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June 09, 2005
Alternative Ends to the Bubble
Today's WSJ summarizes the conventional wisdom about how the U.S. housing bubble and current account deficit will play out:
The debate is over how, not whether, the global economy rebalances: Will it be smooth, through some combination of declining dollar and accelerating foreign demand? Or will it be chaotic, with a dollar collapse, much higher U.S. interest rates and perhaps a global recession?
Just two possibilities? That's two-dimensional thinking in a three-dimensional world.
Here's two other scenarios which could follow today's housing bubble/current account deficit:
1. The "China Meltdown" Scenario--China's financial system is shaky, and nobody knows the extent of bad loans. A financial crisis in China is a real possibility. If that happens, the U.S. could look like a safe haven, just as it did during the Asian financial crisis.
2. The "Son of Tech Boom" Scenario--There are signs that Intel and other tech companies are seeing higher sales (Intel is giving its mid-quarter report this afternoon). A rebound in tech spending could shift the load from housing, and make a smooth transition much more likely.
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Or try this - Asia tires of buying Treasuries and starts buying US real estate driving it into the stratosphere like Japan in the late 80s.
Or this - The US tires of Asian products, and this triggers an Asian slowdown leading to reduced prices and a reduced trade deficit, leaving the US with even more money to pour into real estate.
Maybe we haven't seen anything yet.
Posted by: Lord Liege at June 9, 2005 01:40 PM
Enough talk about "rebalancing". The global economy, national economies, regional economies, local economies, business sectors, individual businesses, and individual consumers are *continually* rebalancing, on their own.
Sure, government macro policies have *some* effect, but why on earth should we be be giving so much credence and press to those "professional" economists who basically advocate command and control economics?
The Fed jiggering of short-term interest rates should be the *limit* of efforts to try to *force* "rebalancing".
Yeah, I know some people yearn for the old Soviet command and control economics, but that's *not* the way the global economy *is* run and its not the way it *should* be run.
Yes, the U.S. should *gradually* seek to reduce the federal budget deficit.
Yes, China should *eventually* float its currency.
Yes, Fed monetary policy should seek to stabilize prices and assure that money or lack thereof is not a major problem within the U.S.
Yes, the G7 or G8 or G-whatever should continue to meet to try to understand what each country may be doing right or wrong.
But, those who seek "policy coordination" to try to "tweak" the global economy into some "preferred" equilibrium are 1) fools, and 2) should not be given any credence.
We don't *know* precisely how the economy will evolve in the coming months and years. Those who claimed they did a year ago are now back-pedaling. Our best bet is to simply have ever-greater faith in free and open markets and light regulation and let the economy and the human spirit "do its thing".
And finally, the best thing the WSJ can do is simply stay the out of the way. I don't think the WSJ editorial staff was what Adam Smith had in mind when he referred to an "invisible hand".
Why exactly is it that people have so little faith in "the market" these days?
-- Jack Krupansky
Posted by: Jack Krupansky at June 9, 2005 02:01 PM
a replay of asia centered around china would drive the chinese current account surplus from say 7-8% of GDP (expected 05) to 12% or more of GDP, and drive the US Current account deficit from 6.5-7% (expected 05) to 10% -- or something like that (assuming other asian currencies fall in sympathy with China).
and what exactly is the chinese banking system meltdown scenario? sure, the chinese banks have bad loans. but what's new about that. they have had large stocks of bad loans for sometime. NPLs are going down on the back of the lending boom. deposits are going up. and chinese citizens with savings abroad are bringing funds home (see the PBoC's latest report, discussed on macroblog), adding to reserve accumulation -- they are running into, not away from, the banking system. And china's capital controls continue to limit chinese citizens capacity to do anything other than put funds in the banking system. I can see plenty of possible scenarios, but a run out of the banking system is not high on my list unless something really, really changes. the banks are not in any worse shape than they have been for a very long time. and the capital controls won't go away if the result is a huge run on china. and unlike asia, china does not have any meaningful vulnerability to an external bank run. its reserves far exceed its short-term debt.
the more plausible scenario to me is an investment bust triggered by a capacity glut, including a bust in chinese residential property investment. if savings doesn't fall, that could trigger a surge in China's current account surplus as the domestic economy slows -- and free up more chinese savings to invest in the US.
Posted by: brad at June 17, 2005 04:31 PM
I agree that an investment bust in China is a real possibility. The question of whether that leads to a bank crisis, though, is really a political issue, not an economic one. We know from history--and the Japanese example--that faced with a bust, the right policy response is to both pump in money and to close down money-losing banks and companies. The Chinese government will be able to do the first, but the second is beyond the reach of the current political situation. As a result, I think you are much too sanguine.
Posted by: Michael Mandel at June 20, 2005 01:33 PM