Bretton Woods II

Your humble blogger has a rather long essay in the Fall 2009 issue of International Security.  What's a lowly IPE scholar doing publishing in a high and mighty security journal?  Assessing whether China's massive holdings of dollar-denominated assets is a big deal or not.  The title may or may not give away my argument:  "Bad Debts: Assessing China's Financial Influence in Great Power Politics."

Here's the abstract: 

Commentators and policymakers have articulated growing concerns about U.S. dependence on China and other authoritarian capitalist states as a source of credit to fund the United States' trade and budget deficits. What are the security implications of China's creditor status? If Beijing or another sovereign creditor were to flex its financial muscles, would Washington buckle? The answer can be drawn from the existing literature on economic statecraft. An appraisal of the ability of creditor states to convert their financial power into political power suggests that the power of credit has been moderately exaggerated in policy circles. To use the argot of security studies, China's financial power increases its deterrent capabilities, but it has little effect on its compellence capabilities. China can use its financial power to resist U.S. entreaties, but it cannot coerce the United States into changing its policies. Financial power works best when a concert of creditors (or debtors) can be maintained. Two case studies—the contestation over regulating sovereign wealth funds and the protection of Chinese financial investments in the United States—demonstrate the constraints on China's financial power.

Read it and weep. 

Rob Reich is upset that the New York Times and Center for American Progress are taking the question about rising levels of U.S. debt seriously.  He is so upset that he goes back into 1990s memoir mode and starts rolling out the conspiracy theories: 

Odd that it would return right now, when the economy is still mired in the worst depression since the Great one. After all, consumers are still deep in debt and incapable of buying. Unemployment continues to soar. Businesses still are not purchasing or investing, for lack of customers. Exports are still dead, because much of the global economy continues to shrink. So the purchaser of last resort -- the government -- has to create larger deficits if the economy is to get anywhere near full capacity, and start to grow again.

Odder still that the Debt Scare returns at the precise moment that bills are emerging from Congress on universal health care, which, by almost everyone’s reckoning, will not increase the long-term debt one bit because universal health care has to be paid for in the budget. In fact, universal health care will reduce the deficit and cumulative debt -- especially if it includes a public option capable of negotiating lower costs from drug makers, doctors, and insurers, and thereby reducing the future costs of Medicare and Medicaid....

Why are the ostensibly liberal Center for American Progress and New York Times participating in the Debt Scare right now? Is it possible that among the President’s top economic advisors and top ranking members the Fed are people who agree more with conservative Republicans and Wall Streeters on this issue than with the President? Is it conceivable that they are quietly encouraging the Debt Scare even in traditionally liberal precincts, in order to reduce support in the Democratic base for what Obama wants to accomplish? Hmmm.

I actually think Reich has half a point -- if you read either Tim Geithner or Paul Volcker's speeches over the past few years, they've been sounding the debt alarm for some time.    

That said, the notion that this is a non-issue being pushed by conservatives and conservative lackeys borders on the absurd.  Daniel Gross is pretty sympathetic to Reich's substantive view on the U.S. debt issue, but in this Slate essay he's also pretty clear about why the debate has moved to the forefront: 

The interest rate of the 10-year Treasury bond has spiked from 2.07 percent in December 2008, when the world was falling apart, to a recent high of 3.715 percent on June 1—a 79 percent increase. The 30-year bond has risen from 2.5 percent last December to about 4.5 percent today.

You can debate about why this is happening (Gross is worth reading).  A simple dismissal of the issue, however, seems kinda loopy. 

[So you think Reich is wrong on policy?--ed.]  Right now, no -- jumpstarting the economy has priority over mounting levels of U.S. government debt. 

I suspect, however, that my concerns about rising U.S. debt levels will start rising before his.  Anyone who can write this sentence scares me: 

True, [the debt/GDP] ratio is heading in the wrong direction right now. It may reach 70 percent by the end of 2010. That’s high, but it’s not high compared to the 120 percent it was in 1946, after the ravages of Depression and war.

My latest Newsweek column is online.  It looks at China's recent moves to challenge the dollar's status as the world's reserve currency and what to make of them.

The closing paragraphs: 

If these moves do not amount to much, then why all the hubbub? To be blunt, America is out of practice at dealing with an independent source of national power. For two decades the United States has been the undisputed global hegemon. For the 40 years before that, America was the leader of the free world. As a result, American thinkers and policymakers have become accustomed to having all policy decisions of consequence go through Washington. Our current generation of leaders and thinkers are simply unprepared for the idea of other countries taking the lead in matters of the global economic order.

Most of China's recent actions do not constitute a real threat to the United States; indeed, to the extent that China helps to boost the economies of the Pacific Rim, they are contributing a public good. Obama—and Hunstman—need to make the mental adjustment to a rising China, welcoming many of China's policy initiatives while pushing back at those that threaten American core interests. If they can make this cognitive leap, then Sino-American relations can proceed on the basis of shared interests rather than mutual fears.

Go read the whole thing. 

The New York Times runs two op-eds today on the future of the dollar's status as the world's reserve currency, particularly with regard to China. 

Victor Zhikai Gao's essay doesn't actually say a whole lot on the matter, except for this excerpt: 

Beijing recently called for a greater role in international trade for the special drawing rights currency of the International Monetary Fund. But China is also fully aware that the United States can veto an I.M.F. decision. China’s call was more meant to sound an alarm to the United States.

Many Chinese people increasingly fear the rapid erosion of the American dollar. The United States may want to consider offering inflation-protection measures for China’s existing investments in America, and offer additional security or collateral for its continued investments. America should also provide its largest creditor with greater transparency and information.

As Brad Setser points out, it's a bit rich for the Chinese to fret about U.S. inflation, since if the renminbi started appreciating, many of the macro imbalances currently plaguing the international monetary system might be lessened.  Of course, talking about "currency appreciation" puts the onus on Beijing, while talking about inflation conveniently puts the onus on the United States.  

The other op-ed is by Nouriel Roubini -- a.k.a., Dr. Doom.  It's a good primer on the benefits that accrue to the United States from having the dollar as the world's reserve currency.  That said, this part confused me: 

We have reaped significant financial benefits from having the dollar as the reserve currency. In particular, the strong market for the dollar allows Americans to borrow at better rates. We have thus been able to finance larger deficits for longer and at lower interest rates, as foreign demand has kept Treasury yields low. We have been able to issue debt in our own currency rather than a foreign one, thus shifting the losses of a fall in the value of the dollar to our creditors. Having commodities priced in dollars has also meant that a fall in the dollar’s value doesn’t lead to a rise in the price of imports (emphasis added).

The other parts of that paragraph make sense, but that last sentence mystifies me.  Wasn't part of the reason that oil and other commodity prices spiked last year was the declining value of the dollar? 

In general, both op-eds urge the U.S. to get its financial house in order.  I certainly don't disagree with that recommendation.  Still, it's a bit disingenuous to suggest that the U.S. is the only country at fault for the current overhang of dollar reserves.  Beijing needs to take a good hard look in the mirror on this issue. 

Apparently the foreign exchange markets got taken for a ride earlier today in response to Tim Geithner's chat at the Council on Foreign Relations.  This makes me wonder if anyone working in forex markets actually listened to the words that came out of Geithner's mouth. 

Here's Kathy Lien at FX360 explaining what Geithner said that caused markets to go into a tizzy: 

In a blink of an eye, the U.S. dollar has collapsed against the Euro, Japanese Yen and other major currencies. The trigger was comments from Tim Geithner who said that the U.S. is "quite open" to China's suggestion of moving towards a Special Drawing Right (SDR) linked currency system. If the world adopts the SDR, which was created by the IMF as an international reserve asset, it would mean that countries around the world would need to hold less U.S. dollars. (emphasis added)

Except that this is not what Geithner actually said.  To be more specific, he did say "quite open," but that's not all he said in his first response.  This is from the CFR transcript:   

[A]s I understand his proposal, it's a proposal designed to increase the use of the IMF's special drawing rights.  And we're actually quite open to that suggestion.  But you should think of it as rather evolutionary, building on the current architectures, than -- rather than -- rather than moving us to global monetary union.

Here was my contemporaneous read of what Geithner said: 

Geithner is asked about China (not my question) and the IMF's new proposals for expanded lending.  He responds by praising Zhou Xiaochuan, China's central bank governor, but claims that he hasn't read his proposal in detail.  Geithner makes it clear that he is quite open to expanding the IMF's Special Drawing Rights for less developed countries.  Still, he wants it to evolve and be integrated within the current international monetary system -- as opposed to the de novo creation of a new global currency. 

I've read the report (Tim, it's not that long, take a look!) and Zhou is not proposing anything so radical so soon, so this is a bit of a red herring.  Still, Geithner's statement here carries the same kind of firm pushback that Obama gave yesterday about any move ending the dollar as the global reserve currency. 

SDRs are intended for least developed countries, so expanding that program would not profoundly affect the distribution of currency reserves among the world's principal players.

And yet, after Geithner reaffirms this point later in the talk, Lien interprets it as follows:

A few minutes after saying the U.S. is open to an SDR linked currency, Geithner clarified his comments by saying that there is "no change in dollar as world's reserve currency and likely to remain so for long time." In our alert, we said that the dollar would rebound if he attempts to clarify his comments. These contradictory statements are clearly the act of an amateur Treasury Secretary that has been thrust onto the public forum and is struggling with the need to be very particular in his choice of words.

Okaaaaaay..... except there was no contradiction between his statements, and anyone who's been following this stuff for the past week should have understood Geithner's point the first time.

Question to readers:  shouldn't the forex markets have interpreted these statements better than your humble blogger?  What does this say about the wisdom of crowds? 

UPDATE:  The Financial Times' Krishna Guha, Tom Braithwaite and Peter Garnham provide more precise reporting on this point: 

The dollar fell 1.3 per cent against the euro as headlines saying “Geithner open to SDR currency” flashed across traders’ screens. With the currency falling, Mr Geithner’s interviewer – Roger Altman, a deputy Treasury secretary in the Clinton administration – gave Mr Geithner the chance to clarify.

The Treasury secretary said: “I think the dollar remains the world’s dominant reserve currency.” The dollar subsequently recovered much of its losses.

One fuzzy headline, and you get majoy gyrations in the forex markets. 

James Carville once said, "I want to come back as the bond market. You can intimidate everybody."  I want to be reincarnated as a headline editor. 

Your humble blogger is listening in to a Q&A with Treasury Secretary Timothy Geithner, courtesy of the Council on Foreign Relations, which has said, "Chatham House Rules be damned" and is allowing bloggers like me to prattle on.  This post will be updated through the next hour.  On to the show!!

9:15 AM:  We're also allowed to e-mail questions.  I resist the temptation to write, "Just how much do you want to gut-punch Paul Krugman?" and instead submit a question about China.  Let's see if it gets in the queue! 

9:20:  Roger Altman is moderating, and opens by noting that the Fed has provided an estimated $14 trillion in various of guarantees and injections of capital into the global financial system.  Gulp. 

9:22:  Geithner opens with a shout-out to his old staff at the New Yor Fed.  This is one reason why past staffers like him so much. 

9:23: Quotes former Mexican president Ernesto Zedillo:  "Markets overreact, so policy should overreact."  Says we've borowed too much, taken on too much risk, and ordinary Americans are now bearing the cost, which makes it fundamentally unfair.  American people are justifiably pissed (he did not use that word).  Notes that the absence of a serious recession over the past two decades created false expectations of continued prosperity. 

9:24-9:31:  Basically a reprise of his testimony from yesterday. 

9:31:  Now pushing for global coordination of standards at the G-20. 

9:32:  OK, let's get to the actual Q&A!!

9:37:  Altman asks about the future of the plan if Congress does not authorize any additional TARP funds.  Geithner tap-dances, basically says that they would need to muddle through. 

9:43:  Oh, sweet Jesus, Benjamin Barber is asking a question.  And Timothy Geithner just said he sounded like an economist!!!

Seriously, Barber asks a semi-decent question about whether the bank plan socializes losses and privatizes the benefits.  Why not nationalize? 

Geithner responds by saying that governments, in a time of crisis, have to be prepared to assume risks that private actors cannot absorb -- but still have o avoid assuming too much risk.  The complexity and scale of these financial institutions would force the government to assume way too much risk if nationalized. 

9:46:  A lawyer asks whether the Treasury has an estimate of the value of the toxic assets held by the ten largest financial institutions.  Geithner responds :  "If that was a knowable, high enough number, we wouldn't have a crisis."  Then says that they're relying on a range of public sector and private sector estimates.  States that the market value of these assets now is probably much less than they might be in a less panicked future. 

9:52:  Geithner is asked about China (not my question) and the IMF's new proposals for expanded lending.  He responds by praising Zhou Xiaochuan, China's central bank governor, but claims that he hasn't read his proposal in detail.  Geithner makes it clear that he is quite open to expanding the IMF's Special Drawing Rights for less developed countries.  Still, he wants it to evolve and be integrated within the current international monetary system -- as opposed to the de novo creation of a new global currency. 

I've read the report (Tim, it's not that long, take a look!) and Zhou is not proposing anything so radical so soon, so this is a bit of a red herring.  Still, Geithner's statement here carries the same kind of firm pushback that Obama gave yesterday about any move ending the dollar as the global reserve currency.   

Geithner follows up by saying that the future of the dollar in the international system is really a function of long-range U.S. fiscal policies.  Wants to keep U.S. debt-to-GDP ratio stable, and asserts that there is now a consensus in Washington about fiscal rectitude.  This is juuuust a little strange to hear given this year's fiscal balance sheet.

10:00:  Asked a question about what he expects from the G-20.  Boilerplate response, which is not encouraging.  Wonder if he's read the Czech PM's recent statements. 

10:08:  A good follow-up to the G-20 boilerplate, asked about the Scandanavian plan to rescue banks.  Geithner's response:  "We are not Sweden," though looking at the  Seems his chief concern is that there will be a premature withdrawal of rescue efforts

10:09:  Herb Levin asks the extent to which exchange rates play a role in these decisions.  Geithner:  "Is this a trick question?"  and laughs it off.  A little too much tap-dancing here.

10:10:  Asked if there is a limit to the Fed's balance sheet, and Treasury's ability to backstop that balance.  Geithner punts it to Bernanke, then references this joint Treasury/Fed statement. 

10:13:  Asked what headline he wants from the upcoming G-20 summit, and he replies something like "Broad, coordinated action across range of issues by G-20."  And this is why Geithner is not in the newspaper industry. 

10:14:  Last question.  Roger Altman asks Geithner "on behalf of the markets" to clarify his response to the PBoC plan on the future of the dollsar.  Says he continues to see the dollar as the world's reserve currency for both the short-term and the long-term.  Also stresses the need for macro-fundamentals to be strong enough to ensure that this continues to be the case. 

That's a wrap!

Chinese premier Wen Jiabao, in his annual press conference, fired a verbal shot across the bow of U.S. asset markets: 

Speaking at a news conference at the end of the Chinese parliament’s annual session, Mr. Wen said he was “worried” about China’s holdings of Treasury bonds and other debt, and that China was watching United States economic developments closely.

"President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures,” Mr. Wen said. “We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

He called on the United States to “maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

When a country that owns $1 trillion of your debt starts making these noises, it's time to fidget a little.

Or is it?  I'll have more to say about this later, but for now it's worth pointing out that China's financial leverage over the United States might not be as great as people think.  The Wall Street Journal's Andrew Peaple explains why:

Rhetoric aside, it bears repeating that China will find it hard to make a meaningful shift out of Treasurys, the prime current channel for investment of its $1.95 trillion foreign exchange reserves.

Some say China could switch holdings into gold -- but that market's highly volatile, and not large enough to absorb more than a small proportion of China's reserves. It's not clear, meanwhile, that euro, or yen-denominated debt is any safer, more liquid, or profitable than U.S. debt -- key criteria for China's leadership.

Most pertinent of all, even if China decided to sell off some of its U.S. Treasury holdings, it would scarcely be able to dump that in large blocks. And a partial selloff would surely lead to a slump in the Treasury market, eroding the remaining value of China's portfolio.

I'm listening via conference call to Federal Reserve Chairman Ben Bernanke deliver this speech to the Council on Foreign Relations. 

There will be Q&A afterwards, which I shall liveblog with updates to this post. 

UPDATE:  Looking at the speech, I'm seeing some eliding of the international dimension of policymaking (which is kind of odd, given that it's a speech at the Council on Foreign Relations).  Consider:

I also will not say much about the international dimensions of the issue but will take as self-evident that, in light of the global nature of financial institutions and markets, the reform of financial regulation and supervision should be coordinated internationally to the greatest extent possible.

and: 

[G]iven the global operations of many large and complex financial firms and the complex regulatory structures under which they operate, any new regime must be structured to work as seamlessly as possible with other domestic or foreign insolvency regimes that might apply to one or more parts of the consolidated organization.

Y'know, you can't just wish these things into being.

ANOTHER UPDATE:  Ah, I'm seeing the Fed requests for greater supervisory authority: 

Currently, the Federal Reserve relies on a patchwork of authorities, largely derived from our role as a banking supervisor, as well as on moral suasion to help ensure that critical payment and settlement systems have the necessary procedures and controls in place to manage their risks. By contrast, many major central banks around the world have an explicit statutory basis for their oversight of these systems. Given how important robust payment and settlement systems are to financial stability, a good case can be made for granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems.

And here on whether the Fed should be the institution to provide "macroprudential" supervision for systemic risk: 

As a practical matter... effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role. As the central bank of the United States, the Federal Reserve has long figured prominently in the government's responses to financial crises. Indeed, the Federal Reserve was established by the Congress in 1913 largely as a means of addressing the problem of recurring financial panics. The Federal Reserve plays such a key role in part because it serves as liquidity provider of last resort, a power that has proved critical in financial crises throughout history. In addition, the Federal Reserve has broad expertise derived from its wide range of activities, including its role as umbrella supervisor for bank and financial holding companies and its active monitoring of capital markets in support of its monetary policy and financial stability objectives.

ANOTHER UPDATE:  OK, now the Q&A!

Bernanke does not expect any "major disagreements" with either Treasury or the Obama administration on any proposed legislative reforms. 

He sees recovery beginning in 2010. 

He observes that between 1929 and 1931, the Great Depression was your garden-variety financial panic.  It was the collapse of Austria's Creditanstalt Bank in 1931 when things really went south.  Obviously, he'd like to avoid a replay of that trigger event. 

On proposed reforms of accounting rules:  "These things move slowly... there's a lot of more deliberation."  Wants to see more rapid movement at the global level. 

In response to a question about whether he's worried more about inflation or deflation:  "Mostly I'm worried about the overall economy." 

When asked about the international dimension, he gives a pretty vanilla response -- greater coordination between jurisdictions, etc.  He is skeptical of the G-20 producing a detailed coordination proposal (as opposed to providing overall guidance).  Bernanke praises the actions following up the October G-7 meeting by central banks at injecting liquidity into the system.   

His closing comment:  "economics is not music or math... it's useful only to the extent that it helps people.  Economics is not worth the effort unless it's applied in a way that helps people in the world." 

LAST UPDATE:  Here's a link to Jack Healy's write-up in the New York Times.