Monday, March 2, 2009

China, Gold and the $US

In the current chaos in the world economy, with endless potential avenues of news to pursue, with ever more extraordinary actions by government, it is becoming increasingly difficult to pursue all of the points of interest that I am seeing. For example, I would like to dig around a little to find out exactly what the Fed is up to with quantitative easing (QE - Printing Money), and hope to cover this in the near future.

I decided that, for the moment, a greater priority would be to try to find out what China is buying with its amassed foreign currency reserves, as this is possibly the most important single factor at this moment in time in the future of the world economy. In particular, China has the potential to make or break the $US. In several posts I have speculated that China will seek to offload $US assets, and will divest as many as possible before markets take fright. China's main holding of $US is in treasuries, and any significant sale of treasuries from China (or possibly stopping purchase of treasuries) will see the $US fall dramatically - or even collapse.

I believe that the $US is looking extremely vulnerable at the moment, and it would not take much for a collapse in confidence. Of particular note is that Warren Buffet appears to have come to the same conclusion, with his discussion of treasuries (and therefore the $US) as a bubble. The recent collapse in the prices of stocks has seen a new surge into treasuries, as investors seek safety, so a prediction of a collapse in this market at this time might seem unusual. However, the action of frightened rabbits caught in the headlights of an oncoming truck might not be considered as an indication of what will happen when there is time for thought.

The steep falls in the stock market are simply another indication of the fundamental weakness in the US economy, and that weakness suggests that the $US must eventually fall. China meanwhile has a delicate balancing act if they are to exit the US treasury market. Any hint of a mass sell-off would lead to a collapse in the $US, and would destroy the value of a large swathe of their reserves.

Within this scenario there is a major question that needs to be answered. If China does start to dump US treasuries, where will they hold their reserves?

The two most obvious contenders are the Euro and the Yen, but both are problematic. With regards to the Euro, this is looking increasingly unstable, though with some potential to buy into the government bonds of countries like Germany. Japan, as ever, I find difficult to fathom, but the speed and depth of the collapse of their export machine does not encourage much confidence. If China does exit the US treasury market, it is not immediately obvious where they might want to put their money. I have had several readers of the blog ask me where they should put their money, and China is in the same position as those investors but on a different scale.

The key difference that arises from such scale is that China has the potential to massively impact upon any market with which it is involved. The sheer size of their reserves means that they can swing any market up or down according to their actions. Aside from this difference, which requires a circumspect approach from China, I would probably find myself having made the same recommendation that I made to individuals nearly a year ago. This was that gold was the best prospect and an asset that might survive the turmoil (though I offered many caveats to this advice, as I am not an investment advisor).

The position of China as a potential maker or breaker of a particular market means that China will act in a way that is as opaque as possible. Even a hint that it is planning to exit treasuries would possibly see a rout, and any hint of entering a market likely to see asset prices rise. However, it is possible to pull some pieces of news/information together, and try to work out what China might do.

This is no easy task as we have the mixed messages coming out of China. For example, back in February, we have the now famous statement from the Chinese authorities on US treasuries, expressed in the following colourful language:

Even at the elite level, the sense of frustration occasionally bubbles over. "We hate you guys," Luo Ping, a director-general at the China Banking Regulatory Commission (CBRC), complained last week on a visit to New York. "Once you start issuing $1-$2 trillion . . . we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

The same article goes on to say:

As China's economy slows sharply, the debate on how to manage its reserves is intensifying. Some propose spending the money at home; others want more diversification of investments. But the consensus behind recycling foreign currency into US government securities is coming under attack.

Essentially, China has expressed awareness of the delicacy of the position of the $US, but has still suggested a commitment to $US assets. The US government is clearly nervous of the situation, as can be seen in Hilary Clinton's begging bowl mission to China, which took place with unseemly urgency. Whilst China is making reassuring noises, this does not necessarily indicate China's actual intentions. As I have mentioned in previous posts, it would be likely that, even if selling treasuries, China would still make reassuring noises to prop up the value whilst they were undertaking the sales.

In one respect, China has been relatively open. It has made it clear that it expects that the US will follow a sound monetary/fiscal policy, if it is to continue as a buyer of treasuries:
The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.
It is here that we encounter the current policy of the US government. We have now had the first Obama budget. This budget was notable for considerable rhetoric on responsibility by Obama, but was lacking in any credible plan on how to reduce the budget or current account deficits. The actual substance of the budget was a massive expansion in deficits, and the budget therefore simply adds a new driver to the massive increases in US indebtedness that has resulted from the various bailouts, stimuli (monetary and fiscal), and the other many drivers of ever mounting borrowing. In total, the current US policy might be summarised as an expansionary spending binge, with no clear plan on how to pay back the borrowing . This will hardly conform with Chinese expectations of protecting their investments, and the Chinese government will surely not be taken in by Obama's rhetoric.

As such, if the Chinese were not simply trying to influence US policy with idle threats, it seems unlikely that they will be willing to continue to support the US economy with further lending.

Note: I was just set to publish the post and came across yet another article saying that the bail out in the US is expanding yet again, with Bernanke proposing more money to 'save' the banking system. At what point will anyone think 'enough!' Whatever the severity of the problem, the answer just keeps coming back - just pump in more money, at whatever cost....

With regards to actual Chinese activity, it is apparent that Chinese treasury purchases were already slowing in January, with some analysts suggesting that the mix of assets held have been altered in preparation for a fast exit from treasuries:

The U.S. Treasury’s international capital statistics showed that in November, China’s net holdings of long-term U.S. Treasury securities fell by more than $9 billion. However, the country’s short-term holdings rose by $38.2 billion. Determining the motivation here is difficult — it could simply be that China followed the rest of the crowd in jumping headlong into the safest securities possible, or more worrisome factors could be at stake.

“When any creditor shortens the term structure of its holdings, the borrower should probably be cognizant of that, because the creditor is giving up yield to give itself the option of exiting quickly,” says Brad Setser, fellow at the Council on Foreign Relations. “That’s one way to interpret the shortening of the structure of China’s holdings.”

A you would expect, I have tried to get some hard figures on what China is actually doing at the moment with treasuries, but have been unable to find any sources of this information (links/comments welcome). As such, I am unable to provide any firm information on the actual situation, which is rather frustrating. The same can be said for the Chinese position on European and Japanese bonds. However, with regards to European bonds, it seems unlikely that China has been moving out of treasuries into European bonds, as there have been problems in the sales of bonds in many auctions in Europe, even including German bonds. Had China been shifting holdings into these markets in any significant way, then such outcomes would be unlikely.

On the other hand, it has become apparent that China has been dabbling in the US stock market, and has therefore seen significant losses with the plunge in US stocks:

Provisional figures from the US Treasury department showed that Beijing was holding $99.5bn of shares in June 2008, up from $29bn in 2007. Two years ago, China only held $4bn in US equities, preferring to concentrate on Treasury bills.

However, economists said the latest figures suggested that China may have bought as much as $150bn of equities worldwide, or 7pc of its vast foreign exchange reserves.

Brad Setser, an economist with the Council on Foreign Relations, a US think tank, said the State Administration of Foreign Exchange (SAFE), a branch of the Chinese central bank charged with looking after the foreign reserves, was responsible for the buying spree.

This outcome might signal a return to treasuries, but just as likely might be a warning to China about the risks inherent in remaining in the US. Either outcome is possible, but I believe that the latter outcome will certainly be a consideration in the thinking in China.

Finally, we come to gold, the other possible asset that China might consider as a safe haven for their reserves. As I dug around, it became apparent that China has been beefing up gold investments for quite a while, as well as having a booming gold mining industry. Overall Chinese demand for gold is now the second highest in the world, with tantalising hints (unsubstantiated - see original article) that China is actively beefing up official reserves as well. However, before we get too excited that China will dump treasuries for gold, one analyst points out the following:

What about gold? That one’s easy: it’s estimated that all the physical gold in the world that’s ever been produced amounts to roughly 140,000 tons (worth about $4.5 trillion dollars using $1,000 an ounce). About 75% of that is either in coins or jewelry… not available to China, or to any other government.

The new gold available each year is miniscule: about 2,600 tons (almost $83 billion dollars worth) of new gold is being mined and refined annually, increasing the total supply by 2% per year.

You can see that China’s problem - if it wants to invest in gold as a diversification strategy - is that there isn’t enough available for sale. 30,000 tons are held in various government central bank vaults. Privately held bullion amount to about 20,000 tons.

Any major purchase of gold on the open market - which is where China would have to buy it - would drive up its price. To put this in perspective: China buys enough U.S. treasuries in one month to pay for all the gold mined in a year everywhere in the world.

I mentioned at the start of the post that gold represented a good opportunity for China, but there are limits to how far China might take such a policy. The same might be said for other precious metals. However, it does seem quite likely that precious metals will play a larger part in China's overall mix of assets. This still leaves the central problem of what else China might move into, if it moved out (is moving out of?) of US treasuries? The same analyst who points out that China can not shift into gold, also argues more broadly that there are no credible alternatives to US treasuries.

However, the analyst makes a basic error in thinking that China would have to take an all or nothing approach. He does not consider that China might spread their reserves over a wide range of assets, and this is my best guess for the direction of China's policy. If they follow this strategy, and implement it with care, China has the potential to rapidly jump towards becoming the world's most powerful economy.

The first step is to manage the sale of US treasuries with the greatest of care, such that they gain as much value of the sales as possible before the $US collapses. As they move out of $US they would likely buy as many precious metals as possible without driving the price too high, as well as buying into emerging market, European and Japanese bonds. In doing so, they will be taking risks but with the benefit that they will be positioning the RMB as the next reserve currency. Furthermore, it is no secret that China has been trying to buy into various commodity companies (or natural resource companies), such as the ongoing saga of the Chinalco purchase of Rio Tinto or their wider expansion of investments in this sector.

When the markets finally do spook, and the $US falls, China would need to keep selling hard into the market until the $US reaches a planned point at which China will halt further sales. I have no idea where that halt might be against what, but would guess that at the very least (whether I am right or wrong about the overall picture) China will have made contingency plans. With such large holdings of $US and the abysmal state of the US economy, it is hard to imagine that there is not an exit strategy for China.

Assuming that I am correct (a big assumption) at this point the US and OECD economies will probably go into a state of crisis, with stock markets collapsing and a wider state of panic amongst governments. Whilst the OECD governments will (I guess) have contingency plans for such an eventuality, there will be nothing that can be done to halt the slide when it happens. It is quite possible that there will be plans in place to support the $US in the event of a slide, in both Europe and Japan. However, I do not think anything will halt the slide once it starts.

With the US in shock, China can then use the remaining holdings of $US to go on a shopping spree into the US. In particular, China can offer to enter the markets with an offer of salvation - but at the cost of unopposed access to purchase the companies that might provide a leap into the high added value industries with technology or specialist skills. They will not put it this way but, in a climate of economic panic, they will be in a position of calling the shots, as the only significant player able to halt the slide. As a result of the panic, they will be able to buy even good companies at fire sale prices. As such, they will be able to use whatever $US assets they still hold to take a major leap up into added value industries.

Inevitably, such a large fall/collapse in the $US will see the undermining of the status of the $US as a reserve currency. The Euro is now in a position of such instability that it will not have the potential to act as a replacement. The Japanese Yen might have some potential as a replacement, but the RMB will be better positioned as the strongest contender. In particular, the Japanese will likely act to rescue the $US during the crisis, but will fail to stem the tide, and undermine the credibility of/weaken the Yen in the process.

If China was to follow such a course, it would put itself in the position of being the major world economic power, or would do so at least in principle.

So far, so gloomy and so apocalyptic......Astute readers may realise that this is all very highly speculative, and misses the underlying flaw in the whole strategy.

The flaw is that, if China were to follow such a course, it would also risk self-destruction. I have discussed this problem in many previous posts. The problem for China is that it has built its economy to service Western economies through high levels of exports. As such, if there is an economic collapse in the US and Europe, China will also destroy the markets for its goods. In doing so, it will see a massive contraction in the export sector of its economy, with a commensurate explosion in unemployment. The Chinese government is almost certainly aware of the fact that their legitimacy rests upon economic growth and nationalism, and that any dramatic fall in the economy might cause significant social unrest, including the possibility of major revolt.

Whilst this might suggest that China must continue to support the $US, in order to keep their export machine turning, it is not clear that this provides a solution for China. It is becoming increasingly clear that, whatever China itself does, the US is rapidly sinking into a quagmire. Under such circumstances it looks increasingly likely that the US is in any case collapsing as an export market and that, even without any action on the part of China, the $US must eventually sink. Whilst China can continue to prop up the US economy in return for increasingly worthless bits of paper (in exchange for the labour of their population), the US economy must in all cases eventually see a considerable contraction.

China is therefore faced with a choice of an all or nothing approach - or letting the US rapidly decline whilst they pursue a futile policy of trying to prop up the unsupportable. In one case they have an opportunity to extract the maximum remaining value from their reserves, and in the other they will simply pour more of their resource into a black hole.

I must emphasise that this is all speculation, as I do not know what the Chinese are planning, and what they might do in the current situation. China being China, it is hard to ever discern what their actual plans might be, as they lack any form of transparency whatsoever. However, it does seem that they have some hard choices on the best way for them to deal with the economic crisis. Whatever they do, they risk social instability, and even the possibility of major social unrest. Whichever direction they take, they will be entering into a high stakes game, with the potential for chaos should they make the wrong choices.

In all of this speculation, I am also making an assumption. The assumption is that the current US policy must mean that the $US will eventually collapse. I simply do not believe that a massively indebted country with very little in the way of savings, a massive current account deficit, can get out of trouble through an explosion in new borrowing and massive increases in deficits. It might be argued that this is simplistic, but I make no apologies for taking such a straightforward approach. However, with every new bailout or stimulus, the economic situation of the US just seems to deteriorate further. I think that China will be observing this and will take note of the fact that nothing seems to work in stopping the US economy from collapsing.

I can imagine that, within the closed world of Chinese policy making, there will be some heated debates on the best course of action. If, and it is a big 'if', I am correct, then it appears that the world economy is on a knife edge. If China is debating the position of the $US, they will be aware of the risks in waiting compared with the risks of acting to preempt the slide. Whilst I admit to being speculative in much of the post, I can not believe that China is not discussing this subject and, if there is a discussion about the risks, there will certainly be contingency plans. The big question is - which way will they jump?

(alternative scenarios welcomed in the comments section)

Note 1: For regular readers, they will be aware that I have long been expressing my concern both at the policy of QE (Printing Money), and the opacity of the policy with which it is being undertaken. I have recently written to the Bank of England (BoE), requesting some details on the policy, and have encouraged readers to write to their MPs asking for more information (see note 2, I have copied a suggested letter).

My concern has been that the most radical policy ever undertaken by the BoE, with potential for profound effects on the UK economy, has seen no detail of how the policy will be undertaken, without even any discussion of how much money will be created. Furthermore, in the information provided, it is clear that there is no formal mechanism for reporting what is taking place.

The bottom line is this. At present there is absolutely nothing provided by the government or BoE to distinguish what is going on from what happened in Zimbabwe.

A short while ago I received a letter from a BoE Press Officer requesting a 'chat'. I have now had that 'chat'. The summary of the conversation is that no further detail on the policy will be provided until the publication of the letters between the Chancellor and the BoE which discuss the policy. Whilst the BoE press officer was inevitably polite, he cast no light upon the policy. A long conversation amounted to 'wait for the letters to be published'. The only point of substance was a suggestion of a possible means of reporting the QE activity, but this was not an official statement of intent.

The worrying part of this is that this means that the first we will know anything about the policy is when it is actually implemented. As such, we will be seeing one of the most radical economic policies ever undertaken implemented without any discussion of the details of the policy prior to implementation. The idea that a policy with such magnitude of potential consequence for the wider economy should be undertaken in circumstances of such opacity is quite extraordinary.

The BoE letters are apparently going to be published very shortly, so I will await the publication. If they fail to clearly answer the questions that I have asked, then I will continue to pursue this matter as far as I can, including putting as much pressure on the BoE as possible. Whilst this blog now has a large readership (which is gratifying) I would also urge you to write to your MP requesting greater transparency.

To date I have expressed the view that QE is a method of financing government operations through the printing press. I have argued that the UK government is aware that it will have problems raising the money to finance operations of the government. As you will have noted in the above post, raising money through bond sales is becoming increasingly difficult. It seems more than a coincidence that, at such a time, the printing presses are about to start running. The opacity of the policy just serves to confirm my worst fears.

As such, when I review the BoE letters when they are published, my aim will be to closely analyse exactly what they commit to, and whether they leave any 'wriggle room' for either the BoE or government on the issue of full disclosure of exactly what they are doing with the policy.

Quite simply, this policy has the potential to wreck the UK economy, and I have seen nothing to date, and heard nothing to date, that offers any reassurance.

Note 2:

You can find the email address for your local MP here (click on the map for your constituency).

This is is my suggested letter which you can copy and paste, or alternatively write your own version:

I am writing as I have very increasing concerns over the recent Bank of England policy to implement quantitative easing. In particular, I am worried about the following:

  1. There is no policy document that clearly outlines how this policy will operate, what quantity of money will be created, what assets the money will be used to purchase, and what method will be used for the purchases.
  2. In addition to this Mervyn King has suggested that the method of reporting for Quantitative Easing will be through the MPC minutes. This is not the purpose of the MPC minutes, and there is no requirement for full disclosure of activity in such a method of reporting.
This is all very opaque.

I am very concerned at such opacity in consideration of the fact that the Bank of England will be using money creation to purchase gilts. In this situation the Bank of England will therefore be creating ('printing') money to purchase government debt. This might be seen as government operations being funded by printing money.

Under such circumstances, it would be reasonable to expect the Bank of England to offer a transparent and detailed discussion of the policy as a formal policy document, as well as a formal, full and transparent procedure for reporting their activity.

I would therefore be most grateful if you could, on my behalf, seek to clarify why this process is being undertaken in such an opaque manner, and clarify exactly what the policy will be. I would also be grateful if you could press for a proper method of reporting on the policy of quantitative easing.

Additions, suggestions for improvement will be welcomed. Just leave a comment below.

Note 3:

I predicted a while ago that the £GB or $US would collapse within three months, and that after the collapse of one, the other would follow shortly after. I am still convinced of the extreme fragility of the economic situation for both countries, and still think that I may yet be right. I have not checked the exact date I made this prediction, but I think I still have about 2-3 weeks to run before I am wrong.

I have been wrong about the $US before, and hope that I am wrong again this time. However, it seems that others such as Warren Buffet are also expressing concerns about the sustainability of the $US (if treasuries go, the $US will follow). I still think it will need an external shock to kick the $US down, but am becoming less certain of this. If I am right about China (a big 'if') then it might be that China will precipitate the fall...

Note 4: An interesting reply to one reader's request to his/her MP on the subject of QE (I assume using my standard letter). I will quote it in full, as it is more than a little disturbing:
'Have sent a copy of the letter to my local MP (Labour, Scotland). His reply:
Thank you for your email and I do appreciate your concerns at the current economic crisis. I am quite unsure as to the alternative that you believe may help steer our financial institutions out of the current mess?!'
That an MP can send such a reply sends shivers down my spine. If we take even a modest interpretation, we are getting a response that says that this is a desperate gamble.....

Note 5: There have been lots of comments on my post on the underlying cause of the economic crisis. I have has a further request from Josiah Stamp's Ghost and Jonny for some kind of forum, and will try to look into this at some point in the future. I am not sure that there is sufficient critical mass of readers (yet) to support the forum, but probably not far off. However, finding the time is not easy...

ChasH makes an interesting point, suggesting that offshoring might mean that there will be continued decline in strong companies in the OECD. I think that, once the balance of labour costs adjusts, this process might come to a halt as the cost versus benefits will alter. However, we will see...

Some interesting points of view from Lord Keynes, which I would like to address at some stage, time allowing. Lord Keynes appears to the devil's advocate amongst the commentators, which is useful to have on the blog. It is good to have challenging views.

Also, thanks in general for some interesting and stimulating links, which I nearly always follow up (I do occasionally miss one or two). One stood out as I already think highly of the author, which is as follows:

Niall Ferguson is very astute, though I do not agree with everything he proposes. I am currently awaiting the arrival of his recent book on the history of finance, which may be an interesting read. If it is as good as I think it might be, I will let you know....

Sorry, yet again a quick review on the comments. I have taken a part random sample on this occasion, and will try to continue to address as many comments/questions as possible. I hope I will be forgiven, but I have had to devote quite a bit of time to posts recently.

Note 6: It occurs to me that this post is very speculative. I hope that it is seen in this light, and other scenarios/views on what might happen next are welcomed, as well as any critiques of my scenario.


  1. Sorry, I forgot to thank those who were concerned/provided advice for the BoE 'chat'. All appreciated.

  2. Cynicus, phew! - you're still with us.

    How on earth do you find time to write such eloquent material?

    My wife and I are speculating that you're an economist by night masquerading as a sports journalist for the BBC by day. True/false?

    Keep it up.

    Ketley, Vancouver

  3. Here is testimony by Michael Pettis, Professor of Finance, Peking University, before the U.S.-China Economic and Security Review Commission on Feb 17 2009 entitled China's Role in the Origins of and Response to the Global Recession

    I think it feeds well into your discussion on China.
    All the best

  4. Forgot the link!!

  5. Great commentary Cynicus though I appreciate it's very speculative.

    Peston's out in China and it looks like they are massively feeling the pain of this crisis:

    As you say... the world is balancing on a knife edge

  6. I've written to my MP, although I think I'll get a very similar vague response to wait and see - particularly because he's a Labour MP and they've gotten very much used to comfy inaction in past years.

  7. Cynicus, thankyou for another great post.
    Far to speculative for me to comment on. Therefore please alow me to vent on a completly unrelated matter, for today is a significant day for my family.

    I consider myself Mr slightly above average. With a Net income of aprox £2k per month inclunding insane amounts of overtime, 2 kids and a wife that stays home to bring up the kids.

    Today we offically entered fuel poverty with an increase of the direct debits for gas and electricity to £101 & £114 per month. more than 10% of my income.

    Dark days indead !
    Time for a wood burner and veg patch me thinks.

  8. History suggests that every major economic upheaval or change (or attempt)in the economic hierarchy results in war. USA still has the most aircraft carriers but with lots of nuclear weapons about.....?

  9. What will China do with it's reserves?

    Buy real wealth.


  10. I can see WW3 brewing.

  11. Food prices surge 9% despite inflation fall

    Could this be an early effect of money printing? I know it isn't officially started, but since the Banking Bill passed the BoE could have been doing it and we would be none the wiser without the weekly report.

  12. Financial Regulation

    From the 1930s to the 1980s, most countries had vigorous and effective financial regulation (which is sometimes emotively called financial “repression” by those opposed to it).

    The policies of financial regulation included the following (but did not have to include all of them to be effective):

    1. Interest rate ceilings
    2. Liquidity ratio requirements
    3. Higher bank reserve requirements
    4. Capital Controls
    5. Restrictions on market entry into the financial sector
    6. Credit ceilings or restrictions on the directions of credit allocation
    7. Separation of commercial from investment (“speculative”) banks
    8. Government ownership or domination of the banks

    Ito, H. 2009. “Financial Repression,” in K. A. Reinert, R. S. Rajan et al. (eds), Princeton Encyclopedia of the World Economy, Princeton University Press, Oxford and Princeton, N.J. pp. 431–433.

    There were no massive and destructive asset bubbles in these years. In all Western countries, there was spectacular economic growth in the real economy.

    In fact, the modern financial collapse of 2008 was very much like the Scandinavian banking collapse of the early 1990s, after financial deregulation:

    “The control of the external flow of capital was a major pillar for post-war stabilization policies [in Scandinavia] because it isolated Finland, Norway and Sweden from international financial developments, thus allowing for far-reaching domestic interventionist and selective monetary and fiscal policies. The capital account controls served as the wall behind which the central banks determined the rate of interest and the distribution and size of capital flows within the domestic economies according to political priorities …
    [But after deregulation in the 1980s] bank lending could now be expanded without any binding regulatory restrictions. Banks entered into a fierce competition for market shares. A lending boom started, channelling credit to the asset markets, mainly to the real estate and stock markets and causing rising asset prices. Asset prices grew more rapidly than consumer prices. Rising asset prices formed the basis for rising collateral values, further fuelling credit expansion in a cumulative process”

    Jonung, L. “Lessons from financial liberalisation in Scandinavia,”
    Comparative Economic Studies, Dec 2008

    This all ended in the Scandinavian financial collapse of the 1990s. It was a similar story in Japan, and now in the US in 2007-2008. We all know that Alan Greenspan was a devotee of Ayn Rand. He was appointed to the Federal Reserve by Reagan (also a free market ideologue), an institution that had partial responsibility for regulating the financial sector.

    Greenspan gave up all pretence of serious regulation of the financial sector in the US.

    This article shows that the 2 major US asset bubbles of the past 20 years could have been stopped:

    To deal with the high-tech bubble, [Greenspan] could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation - or "liar" - loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn't have the tools, he could have gone to Congress and asked for them

    Joseph E. Stiglitz, “Capitalist Fools” Vanity Fair, January 2009

    Pre-1980s Financial Regulation and Basel I and II

    Financial liberalization in the 1980s was associated with a shift in prudential regulation from direct regulation of banks (by, for example, regular site visits and investigations of the banks’ investments) to an indirect approach based on the monitoring of bank capital to ensure that it remained adequate in relation to the risk being taken.

    Thus Basel I and later Basel II were born.

    But the Basel Accords are just watered down and absurd substitutes for the serious, vigorous and effective regulation that existed before the 1980s.

    Basel I and II are almost like toothless “rule books”:

    One type of prudential standard ripe for revision concerns banks’ capital adequacy. The Basel II standard of capital adequacy, which came into force at the start of 2007 after some nine years of negotiation, marked a shift from the external regulation of Basel I to self-regulation—making it an invitation to careless behaviour and ‘moral hazard’ at a time when big banks are more confident than ever that they will be bailed out by the state. Basel II requires banks to use agencies’ ratings and their own internal risk-assessment models—both of which have been shown to be pro-cyclical and to have failed spectacularly in the run-up to the present crisis—while raising capital standards during periods of illiquidity, precisely when banks are less able to meet them

    Robert Wade, Financial Regime Change?

  13. I just found the following blog entry on the BBC:

    That said, there are big practical differences between this policy and Zimbabwe-style money financing. The most important is that the Bank is choosing to buy gilts as a means to an end. It is not being forced to buy them because the government has nowhere else to go.

    Also - and crucially - the Bank has every intention of unmonetizing the debt when the storm is past. In other words, it's going to sell it all back.

    So in that sense, QE will not directly affect the stock of government debt one way or another. (Certainly there won't be any direct change to the amount of debt on the Treasury's books.)

    She is indicating that their motives are not to finance the government. Not sure where she is getting her information from though.

  14. Food price increases to date are pretty much a direct result of the devaluation of the £ against the Euro, since any produce raised or grown in the UK can easily be sold to the continent.

  15. Your three month prediction was stated on Jan 19th. In my previous comments I've balked at that, just because I believe as many others do that there are too many with too much to lose and not enough with nothing to lose to let the system fail.
    However, I recognise the complexity of the macro picture and have always held that there are multifarious social and political factors coming into play which could tip the balance...

    One of my eyes will be on the G20 summit... For many reasons.

    One more thing... As I've said before, beyond the obvious dramatic value added to the narrative of your blog - I'm not sure what you are hoping to achieve by asking readers to write to their local MP's...?! No-one is likely to get the response you are looking for for reasons I have mentioned previously - the state is doing what the state thinks is best for the country - do you think you could run the country better? You better start learning the art of politics in a democracy if you do, and become expert in a number of other subjects besides. Do you think Obama, who Laurence Lessig has commended many times pre-public office for his ethical constitution can put the world to rights by just stepping up to the plate? Do you not think he has had to try & understand the macro-picture in its many forms and take advice where he has to? The lazy and unenlightened will no doubt eternalise the blame for this situation and seek retribution in all the wrong places and from all the wrong people, and when the riots start it will be rioting against a phantom that resides metaphorically in ourselves as the selfish, untutored individual, and physically as the fat cat banker who is now knocking back pina coladas in Tahiti... Either way its a phantom.

    There is no point in insighting people in this way - it is making a circus of your otherwise brilliant blog.

  16. I wrote to my MP back on your first suggestion. I'm in a lucky position, because I know my local MP well and also because he's a truly excellent MP.

    I had an answer within a day, but the answer was: "I'll ask". Mainly because my MP isn't a specialist economist and would not have been able to offer any better insight than the rest of us.

    However, I saw him last Friday and he told me he'd asked the question of the Powers That Be and demanded more than a stock answer.

  17. You may be interested to look into the increasing amount of barter deals being struck between Asian economies - they are trying to bypass any foreign currency at all in their dealings with each other - particularly the US dollar.

  18. @Red
    CE is asking us to question our elected representatives to ask for the transparency that should already be there for such a radical and potentially damaging policy.

    I see nothing that incites political or other action, just asking for clarification of the policy and full disclosure so that the amount of money injected in the system is able to be accurately gauged.

    You may feel that it will not get the answers in the replies, that may be true as the MPs will have to refer to official policy (when it actually comes) rather than giving uninformed opinions.

    However it should indicate to politicians that there is some concern about the obscuration of the policies and that trying to make it more open to public view will ease confusion and discontent, which is something the economy doesn't need at the moment.

    If CE was telling readers to write saying the policy of QE is wrong and it should be abolished, I would see your point about thinking better at running the country, but in the ways he has termed it, it is really a request for more information so can better judge the effectiveness of the policy.

    I can understand your irritation at amateurs discussion things that may be beyond their comprehension if they go on to make unreasonable demands of an authority body, but I feel that this is not the case here.

    If you think the sample letter could be worded in a better way, why not write your own version to show the way you feel it should be worded. constructive criticism is always welcomed.

    lefty feep

  19. I don't buy the $US collapse. I can see significant weakening of $US if economy starts to recover, but not collapse. There is four things government does that have effect on $US:

    1. Stimulus package tries to put money into infrastructure investments (human and material) and necessities. Investors understand that. These will build up the future.

    2. Money supply is artificially bloated by Fed, but velocity of money is so slow that it does not matter. Fed can scoop extra money from system within weeks if inflation builds up and economy gets out from Liquidity trap

    3. Bailout is the weak point of Obama administration. Instead of nationalizing them, they are given money as needed. Just like Japanese government did once. If Obama does not change course, this will create havoc and prolong recession.

    4. Military spending is constant $1 trillion/year money sink. It continues to be overlooked when there is these new spending initiatives, but defense budget continues to be the biggest drain of money (in several year perspective). Current stimulus package could be easily financed by permanently cutting military spending 10-20%. Same for bailouts. Does US really have money to spend $10 trillion in next 10 years.

  20. @cynicus see this


  21. On the radio over the weekend I heard someone say that communism and capitalism were dead, primarily because they were 19thC. terms that had outlived their environments.

    While true, some of the worst aspects of communism as practiced by Soviet-era goverments are still practiced today.

    I believe China thinks in the very long term, so long term that it's beyond the understanding of most of us - certainly politicians who keep one eye on the next election.

    The opportunity may exist for them to use the crisis in capitalism-led economies to completely reorder the world to their long-term liking.

    Appealing to the short term greed of someone who knows that they may in fact own it all in the long term seems a dubious basket into which to place your eggs.

  22. Another article from Ambrose Evans-Pritchard in the Telegraph:

    The thrust of the article is that European banks have huge amounts of debt which are denominated in $US. Therefore there is demand for $US, which will stop it collapsing.

    At the end of it there is a quote:

    Simon Derrick, currency chief at the Bank of New York Mellon, said the implications are obvious. “The global bullion of the last eight years was funded on dollar balance sheets, so the capital destruction we’re seeing leaves banks starved for dollars. Dollar is clearly going to appreciate a lot further,” he said.

    I would be interested in peoples' thoughts on this. It seems to me that this might be another thing that delays an inevitable collapse in the $US.


  23. General,

    With regard to the above comments by 'Red' about Cynicus 'insighting people' and 'making a circus' by asking readersto write to their MPs re QE. This is not how I see it.

    It does not matter that 'no-one is likely to get the response' (that Cynicus, or you, or the readers themselves) 'are looking for'. The point is that by the very process of asking for such a justifiction people make the dramatic transition from passive observers to engaged citizens.

    Hitting the brick wall of an MPs' token response is precisely the shock some people to impress upon them the necessity of their own involvement in getting through the hard times ahead. As such, anything that seeks to empower individuals in such a way is, in my view, legitimate.


    It is to further debates such as this (over essentially tactical issues) that a user forum is needed.If the 'critical mass' you spoke of has not been reached then I suggest it will be very soon.

    In the last week I have seen your site linked numerous times by commentors on sites as varied as the guardian, the telegraph and znet, and heard it raised in debates about the economic future of the city I live.

    I think it's crucial that when this wave of interest hits (as it may have already - you have the stats I presume) there is something that:

    - gives people some ideas as to what to do with the wealth of pertinent information you present them;
    - creates an easier way for the information to be accessed than just rereading through older posts;
    - allows people to debate to further their understanding of the issues;

    Not only a forum, but other tools, (such as wikispaces, link sharing, pamphlets, videos, etc) may also seen as necessary and, since your only one man (albeit one who manages to get a lot done in the time he has), this is where a community would be useful.

    If Steve Tierney does not follow through on his original offer to facilitate this, please let me know and I will.


  24. Anonymous - the food price rise is most likely the recent oil spike working its way through the system.

  25. Mark

    The BoE has now given figures for the amount of money it will print. Is this the answer you wanted?

    If the figures are now known, doesn't that mean that the pound will simply devalue proportionately to compensate for the extra loose cash known to be sloshing around? Or is the idea that the money is going to be 'loaned' to people, thereby making it 'sound' money, as opposed to money simply given away?

    I have to admit that I'm still hazy on these 'assets' the BoE will be buying. Are they rubbish that no one would normally buy?

  26. The amplifier.

    Have you ever tried to bring a mic close to the speakers? The increasingly loud sound you hear is the result of feedback. The sound of the speaker goes into the mic, it amplifies through the stereo, goes to the speaker where it gets picked up by the mic, that sends it back to the stereo to be amplified and so on, in a infinite loop.

    Your stereo works on the principal of feedback as well. The amplifier in it, has a mechanism that takes the output and feeds it back to the input. When you set the volume up or down, you effectively control the amount of the output that will feed back to the input. You set the gain of the amplifier. Gain that way, is a simple context. It means, how many times the voice on the mic gets multiplied. With a gain of 5, a whisper in the mic gets 5 times louder.

    (disclaimer: To people that really understand what I'm talking about, chill out, I'm trying to make a point. As a whole, it works more or less like this).

    Amplifier theory looks very inviting. You get more every time the mic-amp-speaker-mic loop gets involved. We can solve all the problems human kind faces. We can always go through the loop and gain what we need to continue. We need energy? Put our energy to the loop and we will get more energy. (and to the people of the last disclaimer, don't laugh... cry instead).

    Inflating FRB, works more or less like that. You put the same investment, over and over in the market and you end up with growth. The only problem is your limit.

    Theoretically, the feedback system can go to infinity. Yet, any electronics student can tell you that you cannot do it. If you glue your mic to your stereo speaker, you will simply overheat the amp (lol, global warming), and end up with an amp either burned or blown out.


  27. i was shocked to see the topic titled "china gold and us" but after reading a bit i thought cynicuseconomicus is right in choosing the topic. haha..


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