One answer to my question "what do you mean by worse" is that the value of the dollar will fall. I'm not sure why I'm supposed to be so excited by this. Yes, I love my Panasonic television. But with 90% of our production bought and sold domestically, the value of the dollar is of limited relevance to the fate of the economy, or the living standards of most Americans. And some of our biggest trading partners seem pretty determined to stop the dollar from falling against their currency By Any Means Necessary. I am sad that I will not be able to vacation cheaply in Europe. But this does not seem like a good reason to urge a double-digit contraction in output.
Of course, a falling dollar also may make it harder to borrow abroad. On the other hand, even the treasury doesn't, mostly. Besides, the people who are intensely concerned with the dollar's exchange rate don't want us to borrow abroad, so I'm not sure why this is supposed to be more important than preventing the next Great Depression.
Currency crises are huge problems in countries where foreigners are the main source of capital, and profligate governments are forced to borrow in their own currencies. But we are not one of those countries.
What am I missing?
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Currency crises are huge problems in countries where foreigners are the main source of capital, and profligate governments are forced to borrow in their own currencies. But we are not one of those countries.
What am I missing?
I feel like we're heading towards here if we throw 700 billion into this sinkhole of a solution that Paulson apparently can't define. We need to do something; but we don't need to act in a week. We can do something like Schumar suggested and follow up as we take the time to asses. Given the fact the adminstration's been making plans for a while on the down low, I don't think this is irresponsible.
"Currency crises are huge problems in countries where foreigners are the main source of capital, and profligate governments are forced to borrow in their own currencies."
Don't you mean "in other currencies"?
You're right that the rest of the first world won't let our currency fall too far relative to theirs, but that's too bad, in a way. Look what happened to Buenos Aires when the peso fell to 3 to the dollar! American and European artists and restaurateurs flowed in, and it became an antipodal Brooklyn with more white people and better architecture.
I have a question about securities backed by mortgage debt...I could see a situation where every mortgage's chance of failing is viewed as independent, like a series of coin flips or die rolls...like if a security is backed by 1000 mortgages of $10,000 each and each mortgage has a 10% chance of not being repaid, then the expected payoff of the security is $9 million.
This isn't right, because the chance of all those mortgages being repaid are not independent from one another due to being highly dependent on macroeconomic conditions, which are the same for all mortgages.
It occurs to me that the Pentagon almost certainly has a dusty file somewhere, duly indexed in a locked file cabinet, containing plans to invade Iceland: ships required, stores required, targets for initial bombing, etc. Probably it calls for mountains of 30-06 and .45 ammo and lakes of 100-octane avgas, but it's a place to start.
Does Treasury have contingency plans of any sort? Why are we making this up on the fly? You can't anticipate everything, but it's not like there's never been a bank run before.
MEGAN: The problem is that, although the US is a closed economy, by and large, in terms of most consumption items, the current account deficit is funded almost exclusively by the People's Bank of China.
And yes, supporting the dollar is a matter of Policy with China, and they have certainly been heroic about taking it on the chin for Team America so far. But if they decided "enough is enough" and pull the plug, we'll see long term rates skyrocket, which will push all adjustable rate mortgage owners, both subprime and Alt-A, into default. This will be a TERRIBLE THING for the economy, and this is why Paulson formally took the GSEs onto the government books.
The fact that the US can borrow in its own currency greatly helps its position. But this will not always be the case -- the world may very well move off the dollar. This has happened to every fiat currency in the past, and there is a non-trivial chance this will happen here.
Think of things another way -- the US has dollar obligations that far exceed the actual number of dollars in circulation. Any by "far" I mean an order or magnitude, maybe two. This is considered to be "risk free". That perception is *certainly* wrong. When perception shifts for "risk free" to "risky" the result is a bank run. A bank run on the dollar will be extremely ugly.
-winterspeak
Seems to me that if OPEC decides that they don't like the dollar anymore and decide to denominate in Euros, the price of gas would instantly double. That's gonna be ugly, no?
But this does not seem like a good reason to urge a double-digit contraction in output..
You keep saying that. Why are you so sure that a depression is inevitable?
The dollar decline would likely be accompanied by increasing long term interest rates b/c foreigners want a premium to guard against the expected inflation or risk. It would be reasonable to believe that might affect borrowing costs and thus the macro economy.
Seems to me that if OPEC decides that they don't like the dollar anymore and decide to denominate in Euros, the price of gas would instantly double.
Why? It could possibly happen, but not for the reason I think you are suggesting.
the US has dollar obligations that far exceed the actual number of dollars in circulation. Any by "far" I mean an order or magnitude, maybe two.
There are something north of $750B in greenbacks in circulation. Back out the "lockbox" debt, and you're not at 10:1 US Debt to Cash, nevermind 100:1. Unless you're refering to all public and private USD denominated debt, in which case is does look a lot worse.
So the problem with having too much credit available is that the dollar will fall and then we won't have so much credit available . . .
Great.
I actually am going to Europe for a couple of weeks in the very near future.
Oh well, I guess we'll just have to scale back our fun.
Huh?
A lower US dollar makes it more expensive to buy anything imported, including oil, including almost anything sold at WalMart, including a lot of the components for stuff made in the US. A lower dollar means higher inflation.
A lower dollar makes it much cheaper for foreigners to buy out America. For them that nice piece of coastal property is cheap, that investment bank is cheap, that tool and die company is cheap, that oil company is cheap. Before you know it, not much is left American owned.
And yes, supporting the dollar is a matter of Policy with China, and they have certainly been heroic about taking it on the chin for Team America so far.
Come on, now. China isn't "taking it on the chin" for us. They aren't motivated by philanthropy. They're motivated by the facts that (a) a huge chunk of their economy relies on exports to the United States and (b) they hold a lot of US debt, repayable to them in *dollars*. If the value of the dollar plummets, China will (a) see its OWN economy shrink by double digits and (b) lose most of the value it has invested in US debt.
we'll see long term rates skyrocket, which will push all adjustable rate mortgage owners, both subprime and Alt-A, into default.
Most adjustable-rate mortgages have a cap on how much the rate can rise, and most of the funding for mortgages is domestic. Your nightmare scenario will not happen.
Think of things another way -- the US has dollar obligations that far exceed the actual number of dollars in circulation.
If by obligations you mean "outstanding loans" then the prospect of a devalued dollar is a problem for our *creditors* more than it is for us. If you refer to future payments that the government has promised it will make but has no actual obligation to pay, e.g. Social Security and Medicare, then that's a different kettle of fish. We can't meet *those* obligations no matter what the dollar does.
Before you know it, not much is left American owned.
Who cares? This is just naked xenophobia.
There is no evidence whatsoever at this point that the dollar will fall. Just 'cuz everyone thinks it will or says it will doesn't make it so.
The buck has already fallen by almost half vs the Euro over the last 8 years or so. That's an enormous decline. Followed by a 12% rally over the past month before the selloff of the last week. Just a month ago, you couldn't find a dollar bull and the $ rallied huge.
Don't believe anything anyone tells you about what's gonna happen. They don't know what the future holds.
Our debased currency is the reason for this mess. Too low interest rates enabled excessive borrowing and encouraged firms to leverage higher. The weakened dollar gave us a summer oil shock, which only subsided when the Fed paused its rate cutting. If we want to establish a meaningful floor for these MBS's, stabilize the price of oil and encourage creditors to lend, we must have a strong dollar.
MEGAN: You are right that i) the US economy is predominantly closed, and ii) a falling dollar will shrink credit (which is good, because we have too much).
The problem is, that although we in the US think of the $ as a domestic concern, it is, in fact, a global currency, and that matters. A large value of the US$, which the economy relies on, comes from the fact that is *is* the reserve currency.
Look at it this way, most countries, in the middle of a huge financial crises, would not have the yield on their debt go to 0% (or even negative). If this goes away, then the dislocations to the US will be even more dramatic than a mild (or even moderate) contraction.
-winterspeak
Nothing, you got it right.
To go along with that, the absolute value of the national debt doesn't really matter either. Since the federal government is the source of dollars, it must maintain a debt in order for everyone else to have savings.
The money that pays taxes comes from spending.
In fact no country that has a floating currency needs to borrow in anything but their own currency, and on top of that, they don't actually "need to borrow." Since spending preceeds taxation, the sale of treasury securities functions only to maintain interest rates.
Well, the price of oil is a big one. But overall, I agree with you---a lower currency has some advantages, some disadvantages, and is overall a net negative but not something to scream "NOOOOOOOOOOOO!!!!" about.
I'd guess that those focused on the dollar are pointing out that you cannot get something for nothing.
If you think that $700 billion isn't going to come at some price in the exchange markets, you are wrong.
The idea that the U.S. is "forever" and exceptional country/currency is tenuous.
If the dollar falls really, really precipitously, and officials show no care or understanding of taking care of it, who will lend to us/U.S. in dollars?
A couple implications you missed: the impact to (investment) demand for dollar-denominated assets, and the (closely related) increase in the cost to finance US gov't debt.
Megan is right. One of th reasons that the US can be so indifferent to the weakness of the dollar is the petrodollar. The problem is the continuing slide of the dollar may break the petrodollar.
Where did they get the dollars that they "lend" to us? There only choices are to lend to us (buying treasuries), or to buy our goods. Either way the dollars have to come back to the USA at some point.
I don't understand how some people can simultaneously attack China for supposedly manipulating its currency to be weaker, to encourage exports, and the we have posters here saying how a weakening dollar will hurt us by making imports more expensive.
Yes, your imports will become more expensive. But your exports will become cheaper and foreigners will buy more of them. This not only includes merchandise exports, but also tourism and student fees from foreigners.
p.s. If the weak dollar makes US assets, like, say condos in Florida, look attractive for Europeans to buy for vacation homes, is this a bad thing? NO.
I'm probably missing something, but to my eyes we need a weaker
dollar. In fact I'd go so far as to say that we desperately need
a weaker dollar. For one thing we have a massive trade deficit.
Bill Wilson complains that "a lower dollar makes it much cheaper for
foreigners to buy out America" and yes in a sense that's true but
what has really made that a threat is our prolonged and ever increasing
trade deficit. If a major proportion of american assets due end
up under foreign ownership it'll be because of what has already
happened and what will inevitably happen in the future if we don't
change our behavior.
Maintaining a strong dollar will not keep this from happening, it
just postpones this slightly and, worse, makes the problem larger.
We can shrink the deficit either by lowering government expenditures
or by decreasing the relative value of the dollar or by both.
Realistically the second option is more plausible that the first.
Winterspeak said, "And yes, supporting the dollar is a matter of
Policy with China, and they have certainly been heroic about taking
it on the chin for Team America so far."
I don't really understand that statement. Yes, of course, the government
of China spends an astonishing amount of money each month keeping
the dollar high, as for that matter so do Japan and Saudi Arabia.
But none of these countries are being "heroic" in doing so. On the
contrary their motives have everything to do with self-interest.
China, in particular, benefits because maintaining the yuan at
an artificially low level helps to suck jobs and factories and businesses
from america to china. But despite these formidable benefits
to China, that government can't maintain their current position
indefinitely because the cost of doing so keeps rising dramactically.
At some point soon they have to start accommodating reality.
Even if we wanted to we can't maintain our current level of the
dollar with the respect to the yuan, or perhaps I should say
the chinese can't.
Obviously we don't want a dramatic collapse, but what we really need
is prolonged and steady drop. Or so I imagine.
Yes, I know it will have it's costs. In particular it will decrease
real incomes. But the alternative is worse.
M&M - I think that the dollar argument is similar to your argument about contraction in that it depends on the scale at which it occurs. In any case, I think that your analysis thus far has been deficient.
Yes, a reasonable fall in the dollar, let's call it a "soft landing", would not be so bad. Likewise, a small recession would not be so bad either.
Things start to look bad when the fall starts to get more severe, in either magnitude or speed. As Winterspeak notes, the dollar's current value depends on the fact that it is the world's reserve currency. If its value starts to fall fast enough that investors decide that they cannot risk exposure to it, dollars could get dumped on the market faster than the market could absorb them.
This phenomenon of market collapse is exactly what has happened in our credit markets, as you have so aptly described. As you have noted, the result is not just a rational fall in value to a new price but a non-functioning of the market or its total debasement. This could very well result in hyperinflation.
No, China, et al. does not want this to happen. However, they may not be large enough alone to stop this should it begin. More importantly, they would also not like to see their reserve suddenly become worthless - see their recent moves to establish a sovereign wealth fund to earn higher returns and to invest more in baskets of currency rather than just the dollar - and therefore they might also become players in this phenomenon. To wit, if they think that the dollar really is collapsing, they could decide to write off our market as an export market for the time being or start demanding that contracts be valued in their currency rather than trying to prop up a failing currency. In any case, every currency has a breaking point beyond which central banks become helpless - I am sure that you know this - and we would be foolish to think that our position as a consumer market makes China more committed to our currency's strength than the central banks which historically have tried to hold up a currency and have been broken.
In any case, the result is to realize that we should be comparing the effects of various amounts of contraction with the effects of various amounts of inflation, adjusting for the probabilities of each. Thus far, "Do Something!" has won the day because, as you have noted, the effect of a depression-style contraction is so awful that we cannot even take a small risk that it will occur. The calculus changes, though, when you consider that the "Do Something!" plan could result in hyperinflation, which also has a really high awfulness value.
I do not know to which decision that analysis leads. However, if the probability of hyperinflation occurring is decently above zero, and if that probability could be increased by the proposed bailout, then, because hyperinflation is so freaking awful, we really need to think this through.
Jane,
What you are missing is the danger that USD ceases to be the default currency world's transactions are done in. Once that happens, central banks that hold treasury debt will slowly unwind their position and treasury will not be able to issue bonds without increasing interest rates significantly, and drive up inflation. This can happen quite rapidly, in the space of a few years. At least that's what happened to sterling pound at the end of the second world war.
Disclaimer:
I am not a macro-economist, or even an economist, so take this with a liberal (or libertarian) fistful of salt. My employer probably knows I visit blogs, but does not in any way approve this message, nor thinks that I should write any disclaimers of any sort.
"If you refer to future payments that the government has promised it will make but has no actual obligation to pay, e.g. Social Security and Medicare, then that's a different kettle of fish."
The government DOES have an obligation to pay. Social Security, Medicare and Medicaid are mandatory spending, meaning that by law the government MUST PAY benefits to qualified persons. The only way we reduce our mandatory program exposure is to change the laws. Until that happens, the Treasury must pay the claims.
Of course Megan isn't worried about a falling dollar (inflation -needing more dollars to buy the same goods and services), it helps those connected to the government -like her buddies in Wall Street she's always defending- and hurts everyone else.
How? All those new dollars go to specific groups first. Those people (the banks, investors, bureaucrats) get to spend them at the old prices while the rest of us get those dollars only after prices have adjusted upwards. Thanks Megan.