Liquidity trap?
The current account surpluses of China and the Middle East are large and growing. China’s foreign exchange account is about $1.5 trillion. Invested surpluses in the Middle East are perhaps as much as $3 trillion. If China’s position is indicative, much of that cash is sitting in government bills and bonds, and other low yielding instruments.
There is a substantial and urgent need to recycle the current account surpluses back into those countries that are running large current account deficits (the US current account deficit is about a trillion dollars annually). An effective way to do so, and lower the risks for surplus and deficit nations alike, is for the surplus countries to invest in long term assets of the deficit nations that appreciate over time — in other words, equities.
Global equities are worth about $50 trillion, maybe $60 trillion, today. US equities are worth about $20 trillion or so. The equity markets (public and private) can absorb a great deal of the imbalance between the deficit and surplus countries, but progress on this front appears to be somewhat sluggish. This is not the central reason for the depreciation of the dollar, but it is a contributing factor. (Such imbalances also complicate the process of regulating money supply, one of the key functions of central banks.) The massive build-up of unrecycled liquidity in a few exporting nations is one of the preeminent financial dangers of our time, and so far almost no one seems to be talking about it.
November 8th, 2007 at 7:46 pm
There’s more than one way to recycle dollars.
Realizing that public- and private-sector mismanagement has made the American economy wobbly, you convert your large trove of dollars into a currency that you expect to hold its against the dollar. You use that currency as collateral for sustained cumulative shorting of our stock market, converting the proceeds of the short sales into the robust currency. When your selling precipitates a market break, US equities and the dollar crash together and your short-covering yields a dual profit.
IMO such financial warfare is not in China’s interest at present, but perhaps some oil producers would find it to their advantage and maybe there are hedge funds that bet on such a double-crash scenario.
November 9th, 2007 at 7:46 am
How, exactly, does one “convert that large trove of dollars” without driving up the price of the dollar relative to that currency? How does, for example, the Euro or the Yen hold its value if you trigger a depression in your largest export market?
That kind of “screw the world, I’m getting mine” play makes sense for a George Soros. I doubt China would be interested in triggering massive layoffs among the people working in its factories.
November 9th, 2007 at 5:22 pm
MarkD, I don’t understand your comment.
How, exactly, does one “convert that large trove of dollars” without driving up the price of the dollar relative to that currency? If many people sell their IBM stock and switch into Apple, the price of Apple shares will tend to rise relative to IBM.
How does, for example, the Euro or the Yen hold its value if you trigger a depression in your largest export market? Perhaps via deflation. Furthermore, in assessing the risks, costs and benefits of a financial attack, an unfriendly oil producer might not be deterred by economic considerations.
That kind of “screw the world, I’m getting mine” play makes sense for a George Soros. Soros’s name was on my mind when I mentioned hedge funds. I’m no fan of his politics, but ’screw the world, I’m getting mine’? Money managers are supposed to act on behalf of their clients.
I doubt China would be interested in triggering massive layoffs among the people working in its factories. I wrote, “IMO such financial warfare is not in China’s interest at present“. It might well be part of their future geopolitics.