Friday, March 06, 2009

Ganging up on Geithner

I had a front row seat at the Asian debt crises of 1998, which blew up Long Term Capital amongst others. I did not know Geithner was involved, but Paul Keating's assessment of the situation is mirrors my own:
Geithner thought Asia's problem was the same as the ones that had shattered Latin America in the 1980s and Mexico in 1994, a classic current account crisis. In this kind of crisis, the central cause is that the government has run impossibly big debts.

The solution? The IMF, the Washington-based emergency lender of last resort, will make loans to keep the country solvent, but on condition the government hacks back its spending. The cure addresses the ailment.

But the Asian crisis was completely different. The Asian governments that went to the IMF for emergency loans - Thailand, South Korea and Indonesia - all had sound public finances.

The problem was not government debt. It was great tsunamis of hot money in the private capital markets. When the wave rushed out, it left a credit drought behind.

But Geithner, through his influence on the IMF, imposed the same cure the IMF had imposed on Latin America and Mexico. It was the wrong cure. Indeed, it only aggravated the problem.
East Asian debt markets were financed primarily by hedge funds, all levered, and all with identical "diversification". When Russia defaulted on its ruble denominated debt, the funds all had to make margin calls, requiring them to sell identical positions, which moved those markets against them, requiring additional margin calls, etc. In times of crises, covariance goes to 1. The commercial paper markets went down first.

It's a bad sign that Geithner made the wrong call then. His insistence that the US is in a liquidity crises, when its in a solvency crises is similarly making the situation worse today.

I can see how Asian countries, especially China, would decide to stockpile dollars. While China cannot issue US$, it has a huge stockpile that it can release if needed. China's demand for savings enabled the US to run very large deficits without triggering inflation, but the Rubin/Summers Treasury (which is in place again) ran surpluses in the early 2000s, drawing down private savings. The Y2K business investment boom of 1998, and the Internet bubble of 1998-2000, maintained aggregate demand and kept the economy out of recession in the face of Federal demand destruction. Low rates under Greenspan expanded private debt to substitute for savings from 2000-2007, but private debt of course cannot substitute for Federal deficit funded savings, and that bubble is now deflating. This is the secret macroeconomic history of the US from 1998 to 2009.

(Thanks to Yves for the link)


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