Two Posts That Reveal The Long View
There are two very important posts that I just ran across that explain my long term concerns perfectly.
The first comes from Brad Setser. Here are the relevant points:
“Both private and official demand for US financial assets has collapsed. Gross inflows are close to zero.”
“The US government was — according to the latest US balance of payments data – a large net lender to the world. Yes, a net lender, not a net borrower. Foreign central banks are no longer providing the US with much new credit…And the US — through the Fed’s swap lines — provided a rather large sum of credit ($268 billion) to the rest of the world. For the year as a whole, the BEA data indicates the US government lent $534 billion to the rest of the world while foreign governments lent “only” $421 billion to the US.”
“How then can the US still run a large current account deficit if the rest of the world isn’t buying its financial assets? There is only one answer: Americans have pulled funds from the rest of the world (call it deleveraging, call it a reversal of the carry trade or call it a flight to safety) faster than foreigners have pulled funds from the US market. Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets.”
“Judging from the data on net flows, Bretton Woods II has in some sense come to an end. The world’s central banks are no longer building up reserves and thus are no longer a net source of financing to the US.”
What does this mean in layman’s terms? Well, it means that because the dollar was the standard currency, the entire world needs tons of dollars to respond to deleveraging, and Americans are pulling away from foreign assets…putting pressure on those currencies. The result is what’s we’ve seen, humongous sums of newly formed dollars are still not stopping deflation and have kept the dollar strong. However, the fact that so much funding is leaving foreign countries means that they are dangerously close to collapse, and it’s only the Fed that has lent hundreds of billions to various countries that has prevented a global calamity thus far. This is the primary reason why the Fed has been printing money out the wazoo.
Here is why I’m so worried about the future: our largest export has long been financial assets, and those exports have predictably collapsed. However, the unwinding process has given everyone a false sense of security about strength in the dollar and treasuries, leading to the massive spending and guarantee programs we’ve seen the past few months. At some point the process has to stop, because Americans will have pulled all they can out of foreign countries and foreign countries will be unable to put money back into us because they are too much of a mess. At that point the dollar will start falling quickly from all the printing, or else interest rates will explode if the Fed stops its “quantitative easing.” Furthermore, as the government is indirectly backstopping dozens of emerging and industrialized markets either through CDS or Fed swaps, when we are forced to stop the presses due to currency devaluation, those markets may collapse very quickly if they aren’t sufficiently deleveraged. Setser says: “For now, Dan Drezner doesn’t need to worry too much about the United States’ ability to be the world’s lender of last resort. A crisis may come when the US government cannot play a similar stabilizing role. But that crisis would be marked by a run out of the dollar — not a global scramble for dollars. The current crisis has constrained the United States’ ability to be the world’s importer of last resort, but not its ability to be the world’s lender of last resort. Not so long as the the world is scrambling to find dollars, the one currency the Fed can create. ” He fails to complete that thought to its logical endpoint: at some point the world has to stop scrambling for dollars faster than we need dollars to fund the deficit*. What then?
* By deficit I mean total deficit, as in all of the printing and guarantees and purchase of assets and direct spending. The people that I’ve read and respect suggest we can get away with $1-$2 trillion deficits a year if the money is being put to productive uses. The problem with the Democrats is that they are spending that much without accounting for all the other stuff, and the problem with the Republicans is that they are complaining about the direct spending while applauding the non-productive other stuff.
Which brings me to the second post, Report: China Suggests New Reserve Currency. “Normal” is gone for good, and we need to recognize that the world is no longer willing (or even able to) support our excessive consumption. The faster we use our resources to move to the “new economy” and setup safety nets for the transition instead of trying to repair broken dreams, the less damage will be done.