Brad Setser claims to be surprised at this statement from a Merrill Lynch analyst:
“The failure of TARP legislation worsens the short-term credit situation. But in so doing it increases the likelihood of a Swedish-style recapitalisation of the banking sector in the U.S,’ says Merrill Lynch emerging equities strategist Michael Hartnett. The Swedish government in Sept 1992 decided to guarantee the whole banking system and transfer bad debt to state ownership. ‘This chemotherapeutic event marked the beginning of a multi-year bull market in Swedish equities,’ Hartnett says.”
Setser says:
This crisis has produced a lot of surprises.
I never thought I would see the Wall Street that pitched privatization as the solution to most of the emerging world’s problems in the 1990s enthusiastically welcome (partial) state ownership through sovereign wealth funds. That though may have reflected my own naivete. Fees talk; many large fund managers have been close to the big sovereign funds for some time.
Yes, Brad that is naivete. Wall Street is always bullish. Setser also seems surprised at faux conservative David Brooks:
I never thought David Brooks would channel Dani Rodrik and warn of the danger of too much capital sloshing around – and imply that financial liberalization had gone too far. That concern presumably extends to too much Chinese central bank money sloshing around; China after all was the ultimate source of a lot of the money sloshing through the US housing market.
Brooks is a fan of big government conservatism and no one should be surprised that he supports more government. The only thing that surprises me is that last sentence by Setser:
That concern presumably extends to too much Chinese central bank money sloshing around; China after all was the ultimate source of a lot of the money sloshing through the US housing market. (emphasis added)
I didn’t know the Chinese had the authority to manufacture dollars. I have read Setser’s site for a long time because he is good at tracking down money flows, but this statement really makes me wonder whether I’m wasting my time there. If the Chinese had converted their surplus dollars to another currency and invested elsewhere, those dollars would have still found their way back to the US. The dollars would exist even if they were transferred to a third party. The source of the dollars is the Fed; you can’t blame the Chinese for our monetary policy mistakes.
bsetser
October 1, 2008 at 4:41 amI probably should have used a term other than money — as only the Fed creates money in the monetary policy sense. But I was using money a bit more loosely, to mean funds than can finance an excess of investment relative to savings
Moreover, China could have used the dollars it acquires from its exports to buy US (or european) goods rather than US financial assets. Moreover, the absence of any move in long-term rates when the US raised short-term rates from 04 reflected — in my view — ongoing central bank demand. Monetary tightening (raising the policy rate) didn’t slow the rest of the economy as much as the fed expected. Maybe the Fed should have tightened more in response, but I do think China can and should be blamed for distorting long-term rates. The inverted yield curve created market incentives for a lot of the excesses we saw.
or to put it simply, without China’s willingness to use its export proceeds to buy US debt, the US household sector would have been forced to cut back by rising US interest rates (independent of fed policy, the fed doesn’t set long-term rates) well before some of the worst excesses of the housing bubble manifest themselves.
Joseph Y. Calhoun, III
October 1, 2008 at 11:43 amBrad,
You are making an assumption that it was low interest rates that drove the housing bubble, but housing and other hard assets are driven more by the value of the dollar. Take a look at the 70s when we had high and rising interest rates and also rising home prices. When money is being debased, investors run to the real. There are also other factors which affected the real estate market. Clinton cut the capital gains tax on primary residences so the real estate market was further distorted through the tax code.
Furthermore, what were the Chinese supposed to buy? They already had a capital spending boom and with a high savings rate, there wasn’t enough demand for consumer goods, which frankly we couldn’t provide anyway.
Even if the household sector had to cut back because of higher rates, the dollars still existed and they would have been spent on something. They weren’ t going into someone’s mattress.