Global View: Printing a global bubble
By Ian Campbell
Published 2/7/2004 11:20 AM
upi.com
Globalization is a misunderstood concept. It is a target for demonstrators, seen as a way in which the rich world and big companies exploit the poor world. But globalization is an old phenomenon, even if the term is new. Merchants have been traveling for thousands of years and bringing new products, new services, new ideas to countries that are unfamiliar with them and building fresh industries as they do.
In one particular regard, however, the world probably is much more globalized than ever before: in the flow of capital around the globe. This is by no means a new phenomenon either but improved communications have caused it to grow. One clear and very important example at present is that about half the huge fiscal deficit being run by U.S. President George W. Bush is being financed by Asian countries, in particular Japan, but also China.
These flows of capital have consequences, important ones, and, given the current behavior of the U.S. government and U.S. Federal Reserve and that of other governments and central banks around the world, extremely dangerous ones.
To illustrate what is going on, let us begin with a news headline that took your correspondent's eye this week: "Treasuries Barely Blink at Refunding Bill." The U.S. government had announced its intention to borrow $56 billion as part of its quarterly refunding plan. That is a lot of new debt to put into the market. It ought to make investors, the government's creditors, wary. But the news did not drive down Treasury prices. Why?
One reason was a rumor in the market that Japan has been intervening heavily in the currency market, buying dollars and selling Yen in order to bid up the price of dollars and prevent further appreciation of the Yen -- which would be bad for Japan's exports. These newly purchased dollars are likely to be invested in Treasuries.
All this is part of a pattern (which we explored previously in "China and U.S. symbiosis," published Dec. 11.) Asian central banks are buying up dollars and the debt of the U.S. government and increasing their foreign exchange reserves. That has two principle effects.
The first is that there seems no limit to the amount of money the U.S. government can borrow at very lost interest rates. Is it good to have no limit? Think of an individual or a company with no limit on their borrowing. How safe would that be?
The second main effect is felt in Japan and China and other countries that are accumulating reserves. Reserve accumulation stimulates monetary growth. Central banks therefore usually seek to "sterilize" the monetary expansion by acting in the markets. But sterilizing the impact of reserve accumulation often does not work well. A piece of research this week from Steve Barrow, currency strategist at the investment bank Bear Stearns, argues that there is "a pretty good relationship (correlation) between the monetary base and reserve accumulation" in Japan, while in China the "authorities themselves complain that the central bank finds it hard to soak up all the excess liquidity."
The dangers of this reserve accumulation seem particularly great in China where an investment boom is taking place. According to Qu Hongbing, China economist of HSBC bank, "After a surge of 27 percent in 2003, fixed investment as a proportion of GDP is already above 47 percent...and the loan-to-GDP ration is 128 percent. These ratios exceed those of Thailand and other Asian economies prior to the 1997-98 financial crisis."
In his excellent research piece, Barrow points further to the role of fixed rate currencies in the process of reserve accumulation. China's exchange rate (unlike Japan's) is fixed against the dollar. This means that currency appreciation cannot act as a balancing mechanism, with a stronger currency making imports cheaper (and therefore more abundant) and helping to cut a current account surplus, as well as acting to stem some of the growth in exports and the economy as a whole. Floating rates are generally better, enabling balancing mechanisms to function.
Ultimately, however, what the current trends point to are the potential dangers of fiat currency: the capability of central banks around the world to print the money they require (or think they require.) In the United States and Japan, the world's two largest economies, the short term, Federal Reserve-determined interest rate is now no higher than 1 percent. In much economic commentary this approach has been applauded, for many economists see relaxation of monetary policy as the way to counter weak growth. (Japan is often criticized for failing to expand its money supply more swiftly and dramatically following the collapse of its stock market in the late 1980s.)
But again this column must point to the dangers of seeing more and more money as a fix. In the United States (as well as in the UK), as we have repeatedly pointed out, house price inflation, through the mechanism of mortgage refinancing, is generating consumer spending. In our view the United States, far from requiring higher growth, is simply living beyond its means -- as the huge trade and current account deficits show.
Loose monetary and fiscal policy in the United States has also had the effect of driving up the stock market, making it, too, vulnerable to a crash.
The dangers simply cannot be overstated. What the excess global liquidity (which is what economists call cash!) could lead to is an international economic slump, with, to take the two countries on which we have focused, Americans finding themselves with a huge fiscal deficit that requires tax increases, mortgages that exceed the value of their homes, and an economy in recession for years, while China battles against collapsing banks and companies because of the over-capacity that has been built in industry on over-supply of money (via loans.)
In an article for the Washington Post published June 11, 2000, this author warned that "after so many crises ..have been triggered by asset price inflation, the (central banking) orthodoxy needs to change." Instead what has happened since 2000 is that Federal Reserve Chairman Alan Greenspan has deliberately fostered inflation in house prices while the U.S. government racks up more and more debt, feeding off the willingness of Asian central banks to buy it.
Money can be printed so easily and, nowadays, transferred swiftly around the world. In that lies opportunity -- and great danger if freedom is abused.
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Global View is a weekly freelance column giving a personal view of issues of importance for the global economy. Comments to icampbell@upi.com.
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