Wednesday, March 17, 2010


Well, in the end the FOMC announcement was much ado about nothing. There were a few tweaks- a couple of positive, one negative- to the January statement, and by 2.16 pm EDT markets were left back in "buy everything!!!" mode. As if there was any doubt, the rather unusual choice of language from the Three Stooges in Monday's press release left Macro Man wondering if the president plans to appoint Mr. Subliminal to the Federal Reserve Board of Governors.

As alluded to yesterday, Macro Man is starting to get a little uneasy by the risk asset/ short end roll up love-in. Exactly four weeks before yesterday, your author bought a bit of S&P exposure. He sold the position out yesterday for a tidy 7% gain: it all looks like it's going a bit too far, a bit too fast.

After all, rumbling beneath the surface of the "steady as she goes" monetary policy regime of major central banks (excepting an increase in short end funding from the BOJ) are the makings of a rather nasty bout of protectionism. This is something that's been on the radar for some time, but let's just say that the beeping from the screen is getting a bit louder.

Readers are encouraged to run, not walk, to the latest Martin Wolf piece in the FT, which does a good job of providing a common sense deconstruction of the positions held by China and Germany (or, as he terms them, "Chermany.") These are the two largest exporters of manufactured goods in the world.

Each, in their own way, has locked in an uber-competitive exchange rate with its major trading partners: Germany via EMU and China via serial piss-taking in currency markets. Each in their own way is acting hypocritically: neither wants their major customers to borrow profligately, but neither do they wish for them to quit buying.

One didn't have to be Cassandra, Tiresias, Nostradamus, or even Mystic Meg to forecast that Greece's entry into EMU would eventually cause problems. Macro Man was curious to see that Mr. Wolf arrived at the same conclusion that he himself reached long ago: that the most feasible country to leave EMU is Germany itself.

But hey, at least Greece chose to enter EMU. As has been discussed ad nauseum in this space, the US never signed up to Bretton Woods II: China (and, to a lesser degree, others in the region) imposed it unilaterally. To be sure, the US has reaped the same sort of benefits from BWII that Greece garnered from EMU: much lower than otherwise borrowing costs and a steady stream of much cheaper than otherwise goods from "the daddy" of the arrangement.

It has been a frequent lament of Macro Man and other interested observers in this space that the relevant multilateral institutions (IMF, G20) possess neither carrot nor stick to wean China off of BWII; nor do they seem particularly intent on acquiring them.

However, unlike Greece, the US is not part of a formal de jure currency union, merely a de facto one. The implication is that with sufficient political will, the United States can extricate itself from the current arrangement. To be sure, there may be demerits associated with such a move: higher borrowing costs as China stops buying/sells Treasuries.

But if the perceived benefits outweigh the costs, there are steps that can be taken. Perhaps it is not a coincidence that just a few weeks after the president announced his intention to double America's exports within 5 years, a) he takes China to task over their exchange rate and b) more importantly, the Schumer bill is revived.

After all, Wen Jinbao's complaints over the weekend about countries trying to weaken their currencies to boost exports would be laughable if they didn't constitute the rankest hypocrisy. While it's certainly true that China's trade surplus dipped sharply in February, let's see what it looks like in March without the New Year disruptions.

In the meantime the performance of other Asian currencies since the beginning of last year provide a pretty telling contrast to the flat-line trajectory of the RMB.
The great irony, of course, is that "standing up to China" hardly guarantees a boost to either exports or employment, particularly in the near term. Low value added manufacturing will merely shift to Vietnam or some other economy with a surplus of cheap labour. (Hey, at least Vietnam runs a c/a deficit!)

And by increasing import prices and borrowing costs, the near term impact of "super tariffs" would clearly be negative for risk assets: another reason to be wary of Spoos after this move. Ultimately, however, a rebalancing of the US economy towards less borrowing/consumption and more exporting can only be a positive...well, except for China, which is why they're so opposed to it in the first place.


Harry said...

Nice post MM.

Rossco said...

When the US talks about increasing exports by x in the next x years the questions remain :
to who?
where does the capex come from ?
what comparative advantage do they still enjoy ?(ex autos)

I think the AUD will bear the brunt of any negative sentiment around world trade and protectionism. As for HG1...i think this is one of those rationality vs solvency moments

Charles said...

"Low value added manufacturing will merely shift to Vietnam or some other economy with a surplus of cheap labour."
That is supposing that the comparative advantage of China for the last few years was cheap labor. This is not obvious : it also comes from cheap funding, tax base biased towards exporters, subsidized energy, and, may be the most toxic of the mix, "ghost FDI".

Macro Man said...

Oh, those things matter, but it's not exactly like no one else offers them either. I think it's very much a case of "you'll come for the cheap labour, you'll stay for the tax breaks".

Ivanovich71 said...

Ah yes, another reason the AUD should take it on the chin (any protectionism) but just another reason it will defy gravity once more and remain in the stratosphere.

It's all about yield. Or haven't you heard?

Leftback said...

A big dump after OpEx is always on the cards in this kind of market, no? Of course it is quite normal for the small caps to have a P/E approaching 50 according to some estimates ... and so it continues, with a massive short squeeze day after day after day, until someone turns off the tap.

It's all about liquidity.

m* said...

The US did have a choice back in 2001 when it acceded to China's entry to the WTO with an inconvertible currency.

The backpedaling on free-trade now (see Krugman this week)is more than a little ironic.

Old comments from me:

Pimco paper on China policy:

Palley paper on BWII:

Leftback said...

Speaking of the Krugmeister, LB is not a huge fan of his unlimited printing philosophy, but he has two good pieces today:

Liquidity Trap?


Irish Crisis

Macro Man said...

Sigh. Remember when Krugman was just an economist, rather than an ideologue? He always seems much more interested in making/scoring snide little political points than in real economic analysis these days. When the conclusion/interpretation is known in advance, there's not much point, is there?

Having lived in Ireland, I can tell you that my experience most definitely was that uber-cheap money was THE prime mover of the real estate bubble. Ireland had a long and sordid history of, shall we say, "morally compromised regulators" well before 1999; without the cheap money, the booms were nowhere near what the ROI experienced from '02- '07.

Rossco said...


fair enough, but last time i checked copper didn't have a coupon

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