Without changes to reserve currencies another crisis is inevitable

We saw that Joseph Stiglitz proposes a new reserve currency to alleviate pressure on trade imbalances. Michael Pettis is now also proposing a similar move away from the U.S. dollar. In an FT Op-Ed, Michael wrote that every generation we hear warnings that the dollar’s dominance will wane. In his view, these warnings have intensified of late. The reality is that the US dollar’s reserve currency status is a ‘public good that comes with a cost’. And the cost is debt accumulation in net importing countries along with trade imbalances that becoming a lightening rod for economic nationalism and protectionism. He recommends the US take the lead in moving to a multi-currency world. I support this recommendation and believe that another crisis is inevitable if we do not move in this direction

Rising economic nationalism

I read a very good piece on the psychology of economic nationalism by SocGen ‘s Dylan Grice earlier today. Because of some relevant thoughts from a reader regarding austerity, I wanted to pass on my thoughts on what he wrote in the context of the present economic situation.

This is going to be more a ‘political economy’ post than an economics or financial one. I take an extremely negative view on economic nationalism; and it would probably take too long to explain why here. But I will lay out the arguments as neutrally as I can so you can see what is happening.

Debt Ceiling Showdown Coming

A sovereign nation that issues debt in its own fiat currency cannot default involuntarily. Again, this is the Ecuador risk factor, defaulting for purely political reasons, not because of the inability to pay. It is not clear whether there will be a risk premium associated with this risk, increasing the yield of Treasury bonds, as the showdown draws near. We saw this in Russia when the Rouble crisis hit in 1998.

Here are the issues

INET Video: Richard Koo on Balance Sheet Recessions

Below is a video of Richard Koo from this past weekend’s INET conference in Bretton Woods giving us his latest thoughts on policy responses to a balance sheet recession. He believes that Europe, the U.S. and China have much to learn from Japan ‘s post-1990 balance sheet recession.

Stiglitz proposes new reserve currency

This topic needs a lot more attention. And I think today’s so-called Bretton Woods II fiat system is unstable. Excess money creation and trade imbalances are secular problems that fiat currency has allowed to become destabilizing. If countries like the U.S. can create as much money as they want and run current account deficits as large as they want without any constraint, isn’t it likely that credit growth will always eventually outstrip nominal economic growth? Isn’t it equally likely that this will always lead to a destabilising financial crisis and the recrimination that global trade imbalances create? That’s my takeaway at least.

Despite Stiglitz’s efforts and the attention paid to this issue by economist Paul Davidson, I doubt we are going to get a voluntary departure from the existing monetary system. I say wait for the next crisis for reform of the monetary system. That is when the issue will be urgent and resonate more with policy makers

Capital Offense

By Marc Chandler A disproportionate amount of mind share has been devoted to the financial aspects of the crisis. Investors and policy makers alike may be distracted by this over-emphasis and thus leaving them vulnerable to other aspects of the crisis. More specifically, the underlying challenge is sustaining aggregate demand in the face of a

Reforming the banks

By Michael Pettis I just got back from a very interesting but hectic week in New York and Washington, followed by two days at a conference in Hangzhou. During my meetings I noticed that much of the discussion, and many of the questions I was asked by both government officials and investors, focused on debt

Chart of the Day: M1 Money Multiplier

M1 is the narrowest definition of money. It includes currency and coins, traveller’s checks, and checking accounts (so-called demand deposits).  The chart below from the St. Louis Fed shows the relationship between base money that the Fed controls and M1 (hat tip Dan). Since the bull market in equities and fixed income began in the

“The Fed lent freely, but at a low rate, on dodgy collateral”

In September 2008, the Federal Reserve let banks turn more than $118 billion in junk bonds, defaulted debt, and other securities into cash.

The role of a central bank in a crisis is to act as a lender of last resort by helping market participants discriminate between the truly insolvent and the unfortunate illiquid. If the Central Bank lends against good assets at a penalty rate, the truly insolvent financial institution goes bust but the unfortunate illiquid institution gets bailed out. I have been making this point for quite some time

The Irish stress tests and euro zone options: monetisation, default, or break-up

The results of the Irish stress tests are going to be released this afternoon at 430PM Irish time. I will be talking about the implications for investors in European markets on CNBC’s Power Lunch show.

I think one has to be cautious about the sovereign debt of any of the periphery countries at this point. I also think haircuts on Irish bank debt is coming as well as a Portuguese bailout. But there are a lot of unsolved issues concerning Spanish banks and as well as the German, British and French holders of Irish bank debt. Here’s the background to what I will say on the show

Unintended Consequences

By John Mauldin Loose Monetary Policies and Emerging Markets So far we have focused on the United States and other mature, developed economies that have far too much debt. With Japan, the United States, the United Kingdom, and Switzerland at close to zero percent interest rates, it seemed like a good idea to stimulate the

Surely There Is Nothing “Funny” About What Is Going On In Japan?

By Edward Hugh As Japanese officials continue to toil away in what we all hope will be a successful bid to avert a worst case nuclear meltdown, even while thousands of Japanese remain missing and unaccounted for, financial market participants across the globe have been struggling to answer one and the same question: just how