Apr 19 2009

Be-BOP: Sudden Stop

April 19, 2009

Once upon a time in lands not far away – a different paradigm – held sway. Economists, bankers,  bad boy dictators. They drummed up trouble with inflation, and debt. The typical targets? Emerging markets. And when things got hot, all the hot money stopped. Balance of Payments – also known as BOP – went negative. Fast. This mostly happened in the 80′s. Asia some. South America lots. Ecuador, Malaysia, and Argentina (twice). Money’s like rice. You must fear rot. But most of all you must fear The Sudden Stop.

blek-le-rat-buenos-aires-2004

Now we come to 2009 and, (I will now drop the rhyme) lots of attention has turned to the faltering capital flows into the United States.To be blunt, the United States now has to print money to fund its operations. Because there is not enough demand to cover the issuance of US Treasuries.

This situation actually started to develop back in 2007, as foreign demand for Agency Debt started on its present downward path. Brad Setser, in a November 2007 post, even used the term Sudden Stop to capture the totality of the falling net inward flows to US assets. As we know, the bulk of the Federal Reserve’s monetization was focused through through mid-March of 2009 on Agency debt. But, with the March FED meeting, the FED added its first 300 billion of planned purchases of actual Treasuries, to its gargantuan purchases of Agencies. The reason is simple. When we take the current rate of private savings in the US combined with inward flows of demand, for Treasuries, and we compare this to the acceleration in US Treasury supply–the result is a shortfall. I currently peg this at about 300 billion. And I agree with a number of analysts who are forecasting a tripling of this shortfall this year.

Now, there have been a number of wrong-headed views about this developing situation floating about in the last six months. Please don’t tell me, for example, that the US has printed its way out of a hole before. Sure, we’ve printed. But whenever we have printed in the past, there were actually buyers for the new debt issuance. We have not printed and then monetized the operating budget of the United States, using the Federal Reserve as the buyer. Equally, please stop claiming that the US is in a nifty little catbird seat of untouchable privilege because it can simply print fresh money to pay off holders of maturing Treasuries. Sure, we’re doing that right now. We’ve been doing so for only a month.

And how does it feel? Can we go on like this for a couple of years? The fact is that the US is already experiencing Sudden Stop. US Treasury issuance is dwarfing the pace of US savings (at 450 billion) and the inward demand flow for Treasuries (200-400 billion). The Fiscal Year is only half over, and the budget deficit is already hitting one trillion.  A big part of the collapsed demand for US Treasuries from foreign central banks is actually less discretionary, at this point, and is the direct result of the drop in global trade. The previous consumption generated by Americans is no longer there, to come back to us in the form of US Treasury demand. Alas, US Treasury demand relied also on the credit cycle.

Were the US Argentina, the currency crisis and debt crisis so familiar to many would already be underway. In February I wrote that we would eventually repudiate the debt, and we are indeed repudiating. It’s nothing short of outrageous that we are printing to fund our own operating budget. But, the notion that the US Dollar can remain the singular reserve currency of the world under such conditions is absurd. Sorry, but, the Ivy League doesn’t do correspondence-course undergraduate degrees, and Reserve Currency nations don’t print. The UK, Switzerland, and the US can print away all they like. But the price they’ll pay is to be replaced by the Chinese Yuan, Gold, or yes, even lowly Copper. Being displaced by a base metal used in electrical wiring seems quite fitting.

The only phase that remains in this dance is what I would call the Recognition Phase. As soon as the Epiphany hits and consensus reality stumbles, as it always does, then the changes which are already underway will become extant. Plan for it.

-Gregor

Photo: Buenos Aires Mural 2004, Traveller and his Sheep, by Bleck le Rat

Further Reading:

Calvo: Explaining Sudden Stop, Growth Collapse, and BOP Crisis: The Case of Distortionary Output Taxes, 2003

Janszen: Headed for a Sudden Stop, 2008

This post is available in .pdf version. Click here: Be-BOP: Sudden Stop

• Comments are closed.
Author: Gregor Macdonald   Posted in: crisis  currency  Debt  Policy   Tagged:                
  • Fullcarry

    I wonder if you have a sense of the timing for the recognition phase to happen? My sense is it happens once reflation gets underway. In a way the US should fear reflation more than a slow grind.

  • dsonnen

    This scenario, unfortunately, makes complete sense.

    Consider the currency crisis, below-margin energy pricing, declining oil outputs, and the evaporation of real working capital. These factors are eventually going to converge and the “Everybody is worse off than us, so we'll be OK” myth will implode.

    The timing is still a guess, but 2011-2012 are starting to look like Apocalypse Now.

  • gregor.us

    That's what I'm working on now. I'm trying to come up with a schedule for the recognition phase. Your notion, that it gets closer as reflation gets underway, it dead on. Indeed.

    Cheers,

    G

  • gregor.us

    Thankyou. It's heartening that someone else recognizes the Everybody is worse off than us, so we'll be OK myth

    I have to prepare that this does not unfold quickly. Just as you appear to be thinking, in your 2011 to 2012 timeline.

    G

  • mike

    I think of the US as any publicly traded entity. State and federal revenues are crashing, spending has ramped (deficit expansion), and newly issued debt is scheduled to be a record for 2009. The loophole is the ability to “create” demand for UST's by printing money. As a sound creditor to this said entity, how can one not be concerned? If the US does not have the ability to fund its operations using foreign capital inflows, what is the answer? How will this effect daily life for US citizens?

  • dsonnen

    My guess on timing is based on an assumption that the couple trillion or so Treasury is pumping into banking institutions will take 24-36 months to clear the system and will not spur adequate productivity.

    The Treasury's newly minted cash, as you've indicated, is phony — not tied to real assets or productivity. The Treasury's bet seems to be that magic will occur and productivity will somehow climb to give their fresh cash adequate validity. Given your analysis of energy's future and the current down trends in real productivity, the Treasury's bet seems pretty sketchy, even desperate.

    I hope I'm dead wrong.

  • http://scriabinop23.blogspot.com Michael Krause

    ” The UK, Switzerland, and the US can print away all they like. But the price they’ll pay is to be replaced by the Chinese Yuan, Gold, or yes, even lowly Copper.”

    From WSJ a few days back:
    “The lending surge came as China's broadest measure of money supply, M2, jumped 25.51% at the end of March from a year earlier. The growth rate was well above the median 21.8% rise forecast by 11 economists surveyed earlier by Dow Jones Newswires, and up from the 20.48% rise at the end of February.”

    http://online.wsj.com/article/BT-CO-20090411-70…

    Everyone is printing. That said, buy some gold to hedge. Regardless though, we are monetizing to fund stimulus spending, the most efficient way at making sure this new money (with intent to reflate) circulates rather than accumulates as inert bank reserves (ie Japan).

    The current price level we have today is based on an arbitrary credit multiplier we've been so adapted to. With US assets at 50T or so, give or take 10T, against a monetary base of 2T, that is 25:1 leverage on the monetary base. With the loss of faith, lets say that multiplier chops down from 25:1 to 5-15:1… That gives the Fed permission to print another 2 or 3T and that just achieves a reflation and short run increase in global output.

    That said, expect the Fed to announce another 500B of treasury purchases soon, continue with long term agency debt monetization (1250B to chip away at), etc. etc.

    When money supply increases, interest rates fall. Right now, long duration treasuries are only a tad weak because the stimulus spending is ahead of debt monetization, at least at these interest rate levels. We need more money, not less.

    Inflation 5-10 years out, just when everyone has given up on stocks, their only accessible inflation hedge will start performing … Until then, misery.

  • Jeff Burton

    If you don't stop freaking me out, I'm going to remove you from my rss reader.

  • gregor.us

    Timelines will change. Timelines will surprise, and turn quickly. And I agree with you that monetizing the StimPack is the most effective method for countering dead velocity. If the majority of the StimPack was actual engineering projects and not transfer payments then my view has been that dead velocity would be attacked even more efficiently.

    See @mikestiller on Twitter for some of the work he is doing on the Output Gap. He is less convinced that we are headed for a classical, idle factory driven deflationary paradigm.

    If you are suggesting that China could have an inflation problem, I agree.

    G

  • gregor.us

    Timelines will change. Timelines will surprise, and turn quickly. And I agree with you that monetizing the StimPack is the most effective method for countering dead velocity. If the majority of the StimPack was actual engineering projects and not transfer payments then my view has been that dead velocity would be attacked even more efficiently.

    See @mikestiller on Twitter for some of the work he is doing on the Output Gap. He is less convinced that we are headed for a classical, idle factory driven deflationary paradigm.

    If you are suggesting that China could have an inflation problem, I agree.

    G

  • gregor.us

    Timelines will change. Timelines will surprise, and turn quickly. And I agree with you that monetizing the StimPack is the most effective method for countering dead velocity. If the majority of the StimPack was actual engineering projects and not transfer payments then my view has been that dead velocity would be attacked even more efficiently.

    See @mikestiller on Twitter for some of the work he is doing on the Output Gap. He is less convinced that we are headed for a classical, idle factory driven deflationary paradigm.

    If you are suggesting that China could have an inflation problem, I agree.

    G