Nouriel Roubini's Global EconoMonitor

Global Imbalances: A Contemporary Rashomon Tale with Five Interpretations…

In the classic Kurosawa film Rashomon, a heinous crime is perpetrated in a forest. This crime is reported by four witnesses, each giving his or her own point of view. Who is telling the truth? Who is lying and what is truth? Which version of the story, if any, is the real truth about what happened in the forest?

Today, the large global imbalances are a similar heinous event that requires explanation and interpretation. In this contemporary Rashomon drama, the basic facts are known: the US is running large fiscal and current account deficits while the rest of the world is running large current account surpluses. The flow of capital that is financing these US twin deficits is mostly (three quarters or so) coming from foreign central banks – mostly in Asia but not exclusively – that are aggressively intervening to prevent an appreciation of their currencies.

While the basic facts are undisputed, the causes of such imbalances, which country is at fault and the policy solutions to such imbalances are much disputed. Like in Rashomon, every actor in this tale is spinning a different interpretation, blaming someone else for the problem and providing a different policy solution.

So, in this note I would like to present a roadmap of the current Global Imbalances Rashomon debate and discuss five alternative views of this contemporary debate, rather than the four in Rashomon. Putting in logical focus the various interpretations will allow us to understand the specific flaws of the various arguments and, hopefully, direct us to the right interpretation and policy solution. So, here is my take on the five interpretations of the global imbalances.

1. The Deutsche Bank’s “Bretton Woods Two” Panglossian View: No need to change fiscal balances, current account balances or exchange rates.

The Deutsche Bank’s “Bretton Woods Two” hypothesis has been presented by Dooley, Garber and Folkerts-Landau in a series of five papers (Is it 1958 or 1968? Three Notes on the Longevity of the Revived Bretton Woods System; An Essay on the Revived Bretton Woods System; The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates & Exchange Rates in Center Countries; Direct Investment, Rising Real Wages and the Absorption of Excess Labor in the Periphery; and The US Current Account Deficit and Economic Development: Collateral for a Total Return Swap ). Their view is one of a Panglossian world where these global imbalances are optimal,and thus they do not require any adjustment either in quantities (fiscal or current account balances) or prices (exchange rates). In this Ricardian cum Tax-Smoothing view of the world, the US fiscal deficit is optimal, not a problem as the US is running some temporary wars. Garber claims that global imbalances are not caused by “US fiscal profligacy”, i.e. the US budget deficits. He presumably views the latest US fiscal deficit as driven by a transitory increase in military (and homeland security) spending related to the “temporary” wars against terrorism, Afghanistan, Iraq and the need to prepare to confront other rogue states (Iran, North Korea, etc). Thus, it is “optimal” to run budget deficits and, thus, current account deficits. Indeed, history and a tax smoothing approach to fiscal policy suggest that, during a transitory war, it is optimal to run fiscal deficits that lead to current account deficits. In this view, the US is borrowing from abroad to provide the global public good of “international security”.

Moreover, in the Deutsche view, China and Asia desire to run current

account surpluses and they will eagerly finance the US for a generation or more as China needs to absorb hundreds of millions of rural workers in the urban sector and Asia loves a mercantilist export-led growth model. Thus, there is no problem to solve and we do not need either an adjustment of quantities (fiscal and current account) nor an adjustment of prices (exchange rate). The world is in its Panglossian optimum and will stay so for the longest time.

The flaws of this Panglossian view are clear and Brad and I have fleshed them out in excess detail in our long paper on the coming demise of the Bretton Woods Two regime. Here only a few reminders.

First, the current war against terrorism and various “rogue states” is not “temporary” and may last a generation instead. Thus, a tax smoothing model implies such semi-permanent spending should be financed by an increase in tax rates, not debt and deficits. Second, most of the worsening of the US fiscal deficit has not been driven by an increase in defense and homeland security spending but rather by a structural fall in revenues; this is a perversion of the tax smoothing logic. Third, a tax smoothing model suggest that, during a transitory increase in spending, tax rates should remain constant (smoothed) not sharply reduced as they have been in 2001.

Fourth, and most important, it does not make sense for the US – the only hyperpower in the world – to have most of the financing of its fiscal and current account deficits to come from the country – China – that from a geostrategic point of view is the most significant long-run challenge to the United States. For the first time in history, the contemporary superpower/hegemon is a net debtor, rather than a net creditor, is the largest net borrower, rather than net lender, and is being increasingly financed by its most challenging long run geo-strategic rival.

Thus, even leaving aside all the other reasons why the BW2 regime is fragile and unstable and likely to collapse in the next year or two, an optimal tax smoothing and consumption smoothing approach cannot lead to the conclusion that the US twin deficit are optimal or sustainable. The US is playing a fiscal and current account Ponzi game that clashes with any intertemporal solvency condition found in tax smoothing and consumption smoothing and optimal current account models. And once one agrees that such fiscal and current account imbalances are not sustainable, the Deutsche argument that China should not move its peg and should keep on piling up reserves appears as flawed as well. We will consider below in more details the arguments in favor and against a Chinese/Asian currency move.

2. Ronald McKinnon’ View: the US fiscal deficit is the problem but the Chinese/Asian currencies do not need to move.

Ron McKinnon wisely argues that the US fiscal deficit (in significant part driven by an unsustainable cut in tax revenue) is a serious global policy problem; such fiscal deficit is also the source of the current account deficit (McKinnon’s views have been presented in a series of papers, here and here and here). He also agrees that such twin deficits are unsustainable and as source of severe global imbalances. Thus, he is in favor of a US fiscal adjustment that will reduce such global imbalances. However, he believes that a Chinese or Asian currency move is inappropriate. The global rebalancing can fully occur, in his view, via “expenditure reduction” policies without the need for the “expenditure switching” effect of changes in nominal and real exchange rates. His view is based, in part, on his long-standing arguments that a regime of global fixed exchange rates among major economies (US, Europe, Japan/Asia) would be ideal. In his
view, currency adjustments are destabilizing rather than stabilizing. He blames the US pushing for a revaluation of the Japanese yen in the mid 1980s that, in his view, caused the ensuing bubble and then deflation that plagued Japan in the 1990s. He is concerned that forcing China to move its peg would lead to the same destabilizing deflation that plagued Japan. Thus, in his view, quantities (i.e. global savings-investment imbalances) can be adjusted – and should be adjusted – without destabilizing relative price movements. In his view, the real appreciation that fast productivity growing countries require can be achieved via domestic inflation rather than nominal appreciation.

McKinnon view overstates the role that the Yen appreciation in the late 1980s had in triggering the Japanese real estate bubble and its burst into deflation in the 1990s. Other more structural micro distortions in the allocation of savings to capital explain the bubble of the 1980s and its deflationary bursting in the 1990s. He incorrectly downplays the role that exchange rate movements had in the late 1980s in leading to an orderly global rebalancing where US fiscal contraction cum a US dollar fall led to a gradual shrinkage of the US twin deficits of the early 1980s.

Nominal exchange rate movements had an important role in adjusting equilibrium relative price for a country such a Japan during its 30 year period of high growth since the early 1960s. In 1960, the yen was at 360 to the dollar while today it is closer to 100. In spite of such a sharp long run nominal appreciation Japan has not lost its competitiveness because high productivity growth until the early 1990s allowed Japan to experience an appreciating currency without a loss of competitiveness. Also, Japan grew very fast in the years after the breakdown of the Bretton Wood system in 1971 when the yen started its appreciation. Japan grew rapidly for almost two decades after the time when the yen became flexible and well before the 1990s slump. Thus, it is incorrect to blame flexible exchange rates for the economic stagnation of Japan in the 1990s. Similarly, China has already had a long decade of high productivity growth with essentially fixed nominal exchange rates. Since its equilibrium real exchange rate is appreciated, an orderly adjustment of the actual real exchange rate requires a nominal exchange rate adjustment as well; otherwise the real appreciation will occur via socially and politically disruptive increase in inflation. McKinnon mistakenly downplays the risks of high inflation in China: in the early-mid 1990s when China experienced high inflation the real economy went into a hard landing with growth slowing sharply in the late 1990s.

So, McKinnon is correct in stressing the important role that US fiscal adjustment can play in supporting an orderly global rebalancing. But his view that such rebalancing does not require any exchange rate adjustment is at odd with over thirty years experience with flexible exchange rates where exchange rate flexibility has helped undoing exchange rate misalignments that do occur from time to time. Adjusting relative prices via nominal exchange rate movements is less costly that trying to adjust such relative price via costly deflation or inflation.

One can also point out that the risks of a deflationary spiral in China are minimal. Currently, in China inflation is increasing, not decreasing, and the actual inflation rate is artificially kept low via various administrative freezes on the price of energy and the price of many public services. So, the risk of deflation via a currency appreciation is minimal. If anything, by appreciating its currency China could successfully control inflationary pressures while providing to its citizens an increase in terms of trade or purchasing power over foreign goods.

Also, the McKinnon concern about the deflationary effect of a Chinese and Asian appreciation on their economies can be turned on its head as a failure to flexibilize the Chinese and Asian currencies may lead to deflation in the US, Europe and Japan. Indeed, if the Chinese/Asian appreciation does not occur via a nominal appreciation and it does not occur via higher inflation in China (as slow growth of Chinese real wages may keep such inflation under control), then the only way in which such real appreciation can occur is through the fall in the price of traded goods in the rest of the world (i.e. a fall in prices in the US, Europe and Japan). Thus, while McKinnon worries about Chinese deflation, he does not consider the possibility that the needed real exchange rate adjustment could occur through a severe and destabilizing deflation in advanced economies. And, as the experience of Japan in the last decade suggests, such deflationary pressure would have severe consequences on the productive sector of the advanced economies.

Thus, a US fiscal adjustment without a change in relative prices (the Chinese/Asian nominal and real exchange rate) will not trigger enough of an expenditure switching effect that is required to reduce the global imbalances. Both are required to have an orderly global rebalancing.

3. The Fed’s view (or views): the US current account deficit derives from a “global savings glut” rather than a lack of US savings. US fiscal deficits may be a problem but their reduction may not shrink a US current account deficit whose source is foreign, not domestic. Foreign investors’ willingness to finance the US current account deficit will continue for quite a while as this global savings glut is attracted to the high growth and returns of the US.

It is hard to know what the Fed’s view on the global imbalances exactly is as, over the last weeks and months, Chairman Greenspan, several Fed Governors (Kohn, Bernanke, Geithner, Ferguson, Yellen, Pianalto to name a few) and the Fed staff have all widely written on the subject. I will take as the Fed view the recent and influential piece by Ben Bernanke on the US current account deficit due to a “global savings glut“; but I acknowledge that 1000 flowers may be blooming at the Fed when it comes to the issue of the global imbalances. That Bernanke speech, together with other recent musings by Ferguson, Kohn and Greenspan may represent the core of the Fed view.

Bernanke has argued that the US current account deficit derives from a “global savings glut” rather than a lack of US savings. US fiscal deficits may be a problem but their reduction may not shrink a US current account deficit whose source is – in his view – foreign, not domestic. Foreign investors’ willingness to finance the US current account deficit will continue for quite a while as this global savings glut is attracted to the high growth and returns of the US. But the Chinese/Asian currencies may need to appreciate and the US dollar fall to adjust over time the current account imbalance. A currency move will benefit the US, regardless of US fiscal adjustment, as net exports will sharply increase once the dollar falls. While a fiscal adjustment is not crucial for global rebalancing, in the Fed’s view, a fiscal adjustment will occur in the US by default and semi-automatically via the political process.

As a starting point of the critique of the Fed’s view, note that the term “global savings glut” – used by Bernanke – is a total misnomer.

The alleged “excess” of foreign savings does not come from a sharp increase in global savings, as the evidence shows that private and especially public savings are falling in most regions (US, Europe, Japan), apart from china. This alleged excess of savings, instead, derives from a lack of real investment that leaves more of the relatively low national savings available for foreign inv
estment (i.e. a current account surplus). In other terms, Bernanke should have referred to a “global investment drought” as the current account surpluses of the rest of the world do not derive from a sharp increase in global savings, but rather by a fall and lack of real investment that went bust in 2000 and has failed to sharply recover so far in most advanced economies and emerging market economies as well. So, the “global savings glut” term is altogether improper and incorrect and leads to the non-sense of the Fed arguing that the US CA deficit is not caused by a US savings drought but by a non-existent “foreign savings glut”. Obviously, it is convenient for Bernanke to speak of a global savings glut as that term supports the equally flawed and incorrect view that the US current account deficit is not caused by poor US domestic policies, but rather by exogenous foreign/external factors.

Instead, once we talk more appropriately about a “global investment drought”, the issue becomes of whether such drought is permanent. The Fed happens to believe that the world is now in a new long run equilibrium where there is too much capital in the world, and thus the low returns on all sort of assets. In this world of excess capital, the investment drought will remain for a long time and thus, real interest rates will remain low regardless of the US fiscal deficits.

But let flesh out in more detail the flaws of the Fed arguments.

First, as discussed above, data are consistent with a “global investment drought”, not a “global savings glut”. As a number of studies have clearly shown (and see the excellent Economist article on the global shift away from thrift/savings), the problem in the world economy is not one of a glut of savings but rather a dearth of savings. Large and growing fiscal deficits in the US, Europe and Japan imply negative public savings. Private savings are dismally low in the US while higher – but falling – in Europe and Japan where the private sector is saving in order to compensate for the current and future expected negative public savings. Savings rates are high in China and Asia but investment rates are also high in those regions; so there is no global savings glut. The “global savings glut” is a myth and Bernanke and the Fed know better.

Second, the argument that the US has a large and growing current account deficit because the glut of global savings is chasing the safe and high returns of the US is also incorrect. In the 1990s, when the US current account was driven by an investment boom, net FDI and portfolio equity inflows from abroad to the US were massive, to the tune of about $200 billion a year and financing a large fraction of the US current account deficit. Since 2001, when the US current account deficit has worsened in spite of an investment bust because of the fall in public savings (the fiscal balance going from a 2.5% of GDP surplus to a 3.5% deficit), net FDI and portfolio investment has gone from a $200 b surplus to a $200 b deficit per year in 2003-2004. So, private investors not only are not financing any more the US current account deficit; they are actively pulling out $200 b a year from equity investments in the US. So, the argument that foreign investors are attracted to the US and attracted to US high returns is non-sense: they have been pulling out $200 b a year from equity investments as those investments (as measured by stock market returns) have had average returns that have been negative since 2000 (all US stock indexes today are still well below their 2000 peaks).

Third, the myth of a glut global savings being willingly invested in the US by private investors is also altogether false. In the last two years, three quarters of the US current account deficit has been financed by foreign central banks, not foreign private investors (with 2004 seeing an accumulation of dollar reserves of $500 billion out of a US current account deficit of $660 billion). So, Bernanke (or whoever wrote his speech) got the basic facts wrong and the interpretation even more wrong (and the same holds for the speech by Ferguson presenting variants of the Bernanke view).

Fourth, there are plenty of counterarguments to the Fed view that we live in a world of excess capital, where the returns to many assets are low and thus future investment will remain low and thus maintain the “global savings glut”. In a separate and forthcoming paper with Brad Setser, we will discuss the bond market conundrum/puzzle and the other asset markets puzzles (high price ratios, low returns and low spreads). Here, one point should be noted. To maintain the economic growth rate of most of the parts of the world close to potential, investment as a share of GDP needs to increase relative to its low levels of the last few years in US, Europe, Japan, and even most of non-China Asia. For a while after the tech bust and 9/11, private corporations and firms were into cleaning up their balance sheets, reducing excessive leverage and boosting profitability. Now, that process has occurred and firms have the resources to invest more once they get more confident about the path of global growth. So, we do not live in a world with too much capital: certainly in most of the emerging markets there is too little capital, not too much and the move of many emerging market economies to become capital exporters, rather than capital importers, is temporary and driven by the temporary slack of investment after the financial crisis of the 1990s.

Even in advanced economies, the low investment rates of the last 4 years imply that investment is well below what is necessary to sustain potential growth. So, eventually investment rates will rise across the world and this will put pressure on low global savings and thus on long term interest rates and the return on many risky assets.

Fifth, arguing, as the Fed does, that a glut of global savings and a permanent dearth of global investment will keep global long rates low and will allow the US to happily finance its twin deficit with little risk is naive at best and reckless at worse. It is amazing how the Fed (or at least some at the Fed) have become blasé about the US current account deficit (see this recent story on the Economist). At least, at the Fed there are those like Tim Geithner that, based on their wide experience dealing with emerging market crises, well realize the unsustainability of the US twin imbalances and the risks of a systemic crisis deriving from such global imbalances.

4. Richard Cooper‘s View: the current account is sustainable as foreign investors love to invest into safe US assets; also a Chinese currency move is inappropriate as it would seriously hurt China’s growth.

Richard Cooper’s view is clear from the title his recent Financial Times column: “America’s current account deficit is not only sustainable, it is perfectly logical given the world’s hunger for investment returns and dollar reserves”. That says it all. In addition to the view that he is not concerned about the sustainability of the US current account, he is also against a movement of the Chinese currency, even if for reasons different from those of McKinnon. McKinnon is generally in favor of fixed exchange rates globally and against exchange rate flexibility. Cooper is not opposed in principle to trade adjustments occurring via the nominal exchange rate movements but, in the case of China, he believes that a currency adjustment would not be appropriate. Why? China’s fixed rate regime has served China well and further forex accumulation is not such a bad idea given that it guarantees continued high growth (as he says: “Their motives stem purely from the
ir desire to inhibit export-damaging currency appreciations that may well be temporary. This is not a foolish strategy, if not carried to extreme”.) In his view, given the fragility of the Chinese financial system, a currency appreciation may severely hurt the Chinese traded/export sector and thus lead to a sharp increase of the non-performing loans of such a sector. Thus, a Chinese currency movement is risky. Moreover, his view is that the US current account is sustainable – actually “logical”- (even if eventually the deficit will have to shrink as a share of GDP to make it sustainable in the long run) as foreigners desire to accumulate US dollar assets, and this factor will keep on supporting the exchange rate value of the US dollar. In his view, it is not the US that borrows from abroad when accumulating public and private external debt. It is rather non-residents who want to invest into US dollar assets.

Let us consider the arguments against the Cooper’s view.

First, as in the case of the Bernanke argument, the view that the deficit is due to foreigners wanting to buy high return assets is refuted by the data: net FDI and equity portfolio investments have been negative to the tune of $200 b for the last two years and three quarters of the US twin deficits are financed by central banks, not by private investors. So, enough of this false argument that the US current account is reflective of the US capital account surplus and the desire of the world to buy US assets: foreign private investors have voted with their feet and have not accumulated much net new US dollar assets for the last few years while massively reducing their net holdings of US equity (FDI and equity portfolio): it is mostly official political agents, not private ones, that finance the US fiscal deficit and the US current account deficit. Thus, his argument that the US does not “borrow” from abroad, but rather that the foreigners are willingly “investing” into the US is not supported by the facts.

Second, the argument that China cannot manage a 10-15% revaluation of its currency has little basis. Given the peg of the last few years and the sharp increase in Chinese manufacturing productivity, Chinese tradeable firms’ profit margins have been increasing over the years. And the nominal and real appreciation of the Chinese currency relative to the Euro and the other floating currencies has further increased the Chinese exports’ profitability. Chinese export firms can manage the effects on their operational balance and their balance sheets of a Yuan appreciation; the risk of severe debt servicing difficulties is minor. Other firms – especially state owned ones and service sector ones – that are not in the tradeable sector have much weaker balance sheets and a lack of profitability; for those firms, a Yuan appreciation would be beneficial as its would reduce the relative profitability of exports and tradeables.

Third, Cooper seems to ignore the systemic problem of a world where global imbalances exist but where a group of countries (Eurozone, UK, Canada, Australia, New Zealand, etc.) has flexible exchange rates and has thus more than contributed to the global rebalancing through a sharp nominal appreciation while another group of countries (China and the rest of Asia) have pegged to the US dollar and have thus, not only not contributed to the global rebalancing, but they have been free riding on the downward movement of the US dollar by depreciating sharply relative to the currencies of the free floating regions. Thus, China and Asia have not contributed so far to the global rebalancing.

5. The Roubini and Setser (and consensus view): global rebalancing requires both US fiscal adjustment (and private savings increase) and a Chinese/Asian currency appreciation.

I refer to our view as the “consensus view” as a large number of authoritative commentators have expressed serious concerns about the U.S. “twin deficits,” the sustainability of the U.S. public and external debt accumulation and the risks deriving from the reliance on foreign central bank financing of these twin imbalances. Similar concerns and alarms have been expressed in academic, policy, press/media and Wall Street circles by Rubin, Sinai and Orszag, Summers (and here, too), Peterson, Roach, Gross, Bergsten, the IMF (also, here), the World Bank, Rogoff and Obstfeld (plus this), Eichengreen, Wolf and Volcker, just to cite a few.

As we have argued before, orderly global rebalancing requires both “expenditure switching” via a Chinese/Asian appreciation relative to the US dollar and other floating currencies and, at the same time, “expenditure reduction” via a meaningful reduction of the US fiscal deficit that will require some increases in taxes.

A Chinese/Asian currency appreciation will lead to a reduction of the rate of forex intervention by such central banks. Thus, reduced Chinese/Asian forex intervention would lead to a soft landing and orderly adjustment if the U.S. fiscal deficit is reduced in tandem as the Asian currencies appreciate: In that case, the reduced supply in financing of the US deficits from Asia is matched by reduced demand for fiscal financing by the US. Then, the US the dollar can gradually fall without sharp effects on U.S. long-term interest rates: thus, “expenditure switching” via real depreciation would lead to an improved trade balance via fiscal “expenditure reduction,” an orderly rebalancing that maintains U.S. and global growth. Also, as Brad Setser and I have argued in our recent China Trip Report paper, China would benefit from an appreciation of its currency for domestic – internal balance – purposes separately from the contribution of such an appreciation to the orderly global rebalancing.

But if the reduced foreign financing occurs without a parallel reduction in the U.S. fiscal deficit (in part via tax increases), then we are in hard-landing scenario, where the reduced supply of financing hits a still-persistent demand for fiscal deficit financing. In that case, not only the dollar does sharply fall, but long-term interest rates shoot up sharply, prices of risky assets (housing, equities, high-yield debt) fall sharply, a systemic crisis occurs and we risk a U.S. and global economic slowdown, if not an outright recession, as sharply higher real rates and negative wealth effect reduce private consumption and investment. In that scenario, the trade deficit will shrink in a disorderly and recessionary way for the U.S. and global economies.

Thus, to all of those we say that we do not have to worry about the US fiscal deficit or we do not have to worry about the US current account deficit or that we do not need a Chinese/Asian currency movement, one can reply: you are incorrect as an orderly global adjustment requires both a US fiscal deficit reduction and an Asian currency adjustment. Curre
ncy adjustment in China and Asia without a parallel US fiscal deficit contraction will lead to a hard landing triggered by higher US long term interest rates. A US fiscal adjustment without a change in relative prices (the Chinese/Asian nominal and real exchange rate) will not trigger enough of an expenditure switching effect that is required to reduce global imbalances.


In the film Rashomon, each story and interpretation given by the various characters is self-serving, and all these stories are mutually contradictory. At the end the viewer is left completely unable to determine the truth of the events, what really happened and who is to be blamed.

Hopefully, this note has brought some clarity on the causes and appropriate solutions of the current global imbalances. Some interpretations are highly self-serving, others conceptually and empirically flawed, other altogether Panglossian. There is an emerging consensus view on the multiple causes of these global imbalances and the need for a cooperative solution that requires each major region of the world to do its part. The main obstacle and problem is that the fiscal policy stalemate in Washington: the administration and the Republican Congress live in the delusional dream that the fiscal deficit can be meaningfully reduced without any tax increase (and actually via aggressive and reckless moves to make all the tax cuts permanent). Such reckless policy stance makes the probability of an orderly rebalancing smaller and increases the chances that the global rebalancing will be disorderly and occur through a hard landing of the US and the global economy.

39 Responses to “Global Imbalances: A Contemporary Rashomon Tale with Five Interpretations…”

D. BarnesMay 2nd, 2005 at 2:07 am

 Very comprehensive article but,  “it is mostly official political agents, not private ones, that finance the US fiscal deficit and the US current account deficit. Thus, his argument that the US does not “borrow” from abroad, but rather that the foreigners are willingly “investing” into the US is not supported by the facts.”  It is an interesting line you define between foreign public and private investment/lending. The U.S. “borrows” from the foreign public sector, while the foreign private sector “invests” in the U.S.  I disagree that the foreign public sector is unable to “invest” in U.S. financial assets.   The requirement that only the private sector can “invest” is deficient in our current unstable world. If you take the public subsidies of farmers as a public “investment” targeted at a strategic resource (the food supply) you can see where advanced economies gradually reduce public “investment” in the private sector to those required for domestic “survival”.  China etc. are just taking the subsidy of a single strategic market (food supply) to an extreme and are targeting their entire economy through currency manipulation.   The public “investment” in the depreciation of their currency through purchases of U.S. financial assets may seem backward, but is in fact just a much broader intervention (investment)in private markets than most “advanced” countries are currently willing to make. It possibly could be argued a fairer one, though usually such interventions tend to concentrate benefits towards “exporters”.

marc russoMay 2nd, 2005 at 4:57 am

Great post, Mr Roubini.  So the question is how long will the Chinese hold out? What is the trigger they are looking for to rebalance? Are they out to specifically maim the US$ as a global currency or are they looking at domestic outcomes?  Can anyone put themselves in the mindset of the Chinese leadership and rationally nut out what they are up to?

kasperMay 2nd, 2005 at 8:28 am

another super piece.  on a practical note – why dont you make available a printer friendly version?  cheers,

Joseph WangMay 2nd, 2005 at 9:18 am

I’m curious what people think the optimal strategy for the PRC given that the People’s Bank of China has no control over US fiscal policy. Without a US commitment to reduce deficits (which won’t happen in this administration), what is the most responsible thing for the PRC to do?  Also, I think that there are some very strong non-economic reasons for the PRC to continue to finance the US budget deficit. Strategically, it makes it impossible for the United States to undertake a policy of containment or a hostile anti-China policy. As long as the PRC continues to finance the US budget, the US is not in a position to match military spending increases in the PLA.   This has already had a major impact on the PRC-Taiwan military balance. The US has been trying to sell Taiwan more advanced weapons since 2001, but the Taiwan legislature has been balking at the cost. The logical question is why the United States doesn’t cover the cost of the $18 billion package and this goes back to who is financing those weapons.   There were a number of analysis circa 2001 which argued that the military balance in the Taiwan Straits would shift about 2005 (i.e. now) even with those arms purchases (which didn’t happen). One could surmise that in a straight PRC-Taiwan conflict the balance of power is now tilted quite substantial toward the PRC, which explains some of the news headlines you’ve been reading.   Given the overwhelming advantages of being the chief creditor to your largest potential enemy, I suspect that the PRC will be willing to finance the US deficit indefinitely as long as it doesn’t cause a crisis in its domestic economy.    

VorpalMay 2nd, 2005 at 3:18 pm

Your post may be true, but from a US policymakers point of view, it is not really useful.   If the Chinese or some other foreign power wish to peg their currency, then that is their right. We can’t control others and are foolish to think we can. If there is a problem in OUR country we should try to do what WE can to address it.   So, if there truly is a current account balance problem, then the role of an economist who wishes to make policy recommendations should be to suggest options that are within the control of the policy-maker. The Chinese currency peg is NOT one of those things. To repeat this over and over is whining.   The question should be, what is the best policy for the US to pursue? Get it through your stubborn ivory-tower brain that changing the yuan is not an option.   Finally, I’ll add that this dwelling on China is a bit bizarre. We have deficits with the entire world. We have huge deficits with Japan. Why can Japan have a massive export base and still maintain a high per capita income?   It just seems like you all are making excuses. That somehow, the ONLY option available to the US is for the Chiniese to revaluate their currency, any other recommendation is too distasteful for any true economist to consider.  America is getting it’s ass kicked and you all aren’t making constructive suggestions.   

Rodolfo MartinezMay 2nd, 2005 at 4:14 pm

Such clarity is amazing! I think there are a couple of loose threads maybe.   – You should address the fact that it is almost impossible to rationalize the very small (very small and falling), interest rates on long term US government debt with even a small probability of your main scenario taking place. I think it would be entirely possible for china to hold its peg and yet for US rates to rise, which should have happend regardless, if you are right. (maybe citing Eichengreen’s observation of repeated large market misspricings in history would be a start)   – If this ‘low-investment-glut’ is such an important part of the Why are we here? part of your world, I think you should atempt explaining it. Maybe it is also part of the Where are we going? part. That is, it is much easier to believe in the Richard Cooper story that foreigners don’t think US assets are particularly overpriced, and therefore the marginal investor’ keeps their price up, if this global investment slowdown represents a big regime change for the world, where the the world is aging quickly and US is likely to be one of the few long term growth, stability (and political power) engines.  – finally I value the huge effort you put into making this debate public and raising awareness, but I aslo feel you could be more realistic in taking a middle ground view. It is clear your story is part of the story. It is also, I think, transparently clear it is not the only part. thanks a lot!

Joseph WangMay 2nd, 2005 at 4:36 pm

I think part of the issue here is that the Chinese political and economic leadership are open to suggestions and ideas about what to do. I get the sense that there is a lot of internal debate about what China should do, and so ideas and suggestions, including those by Western economists and politicians, are going to be taken very seriously.  By contrast the political leadership in the United States has decided what they are going to do (cut taxes), and I think it’s pointless to try to talk them out of it.  So telling the American government that they need to raises taxes or cut spending is pointless, since no one is listening. Telling the Chinese government that they should or should not revalue the yuan is useful, since people there are really listening.  Part of the reason for this is that the American leadership can’t imagine an economic crisis so bad that it would destroy the United States. By contrast, if you look at Chinese politicians, most of them are scared out of their minds.   

chuckMay 2nd, 2005 at 4:57 pm

What is the agenda of all the various parties is the question. Foreign glut of saving sounds like meaningless talk. When our economic leaders talk to us there is something left out, what we do not know, and perhaps something else, what I call half truths or as Natalie Grant, the lady that discovered the “disinformation” propaganda of the Soviet Union said about disinformation, what is the agenda? Since we as a nation go deeper and deeper into debt every day my guess is that we need a crises before we can address the problem of all our debt and low saving in the U. S. Thus a hard landing is the most likely outcome. Then the agenda will be SAVE THE COUNTRY by the very same people who say what problem today. Therefore the agenda is we are in power and lets do and say anything we need to to stay in power. Power trip baby. Thats what life is all about for some people.

JoanMay 3rd, 2005 at 5:17 pm

Vorpal, To some extent I agree to your words, however, is there any chance to tell Bush to cut the military spending? Moreover, US is trying to intervening China’s economy and it does be powerful. I agree that China should move its peg because of both domestic and international contitions, but now it’s not a good time to conduct this action.

Winslow R.May 3rd, 2005 at 5:42 pm

As always the general confusion between “savings” of financial assets and “holdings” of nonfinancial assets muddles the discussion.  How will “wealth” concentrations be resolved? Recent history provides us with the range of choice between WWII and the hyperinflation of the 70’s.   Japan is still waiting to choose while the rest of the world wanders closer to making the choice as well.  The “rich” would like the U.S. citizen to accept a lower standard of living, we’ll see…  “Today, the global economy is on the threshold of more change. Severe global trade and financial imbalances pose grave risks to international stability. While the costs of restructuring these imbalances will be substantial, the most pressing issue will be the global distribution of the costs. The underwriter of the existing restructuring, the United States, will face a tremendous challenge in arranging a revision of the current global economic regime, which requires the cooperation of other important countries and regions to bear a portion of the cost.”  

RichLMay 3rd, 2005 at 9:26 pm

Well done, but with a few issues.  Asia borrowed too many US dollars in the 1990’s, which led to the Asian debt crisis. From their perspective, it’s rather less painful have excess savings in maybe overvalued dollars than to have loans that cannot be rolled over in same. A short term dollar loan for an Asian country is really a USD short position, and covering hurts plenty when banks and economies suffer the occasional contagion.  Second, if there is such a drought of savings in the world, why are Japanese interest rates on the floor, the 10 year note at “conundrum” rates (to coin a phrase), and world equities looking overvalued? As a long-time habitual saver, it pains me to have so few bargains in the stock market and so many in retail stores. Can it be that the low US personal savings rate is simply a rational response to the prices on offer?  If both observations have any validity, the RMB will trade at higher levels (a move like JPY), but later than you would think and at a time when the PRC needs the change and would most benefit.

DORMay 4th, 2005 at 4:09 am

 In a nutshell, the US is running large fiscal and current-account deficits; the financing is mostly coming from foreign Central Banks that are striving to prevent their currencies from appreciating.  1. Duetsche Bank appears to be “differently clued”. Enough said.  2. Ronald McKinnon is an optimist. While he notes that forcing China to move its peg would lead to the same destabilizing deflation that plagued Japan post-Plaza Accord, has he really taken into account the vast differences between late-1980s Japan and current China? Financial system, market mechanism, political structures.  3. The Fed view(s) look at the world in what is becoming the key characteristic of the Dubious Administration: Us vs. Them. It isn’t our fault; they are to blame. I suspect that if they get their wish, and China revalues, we will hear about “imported inflation” a few months later. (I am reassured by the comment that the political process will play a role in the adjustment: throwing these dangerously irresponsible bums out would be a great start!)  4. Richard Cooper sounds like a great guy to have a beer with: he wants to make everyone happy. He also seems to know a bit about the fragility of the Chinese financial system and the importance of continued employment growth.  5. The Roubini and Setser (and consensus view) adds a critical element missing thus far: the quid pro quo. For every 1% reduction in the US fiscal deficit, China might agree to a 1% increase in the value of the renminbi. Thus, a 15% appreciation would require about $62 billion be trimmed off the US budget deficit. Since the GOP is so against tax increases (and, 2006 is an election year), that works out to something like a $200 billion cut in spending.  Question: what would be the impact of a $62 billion fiscal improvement? And, what if it came via a $200 billion spending cut?   * * *  While things may move faster today than in the past, I find it difficult to accept that Japan’s 30 year growth spurt is equal to China’s decade of high growth. Shouldn’t we compare China 1995-2005 to Japan 1960-70?  On the inflation risks in China, the early 1990s had two major new characteristics: high inflation and mass migration from farms to cities. Through a combination of policy measures (mainly administrative guidelines), inflation was brought under control at about the same time as the rural migrants were hitting their stride in urban work. That shut the door on wage hikes for unskilled workers, which suggests that inflation is less of a risk today than in the previous decade.  I also feel that the deflationary effects (on China) of an appreciation are over stated. The import component of domestic demand is minimal, and is likely to grow only very slowly as a small share of the urban population develops a taste not just for foreign branded products, but also for foreign-made products.  * * *  “Given the peg of the last few years and the sharp increase in Chinese manufacturing productivity, Chinese tradeable firms’ profit margins have been increasing over the years.” —Note that 55% of China’s exports are from foreign invested enterprises (FIEs). The FIEs’ share of increased profitability is likely to be much more than 55%.  * * *  Joseph Wang, The PLA is a land-based military. It has no ability to (nor record of) successful power projection outside China’s borders. None.  Vorpal, The US domestic policy options are less attractive to politicians than blaming China. Hence, China gets the blame. Sad, but true.  RichL, You raise an important point: the Asian Financial Crisis was not long ago, and about as well remembered out here as the US depression was in 1940. .

John DerpanopoulosMay 4th, 2005 at 6:44 am

A pretty good summary of this ongoing debate in which, as with all debates, there is some truth to each side. Hence a selective synthesis is in order which you (N. Roubini) put together. One important aspect that was surprisingly left totally out of this discussion is the role of the US private sector’s deficit (or dissaving) in contributing (in my view) the most to the existing international imbalance. It is no secret that whilst most corporations (in the developed world) as well as non-US consumers are rationally spend-thrift in view of the uncertainty over the growth and jobs outlook, US consumers are mortgaging every last bit of their untapped wealth to invest in real estate and/or spend to keeping up with the Jones. Current consumption out of housing equity extraction (through refinancing) is well documented and we don’t need to go through it again. While it has helped pull the US economy out of the 2001-2 recession, it is based on unstable ground and has certainly contributed to the US’s external imbalance. This over-consumption and real-estate frenzy is directly the result of low/negative real interest rates. The problem is how to reign back the US consumer (with higher interest rates) without tipping the economy and the rest of the world into recession. It is here where expenditure switching (aided by exchange rate re-allignment) is in order. If it is enough to save the day is another matter. My own view is that it is a bit late in the game to avoid another recession in the West as the curtailment of domestic spending will not be met promptly by higher demand from Asia. Longer term though I think we face a different problem altogether: that of critical supply shortages (oil being the prinicipal example) which will ration current living standards towards the growing Asian blocs.

mike wMay 4th, 2005 at 10:58 am

Warren Buffet recently put over 20 billion in foreign currencies-and he reportedly would like some more. Shouldn’t an american push some wealth abroad to hedge his own risk for the next several years? And what would happen if more than just a few people got the same idea in a short amount of time?

Joseph WangMay 4th, 2005 at 12:53 pm

The PLA *was* a land-based military. Since 1985, its been remaking itself in order to present a credible threat of force against Taiwan, and it’s only in the last two or three years that these efforts have started to make a major political impact. The main shift that has happened in the last three years, is that it is now pretty clear that Taiwan cannot defend itself without massive direct American military intervention, and that changes the political situation quite a bit.  Military and economic power are very closely connected. If you make your army too large, then your economy sinks.      

Alex GreyMay 4th, 2005 at 1:40 pm

I couldn’t agree more with your analysis. I might add that the U.S. current account deficit, Fed policy, asset bubbles, Asian purchase of US Treasuries all potentially stem from deeper problems in the global economy.   The main problem is the growth over the past 20-30 years growth of industrial capacity globally that has outstripped demand. This is perhaps the explanation for why the world currently does not face a savings glut but instead inadequate investment. This problem of excess capacity has never been completely resolved even by three recessions (1981-82, 1990-1991 and 2001). Prior to this period Keynesian countercyclical policies prevented a rationalisation of capacity. However, in the post-Keynesian era, government stabilisation has been replaced by deregulation of financial markets and declining nominal interest rates which to my mind were the most important policies adopted during the neo-classical/monetarist era. Obviously as we live in a neo-classical world most economists emphasise product market and labour market deregulation, which to me are a distant second and third in terms of their impacts on the economy. The result of financial deregualtion and declining nominal interest rates has been a sustained stimulus to aggregate demand through growth in credit.   Financial deregulation and consequently credit growth has played itself out unevenly across the global economy, with the Anglo-Saxon economies having gone the furthest in financial deregulation of their economies. The result has been huge global trade imbalances, and not surprisingly now at this late stage an almost desperate desire of foreign central bankers to prop up US consumption and forestall adjustments in global trade. All this is really saying is that governments have managed to prop up demand to forestall a period of global capacity rationalisation but their impact has varied so greatly across the global economy that it has been associated with huge trade imbalances. Therefore, aAll I have does is to turn the argument that there is a savings outside of the US are too high on its head. In fact, savings in Europe and perhaps even Japan are probably normal, while savings in the Anglo-Saxon economies are too low because of the influence of financial deregulation that has lead to massive credit growth and a succession of asset bubbles. When global savings are pushed back to normal levels as they inevitably must be, this will expose substantial excess capacity in many industries, the implication being that this will be the process of global restructuring which is likely to both accompany as well as accentuate a major global recession.   The risks of this strategy are becoming painfully apparent in the massive speculative flows that have been generated in an era of financial deregulation combined with low nominal and real interest rates. It appearsd that we are in the final stages of a long period of credit growth where in fact only a housing bubble supported by low long-term interest rates in the has provided sufficient incentive for the continued accumulation of consumer debt and hence faster demand growth to offset the structural headwinds facing the global economy, notably in the U.S.   Speculation and the asset bubbles that it endangers substantially raise the risk of a period of debt deflation. To me Fisher’s theory of deflation offers the best explanation for the development of a Keynesian liquidity trap. This is exactly the situation Japan now finds itself in, with their main policy being to try to stop the process of the liquidation of assets under the pressure of massive bad debts. In other words the Japanese are doing the best they can to forestall a very damaging process. Unfortunately it looks like time is running out. To me it looks like we increasingly risk setting this process in motion in the U.S. and elsewhere in the global economy. This will signal to me the end of the neo-classical/ monetarist experiment. The problem is that I see no way out of the morass the global economy is falling into. Even Keynesian policies are likely to prove inadequate in offsetting large asset market effects on the real the economy as speculative bubbles deflate.   

steve kyleMay 4th, 2005 at 9:57 pm

A slightly different way of saying it is that there is going to be an expenditure reduction in the US whether we like it or not. Ex ante, WE get to pick which expenditures get reduced by lowering our deficit in a manner of our choosing. Ex post, it will be done for us by the market. The first sectors to take the hit will be interest sensitive ones since these will bear the brunt of the hard landing when it comes.  Similarly, China will appreciate whether they want to or not. Ex ante, they can pick the time and extent of it if they want to manage the building pressures, Ex post, poorly sterilized inflows plus 10 per cent growth will eventually lead to inflation and a real appreciation whether they like it or not. And such an inflation once started is not so easy to manage.  The fallacy is in thinking that there is a choice about whether these adjustments will happen. They will. We can choose how the pressures get relieved if we act ourselves or we can wait and have the choice made for us. We can only pick the timing and the composition of the adjustment, not whether there will be one or not.

DORMay 4th, 2005 at 10:43 pm

Joseph Wang,  China brought into service its first amphibious mechanized division in the late 1990s. The 127th amphibious Mechinized Infrantry Division, based in the Guangzhou Military Region, is still experimental. Current capability is moving one division across the water. The South China Sea Fleet has a single Marine Brigade. Grand total amphibious capability: one division plus one brigade.  The landing craft are Yukan Type 72, 72-II and 72-III The highest estimated numbers in service in August 2004 was 23. At maximum load, that’s 5,750 troops or 253 tanks, with no losses. [source:] Figure 10% mechanical breakdown per trip and then imagine moving a dozen or more divisions under conditions of less than absolute air and naval superiority. Just the number of landing craft required would be on the scale of the numbers built in WWII! . 

Movie GuyMay 4th, 2005 at 11:57 pm

“Hopefully, this note has brought some clarity on the causes and appropriate solutions of the current global imbalances. … There is an emerging consensus view on the multiple causes of these global imbalances and the need for a cooperative solution that requires each major region of the world to do its part.”  Nouriel,   You wrote a good piece, but simply ignored the role that global trading policies play in the current imbalances we observe.   Why is there this great fear or hesitation to zero in on the trade policies that opened up many of the current problems?   Eliminate all of the fiscal deficits, and there are still the large trade imbalances.   Eliminate all of the currency exchange problems, and there will still be large trade imbalances.   When is someone, anyone of stature, going to zero in on the global trade policies as one of the causes of trade imbalances?   Not one mention of global trade policies, Nouriel. You have to be kidding…   

SigurdMay 5th, 2005 at 12:43 am

In the defense of Bernanke, he doesn’t really say in his speech that foreign investors have continued since 2000 to invest in the US to ‘chase safe and high returns’.  In fact its quite notable that he doesn’t mention this at all.  In his speech much is made of the period up to 2000, where investment in the US by foreign private investors was strong. Much is made of the effect on interest rates and home prices of capital inflows since 2000. But he doesn’t even mention the source of the inflows since 2000.  Obviously you have already answered why. 

StormyMay 5th, 2005 at 10:54 am

Movie Guy,  The argument always seems to be that some sector of the economy will grow proportionally to take up the slack: Somehow a natural law of economics. If because of trade policies, jobs are lost in one area, then skills will be honed in another area. Unfortunately, we are slowly moving up the food chain. It is very interesting to read the latest advice to displaced workers. It has changed slowly, advising every higher and higher skill levels. Having been in the IT field for some time, I have been consistently amused with what is increasingly being asked of the average worker.  The problem with much economic analyses, in my very uninformed opinion, is the level of abstraction. General flows are noted and followed—and laws of economics are applied, but how the money actually changes hands is not. Who really gains…who really loses. I am sure you already know too much of my thinking on this, but a simple example. Company A from Land A decides to move its manufacturing and some of its support staff base to Land B, where the labor is far cheaper. Wise business move. What happens when many companies from Land A decide to do the same thing? Does Land A gain? Does Land B gain? Who gains? Where does the money go? I have rarely seen any complex modeling done at this level. (Game software people could do it. But that is my bias. Lol)  Those who favor the way this is happening see the deficit as an investment in the United States. And I can understand, from a purely business point of view, why they do; after all, American businesses are out there doing their thing, competing. Profits are up. Those who worry see a cash flow and currency problem between countries. The former says there is no problem; the latter says there is. While I agree with the latter analyses, in either case, the modeling in both lacks real depth.   Globalization will occur; those countries not blessed with immense natural resources have serious issues. Capital can go anywhere for cheap labor, and it is natural for capital to desire to keep the labor as cheap as possible. On the other hand, it is the obligation of each country to protect its citizens. Unfortunately, we are now at the level where governments must coordinate their efforts to insure that the free movement of capital is not simply exploitive in every sense of the word. Can they do this? I don’t think so. Watch what happens when two local communities vie for a firm—tax breaks, incentives. And when a third community enters sometime in the future to make a better offer, the firm up and leaves…the community crashes. If we cannot manage this within our boundaries, how can we handle it outside? 

Pingfan HongMay 5th, 2005 at 2:30 pm

More than two hundred years ago, China had for the first time in its history registered a sizable trade surplus vis-à-vis the West, as the growing demand in Europe and America for Chinese goods, such as tea, porcelain and silk, had not been matched by Chinese demand for Western exports such as cotton and woolen goods, fur, clocks, tin and lead. Under the old international monetary system of bimetallism (gold and silver), the result was a serious balance-of-payments problem, a steady outflow of silver from the West to China. By the late 18th century, the British had developed an alternative product to balance its trade deficit with China: opium (see for details in Jonathan Spence, The Search for Modern China). We all know the disastrous consequences to China.   Today, under the dollar-center international monetary system, the Americans have a better alternative: the greenback, which is virtually costless to print, and not deleterious (is it also not addictive either?). Anyway, China seems to be delighted to keep accumulating the greenback, at least so far.  

mundensMay 5th, 2005 at 10:45 pm

To DOR – Why does Tibet not count as a successful power projection by the PLA outside China’s borders?  For those who seem to think China is happy to continue buying US dollars, I would point out that the recent revaluation of the US dollar was caused by the the Chinese and Indian governments selling US dollars and buying Euros, and was a direct warning to the US, as shown by the simultaneous press releases from the finance ministries of both countries   It may not be visible from within the US, which has a very egocentric view of the world, but out here it’s very clear who is in command. China, and India, the US is just dancing like a puppet on their strings.   As to when and how the crash comes, that is purely in the hands of the PRC’s government now. If they want to cause a crash and induce massive dislocation they can. If they want to slowly ruin the US, the way the US ruined the former USSR, they can. Or they can choose the “enlightened self-interest” route.   The problem is that the leaders of the US stil have not digested the concept of total warfare as outlined by a seminal paper from the PRC’s top strategist (I can’t find the link to that anymore,but there is a fictioanlization of the strategies outlined in the original paper, called “Dragon Strike” here : .   In that frame, buying and selling dollars is just another weapon in the ongoing war. US strategists are focussed on getting greatest short-term gains for the Skull&Bones club and are not focused at all on protecting the US as a country. The PRC’s strategists, on the other hand, are focussed on long term success for their country.   As the two goals are not diametrically opposed, and in fact, in the short term are directly aligned, the PRC’s strategists effectively have had a free hand.

DORMay 5th, 2005 at 11:02 pm

mundens,  I’ll avoid going into the issue of whether Tibet is or was part of China. Instead, I’ll neatly side-step the issue and point out that it was strictly a land-based projection of power, and that no one with any combat experienced gained in that conflict is still in uniform.  “Dragon Strike” was a fun read. Pure fiction, but fun. . 

Joseph WangMay 6th, 2005 at 9:01 am

DDR,  Current PRC thinking on dealing with Taiwan doesn’t involve a Normandy-style invasion. Rather it involves rapidly gaining air superiority. Once you have that, then you don’t need a huge amphibious capability, since you can destroy any mass of defending troops from the air and you can make it impossible to perform command and control.  If you go into, you’ll see a report issued circa 2001 on this. Also, the importance of air power (and the total unimportance of amphibious firepower) becomes pretty obvious if you wargame the situation. If the PLA can knock out the ROCAF because the carriers arrive, it wins. Conversely the goal of the Taiwan player is to stay alive long enough for the US aircraft carriers to arrive.  One division is about the right size for an invasion force. If you have control over the air, its more than enough to win. If you don’t have control over the air, then any amphibious force is useless. Since resources are finite, you don’t want to overspend on the amphibious force because that decreases the amount available to spend on fighter aircraft and ballistic missiles, which are the key to winning.  Stepping back a bit. I think its often forgotten that militaries are ultimately political tools, and that if you have to fire your weapon, you’ve failed. If the PLA didn’t exist, Taiwan would have declared independence long ago and the US would have recognized this. The point of the PLA is to have enough credible force to prevent the United States from doing certain things (and vice versa).   I do find that military discussions on the internet tend to be fairly useless, because they all tend to degenerate into “my army is better than your army” which is the wrong way to think about it.   

Joseph WangMay 6th, 2005 at 7:38 pm

Note on Roubini-Setser’s report….  There were a few points that I disagreed with. The first is the description of center-local relations. In actuality there are many layers of government, but you can simplify a bit by dividing into central-provincial-local.  The provincial governments do not have a finance crisis as they are funded by part of a value-added tax which share with the central government. Also a real estate boom isn’t going to improve provincial government finances that much as provinces are large diversified economies, most being the size of your typical European nation. Finally, provincial leaders are “close” enough to the central government that Beijing can keep a close watch on them.  The trouble is the local governments which do not not have much of a revenue base. They are tempted to turn land over the real estate developers, but fortunately they are much too small and localized to politically pressure banks too much. In fact, the state banks aren’t terribly interested in lending to support these rural development projects.  The conclusion also I think neglects one thing and that is that China is still at a very low level of development and can absorb quite a bit of capital spending. Capital focused development turned out to not be useful to Japan in the 1980’s, but it was useful in the 1950’s and 1960’s, and China has a decades to go before it reaches the economic development level of Japan-1980’s when high capital spending became self-defeating.  One other minor but important point. China has a hugely complex and arcane land tenure system, but the interesting thing is that most peasants don’t dislike the system (see recent issues of China Quarterly). The trouble with giving peasants full individual ownership rights is that it removes the possibility that a peasant will go off to the city, work, and return to the land if things don’t go well for the peasant.   Also, it’s not clear that giving peasants individual title will protect them from local officials. As the system stands right now, local officials do illegally sell off land to developers, but the cost of that illegal sell off is distributed among all of the peasants in the community, and so no one ends up totally destitute. The fact that land is owned collectivelly also limits the amount of illegal activity that the local government can undertake, because in illegally selling land to developers, the government ends up taking a bit from all of the peasants in the village, who can and do fight back using legal methods or sometimes by just staging a local revolt.  If you moved to a system of individual titles, then the government can either force peasants to sell or just confisicate the land, leaving the peasants with absolutely nothing. Also, in seizing land, the local officials can divide and conquer peasants making illegal action easier than it is now. Keep in mind that if you just move to individual titles, the peasants with those titles are going to have to go through the same flawed and biased legal system that currently exists to defend those titles.   The other thing that the current system prevents is for people with strong local official connections from seizing control of the agricultural lands. This prevents some of the worst situations that one sees in Latin America from cropping up.    

DORMay 10th, 2005 at 10:03 pm

Joseph Wang,  I read the Rand report when it came out. Unconvincing. The assumption seems to be (a) China rapidly develops an air superiority capability, an airlift capability, an AWACS capability and in-flight refueling capability; (b) Taiwan does not improve its air force or air defense systems at all; (c) the US does nothing.  As was shown in Vietnam, Iraq and other places, air power alone can cause a lot of damage, but it cannot decisively win. Boots and heavy hardware, on the ground, are needed.  Amphibious force isn’t about firepower (except very local). It is about moving huge numbers of men and very heavy equipment across water. One PLA division on the island of Taiwan would face the 300,000 man ROC armed forces, and die.  China has zero carriers and an equal number of pilots who have ever made a landing on an aircraft carrier, day or night.  I agree on the point about military being a political tool. Why is it that the day a country goes to war the foreign minister doesn’t resign as a failure?  Check out the forum. You have to register, but it is free and there are a whole lot of people with a whole lot of knowledge and experience who have been analyzing and discussing these issues for about eight years.  David Davenport,  If you move to a land title system, you also are able to move to a mortgage system and free up an incredible amount of capital. . 

DFMay 13th, 2005 at 3:59 am

Great post, yet, it would have been nice to hear the chinese view. May be the japanese or korean one.  The review is 4 americans, one european, and we’re talking about CHina. Something’s missing here, clearly.   Besides, I do not agree with your view on inflation-deflation in China. Clearly China is a booming economy on an unsustainable path (50% of GDP is investment, you bet they can’t do much more !) 33% is export. I would like to know what was the situation of japan back in the 80’s. I bet they were a less open country. So China is very sensitive on currency issue, much more than the USA and this is understandable.   This said, I’m not saying devaluation has not to occur. I’m just saying there should be an organised process. May be CHina should put control on capital movements before it reevaluates. May be it should force the USA and Europe to commit to stabilize the relative price of their currencies.  Also, it is necessary to ask why investment is not increasing. May be there is no profitable investment anymore, not at this level of price, not at this level of wages. Present and future global wages are too low, present global profits are too high, that’s the reason why investment does not grow. The marginal investment can only reduce the rate of profit. May be there’s no profitable investment anymore, profitable sells can only happen with increased loans to overindebted consumers.  If so the path for recovery is through agressive moves for higher wages and higher employment.    But may be the crash is now unavoidable, and the only aim of political leaders is to put the blame on others.  If it is so, the best solution for them is to do nothing, wait for others to move first. And when those others do not, agressively blame them. When the crash happens the power will shift from global companies to national political leaders eager to close borders, and control the economy…  

W. Raymond MillsMay 14th, 2005 at 11:45 pm

Mr. Roubini has one hit and one miss.  He is correct that the speech by Bernanke is full of confused thinking. We need better leadership from the Board of Governors. The U. S. trade deficit is created by U. S. citizens. We purchase more imports than can be paid for by our exports. Our trade deficit is within the power of the U. S. to correct.   His mistake is that he accepts the all too common assumption that foreign governments are the necessary source for financing either or both of our twin deficits. It is true that foreign governments are curretly purchaseing more than half of the U. S. Treasury Certificates. That is a decision that they make and is not necessary to finance either deficit. Financial assets in the U. S. are adequate to finance both deficits. Foreigners take a high proportion of our Treasury Certificates only because they are willing to accept interest rates that U. S. investor consider too low.  It is true that a trade deficit requires a diminuation of the Net International Investment Position of the debtor country and an increase in the NIIP of the surplus country. But it is an error to think that the purchase of U. S. Treasury Certificates by foreign governments is the means of changing the NIIP. The purchase of U. S. Treasury Certificates by foreign governments is a financial asset-to-asset transfer. By definition, such an interchange leaves the NIIP of both countries equal.  What changes the NIIP of both countries is the initial movement of financial assets from the U. S. to another country to pay for our trade deficit. That is an exchange of financial assets for goods and services and does change the NIIP of both countries.  This means that the U. S. trade deficit is financed by U. S. citizens. No need to worry as to how long foreigners will be willing to purchase our Treasury Certificates. Such purchases have no bearing on the sustainability of the U. S. trade deficit. Such purchases restrain, somewhat, U. S. interest rates but the U. S. economy needs higher interest rates to reduce consumer debt.  Mr. Roubini is a brilliant thinker but his viewpoint is flawed by a misstatement concerning how the U. S. trade deficit is financed.

StormyMay 16th, 2005 at 12:57 pm

W. Raymond Mills,  I am not sure that purchase of U.S. securities is a simple asset-to-asset transfer, netting everything out to zero. There is the question of interest to be paid: It is a bond, a loan. That, in itself, is a payment. In addition, the demand for such securities keeps interests rate down…providing for such things as lower mortgage costs and purchases of other goods—and many of these goods come from abroad. In short, there is a direct connection between the twin deficits.  Furthermore, purchase of those securities allows financing of the war machine.  The government sells securities to raise cash. At some point, the US must repay the principle with interest. The more U.S. securities that are sold the more chance of creating a snowball effect: New securities are needed to cover the payment of old. It is not by chance that some are now in favor of the 30-year treasury.  Higher rates are needed…but what happens then? The whole machinery becomes a bit more expensive to maintain. People buy less, from abroad as well as at home. The tax revenue base shrinks even further. The government, now deep in debt, finds the financing of that debt much more expensive both in terms of interest and sell as its ability to repay old debts. 

StormyMay 16th, 2005 at 12:59 pm

Sorry…my last sentence was gibberish…silly keyboarding.  Should read:  The government, now deep in debt, finds the financing of that debt much more expensive both in terms of interest as well as its ability to repay old debts.

one questionMay 18th, 2005 at 3:41 am

i just have one question, lately Stiglitz has been making a big stink about how china should not change its currency peg, but should use an export tax. what do you think? he seems right to me.

jult52May 24th, 2005 at 8:31 am

This conversation may be dead but I printed out and read Mr. Roubini’s very thoughtful analysis and gave it some thought. I don’t think the US federal gov’t reining in its fiscal deficit in short order is any sort of imminent possibility — (through a tax increase?) — and I don’t understand why a failure to reduce the fiscal deficit would necessarily cause a “hard-landing scenario.” I think the causal chain of events in such a scenario needs to be spelled out in some detail before it can be accepted.  I look forward to reading more of this blog in the future.

Liberalize ThisMay 25th, 2005 at 7:35 pm

Here’s a very simple and easy solution: Let the rest of the world dump the American Dollar like a bad rash, and let the American Empire fend for itself.  All this propaganda rhetoric about “global rebalancing” that Capitalist “economists” (read: Pro-American apologists like this Roubini) love to rant about is so much Doublespeak for PASSING ON America’s problems to the rest of the world.  America’s problems are America’s. Don’t expect the rest of the world to bail the American Empire out. You don’t deserve it.   A second favorite propaganda phrase that American shills love to cry about is “currency manipulation.” “Currency manipluation” is yet more American Doublespeak for any country that refuses to obey American dictates and open up their financial markets to American financial predation, such as exemplified by George Soros and his ilk.  What Free Market fundamentalists conveniently overlook is that many countries around the world including (not just China or even Japan) peg their currency to the dollar, AS THEY SHOULD. While it may benefit American predators and their Neoliberal ideologues like Mr. Roubini, “liberalization” of financial markets DO NOT BENEFIT THE PEOPLE IN THE TARGETTED NATION.  In fact, after the 1997 Asisn Financial Crisis, nations that refused to heed America’s benevolent “advice” to liberalize their financial markets like Malaysia, China, and Vietnam survived relatively unscathed, while those nations that appeased America and foolishly accepted the USA’s self-serving advice (like South Korea) got screwed over by Uncle Scam.  A coincidence? Of course not.   This is of course is nothing new for American vultures who specialize in raping the economies of the world through “international” institutions like the IMF and World Bank.   EVERYTHING AMERICA DOES, IT DOES FOR ITS OWN CRIMINAL ‘INTERESTS.’ Trusting America and its “advice” is suicidal to the core, for every nation.  In fact, it appears that nations like Japan and China are finally starting to wake up and realize that propping up the American Dollar is not a wise business decision anymore, as can been seen in the URL below.  Let America and its Free Market fundamentalists like Roubini scream about this new development. The Perfect Storm is coming for the USA and it is fully deserved….

ramgopal agarwalaJune 7th, 2005 at 3:33 am

Congratulations on your excellent review of issues for correcting global imbalances. But the conventional solutions- appreciation of some Asian currencies, reflationary policies in EU and budgetary austerity in the US- are unlikely to do enough to correct the large global imbalances. As Larry Summers has emphasized, we need to increase global demand and not focus on “demand-switching” alone.  How about using regional infrastructure investment in Asia to provide that demand stimulus? According to UNESCAP, there is an unfilled demand in Asian infrastruture investment to the tune of $150 billion a year. Through its multiplier and acclerator effects that can, over time, create substantial additional demand in the world economy and reduce the pressures for exports to the US by Asian economies. And financing of these infrastruture investments should not be a major problem because the Asian economies are sitting on a mountain of foreign exchange reserves which are likely to increase even further in the medium-term future. Even 50% of the incremental reserves can finance all the infrastructure investment gap in Asia.With dollars flowing less slowly to the US Treasuries,US will face a harder external budegt constraint which will help it reduce its excess expenditures. Thus this Keynesian approach will be a win-win solution to the gloabl imbalances : it will help Asia acclerate it growth rate and help US reduce its current account deficit without hurting its growth. Does it not make sense to bring this Keynesian solution (through Asian regional infrastructure investments) into the global discussion on global imbalances?

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