The Peg is Dead

China's controversial currency policy may finally be headed to the gallows, but what remains unclear is how this will affect and prompt movement on numerous politically sensitive issues in the United States, namely its large twin deficits, the current account and government primary deficit.

Make no mistake: China's move is largely motivated by domestic factors - the need to allow inflation to finally creep into its possibly overheating economy and re-balancing its export-based economy with a decidedly smaller dependence on other economies - but, certainly, it was also under pressure to allow the yuan to appreciate by external players.

But for this move to re-balance global economic flows, the United States will have to do its part in the medium to long term. That is, to reduce its deficits and minimize its dependence on foreign creditors to finance those deficits by cutting spending and boosting national saving. Some of this could be accomplished by the hoped-for re-balancing in the current account. But currency values alone do not dictate trade, and therefore current account, balances. The United States needs to go back to being a center of innovation in manufacturing for a real re-balancing to be meaningful. And, with the current crisis in the eurozone, there is even one view that the revaluation could actually backfire.

The Obama Administration and his Treasury have achieved a victory long-sought by the president's predecessor. But now that China has been tamed on the currency issue, the ball is in the American court to do what is necessary to allow the full economic results of a yuan appreciation to benefit those constituencies who yearned for it.

More on the ECB...

More soul-searching at the ECB...

http://www.nytimes.com/2010/05/31/business/global/31deflation.html

Taro Aso's Nightmare

Less than one year after Japanese Prime Minister Taro Aso took the reigns of the hobbling Japanese government and economy, he is faced with a daunting prospect - the end of his term as Japan's leader, and of one-party rule in Japan.

While Aso is well regarded by foreign leaders, his tenure is sure to come to a close now that Tokyo municipal elections delivered a smashing blow to Aso's party, the Liberal Democratic Party (LDP), in favor of the rival Democratic Party of Japan (DPJ).

As various news outlets have reported, Aso has attempted to use pork barrel spending - a time-worn tradition in modern Japanese politics - to assuage voters ahead of the election he has called for Aug. 30. And recent economic data show Japan's slump could be nearing an end. Aso hopes these factors will renew some public trust in the LDP's national leadership in the next month.

The elastic thinker thinks Japan deserves and is ready for political change. The LDP has not necessarily squandered Japan's economic might - but it has certainly allowed back-room politics to become even more entrenched. Whether the DPJ will bring fresh ideas, or serve simply as the "anti-LDP," is a huge question mark, but one that the Japanese people deserve an answer for after years of LDP dominance. The biggest risk from DPJ election gains, of course, is a government that much more politically polarized that solving Japan's myriad economic issues will become even more onerous.

But the Japanese public, who are about to descend in what could be another "lost decade" of economic stagnation, most likely want change. It appears they will get it this time around. This will prove to be a significant development in world politics, and in the world's second largest economy.

Time for a New Plaza Accord?

When politicians discussing the current economic situation tell us "it's likely to get worse before it gets better," it seems they weren't kidding.

Yesterday the U.S. Senate failed to come to an agreement on a $14 billion bailout for the U.S. auto industry, and this morning, the Japanese yen hit a 13-year high against the U.S. dollar, a troubling signal for two of the world's largest economies.

Apart from Germany and China, Japan is the world's preeminent export economy, relying on a weak Yen to peddle its goods to primarily the U.S. market. With slumping demand in the U.S., and the rapid depreciation of the dollar versus the yen, Japan stands to lose out significantly. This has helped to reduce Japan's current account surplus significantly, as exports fall. The drop in the oil price might help in relieving the costs of imports, but a country once known for its massive trade surpluses seems to be losing its edge.

I have argued frequently in favor of a larger role for Japan in the world economy. Too infrequently during the current economic crisis have we seen the kind of leadership that Japan is capable of and responsible for. Perhaps it is the ruling Liberal Democratic Party's precarious political prospects that are discouraging it from taking the risky but potentially rewarding policies needed to stabilize the world economy.

It may be time for a new type of "Plaza Accord," in which the U.S. coordinates with Japan a managed exchange rate revaluation. Only this time, it is the U.S. dollar, not the yen, that is increasingly depreciated and needs propping up. Another factor is that the value of the dollar, of course, has been partially supported by the massive stockpiling of U.S. dollar reserves by China, which itself enjoys a massive trade surplus because of an undervalued, but steadily appreciating, currency. But now, the problem is the Chinese also face the prospects of slower economic growth, primarily due to the American recession. And like Japan, China may face a threat of a political reckoning if it cannot help its people absorb the impact of the global recession.

Revisiting Alex Hamilton, Bretton Woods

Here is an interesting take on the redistribution of economic power - is a meeting of just the G-7 industrialized nations enough to find a solution to the financial crisis? At this juncture, and certainly down the road, the G-20 (which includes Australia, Saudi Arabia, and some developing but nevertheless powerful nations such as China and India) will play a significant and imperative role in resolving financial crises.

Also, here's an interesting (if superficial) article on one woman's effort to move her bank savings from a large bank, Wachovia, to a smaller community bank that has been operating since before the American Civil War. Could we be returning to those 19th century days when Americans didn't trust centralized financial authorities (i.e. a national bank) or large banks (sorry Alex Hamilton)? After the Riegle-Neal Act, we became accustomed to widespread bank mergers, and the current economic crisis has accelerated them. Our assets increasingly were held under large entities. But the backlash could be a return to depositors preferring their local banks, where they can get to know the management and have a better sense of what's in those community banks' loan portfolios - thus great security for their assets.

Making something out of nothing: A turning point for Europe's standing in the world?

It was Europe's time to shine, and shine it did.

Europe's leaders should be lauded for their joint efforts to infuse banking systems with cash by nationalising important and responsible financial intermediaries - and without the tired partisan – albeit pre-election - bickering exhibited in Washington. Europe's response to the still-unfolding financial crisis is not only a vindication of sorts of Europe's steady financial acumen, it illustrates the strength of common purpose borne out of a common market. Interdependence, in this case, brought all parties to their best. And it was Gordon Brown's and Chancellor Angela Merkel’s schemes, not President George W. Bush's, that are setting an example.

Still, questions remain for whether the efforts to recapitalise banks address the underlying problem that created the mess. Flooding cash into a banking system that did not behave the last time money was cheap is like giving a drug addict even more of a fix. Still, leaders also understand the reality that, for the sake of households and businesses, the economy can't quit cheap cash “cold turkey.” Now, there is but one certainty: it's the risk analysts and credit rating agencies who will have any kind of job security in the credit-crunched months ahead.

Post mortem of Greenspan's legacy

Aptly timed of course to my previous post, The New York Times' Thursday edition contains a really good write-up of Alan Greenspan's tenure, and its contributions to creating an environment where a housing bubble could form under a weakly regulated financial system. Check it out here.

The wheel keeps on spinning...

Some more news today:

On the heels of Germany's announcement over the weekend to guarantee all private savings, and potentially based on the bailout precedent set by the United States last week, the British government announced a massive bailout to help the banking system.

Meanwhile, the Nikkei average in Japan experienced its biggest drop since 1987, and Iceland is approaching bankruptcy. I guess that means no more Bjork...

Credit Crunch: The world's new soggy cereal

OK - I have some catching up to do. Like many of my self-initiated assignments, this blog started off with a momentous roar and then retreated with a whimper. Maybe it's that while I try to adjust to a new school and new city, the world is encountering new challenges each day that a word written about it in one minute is outdated the next.

We now know that the financial crisis is cascading to Europe, like a massive fan "wave" at a college football game. This really is the test of our time, perhaps more devastating than 9/11 in both its real economic and psychological impacts -- and the numbers are starting to come out as to what the impact on households will look like. It took America a couple of years to recover from 9/11, and it will likely take a lot longer when all the dust settles and the Congress settles on permanent legislation to regulate the evolving financial sector.

In one hour, the American presidential candidates will spar for the second of three times before Nov. 4, and for the first time since Gov. Sarah Palin accused Sen. Barack Obama of "palling with terrorists." It's an outrageous but certainly answerable claim, considering her source was The New York Times, which, undoubtedly to the dismay of the Obama campaign, Gov. Palin (or her speechwriters) most likely was reading for the first time when the article appeared.

Those are my "brain droppings" (RIP George Carlin) for now. Check back for a couple write-ups soon on recent lectures I attended here at the LSE. This truly is an amazing place; 160 countries represented, and lectures and professors that cover almost everything under the sun.

welcome: stretch your thinking

Welcome to the elastic thinker.

At the outset of my one-year graduate school experience in the great city of London, the world is facing obstacles unseen in my lifetime, certainly for the generation preceding mine. We are now entrants into an age where a Treasury secretary can be compelled to kneel and beg in front of the House Speaker for emergency legislation that, under normal circumstances, a lobbyist would ask for over a glass of wine and dinner at The Mayflower Hotel in Washington.

All rules are thrown out the window. Indeed, as the United States Congress mulls over throwing the nation’s most expensive life saver to the damsel in distress, the U.S. financial system, we have to consider the economic implications and social equity of a $700 billion bailout, and all the while understand the impact on the political scorecard in the 2008 presidential election.

The purpose of this forum, and thus of its title, is to discuss both sides of a variety of subjects under the sun. While much of the mainstream business press lauds the markets, the ways of Wall Street and its every move, the latest financial collapse is further proof that the markets in the short run tell us nothing about real growth and economic strength. Give a bull market five years and out comes an Enron, Worldcom, Tyco, Freddie/Fannie, Lehman Brothers, AIG and Washington Mutual. Once the next bubble forms and bursts, how big will the bailout have to be?

During my experiences as a business journalist and government grunt, I have seen that nothing is absolute. One camp may argue that free trade uplifts the direst developing countries and another may argue it destroys American industry and thus the fabric of the American middle class. Both side have valid arguments – this forum will attempt to bridge those views.

Of course, this will also serve as a sort of day-to-day diary of my experience in London, so be sure to check out those posts too.

Over the next year, read this spot for my views on international politics and economics, music, sports, and I hope you can join in the conversation.