Monday, November 28, 2011

More US Debt Needed?

. Monday, November 28, 2011

So says David Andolfatto (via Mark Thoma):

I believe that the decline in real rates on U.S. treasuries reflects a steady change in how agents and agencies around the world want to structure their wealth portfolios. There has been a massive substitution away from many asset classes into U.S. treasuries; and it is this fundamental market force that is driving real interest rates lower. 
The phenomenon began in the early 1990s, with the collapse of the Japanese stock market. Then Mexico in 1994, the Asian crisis 1997-98, Russia in 1998, and Brazil in 1999; see Bernanke (2005). Investors became rationally pessimistic about the returns to investing in these countries, as well as similar countries that had not yet experienced crisis. The natural effect of this would be capital outflows from these countries into relative safe havens, like the United States.

The basic thesis here is very much related to what Ricardo Caballero calls a "global asset shortage."
I wrote about this over a year ago, in response to a similar argument by Brad DeLong. You can read that post for more details, but the gist is that Kindleberger argued that in a crisis a hegemon is needed to stabilize the international system by providing five public goods: a market for distress (unsalable) goods, lender of last resort and provider of liquidity into the global financial system, a stable system of exchange rates, macroeconomic coordination, and countercyclical lending.

But what if there's a 6th? What if the hegemon should also create large amounts of highly-rated financial assets that firms can keep on their books without worrying about default?

In a sense, such a role is already encapsulated in Kindleberger's five. It would, in a sense, provide a market for distress goods, which in this case is speculative finance. If these assets are heavily-traded enough an increase in their supply could also constitute a form of liquidity. And they could be used to fund a program of countercyclical lending, by borrowing funds from skittish investors and channeling them to needy borrowers.

As Mark Blyth and Matthias Matthijs argue in a recent issue of Foreign Affairs, Germany is either incapable or unwilling to play this role in Europe. (I'd argue both.) In which case the U.S. should step in and be more aggressive. The Federal Reserve has taken some steps in that direction, opening up swap lines with most major central banks worldwide, and lending directly to foreign banks. But many of those programs have ended. It's not clear that the Fed is doing much to stabilize Europe now. Meanwhile, the federal government has no appetite for such a role.

Put all this together and it's hard to escape the belief that things are going to get worse before they get better. The U.S. may be relatively insulated from a European collapse, but that doesn't mean we're perfectly insulated. And plenty of other places are much more exposed. As the systems level, then, unless the U.S. steps up instability is likely to worsen.


Emmanuel said...

If low yields alone reflect demand, then there are more attractive sovereigns out there alike those of Switzerland, Japan, Hong Kong, Sweden, and Singapore which have lower yields.

With them, you also don't have to explain why the dollar is near all-time lows on currency indexes if there is so much demand for dollar-denominated assets--especially against the likes of the yen, Swiss franc, etc.

Apparently, others don't take it as a signal to run up gargantuan debts despite having both extraordinarily low borrowing costs and strong currencies to vouch for continuing demand unlike a certain North American country.

Since we're supposed to be international political economy people, we shouldn't be fixated on one country alone. Leave economists with their navel-gazing sample selection bias.

Lasse said...

In my opinion, understanding the role of debt is more interesting through its function in the political economy of speculation than Kindleberger. The production of debt is key to sustaining long periods of asset price inflation. (See Knafo on speculation: we need more debt to create a new bubble to get us out of the current slump (only to be faced with bigger problems in the future).

The reason I emphasise this is that it is my opinion that almost all of finance (and a worryingly large chunk of the 'economy') is speculative (purchase of an asset only to profit from a movement in price). Thus, I see it as more central than Kindleberger's 5 points.

@Emmanuel: Please open your blog for comments ;) Your Marx revisited post a couple of days ago does not do any justice to, or highlight, the massive differences between Marxian thought and World Systems Theory. The latter is based on a completely objective ontology and has, despite its appeal, been thoroughly discredited within IR/IPE/GPE. Whereas Marxian thought within a synthetic dialectic overcomes the Cartesian subject-object divide. Das Kapital should be understood more as a study of how subjectivity acquires form, than the economistic piece it is presented as by inter alia Althusser (the rubbish about an epistemological break). (PS! I am not feeling aggressive, just get very worked up about this sort of stuff:P And would love to be able to have a lively debate in your comments section)

Kindred Winecoff said...

Emmanuel -

The point is that there isn't enough of that other debt to place a central role on financial institutions balance sheets. That's why demand for more highly-rated, highly-liquid debt is out-stripping supply. There are other sources, but none big enough to satisfy the huge demand.

Anyway, given that this is about international markets and global financial system, it IS about other countries.

Lasse -

Thanks for the comment, and the pointer to the Knafo article. Very interesting. I agree that much/most of modern finance is speculative, but price discovery is an important component of asset allocation. The question is whether we're in an Austro-Marxian world or not. If so, then supporting asset prices can only lead to a bigger crash later, as you say. I'm not sure that's the world we're really living in, but I'm open to the possibility.

And I agree that Emmanuel should re-open his comments.

Emmanuel said...
This comment has been removed by the author.
More US Debt Needed?
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