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Tuesday, June 02, 2009


government borrowing as refinancing

one of the oft-stated aversions to government borrowing as fuel for fiscal stimulus is that more debt cannot be a solution where too much debt is the problem. and that might be true, as far as it goes. but there's something of a non-sequitur in jumping from fiscal stimulus to debt growth -- and brad setser attacks the fallacy of the meme in two postings, here and here.

Why hasn’t the expansion of the fiscal deficit pushed the amount the US borrows from the world up? Simple. American households and businesses are borrowing a lot less, so the total amount of money that Americans are borrowing isn’t rising.

this is a critical point, as it recasts what some think of as "more debt" in the proper light of a refinancing -- increased household savings and redirected business investment represent funds not borrowed, and in order to prevent monetary aggregate collapse the borrower of last resort must compensate by taking private debt repayments and turning them through fiscal stimulus into income which can then pay down more household and business debt until private sector balance sheets are repaired.

and yet:

... [W]hile the US is borrowing less from the rest of the world, it is still borrowing from the rest of the world. A smaller trade deficit is still a trade deficit, and financing that deficit requires ongoing inflows from the rest of the world. That means that some creditor needs to increase their exposure to the US.

Yet the crisis also has alerted China’s population — rather belatedly in my view — to the risks of lending to the US. ...

The dislocations associated with the crisis temporarily eased the financial pressures facing the US. Americans sold their foreign assets faster than foreign investors sold their US assets (in part because American money market funds stopped lending to European banks, forcing them to scramble for dollars cash). But those dislocations have eased — and with commodity prices rising on hopes that the emerging world will rebound quickly from the crisis, the US is likely starting to need to borrow more from the world just when private demand for American financial assets is starting to fade.

That isn’t terribly comfortable – even if it actually isn’t all that different from 2007.

and this goes to the heart of john hempton's point on the propensity for sudden-stop collapses in current account deficit nations whose banking systems are characterized by a dependence on wholesale funding of international ultimate origin. with bright chinese kids laughing in the face of the secretary of the treasury of the united states, what was once belated is now the pinnacle of timely awareness. it will be decisions made in china -- with regards to the renminbi peg to the dollar, with regards to diversification of chinese forex -- which will primarily determine outcomes.

the united states treasury, faced in crisis with the decline of global trade and the rapid retracement of america's massive current account deficit, is unexpectedly joined in a heated competition on the international debt market for much-diminished marginal capital that it must win if it is to continue to backstop its banking system by substituting private-interbank-market wholesale funding with the fed in an effort to prevent collapse. this was a competition japan never had to contemplate in its long malaise, and it is forcing yields on treasury debt instruments higher even as the threat of a deflationary liquidation cycle remains at the forefront.

setser presents the history of government, household and business borrowing and comments:

Both charts highlight the risk that worries me the most. In both the early 1980s and the first part of this decade, both the private sector and the government were large borrowers. And in both cases, borrowing rose faster than domestic savings, so the gap was filled by borrowing from the rest of the world. The trade and current account deficit rose. In the early 1980s, the US attracted inflows by offering high yields on its bonds. More recently, it did so by borrowing heavily from Asian central banks, together with the governments of the oil-exporting countries. But now yields are low (even after the recent rise in the yield on the ten year Treasury bond), and need to be low to support a still weak US economy. And China (and others) are visibly uncomfortable with their dollar exposure; banking on their continued willingness to finance a large external deficit seems like a stretch.

UPDATE: commented at baseline scenario.

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