businesses.

    Rebecca, I’ve heard that, but know nothing about it.

    Richard, I agree that the Asians have been saving a lot more since 1997, but that fits my theory. Those savings depressed world interest rates, and helped create the US savings/investment imbalance.

    Morgan, I’ll never compete with Yglesias in technology.

    Benjamin, Yes, and when I have time I’ll mention another interesting coincidence.

    Mark, I agree.

    Marcus, I’ve noticed that fluctuating exchange rates bring out all the worst of economists.

  12. Gravatar of JTapp JTapp
    19. October 2010 at 19:07

    Also off-topic, but the Financial Times Alphaville blog has this interesting note about the Fed’s SOMA limits theoretically limiting its ability to do QE. The Fed has a self-imposed limit on how much of any one Treasury issue it can purchase.

  13. Gravatar of Richard W Richard W
    19. October 2010 at 19:32

    Here is an illustration of how demographics impact the current account. The frugal Germans who do not consume is a total myth. Their economy enjoyed a private consumption boom until the median age breached 40.

    Household borrowing.

    Corporate borrowing.

    Total private sector borrowing.

    German median age passes 40 and the economy switches to export-led.

    German current account.

    The REER was initially too high for an economy switching to export-led growth. The chart also illustrates the scale of adjustment to regain competitiveness that Spain on the periphery have to make.

  14. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 19:36

    I ocassionaly wonder how long this “uncertainty” ploy will survive after the Republicans take control. I suppose everything will be absolutely “certain” thereafter. I can’t wait.

  15. Gravatar of Michael Pettis Michael Pettis
    19. October 2010 at 21:46

    Scott, I don’t have the numbers in front of me but I thought the US had a trade surplus in 1933, not a deficit. The US surplus contracted probably because international trade collapsed (and Smoot-Hawley helped it to collapse). The British, on the other hand, had a large trade deficit, and as they devalued and raised import tariffs their deficit contracted and they began to grow. This suggests that beggar-thy-neighbor may be bad for the world, but not equally. Deficit countries may actually expand while surplus countries bear more than 100% of the cost.

  16. Gravatar of Bogomil Bogomil
    19. October 2010 at 22:18

    If the Fed buys $100,000,000,000 a month in treasuries, will Congress take that found money and (1) cut taxes so the benefits inure to the private economy or (2) expand the Federal workforce (and make grants to state governments to maintain and expand their workforces) and, necessarily, their regulatory reach? When Congress spent 8 months worth of QE2 as stimulus, it went gangbusters for Choice (2), leavened by a little bonus depreciation.

    Choice (2) creates a hard-to-remove millstone on the productivity of the private sector. Each new Government employee enjoys salaries, benefits and conditions that private employers must compete with, provide low productivity, and probably be tasked with something that makes life hard on business activity.

    Couldn’t the Fed just drop $100,000,000,000 a month from helicopters over various metropolitan areas? Sell $1 bills for 90 pennies? Anything else?

  17. Gravatar of Doc Merlin Doc Merlin
    20. October 2010 at 00:32

    100B a month? Will they sterilize that with interests on reserves? Will this accidentally bring about 100% reserve banking? j/k

    On a more serious note, thats a crapload of money. The entire AMB is about 2T dollars.

  18. Gravatar of Doug Bates Doug Bates
    20. October 2010 at 02:39

    I think the benefit from devaluing the dollar is a reduction in the debt burden, which should allow us to borrow even more, hence more trade deficit. Welcome to the perpetual devaluation machine!

  19. Gravatar of mlb mlb
    20. October 2010 at 04:18

    To those making the point that lack of sales is the issue, I agree. But to me, the lack of sales reflects a lack of confidence in future inflation-adjusted income and profits. Aggressive Fed intervention simply makes this worse – for every dollar of QE some company/consumer is thinking about the future unwinding of QE or about how the markt will react to the distorted price signals. Whether or not the USD will be devalued relative to goods by a few % is almost meaningless in my opinion.

    There is a reason consumer confidence is still terrible while financial assets have largely recovered. All the actions that have helped financial assets recovered have actually worsened the long-run outlook for the majority of consumers – or at the very least added a lot of confusion. When you see gold, oil, food go up every day and employment fall every month it is no wonder confidence is low.

    Pull up the the quarterly earnings call transcripts of a cross-section of the S&P 500 companies and you will find – 1) a lack of sales, 2) a lack of confidence in the US as a long-term growth driver, 3) no positive mention of inflation but perhaps a negative mention, 4) a desire to increase spending in overseas markets (largely as a result of under-leveraged consumers/governments which in CEO’s minds equates to being a long-term driver of growth.

  20. Gravatar of scott sumner scott sumner
    20. October 2010 at 04:34

    JTapp, Thanks. That’s almost comical, given how close the 35% limit is the the gold ratio that hamstrung fed policy in 1932. That was also about 35% (gold/base) Of course Congress promptly altered it when it got in the way.

    Richard, Thanks for that info. Of course I would never suggest anything to the effect that the Germans don’t consume and only save. It is a fact however, that Germany saves far more than it invests.

    Mark, Good point.

    Michael, I am pretty sure that that is not correct. I recall reading that after the US devalued the dollar, industrial production soared upward so fast (57% gain in 4 months) that we sucked in a lot more imports. By late 1933 imports were up 20%, but US exports had only risen slightly.

    A nice little example that counteracts both liquidity trap views of monetary policy ineffectiveness at the zero bound, and also beggar-thy-neighbor views.

    Bogomil, Dropping money from helicopters would be much more effective that what they plan on doing, which is precisely why they won’t do it. This isn’t really found money for Congress, as this money is interest bearing, just like deficit spending.

    Doc Merlin, Yes, it’s a lot of money, and yes, it will be sterilized with IOR.

    Doug Bates, Yes, I long for the days before the recession when we had a big trade deficit and 5% unemployment. I’d love to get back there.

    mlb, There is a mountain of empirical evidence that you are wrong. In past recessions, when output has already fallen sharply a big increase in NGDP always results in a big rise in RGDP. The same would occur this time. BTW, this pattern even occurs when there are structural and banking problems much worse than we have now (i.e 1933.

  21. Gravatar of Steve Steve
    20. October 2010 at 05:31

    Scott, mlb, et al.,

    I think there is an important micro point to be made about commodity prices, stimulus, and the dollar. This is the same point I started to make when I criticized “Mish” Shedlock.

    Many commodities, oil for instance, have very inelastic short-term supply curves. Demand is also a linear function of aggregate demand in the short-run because it takes a long time for substitution effects to kick in. Therefore, stimulus tends to show up first in a sharp rise in commodity prices.

    This initial rise in commodity prices has knock-on effects. For a large importing nation like the US, it worsens the trade deficit, which leads to a fall in the dollar in order to finance said deficit. It’s not entirely clear which way the causation runs; does the stimulus cause the dollar to fall which causes commodities to rise, or does the stimulus cause demand for commodities to rise, which causes the trade deficit to worsen? Probably stimulus causes both effects, which explains the exaggerated reaction in commodity markets.

    But remember all these effects are short-run effects. Higher commodity prices lead to accelerated investments in supply, accelerated substitution effects, and accelerated capital investment in efficiency. Over a reasonable period of time (a few years?) commodity prices will go to where structural considerations dictate. And the trade deficit may actually fall if the US gets a jump start on investment. Look at what has happened to natural gas prices over the last three years despite the so-called “dollar debauchment.”

    The problem is that there is a whole cottage industry of pundits who think they are smart because they can run daily correlations between commodity prices and the dollar or QE prospects. These pundits predict the demise of the US if we go ahead with QE. But their error is one of microeconomics, not macro. The macro conclusion is wrong too, but it’s because the micro analysis is wrong.

  22. Gravatar of OGT OGT
    20. October 2010 at 05:53

    Sumner, Michael-According to this chart from the BEA the US had a surplus when FDR took devalued, which briefly surged, then fell. Not sure who that supports.

    Sumner- I am surprised you were not familiar with BWII, as a monetary guy, I’d have thought it would peek your interest since it springs from the USD being the most money-ish of moneys.

    In any case, I’ve always understood it as being an arrangement where essentially we export financial instruments in exchange for goods. This marginally realigns the US economy towards the finance sector (40% of corporate profits in 2008) and away from other tradable goods sectors.

    Again under my interpretation of the model, it was relatively stable until Japan’s economy grew to a size that the capital flows to maintain the peg were destabilizing, hence the Plaza accords. Then again after the Asian financial crisis and subsequent rough treatment by the IMF, when demand for USD financial assets grew tremednously. (Also, I am not sure about your East Asian cultural interpretation, I do not believe South Korea, Thailand and Indonesia had CAS before 1998, hence their vulnerability to runs on their currencies).

    Lastly, if one assumes that credit in the US is subsidized from abroad by this arrangement, is it a violation of neutrality of money to assume that the capital structure of households, corporations, and government would be marginally tilted more towards debt and away from equity?

    Interesting post.

  23. Gravatar of Morgan Warstler Morgan Warstler
    20. October 2010 at 06:36

    You folks shouldn’t get to attached to $100B a month.

    At 2% inflation it ends. And with a fine Republican Congress in place, Fed attitudes change. At winning no, or only one house, maybe, but if the good guys get two – I think circumstances change.

    Mark, you occasionally wonder? Democrats not kissing ass like Bill Clinton = Uncertainty

    Business is OWNED AND OPERATED by Republicans, the correct attitude of ANY economist is to accept reality… when liberals and professor eggheads start screaming that they get to have an opinion about business – REAL BUSINESSMEN become uncertain…. they immediately begin to factor in HORRIBLE NIGHTMARES into their equations…. their positive greed remains, but it is tempered by the fact that some worthless liberal’s greed is suddenly involved in the equation.

    Glad to provide this insight – it will help you do some figuring.

  24. Gravatar of mlb mlb
    20. October 2010 at 06:38

    Scott, there was also a mountain of evidence suggesting that home values would never fall nationwide. Economics is not a hard science. Any analysis is incomplete without an assessment of how maket participants are positioned. In housing the “mountain of evidence” made the problem far worse as the market was positioned according to the historical evidence. I would argue we are in a similar position now.

    Western economies have now positioned themselves to be long inflation and short a deep, lasting recession or deflation. In other words there is an enormous amount of leverage layered on top of financial assets with very little capital chasing goods or inflation protection (I would argue the average investor has less than 1% of his/her savings in inflation hedges).

    By 1932 financial assets fell to extremely low valuations (near the lowest ever). Stocks had a P/E of 6 on 10yr smoothed earnings. I would argue that easing is positive given that backdrop – financial assets have a lot of room to appreciate without worrying too much about inflation. We are now in the opposite situation. Financial assets remain at very high valuations so a unit of inflation does nothing but encourage more capital away from financial assets into other economies or inflation hedges (e.g., commodities). We also have a situation where the USD is the reserve currency. I would argue that every unit of debasement has offsetting effects – a slightly positive effect on the economy and a negative effect due the fact that the odds of the US losing reserve currency status has increased.

    Today’s analysis is nothing like past experiences. In fact, it may well be the opposite much like housing was.

  25. Gravatar of Morgan Warstler Morgan Warstler
    20. October 2010 at 08:08

    I’m enjoying rubber-meets-the-road politics today on Drudge…

  26. Gravatar of Bababooey Bababooey
    20. October 2010 at 09:24

    From their subjective view, $100,000,000,000 a month is found money for a Congressman. When a Ways & Means committee person appropriates that money they do not have a concern for how to repay it or fund the interest. Such persons primary concern is deliver the largest amount to constituents in order to secure reelection, an academic position, or a think tank/lobbyist job. (The flip side of bribing constituents is not pissing them off, which is why non discretionary (the name is the excuse) spending is never cut.)

  27. Gravatar of Bob OBrien Bob OBrien
    20. October 2010 at 09:48

    Scott said:

    “mlb, There is a mountain of empirical evidence that you are wrong. In past recessions, when output has already fallen sharply a big increase in NGDP always results in a big rise in RGDP. The same would occur this time. BTW, this pattern even occurs when there are structural and banking problems much worse than we have now (i.e 1933.”

    Yes, but what evidence do we have that QE2 will cause a big increase in NGDP?

  28. Gravatar of David Tomlin David Tomlin
    20. October 2010 at 12:07

    Is there any historical precedent for a government imposing a de facto embargo while officially denying it was doing so?

  29. Gravatar of StatsGuy StatsGuy
    20. October 2010 at 13:38


    “Doug Bates, Yes, I long for the days before the recession when we had a big trade deficit and 5% unemployment. I’d love to get back there.”

    Forgive me, but this is somewhat like a compulsive shopper longing for the days before the banks cancelled his credit cards.

    Among other things, much of the 5% unemployment was in industries targeting domestic consumption (massively overdeveloped retail complex, excess marketing spend, overly expensive and costly-to-maintain housing etc.). Certainly, from an economists perspective this appears better because it offered more consumption – the market wanted it, right? Yet that consumption was borrowed from the future, and unsustainable.

    I long for a sustainable growth path, which clearly involves NGDP reflation, and will necessarily bring a lower dollar that MUST rebalance world trade eventually – IF the US actually just keeps at it. In the process, the EU may end up with a choice of also devaluing, or losing export share to the US. But that’s the ECB’s choice.

    China cannot continue its export dominance in the face of a declining dollar. Export margins are already being squeezed. It is buying (increasingly expensive) commodities using dollar-based earnings, to re-fabricate them into dollar-earning exports.

    China has recently played one of it’s most powerful cards – export embargo on rare earths. It’s not common that nations in a demand-seeking world impose export restraints. I would bet a lot of money that somewhere, there are high level negotiations occurring regarding how much devaluation of the dollar China will tolerate, and how fast.

  30. Gravatar of scott sumner scott sumner
    20. October 2010 at 17:59

    Steve, Those are good points.

    OGT, I relied on memory regarding the trade data. I am pretty sure the data I read about was the trade deficit, not the current account deficit, but can’t say for certain.

    Good point about South Korea, which did run deficits in the 1980s. It’s also a useful reminder that the East Asian growth miracles are not caused by mecantilism. HK and Singapore have free trade, and Korea had a deficit when it grew fastest.

    My sense is that the demographics are important. Korea’s population was growing much faster in the 1980s, and so was its economy. Korea is rapidly becoming a mature economy like Japan. Population growth will turn negative and RGDP growth will slow sharply. High saving rates make sense under those conditions. But this begs the question of why China already has a big surplus—arguably they should run deficits until they become richer. I can’t answer that question.

    I don’t consider Indonesia and Thailand to have East Asian cultures. I include the Chinese, Japanese, Korean and Vietnamese cultures. In the future, I believe those will be the richest parts of Asia.

    As I said in my essay in The Economist, I regard BWII as a fiscal regime and trade, not a monetary regime. I don’t see it having much of anything to do with monetary policy. I prefer closed economy macro, and so I don’t focus much on open economy issues. I never even had strong views as to whether the euro was a good idea. BTW, I don’t see any violation of money neutrality in the example you discuss.

    Morgan, When the Fed starts talking about this particular egghead’s opinions, the stock market seems to rise.

    mlb, It’s always dangerous to hypothesize about the “new normal” but if I was forced to I’d say that real interest rates may be on a permanently lower track. What Keynes predicted is finally coming true–at least for a while. In that sort of world, equities become more attractive. My hunch is that this explains some of the high valuations of stocks.

    bababooey, But QE isn’t money that Congress can spend.

    Bob OBrien, There is no guarantee it will raise NGDP. But there’s no cost if it fails. So it’s worth a try. I would prefer the Fed use a more effective technique like NGDP targeting, or at least combine QE with lower interest on reserves.

    David, Embargo on what?

    Statsguy, Yes, after we get back to full employment let’s deal with the saving issue. In my view this country need a much higher saving rate. If we do that successfully, I couldn’t care less whether or not it reduces our CA deficit. The CA deficit is not a problem in an of itself, it is a symptom of other problems.

  31. Gravatar of Lee Kelly Lee Kelly
    20. October 2010 at 19:18

    It concerns me that so much lending has been to the U.S. Government, because I assume most of the resources are squandered. In the long run, private investment must overcome the destruction of wealth that is government debt. While the purchase of government debt may be an investment for its purchaser, for the economy as a whole it is probably disinvestment. That is, the way in which government spends borrowed money probably makes it more difficult for future tax payers to pay back.

  32. Gravatar of Bonnie Bonnie
    21. October 2010 at 04:37

    I’m interested in the legal framework for currency agreements such as “Bretton Woods II” but have been unable to find any references to agreements ratified by the Senate, or any legislative history that permits these to be undertaken on a sort of off the cuff basis by the Executive branch, even for the original Bretton Woods agreement. It is probably there somewhere because the constitution provides that power to the Congress, but I can’t find it. It would seem that Congress should have a say in the matter on a case by cases basis rather than delegating that kind of power and maintaining an eyes wide shut approach to currency agreements that have real effects on the nature and character of our economy and our quality of life. It might be that no one really knows for sure what the real effects are, if any. All I have for evidence is what the complaints are regarding our trade relationship with China, which consist mainly of siphoning off manufacturing operations and other kinds of jobs that used to be performed here, abuse of the currency peg, and unfair trade practices. It might be that none of these complaints have any real material effect on our quality of life; it is hard for me to say one way or the other.
    Looking at our savings situation, however, it likely is not helping to have agreements in place that incentivize overindulgent consumption in order to prop up the economies of other nations, and of course, there are always those who are left out which probably causes problems in the areas of diplomacy and national security. I think at some point we should take a long look at our reality, the change in demographics and economic wherewithal, and evaluate whether these things are actually in our best interest going forward. I also think Congress should start taking an active rather than passive role in the development and maintenance of such agreements so that they are done out in the open and subject to public scrutiny.

  33. Gravatar of Scott Sumner Scott Sumner
    21. October 2010 at 05:44

    Lee, You may well be right.

    Bonnie, BWII is not a formal agreement, just a term to describe an informal system that has evolved over time.

  34. Gravatar of OGT OGT
    21. October 2010 at 05:59

    Sumner- Personally I would put more weight on the demographic factors than cultural in terms of trade balances.

    The demographic factors do raise some interesting questions. At what point does an aging society like Japan begin to dissave? How reliable will the claims on foreign income that they’ve built up prove to be?

    When I wrote that BWII was monetary, I was thinking in a theoretical Nick Rowe kind of way. Why are so many governments and private entities willing to hold USD financial assets with lower returns than in other markets? Risk is one factor and USD liquidity is another. So, in a sense, everyone wants USD financial assets because everyone else wants USD financial assets.

  35. Gravatar of ssumner ssumner
    22. October 2010 at 18:17

    OGT, My wife is Chinese so I see a lot of the Chinese culture. It does seem like a high saving culture to me. I wonder if there is any data on how much Asian Americans save. I’d bet it is a higher rate than for other Americans.

    The point about Japan is an interesting one. I have also wondered where the demographics turn to dissaving. I’m afraid that is not my area of expertise, and I don’t have good intuition about what is likely to occur in a steadily falling population.

    I see your point about T-bonds, and again don’t have any special insights into that issue. I don’t view them as money, so it never was an issue I gave much thought to. I’ve generally assumed that if the Chinese held less T-bonds and more of other bonds, the people who were formerly holding more of those other bonds (sold to the PBOC) would then hold more US bonds. I’m not saying there’d be no effect, but I don’t see it changing imbalances in any dramatic way.

  36. Gravatar of liability insurance quotes liability insurance quotes
    23. October 2010 at 05:42

    Bringing it back to China, apparently trade of rare earths is being blocked to Japan and the U.S., and it remains to be seen how strong a reaction comes from that.

  37. Gravatar of Scott Sumner Scott Sumner
    24. October 2010 at 07:02

    liq, And how does that relate to BWII?

  38. Gravatar of Doc Merlin Doc Merlin
    25. October 2010 at 05:08

    On a humorous note, If they sterilize QE2, won’t that move us closer towards Rothbardian 100% reserve banking?

  39. Gravatar of ssumner ssumner
    25. October 2010 at 07:08

    Doc Merlin, We’re there already for M1.

  40. Gravatar of Doc Merlin Doc Merlin
    25. October 2010 at 18:39

    Thats terrifying, Scott.

  41. Gravatar of Doc Merlin Doc Merlin
    25. October 2010 at 18:41

    I should clarify why its scary:
    One misstep by the fed and BAM, V will go through the roof. This doesn’t seem very stable to me. I guess it will start happening when banks start buying nondebt assets instead of holding cash.

  42. Gravatar of ssumner ssumner
    26. October 2010 at 06:01

    Doc Merlin, I’m not terrified, as I’m confident the Fed would pull out the excess money before that happened.

  43. Gravatar of Nakazahn Nakazahn
    11. April 2016 at 09:43

    Free trade relied on the free convertibility of currencies. Negotiators at the Bretton Woods conference, fresh from what they perceived as a disastrous experience with floating rates in the 19, concluded that major monetary fluctuations could stall the free flow of trade.

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