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The G-20 finance ministers and Central Bank governors met over the weekend in St. Andrews, talking about the data they will need to look at in order to monitor each other's economic performance and sustain growth (seriously).
The underlying idea is that if you talk long enough about the US current account deficit and the Chinese surplus, stuff happens and the imbalances will take care of themselves—or move on to take another form.
Warren Buffett seems to agree.
Buffett's big investment in railroads looks like a shrewd way to bet on growth in emerging markets—which is where most incremental demand for US raw materials and grain comes from. It's also a polite way to bet against the dollar or, even more politely, on an appreciation of the renminbi.
When China finally gives way to market pressure and appreciates 20 to 30 percent, their commodity purchases will go through the roof. You can add more land, improve yields, or change the crop mix of choice (as relative prices move), but it all has to run through Mr. Buffett's railroad.
Of course, Buffett is nicely hedged against dollar inflation—this would likely feed into higher inflation around the world, and commodities will also become more appealing.
And Mr. Buffett is really betting against the more technology-intensive, labor-intensive, and industrial-based part of our economy. If that were to do well, the dollar would strengthen and resources would be pulled out of the commodity sector—the more "modern" part of our production is not now commodity intensive.
The G-20 will stand pat, waiting for the recovery and hoping for the best; "peer review" will turn out to be meaningless. But this raises three dangers:
- China will overheat, with capital inflows fueling a giant credit boom. Books with titles like "China as Number One" and "The China That Can Say No" will appear. The boom-bust cycle will resemble that of Japan in the 1980s—you don't need a current account deficit in order to experience a costly asset price bubble. Other emerging markets may follow a similar pattern (think India, Brazil, Russia.)
- US and European banks will be drawn into lending to China and other emerging markets, directly or indirectly. In a sense this would be a rerun of the buildup of debt in Latin America and Eastern Europe in the 1970s, leading to the debt crisis of 1982 (remember Poland, Chile, Mexico). Banks with implicit government guarantees will lead the way.
- We hollow out the middle of the global economy—with a few people doing ever better and most people struggling to raise their living standards. Increasing commodity prices hit hard at poorer people everywhere (recall the effects of the relatively mild run-up in food and energy prices in the first half of 2008). Global volatility of this nature helps big business but at the cost of undermining the middle class.
By betting on commodities, Mr. Buffett is essentially taking an "oligarch-proof" stance. Powerful groups may rise to greater power around the world, fighting for control of raw materials and driving up their prices further. As long as there is growth somewhere in emerging markets, on some basis, Mr. Buffett will do fine.
As for the G-20, they are already a long way behind the curve.
Ackermann Versus Hoenig: Take It to the WTO
November 3, 2009
Josef Ackermann, chief executive of Deutsche Bank and chairman of the Institute of International Finance (an influential group reflecting the interests of global finance in Washington) is opposed to breaking up big banks. According to the Financial Times, he said:
"The idea that we could run modern, sophisticated, prosperous economies with a population of mid-sized savings banks is totally misguided."
This is clever rhetoric—aiming to portray proponents of reform as populists with no notion of how a modern economy operates. But the problem is that some leading voices for breaking up banks come from people who are far from being populists, such as the UK authorities (in the news today) and the US's Thomas Hoenig.
Hoenig is an experienced regulator, who has dealt with many bank failures. He is also currently president of the Kansas City Fed and an articulate voice regarding how banks became so big, why that leads to macroeconomic problems, and how consumers get trampled (answer: credit cards issued by big banks; p. 6). He supports a resolution authority that would help deal with some situations, but also says (p. 9):
"To those who say that some firms are too big to fail, I wholeheartedly agree that some are too big. However, these firms can be unwound in a manner that does not cause irreparable harm to our economy and financial system but actually strengthens it for the long run."
Mr. Hoenig is, if anything, a little too polite. There is no evidence that huge banks, at their current scale, provide any social benefit. When these same banks were much smaller, in dollar terms and as a percent of the economy, the global economy functioned no worse than today.
Mr. Ackermann and his colleagues are pursuing a purely self-serving line. Reasonable centrist opinion is turning against them. Either the big banks need to shrink voluntarily or they will potentially face consequences that they cannot control.
Building on ideas from the Kansas City Fed, the Bank of England, the UK Financial Services Authority, and the European Commission, the consensus is moving toward the view that state-supported banking (i.e., operating through implicit guarantees on too-big-to-fail banks) constitutes an unfair form of protectionism. Financial services in this guise do not currently fall within the remit of the World Trade Organization, but it would be a simple matter to extend its mandate in this direction.
In any reasonable judicial-type process, involving relatively transparent weighing of the evidence, Mr. Ackermann would be most unlikely to prevail.
Britain to Break up Biggest Banks
November 2, 2009
The Wall Street Journal reports (online): "The UK's top treasury official Sunday said the government is starting a process to rebuild the country's banking system, likely pressing major divestments from institutions and trying to attract new retail banks to the market." The British style is typically understated and policymakers always like to play down radical departures, but this is huge news.
Pressure from the European Union has apparently had major impact—worries about unfair competition through subsidizing too-big-to-fail banks are very real within the European market place. Also, strong voices from within the Bank of England have helped to move the consensus.
The US position on protecting everything about our largest banks is starting to look increasingly isolated and out of step with best practice in other industrialized countries. Time to start planning for the breakup of Citigroup.
