THE FED'S WILD IMAGINATION by Dr. Kurt Richebächer
- From: bromselick@xxxxxxx
- Date: 14 Sep 2005 16:48:00 -0700
In his testimony to Congress on July 20, 2005, Mr. Greenspan declared
it
quite likely that the world is currently experiencing a global savings
glut. Agreeing with Ben Bernanke, he mentioned this glut as one of the
factors behind the so-called interest conundrum, i.e., declining
long-term
rates despite rising short-term rates.
Having read a lot from the Fed's luminaries, their inability to
distinguish between rampant global credit excess and a global savings
glut
does not surprise us. In this view, the Federal Reserve has come to the
rescue of a world where excessive saving is threatening depression by
eliminating savings.
Attracted by superior rates of return on U.S. assets, investors around
the
world have been scrambling to pour their excessive savings into direct
investments, stocks, bonds and real estate in the United States, in
this
way financing the resulting huge U.S. trade deficit.
While this explanation may seem to make sense, there is one big snag:
Not
one word of it is true. First of all, in reality, private foreign
investors have drastically curbed their investments in the United
States.
According to the Bank for International Settlement - the international
organization of the world's central banks - Asian central banks
financed
75% of the U.S. current account deficit in 2004.
First, private capital flows into the United States have slumped.
Without
the massive interventions by the Asian central banks, the dollar would
have collapsed long ago.
Second, the dollars with which these central banks have been buying
U.S.
Treasury and agency bonds have definitely nothing to do with Asian
savings. Evidently, the central banks are recycling the dollars, no
more,
no less, which they receive from U.S. trade and capital flows. These
dollars have come into the central banks' possession through their
interventions in the currency markets, to prevent a rise of their
currencies against the dollar.
To speak of a global savings glut as a possible cause of the
surprisingly
low U.S. long rates in the face of these blatant facts is truly the
height
of insolence and absurdity. That this opinion comes from the leading
figures of the Federal Reserve is more than shocking.
True, Asian countries have very high savings rates. For China, it is
reported to be as high as 45% of disposable income. But this does not
necessarily imply an existing savings surplus be lent to America. The
bulk
of available savings in China domestically is locked up in an even
higher
domestic investment ratio.
Looking at the global financial system, a straightforward fact to see
is
that central banks have been amassing foreign exchange reserves at an
accelerating pace since the early 1970s. Rising in several large waves,
their main source is plainly the soaring U.S. trade deficits.
Having no use for dollars in general, the first dollar recipients in
the
surplus countries sell them to their banks against their own
currencies.
These banks, in turn, found ready dollar buyers in firms and investors
around the world, wanting to acquire direct investments or other assets
in
the United States, at least until 2000. Since then, though, capital
inflows on private accounts into the United States have drastically
receded, while U.S. trade deficits have exploded. In order to prevent a
rise of their currencies against the dollar, central banks had to step
in
as buyers of last resort.
Apparently, it is not widely realized that this big shift in dollar
recycling from private accounts to central banks essentially has
far-reaching monetary implications for the participating countries and
even for the world economy and world financial markets. Buying dollars,
the central banks credit the commercial banks in their country with
interest-free deposits.
Now, the critical point to see is that the banks, on their part, regard
these deposits as their liquid reserves to be used for profitable
lending
or investment. Inundated with liquid reserves by the dollar buying of
their central bank, the commercial banks in these countries embark on
faster credit expansion. Shifting the rising surplus of liquid reserves
between them, they create credit for consumers, businesses and
speculators
many times the amount of the liquidity injection by the central banks.
Our focus in particular is on China. As in the United States, the
resulting credit deluge is boosting components out of proportion to the
whole economy. In China, however, the specific components are real
estate
and manufacturing investment, while in the United States, it is
consumer-spending excess.
What the Asian central banks truly recycle is the U.S. credit excess.
But
in flooding their banking system through the dollar purchases with
liquid
reserves, they transplant the virus of credit excess to their own
economies. For U.S. policymakers and economists, this is a reasonable
and
sustainable division of labor. The U.S. economy runs on wealth creation
through asset inflation with a high rate of consumption, while China
and
Asia run on wealth creation through saving and investment with a high
rate
of investment.
We are fearful of this development, because it affects more or less all
industrialized countries with high wage levels. In this way,
overconsuming
America is force-feeding the rapid mutation of China's backward economy
into a first-class manufacturing power. When China's credit and
investment
boom started, in 2000-01, its central bank had foreign exchange
reserves
in the amount of $165.4 billion. Today, they exceed $700 billion.
We are wondering what is worse for the whole world, China's further
rapid
manufacturing growth or a disastrous hard landing. Observing the same
monetary and economic follies as in the late 1980s in Japan, we
consider
the second possibility highly probable.
A persistent, sharp slowdown in China's imports strikes us as ominous.
The
general comforting explanation is inventory liquidation. But how to
explain, then, the continuous oil and commodity boom? We suspect
speculation far more than economic growth as the reason.
With all the talk about a savings glut, we feel obliged to make some
remarks about the subject. First, please take another look at the
Wicksell
quote on the first page, stating, "The supply of real capital is
limited
by pure physical conditions, while the supply of money is in theory
unlimited." "Supply of real capital" is actually a synonym for
available
savings.
At an international conference in 1953 about savings in the modern
economy, with many heavyweights in economics in attendance, the famous
former chief economist of the Fed E.A. Goldenweiser gave a rare precise
definition of saving. He said: "Saving means the withdrawal of
sufficient
resources from the production of consumption and services to have
enough
for maintenance, expansion and improvement of the plant." Then, he
complained, "that ever since Wesley Mitchell's Business Cycles there
has
been a tendency to concentrate too much on the monetary expression of
economic developments, and it has become reactionary to think in
physical
terms."
>>From the macro perspective, "saving" provides the physical resources
for
the production of capital goods in that consumers abstain with part of
their income from consumption. Of course, this also involves money
flows,
but saving's decisive distinguishing feature is the partial abstention
from current consumption to make real resources available for the
production of capital goods.
It is ludicrous, therefore, when American economists claim that rising
asset prices, increasing consumption, should by counted as saving. When
we
read decades ago that Mr. Greenspan, long before he became Fed
chairman,
had expressed precisely this view, he was once and for all finished for
us
as a serious economist.
The world economy seems to be flooded with liquidity. But there are two
diametrically different kinds of liquidity: earned liquidity and
borrowed
liquidity. The former comes from surplus income or savings; the latter
comes from credit and debt creation.
In a country with virtually zero savings like the United States, any
liquidity essentially arises from debt creation. This is really fake
liquidity depending on permanent, prodigious borrowing facilities,
presently the housing bubble. Once this bubble evaporates or bursts,
the
U.S. economy loses its chief liquidity source - with disastrous effects
on
asset prices.
The crucial question concerning the U.S. economy is whether it is
slowing
or accelerating. As explained in detail, we see a lot of fudge in the
recent economic data. Our main critical consideration is that a
self-sustaining recovery would absolutely require a strong rebound in
business investment. But that is not in sight. On the other hand, the
turnaround in the housing bubble is only a question of time. A fairly
short time, we think.
The consensus expects that the U.S. economy has the "soft spot" behind
it
and will surprise positively. We expect shocking economic weakness. All
asset prices, depending on carry trade, are in danger, including bonds.
Regards,
Dr. Kurt Richebächer
-------------------------------------------
Editor's Note: The Fed has remained irrationally confident in the U.S
economy - because they can't afford from American consumers to see the
truth - that the basis for this confidence is a shamelessly fraudulent
farce of trumped-up statistics. Fortunately, Dr. Richebächer isn't
afraid
to tell the truth.
Former Fed Chairman Paul Volcker once said: "Sometimes I think that the
job of central bankers is to prove Kurt Richebächer wrong." A regular
contributor to The Wall Street Journal, Strategic Investment and
several
other respected financial publications, Dr. Richebächer's insightful
analysis stems from the Austrian School of economics. France's Le
Figaro
magazine has done a feature story on him as "the man who predicted the
Asian crisis."
.
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