The G-20 Growth Strategy: Self-Flagellation, Prayers and Threats

The media and pundits parsed Mark Carney’s speech today to the Ottawa Economics Association (OEA) every which way to Sunday today and concluded that Carney had effectively signaled the Bank’s intention to raise its target for the overnight interest rate sooner rather than later.

But in all the hand wringing about the inevitability of rate hikes (do people ignore Japan on purpose? — just asking) and their consequences for debt of all kinds, everyone seemed to miss the most important message in Carney’s speech: China got us into this mess (by “financing” US deficits and presumably allowing rates to fall below some sort of Wicksellium natural rate — never mind the role of institutions like Goldman Sachs, control frauds, and all the other untoward activities of the financial sector) and only China can get us out:  the G-20 economies are doomed unless China allows the Yuan to float and generally starts buying our stuff.

To make the case, Carney outlined three scenarios.

  • Business as usual scenario (1): Governments run deficits that “crowd out” private investment and generate unsustainable government balances. China continues to “artificially” peg the yuan and finance the US deficit.  We find ourselves however back in a crisis situation similar to 2007-08. Growth is modest.
  • Fiscal Consolidation scenario (2): G-20 countries “consolidate” their fiscal balances but China refuses to allow the Yuan to float and continues to generate large trade and current account surpluses.  Growth is very weak and we find ourselves in a deflationary environment.
  • G-20 “Framework” Scenario (3): G-20 countries “consolidate” their fiscal balances and China allows its currency to float.  Chinese buy more of our stuff instead of hoarding savings. Global demand is rebalanced.  Smiles around because of the “Pareto improving” nature of this brilliant plan. Growth is strong.

Call me crazy but this is insane.  The G-20 Framework scenario — which is the one our leaders appear to have bought into — is essentially the Fiscal Consolidation scenario (i.e., no 2) plus a prayer augmented by a threat (more on that in a moment).

If the fervent G-20 prayers aren’t answered and China does what it has done for the last 20+ years, the Bank of Canada’s analysis suggests that the global economy will be about 5% smaller by 2015 than it would have been under the “Business as Usual Scenario” (and about 10% smaller than under the very optimistic G-20 Framework Scenario).

Setting aside incantations to higher powers, for all intents and purposes, the G-20 “framework” scenario amounts to the following threat built on the edifice of fealty to the gods of balanced budgets: revalue your currency China and buy our stuff or we’ll destroy the global economy by pursuing fiscal consolidation.(ADDENDUM: I see the EU nations are well on their way to delivering on their end of the bargain…way to go Europe! That’ll teach them Chinese).

That is some warped logic my friends but such is the state of the economics profession which, far from learning anything from the financial crisis, seems to have dug in its heels and reverted to type: deficits are bad, governments must shrink, markets are best, and you, sadly, know the rest.

One comment

  • China has their reasons, which are not just for exports, but also their treasury holdings since they really did not want to take a hit in their percentage US reserves as the dollar dropped, but as the dollar has raised of late, so has that led to a rise in the Yuan.

    The only way I see the Yuan rising is if China sells their holdings of treasuries, and, or at the very least will stop purchasing UST bills, as too reduce the amount of yuan in circulation.

    However I touched on this in these forums long before, and many others, all this big stink created by Krugman; Who thinks the US superweapon of economic superiority is the ability to simply print greenbacks.

    In this mindset china would not gain from such a stance, it would also loose its ability to sell to its best customer, & suffer severe dollar holdings.

    He talk about losses if they sold their holdings, what about losses if their currency rose? Either china has to take a loss or allow the treasuries to mature and demand their money from the states back with out selling treasuries on the open market. Adding that it would not impact long term interest rates. He would be right, if someone other then the FED purchases said treasuries from China on the open market.

    Any collapse in the dollar value wont lead to a sudden boon for US exports but it would collapse US imports, and force Americans higher prices domestically, because they would be priced out of imports. Also as the dollar weakens every American wages takes a hit, all Americans have are US dollars. This view is just as dangerous as when people thought and do think real estate are ever appreciating. China would suffer but the US would be worse off.

    When selling your debt to another, they use there own savings, or expand there money supply. When selling the debt to yourself as Krugman advocated the FEd could do. Say by whatever percentage in treasuries the FED purchased would lead to an increase in the money supply in the US by a corresponding amount.

    Krugman also never even mentioned, what would occur if China were to not roll over the shorter term maturities that china has been purchasing on the back of selling longer dated treasuries on the open market and asked for their money back, they do not have to sell in the open market. The US now has the biggest short term “teaser rate“ in history.

    His commentary is indicative of the view that no matter how many dollars a country prints, or how much values is lost compared to others, as long as unemployment remains elevated. Yet, as I wrote long before Translated into English, that the central bank will continue pumping up the money supply and maintaining easy credit conditions for a “considerable period,”.

    Its view is that the economy is like a bucket that has been partially drained: Until the bucket is full again, there cannot be inflation. Therefore, the central bank will continue stimulating demand indefinitely.

    The problem with this theory is that it is not borne out by experience. In the 1970s, there was high unemployment and low capacity utilization, yet high inflation. A key reason is that labor, plant, and equipment are not homogeneous. When demand is stimulated, it may require workers with different skills in different places to satisfy it. Similarly, producers may not have the right equipment to make the things people want. Therefore, new investment must take place first before production can rise

    capacity-utilization index may be at a historical low, much of that unused capacity however is worthless. A lot of growth was attributed to unsustainable policies and should have never existed in the first place. It is bad investments that simply must be written off. This means that inflation could easily reemerge well before capacity hits historic norms, generally considered to be the tipping point. It also means that unused capacity is no barrier to new investment

    If in the next few years the dollar tanks, what will the FED, and Us government do, triple it balance sheet again. We would look to rising rates to protect a falling USD; but with the economy on life support still, the FED will probably ignore a weakening dollar, and try to fix unemployment through lower rates.

    However, keeping the LIBOR rate or Fed Funds down for an extended period will only work for US debt, but not other forms of debt for homeowners, credit cards, corporations, or municipalities, and state governments, all forms of debt in US dollars, the FED would be the last lender of only resort as investors demanded higher rates of interest.

    Once the FED shows it is commitment to low rates limitless pit, value be damnation. Institutions, private and government creditors will quit and opt out. It would happen to quick that average Joe Americans would hit the FED up on their bid. It would be the housing market all over with a race to the exits but no buyers and Americans are left with their assets the now worthless paper for burning or toiletry uses.

    Americans must be honest with themselves and accept their lifestyle(s) has been largely financed by austerity in China for years.

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