the party kept going long after private investors ceased to be willing to finance it

TO BE NOTED: From Follow The Money:

"How much “capital flow reversal” insurance should the world offer?

Posted on Sunday, April 26th, 2009

By bsetser

That isn’t a question that is usually asked in the debate about the “right” size of the IMF. But it strikes me as a question worth asking.

Back in 2006, US growth slowed relative to growth in the world. Private demand for US assets fell.* But the US didn’t have to “adjust” — that is to say bring its trade deficit down to reflect the reduced availability of private financing. Why not? Emerging economies, who received most of the influx of private money not going to the US, generally used this influx to build up their reserves. A rise in financing from central banks and sovereign funds offset the fall in (net) private demand for US assets.** The US trade deficit fell a bit relative to US GDP, but not by all that much.

Thanks to a generous supply of credit from the emerging world’s central banks, the party kept going long after private investors ceased to be willing to finance it.

Suffice to say that when emerging economies running comparable deficits to the US encounter a comparable fall off in private financial flows, the amount of financing that gets recycled back their way by the US and EU (though institutions like the IMF) is far smaller. Between 1997 and 1999, “volatile” private capital flows (bank loans and portfolio flows, I left FDI out) swung from a $100 billion inflow to a $100 billion outflow. The net increase in IMF’s lending over this time by contrast was only around $30b — not all that much relative to the $200 billion swing.

The current crisis isn’t all that different. Between 2007 and 2009, volatile capital flows are expected to fall from a positive $250 billion to a negative $400 billion — a swing over over $650 billion. IMF lending — based on all existing programs — will increase by close to $120 billion (see this chart by my colleague Paul Swartz). That is more than in the past, but not enough to offset the fall in capital flows, and certainly not enough to offset the combined impact of lower capital flows and lower commodity prices on the commodity exporting region.

Scaled to world GDP, the current swing in private capital flows and the (projected) rise in official lending looks roughly similar to the swing back in 97-98.

I don’t know what the right balance between financing and adjustment is. No one probably does. And it clearly varies from country to country. Some countries are in worse shape than others.

But it is still striking that the emerging world did more to help the US avoid adjustment from say early 2006 to mid 2008 than the US, EU and Japan seem likely to do (through the IMF and World Bank as well as bilaterally) to help the emerging world avoid adjustment now, even with the recent expansion of the IMF.***

Call it part of the United States exorbitant privilege. So long as key emerging economies peg to the dollar and allow their reserves to rise when private demand for their financial assets rises, the US gets more protection from a sudden reversal in capital flows than other countries with large deficits.

But also call it part of a broad system that has resulted in a persistent uphill flow of capital — and thus part of a broad system that led the US to run larger external deficits over the past few years than really were healthy.

* US investors started buying more non-American long-term assets while (private) foreign investors lost interest in US assets. The fall in private demand though wasn’t immediately apparent because a lot of official flows initially registered as private flows through the UK and other financial centers.
** $100 billion in “private” outflows from China in 2006 lowered the global total. Those private outflows though were clearly the product of an effort to hand some of China’s reserves over to the state banks to manage. They weren’t really private.
*** It also interesting that the $200 billion or so in financing Russia got from the sale of its reserves far exceeds the IMF’s total commitments to date; that helps put the IMF’s actions in context."

Businesses are using up their goods on hand before they start ordering or producing more

TO BE NOTED: From the WSJ:

"By Kathleen Madigan

The Commerce Department reported Wednesday the U.S. trade deficit fell to $26 billion in February from $36.2 billion in January. That was the lowest level in more than nine years and a far greater narrowing than economists had expected.

The trade shrinkage reflects the drags plaguing the domestic economy: Consumers aren’t spending, businesses are using fewer raw materials, and everyone is trying to use less energy.

But perhaps the key trigger to the deficit decline is the sharp drawdown in inventories going on in the U.S.

A decline in imports is expected when demand falls. But businesses are not only selling less; they are stockpiling fewer goods as well. Wholesale inventories dropped 0.9% in January and 1.5% in February, manufacturing inventories fell 1.1% in January and 1.2% in February.

However, the current inventory decumulation could be hitting foreign producers to a greater extent than it is U.S. manufacturers. As a result, the interplay between inventories and imports makes projecting economic growth in the first quarter trickier than usual.

To be sure, the global downturn means trade flows everywhere have shrunk. That’s why U.S. manufacturers are shipping less overseas. Despite a 1.6% gain in February, U.S. exports are down 24.3% since the trade deficit peaked in July 2008.

One bit of good news is that capital-goods exports — the one trade area where the U.S. still retains some muscle — are faring relatively better than other overseas shipments. Such exports make up about 36% of U.S. exports but account for only 23% of the total export decline since July.

But given that U.S. imports outnumber exports by a 5-to-4 margin, imports take center stage when it comes to trade. And most of the recent narrowing in the trade deficit reflects falling imports, down 5.1% in February and off 37.8% since July.

Brian Fabbri of BNP Paribus points out that imports are dropping much more sharply than business inventories have so far in this recession. He suggests that business inventories — which will include retail data — could post big declines in February (data will be out April 13) and March.

Economists expect that the severe inventory drawdown worsened the contraction of real gross domestic product in the first quarter. Businesses are using up their goods on hand before they start ordering or producing more. At the same time, the sharp narrowing of the real trade gap contributed to GDP growth.

The trick is calculating the mix between the two sectors. To the extent that the drop in inventories came from fewer imports on hand, some of the inventory drawdown will be offset by the decline in the trade gap.

Joshua Shapiro of economics firm MFR hypothesizes that the difficulty of balancing out inventories and trade explains the wide range of estimates for first-quarter real GDP. According to the Journal’s latest survey of economists, forecasts for real GDP growth last quarter vary from an optimistic 2.6% to a gut-wrenching -8.0%."

"now we must make our congress the direct investors of last resort."

From Notes on Credit Spreads:

"Why Infrastructure Spending is Preferential to Tax Cuts

by David Levy

Much concern exists over Obama’s proposal to make tax cuts a major portion of fiscal stimulus. Through a tax cut, we (the government) are increasing the income of those still employed( NOT IF THEY'RE DIRECTED AT INVESTMENT AND CREATING JOBS. ). Hopefully, tax savings will buy goods and services, increasing GDP. In today’s environment, we’re not enacting a stimulus to buy goods, we’re enacting a stimulus to buy jobs.

GDP = government spending + investment + consumption + net exports. The marginal dollars in a tax cut will either be saved or spent.

While savings should be encouraged in the long term, a savings glut currently exists. Fed Funds rate trades near zero, while cash reserves within the Fed have ballooned.

More damaging, marginal spending could be directed at imported goods. From Martin Wolf to Warren Buffet, many shudder at no improvement in our trade balances. Dollars used for imports are either locked up as foreign reserves or exchanged for investments in future US cash flows. Those future cash flows are either US tax receipts or profits distributed as interest or dividends. Those tax receipts could have put new teachers in the class room. Those profits could have built new factories. Those cash flows will never to be re-invested in the US.

By definition then, an increasing current account deficit means the same standard of living - GDP - costs more. If this is not the purest form of inflation( WE WANT INFLATION ), I do not know what is.

Many believe too great a mismatch exists between jobs lost and jobs needed for “shovel ready”. Cokie Roberts on “This Week” opined on finance professionals helping on infrastructure: “Well maybe instead of going to their personal trainers, they can actually get out there and start digging.”

The purchase of infrastructure projects buys jobs across the food chain. Almost every project will go out for private competitive tender. Forget defunct residential home construction (shovel ready employees), companies bidding will require talent to prepare bids, obtain financing, manage payroll, and review costs. Every contract guarantied by the government (state or federal) will give lenders the confidence to finance, spurring new growth.( THAT'S THE POINT OF THE STIMULUS. TO ATTACK THE FEAR AND AVERSION TO RISK. )

The long term benefits (aside from jobs) are then improved transportation, reduced energy costs and reduction of barriers to education( MAYBE YOU COULD LOOK INTO THE BIG DIG AND THE BAY BRIDGE AS RECENT EXAMPLES OF INFRASTRUCTURE. THEY CERTAINLY COST A LOT OF MONEY. ). Thus reduction of risks for future runaway inflation - those risks prevalent in increasing current account deficits. Faith in government is presently difficult yet now we must make our congress the direct investors of last resort( I CALL THEM THE SPENDERS OF LAST RESORT. )."

I agree with the need for a stimulus, and that the government needs to be a SOLR, but I don't understand the problem with tax cuts targeted towards encouraging investment and jobs. What am I missing?

"The dollar doesn’t have to go south if all the economies reflate at the same time.”

I like William Gross, so here's a chance to quote him from Bloomberg:

"By Ye Xie

Dec. 11 (Bloomberg) -- The dollar fell to a six-week low against the euro and yen as the cost of borrowing in the U.S. currency tumbled, signaling less demand for year-end funding.

The greenback also dropped after a report showed the U.S. trade deficit unexpectedly widened in October. The Swiss franc dropped against the euro and yen after the central bank reduced its main interest rate to a four-year low of 0.5 percent.

“Dollar liquidity and funding concerns are starting to fade,” said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc., a unit of Canada’s second largest bank. “These factors have been important sources of support for the dollar in the past few months.”

The U.S. currency fell 1.7 percent to $1.3243 per euro at 8:40 a.m. in New York, from $1.3023 yesterday. It dropped 1.6 percent to 91.28 yen from 92.76. The euro traded at 120.77 yen, compared with 120.78 yen.

The cost of borrowing in dollars for three months in London fell to the lowest level in more than four years. The London interbank offered rate, or Libor, that banks say they charge each other for such loans slid 0.1 percentage point to 2 percent, the lowest level since September 2004, British Bankers’ Association data showed. That’s still one percentage point above the Fed target, up from an average of 16 basis points in the seven years to August 2007, when the credit freeze began.

“From a fundamental basis, there’s a case for avoiding the dollar,” said Adrian Schmidt, a London-based senior foreign- exchange strategist at the Royal Bank of Scotland Plc, the fourth-biggest currency trader. “For the moment the dollar’s on the back foot.”

How interesting.

"The ICE’s Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, fell 1.2 percent at 84.449, below the 55-moving-day average of 84.5, as traders took advantage of the low liquidity to test how far it may fall, Hardman said. They will drive the dollar to $1.345 per euro this year, he said.

The dollar has gained 11 percent against the euro in 2008 as the credit-market seizure and $980 billion of losses on mortgage-related securities worldwide led investors to repatriate overseas investments to the U.S. and seek funding in the greenback.

The yen gained versus all 178 currencies tracked by Bloomberg this year as the global recession encouraged Japanese investors to bring funds back home and global equities plunged.

Japan’s currency jumped 21 percent versus the dollar, 34 percent against the euro and 66 percent against Brazil’s real as the financial crisis prompted investors to reverse carry trades, in which they purchase higher-yielding assets funded in countries where borrowing costs are lower. Japan’s benchmark rate of 0.3 percent is the lowest among major economies.

The U.S. trade deficit expanded 1.1 percent to $57.2 billion in October from a revised $56.6 billion in September, the Commerce Department said today in Washington. The gap was projected to narrow to $53.5 billion from an initially reported $56.5 billion in September, according to the median forecast in a Bloomberg News survey of 70 economists.

The U.S. budget deficit in November swelled to $164.4 billion, from $98.2 billion in the year-earlier period, as the government used taxpayer money to shore up the financial system by buying stakes in banks, the Treasury Department reported yesterday. Government revenue fell 4.2 percent, while spending soared 24 percent."

Let's see what Gross says:

"The dollar may extend its decline as the U.S. government increases its budget deficit by spending “trillions of dollars” to revive the economy, said Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California.

“There’s some risk” for the dollar to weaken, Gross said in an interview on Bloomberg Television yesterday. “It is fair to say other economies are doing much the same thing. The dollar doesn’t have to go south if all the economies reflate at the same time.”

Let's hope for "reflation" ( Another term. Yikes. ) , I suppose.