Friday, May 25, 2012

Possible Chinese financial crisis

An excellent article that explains in plain terms how the system has been working is Why China’s RMB exodus IS the story.

My interpretation is China could experience the same capital flight that triggered the 1997 Asian financial crisis.

"The problem the PBoC now has, however, is that its stock of yuan bills is growing quicker than its stock of US Treasuries. This has consequences for its ability to control the yuan-dollar peg.  If the situation worsens, and the dollar shortage gets more extreme, there will come a point where Chinese dollar liabilities will be stretched to the limit, and potentially defaulted upon."

That means the dollars the PBOC owes to domestic entities that traded the dollars they got from exports to the US into yuan they could use in China.

"What happens if foreigners decide the last thing they want is yuan exposure (due to China economic bubble fears), and would much prefer to keep hold of their US dollars? What happens if instead of a dollar inflow you get a mass capital outflow from China, with as many Chinese as possible converting yuan-denominated assets into dollars?"

If China chose to sell some of its Treasury holdings to meet the demand for dollars, that would be a problem for the US.


Cash Exiting China

"Domestic money in China will be the first to head for the exit - insiders will always know more than outsiders about the underlying economic conditions.  So the exodus of cash could indicate that the Chinese story is coming to a close - and that will have significant consequences for the global economy."

Monday, May 21, 2012

Germany's Eurozone bad debt illustrated

From Mish, a very plain illustration of  what the Eurozone situation is:  Germany is owed massive amounts by the rest of the countries.  We know that a sizeable proportion of the "assets" are worth a fraction of their face value.  The only way to get the trend lines to converge is haircuts on Germany's claims.  Of course, to propose this would be political poison for German leaders. 

Thursday, May 10, 2012

Foreign holdings of Treasury debt

The chart is based on the latest data from the Treasury:

Notably, Japan's amount continues to rise while China's amount is flat; and there was a large drop for the UK.

Monday, May 07, 2012

Fed policy benefits wealthy

From Tim Duy:

Bernanke's Shift

"There has been a fierce counterattack to Federal Reserve Chairman Ben Bernanke's assertion that he is indeed the same Professor Bernanke that advised the Bank of Japan a decade ago. DeLong identifies this 1999 Bernanke quote:
[Si]nce 1991 inflation has exceeded 1% only twice... the slow or even negative rate of price increase points strongly to a diagnosis of aggregate demand deficiency…. [C]ountries that currently target inflation… have tended to set their goals for inflation in the 2-3% range, with the floor of the range as important a constraint as the ceiling….
and concludes that Bernanke previously believed the inflation target should be between 2 and 3 percent, with 2 percent being a floor.  One could infer, then, that Bernake at one point believed in a symmetric objective around 2.5 percent, with a hard floor and ceiling on 50bp of either side of that objective.  Now the Fed has sanctified a 2 percent target.

I think we can conclude, by Bernanke's statement's in the past and the actual path of inflation now, that Bernanke has embraced the recession as yet another exercise in opportunistic disinflation in which the Fed can knock another 40bp off the expected rate of inflation.

Monetary policy is not neutral with regards to the distribution of income and wealth.  The Fed does not want inflation to exceed the 2 percent inflation target as that will result in a new distribution.  The subsequent alterations to the outcomes will not be symmetric; some will gain more than 2.5 percent, some will lose more.  

Note - and I think this is important - when Bernanke's Fed took the opportunity to shift down the path of inflation by sanctifying the 2 percent target, they were comfortable with the subsequent shift in the distribution of outcomes.  And consider that shift.  At a time when households were overwhelmed with excessive debt, the Fed deliberately chose to increase the real burden of the debt by changing the inflation trajectory.

Why one would use a balance sheet recession to shift downward the path of prices is certainly something of a mystery.  But it does imply that the Fed wanted to induce a new distribution of outcomes, even knowing that the beneficiaries would not be households. The Fed must also know that the by reducing the path of inflation they have knowing altered the distribution of outcomes in a way that is likely to slow the pace of recovery.

To summarize, the Fed has shifted monetary policy to favor those who hold large amounts of financial assets; and claims it hasn't done so.


Friday, May 04, 2012

Fiscal policy logjam at the end of 2012

Here's an informal list of items that will require the post election lame duck Congress to act to prevent expiration at year-end; with major economic consequences:

-Bush/Obama tax cuts expire - without reapproval this will be a significant increase in taxation
-Defense budget cuts automatically occur starting in 2013 unless Congress takes action to repeal
-Expiration of moratorium on taxability of discharged mortgage debt
-End of unlimited support for the GSE losses on mortgage defaults
-FDIC unlimited deposit insurance for transaction accounts ends 12-31-12 UPDATE

"through December 31, 2012, all noninterest-bearing transaction accounts are fully insured, regardless of the balance of the account, at all FDIC-insured institutions. The unlimited insurance coverage is available to all depositors, including consumers, businesses, and government entities. This unlimited insurance coverage is separate from, and in addition to, the insurance coverage provided to a depositor’s other deposit accounts held at an FDIC-insured institution."

Maybe the FDIC is waiting for this to expire before getting more agressive on the receiverships.