No misunderstanding

Post #35,370 by ben_tilly 4/14/02 1:00:28 PM 4/15/02 7:11:24 AM Reply	No misunderstanding I am perfectly aware that the US trade balance is supported by the outside world investing in the US. I am also aware that savings are low. Neither of these facts make me more comfortable. The reason that outside investments continue to be made is that the rest of the world thinks that the US will be a good investment opportunity. For instance bonds in US dollars can have a low yield, but if you think that the US dollar will continue to rise, it may be a much better investment than a high-yielding bond in another currency. And if the dollar has a habit of surprising in strength, it makes sense to invest in the US. So the present investment flow into the US is a form of credit - it comes in now and we will have to pay the piper in the future. In other words, whether you look at it in terms of a trade imbalance or an investment imbalance, you are lead to the same conclusion. The current US lifestyle is being actively supported by expectations in the rest of the world, and not by actual production in the US. With that in mind, my point is that I simply cannot believe that this situation can last. The US cannot indefinitely consume without having corresponding production levels. And I don't think that the reversion to the norm will be fun. (Financial markets have this disconcerting tendancy to try to figure out now where they will wind up in the long term, and try to get there in a hurry.) Furthermore after reverting, we will be left with a lot of people with investments they still want to be paid. Allow me to make this point with a concrete, extreme example. The basic accounting identities that you are talking about hold at any level. Normally we talk about them with countries, but we can talk about them with companies instead. Say, with dot coms. It is true that for the dot coms, savings minus investments were indeed exports minus imports. Like the US - but more extremely - savings were poor, investments were strong, exports (ie actual product sold) were poor, and imports (ie purchases) were strong. What could be looked at as an imbalance between consumption and production could be looked at as confidence by the rest of the world about eventual performance. Like the US, though again more extremely, the result was conspicuous consumption beyond a level sustainable from internal production. And it was much nicer to be inside than outside while the going was good. I didn't think then, and I don't think now, that such a situation could be stable. And in that case it wasn't stable, nor was the ending of the fun very pleasant. I fear the same will be true for the US. (Albeit on a larger but less extreme scale.) As for the reserves, my concern is not with the advantages of having them be there. Or how big an impact it would have on us if they weren't. My concern is that there is a very large amount of US currency tied up in the belief that the US dollar is, and will remain indefinitely, strong. Markets have demonstrated that when they re-evaluate beliefs like that, they tend to do so quite suddenly. (Everyone tries to predict the future reality and move there ahead of everyone else.) Therefore if that belief was to receive a sudden shock, there are large potential supplies available to imbalance the old supply/demand ratio. In other words we have an economy which is based on a belief that I see as unsustainable in the long-term. We have a lifestyle maintained by that belief. And if that belief changes, we have a large and potentially volatile supply of money that can start moving. With that let me close with a comment that I heard a vice-president of Moodys make last week. And here is what keeps Alan Greenspan awake at night. The amount of money tied up in the swaps market is 9 times the US economy. Any major failure there would ripple through a lot of companies. Need I mention that swaps were one of the ways that LTCM managed to aquire a set of positions that nearly took down the Western World in 1998? They were also a favorite tool of Enron, various dot bombs, etc? Cheers, Ben PS You live in Boston, don't you? Any chance of your coming down to Bill's party July 6? I would be willing to help cover your ticket if you did... "... I couldn't see how anyone could be educated by this self-propagating system in which people pass exams, teach others to pass exams, but nobody knows anything." --Richard Feynman Edited by ben_tilly April 15, 2002, 07:11:24 AM EDT Expand All History
Post #35,455 by neelk 4/15/02 1:23:18 PM Reply	Re: No misunderstanding The reason that outside investments continue to be made is that the rest of the world thinks that the US will be a good investment opportunity. For instance bonds in US dollars can have a low yield, but if you think that the US dollar will continue to rise, it may be a much better investment than a high-yielding bond in another currency. And if the dollar has a habit of surprising in strength, it makes sense to invest in the US. So the present investment flow into the US is a form of credit - it comes in now and we will have to pay the piper in the future. Your statement about bonds is true, /if/ you think that the currency markets expect the US dollar to continue to appreciate. But I don't think that's a rational expectation to have about the markets (so to speak). At the end of 1987, at the height of the Japanese bubble, the US dollar traded for 128.24 yen to the dollar. At the end of March 2002, the US dollar traded for 131.06 yen to the dollar. Furthermore, between 1998 and the present the yen has gone from 144.68 to a high of 102.58 in Dec 1999 back up to 131.06 in March. So I don't think the exchange rate history should lead anyone to form the belief that the US dollar is in a long-term appreciation pattern. So I don't think the currency traders have formed that belief. So, no currency bubble. If you mean the weaker statement that the currency markets expect the US dollar to remain at the same historically high level is true, then there's no such implication, because the expected rate of return on a dollar bond is the bond's nominal rate plus the expected currency appreciation. If there's no expected appreciation, then the ROI on the bond is just the face rate. If you think that the markets are likely to suddenly and unexpectedly drop the price level of the US dollar, then there won't be any investment flight. If the price of the dollar fell suddenly, then for foreign investors the price of assets in the US would fall, too. The drop in the asset price would increase the return on investment in the US, making it more attractive to invest in the US. Sure, the current foreign investors in the US would take a bath, but that's what currency hedges are for. Allow me to make this point with a concrete, extreme example. The basic accounting identities that you are talking about hold at any level. Normally we talk about them with countries, but we can talk about them with companies instead. Say, with dot coms. It is true that for the dot coms, savings minus investments were indeed exports minus imports. Like the US - but more extremely - savings were poor, investments were strong, exports (ie actual product sold) were poor, and imports (ie purchases) were strong. What could be looked at as an imbalance between consumption and production could be looked at as confidence by the rest of the world about eventual performance. Like the US, though again more extremely, the result was conspicuous consumption beyond a level sustainable from internal production. And it was much nicer to be inside than outside while the going was good. The dot-coms failed because people misjudged the ROI on internet companies. I have a hard time believing that people are systematically making the same error across dozens of different industries. Especially when the underlying economic statistics like labor productivity growth are at levels not seen in 30 years -- in Q4 2001, productivity grew at an annualized rate of 5% a year. That's an amazing number: in most recessions productivity falls, because companies cut production but retain their most productive workers, so that they can ramp up in the recovery. I think people are investing in the US economy because it is in fact extraordinarily productive, not because of expectations about the price level of the US dollar. The price history of the US dollar doesn't seem to offer any evidence to create expectations for price increases in the dollar, and the economic statistics suggest that the US economy is growing much faster than any other industrialized nation (except Korea, Ireland and Finland). So it's real economic activity that's driving investment. In other words, whether you look at it in terms of a trade imbalance or an investment imbalance, you are lead to the same conclusion. The current US lifestyle is being actively supported by expectations in the rest of the world, and not by actual production in the US. Hold on! Investment inside the US means there's increased production inside the US. It doesn't matter whether the automobile factory has Honda or Ford on the big sign on the outside: the workers get paid and the cars get built just the same. Now, let's take your example of the LA port dropping goods off in the US and taking nothing out. Now assume that what they are bringing in Japanese robots and German machine tools: in what sense is this a hollowing-out of the US economy? This is increasing its productive capability! As for the reserves, my concern is not with the advantages of having them be there. Or how big an impact it would have on us if they weren't. My concern is that there is a very large amount of US currency tied up in the belief that the US dollar is, and will remain indefinitely, strong. Markets have demonstrated that when they re-evaluate beliefs like that, they tend to do so quite suddenly. (Everyone tries to predict the future reality and move there ahead of everyone else.) Therefore if that belief was to receive a sudden shock, there are large potential supplies available to imbalance the old supply/demand ratio. I don't think this is a big deal. The dollar forex markets are among the most liquid in the world, and the US government has committed to a free float, so everyone is used to coping with really big fluctuations in the price of a dollar. Eg, in the two years the US dollar has traded with the euro, there's been a ~30% shift in their relative prices. In the past 15 years, the yen has had about a factor of 2 band it's traded in. (Over 20 years, it's a factor of 3 band.) PS You live in Boston, don't you? Any chance of your coming down to Bill's party July 6? I would be willing to help cover your ticket if you did... I follow the Open Forum only intermittently, so this is actually the first I've heard of it. When and where is it?
Post #35,530 by ben_tilly 4/15/02 9:32:17 PM Reply	I may have a narrowly focussed view My direct exposure to finance is almost all within the context of securitizing loans into bonds. Thus I am rather aware of the fundamental shift in how debt is being funded as securitization becomes accepted in more and more markets. What I see are historically amazing debt levels, and fundamental increases in how much debt there can be. However I don't deal with macro-economics much, so see that out of context. As for the party, it is at Bill Patient's house (bepatient), near Philadelphia, on July 6. It has been a tradition for a long time, and the last couple of years some IWETHEYers have started coming. People who have shown include bepatient, myself, broomberg, imric, jb4, boxley, kmself, and Dhyana Wood. (I know I have missed some...) I would expect some postings closer to the time around the water cooler... Cheers, Ben "... I couldn't see how anyone could be educated by this self-propagating system in which people pass exams, teach others to pass exams, but nobody knows anything." --Richard Feynman
Post #35,575 by neelk 4/16/02 9:22:30 AM Reply	Re: I may have a narrowly focussed view My direct exposure to finance is almost all within the context of securitizing loans into bonds. Thus I am rather aware of the fundamental shift in how debt is being funded as securitization becomes accepted in more and more markets. What I see are historically amazing debt levels, and fundamental increases in how much debt there can be. However I don't deal with macro-economics much, so see that out of context. That's so cool! What I do is program automated valuation mechanisms, and one of the big feedback loops for our business is the increasing securitzation of the mortgage industry. Banks and mortgage companies with mortgage securities are really interested in our AVM because it gives them a way to estimate the risk exposure of their portfolios. (In turn the banks' loan origination and compliance people realized that they could use AVMs themselves.) It's really cool that you are on the other end of that. I don't think there's any question that real estate is doing something funny, and that the something is quite possibly a bubble. Real estate is an extremely incomplete and inefficient market, so price bubbles and busts are pretty much par for the course. Debt and price levels in the real estate market are at decade-long highs, and we're amazingly lucky that the real estate and stock markets didn't come down at the same time. God clearly still favors drunks and Americans. From my perspective, securitization is on the whole a good thing, because it offers banks a way of dispersing risk. Ten thousand investors losing a million bucks is a lot less dangerous than 10 banks losing a billion each. If leads to products that let homeowners reduce their risk exposure -- like home price insurance or shared-appreciation mortgages -- then it's wonderful. A home is almost always the single largest piece of undiversified risk a family has. When I think about it, that fact gives me the willies. As for the party, it is at Bill Patient's house (bepatient), near Philadelphia, on July 6. It has been a tradition for a long time, and the last couple of years some IWETHEYers have started coming. People who have shown include bepatient, myself, broomberg, imric, jb4, boxley, kmself, and Dhyana Wood. (I know I have missed some...) Cool.
Post #35,692 by ben_tilly 4/16/02 7:28:04 PM Reply	What kind of real estate loans? I suspect we aren't actually on the opposite sides of the same industry, but we aren't far from it. If you want to take this offlist, my email is my user name at operamail dot com. Cheers, Ben "... I couldn't see how anyone could be educated by this self-propagating system in which people pass exams, teach others to pass exams, but nobody knows anything." --Richard Feynman

Welcome to IWETHEY!