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Rogoff: China’s Dollar Problem

Ken Rogoff talks about China's serious dollar problem:

CAMBRIDGE – When will China finally realize that it cannot accumulate dollars forever? It already has more than $2 trillion. Do the Chinese really want to be sitting on $4 trillion in another five to 10 years? With the United States government staring at the long-term costs of the financial bailout, as well as inexorably rising entitlement costs, shouldn’t the Chinese worry about a repeat of Europe’s experience from the 1970’s?

During the 1950’s and 1960’s, Europeans amassed a huge stash of US Treasury bills in an effort to maintain fixed exchange-rate pegs, much as China has done today. Unfortunately, the purchasing power of Europe’s dollars shriveled during the 1970’s, when the costs of waging the Vietnam War and a surge in oil prices ultimately contributed to a calamitous rise in inflation.

Perhaps the Chinese should not worry. After all, the world leaders who just gathered at the G20 summit in Pittsburgh said that they would take every measure to prevent such a thing from happening again. A key pillar of their prevention strategy is to scale back “global imbalances,” a euphemism for the huge US trade deficit and the corresponding trade surpluses elsewhere, not least China.

The fact that world leaders recognize that global imbalances are a huge problem is welcome news. Many economists, including myself, believe that America’s thirst for foreign capital to finance its consumption binge played a critical role in the build-up of the crisis. Cheap money from abroad juiced an already fragile financial regulatory and supervisory structure that needed discipline more than cash.

Unfortunately, we have heard leaders – especially from the US – claim before that they recognized the problem. In the run-up to the financial crisis, the US external deficit was soaking up almost 70% of the excess funds saved by China, Japan, Germany, Russia, Saudi Arabia, and all the countries with current-account surpluses combined. But, rather than taking significant action, the US continued to grease the wheels of its financial sector. Europeans, who were called on to improve productivity and raise domestic demand, reformed their economies at a glacial pace, while China maintained its export-led growth strategy.

It took the financial crisis to put the brakes on US borrowing train – America’s current-account deficit has now shrunk to just 3% of its annual income, compared to nearly 7% a few years ago. But will Americans’ newfound moderation last?

With the US government currently tapping financial markets for a whopping 12% of national income (roughly $1.5 trillion), foreign borrowing would be off the scale but for a sudden surge in US consumer and corporate savings. For the time being, America’s private sector is running a surplus that is sufficient to fund roughly 75% of the government’s voracious appetite. But how long will US private sector thrift last?

As the economy normalizes, consumption and investment will resume. When they do – and assuming that the government does not suddenly tighten its belt (it has no credible plan to do so) – there is every likelihood that America’s appetite for foreign cash will surge again.

Of course, the US government claims to want to rein in borrowing. But, assuming the economy must claw its way out of recession for at least another year or two, it is difficult to see how the government can fulfill its Pittsburgh pledge.

Yes, the Federal Reserve could tighten monetary policy. But they will not worry too much about the next financial crisis when the aftermath of the current one still lingers. In our new book This Time is Different: Eight Centuries of Financial Folly , Carmen Reinhart and I find that if financial crises hold one lesson, it is that their aftereffects have a very long tail.

Any real change in the near term must come from China, which increasingly has the most to lose from a dollar debacle. So far, China has looked to external markets so that exporters can achieve the economies of scale needed to improve quality and move up the value chain. But there is no reason in principle that Chinese planners cannot follow the same model in reorienting the economy to a more domestic-demand-led growth strategy.

Yes, China needs to strengthen its social safety net and to deepen domestic capital markets before consumption can take off. But, with consumption accounting for 35% of national income (compared to 70% in the US!), there is vast room to grow.

Chinese leaders clearly realize that their hoard of T-Bills is a problem. Otherwise, they would not be calling so publicly for the International Monetary Fund to advance an alternative to the dollar as a global currency.

They are right to worry. A dollar crisis is not around the corner, but it is certainly a huge risk over the next five to 10 years. China does not want to be left holding a $4 trillion bag when it happens. It is up to China to take the lead on the post-Pittsburgh agenda.

GDP: Grossly Distorted Product

An inside look of Q3 GDP data (source: WSJ):

If the Obama administration was managing a company, it might have hoped the latest gross domestic product numbers would be greeted with cries of "great quarter, guys!"

At least the stock-market obliged, rising on better-than-expected GDP data Thursday morning. But then bulls have grown used to looking to Washington, D.C., for inspiration. Zero rates and stimulus programs boost economic data as well as nudge money towards riskier assets.

Fully 2.2 percentage points of the third quarter's 3.5% growth figure related to vehicle purchases and residential construction, both juiced by government support. Federal spending added 0.6% to growth.

If these GDP data really were company earnings, they would be what analysts euphemistically call "low quality." Investors buying into the market on these figures are ignoring weekly unemployment claims data that came in above 500,000 again on the same day.

The wider danger is that all these short-term fixes leave the economy dangerously addicted to taxpayer-funded steroids. The circularity in the housing market, whereby Washington provides tax-breaks to first-time buyers, guarantees most of the mortgages written, and then buys most of those, beggars belief — and suggests a worrying case of amnesia following the bursting of the housing bubble.

Another idea that has been floated is to give tax-breaks to firms encouraging them to hire. Yet with quarterly earnings besting forecasts so far, it doesn't look like firms are exactly short of funds to pay workers. What they lack is a clear sense that the economy is on a stable footing. Distorting the cost of money, durable goods demand and labor productivity will not help that; it will merely serve to build up further problems.

Market valuation

Let’s look at where the market stands in terms of valuation.

(click to enlarge; source: David Rosenberg)

Facts about "Great Crash 1929"

Financial Historian on ’29: ‘Great Crash’ Vs. ‘Break in the Market’

Today marks 80 years since the best known part of the 1929 stock market collapse, a two-day rout on Oct. 28 and Oct. 29 of that year. The equities crash brought a painful close to the period of unbridled financial optimism that was the 1920s.

To mark the occasion, MarketBeat has been asking financial historians for their thoughts — mini-essays if you will — on how the Great Crash informs the way we think about the current market recovery. Today’s offering comes from Richard Sylla, Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University:

Because their teachers and their history books said so, most people know that the Great Crash of 1929 caused the Great Depression of the early 1930s. I am not one of these people.

What I know is that the Dow Jones Industrial Average closed at 306 the day before Black Thursday, October 24, 1929, and at 199 on November 13, three weeks later. That drop of 35 percent was the Great Crash. I also know that on April 17, 1930, the day before Good Friday, the Dow closed at 294, or 96 percent of its level before Black Thursday. In other words, almost all of the decline of the crash proper had been undone by a recovery of 48 percent in the Dow between Halloween ’29 and Easter ’30. Most people don’t know that, or if they ever did they forgot it.

On Good Friday ’30, the New York Times referred not to the Great Crash, but to “the break in the market last Fall.” The Times that day also noted that the day before, April 17, “average prices worked higher and a few outstanding issues shot up smartly to new high prices for the year to date,” and that “British interests were investing heavily in these issues.”

The Great Depression began sometime after the spring of 1930, most likely when a lot of banks failed late that year. But the so-called Great Crash a year earlier had almost nothing to do with those bank failures, the first of thousands of bank failures that occurred from late 1930 to March 1933.

What’s interesting from the perspective of 2009 is that from September 12, 2008, the Friday before Lehman, to the low of March 9, 2009, the Dow lost 44 percent. The Great Crash of 2008-09 was actually a greater crash than the Great Crash of 1929. And half a year after the crash lows of last March, the Dow again is up about 50 percent, as it was half a year after October 1929.

Is the market’s recovery since March now giving us a better forecast of what lies ahead than it did in April 1930? Let’s hope so. Let’s hope, too, that people stop exaggerating the effects of “the break in the market” in October ’29.

Why industrial revolution happened in Britain?

An excellent piece that offers convincing evidence and reasoning of why industrial revolution happened in Britain, not in China, India or France.

(click on the graph to watch; best material for weekend musing, lasting about one hour)

China to become the global center for auto design

It’s amazing to read this piece…thinking about it in a global macro context: Japan suffered two decades of stagnant growth; the US just barely emerged from the worst crisis in a century; while China has emerged as the No. 1 car market in the world. The world is fast changing, indeed. (source: WSJ)

Chinese Inspire Car Makers’ Designs

BEIJING — A decade ago, in search of inspiration for an ultra-luxurious Mercedes-Benz, designer Olivier Boulay studied Japan’s chauffeur-car culture.

Now, as he dreams about the future of the automobile, he zips around the streets of Beijing on a $367 electric bike, along with throngs of the city’s residents.

“China is the perfect place to think about the future shape of mobility,” said Mr. Boulay, the 52-year-old design chief for Daimler AG’s Mercedes-Benz unit in China, who moved to Beijing from Tokyo this year. “It’s my job here to push my staff to push the envelope and think about the global automotive future from Beijing.”

Mr. Boulay reflects a profound shift taking place in the car industry. As the Chinese car market expands, global auto makers increasingly are making design decisions in China. The result is that consumer trends in China are being felt in models sold around the world.

[Shift in Fortunes chart and photo]

Car makers from General Motors Co. to Volkswagen AG to Toyota Motor Corp., are pouring resources into China, which displaced Japan as the world’s second-biggest auto market a few years ago and is now poised to surpass the U.S. this year as the world’s biggest.

The consequences are on stark display at the Tokyo auto show, which runs through Nov. 4. Regular exhibitors including Mercedes-Benz, GM, and Hyundai Motor Co. from neighboring South Korea all stayed home this year.

After emerging from bankruptcy protection in July, GM located its international headquarters in Shanghai, where it has a flagship joint venture with Shanghai Automotive Industry Corp. And Ford Motor Co. recently decided to move its Asia-Pacific head office to China from Bangkok.

GM already has three global vehicles designed with China-inspired features: the Buick LaCrosse and Regal and the Chevy Cruze. The LaCrosse emerged from a concept car called the Invicta GM developed by GM’s design studios in Shanghai and Warren, Mich.

The LaCrosse’s interior is splashed with light and warm colors. The wood grain on the steering wheel and dash blend in almost imperceptibly with the seat leather, a nod to the Chinese, who are used to monotone color schemes.

“We take our Chinese customers’ and we take our Chinese partners’ input extremely seriously,” said Lowell Paddock, vice president of product development for GM’s international operations.

In China, global auto makers are pondering not just the next model cycle in four or five years but also the shape of cars 10 to 15 years down the road.

“China is a very important pillar for Daimler and its global strategy,” said Ulrich Walker, chairman and chief executive of Daimler Northeast Asia, who is overseeing Mercedes-Benz ‘s expansion in China.

Through September this year, Mercedes-Benz sold 44,300 vehicles in China, up 52% from a year earlier, according to company figures. During the same period, sales in Japan fell 28% to 21,829 vehicles. (Sales in the U.S. reached 147,800.)

Separately, Daimler on Tuesday posted an 80% drop in third-quarter net profit, but rebounded from two quarters of losses as sales at Mercedes improved. The Stuttgart-based car maker said third-quarter profit was €41 million ($60.9 million). Third-quarter revenue fell 21% to €19.3 billion.

Japan is now the eighth-biggest market for Mercedes-Benz, slipping from sixth place three years ago. China has become the brand’s fourth-largest market, compared with 10th in 2006.

China is one of the biggest markets for the top-of-the-line S-Class sedan, whose redesigned model was launched in China earlier this year after significant input from Chinese consumers. Mercedes even flew some of its customers and those of competitors to Germany to see early prototypes.

While China accounts for only about 4% of overall Mercedes sales, customers around the world are seeing features the Chinese like: bigger, limousine-like back seats with more-advanced entertainment and climate-control systems, among other amenities. In China, many upscale buyers have chauffeurs and drive on their own only on weekends. Such customers also are generally in their 30s and 40s — much younger than elsewhere. They prefer light-colored interiors, such as tan, not the somber blacks and grays often preferred in other regions.

Mr. Boulay’s arrival in Beijing illustrates China’s rise. A Frenchman by birth, he had spent 17 years in Japan, where in the late 1990s, as head of the Mercedes design studio in Tokyo, he styled the car maker’s ultra-luxurious Maybach sedan.

In Beijing, he wants to soak in the country’s new fascination with electric-powered bikes and cars to develop concepts for future Mercedes global products, including a luxury electric vehicle. His advance-design center is one of five that Mercedes operates around the world.

Mr. Boulay is especially fascinated with how ordinary Chinese people embrace e-bikes for daily transportation, and the way the country’s governments at all levels are prompting a rapid adaptation of all-electric battery cars and plug-in hybrids.

“You can see how a new generation of consumers in this country is way out in front,” said Mr. Boulay.

He believes the shift to electricity opens up new possibilities for designers to be more creative because of the simplicity of fully electric cars, which need neither bulky engines nor transmissions. Some companies such as Japan’s Nissan Motor Co. are experimenting with round, cartoon-like electric pod cars with no hoods or trunks.

China’s culture of conspicuous consumption and its big luxury market make the country an ideal place to “generate new ideas and new concepts,” Mr. Boulay said.

“We want to use China as leverage to push ourselves,” he said. “That’s why I am here and why we are setting up an advance design studio-just like we did years ago in Japan.”

Financial deregulation to the extreme

PBS FRONTLINE, “The Warning”. The inside story: why this financial crisis could have been avoided.

The deeper question is: even with regulation in place, could we have been able to prevent this crisis? I am not sure.

Ferguson on the US Dollar

Two pieces of the perspective of US Dollar: