Does not Dionysius seem to have made it sufficiently clear that there can be
nothing happy for the person over whom some fear always looms?
Cicero, commenting on the story of the sword of Damocles.
Being the Treasury secretary of the United States can easily be described as
the worst job in the world; a modern-day equivalent of the Greek myth involving
Damocles, who recognized the hazards of power when he noticed a sword suspended
above him, held there by a single horse hair. Not only is the job of being the
borrower-in-chief for the world's sole superpower full of its own
contradictions, ranging from how much you bow relative to the power of the
country you represent; there are also the pesky
aspects of democracy to deal with - congressional panels, presidential
attention spans and political expediency.
All that, before dealing with the markets and what they will do in reaction to
everything you do. It now appears that another front has opened to make the job
of Treasury secretary that much more "interesting".
Ever since the build-up of deficits egged on by George W Bush, the job has
become a virtual revolving door, going from Paul O'Neill to John Snow, then to
the more combative Hank Paulson; only to be inherited by Tim Geithner after the
election of Barack Obama as US president.
On February 3, the following report was published by various news outlets:
Moody's
Investors Service fired off a warning on Wednesday that the triple A sovereign
credit rating of the US would come under pressure unless economic growth was
more robust than expected or tougher actions were taken to tackle the country's
budget deficit.
In a move that follows intensifying concern among investors over the US
deficit, Moody's said the country faced a trajectory of debt growth that was
"clearly continuously upward".
Steven Hess, senior credit officer at Moody's, said the deficits projected in
the budget outlook presented by the Obama administration outlook this week did
not stabilize debt levels in relation to gross domestic product.
"Unless further measures are taken to reduce the budget deficit further or the
economy rebounds more vigorously than expected, the federal financial picture
as presented in the projections for the next decade will at some point put
pressure on the triple A government bond rating," the rating agency added in an
issuer note.
We will not know for a while the justifications
for the mistakes that Geithner is apparently making at the job or has been
doing for the past year and counting; meanwhile, the just-published book of
Paulson casts light not only on the political pressures surrounding the job but
also on the apparent efforts of international investors to extract political
mileage from their holdings of US government bonds.
This revelation puts the economics of funding massive Group of Seven (G-7)
deficits at the epicenter of discussions surrounding the emerging political
realities. Since 2007, it has been clear to me that old set-ups like the G-7
are past their sell-by date, even as potential replacements such as the BRIC
(Brazil, Russia, India and China) economies have failed to gather any momentum.
In this environment of undefined if not uncertain power games, the job of
borrowing money on an epic scale cannot but be fraught with sundry compulsions.
Paulson, in his recently released book, makes the now widely reported claim
that following from Western criticism of its actions in Georgia, Russia
attempted to co-opt China in selling down bonds of Fannie Mae and Freddie Mac
(see And now
for Fannie and Freddie, Asia Times Online, July 12, 2008). Paulson goes
on to suggest that the Chinese demurred at the request of the Russians, but
instead may have secured more direct assistance from the US which went on to
nationalize the two agencies (or "placed in conservatorship", to use the
official description) in the aftermath and buy-out of the Chinese holdings of
such agency bonds.
As the Financial Times reported on January 29:
Mr Paulson said that he
was told about the Russian plan when he was in Beijing for the Olympics in
August 2008. Russia had gone to war with Georgia, a US ally, on August 8.
"Russian officials had made a top-level approach to the Chinese, suggesting
that together they might sell big chunks of their GSE holdings to force the US
to use its emergency authorities to prop up these companies," he said.
Fannie and Freddie are known as GSEs,or government sponsored enterprises.
"The Chinese had declined to go along with the disruptive scheme, but the
report was deeply troubling," he said. A senior Russian official told the
Financial Times that he could not comment on the allegation.
Separately, Mr Paulson makes it clear that he believes that Mr [Alistair]
Darling [the British Chancellor of the Exchequer] prevented a takeover of
Lehman [Brothers] by [UK-based bank] Barclays out of fear that it would
endanger the UK bank.
Mr Paulson said that Mr Darling telephoned him on Friday, September 12 - as the
US authorities were scrambling to find a buyer for Lehman - to express concern
about a possible Barclays deal. Mr Paulson said that he did not realize at the
time that this was a "clear warning".
He was stunned to discover on Sunday, September 14, that the UK Financial
Services Authority would not approve the merger on an accelerated timetable or
waive the requirement for a shareholder vote.
As a background
note, perhaps Paulson forgot that in the run-up to the above-mentioned
Olympics, it just so happened that Beijing was also put under severe pressure
with respect to Tibet, a series of developments I found distasteful enough to
write about in April that year. (See
Asia must rally behind China, Asia Times Online, April 19, 2008.) There
was palpable anger within China over the G-7 efforts to demonize the country
and attempt to cast a pall over the country's "grand arrival" party that was to
be the Olympics opening ceremony.
Travelling back to the main topic of discussion, it is apparent that Fannie and
Freddie (the largest of the government-sponsored enterprises) became political
footballs due to their dual roles involving government policy (to encourage
home ownership in the United States) that contrasted with the size and scale of
their ambitions in the markets.
By the late 1990s, the size of the US mortgage market had become bigger than
that of the US Treasury market, and the size of agencies' balance sheets had
grown commensurately. Calls to trim the agencies to make them more manageable
and less prone to default proved politically unpopular because of the potential
impact on mortgage borrowing costs - then, as now, the sacred cow of American
politics.
The trouble with having a sacred cow is that your neighbors, who normally just
covet your other cows, would really, really want to steal this one. In the case
of the example provided above, the Russians targeted Fannie and Freddie not so
much for the objective of making a quick profit but because they well realized
the political costs in the US of allowing the two agencies to fall down or go
bankrupt.
Dealing with the lame-duck government of George W Bush and a possible regime
change (even if it was the Republican candidate John McCain who was leading the
polls in August of that year), the Russians must have shrewdly calculated that
the time was opportune to give the US financial establishment a bloody nose in
response to alleged interference in Russian affairs.
That the Chinese refused to go along with the Russians is also not a surprise
per se. After all, the Chinese government has shown more than a rudimentary
understanding of geopolitical strategy for the better part of the past 20
years, playing various factions deftly against one anther even as Chinese
interests are preserved and protected. In this case, the benefits of making a
quick buck by selling down agency debt (and perhaps shorting) would have been
too small, not to mention too risky, against the potential costs to the rest of
the Chinese portfolio of American bonds.
Instead, the Chinese used the "revelation" of the Russian attempt to their own
advantage, by essentially forcing the US government to bail out its sacred cows
and ensure full repayment to investors (the most prominent of which happened to
be the Chinese).
The Russians were probably not this comprehensively outplayed by an Asian power
since they lost to Japan in 1905.
That was the first jitter.
Even as we attempt to lay the story to rest, the fact is that the US, as well
as all the indebted governments of Europe (Britain, Portugal, Spain, Italy and
Greece), will have to acknowledge the new reality that has been made public by
Paulson. To put it bluntly, the terms of borrowing from the East have now
changed, and perhaps inexorably so.
Last month, I suggested (tongue in cheek) the following name changes to reflect
the new realities:
General Motors to be renamed Government Motors - which in all fairness is what
the company is being called on the Internet.
Various bailed-out banks in the US and Europe to be renamed for prominent
taxpayers in those countries, or simply as "Taxpayers Bank of ... "; so for
example the Royal Bank of Scotland would be renamed the "People's Bank of
Britain" and so on.
Given the volume of bonds issued by US agencies in Asia, perhaps the Federal
National Mortgage Association (Fannie Mae) could be renamed "Chinese Grants to
Bankrupt American Citizens" and the Federal Home Loan Mortgage Corporation
(Freddie Mac) could be renamed "Asian Donations to Bankrupt American Citizens".
Given that its very survival in the debt markets was assured by support from
Germany at the right moment in December, the Hellenic Republic (Greece) could
be renamed the "German Tourist Board".
Then there is the vexing question of what to call the various American states
that are technically bankrupt and in need of tender mercies from their
creditors. Perhaps if California and Florida could change their names
respectively to Xinjiang (West) and Fujian (West), they could come to some
arrangement to prevent an actual default from occurring; just a thought. (See
What's in a name?, Asia Times Online, January 7, 2010).
(We have seen this first week in February that the US government's ownership of
GM exposed it to allegations of favoritism with respect to the cases involving
Toyota vehicles, now the subject of recalls over defective accelerator pads and
possibly brake units. Doing the right thing for US consumers while avoiding
conflicts of interest has never been as complicated as it is now for the US
government.)
Avoiding the landslides associated with borrowing from pesky new powers such as
China, Russia and others would basically force painful new realities for
Europeans. There is the apparent Irish solution - namely significant pain to be
taken through the budget, comprehensive austerity and so on - but this could
prove immensely unpopular, not to mention economically restrictive at a time
when global consumption remains under pressure and corporate investments are
muted.
Accommodating the aggressive newcomers may be another course of action, and one
that is being pursued by governments that either don't have sufficient popular
mandates or which are no longer secure in having those mandates in place; I
would certainly include both the United Kingdom and the US in this category of
countries. For such countries, humiliating deals would essentially be par for
the course.
As I write this article, rumors are swirling around Washington of an imminent
sacking of Geithner, even though there are far too many potential contenders
for the job to allow any particular front-runner to be named at this moment.
Geithner will probably write a book to explain what happened with the AIG
bailout, now that the Russians and Chinese have been implicated by his
predecessor in the Fannie-Freddie story. Perhaps he will focus on what the
Indians and Brazilians did to cause the US government's takeover of AIG.
Jokes aside, his successor will inherit a deadly combination of rising debt and
falling investor confidence. Much like Geithner and his predecessor Paulson,
any Treasury secretary will first have to visit Asian investors to present his
credentials.
That is not just the new reality for the next Treasury secretary, but most
likely also for the next 10 people to take that job.
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