Page 1 of 5 CREDIT BUBBLE BULLETIN Periphery rising
Commentary and weekly watch by Doug Noland
The Shanghai Composite, China's leading equities index, has posted a 33%
year-to-date gain. Taiwan's Taiex index has gained 20.4% so far in 2009, with
major indexes in South Korea up 14.2%, Indonesia 10.7%, Philippines 8.3%, Hong
Kong 8.7%, and India 7.3%. Russia's RTS index has posted an 18.1% year-to-date
gain, with fellow "BRIC" nation Brazil up 18.0%. Benchmark Brazilian dollar
bond yields are down 60 basis points (bps) over the past month to 6.40%, and
Mexico's dollar bond yields have declined 100 bps to 5.91%.
Last week, Group of 20 leaders meeting in London lent extraordinary support to
global reflation efforts. Anthony Failoa
and Mary Jordan captured the essence of the G20's accomplishment in their
article featured in Friday's Washington Post:
The US$1.1 trillion
pledged by world leaders to combat the worst economic crisis since World War II
effectively amounts to a rescue package for both poor and rich countries,
potentially including the United States. The bulk of that money will be
channeled through the Washington-based International Monetary Fund, which
emerges from the summit with a vastly redefined and enhanced mission. The IMF
has long focused almost exclusively on helping developing nations in crisis. As
part of Thursday's agreement, it will take the extraordinary step of
effectively extending a $250 billion line of credit to boost liquidity in
nations hobbled by the credit crunch, with the bulk of the funds going to the
industrialized nations of Europe, United States and Japan. The fact that the
United States, for instance, could draw as much as $42.5 billion of those funds
to help jump-start domestic lending underscores the breadth of the global plan,
which has both short-and long-term fixes for a crisis that has hit nations
small and large, wealthy and not.
In our age of really big
numbers, the G-20's pledge of $1 trillion of loans and guarantees for new IMF
(bailout) programs and another $100 billion for World Bank lending didn't raise
eyebrows. It is nonetheless an incredible case of institutions virtually given
up for dead coming back to adrenaline-induced vivacity - and likely sporting
greater influence than ever before. "Developing" economies - having feared they
had nowhere to turn for help in stabilizing their financial systems and
economies - suddenly know precisely where they will be greeted with open arms.
IMF director Dominique Strauss-Kahn celebrated the organization's newfound
"firepower" and exclaimed, "The IMF is back!" The IMF's new resources and
mandate must have the "periphery" pinching themselves with giddiness. Markets
are certainly giddy.
If pledges and commitments are indeed fulfilled, the IMF will possess a
formidable $750 billion war chest to do battle with. In addition, the IMF will
expand ("print") its own currency of account - "Special Drawing Rights" (SDRs)
by $250 billion - to be distributed to member countries large and small. This
is a nice win for Chinese and Russian policymakers who have been calling for
SDRs to play an expanding role as a world reserve "currency".
On Friday, from Bloomberg's Rich Miller and Simon Kennedy: "Global leaders took
their biggest steps yet toward a new world order that's less US-centric with a
more heavily regulated financial industry and a greater role for international
institutions and emerging markets ... 'It's the passing of an era,' said Robert
Hormats, vice chairman of Goldman Sachs International, who helped prepare
summits for presidents Gerald R Ford, Jimmy Carter and Ronald Reagan. 'The US
is becoming less dominant while other nations are gaining influence.'"
The days of the US dictating the workings of the Group of Five (the US, France,
Germany, Japan, the UK), later the G-6 (Italy was included), the G-7 (Canada
was added in 1976), the G-8 (when Russia was included) or even the G8+5 have
given way to altogether different power dynamics with the relatively nascent
G-20 (Group of Twenty Finance Ministers and Central Bank Governors).
Having accumulated trillions of (chiefly dollar) reserves during the bubble
years, China, Russia, India, Brazil, the Organization of Petroleum Exporting
Countries and others today wield unprecedented power and influence when it
comes to the course of international policymaking. US influence has waned
remarkably. And the days of the Washington-based IMF responding to global
crisis by imposing monetary tightness, fiscal discipline and economic overhaul
(as in Southeast Asia in 1997) are over.
From an analytical perspective, the (US) "core" and the ("developing")
"periphery" of the world system are these days atypically like-minded when it
comes to supporting the cause of unbridled global bailouts, stimulus and
reflationary measures more generally. It all provides ample fodder to fuel the
ongoing inflation versus deflation debate. Yet when pondering the prospective
global monetary structure perhaps the strongest case is to be made for ongoing
monetary disorder.
One could reasonably argue that the "core" has made such a mess of domestic and
global finance that a shift of power out to the "periphery" couldn't make
things any worse. From a credit perspective, however, there are important
nuances. For decades, the US-dominated "dollar reserve" system at least at the
margin constrained "periphery" credit systems. Regrettably, this dollar-based
"system" failed to discipline the US credit system, and this failing has led to
the failure of this monetary structure.
The dysfunctional global system's recurring boom and bust cycles saw the
periphery hopelessly flooded with hot money, only to then have these credit
systems crushed by the inevitable reversal of speculative flows. The periphery
became absolutely fed up. More importantly, it is now finally in a position to
do something about it. A new system is in the works that would seemingly ensure
that even the periphery becomes insulated from market discipline.
Today from the Los Angeles Times' Don Lee: "Could the world's currency of
choice have the face of Mao Tse-tung on it, not George Washington? Quixotic or
not, the Chinese are preparing for that day. In a series of what might be
called baby steps, Chinese officials recently have moved to globalize the yuan
and promote its influence overseas, with Shanghai designated as command
central. Since last December, China has signed deals with six countries,
including South Korea, Malaysia and most recently Argentina, for currency swaps
that would inject Chinese money into foreign banking systems. That would allow
foreign companies to pay for goods they import from China in yuan, bypassing
the dollar ... Beijing is also taking initiatives to use the yuan ... to settle
trade accounts between some Chinese provinces and neighboring states ... 'The
central bank has set promoting the renminbi [the yuan] for payment settlements
as the main task for this year's work,' said Shi Lei, an analyst ... at Bank of
China ... China is also spreading the yuan's influence in Asia by making loans
and investments in other countries ... "
The media and Internet are abuzz with commentary contrasting the declining US
position to that of China Rising. For the moment, my analytical focus is not in
passing judgment on disconcerting secular trends. I'm instead trying to figure
out the more immediate consequences of (moving-target) reflationary
policymaking at home and abroad. Many analysts who focus primarily on the US
credit system and economy see only an intractable deflationary spiral.
Examining the incredible global policy and monetary backdrop, I see potential
"firepower" that I do not want to dismiss or underestimate.
When the technology bubble burst in 2000, there was an unappreciated fledgling
mortgage finance bubble poised to balloon to unimaginable extremes. I have
theorized that a global government finance bubble today exerts a robust
inflationary bias, counterbalancing the collapse of the Wall Street Bubble.
The extent and duration of this ongoing "counterbalancing" is an open issue of
great significance. I view the resuscitation of the IMF and World Bank as
critical developments for the unfolding government finance bubble thesis. I
view the heightened role of the periphery in global matters as supportive of
global reflation. And, most importantly, I view the dynamic of an increasingly
assertive China as integral to global reflationary efforts.
Back in 2000, conventional thinking (including that of the US Federal Reserve)
was convinced the collapse of technology stocks equated to the bursting of the
US bubble. Similarly today, the bursting of the US bubble is thought to
correspond with the bursting of bubbles across the globe. Especially when one
examines the horrendous numbers coming out of its export sector, it is
reasonable to presume that China is intertwined in the US bust. Yet it's my
view that China is in fact a historic bubble - and that it may have commenced
what may prove a powerful new phase of inflationary excess.
It is commonly appreciated that China has about $2 trillion in reserves to go
with its population of 1.3 billion. This alone provides China with
unprecedented reflationary capabilities. China also maintains a tight
relationship between its banking system and government policymakers, and it is
worth noting that recent reports have Chinese bank lending posting another
eye-opening month of expansion ($234 billion!). China is also now aggressively
using currency swaps and other financing mechanisms to drive exports and trade,
especially in Asia.
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