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Politics : Politics for Pros- moderated -- Ignore unavailable to you. Want to Upgrade?

To: JohnM who wrote (106778)	3/30/2005 10:56:14 PM
From: LindyBill	Respond to of 793835

The large one on the horizon at the moment is the confluence of the debt, the trade deficit, and foreign, particularly, Asian, ownership of Treasuries. I read a ton about this and post very little. Too much "on one hand, but on the other hand," from the economists, and the details are boring. It's the old story that if you owe a banker a huge amount of money, the banker is stuck. The Chinese are really helpless on this issue. Long term, we have to reign in our spending. Short term, the world will buy the debt. The biggest problem the Dems have with this issue is believability. Best blog out there on this subject is Brad Setser. Too big to behave rashly roubiniglobal.com According to Andrew Samwick, the world's central banks are too big to behave rashly. As he puts it: "We're too big an economy, and our creditors' portfolio holdings are simply too large for them to behave rashly." That, according to Samwick, and I suspect Altig and Polley, is a key reason why the US will be able to reduce its large current account deficit gradually, without any major disruptions in financial markets or a sharp slowdown in US economic activity. Foreign central banks won't sell their vast dollar holdings; hell, they might be willing to keep adding to them to keep the global financial system safe and sound. I have one problem with the Samwick argument. It relies on a strange definition what constitutes prudent (assuming prudent is the opposite of rash) behavior by Asian central banks. Why exactly is it prudent for central banks to be issuing large quantities of local currency denominated debt (if they sterilize) to buy $500 billion of dollar denominated claims on a country that is running a current account deficit that looks set to approach 7% of GDP in 2005? Does the coupon on US dollar denominate debt -- currently a bit over 4.5% for long-term Treasuries, and somewhat less at the short-end of the curve -- really compensate them for the exchange rate risk that they are taking? You know, the currencies of countries with 7% of GDP current account deficits often do fall. See: Mexico, 1995; Thailand, 1997, Brazil, 1998. The dollar does not have to fall further against the euro to hurt the big reserve accumulaters either; what counts is what the dollar does against their own currencies. And is China really behaving prudently and strengthening its financial system by forcing state-owned banks to absorb low-yielding sterilization paper to prevent huge reserve growth from leading to a huge increase in the money supply? Behaving prudentally by letting strong money growth continue even with all their efforts to find (cheap) ways to sterilize the reserve inflow? Creditor countries usually do not extend credit in the currency of the debtor. Afterall, why should the creditor, rather than the debtor, take on the currency risk? So, at least to me, it is rather strange for the world's major creditor countries (China is rapidly joining Japan as its current account surplus looks set to explodes) to be accumulating assets denominated in the currency of the world's largest debtor country. China look sets to add at least $250 billion to its reserves in 2005, or around 15% of its GDP. That is a lot of money to spend propping up your biggest customer by lending on what amounts to quaisi-concessional terms. The stability of the world economy hinges on the central banks of major emerging economies not doing anything that would shake up the status quo too much, anything "rash." But not shaking up the status quo requires that they rashly put their balance sheets at risk and keep on extending large amounts of credit at low rates to the world's biggest net debtor ... In a recent discussion at the Council of Foreign Relations that touched on a lot of the themes of this blog, and the Roubini-Altig debate, Ethan Harris of Lehman Brothers noted: "You know, you could make the case that we're sitting on a powder keg here." Indeed you could.