Posts Tagged ‘Sovereign Defaults’

Great Explanation Of Trade Deficits And Surpluses By Michael Pettis. A Must Read.

Monday, June 27th, 2011

I’m going to start reading this guy regularly and I’m posting a link to China Financial Markets,  his blog, particularly a recent piece explaining national trade and how various policies affect who’s going to have trade surpluses and who’s going to have deficits.  Here’s Pettis’ resume.

Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.  He is also Chief Strategist at Shenyin Wanguo Securities (HK). 

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.

I’m particularly interested in having Capt. read this post, entitled How To Become Virtuous And Save More.  So read it Capt!  Here’s a small sample from the piece.

For this week’s blog entry I want to go a little abstract in order to suggest how different countries that participate in the global imbalances are going to adjust.  The debate over the root causes of global imbalances is as fierce and as confused as ever.  The confusion isn’t helped by the vast army of moralizers who like to contrast the hard work and thriftiness of households in high-savings countries with the laziness and binge-buying behavior of households in high-consuming countries.  The world cannot possibly rebalance, they argue, until the later become more like the former…

There are nonetheless some obvious flaws in the argument.  First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment will rise.  In that case global savings won’t go up.  They will go down, since rising unemployment causes income to decline faster than consumption.

Second, lazy spendthrift Americans are actually more productive and work longer hours than people in almost any other rich country, including the harder-working and higher-savings counties in Europe.  Still, the argument does anyway fit in with a lot of cultural stereotypes about Spaniards and Greeks, with their wild lifestyles, long siestas, and dissolute charm, or about Germans and Dutch, whose tasteless food, boring sex lives, and grim movies leave them no choice but to work away at office and factory.

But is this really why people in some countries love to save and people in other countries love to consume?  No, it isn’t.  Aside from the satisfaction it brings, this moralistic argument is almost meaningless.  Individual preferences may cause some of us to save more of our income than others, but we have to be very careful about generalizing.  When entire countries have abnormally high or low savings rates, individual preferences are never the reason.  Abnormally high or low savings rates are almost always caused by trade, industrial or tax policies at home and abroad that distort the relationship between consumption and production.

As with any well written article, particularly one that seems to dismisses cultural tendencies, the article sparked a terrific series of comments, pro and con.  One in particular details a specific German company that the author says exists because of German culture.  My take is that culture does matter, but in most cases not as much as most people assume.  Here’s one of the exceptions.

I really value your blog and read it regularly. But with a caveat: like almost all modern economists you configure the world into monetary relationships and disregard culture, education et al into a black box.
Unfortunately the real world is very different. Spain might devalue its currency as much as it likes; it simply has nothing to the world to sell.
Conversely Germany (or Japan where the Plaza accord of the Eighties had no long term effect on the trade balance) can consistently hike their currencies (as Germany did with the mark appreciation from 4 to the Dollar in 1973 to 1,5 to the Dollar in 1979 and will still run a surplus (in this case with the States).
Case in point is a factory complex making low voltage circuit breakers near Mannheim in South West Germany, which I helped to evaluate for a bank loan. It was formerly called Stotz then became a unit of ABB. (Won´t be more specific for obvious reasons)
The product is not high tech but these 2000 employees churn out a good part of circuit breakers in the world and forced from the market factories in the US and in GB and companies like GE. The workers at ABB are all unionized, get huge salaries, five weeks paid vacations a year and can´t be fired without a very, very good reason.
Now people who are for unions say that is the reason for the success and other people might say it is, because workers are represented in the workers council of the factory. But the real reason why they manage to dominate the market for such a low technology product that could – theoretically – be produced everywhere (they just try in Shanghai up to now in vain) is very simple if you look closer.
It is their production line called Goliath and that was preceded by David. These are in house developments costings upwards of a hundred Million Euro. These are hugely complex machines requiring the harmonisation of workers and engineers skilled in anything from cutting metal to a thousands millimeter to an advanced knowledge of chemistry and take years to build. (Three years in the case of Goliath) These production lines take huge up front investments but once they are in place they deliver a quality product with unbeatable low productions costs. No matter how low the wages anywhere else as wages are anyhow only a small fraction of production costs as soon as something like Goliath is up and running.
And these are not machines like a car that anybody can drive. Only the people who built them can operate them as it just turns out in Shangahi where they shipped David.
First, that something like that is possible has something to do with German business culture. In the US after a take over by private equity they would have never renewed the line but squeezed profits from it until it fell apart. That would have been the end of the factory and it happened in a good many cases which are well know to their German competitors. But that is only one and not even the main point regarding culture.
Goliath and all the other in house developments in German factories are the result of a combination of fabulous in house training of the shop floor people; strong emphasis of tradition (old teaching the young) and the non existence of barriers between engineers and the people implementing their designs.
These are not simply reproducible around the world. ABB is a multinational with branches all over the world and they would love to relocate and get rid of the pesky German wages and workers rights. But they tried and didn´t succed.
In Great Britain you can´t build something like that because there´s no vocational training that´s good enough. Also there´s the problem of the cultural barrier between engineers and workers. (In Mannheim they all talk the same dialect). In the US (as BMW has discovered in its plant in Savannah Georgia) only college graduates have the required reading and mathematics skills to do, what shop floor workers in a German factory are expected to do. But these people are difficult to motivate to get their hands dirty.
In Spain there are similar problems.
These are cultural problems and in China at the moment the greatest problem is, that shop floor workers are afraid to think for themselves. But without it you can´t operate a machine like David.
About China I believe they will learn and eventually become a strong competitor. But only if there is a cultural and probably concurrently also a political shift. Right now the hierarchies are too rigid and there´s no chance for workers to think for themselves. I am confident about China because the Japanese managed this as well. And their culture is ultimately derived from China.
I don´t really see a way out of the crisis along the line that Michael Pettis has sketched. I see no way out in fact. Regarding the situation now in Europe there´s only one solution: for Germany to pay up and shut up. For indeed the advantages of Germany are not due to harder work (they work less hours that Spanish workers) but simply the product of a unique set of historical and cultural circumstances. Best would be for Germany simply to pay the Spanish to buy their products. And the Chinese (which do have the advantage of extremely low wages) to pay the US to buy theirs. Which both did until now in a way. But that will not happen I am afraid so there´s only one solution: default.

How come?

Beezer here.  Pettis writes clearly and I believe very accurately.  That said, the comment reproduced above, clearly shows that culture does matter.  This doesn’t negate Pettis’ arguments but it does show that strong cultural preferences (another comment points out the Japanese and Chinese preference for liquidity) do matter and cannot be dismissed entirely.  Great post and several great comments too. 

The Real Debate Is Will The Wealthy Pay More Taxes.

Friday, May 6th, 2011

The best way to reduce debt is to grow.  Right now Washington seems obsessed with the idea that cutting taxes in combination with cutting federal spending is the best way to go.  Otherwise, we are told, the dollar will sink to zero value and our debts will sink our country’s value to zero.

But what if this formula doesn’t work? This formula has been in force for the past 11 years and hasn’t worked.  What happened in fact, was that deficits increased dramatically and the country plunged into a Great Recession that accelerated the pace of the existing deficits.  Now we are told to ‘double down?’

The truth is that countries seldom default because they can’t afford to pay down debt, they default because the public is convinced they cannot raise enough revenue to pay down debt.

From an economix op-ed by former IMF chief economist Simon Johnson and co-author of the best selling 13 Bankers. 

On the first day of 1791, the recently founded United States Treasury had nearly $75.5 million in outstanding debt. This was roughly around 40 percent of gross domestic product, a large amount of debt relative to the size of the economy — but not out of proportion to what we have become accustomed to in recent decades.

However, relative to federal revenues, the debt was enormous — about 20 times the amount that the government was then capable of taking in. In contrast, the total Treasury debt outstanding since 1950 has fluctuated between 30 and 90 percent of G.D.P., with the debt-revenue ratio never worse than 5 to 1 — and in recent decades between 2 to 1 and 3 to 1.

The debt-revenue ratio matters, as it is relevant to whether the country can readily service the debt. Very few countries default because they can’t afford to pay their debts, either to their own citizens or to foreigners. Defaults occur when the political process in a country determines that, for whatever reason, the government cannot raise sufficient revenue……

Most of our government spending, now as always, goes to wars and transfers to relatively poor people and to older people. The military spending will come down — if we can end the wars (as we did in the past). The social transfers were constructed in a more open-ended fashion — and our long-term budget forecasts account for this form of future spending in a more transparent and more honest way than we do for the probability of future wars or financial crises.

The real budget debate is not about a few billion here or there – for example, in the context of when the government’s debt ceiling will be raised. And it is not particularly about the last decade’s jump in government debt level. Although this has grabbed the headlines, it is something that we can grow out of (unless the political elite decides to keep cutting taxes).

The real issue is how much relatively rich people are willing to pay, and on what basis, in the form of transfers to relatively poor people — and how rising health-care costs should affect those transfers.”

Beezer here.  For the past 11 years we’ve had tax cut after tax cut and the net result has been disasterous.   Still, one of our two political parties, the Republicans, maintains that we need yet more tax cuts, while at the same time decrying recession boosted deficits and supposed long term structural debt issues posed by our health care delivery system costs.   We are told we need to ‘double down’ on a formula that produced disasters.  The intellectual dissonance here is astonishing.  So when Johnson points out that historically countries default because they refuse to raise sufficient revenues, not because they don’t have sufficient income, then it certainly appears we could be approaching that position.   If the Republicans persist in resisting efforts to raise revenue then US default on debt is a real possibility.

BEEZERNOTES is proudly powered by WordPress
Entries (RSS) and Comments (RSS).