Well, I finally got a chance to vent at some length about this, thanks to Robin Wigglesworth and Toby Nangle, so I am now going to subject you to this in substack format (in case you somehow have ignored all my efforts to link to the piece in my last stack or in other social media)

HERE IT IS

In 2025, China’s goods surplus reportedly came in at around $1.18tn. The US goods trade deficit that year was $1.24tn. That these two numbers are almost equal to each other has led to a widely shared conclusion that global imbalances stem from Chinese surpluses and American deficits, and an active debate on the causes. But a third number, $1.5tn, or the annual excess of US healthcare spending relative to its developed country peers, has not received as much attention. Perhaps it should.

One view is that the imbalances are entirely China’s fault, as articulated by Michael Pettis. He has insisted for years that China’s industrial competitiveness (and by implication, its trade surplus) is a consequence of policies favoring low wages relative to productivity and thus a low consumption share of GDP. The other, more orthodox, side of the debate, exemplified by Maurice Obstfeld, argues that “the bottom line is that the [US] government’s deficit is a main driver of the trade deficit.” And this is where the dispute has mostly stalled out.

For China at least, the debate does drop from 30,000 to 20,000 feet by mentioning not just broad aggregates but also sectoral considerations. Poor healthcare coverage is seen as a major factor behind an overly high precautionary savings rate that constrains consumption. There is thus a seeming causal chain that connects low healthcare spending (7 per cent of GDP), with excessive savings, insufficient consumption, and a consequent trade surplus. (Note, however, that Arvind Subramanian has just argued that even if China’s consumption share of GDP is low, consumption has been rising at a steady clip over the years.)

In its report on global imbalances, the IMF also makes an unnamed yet clear reference to China on page 24, noting that “in practice financial repression is often combined with forced saving policies that shift the desired saving curve to the right. Examples of these measures are low provision of a social safety net ... . ”

The IMF’s examination of the US counterpart deficit stops at a pro forma declaration that the US should lower its fiscal deficits on page 23 and a tepid call for the US to contain health-care costs on page 38.

But it might help to be clearer. If persistent surplus countries are under-consuming, persistent deficit countries are likely to be over-consuming. And what the biggest deficit country in the world is consuming at a massive scale is healthcare.

At roughly 17 per cent of GDP, the US spends at least an “extra” 5 per cent of GDP on health care compared to some of its closest peers, but with worse outcomes in both coverage and results. Around 27mn Americans are uninsured, and average US maternal mortality rates across all groups are multiples of those seen in the UK or Germany.

If insufficient healthcare spending in China is considered a major contributor to global imbalances, should “excess” US spending of $1.5tn annually be considered in a similar light?

This is not just about inferring causality from the equations that tie consumption, investment, savings, and external balances together (a trend that might be termed “accounting identity politics”). For one thing, the basic economics of a massive and inefficient non-tradeable sector on the overall economy will tend to raise the real effective exchange rate, making exports more expensive and imports cheaper.

But beyond this, there is also the factor of how healthcare costs are distributed, with the US having a uniquely high reliance on employer-provided health insurance plans. Data from the Kaiser Family Foundation shows that roughly half of all Americans receive healthcare plans from an employer health-plan at an annual cost or roughly $27,000 per year, of which $20,500 is picked up by employers.

High insurance costs are a function of extremely high hospital and procedural costs. In a recent essay, Dr Zack Cooper, an associate professor at Yale’s School of Public Health and its Department of Economics, noted that hospitals earn $29,000 for a hip replacement covered by private insurance, and $16,000 for one covered by Medicare. Meanwhile the German system pays hospitals $9,400 for the same operation. So for all the complaints about a runaway fisc, America’s age-restricted single payer system, in this instance at least, is delivering healthcare costs about 50 per cent lower than private alternatives but at 165 per cent the cost of that in other industrialized peers. The organization of US healthcare also leads to high administrative costs, which in 2021 were $925 per person annually versus $245 in peer countries. There is no end to numerical evidence of this kind.

And to add insult to injury from the point of view of less wealthy countries in the global south at the receiving end of US tariffs, the American political system’s inability to fix intractable issues in nontradeable sectors like housing and healthcare seems to have led to a displacement of this anger onto trade.

An example of this rhetorical sleight of hand can be found in this op-ed by America’s Treasury secretary. The cost of this political strategy is evident in the deterioration of US relations with a range of countries in the global south. As countries like India and groupings like ASEAN suffer trade-policy whiplash emanating from Washington, they remain far less skeptical about trade and are seeking alternative trading arrangements.

Political path dependence makes it staggeringly unlikely to happen, but as a thought experiment proceeding from the above litany on American healthcare costs, one might imagine a national single-payer healthcare system funded by a Value Added Tax that delivers universal coverage at roughly 12 per cent of GDP. From the point of view of global imbalances, such an outcome could lower the consumption share of US GDP (thus “allowing” a smaller trade deficit via the accounting identities). At the same time it would reduce non-wage employee costs in the tradeable sector, acting as a tax measure that replicates the effects of a weaker currency.

The above might never happen, but at the very least, it might be worth considering that a largely unremarked outsized combination of expense and inefficiency in the single largest sector of the US economy is the “dark matter” of any debate on global imbalances.

ADDENDA

Since I wrote the piece, I’ve received some pushback, with the big one essentially being that just like the SIZE of the US trade deficit is determined entirely by decisions made by the large surplus areas (particularly China), so is the sectoral composition of US output, with the nefarious practices of large surplus areas pushing the US economy into more nontradeables, (and specifically healthcare) than its peers. I find this profoundly unconvincing for a few different reasons, some of which I go into in more detail here, but the basic idea is that one should not be inferring causation from an accounting identity. The typical answer to that is that the proof of the causation being “push by the surplus areas rather than pull from the deficit areas” lies in extremely low US interest rates. However, that answer has remained the same in fall 2019 (a date I chose because it was probably around when much TWACW was being written) when the US 10 year yield was at 1.75% and 10 yr CGB yields were 125 bps above that, and today when US 10s at 4.55% and CGB 10s at 1.8%. So it’s not quite clear to me how the evidence of causation when UST yields were 125 bps BELOW CGB yields continues to apply when 10 year UST yields are 275 bps ABOVE CGB yields. The other issue is that such a view does not take into account how US healthcare has accounted for a larger portion of GDP than in peers for a very long time. We had the exercise of Hillarycare more than 30 years ago after all. And finally, it seems a bit strange to exclude the endogenous power of US interest groups in this matter — to wit, the power of the AMA, the AARP, the American Hospital Association, the insurance industry and so on. It seems both blind and perverse to attribute all these peculiarities of American political economy to decisions made in Berlin or Beijing.

Second Addendum

You did get a dad joke above (accounting identity politics), but longtime followers also know I have a state capacity fetish. So right now I feel that we are now in a situation where the only remaining Weberian attribute of the American state is its support for barbecuing on Independence Day. Somehow, our administration has chosen the wrong kind of MiniMax solution.

http://www.limesonline.com/cartaceo/legemonia-gramsciana-delle-agenzie-di-rating?prv=true

Posting now because it seemed of some interest given my persistent complaints about how local currency ratings work, but also because it also contains some thoughts on the application of ratings to the Eurozone. Fully prepared for tl;dr.

The Gramscian Hegemony of the Ratings Agencies

Karthik Sankaran

Historians have long understood that the link between the fiscal capacity of the state and its ability to engage in and sustain its position in interstate competition is an essential element in the sinews of power. Beginning with the early modern period, fiscal capacity went beyond just the ability to raise taxes but to include ability to issue debt to investors with those investors displaying the confidence that these debts would be repaid – a confidence that in turn was reflected in both the availability and the price of debt.

Fiscal sinews have historically meant the ability to raise money at home. But in a world marked by immense cross-border capital flows, the ability to deny rivals access to global capital or alternately to funnel global capital to allies becomes another aspect of power. As global capital is predominantly owned and mediated by private individuals and institutions, such an ability can take the form of state suasion targeted at investors or at the gatekeepers that influence the disposition and direction of private capital flows. In our world, the rating agencies play a critical role in this regard, insofar as their assessment and calibration of the risks faced by lenders influences not just private investors but also the behavior of regulators who use ratings as an input in determining the safety and soundness of financial institutions. Ratings agencies thus have enormous power. The question is whether this power is exercised as an overt geopolitical instrument, or whether the geopolitical consequences of ratings power reflect rather a Gramscian concept of hegemony, wherein purportedly neutral judgements in fact reflect deeply rooted values, ideologies and beliefs. I would suggest that the latter interpretation is more correct for most discussions of the geopolitical power of ratings agencies.

One of the oddities of this world is the extent to which ratings agencies are concentrated in the Anglo-American world despite the fact that both the US and the UK are actually a large net borrower from the rest of the world. By various calculations the “Big Three” dominant ratings agencies, Moodys and S&P (both headquartered in the US) and Fitch ((jointly headquartered in the US and UK), account for more than 95% of all global ratings activity, with the first two accounting for roughly 80%.

This in turn is the result of several historical factors. The first is that the US and UK experienced the disintermediation of finance earlier than and to a greater degree than other countries did—i.e., rather than banks channeling funds to companies that they understood well, US and UK financial intermediation were focused to a greater degree on the issuance of corporate bonds to a broader investor base. This in turn put a greater premium on the need for information for investors less familiar with underlying business models than closely linked banks might have been, allowing for the rise of the ratings agencies.

The information infrastructure that grew out of these factors became even more important as the US rose to global prominence in the post 1945 world. By the early 1970s, US financial predominance was reflected not in the US status as a creditor to the world (unlike the model of the UK before 1915), but rather as a large debtor, whose preeminence stemmed from an elaborate quid-pro-quo whereby dollars generated by US trade deficits were readily accepted overseas in exchange for the US provision of a defense umbrella and the US provision of ready markets to absorb excess global capacity. This in turn made the dollar the dominant currency of international finance, a status that it still occupies today, with roughly 60% of all cross-border lending conducted in US dollars (This figure does not count cross-border lending within the same currency area as is the case within the Eurozone). contracted in dollars. Globalized dollar lending made US based ratings agencies a central part of the global system of gatekeepers for finance.

What is interesting that Europe was the first (and only) large economic area to try to extricate itself from its dollar linkage when the collapse of the Bretton Woods system in 1971 led to excessive intra-European currency volatility. This in turn inaugurated a long series of arrangements to limit such volatility that culminated in the creation of the Euro. The deutsche Mark and eventually the Euro replaced the dollar has long replaced as the dominant invoice currency in the region. The Euro has also a moderately high degree of internationalization (albeit less than the dollar), with the Euro accounting for a bit more than 20 % of out of area international lending. Meanwhile, the sheer size of the banking sector means that European banks are dominant players in much of the world. As a region with large net savings, Europe is also a net provider of savings to the rest of the world via its private sector. Notwithstanding all of this, European (or more precisely Eurozone-based) ratings agencies have little influence in the world. The same is even more true of the other large suppliers of global savings –China and (until the Shale revolution in the US) the major oil exporters. It is a commonly pointed out as a flaw that the ratings agencies are compensated by issuers rather than by investors, which may in turn create conflicts of interest. There is also a less remarked meta-issue that the dominant suppliers of credit ratings are headquartered in the sinks for global savings rather than in their source.

Do these factors have geopolitical consequences? Undoubtedly yes, but in a less obvious way than might be believed. It is not too often the case that purely geopolitical calculations (or political pressure to consider the same) influence the extent to which agencies tailor their reviews. Like many modern professional cadres, ratings personnel adhere to a certain standard of technocratic autonomy that is governed by its own rules. They are largely recruited from the group of universities that the dominant institutions of globalized finance themselves patronize. This is an international fraternity (and sorority) largely schooled in orthodox economics (with the usual doctrinal schisms within that orthodoxy), and a set of substantially internalized beliefs on the interactions among institutions and economics.

There certainly are instances in which old-fashioned geopolitics plays a part. For example, sanctions meant that Iran was substantially excluded from ratings by the dominant agencies for several years (though there are reports it may seek to renew its ratings as attempts to access capital markets again following the conclusion of the nuclear deal). But even in the case of sanctions, market power matters. For example, the sheer size of Russian integration with global capital markets (with roughly 700 bio dollars owed to Western financial institutions) may have been one factor that meant sanctions after the invasion of Ukraine were calibrated in such a way as to fall well short of Iranian levels of exclusion from markets. Nevertheless, the experience did mean that Russia (like other countries) is trying to set up its own ratings agencies. It remains to be seen how much purchase some ratings will have with investors outside Russia where the advantages of incumbency will likely be very strong.

However, rather than considering ratings agencies through the prism of pure geopolitics, I would argue that it makes more sense to focus on the rules, ideologies, and beliefs that influence ratings, which then have geopolitical and geoeconomic consequences. It does some quite clear that there are issues of internal consistency across the ratings landscape that seem particularly problematic in the case of emerging markets ratings.

The basic metrics that inform creditworthiness include public sector debt to GDP ratios, the currency composition of debt, the extent of private indebtedness in the economy, particularly in the financial system (which in turn may swell sovereign contingent liabilities), and the extent of net overseas holdings of assets (which in turn may be drawn down by domestic citizens to fund their local government). The issue is that the interaction among these factors is somewhat opaque and not necessarily scaled. So some countries would seem to be unequivocally AAA credits, such as Norway with a debt/GDP ratio of 31% and a positive net international position of 170% of GDP. But so are Canada with a gov't debt/GDP ratio of 92% and an NIIP that is essentially 0% of GDP, and Australia with a government debt/GDP ratio of 40% and an NIIP of -60% of GDP. Conversely, emerging markets sovereigns with much lower debt/GDP ratios and higher NIIPs are rated much lower – for example China's gross general government debt is 42%, its NIIP is +15%, it has virtually no sovereign external debt owed to private creditors, and yet its rating is in the AA-/A+ area. While this might be justified by large increases in private sector indebtedness in the recent past, developed sovereigns with substantially higher government debt ratios, worse NIIPs, larger banking systems (implying a larger contingent liability problem), and possibly greater medium-term political uncertainty (such as the UK) are rated higher than China.

The overall impression is that a hegemonic ideal of high-income democratic neo-liberalism automatically qualifies a country for high creditworthiness despite numerical indicators to the country. The most clamorous example of this was the overrating of Iceland in the 2000s. A tiny country with an immense, internationally active and very risky banking system (whose assets were roughly 9 times GDP) not only achieved the highest rating from one of the agencies, but saw its banks also upgraded (on the assumption of sovereign support) despite the obvious fact that the sovereign was too far small to actually tender such support. Indeed as late as mid-2009, after a crisis had seen the failure of the entire Icelandic banking system and the imposition of capital controls, the country was still rated higher than Brazil by the same agency, though Brazil had largely weathered the2008-2009 crisis and still had ahead of it a few years of a tailwind from a commodity boom.

As stated before, I do not believe that this reflects geopolitical preferences or influences—that Iceland was a NATO member had to less to do with the decision than a more ideological disposition within international capital more broadly. This is the belief that capitalist democracies that respect neo-liberal tropes of “supply side efficiencies” are inherently likely to have better prospects for economic growth and political stability, which makes them better credit risks, even when the numerical indicators of creditworthiness point the other way. To reiterate, this suggests the operation of hegemony in a Gramscian sense as a set of highly influential beliefs (and rules flowing therefrom) that is both widely shared and rarely questioned, rather than in a more “political science” sense of an exercise of state power by a hegemon that seeks to push private entities in a favorable direction during the course of interstate competition.

Nevertheless, these factors can have political and geopolitical consequences. To return to the years before 2008, the major feature of that period was the sharp rise in so-called global imbalances, as current account deficits in both the US and in the Eurozone periphery exploded alongside large surpluses in the eurozone core, East Asia and among the oil exporters. Among the latter two, the task of accumulating and recycling these surpluses savings was undertaken more by the sovereign than by the private sector. The quest for high-quality assets that could absorb those savings led to the creation of synthetic securities grounded in the US real estate market whose putatively high credit ratings proved famously illusory. An important point here is that the effects on US labor of China's epochal reentry into the circuits of the world capitalist economy were hidden for a while as US consumption levels were cushioned by increases in US household leverage enabled longer than they would otherwise have been by the operations of the ratings agencies. The broader geopolitical implications of this—the accommodation of China's rise, the widening rift between globalized capital and national labor in the US and other developed markets (which in turn has led to the Trumpist retreat from globalism) are profound, but once again they seem to stem more from the operations of unconscious rules than from overt pressure to turn the ratings agencies into geopolitical instruments.

The other major node of global imbalances (between the surplus capital exporting core and the deficit capital importing periphery) was the Eurozone, and it is here that the interaction of politics, economics and geopolitics becomes most clear. The decisions of the ratings during the crisis reflected a procyclical pattern observed during the Asian crisis of 1997 of excessively high pre-crisis rating followed by excessively sharp downgrades once the crisis began, which in turn may have contributed to amplifying market responses that exacerbated the crisis. These patterns during the Eurozone crisis (as they did after the Asian crisis of 1997-98) have occasioned a great deal of criticism, but I would argue that that ambiguities in the economic and political governance of the Eurozone may well have heightened the procyclicality of ratings behavior.

As is well known, the central ambiguity of the Eurozone lies in the fact that it is a monetary union that is not also a fiscal union. This in turn creates questions about whether national debts in the Eurozone are contracted in a foreign currency or in a local currency, and simultaneously about the extent to which single countries in the Eurozone can be said to enjoy full monetary sovereignty. These facts have led many market observers to make analogies between the Eurozone and the classical gold standard and to countries that failed to maintain their currency boards (such as Argentina in 1998-2001). Yet even these analogies are in my view, very likely misplaced. The reason is that unlike the classical gold standard, the Eurozone has shared control of a fiat money producing central bank that is capable and substantially (but not unconditionally) willing to moderate the rises in credit risk premia that arise from downturns in the business cycle. The common payment system Target 2 provides unlimited absorption of very large drops in investor appetite for assets from troubled countries. The classical gold standard enjoyed neither of these features nor did hapless countries like Argentina.

At the heart of this difference is precisely the fact that the EU's creation and evolution is a consequence of geopolitical imperatives. The evolution of the EU and the Eurozone reflects first a desire to escape a history of intra-European wars, then the desire to anchor a reunified Germany to its Western neighbors in 1990 and more recently the desire to create an economic and financial unit that gave Europe a semblance of geopolitical and geoeconomic parity with China and the US. These factors are very different from the highly asymmetric motivations that led Argentina for example to import credibility by its peg to the US dollar, even while there was correspondingly relatively little concern on the US side when Argentina finally exited it calamitously.

But what complicates matters further is these geopolitical desires at a pan-Eurozone level have to negotiated against a backdrop of national preferences where there are political constraints on pooling sovereignty (or at least at the pace of such pooling); protests against perceived transfers (whether overtly fiscal or resulting from central bank action) among some countries; and protests against the fact that such transfers are conditional (and consequently seen as a constraint on the exercise of democratic choice) in still others. Political ambiguity is compounded by legal ambiguity—the language of “irrevocable conversion parities” to the Euro is not compatible with Article 50, which explicitly recognizes a right to leave the EU (a right the UK has chosen to exercise). Periodic political messaging around the prospect that Greece might leave the Eurozone, but still stay in the EU clouds matters further.

Recent history suggests an interplay between domestic political constraints and a revealed preference of European leaders to keep the Eurozone alive for geopolitical and geoconomic reasons by agreeing in moments of crisis to hitherto unthinkable expedients such as the creation of fiscal backstop (EFSF and then the ESM,) and the creation of a conditional monetary financing tool (OMT). Against this backdrop, whatever their historic misjudgments it is probably harder for the ratings agencies to get the Eurozone “right” at all times precisely because the fundamental categories of sovereignty and local versus foreign currency debt are more politically fluid as a result of the unique construction (and the ongoing evolution) of the Eurozone. The dominance in the ratings markets of English speaking countries with a particular culture of political economy might well exacerbate ratings misjudgments in the case of the emerging markets. However in the case of the EU in particular, some portion of the blame ascribed to the ratings agencies must also fall on the fact that the financial and political architecture of the Eurozone is in itself a work in creation, with the maximum creativity displayed only in the moments of crisis.

This grows out of a discussion with Matt Klein, when we are talking about the discrepancy between trump fiscal exchange rate and trade policies where he jokingly suggested that the Fed should sell all its USTs and buy Bunds. I thought about it overnight and it struck me that the underlying idea actually makes a great deal of sense. As longtime followers know, I've been insistently pounding the table for a few years now on three related topics-that the combination of floating and large open capital accounts is more destabilizing than stabilizing; that exchange rates frequently overshoot driven by large, instantaneous shifts in desired portfolio balances; and that the interaction of borrowing (domestic vs. foreign currency) and investment behavior ( tradeable vs. nontradeable sector) during such overshoots invalidates the idea that large current account imbalances are an automatic intertemporal smoothing mechanism. Another way to think about this is that in two of four quadrants of a kind of Swan Diagram (that plots Internal and External balance) THERE WILL BE A FUNDAMENTAL CONTRADICTION BETWEEN THE INTEREST RATE REQUIRED TO RESTORE INTERNAL BALANCE AND THE EXCHANGE RATE REQUIRED TO RESTORE EXTERNAL BALANCE.

Sorry to scream, but I'm astounded at how often I've had to explain this to people in the course of a day job. Anyway, this is why I'm increasingly a proponent of capital controls. Nothing new so far for people who have been subjected to real or virtual harangues on this from me. What is new (and the reason for this post), is the idea (2nd best in my view, but potentially best in practice) that maybe the worlds major systemic central banks -- Fed, PBoC, BoJ, ECB (for a start, but think this could eventually make sense at the G20 level)-- should routinely engage in dialogue and coordinated bi-or multilateral interventions whenever a country is identified as being in one of those problematic Swan quadrants where a country might need higher interest rates but a weaker currency or lower interest rates but a stronger currency Right now we have a world in which CBs do indeed have massive balance sheets, but there's a huge difference between EM and DM CBs, with the massive EM CB balance sheets composed to a large extent of foreign assets, while the balance sheets of the Fed and the ECB are composed almost exclusively of domestic assets. This distinction reflects two things--greater financial depth in DMs (i.e. more domestic assets to buy) vs. EMs, but also a preconception among the Fed and the ECB in particular that market set exchange rates are superior to administered ones. This is, of course, ironic on so many levels, starting with the fact that the Euro is a culmination of a 3 decade long project by Europeans to (justifiably in my view) limit and eventually eliminate the impact of the post 1971 forex market on intra-European exchange rates in what was and remains a tightly connected series of small open markets with deeply interlinked supply chains. For those reeling in horror and disbelief at this point, I direct you to my post on why the Euro crisis might not really have been caused by the Euro. ;). http://rajakorman.tumblr.com/post/79194706949/what-might-the-eurozone-crisis-have-looked-like

But it is also ironic because one of the obvious purposes of large domestic balance sheet expansion in DM CBs is precisely to influence the exchange rate. The same goes for negative interest rates. All I'm saying is "Cut the crap." I'm arguing that all major CBs should be prepared to use shifts in the relative size of their domestic and foreign balance sheets as a signaling device (alongside interest rates) as a way to signal not just the aggregate monetary conditions they think of as appropriate, but also the relative contribution of domestic interest rates, the shape of the yield curve, and critically of the exchange rate in determining said monetary conditions.

In other words, central banks should be prepared to use their balance sheets to accommodate and mitigate precisely those large shifts in the private sector's desired foreign portfolio balances that can be inherently destabilizing for both real and financial outcomes. I also think that if CBs do this, they should do it collectively rather than singly, in a coordinated fashion and according to a set of guidelines where it is easy to differentiate purely mercantilist impulses from ones where there is genuine incompatibility between the needs of internal balance and external balance. This also seems to me a much preferable situation to governments messing around with goods market via tariffs and trade barriers when these external balance issues become political Kryptonite. The state of the US-China relationship where divergent cyclical impulses threaten exchange rate behavior that blows up an already fraught politics of trade strikes me as a classic case for such an approach. Market purists will be horrified by the suggestion of routine central bank intervention in yet another market but longtime followers already know I've pinned my flag to the superiority of technocratically driven outcomes over purely market-driven ones. I realize there are technical issues regarding sterilized vs. unsterilized intervention, but coordinated multilateral intervention, even when sterilized, has historically had a pretty strong record of signaling inflection points. See, for example, https://research.stlouisfed.org/publications/review/11/09/303-324Neely.pdf

One other benefit of such an approach is that it would confer the imprimatur of the Fed and the ECB and a broader range of assets (in particular the sovereign liabilities of systemic emerging markets sovereigns denominated in their own currency) as being safe assets. I do not think this is a problem. The dollar's long history of the dominant international safe asset owes a great deal more to geopolitical factors than to its inherent superiority as a store of international value. And perhaps the best thing about such an approach of routine rule-bound multilateral coordinated forex intervention in order to achieve G20 exchange rate target zones is that makes it more possible to return to at least some of the underlying financial conditions of the Bretton Woods 1 era, but in a world with large private portfolio capital flows and large central bank balance sheets (and per the work of Zoltan Poszar, I think there's a compelling case that such large balance sheets are here to stay). What I'm suggesting is that there is a case for using the central bank balance sheets as a way to offset the instability inherent in large private capital flows.

Vive les 30 Glorieuses.

Related posts.

http://rajakorman.tumblr.com/post/102531405985/niip-sustainability-and-the-case-for-capital

http://rajakorman.tumblr.com/post/84527845240/on-spillovers-exchange-rates-and-monetary

http://rajakorman.tumblr.com/post/79194706949/what-might-the-eurozone-crisis-have-looked-like

http://rajakorman.tumblr.com/post/139151237270/tired-of-nirp-try-intervention?is_related_post=1

http://rajakorman.tumblr.com/post/128277678675/on-spillovers-and-the-case-against-giving-in-to

http://rajakorman.tumblr.com/post/114124758065/the-fed-never-talks-about-the-dollar-and-other

.

And if anyone makes it this far.

http://rajakorman.tumblr.com/post/80683018566/ramblings-on-international-inside-money-and

It will borrow (i.e., cut and paste) from an earlier column on the global savings glut entitled “Can anyone be 1930s France anymore?” but what got me thinking about these issues again was a) the BoE explanation of endogenous money and b) the persistent belief that it is essential for the US to run trade or current account deficits in order to provide the world with sufficient USD liquidity. In other words, there seems to be a view that the status of the USD as the world's reserve currency depends on the US running current account deficits.

Let me start with b) because I've dealt with it inside the 140 twitter format but it might be useful to spell it out a bit more clearly. The fact is that both the UK before 1915 and the US before 1962 ran current account surpluses but still were the world's monetary hegemons. This is because both the US and the UK ran very large capital account deficits that met the world's needs for international liquidity. Formally, if the country at the center of the monetary system has a substantial excess of domestic private savings over domestic private investment, then those savings can be exported to the rest of the world. Furthermore, the export of domestic private savings could be so large that it is insufficient to fund domestic government dissaving, leaving that to be funded by the Rest of the World, in turn providing RoW with reserve assets. This model of pre-1915 UK and pre-1961 US behavior also seems to picture German behavior inside the ECU. More generally, I also like this model because it treats the capital account with the respect that I think it deserves (yes, I know the algebra). This idea of relatively autonomous capital account behavior is what is behind my view that the Eurozone crisis (certainly its boom phase) would have been no different even with national currencies (which is the post immediately preceding this one). It also fits with my intuition that greater financial market turbulence is occasioned around the world by marginal shifts in the net US demand for external assets than by shifts in the net US demand for external goods (which latter, I understand, at second hand at least, is the GaveKal view). And of course, that is what the taper tantrum is all about.

What does this have to do with a) above or the Bank of England paper on money creation in the modern economy? I see the key point (at least for my purposes) as this from p.1 of the BoE note.

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

“Saving does not by itself increase the deposits or ‘funds available’ for banks to lend. Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.(3)”

Transposing this to the international arena, I would make the case that it is wrong to infer from the increase in global reserves that occurred between 2002 and 2007 that there was also a simultaneous increase in global savings (i.e., a global savings glut).

And now to cut and paste from my earlier note as to why it makes no sense to speak of a global savings glut from 2002-2008. “Intuitively, one might have thought that such an insufficiency of investment versus savings might have been more likely to occur between 1997 and 2002 as a result of the Asian crisis and the global technology bust, or alternately, during the sharp fall in global trade that followed the collapse of Lehman. When considered in this light, the GSG hypothesis seems based in part on a category error. In essence, the peak period of the GSG is identified by the peak rate of global reserve accumulation. The category error is that the hypothesis treats reserve accumulation under fiat currency reserve asset regimes as being indistinguishable from reserve accumulation under the classical gold standard. However, as Jacques Rueff pointed out half a century ago, fiat currency reserve regimes differ from (the theoretical operation of) the classical gold standard in that there is no necessity for the deficit country at the center of the system to undergo adjustment through monetary contraction and reduced investment as long as its liabilities are treated as substitutes for gold. This explains the otherwise anomalous fact that the peak of the GSG also coincided with extremely high rates of US public and private dissaving and a sharp increase in US liabilities.

By its nature, the fact that algebraically the increase in Chinese saving coincided with a rise in US dissaving makes it hard to speak of a global savings glut though there was obviously an increase in reciprocal regional imbalances with increases in chinese claims offset by increases in US liabilities. Similarly I find it difficult to understand why the period is designated a GSG period when it might as well be designated a period of a global (mal)investment boom, which follows from the algebra.

Meanwhile, I do find Bernanke’s (and others’) periodic analogies of Chinese behavior during GSG to French behavior in the late 1920s/early 30s to be inexact. The refusal of a surplus country to permit monetary expansion in response to increased gold inflows can lead to a shortfall in global aggregate demand since the surplus country will not grow faster while the deficit country would likely be forced into contraction. But in a fiat reserve regime, reserve accumulation continues to permit fiscal or quasi-fiscal (via GSEs in the US case) expansion in the deficit country at the center of the system. This explains why the GSG period also coincided with a higher level of global growth and higher levels of global investment than the periods immediately before or after. My point is that an excess of savings of “outside money” if unsterilized in a gold standard system can lead to a global excess of savings over investment. I see no evidence that this occurred GLOBALLY during the period 2002-2007.”

In a quick TWT conversation with Frances Coppola yesterday, she referred to the US trade deficit as international endogenous money. I think that makes a lot of sense, and per the post above, I was trying to get at a similar idea. Another point I've made (also in 140) is that treat the increase in global reserves as evidence of increase in global savings is similar to treating an increase in M2 or M3 as evidence of an increase in a country's domestic savings, which I think we we would all consider a mistake.

But then, this takes us back to the question of whether or not US trade and current account deficits are essential to grease the wheels of global liquidity. As I laid out above, it might be possible for exports via the capital account to do the same (as the UK did before 1915 and the US did before 1961). In theory, yes, but I think one crucial difference arises from the nature of the claims that such a system would create. A capital exporting reserve hegemon would not be subject to the Triffin Dilemma (which, in a nutshell, states that too small a current account deficit is insufficient for global liquidity, while too large a current account deficit raises questions about the quality of the reserve asset). However, under such a system, the banking system of the reserve hegemon might not expand credit as quickly because it would by construction hold assets in large non-hegemonic capital importers that were perceived to be of lower quality, which might tend otherwise to constrain the expansion of their balance sheets. Conversely, a reserve hegemon that is simultaneously a large current account deficit country can for a considerable period of time (until there is a regime shift and the hegemon is dethroned) provide RoW banking systems with the highest putative quality of collateral (USTs in this instance), permitting much more rapid expansion of global credit. I think that is exactly what happened in the period in question. This in turn would account for something that has always bothered me—the fact that the US functioned as the world's buyer of last resort in goods markets from 2002-2007 but that in 2008, the Fed became the world's lender of last resort.

Anyway, there is obviously a lot more to chew on here but I did want to get this out there. Comments especially welcome. Questions, not so sure I can really answer them.

Nothing like a nice title that uses the word Capital, is there? This post picks up on about two years' worth of conversations, tweets, storms, etc. But the original thought goes back at least to the 2008 election—specifically the Sarah Palin pick for Veep, acclaimed (and allegedly masterminded by) by Bill Kristol--when it became clear that the most loyal and most highly engaged voters of the GOP were the losers from globalization. Ever since then, the dichotomy “nationalism” vs. “globalism” seems to have become the dominant ideological organizing principle for this group of GOP loyalists. I don't think it's a coincidence that Tea Party members describe themselves as Patriots.

The question is how this dichotomy interacts with the elite interests that the GOP has historically represented. I take the cynical view that political parties need both hearts and pocket books. Over time, they need a coherent intersection of elite interests,popular interest and ideology in order to survive. And I think that in a two party system, the logical elite interest for the party of the right to represent is the interest of capital. At the same time, parties of the center right in capitalist democracies have historically finessed the issues of popular interest and ideology by appeals to nationalism and the claim that they have delivered mass prosperity to their constituents, precisely because they are the party of capital.

This was easy enough to do during the Cold War, when the opposing global system defined itself as an international party of labor and presided over a system which delivered far less in the way of mass prosperity. As I've joked, it's really hard to be a materialist party when you do a crappy job of providing material goods. Conversely, those signs pointing out that The American Worker Has The Highest Standard of Living in the World were not just true, but also hit a trifecta, connecting the interests of capital with those of labor in the context of a single country—the US.

All that began to change, less because of things that happened in the US, and more because of what happened in the rest of the world. (I recognize this part is controversial, but I'd still locate the dominant impetus behind the current predicament of the GOP in what happened in China to a greater degree than the limited capacity of the US welfare state to cope with it). Anyway, once huge populations in China, Eastern Europe and South Asia gradually stepped away from socialism (and in the Chinese case, hit upon the genius idea of Leninist post-Marxism, rather than the failed Gorbachevian expedient of Post-Leninist Marxism), metropolitan capital naturally took advantage of the opportunity, inaugurating the second great age of globalization, with the distributional results anyone who has heard of Branko Milanovic can now see.

Capital and capitalism became global, and so did its interests. That portion of the elite (like me) who were involved in the managing, mediating, explaining, commenting on the flow of capital away from the old center of the global economy benefited. So did the recipients of such capital, predominantly in Asia, while the losers (at least in relative terms) were those whose labor metropolitan capital no longer needed, or at least not at the same price.

The problem is that this created a serious rift between elite and mass interests, and elite and mass ideologies that is particularly acute on the center-right. As I've said in another context, what we're seeing now is the next phase in a series of long changes in the ideological-material contours of the global economy, at least as seen from the North Atlantic. The years roughly between 1650-1800 (arbitrarily using the Peace of Westphalia as a dividing line) saw the end of a broad civilizational/sectarian identity among elites in the North Atlantic and the inauguration of a period where elites became “national”. The years after 1800 (you could pick 1776 or 1789 if you wanted) saw a period in which elites remained national but a vast ideological/political/material enterprise was devoted to nationalizing the masses through conscription, education, the gradual expansion of suffrage and eventually the expansion of the welfare state.

But in the world since 1990, the interests of capital (and of capitalism) and of a portion of the elite have become much more globalized, even as labor has remained stubbornly national. Of course, this is a tribute to the ideological success of the anti-Socialist and anti-Communist efforts of North Atlantic capital and its associated parties in that 1800-1990 period (and many historians would see 1865-70 as the real inflection point in this regard). But it still presents a huge problem for center-right parties precisely because the claims of capital and the claims of nationalism are ever more tenuously linked. The issue is less problematic for center-left parties for two reasons—ideologically (and to different degrees in Europe and North America) they have been somewhat more comfortable with an identity that is internationalist, but this would be less effective were it not also for the fact that their sociology to an ever greater degree reflects their appeal to the beneficiaries of this wave of globalization—the mediators of these flows of capital, and those possessors of the kind of cultural capital that either acquires greater value in a global marketplace or is more resistant to global labor arbitrage. It is these facts that seem to explain the US political landscape right now (and with some changes, can help make sense of Brexit too). Center-right ideologies centered on capitalism and the nation state were the dominant forces defining the North Atlantic for the last couple of 100 years, and interestingly, may well play an ever larger part in defining ideology and politics in China and India, both of which seem to be solidly in the “nationalization of the masses” phase. But in old heartlands of capitalism, as the coherence of the capitalism = nation state identity becomes ever more frayed, a new ideological landscape is opening up, on the right above all.

This is a long-winded and likely pompous attempt to explain what must by now seem self-evident but I promised @conorsen I'd do it. If you haven't seen them already, I do recommend these two recent articles in the New York Times http://www.nytimes.com/2015/10/07/opinion/how-did-the-democrats-become-favorites-of-the-rich.html?_r=2

and the Wall Street Journal. http://www.wsj.com/articles/republicans-rode-waves-of-populism-until-it-crashed-the-party-1477492356 that put some more meat on my bloviation.

“An excellent piece, though I do have a question about the widely prevalent assumption that the USD will appreciate as a result of tariffs. This has indeed happened on this occasion but I can think of other occasions when it has not. For example, the imposition of steel tariffs by the Bush administration in March 2002 was a precursor to a multiyear stretch of USD weakness. Similarly, markets reacted negatively to the imposition of semiconductor tariffs on Japan in 1987, as recounted by Steve Solomon in his magisterial The Confidence Game. Indeed, much of 1987 seems to have been about the US trying to juggle market concerns over twin deficits, dollar weakness, and the periodic temptation towards heterodox trade policy, all of which would lead to (an ineffective) Louvre Accord and eventually the October crash. And this market reaction would seem to make sense. To me it seems as though tariffs can affect the exchange rate through at least three channels -- a) a reduction of the external financing requirement as imports fall, which would be currency positive b) a possible reaction to a reduction in external demand in exporting countries that takes the form of either lower interest rates and/or an acceptance/push towards weakening their currencies. But on the other side is the question of capital flows into the country imposing the tariffs. If the tariffs are seen as reducing the efficiency of capital allocation in the importing country; signaling a heightened willingness to resort to import substitution and retreat from the technological frontier; favoring less competitive sectors over more competitive sectors etc., all of these factors might reduce the willingness to send money to such a country, even if a lower external financing requirement would suggest greater m/t sustainability. The capital/financial account response really seems to be another key piece of the puzzle here.”

Paul Krugman

Voodoo Trade Policy Comes to America

OK, I’m going to take a break from the death of democracy to talk about bad economic policies instead. Warning: lots of numbers ahead. That will happen sometimes…

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a year ago · 1116 likes · 341 comments · Paul Krugman

1. https://responsiblestatecraft.org/china-trade (On the overwrought response of the US to China building a port in Peru.,

2. https://responsiblestatecraft.org/scott-bessent/ (a quick take on the Treasury Secretary designate and his plans to use tariffs and dollar centrality as cudgel.

3. https://responsiblestatecraft.org/trump-trade-war/ (on the 4 different trade factions within the US and how it might all play out).

4. https://www.ft.com/content/6c9821f3-924f-4d07-a95e-765512b8c634 (On the interactions among three roles of the dollar — Trade, National Security, and Global Financial Stability).

Thanks to all followers and I will try to keep on posting here. Wishing you all the best for the holidays and a wonderful 2025.

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Anyway the trigger here was a post (Bloot?) by Michael Pettis arguing, along lines already set out by Dani Rodrik in the early 2000s — that globalization had led to a loss of economic sovereignty in the US. As Pettis describes it, countries pursuing persistent trade surpluses are shipping both their surplus goods and their surplus of savings into the US, effectively making the US less sovereign in terms of the economic policies it might pursue.  This is a natural consequence of his well-known belief that the size of the US trade deficit is not determined by US policies but by policy choices regarding the balance of between consumption and savings elsewhere in the world. For my part, I have remarked that this argument is a) inferring causation from an accounting identity and b) conflating the ABSENCE of an external financing constraint on the US with the IMPOSITION of a positive constraint to react passively to other countries’ choices.

I have long had many issues with this argument above and have expounded upon them at greater length but let me just make some quick points regarding the types of economic sovereignty the US does retain in the face of large and putatively undesirable inflows into US markets.

The US can intervene in FX markets to prevent dollar appreciation, not just via the Exchange Stabilization Fund, but potentially through the Fed, which could at various times cite its employment mandate; its inflation mandate in the event of excessive imported disinflation; or its financial stability mandate if such inflows are causing a risk of excesses in pockets of the markets

It could use the dampening of domestic interest rates increases —presumably the corollary in bond markets to an undesired appreciation of the dollar  in currency markets— to engage in fiscal policy measures that might increase the sophistication of certain portions of the tradeable manufactures mix, thus reducing their FX-sensitivity.

It could use such inflows to finance fiscally-led improvements in the US’s most problematic non-tradeable sectors such as housing, healthcare, or working conditions for low-wage non-tradeable services. This might not alleviate concentrated political backlash in those portions of the tradeable sector most exposed to import competition, but would at least improve the lives of the considerably larger number of households engaged in nontradeable activites in what is the least open of the big 3 economies.

As Brad Setser tirelessly reminds us, it could rewrite the Tax Code to limit not just transfer-pricing tax arbitrage but also the offshoring of jobs that goes with it. For my part, despite my appreciation of the enormously beneficial global impacts of ULC arbitrage as a development strategy, I’m less troubled in this particular instance because the tax arbitrage is vexing, and employment/tech convergence effects probably hits developed countries like Ireland (perhaps the biggest beneficiary) less hard than real EM.

It could/could have taken the occasion of the drop in energy prices in the mid-2010s to impose an economy-wide carbon tax (much as countries like India and Indonesia took that as an opportunity to withdraw fuel subsidies). This would have accomplished a couple of things —First, it might have changed incentive structures in the automotive sector in the direction of not just greater fuel efficiency, but also of convergence with automotive preference in the rest of the world, leaving the US less of a Cenozoic Continent when the EV revolution came around. Second, it would avoid the embarrassment of having to explain to the WTO why a country without a countrywide national carbon pricing mechanism is imposing a carbon-adjustment mechanism at its border. Not that the latter matters—the US will maintain its sovereign right to ignore any ruling and face no consequences for this, having already blown up the Appellate Body.

As the last bit of snark suggests, it might well be the case that any or all of the remedies/adjustment mechanisms above are politically tricky (or impossible), but that really ought not to be confused with an erosion of sovereignty. Because for real erosions of economic sovereignty, we must look elsewhere—in emerging markets or possibly (and more trickily) in the Eurozone.

And I am trying to make two points here. The first is that it would be foolish to believe that all countries are equally sovereign in the face of pressures that come either from countries in the international system or from global financial markets. Soem are just most “sovereign” than others, which in turn might affect how one thinks about Rodrik’s “Globalization, Democracy, Sovereignty” Trilemma. Or as Kris Kristofferson sang (in the song that was apparently a favorite of Abdurrahman Wahid — Suharto’s successor after the Indonesian etape of the Asian Financial Crisis) — Freedom is another word for nothin’ left to lose.

The second point is that short of being invaded and occupied, there are few things that are more destructive of a country’s sovereignty than being a deficit area that runs into balance of payments difficulties and then needs concessional assistance from the IMF or other IFIs. (Glad I already worked my Suharto reference into the previous paragraph).  But such assistance is only available on the basis of conditionality. The good thing is that the conditionality might be somewhat less exigent than what markets belatedly demand—the IMF typically asks for things next year that furious investors (whether the trapped kind or the “got out by the skin of their teeth” kind) belatedly realize they should have probably have asked for last year.

But these countries still have to put up with quarterly reviews on a huge range of macroeconomic, microeconomic and institutional targets. Sometimes they can plead extenuating circumstances or appeal ot geopolitical reasons to get off easier, but still it’s a pain. And acceding to conditionality is a task that is usually devolved to non-party technocratic PM or Finance Minister reliant on support from a multiparty majority whose components are torn between the specter of economic disaster now or political disaster at the next election. And that’s the lucky ones that eventual graduate from the program and return to the markets instead of exploding into full-on civil strife.

That dramatic exposition —which will nevertheless be familiar to anyone who has been around EM or the Eurozone in the last 25 years — is meant to do two things. First, to show complainers in the US what a real loss of economic sovereignty looks like. And secondly to reiterate a point that I have made repeatedly—it is precisely to avoid such balance of payments crises and the attendant loss of sovereignty that countries do the things that Pettis complains about as reducing American economic sovereignty.

This typically includes efforts to run persistent trade surpluses;  engage in reserve accumulation that might come alongside an “undervalued” currency; use ULC arbitrage to entice foreign firms onshore in order to gain productive plant closer to the technological frontier and achieve an export mix with high exchange-rate sensitivity. Or as I like to say—the Pettis Paradox is that any remotely competent EM policymaker who has read The Volatility Machine will naturally take the measures that lead to the world he and Matt Klein describe (complain about) in Trade Wars Are Class Wars. In other words, developing countries that have successfully negotiated Globalization 2.0, have not lost sovereignty in the international economic and financial order, they have gained it through the process.

Note that the travails cited a couple of paragraphs above typically happen to emerging countries running deficits. But they don’t happen to developed countries (that time when Truss lost market support was extremely amusing, but really doesn’t count IMO, even if I did make a joke at the time that the UK was a Kwasi-EM). And they certainly don’t happen to the world’s largest external debtor, the US.

And here it might be time to consider how little sovereignty the current international monetary, financial, and trading system costs the US at least in comparison with every other country on the planet. As Jacques Rueff pointed out almost 60 years ago, the ability to settle persistent deficits in a numeraire the US can produce at will allows it to run ‘deficits without tears” at least at an aggregate level (in terms of tears), if not at the level of single sectors on the wrong side of an import surge. And the sheer-size of the US market means that episodes of dollar weakness typically lead to lower inflation passthrough than in other countries because exporters would rather absorb a portion of the loss in their domestic-currency margins than lose market share.

But beyond this, because the US produces the world’s dominant numeraire for both trade and cross border liability issuance, it gets to control much of the access to concessional financing in USD by deciding on conditionality behind IMF programs and Fed Swap Lines. Its gets to surveil USD transactions anywhere in the world, and to impose primary and potentially secondary sanctions (i.e., not just on certain suspect users but also on those servicing said users). And these sanctions don’t even have to be triggered by USD-usage in the first instance—anyone transacting in any currency with a sanctioned entity is at threat of finding themselves cut off from the USD system.

Now one might argue that this is an extraordinary power and the US has by and large used it for good. Be that as it may (And I Have Questions About Some Of This), my point here is about sovereignty. And it seems extraordinarily clear-cut to me that the extent to which the current international, monetary, financial and trading system intrudes on or constrains the sovereignty of the US is utterly dwarfed by the extent to which said system not only constrains the sovereignty of most other countries but even allows the US to intrude on such sovereignty. There can  be little doubt that in terms of “net sovereignty” which one might think of as “doing unto others minus other doing unto you,” the US is far and away the most sovereign sovereign on the planet.

And although this asymmetry in sovereignty is most evident in the economic sphere, it is true elsewhere. I’ve tweeted here that one of the interesting things about the US role in the international system is that it’s domestic political system is extraordinarily jealous of ANY intrusion on its sovereignty. It is not a signatory to the Law of the Sea: not a member of the ICJ or the ICC; has insisted to a greater degree than others that the Article XXI National Security Exemption of the WTO is entirely self-judging; and so on. The thing to note here is that the US claims to be the upholder of the Rule Based International Order, but at the same time its domestic political culture is extremely careful to ensure that US adhesion to the RBIO in most circumstances is discretionary and de facto, rather than de jure (which might bind too much).

Like the Hobbesian sovereign the argument seems to be that in order to uphold the law, it must be above it. This will lead to all kinds of geopolitical/legal excursions that I’m not inclined to go on right now. But purely in terms of international economics, I want to say — stop already with this “free trade is reducing our sovereignty” boo-hoo.

Check your (Exorbitant) privilege.

Gratuitous dad jokes, at least one of which is topical.

Now Is The Time For All Good Men To Come To The Aid Of Risk Parity.

Not to be confused with time during Covid in the UK when it went “Now Is The Time For All Good Men To Come To The Aide’s Party.”

But now imagine that I was someone who had borrowed BTC back then. I would be so screwed, even if I had gotten the loan interest free. But importantly, not only would I be so screwed, so would the person who had lent me the money, because there is no way I could repay the money today. Or maybe there is one way—I might be able to repay it be if I had borrowed the BTC to invest in equipment that mined BTC (but I would have energy and equipment costs etc.) Note that even the equivalent shovels —high performance semi-conductors —most likely would not have worked. If I had bought NVDA at 4.25 in 2010 (I did not), I would be up only about 220x, certainly not 35 million x. But if I had actually borrowed the BTC to invest in a pizza shop, or a machine that made pizza faster, or even one that conjured pizza out of thin air but with some energy costs (like a Star Trek replicator), it’s not clear to me that I would have generated a return in excess of 35 million times over less than 15 years.

My point here is that Bitcoin as designed is a numeraire that is intentionally deflationary. Taken at the word of its apostles, its claim to be an inflation hedge lies in the fact that its fixed supply means that the price of pretty much everything in the world will drop in terms of bitcoin. But while that might make it a good hedge against inflation (taken at its word), its very design  makes it extremely difficult to hedge against the default of pretty much anyone you ever lend your BTC to. You have to hang on to it rather than lend it, because the likelihood that anyone (other than the possible exception of a fantastically efficient BTC miner) that you lend it to will be able to return the BTC amount you lent them is extraordinarily low. It is like the gold standard on steroids, because that at least had the possibility of new supplies of gold being discovered —e.g., the Witwatersrand in the late 19th C. As designed, it is meant to be hoarded, because lending it creates immense exposure to credit risk, which is a risk inherent to  and inescapable from its design. This in turn, IMVHO, creates certain obstacles to its ever forming the basis of anything remotely like a broad-based monetary system.

Anyway, I’m sure someone has already said this. And I’m a rank amateur when it comes to Bitcoin—and as I noted, I don’t own it, but at least I don’t owe any either.  But it struck me that having spent more than a couple of decades thinking about the troubles of Emerging Markets and of the the Eurozone  this might be of some use, in the extremely unlikely event you haven’t encountered something like this already.

It struck me that it might be worth adding another point here. I have in the past said that the single most important aspect of currency internationalization lies not in its use as an “asset vehicle” but rather as a “liability vehicle.” This then leads eventually the provision of an international Lender of Last Resort* in that liability vehicle who can backstop the system from catastrophic cascading risks. Now, if Bitcoin’s deflationary tendencies make it ill-suited as a liability vehicle (as suggested above) and its decentralized and anonymous structure makes it much harder to provide an LoLR (I suppose in theory there might be 1907 Morgan of BTC, but I doubt it)**, that’s just another strike against it as broad-spectrum international money that fulfills all the functions we’ve come to think a money should have.

P.S.

The dad joke. So if I’m right that an all-Bitcoin economy would have a naturally persistent deflationary bias, that means its R* would be negative. Which then means that both lenders and borrowers in that economy would have to face up to the fact that “Default lies both in R*s and ourselves.”

*Excruciating footnote—Without a proper LOLR facility, a money is a second rate version of the real thing, much like those ill-starred places in America in the 1980s where the only place to get bagels was a supermarket that had Lenders of Last Resort.

** About that 1907 Morgan of BTC thing, I was both wrong and right. I was wrong in that the media did speculate about someone as the 1907 Morgan of Bitcoin. I was right in that the media thought it was going to be….. Sam Bankman-Fried!

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One thing both interventions make clear is that the central preoccupation of the US in geoeconomic terms is China. Further, it is obvious that the administration is grappling with the question of how to structure its strategies for a transPacific competition that will proceed on multiple fronts—economics, security, and diplomacy. And underneath it all (but acknowledged only glancingly, if at all) is the substrate of domestic politics in the US, a reminder that Aussenpolitik everywhere, and especially in a narrowly-divided and deeply polarized democracy, can be constrained by Innenpolitik.

Singh’s speech makes several nods to the dilemmas of diplomacy, seeking to reassure countries and corporations. He notes about sanctions that  “their design and implementation must be infused with a sense of humility. By design, sanctions break the bonds of trade, capital, and technology in the global economy—sometimes instantaneously—making unintended consequences almost inevitable.” He adds that “There should be a pledge of caution to “do no unnecessary harm” to the civilian population of the target country and to those of third countries.” One might note here that the limits of “necessary harm” are  in the eye of the imposer of sanctions, but that’s another matter.

The speech is not just about sticks though—it also includes a discussion of carrots. He states that “Specifically, the United States should convey a standing preference for using economic instruments when they positively induce and attract countries via the prospect of mutual gain, rather than feed a perception that the United States’ focus and energy is mostly spent on deploying tools that are designed to inflict economic pain.” All this is well and good, but there is still a (hubristic?) iron fist inside that velvet glove. “There are, however, major geostrategic opportunities for the United States and its allies to attract nonaligned countries into its orbit with positive inducements, and in doing so to gradually isolate China before any conflict unfolds.” Hubris might seem an overwrought term, but how else should one describe a desire to “isolate” the world’s second-largest economy, its largest exporter of manufactured goods, and its largest importer of commodities. It is unlikely that such a course would go over well with much of the rest of the world.

And it is important to note that the bulk of Singh’s carrots come in the form of financial tools —sovereign loan guarantees, a US sovereign wealth fund that invests in other countries and so on.  This builds on the US’s unquestioned strengths as home of the world’s largest and deepest financial markets, and issuer of the world’s dominant safe asset and of the world’s dominant liability currency.  It has long had an unmatched ability to raise capital in its own currency, and to determine the circumstances under which concessional lending happens in that currency—whether in the form of a Fed swap line, or in the form of an IMF package, where the US’s shareholding weight means it has an effective veto.

That said, these financial inducements may be of somewhat less use to a large (and critical) portion of the global economy. Since the 1998 Asian Financial Crisis, many countries in the region have switched to running large trade and current account surpluses. And even  deficit countries like India have engaged in building reserves and benefit from relatively stable financing conditions.  Of course, there are other countries that are in deeper distress that may well need such assistance. But even in this instance, there are large pools of capital (besides China) from whom such financing is available. Japan is of course one such candidate, but the Gulf states are another, and they have been very active in their immediate region, lending support to Egypt and to Turkey (which, in the latter instance, might not have been entirely in conformity with US preferences).

Even so, the US is the heavyweight in the room when it comes to global financial markets—particularly when it comes to the sticks of primary and secondary sanctions. Other countries might be able to lend dollars but only the US can block the pipes through which they flow, or seize them. This is an unqualified superpower that no-one else has, or is likely to achieve for at least a decade and probably even longer.

Nevertheless, for all that it might be peripheral as a power in global finance (the renminbi is a distant also-ran compared even with the euro, the Avis of global currencies), China’s own Avis position in the world economy comes from its role in global goods markets. It is the world’s 2nd largest economy, and even if trade has shrunk as a percentage of its GDP, it remains a very important source of both demand and supply. It is the world’s largest importer of commodities, especially petroleum, copper, iron-ore, and soybeans. It is also the world’s largest importer of semiconductors —something that might annoy the US, but creates strong corporate constituencies against efforts to cut China off.

Of course, China is also the world’s largest exporter of manufactures. Now, some of these manufactures might not be welcome everywhere (especially in the US), but it is important to recognize that across vast tracts of the world, China is the most economical supplier of high-quality capital goods—to name just a few, railroad and port equipment, routers, solar panels, ships, batteries, and most recently, electric vehicles, most of which poorer countries have no capacity to make right now.  This also makes China absolutely indispensable to any effort to fight global warming—not just because it’s the world’s largest emitter, but also because it’s the largest producers of the technologies and products that will reduce emissions.

Further it is important to note that in many instances, the US doesn’t make these products either. Any effort to return to producing them at home for domestic consumption in the US might be bolstered by massive tariffs, but that’s hardly a recipe to wean the world — especially developing countries —off Chinese imports or to get them to buy these goods from the US.  The fact is that the huge chunks of the world’s tradeable-goods manufacturing ecosystem has moved to the Pacific Basin over the last 40 years, with China now just taking the place occupied once by Japan (and then in part by South Korea).  Any idea that the world’s second largest economy can be isolated, either as supplier or as buyer seems a fool’s errand.   

Meanwhile, US attempts to “decouple” from China might only have increased its points of connection to other countries. A fair amount of evidence suggests that the obverse of the fall in US imports from China is not just an increase in imports from other countries, but also an increase in Chinese exports to those countries exporting to the US. This could be a crude throughput operation, or actual inbound direct investment by Chinese corporates in those corporates to assemble (or even produce) goods for export. To some extent this may be a function of tariff-evasion,  and to some extent a response to rising labor costs in China. But the point is that the embedded knowledge of markets, networks, products of Chinese companies can be communicated both to the enterprises they invest in and to their upstream in-country suppliers. Also. China would not be the first country playing that role in the Asia-Pacific region—Japanese outbound investment along theses lines played a major rule in the industrialization of ASEAN and China, as did Korean investment after Japan. China is just following in those footsteps.

US final demand has obviously crucial to all these endeavors, but increasingly so is Chinese supply and know-how of markets and production techniques. Under these circumstances, however much poorer countries in Asia might chafe at many aspects of China’s economic model, there are also advantages to its embrace, and ones that the US might find difficult to replicate.

This points to a larger problem. In a subsequent piece in the FT (link above), Singh and his coauthor focus on the need to increase the resilience of global supply chains through more active public management of demand and supply in critical commodities, not just in the US but around the world. The model is the US Strategic Petroleum Reserve and the stated concern is China’s weaponization of both of its supply of, and its demand for key commodities. This is a worthy goal, even if the idea that the US is opposed in principle to the weaponization of economic networks and relationships might raise eyebrows in some quarters. And the article is also littered with references to “allies,” “adversaries,” and “competitors” of the US.

The first thing to note is that there is a distinction between the latter two terms—the first operates on the plane of security; the second on the plane of economics. More fundamentally, much of the exposition earlier in this piece suggests that many countries  are likely to think of themselves as neither allies nor adversaries of the US (or of China for that matter), and on the occasions that they do think that way, do so so locally and situationally rather than globally.

In other words, many countries do not want to take sides—or at the very least not in eternal lockstep with either the US and China. Even the EU, the Robin/Sundance Kid of the Atlantic Alliance has devoted its talents in scholasticism to come up with a definition of China as a “partner, competitor, and systemic rival,” an exercise in ambiguity that most countries will outdo in actions if not in words.  And any effort to draft either countries or corporations is likely to carry echoes of George W. Bush’s infamous “You are with us, or against us,” in the runup to the Iraq War but without the excuse of 9/11 PTSD. Further, any such efforts would come in the milieu of economics rather than security, potentially making any effort to force countries to pick a side even more fraught, given the sheer weight of China in the global economy.

And if US conduct of a geoeconomic foreign policy is rendered problematic by such considerations on the part of its potential targets, domestic political considerations in the US make things even more difficult. The ability of the US to corral even its most steadfast allies into an economic cordon sanitaire around China will likely be undermined even further by the backlash against foreign economic engagement within critical parts of the US political spectrum. In a previous piece for FPRI , I described the different trade-policy factions within the US as composed of Openers, Decouplers, Repatriators, and Derailers—the names alone should give a clue as to where they stand. But in an election year that is very likely going to come down to grueling battles over a few thousand votes in the rust belt, the Repatriators (of American jobs) have the advantage.

The attractions of friend- (or innocuous-bystander; or enemy-of-my-enemy; or toxic-ex; or skeezy-rebound-guy) shoring to America’s foreign policy elites are incompatible with the opposition of critical components of the Democratic coalition (and their Republican opponents) to any form of offshoring at all. Perhaps the most trenchant example of this is President Biden following Pennsylvania Senator John Fetterman  in opposing the Nippon Steel takeover of US steel on the cited grounds of National Security. This despite the fact that this would not be offshoring, but rather the takeover of an existing US entity by a country that has a 40 year history of investing in the US (especially in the auto industry) because of Voluntary Export Restraint Agreements signed in the 1980s. That this is not even about jobs, but about the optics of takeovers suggests the extent of the obstacles from domestic politics to practicing geoeconomics on a world scale. Or as I have described it, the intersection of the US’s electoral and industrial geographies means that A Foreign Policy For The Middle Class will in practice tend towards A Foreign Policy For The Upper Midwest And Western Pennsylvania.

This is perhaps another reason why Singh’s focus is on financial carrots. US domestic politics make goods market carrots —tariff-free market access, outbound FDI with technology transfer — much, much harder for the US to offer. And that’s under a Biden administration. While it is probably the case that a hypothetical Trump administration would continue with the China policies that he began in his first term (and Biden continued and in many ways intensified), US trade and security policy aimed at Europe, Japan, and other countries could have even fewer carrots and more sticks. If nothing else, the uncertainty over US political outcomes means that the the rest the world will likely listen politely and punt many geoeconomic proposals coming from Washington at least until November. Between domestic politics and the structure of global goods markets, despite the awesome power of US sanctions, the US probably has at least one hand tied behind its back in the geoeconomics contest.

And for having made it thus far, here is your dad joke—All Great Power Rivalry efforts to engage with India will probably come down ultimately to Jioeconomics.

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