<blockquote>
'...After all these years, it is astounding that policymakers still believe there is a chance to inflate debt levels and grow out of global structural imbalances ... Inflationary effects are most pronounced in Asia. Yet most disdain the notion of new Bubbles and would certainly downplay the inflationary consequences of this unprecedented global debt monetization.
...
Such a scenario would seem to assure unwieldy global financial flows and Acute Monetary Disorder. For years now, it has been a dangerous case of using “Keynesian” policies to perpetuate Bubbles and attendant imbalances. Today, inflationism fuels Bubble dynamics on an unprecedented global scale. Policymakers can insist on referring to “global rebalancing,” but the reality is more in line with desperate and universal inflationism.
“Monetary policy is about an environment that’s supposed to be stable. When you try to use it in a way that floods the market with liquidity, you can in fact get very bad outcomes.” Kansas City Federal Reserve President Thomas Hoenig, October 21, 2010.'</blockquote>
Rebalancing the WorldBy Doug Noland
October 22, 2010
SourceThese are really strange times. Markets are still digesting Chairman Bernanke’s discussion of a new Fed “mandate” approach for targeting a higher inflation level. A heavily promoted “QE2” announcement arrives on November 3. It’s just the dimensions of the Q that has everyone unsure and uneasy. Atlanta Fed President Dennis Lockhart jumped into the fray this week with suggestions that $100bn monthly Treasury purchases might be on the table. His comments were soon followed by a report from an advisory service that had the Fed contemplating a $500bn purchase target over a six month period.
The markets were forced to calm down a little when a Financial Times article suggested the Fed may instead settle on a more incremental meeting-to-meeting approach. We’ll find out in 10 days or so. Either way, the Fed is determined to convince the marketplace that ultra-loose monetary policies are here to stay. Such an assurance does wonders for market risk perceptions.
Meanwhile, there’s the issue of intractable global imbalances - and yet another G20 meeting and comforting communiqué. Media focus today was on a letter presented by Treasury Secretary Timothy Geithner in which he recommended that member countries commit to specific caps on trade surpluses – more specifically not allowing current account surpluses in excess of 4% of gross domestic product. “G20 countries with persistent surpluses should undertake structural, fiscal and exchange rate policies to boost domestic sources of growth and support global demand.”
The response was less than enthusiastic. From the Wall Street Journal: “‘Japan’s traditional belief is that...while fiscal balances can be controlled through policy, trade as well as current-account balances can’t,’ a person familiar with the Japanese government’s thinking said.” German Finance Minister Rainer Bruederle rejected a “command economy” approach and “planned economy thinking.” At the same time, Geithner’s proposal was sufficiently toothless to garner little in the way of response from the Chinese.
U.S. authorities remain hopeful that global policy and currency adjustments will somehow work to rectify financial and economic imbalances. Having our trade partners stimulate domestic consumption, while allowing their currencies to appreciate, would go a long way, it is hoped, in shrinking our Current Account Deficits and stabilizing the global system. Such an approach was tried and failed with the Japanese in the eighties. Nonetheless, global rebalancing some years ago became the boilerplate solution for all that ails the U.S. and global economies.
Secretary Geithner apparently assured G20 finance ministers that the U.S. would work to reduce its fiscal deficits and act to support a strong dollar. From Brazilian Finance Minister Guido Mantega: “He guaranteed US policy is not to weaken the dollar, on the contrary, it is to strengthen the dollar. He said the impact of the Fed policy was being overestimated. It is difficult, if you weaken the dollar and want the Chinese to let the yuan appreciate.”
Well, for policies virtually guaranteed to devalue the dollar one would implement near-double-digit fiscal deficits, near-zero interest rates, and a strategy of open-ended monetization of Treasury debt. The G20 ministers clearly want to avoid confrontation and are presenting at least a semblance of a unified front for tackling deep structural issues. While they must think it, they don’t dare address the U.S. as an unmitigated policy “Basket Case.” Perhaps they even believe their policies can successfully rebalance the world. Or has “rebalance” simply become tantamount to “kicking the can.”
The U.S. has run Current Account Deficits almost exclusively going all the way back to 1983. Imports did sink during the early-nineties recession, leading to a single miniscule ($2.9bn) surplus in 1991. Yet by the end of the decade the Deficit had ballooned to a record $301bn. The full force of Bubble Economy Maladjustment, however, took hold beginning in the boom year 2000. The deficit jumped to $416bn in 2000 and, despite the tech wreck and recession, remained near $400bn annually during 2001-02. By 2003 the deficit had swelled to $520bn, then to $630bn and to $747bn by 2005. The Deficit reached a record $803bn in 2006.
And despite the bursting of the mortgage finance and housing Bubbles and the resulting worst recession in decades, the Current Account Deficit remained at $378bn last year. The deficit will likely jump to $500bn this year - an almost unimaginable scenario for an economy operating at almost 10% unemployment. History offers nothing remotely comparable to our decades of exchanging new financial claims for foreign-produced goods and services.
Having de-industrialized and failed to invest sufficiently in productive capacity during our prolonged Credit Bubble, there will be no near-term exporting our way out of trade deficits. And there is little evidence that help is on the way with the current elixir of massive non-productive government debt expansion and ultra-ultra-loose monetary policy. While extreme government stimulus has stabilized incomes, consumption and imports, it has done little to promote the type of productive investment necessary to rebalance our maladjusted economy.
Secretary Geithner sticks with his reference to a strong dollar policy. Meanwhile, the Federal Reserve is on course to further monetize our nation’s ballooning federal debt. Mr. Geithner wants foreign currencies to appreciate against the dollar, yet the overriding policy prescription is for more aggressive foreign stimulus to boost our trading partners’ domestic consumption. After all these years, it is astounding that policymakers still believe there is a chance to inflate debt levels and grow out of global structural imbalances.
The cumulative international reserve positions held by global central banks increased $1.5 TN the past year (to $8.951 TN). U.S. current account deficits and the massive flow of finance away from the U.S. has inundated the world with dollar balances – dollars that are then accumulated by foreign central banks and recycled chiefly back to our Treasury market (Bubble). I believe a strong case can be made that this dynamic helps explain global “liquidity” overabundance and the return of Bubble Dynamics throughout international risk markets. Inflationary effects are most pronounced in Asia. Yet most disdain the notion of new Bubbles and would certainly downplay the inflationary consequences of this unprecedented global debt monetization.
I have seen ample confirmation this year of my Global Government Finance Bubble thesis. And from my analytical framework, I would warn that the effects from another year of similar global monetization could prove quite different than what was previously experienced. If, as appears to be the case, Bubble Dynamics have become more deeply entrenched, one could expect heightened price instability throughout global markets. In this same vein, additional QE might end up throwing gas on an increasingly raging fire of destabilizing speculation.
Has faltering dollar confidence finally reached the proverbial “tipping point”? For the most part, the dollar enjoyed positive market sentiment throughout QE1 and the past year’s massive expansion of global central bank assets. Policy-related inflationary effects were somewhat muted, as global financial and economic systems were still restrained by post-crisis impairment. These restraints are dissipating – especially outside the U.S. Going forward, expect a continuation of inflationary policymaking to elicit increasingly robust global inflationary responses.
It’s difficult to discern “what’s in the markets” right now in regard to QE2. If the Fed doesn’t deliver a big headline number, there could be some near-term angst for the popular global “reflation trade”. But when the Fed actually implements large-scale Treasurys purchases – injecting liquidity into the marketplace - current market dynamics seem to dictate that this intervention will only exacerbate the torrent of flows exiting the U.S. in search of higher returns in “undollars” (“emerging” securities markets, gold, silver, metals, agriculture, commodities, foreign economies, etc.).
With Fed-induced liquidity racing out to play robust inflationary biases overseas, how much monetization will be necessary for the Bernanke Fed to inflate U.S. consumer prices to its desired level? And, with the G20 seemingly in agreement to press forward with more domestic stimulus, I’ll assume that global central banks have no option but to retain their steadfast backstop bid for the global surfeit of U.S. dollars. These dynamics would appear to ensure the ongoing monetization of enormous quantities of government debt.
Such a scenario would seem to assure unwieldy global financial flows and Acute Monetary Disorder. For years now, it has been a dangerous case of using “Keynesian” policies to perpetuate Bubbles and attendant imbalances. Today, inflationism fuels Bubble dynamics on an unprecedented global scale. Policymakers can insist on referring to “global rebalancing,” but the reality is more in line with desperate and universal inflationism.
“Monetary policy is about an environment that’s supposed to be stable. When you try to use it in a way that floods the market with liquidity, you can in fact get very bad outcomes.” Kansas City Federal Reserve President Thomas Hoenig, October 21, 2010.