One of the lasting effects of the 2008 financial crisis was the belief that the distribution of economic power had radically shifted. China rising, West fading, yadda, yadda, yadda. A minor key in this argument has been the notion that a new and important measure of economic power is the size of a country's official reserves. This has led to the occasional panicked article that "China is buying gold!!" or "Russia is hoarding gold!!" or "Germany is moving gold!!" as a first step towards pushing the dollar out as the world's reserve currency.
Which is just so much horses**t.
Here are three facts to remember whenever you read any story about a BRIC economy hoarding gold:
1) Buying gold would have been extremely savvy in 2008. Now it's just silly. The price of gold peaked at over $1900 in September 2011 -- and despite massive amounts of quantitative easing and numerous reports about central bank hoarding, it's fallen by $300 since and trending downward.
2) The BRIC economies did not have a lot of gold to begin with. As Bloomberg notes, "Russia’s total cache of about 958 tons is only the eighth largest [in the world]."
1. The United States (8,134 tons)
2. Germany (3,391 tons)
3. The International Monetary Fund (2,814 tons)
4. Italy (2,451 tons)
5. France (2,435 tons)
So, to sum up: To believe that gold holdings really matter in the global political economy, you have to be willing to assert that Italy is a great power in global finance. I, for one, am not going there.
Let's face it, Americans do not understand the current state of either macroeconomic policy or foreign policy terribly well. According to Bloomberg, only six percent of Americans know that the federal budget deficit is actually shrinking. According to Gallup, just a bare majority of Americans believe that the United States military remains "number one in the world militarily." In a world of these kind of epic media fails, where significant numbers of GOP legislators seem "more concerned about 2% inflation than 8% employment," it's important to to have recognized experts try to clear the air.
Nobel Prize-winning economist and unusually-pithy-writer-for-an-economist Robert Solow has an op-ed in today's New York Times to offer a primer on the implications of U.S. debt. Here, in brief, are the "six facts about the debt that many Americans may not be aware of," in Solow's words. Let me number them here:
1) Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations....
2) The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros)...
3) One way to effectively repudiate our debt is to encourage inflation...
4) Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future....
5) The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.
6) But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market. On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings. When employment returns to normal, we can return to debt reduction.
Some foreign pollicy experts think that Solow is being too sunny. Take Council on Foreign Relations president Richard Haass:
With respect, I think Solow is actually being too pesssimistic, and Haass is being way too pessimistic.
The problem is that, contra Solow, I suspect Americans are keenly aware of his points 1-5. The United States owes a lot of money to China, but I'd wager that any poll of U.S. citizens would reveal that the public thinks we owe even more to China than we actually do. Similarly, much of the policy rhetoric coming from Washington focuses on fears of incipient inflation that have yet to pan out.
It's Solow's last point that is the one Americans need to hear more: in an era of slack demand, bulging coporate cash coffers, and recovering personal savings rates, it's actually pretty stupid to have U.S. government spending and employment contract so quickly. I fear, however, that excessive concern about Solow's first, third, fourth and fifth points will swamp out the rest of his op-ed.
As for Haass, I'm not exactly sure what "rising rates" he's talking about, as just about any chart you can throw up shows historically low borrowing rates for the United States government. Indeed, the U.S. Treasury is exploiting this fact by locking in U.S. long-term debt at these rates. As for foreign governments pressuring the United States, the fear of foreign financial statecraft has been somewhat hyped by the foreign policy community. And by "somewhat hyped," I mean "wildly, massively overblown."
The bias in foreign policy circles and DC punditry is to bemoan staggering levels of U.S. debt. This bias does percolate down into the perceptions of ordinary Americans, which leads to wild misperceptions about the actual state of the U.S. economy and U.S. economic power. I'd like to see a lot more op-eds by Solow et al. that puncture these myths more effectively.
Am I missing anything?
About six months ago, when the world's major central banks all started pursuing aggressive strategies of quantitative easing, I blogged that, "the international bitching and moaning about QE3 seems much less than the 'currency war' rhetoric that QE2 triggered."
With Japan's decision to unleash the monetary taps, the "currency war" meme has cropped up again, but in an odd way. To be honest, I'm reading a lot more essays that smack down the "currency war" claim than are making it. For recent and salient smackdowns, see Felix Salmon, Mario Draghi, Gavyn Davies, Philipp Hildebrand, Matthew Yglesias, and Paola Subacchi.
So this raises an awkward question -- who is claiming that there's a currency war and why? Is there a lobby that's agitating for an end to certain policies and using the guise of a "currency war" to try to make it happen? Who are these shadowy groups?
As near as I can determine, there are three interest groups with the motivated interest in doing this:
1) The Bundesbank. One can think of the eurozone crisis as one long, inexorable weakening of the Bundesbank's grip on European monetary policy. Bundesbank president Jens Weidemann set off the latest round of currency war puffery in a speech in which he bemoaned the "increased politicisation of exchange rates" and warned that central bank indepenence was eroding. Now I'm not a German-speaker, but it's possible that when Weidemann says central bank independence is "eroding" he means, "I don't have a veto over eurozone monetary policy like I used to and Draghi won't return my calls."
2) The bond funds. Bondholders aren't big fans of inflating currencies, which is the designed effect of this collective round of quantitative easing. Or, to put it more pithily, it's not a currency war unless someone at PIMCO is hyping it!! In this case, Mohammed El-Erian:
[T]here is a lot of scholarship demonstrating why such beggar-thy-neighbor approaches result in bad collective outcomes. Indeed, multilateral agreements are in place to minimize this risk, including at the International Monetary Fund and the World Trade Organization.
Yet, when push comes to shove, country after country is being dragged into abetting a potentially harmful outcome for the global economy as a whole. Worse, this process has not yet registered seriously on the multilateral policy agenda.
El-Erian needs to read the Financial Times a bit more often. The problem isn't that this isn't on the "multilateral policy agenda" -- it's that these global governance structures are less stressed about it than El-Erian:
The world’s largest developed nations reaffirmed their commitment not to target exchange rates in a statement on Tuesday aimed at addressing concerns over a fresh round of global currency wars.
In a move widely seen as an attempt to defuse tensions over recent rapid moves in the currency market, the Group of Seven countries -- comprising the US, the UK, France, Germany, Italy, Canada, and Japan -- said they would “consult closely” on any action in foreign exchange markets.
"We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates,” the ministers and governors said.
This doesn't sound like the G-7 is all that troubled -- or, to put it more bluntly, not as troubled as El-Erian wants them to be.
3) The developing world. While the G-7 seems pretty copacetic with the combined quantitative easing, the G-20 is another matter.
The words “currency wars” are too blunt for a G20 communique, but that is what the world’s finance ministers will talk about when they meet in Moscow this week.
A new round of monetary easing in advanced economies is pushing down their currencies and prompting howls of protest from the developing world.
Indeed, the most cogent critiques of the developed world's combined QE strategy comes from officials and op-ed writers focused on the less developed world. And to be sure, the combined effect of developed country actions on the monetary front can create some policy problems in the developing world.
Again, though, what's striking isn't the vocal complaints about currency wars in 2013 but the relative absence of them compared to, say, the fall of 2010 after QE2. Which suggests that while there might be some mild grumbling among the advanced developing countries, they prefer the status quo to policies that cause the OECD economies to contract in size.
So, to sum up: when you read about someone voicing "grave concern" about currency wars, see if they are based in A) an export-dependent developing economy; B) a bond fund; or C) the German central bank. If they are, you can safely tune them out. It's when people outside those places start carping that I'll start getting concerned about a currency war.
Am I missing anything?
The Wall Street Journal has two great stories on the Federal Reserve's decision to go for QE3 -- a third round of quantitative easing. First, Jon Hilsenrath documents how Fed chairman Benjamin Bernanke built a consensus among the Federal Reserve governors:
For weeks, Mr. Bernanke made dozens of private calls on days, nights and weekends, trying to build broad support for an unusual bond-buying program he wanted approved during the Fed's September meeting, according to people familiar with the matter....
Fed officials described the Fed chairman's phone calls as low-pressure conversations. Mr. Bernanke sometimes dialed up colleagues while in his office on weekends, catching them off guard when their phones identified his private number as unknown. He gave updates on the latest staff forecasts, colleagues said. He asked their thoughts and what they could comfortably support, they said.
The calls helped Mr. Bernanke gauge how far he could push his committee. It also won him trust among some of his fiercest opponents, officials said. Nearly all of Mr. Bernanke's colleagues described him as a good listener.
"Even if you disagree with him on the programs, you know your voice has been heard," said [Dallas Fed President Richard] Fisher, one of his opponents. "There is no effort to bully."
So Bernanke did a lot of hand-holding, a lot of listening... to the key Fed decision-makers. What's equally important is who he didn't talk to -- namely, other central bank heads in the rest of the world.
I bring this up because some of these central bank officials are pretty pissed. QE3 has caused the yuan to hit its all-time high against the dollar, for example. Which leads us to the other interesting Wall Street Journal story. Aaron Back and In-Soo Nam document how South Korea and China have reacted to QE3:
Chinese and South Korean central-bank officials criticized the U.S. Federal Reserve's latest easing efforts and advocated reducing Asia's dependence on the U.S. dollar.
The comments Thursday, at a joint seminar in Beijing by the two central banks, are the clearest indication yet of a rising backlash in Asia against U.S. monetary policy, suggesting it could speed up the search for alternatives to the dollar as the main global currency.
"The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices," said Bank of Korea Gov. Kim Choong-soo. "Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations."
Chen Yulu, an academic adviser to the People's Bank of China, said Asia needs a "regional core currency" to reduce its dependence on the dollar. China's ultimate goal is for the yuan to be as important as the euro or the dollar, he said.
Whoa, this sounds pretty bad... until you get to the next paragraph:
But [Chen] acknowledged that will be a slow process, saying it would be possible for the yuan to be fully convertible by 2020, and that the overall yuan-internationalization process may last until 2040. China strictly controls its currency, though it has made small moves to broaden its use globally in recent years and has also allowed a little more flexibility in its movements (emphasis added).
Furthermore, it's worth noting that the international bitching and moaning about QE3 seems much less than the "currency war" rhetoric that QE2 triggered. Why? Based on my half-assed blog analysis I'd speculate that there are three reasons:
1) The global economy is in a more sluggish state in 2012 than in 2010, so it's hard to argue that expansionary monetary policy is inappropriate now.
2) The United States was not the only major economy to go the quantitative easing route in the past few months. Both the European Central Bank and the Bank of Japan have made similar -- if uncoordinated -- moves.
3) The central bank heads have learned frrom QE2 that the bitching and moaning won't accomplish anything. It didn't stop QE2 and it won't stop QE3.
Am I missing anything?
If one myth has been slain by the financial crisis and the response to it, it's the idea that central banks ought to be independent and unaccountable politically.
The idea of central bank independence was that it would guarantee good monetary policy. During the Great Moderation it certainly seemed that way. But now it's no longer the case...
[The] point is that the choice between inflation and unemployment is a political, not a technical choice. What's "better"? To screw debtors or creditors? To make millions unemployed or to "debase the currency"? Those are very important questions. More important, they're questions that cannot be solved by economics. They can be informed by them, but at the end of the day what you prefer is going to come down to your own moral value system. In other words, it's a political choice. And the way we make political choices in modern countries is through the democratic process, not through unelected, unaccountable technocrats....
The bottom line is that the argument of supercompetence of central bankers is dead and once that's gone you need to revert those powers back to the political process (emphasis in original).
Now, this is a pretty powerful argument. One would be hard-pressed to say that Jean-Claude Trichet or Alan Greenspan or Ben Bernanke have covered themselves in glory during the past five years or so. Why not return central banking to the politicians?
Well.... before I answer, I want to object to Gobry's framing of the issue in two ways. First, he sets up a too-simple dichotomy between "independence" and "political control." The devil is in the details here. Political scientists have done a lot of research into how legislatures exert influence over supposedly "independent" institutions like courts and regulatory agencies, and this logic applies to central banks as well. Or, to put it another way, I suspect that Ben Bernanke would be pumping more money into the economy were it not for a fear of Congressional blowback. Furthermore, "political control" is unclear here -- which politicians have control? Would central bankers be directly elected? Appointed by the legislature? Appointed by the executive subject to recall? And so forth.
Second, the notion that central banking decisions are strictly political seems as wrong as characterizing them as strictly technical. It is overly cynical to believe that either technocrats or politicians gin up any old theory to justify the policy ends they seek. As with Supreme Court disputes, there are genuine disagreements in economics on the theory side. At this very moment, different central bankers disagree over the best way to reduce unemployment in part because of different economic theories. Expertise is kinda important in these moments.
OK, these contestations aside, I still have a basic problem with Gobry's argument. For Gobry's process to work better, voters have to punish politicians for poor monetary policy and reward them for wise and prudent monetary policies. I see little evidence that voters would have the necessary knowledge and attention span to do this. Instead, they would likely vote on other considerations, or vote based on short-term considerations such as the unemployment rate and GDP growth without considering whether short-term pump-priming is occurring or long-term sustainable growth. Furthermore, politicians would rig the game just a bit. Political scientists have extensively discussed the existence of "political business cycles" due to fiscal policy. I have every confidence that political control over monetary policy would simply extend the phenomenon to that policy lever as well.
The fact that politicians still control the fiscal lever is what leads me to think that central banking should still be independent. A diversification of political controls over the economy seems like the best minimax strategy over the long run. Thinking back to how U.S. politicians would have handled the last 20 years of central banking, I suspect that they simply would have exacerbated the boom-bust dot-com and housing bubbles. It's not clear at all that the added democratic gain outweighs the loss in policy competence.
That said, Gobry makes a powerful argument, and I'd like to hear from readers. Has independent central banking jumped the shark? What do you think?
In my experience, pundits tend to be risk-averse in calling out a very rich person on their economic or financial analyses. There's a couple of intuitive logics at work here:
1) Most pundits don't know much about economics, and so are leery of entering those waters;
2) The really rich person likely became really rich because they demonstrated a shrewd understanding of the markets -- therefore, who is the low-six-figure-or-less-earning pundit to challenge such high-yielding wisdom;
3) Most pundits refuse to admit that they don't understand something that reads like gobbledgook, because they're afraid this makes them look like an idiot.
Well, your humble blogger has never been afraid of looking like an idiot... which brings me to PIMCO's Bill Gross. I'll occasionally read his monthly newsletter when a link to it pops up in my Twitter feed. Every time, I'm amazed at the florid, rambling, not-really-related-to-his-main-point way he opens these little essays. Sometimes I find the analysis afterwards useful, sometimes I find it eerily similar to what someone says after spending too much time with Tom Friedman. I gather he's had better years as an analyst than he did in 2011, but everyone has down years and bad predictions.
Here's the thing, though -- I can't understand a word of his latest Financial Times column: Here's how it opens:
Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st century – Hyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.
Things get a little clearer towards the end of the op-ed... but not much. His February 2012 newsletter appears to be an expanded version of this op-ed (plus the usual wacky opening), so let's go there to see what he's trying to say:
[W]hen rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street.
What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.”
Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit (emplases in original).
And... sorry, I still don't get it. I get why zero interest rates are bad for bondholders like PIMCO. I get that flat yield curves + high amounts of economic uncertainty = cash hoarding. What I don't get is that:
A) Gross himself acknowledges that the yield curve ain't flat;
B) Low interest rates allow for private-sector deleveraging, which is a prelude to stimulating market demand;
C) Low interest rates prevent today's government binge from being even more expensive than it would be in normal times (by keeping financing costs down);
D) If uncertainty is decreasing -- and that appears to be the case with the U.S. economy -- then low interest rates should spur greater entrepreneurial investments.
So, at the risk of threatening my status in the International Brotherhood of Serious Global Political Econmy Bloggers That Talk Seriously About Economics, I hereby ask my commenters to explain Bill Gross' concerns to me. Because I don't get it -- and I'm beginning to wonder if I'm not the only one.
The unholy trinity in open economy macroeconomics is pretty simple. It's impossible for a country to do the following three things at the same time:
1) Maintain a fixed exchange rate
2) Maintain an open capital market
3) Run an independent monetary policy
One of the issues with macroeconomic policy coordination right now is that different countries have chosen different options to sacrifice. China, for example, has never opened its capital account. The United States, in pursuing quantitative easing, has basically chucked fixed exchange rates under the bus, no matter how many times Tim Geithner utters the "strong dollar" mantra
in his sleep to reporters.
These policies are generating a fair amount of blowback from the rest of the world, forcing President Barack Obama to defend the Fed's actions. And it appears that the developing countries are mostly following China's path towards regulating their capital account to prevent exchange rate appreciation and the inward rush of hot money.
How does this end? I think it's gonna end with a lot more capital controls for a few reasons:
1) It's the political path of least resistance;
2) Capital controls are seen as strengthening the state;
3) The high-growth areas of the world don't need a lot of capital inflows to fuel their continued growth.
What intrigues me is how the financial sector responds to a situation in which their freedom of action in emerging markets becomes more and more constrained. It's possible that they could pressure the Fed to change its position in the future. It's also possible, however, that big firms could see these controls as a useful barrier to entry for new firms.
My money is on the former response, however.
I see I wasn't the only one to muse about the effect of the midterm elections on American foreign policy. See Bruce Stokes, Richard Haass, James Lindsay, Daniel Larison at various other parts of the interwebs, as well as FP's own Phil Levy, Marc Lynch, Peter Feaver, and Steve Walt.
Reading all of this accumulated wisdom doesn't change my mind all that much. For example, I don't disagree that a more conservative Congress will be even more obstreperous in blocking Obama's foreign affairs appointees than it was previously. To be sure, this has a profound effect on individual lives and careers -- but it doesn't really matter all that much in the grand scheme of things. The cumulative effect might be problematic, in that a more obstructionist Congress might lead to some policymakers staying in office for a longer-than-optimal period of time.
On the other hand, I find the notion that a resurgent GOP will contribute to a more adventuresome foreign policy in the Middle East to be pretty absurd. First, to repeat, the administration holds almost all of the policy levers. Sure, Congress can sanction Iran -- again -- but it's not like that's going to change anything.
In his post, Lynch implies that Congress can browbeat Obama into supporting regime change in an echo of the Iraq Liberation Act. I'd point out that it's not 1998 anymore -- Obama is unlikely to fall for the same trap that befell Clinton. Oh, and by the way, the American public is really sick of the current wars, ain't looking for a new one, and clearly wants Washington to focus on the economy and job creation. Republicans know that they didn't get elected because of their foreign policy views. If they start making noise about Iran, I'd imagine the administration lambasting them for taking their eye off the economy.
No, the more I think about it, there is one obvious effect and one longer-term effect that the midterm swing will have on American foreign policy.
The obvious effect is that gridlock will make it that much more difficult for Washington to get a grip on long-term policy problems like debt reduction and global warming. There's no way that any climate change legislation will get through, and I'm pessimistic that the deficit commission will trigger a grand bargain on getting America's financial house in order. None of this will matter much over the next two years, but it will start to matter more over the next two decades.
The more subtle, pernicious effect is that paralysis in the elected branches will lead to more populist outrage at the unelected portions of the U.S. government. Consider, for example, the Fed's decision yesterday to engage in $600 billion more of quantitative easing (translated into plain English here). In today's Washington Post op-ed explaining this action, Ben Bernanke had an interesting comment in his closing section:
The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector.
He's right, but think about this for a second. If Congress and the administration can't agree on anything, then the only public actors capable of taking concrete action on the economy are the central bank and the regulators. These institutions are already ridiculously unpopular. Being forced to take imperfect actions because of elected branch paralysis won't help matters (compared to fiscal and tax policies, there's only so much that quantitative easing can do to stimulate the economy). If you think hostility to elected elites is high, wait until the focus switches to unelected elites.
Note that all of this is contingent on the economy continuing to stink. Robust economic growth will ease populist anger, which will blunt some of the effects I just discussed.
So, in the short term, I still don't think U.S. foreign policy will change all that much. The long-term effects of gridlock combined with a persistently sour economy, however, could be very worrisome.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.