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Dollars, Yuans, and the coming chaos
August 1, 2003 11:08 AM   Subscribe

The Fed is in a dangerous game with China : Chen Zhao, chief emerging markets strategist at Bank Credit Analyst Research Group, has written an article for The Financial Times, postulating that the Central Banks of the US and China are engaging in a massive reflation. When the reflation ends, however, the US may be in a world of hurt. Meanwhile, some members of the Bush administration are calling for china to let the $/Yuan exchange rate float. A prominent expert, however, expects China to continue to peg its currency. Others discuss the ramifications of a floating currency. Read yet another collection of links at the Library of Economics and Liberty.

What should happen to exchange rates? What will happen?
posted by trharlan (24 comments total)

 
Umm... I have no idea what should happen to exchange rates. In other news, today is my last day of work!
posted by hammurderer at 11:30 AM on August 1, 2003


This thread sounds important, but I have no idea what it means. Inflation is bad right? But hasn't the Fed been saying that there is a risk of deflation?
posted by dirtylittlemonkey at 11:35 AM on August 1, 2003


From the little I know about it, it seems like the Fed would rather have inflation than deflation at least partially because it appears to be easier to control and doesn't quickly result in a vicious cycle.

Also, it sounds like the author thinks that the Fed is letting China buy up US Government debt, which will decrease in value as the Fed ratchets up inflation.

The problem with this scenario is that it presupposes that the Fed would be willing to gamble with the entire economy just to screw over the Chinese. Which I highly doubt. If only because if this plot ever was to become public the entire economy could be destabilized by massive investor panic.
posted by bshort at 11:51 AM on August 1, 2003


yeah, i appreciate the post as well, but i can't figure out much about what's going on. i guess i just don't have the background. i do think, however, we're in for a big consumer spending crash (though i've been expecting that for the past 15 years).

*starts stockpiling cans of dog food*
posted by mrgrimm at 11:55 AM on August 1, 2003


I don't understand currency trading worth a flip either, but for a while now I've worried that Joe Sixpack's only real value asset that hasn't gone down the tubes lately is...real. As in estate. As in his house. And if things got really crazy and we went into even a slight deflationary period, the housing market could be in for one hell of a serious correction when nobody could buy or sell a house all of a sudden.
posted by alumshubby at 12:03 PM on August 1, 2003


alumshubby: this would be particularly bad if the unemployment rate starts picking up. Then we'll be in a situation where more and more people are defaulting on their home loans (and loans in general) and losing their homes because of it.

Then, they'll be doubly screwed because if they try and sell some of their property in the hopes of raising cash they'll be selling into a down market. They'll be trying to dump homes, for which they paid a lot of money, and they'll end up having to sell for progressively lower prices.

This will all especially come to a head if the number of new housing starts goes into a tail spin. The price of building a home will start going down, but with significant portions of the country in significant debt, people will put off home purchases because prices will be seen to be dropping.

The other thing I would worry about, besides a rising number of loan defaults, is production advances in building technologies. If it gets cheaper to build a home, the desire for existing homes would plummet. Note that this could also apply to any other change in the desirability of existing homes/buildings/apartments. For instance if it was suddenly discovered that drywall made your hair turn green and fall out, or if people realized that "manufactured homes" != "mobile homes", etc.

At least that's one scenario. :-)
posted by bshort at 12:18 PM on August 1, 2003


This is something billmon over at Whiskey Bar needs to write an article about. He's really top notch at writing lay articles about finance.
posted by Cerebus at 12:38 PM on August 1, 2003


trharlan - You've done the next-to-impossible and left most Mefi-ites - myself included - scratching our heads, stroking our chins, steepling and mumbling "hmmm. Very interesting. A thought provking post [what the hell does it mean?]".

I liked this quote: "The root of the problem is the massive U.S. current account deficit, which reached a record $480 billion at the end of last year and is expected to continue to rise. One-half of it is now financed through short-term "hot money"

I was wondering about the various types of borrowing - federal borrowing at close to 5% of GNP, then there's state, local, personal debt and, of course, business debt. So what's the overall yearly floating debt load as a percent of GNP? - That's what I'm curious about.
posted by troutfishing at 1:18 PM on August 1, 2003


trout: I don't know what you mean by "floating debt load", but I think the answer to your question is here: The federal government...owes its public creditors about 3.5 trillion dollars... it must be compared to the total credit market... Businesses owe about 7 trillion dollars... state and local governments owe another 1.5 trillion dollars...mortgages total nearly 8 trillion dollars... consumer debt totals 1.6 trillion dollars. Thus, although the federal debt is large, it constitutes only 12 percent of the total debt owed by U.S. debtors.

Of course, most of that debt is owed to domestic borrowers, so we get thorny issues when Morgan Stanley owns my mortgage pool, my neighbor owns Morgan Stanley bonds, and my neighbor owes me money for cutting down a tree in his back yard. These figures aren't netted.

Anyway, by my math, 21.6 trillion in debt/10 trillion GDP=

Debt roughly equal to 2x GDP. I'm sure I could have made a mistake, though...
posted by trharlan at 2:16 PM on August 1, 2003


the housing market could be in for one hell of a serious correction when nobody could buy or sell a house all of a sudden.

Which is what idiot me has been trying to explain to our realtor for months. And then we bought a place anyway. Thanks for reminding me that I damn well better like the place because it's going to be 10 years before it's worth more than I paid for it. And never mind in real dollars.
posted by yerfatma at 3:33 PM on August 1, 2003


trharlan - thanks, I'm in your debt (hee hee). Meanwhile, "floating debt load" is just a random phrase coined in ignorance....

2XGDP. Whoah.......
posted by troutfishing at 3:38 PM on August 1, 2003


trout, I don't think for the most part that 2x is too much or unsustainable since a lot of it was/is used for capital investment. Paying off a house over 15 or 30 years, say, is not a big problem because the useful life of most housing (given maintenance) is much longer than that.

Though OTOH I think the current account deficit (and the extremely large FY2003 & 2004 federal deficits) is less desirable because that spending usually finances current spending or indicates an imbalance in relative output (i.e., why does China have so many dollars to spend on our bonds?). This is what people are pointing to when they write about putting out grandchildren into debt.

Then again, I have no (nor will I have) children, much less grandchildren, so big whoop.
posted by billsaysthis at 4:05 PM on August 1, 2003


So would I be correct in saying that, in the medium term, some heavy financial shit is going to go down, and that it would be prudent to wait a while before making a large investment in say, a house?
posted by inpHilltr8r at 4:56 PM on August 1, 2003


billsaysthis - I really don't have any credentials (or enough basic understanding) to get into the "is X amount of debt relative to GNP sustainable" - I was just gaping at the size of the figure - but one thing I do know is that 25% of that debt lies in the US' balance of trade deficit, which is up to about 500 billion per year.

Now, some of this represents good or services which get reinvested in improving productive capacity, sure. But how can the US continue to borrow from the rest of the world at this rate? It simply seems weird to me. I remember the onset of the balance of trade deficit - sometime in the late sixties or early seventies, I think, and I can recall feeling that 20 billion (a year) was a huge deficit. In retrospect, it wasn't. but I don't think I could have imagined that it would simply keep increasing, year after year, to current levels.
posted by troutfishing at 5:11 PM on August 1, 2003


inpHilltr8r - I doubt anyone is going to advise you on that one.....but many analysts have pointed to a housing bubble. Housing has already softened at the high end - will the cheaper housing market also decline? I honestly don't know, but I do know that the very rich - with their extremely well connected fingers to the wind - like to ride out turbulent spots and then buy on the cheap.
posted by troutfishing at 5:17 PM on August 1, 2003


but many analysts have pointed to a housing bubble

Both my accountant, and my step-mom-in-law, who used to work in real estate, have commented that our local housing market is very cyclical, and that the downturn on this one is overdue. It's academic at the moment, for various reasons, but I'm hoping to be pleasantly surprised in about 15 months time.
posted by inpHilltr8r at 6:15 PM on August 1, 2003


Debt roughly equal to 2x GDP. I'm sure I could have made a mistake, though...

You have. It's actually far worse when you take into account institutional debt like Fannie Mae and Freddie Mac(a couple trillion), consumer and corporate debt (God only knows...). Some people estimate that the total debt for the country, including GSE's and personal debt (but not Social Security or Medicare), is around $35 trillion. Fannie Mae and Freddie Mac aren't counted in the debt calculations, but they should be, since a default would almost certainly necessitate government intervention.

wait a while before making a large investment in say, a house
Yes, by all means. People are treating their homes like ATM machines with all the refinancing going on, keeping the prices artificially high. As long as the labor market continues to do so shitilly, eventually people are going to start defaulting big time, prices will drop as everyone tries dumping their investments before they hit rock bottom, while buyers do nothing but wait and see how far things get. If you can, I'd wait another year or two until Bush's economic disaster really takes hold and people start panicking. Until then, invest in something like the European Bond market, which still has a ways more to go up.

Of course, I've been saying this for some time now, and if anyone had listened to me, they could be pretty well off right now. But nooo....
posted by Civil_Disobedient at 7:14 PM on August 1, 2003


Civil_Disobedient's advice echoes Baron de Rothschild's:

"Buy when blood is running in the streets."
posted by alumshubby at 11:38 PM on August 1, 2003


What should happen to exchange rates? What will happen?

I don't know, but my life savings are in Korean won, so I'm darn curious.
posted by stavrosthewonderchicken at 11:55 PM on August 1, 2003


Civil Disobedient: It's actually far worse when you take into account institutional debt like Fannie Mae and Freddie Mac(a couple trillion), consumer and corporate debt (God only knows...)

Reread my post. My numbers (from Hoover) include consumer and corporate debt. The text that I linked also says "mortgages total nearly 8 trillion dollars". I added that to my figure.

I do not know if that debt gets double counted, since the majority of it either: 1) sits on the books of Fred and Fan, or 2)is securitized in a mortgage pool or a CMO. I mean, we shouldn't really count it twice. When FNMA issues a mortgage pool, the "debt" isn't really theirs-- they just write a binary credit option on someone else's debt...
posted by trharlan at 9:09 AM on August 2, 2003


I have never understood currency trading and monetary policy. Does anyone know of any good books on how money works? I tried Grieder's Secrets of the Temple, about the FOMC, but found it not very informative about the technical stuff and sort of dated.

MMulligan still out there?
posted by Mid at 9:32 AM on August 2, 2003


prehaps brad delong can help shed some light on the issue?
posted by specialk420 at 9:58 AM on August 2, 2003


trharlan - Sorry, I missed that you'd included it. I know a lot of people disagree with the debt figure, and I'd really love to hear what Paul Krugman thinks the number is, but I didn't notice anything in his archive. The Office of Federal Housing Enterprise Oversight, which oversees FMae and FMac, did a report recently examining their debt. They have three forms of obligations: the bonds (debt) that they issued, the MBS which they guarantee (a kind of repackaging and reselling for a fixed return), and the derivatives that they bought.

To quote the OFHEO Report on Systemic Risk: "The total of housing-related high-risk obligations is roughly $5.69 trillion," and "by the end of 2002, households in America had an estimated $6.04 trillion in home mortgages. The $5.69 trillion in risky obligations are based on home mortgages, but they are independent instruments that are distinct from, and in addition to, the $6.04 trillion in home mortgages."

Which gives you a total of $11.73 trillion in housing-related paper, both primary and secondary. Then you've got federal debt, plus commercial debt, plus credit-card debt -- I think my $35 trillion number may be closer than you thought. Regardless, the point is, we're running on huge amounts of credit right now, even more than Argentina had before its crash. The only reason we haven't crashed is because investors actually believe we'll be able to get our house in order. If they start to think we don't give a shit, and Bush is really not helping matters here, we're going to start having real problems.
posted by Civil_Disobedient at 11:43 AM on August 2, 2003


"This is something billmon over at Whiskey Bar needs to write an article about. He's really top notch at writing lay articles about finance."

He already did, but I am not too sure about the 'top notch' part (critique).
posted by MzB at 3:12 PM on August 2, 2003


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