Friday, September 21, 2007


There is a useful piece by Floyd Norris in this morning’s NY Times about the Fed’s response to the housing bubble. It echoes the larger debate, which has flared up again with his PR blitz, over whether Greenspan was fiddling while Roman property values went through the roof.

Let’s step back for a moment and consider the larger context. The US has been running a very large current account deficit. Here are the quarterly data since 1990 courtesy of the BEA:

US Current Account Balance as a Percent of GDP

If this were the total story, the US economy would have been moribund since the late 1990s when the deficit really took off. This fraction represents income that leaves the country rather than making purchases that would support domestic employment.

But this is only half the picture. The other half is the return of this money via the capital account, in the form of purchases of debt, like treasury bonds, and assets. This return flow not only finances the current account deficit, propping up the dollar, but also makes possible continued US economic growth. For instance, the willingness of foreign central banks to accumulate treasuries means that the Bush crowd can borrow freely to finance the federal government deficit without fear of pressure on interest rates. (This is not to say that the fiscal deficit is too high in any general sense, which it isn’t.) The infusion of foreign finance also sustains asset prices, like stock values, above what they would otherwise be. This generates capital gains for those who have positions in these markets and also encourages borrowing against paper wealth.

The housing bubble could be seen as a bit of both of these. Foreign purchases of mortgage-backed securities injected large amounts of money into the housing market, so that the demand for loans, no matter how outlandish, never exceeded the supply. This in turn fueled a bubble in the existing housing stock. Now that the bubble is bursting, there are fears of a general financial crunch.

Perhaps, but there is still one more river to cross. If the central banks and oil funds that currently finance the US external deficit continue their willingness to hold dollar assets, the money will simply have to go somewhere else. It can finance government and corporate debt, driving down interest rates. It can go into purchases of US companies, goosing the stock market. As long is it has to go somewhere it will.

The risk, of course, is that at some point the sovereign entities on the receiving end of the massive dollar flow will decide that enough is enough. Perhaps the extent of losses they will suffer due to the mortgage meltdown will force them to pull back. Maybe a private sector stampede, sparked by further bad news about defaults, will overwhelm the ability of CBs to stem the tide and sustain US financial markets.

The larger story, however, is that, as long as the US economy chugs along in a temporary equilibrium of massive external borrowing, bubbles of one sort or another are inevitable. That’s why it’s an equilibrium and also why it’s temporary.


ProGrowthLiberal said...

You are in effect saying that weak net export demand led to low interest rates driving the housing boom and its associated fueling of consumpton demand. This was the position of Dean Baker as he took on a few Angrybears (Kash, Steve Kyle, and even me) who were suggesting that the causation went the other way - strong domestic demand (low national savings) crowding-out net exports. OK, observing price variables (interest rates and real exchange rates) must be fit into this debate, which we Bears were still trying to figure out how we'd defend our position.

Peter Dorman said...

Not really. I think there was a big influx coming from sovereign sources (unaffected by interest rates), and this supported prices in a way that attracted an unhealthy level of private money too.

More generally, I think the reasoning that goes from insufficient US savings to a current account deficit is simply wrong. You can see my argument in the latest issue of Challenge.

Brenda Rosser said...

"..Instead, his model (Mishkin) showed that much of that damage could be averted if the Fed acted rapidly to cut rates — as it is now doing..."

Looks like wishful thinking to me. Here's my incomplete interpretation:

A general insolvency problem exists that is hidden by a refusal of financial institutions to reveal their balance sheets. The new financial accounting dating back to the Reagan admins' delusional 'economics of joy' is still in play. ('Economics of joy' = high military spending, low taxes for wealthy, employment based on high debt-based spending, severe cuts in environmental and social programs with resulting degradation of related infrastructure, national and corporate economic hitmen targeting,ie ripping off other nations, fictitious capital).

Global inflation in essence. Since the late 1960s - favouring, as it does, the concentration of wealth to fewer and fewer appears to have evolved into global asset price and debt booms. Economies growing through the use of cheap money pushed onto many through, often, outright fraud. Spending power (in the context of lower real incomes for workers and the hidden unemployed) boosted through massively increased debt. (More equitable distribution of wealth wasn't on the cards).

Some history:
1971 – Fiat money system begins. Superpowers resort to ‘bashing’ their trading partners. US stats systematically hide inflation as money supply increased 13 fold, or inflation exported. [and inflation through massive environmental degradation not accounted for.]

1970 – 2004 – Dramatic rise in 3rd world debt.

1970 – 1999 The income share of America’s richest 20% and poorest 20% stood at 30:1 in 1970. In 1999 it was 78:1.

1973 – the invention of the Black-Scholes options valuation model in the capital markets. Mathematicians now in great demand in banking sector to interpret an otherwise incomprehensible model and act as risk managers.

1981-1999 – Average interest rate now much higher

Early 1980s – Change in the form of retirement pension funding in the US. The beginning of 401K pension plans related to systematic under-funding of pension plans and PR effort to present corporate-funded pension plans as a form of welfare. Exacerbated by corporate bankruptcies. Financialisation .

1997-2003 – financial meltdown of 40% of the world

1997 – Profits in US Manufacturing cease to grow - overcapacity


juan said...


While the recycle no doubt became a major support for the U.S. and global economy and is, at this juncture, critical, I think it should be seen as only one aspect of the change in credit money creation since the early 1990s.

It has been during this period of financial deregulation and serial 'reliquifications' that we've seen the traditional banking sector pushed to the background with private non-bank asset-based lending and intermediation becoming dominant.

'Pushed into the background' does not mean contracted but does, though memories linger on, mean having less control. Which cannot absolve the Fed since its own actions/inactions made it an accomplice.

Nutshell: an out-of-control global credit bubble was created. The house price bubbles and overproduction of houses have been only the latest manifestation but one which may well mark the larger bubble's highpoint and progressive demise. (Credit) money does not have to go somewhere else but is also destroyed. said...

I would say that the direction of causation between the international imabalances and the housing bubble went from Chinese money flowing in to finance our buying of stuff from them, thereby propping them up against the potential of widespread unemployment among those pouring off the countrysiide into their cities in the current massive transformation, unprecedented in world history. That money flowing in kept long term interest rates down, even after the Fed attempted tightening more recently and pushed up shorter term interest rates (a move now going into reverse).

juan said...

Yes, export-led growth, managed exchange rate, a type of vendor financing are of a package with China's need to create employment but don't you think that 'Chinese money' is related to post-1990 rise of total inwards FDI* and the later export boom.

Causation can be multi-directional.

*(adjusted for 'round tripping' and not, essentially the same pattern)

Brenda Rosser said...

Barkley, was the Chinese 'unemployment' engineered by the Chinese Government in the first instance? I have read of millions of Chinese peasants being forcibly evicted from their land.

The flow of funds from China (and other nations) into the US appears to be consciously engineered (through the petrodollar arrangements the US had with Saudi Arabia and with other OPEC countries.)

“As Eric Helleiner notes, ‘the liberalisation of speculative international financial movements were a linchpin to the competitiveness strategy of the U.S.; since investors would naturally chose to channel their money in the New York financial markets and Eurodollar would preserve the privileged global financial
position of the United States.. In pursuing its competitiveness strategy the United States gained more influence over the international monetary and financial arrangements in the global economy by being able to freely decide the price of the world’s trading and reserve currency8. As Peter Gowan notes, although the DWSR [Dollar Wall Street Regime] did involve other major currencies (especially the yen and Deutsche mark) and other principle financial centres other than Wall Street and its London satellite, the Dollar-Wall Street nexus has proven to be the dominant centre. The significance of the DWSR lies in the fact that the United States, does not face the same balance of payments constraints that other countries face. It can spend far more abroad than it earns there. Thus, it can set up expensive military bases without a foreign exchange constraint; its transnational corporations can buy up other companies abroad or engage in other forms of foreign direct investment without a payments constraint; its money-capitalists can send out large flows of funds into portfolio investments (buying securities)9…
To deter financial outflows, many countries followed suit. This in turn led to increased forms of competition between deregulated areas of offshore money markets and the easing of regulation within domestic finance industries. Philip G. Cerny describes this new interstate arrangement as a shift from embedded liberalism compromise toward embedded financial orthodoxy10. The difference between these two arrangements is that in the absence of the fixed-exchange rate, states would use their increased leeway over monetary policy formation to engage in beggar-thy-neighbour tactics and currency devaluations, so as to draw financial inflows. In doing so, there was a de-linking of the overriding concern for continued economic stability at the international level from national prerogatives.’ .
Eric Helleiner, 'Explaining the globalization of financial markets,’ 323.

1968 - 1981 – Robert McNamara’s stint as president of the World Bank. A ‘massive escalation’ in World Bank resources. Aid focused on improving ‘the productivity of the poor’. The rise of OPEC makes World Bank loans and foreign aid less critical for the 3rd world. And unsuccessful UNCTAD efforts to implement fairer rules for world commodity trade.

juan said...

Correcting for/adding to my emphasis on the financial and then on FDI:

"Yet for all this, foreign investment has accounted for less than 10 per cent of capital formation in the [post-1978] reform era—including investment via Hong Kong. Rather, the internal processes of primary accumulation have been decisive. A vast production of surplus-value undergirds the Chinese economy. Appallingly low wages, long hours and hard work mean an exceptionally high rate of labour exploitation. This allows China to have one of the world’s highest rates of savings—over 40 per cent of gdp—generate huge foreign-exchange reserves—over $1 trillion by 2006—and expand its capital stock at a rapid pace: 20 per cent annually in 1978–94. Annual growth in capital stock is 3 to 4 per cent higher than was the case with France and Germany at their respective peaks..."

Brenda, this is a good article -


The PRC’s breakneck transition to capitalism seen through the prism of 19th-century Europe and America, as its cities rehearse the processes analysed by Marx: commodification of land and labour, formation of markets and capitalist elites. What lessons might the West’s past hold for China’s future?

Brenda Rosser said...

Thanks for the link Juan. Will read this more carefully later.

"..This allows China to have one of the world’s highest rates of savings—over 40 per cent of gdp—generate huge foreign-exchange reserves.."

I read Barkley's paper on OPEC and the Megacorps (from 1981 JPKE).

The concept of xenocurrencies is interesting. How apt is it to merely look at excessive levels of foreign-exchange reserves of various nations? Huge pools of money, not linked to any particular nation, not subject to taxation. Creating instability and speculation in national currency exchanges. Eurodollars, petrodollars, drug dollars. Now with the world's central banks printing money like confetti it doesn't seem to make much difference. The outcome is the same except things happen much faster.

juan said...


Not sure where to start.

When you say: ''s central banks printing money like confetti..', it sounds that you take these quasi-public and public institutions' open market operations to be the primary source of money creation and that this money is tangible, i.e. paper rather than electronic credit money.

Some decades ago the system transitioned into a credit money regime, also to say that almost all modern money, whichever unit of account or 'nationality', is a product of borrowing and lending.

During the 1990s, domestic (U.S. Europe, Japan,,,) money creation through traditional banking, e.g. commercial banks, fell away relative to unregulated and less regulated non-bank banks such as money market funds. As one recent paper by Ingo Walter noted:

"Classic banking functionality, in short, has been in long-term decline more or less worldwide. ... Disintermediation as well as financial innovation and expanding global linkages have redirected financial flows through the securities markets."
(Financial Integration Across Borders and Across Sectors...)

'Huge pools' and flows of claims were created through the dynamics of financialization including dollar recycling, yen carry trade (nearly free money generated by interest rate differentials and facilitated through forward currency swaps markets), mortgage debt securitization, creation of an array of structured products from MBSs to synthetic CDOs to CPDOs, asset price inflation...and so forth. Excess brought forth excess.

Main point though is that the run up in quantities and very much greater complexity of claims, of money creation, escaped control of national central banks and supranationals such as the IMF and has rendered such institutions' actions/reactions increasingly irrelevent.

The neoliberal project finds just desert in helping to create an incomprehensible out of control global financial system. 'Flying blindfolded' is where we are and the 'flight' has a documented history.

The build up of China's forex reserves took place within this, was assisted by a generally worldwide credit inflation without which that nation's high rate of productive investment would most likely have stalled into overproduction and deeper sociopolitical crisis.

Anonymous said...

Our economy is now run on money velocity ...

Any slowdown of velocity and the system tanks .

We see this in takeovers , CDOs , Hedgefunds and most other instruments and markets ...

Hedgefunds and Investment Banks now account for a very large chunk of trading in all markets , most importantly , derivatives ...

Once these markets freeze the game is over ...

We have seen that even the Credit Rating Agencies have fallen from grace ... many loan package defaults went from AAA to Junk overnight. What other securities are rated wrong ?

With NO TRUST in the contents of these packages the whole game is coming to an abrupt halt.


Brenda Rosser said...

Juan said: "When you say: ''s central banks printing money like confetti..', it sounds that you take these quasi-public and public institutions' open market operations to be the primary source of money creation and that this money is tangible, i.e. paper rather than electronic credit money..."

Yes. I can see the problem with the phrase 'printing money like confetti'. Perhaps what I was trying to say is that central banks are creating monetary credit to save the large banks and hedge funds. The latter appear to be insolvent. That this credit creation (and other manipulations) are likely to result in the sharp devaluation of the US it already has. I anticipate that this will probably result in interest rates going up in the US along with taxes and the basic necessities of life. Whilst SUVs and housing will fall in value. Stagflation. Stagflation globally also and exacerbated by climate change and peak oil.

juan said...


In other words, the same treasuries/central banks' directed program that's been used for decades of on again-off again crisis management through monetary policies?

What I'm trying to say though is that

-these same organizations no longer have control of the credit money creation process.
-that this has been at least partially a result of their own previous actions plus the neoliberal program of global financial deregulation.
-that as credit money it cannot come into being other than through borrowing so also debt
-and that even though debt becomes asset(s) which can leverage further borrowing, the whole buildup, the whole inverted pyramid, cannot forever lift itself by its own boots but depends on the real economy that contrary to some appearances has not been all that good.
-that debt, an accumulation of claims, has limits beyond which there is net destruction of credit money.

But then, this implicitly accepts that there is some nearly unmediated causal relation running from money quantity to price and its rate of change, which I don't think is correct.

I do though think that income and effective demand play a part in the realization of price(s) and that as some multiple trillions of [dollars, yuan, yen, real, peso, euro, zloty ...] in demand is eliminated, realization, production, collateral must be affected and that there is not a 1970s rerun.

OK, I admit the evident, that there has already been quite a run in most primary commodities but to the degree this has been a consequence of financial activities can also see that disruption there, forced selling of contracts, can bring these down pretty quickly.

Perspective -

-Reuters-CRB Index, Quarterly Averages, 1960-2007 w/percentage change:!20070925175516+1960+2007+3+0+1+500+1400++0

-CRB Spot Index, QAs, 1960-2007:!20070925181714+1960+2007+3+0+1+500+1400++0

-CPI-U, 1960-- , (Recession bars only to make evident that change in rate continues to follow the classic pattern):!20070925183914+1960+2007+3+1+1+500+1400++0

-Grains Sub-Index, QAs, 1972-2007:!20070925180622+1972+2007+3+0+1+500+1400++0

-CRB Energy Index, same but 1983-2007:

Brenda Rosser said...

Interesting stuff, Juan.

2003 seems to be the beginning of the free-fall...except for Venezuela! (What are they doing there?).

US produced 20% of world GDP. Down from 50% in 1950

Falling rate of profit since the 1970s.

Iraq War. Private contractors set policy.

World Capital Flows 2003. At present around 75% of the world’s investment capital flows entirely within the developed North-Western Europe, Japan and North America. Some 15-20% moves into the newly industrialising countries of South East Asia. The rest of the entire world exists on the remainder.

2003 – 2006 Economic meltdown. The increase in US debt ceiling in this period is 2.5 times the entire federal debt accumulated between 1776 and 1980.

2003 – 2006 – US government contracts handed out to private corporations climbs from 3,500 to 115,000.

2003 – 2006 - Doubling in the price of all global commodities. Linked to rapid economic growth in China, India and elsewhere.

2003 – January 22nd. US Secretary Mel Martinez of HUD denies the existence of a housing boom and talks up homeownership.

2003 – average credit-card debt of US households is $9,205, 310% higher than in 1990.

2003 – failed Cancun meeting on world trade

2003 – Record US Corporate and Consumer Indebtedness, rising house prices, low interest rates

2003 – June. Doug Nolan warns of a dangerous global credit bubble. 25
Late 2003 – Reported that US ‘real money’ (insurance corps, pension funds etc) stopped purchasing mezzanine tranches of US subprime debt. CDOs were then used to export the riskiest tranches of subprime debt to nations with massive trade surpluses with the US (in USD) as well as to petrodollar recyclers.

2003 – 2006 – Incomes of the poor increase significantly in Venezeula

juan said...

'What are they doing there?'

Making the Bolivarian Revolution. Mass social movement assisted, not created, by petrodollars y Hugo,,,the left populist Bolivarian Republic of Venezuela advances.

Probably unfair due to the many years of cross-borders and civil war but contrast with another rapid growth oil rich nation, Angola.

Doug Noland's Credit Bubble Bulletin archive:

Begins in '98 but did not become weekly until 2000. Doug has done a great job of documenting the process though he and I have not been in agreement about its relations to the real economy, i.e. I see the real and financial as necessarily but not automatically related whereas Doug has tended to take the financial as self-reproducing and if not autonomous, nearly so.

Fall in rate of profit - many good papers available but I've found those by Fred Moseley and Gerard Dumenil & Dominique Levy most interesting.

Fred includes the rise in unproductive labor as part of his explanation while D&L looked at not just nonfinancial but also financial sector profit rate between 1948 and 2000.

Would it be a surprise to find that, from moreless 1963 until 1983, the rate of profit (not earnings) for nonfinancial U.S. corporate sector was higher than that of the financial sector whereas from 1987-2000 the contrary?

The alternating relation between these two rates might help explain a few things such as why investment has not moved towards such sectors as alternative energy but has tended towards more strictly financial activities.
Might also be part of an explanation for the more rapid transnationalizing of nominally U.S. production capital as, with the falling away here and most OECD, it has sought to maximize profit rate through labor and national standards of living arbitrage.

Anyway, I believe it's downloadable so, if interested: THE REAL AND FINANCIAL COMPONENTS OF PROFITABILITY (USA 1948-2000)

Brenda Rosser said...

Juan said: Would it be a surprise to find that, from moreless 1963 until 1983, the rate of profit (not earnings) for nonfinancial U.S. corporate sector was higher than that of the financial sector whereas from 1987-2000 the contrary?

It correlates. Thanks. Here's what I have for that period of economic history:

1983 – 1998 World’s largest 500 corporations equal 15% then to 28% of global GDP
In 1983, corporate revenues of the world’s 500 largest corporations equaled 15% of world GDP. By 1998, this ratio had grown to 28% (Kentor 2002). Revenues of the largest 200 corporations now exceed the combined economic activity of 182 nations (Anderson and Cavanagh 2000).³
³. It is interesting to note that while TNC economic activity has grown dramatically over the past forty years, its share of workers has steadily declined. The world’s largest corporations employ less than one percent of the global work force.”

[The Growth of Transnational Corporate Networks: 1962–1998* Jeffrey Kentor]

1980 – 2002 – income gap between North and South doubled 45
1980 – 2002 – rise in global inequality. Absolute falls in income for 4/5 of the world population:

"“Inequality is measured as the ratio between GDP per capita in the IMF’s ‘Advanced countries’ and all remaining countries, in current dollars at market exchange rates. At the beginning of globalisation this ratio was approximately 10 to 1. By 2002 it was nearly 23 to 1. Over this period the real average GDP per capita of the ‘non-advanced countries’ comprising four-fifths of the world’s population, has fallen absolutely, from $1400 to $1100 per year….Measured in the world market’s currency, the wealth-producing capacity
of the world is no longer keeping up with its population growth, and the wealth-producing capacity of nearly a quarter of its people is literally marching backwards.”

[ The new world order and the failure of globalisation
Alan Freeman (2002): The new world order and the failure of globalisation. Unpublished.
The new political geography of poverty. University of Greenwich]/

More history:

1982 – 1993 – TNCs eliminating jobs
1983 – End of OPEC

1983 – Float of the Australian Dollar. Deregulation of financial markets

1983, 1984, 1985 – RJR Nabisco [RJR tobacco. Camel cigarettes a leading brand] Lehman Brothers. Dillon Read. Citibank. Money laundering in the cocaine-heroin trade.
Catherine Austin-Fitts

Brenda Rosser said...

This is my addition to the economic history of the 1980s tonight:

1980 – 1981 – Paul Volker, Chairman of the US Federal Reserve Board and disciple of Milton Friedman, puts Friedman’s theories to the test by tightening money and raising interest rates to very high levels in response to inflation that was primarily cost-push in nature. The result was a ‘horrendous recession which was virtually world-wide’. Huge government deficits were created as a result that compounded at very high interest rates. The debt-to-GDP ratio took off ‘and headed skyward’ for most western countries and 3rd World debt increased dramatically to the point where these nations were about to default on their loans. (At one time the profits from the loans to the 3rd World comprised as much as 60% of total profits for the large New York banks). Paul Volker asked the banks to loan further money to the developing countries to allow them to meet their debt payments until the IMF could come to the party. When the IMF did it involved the use of huge amounts of taxpayer money to bail out the major banks and impose a form of economic colonization on 3rd world nations.

From: ABC Radio National - Background Briefing: 30 May 1999 - Global Finance: Dismantle or Reform?
Paul Hellyer, Leader of the Canadian Action Party