The Face of a New Monetarism???

I was talking on the phone with a Republican friend of mine - we've been arguing for about 20 years, often every day - and he suddenly stopped me and said:

"Pal, a tear just came to my eye."

"Huh?" I said, "What the hell are you talking about?"

"I just realized it.....you're an inflation hawk. I've never been so proud."

I denied it of course because, well, he's a Republican. That's not my friend, there, at right, that's Indian Central Bank Governor Duvvuri Subbarao. But he looks like a nice fellow.

But, you know, I am an inflation hawk - of a sort. And you know what else? This is even worse, but the IMF was kinda right - well at least half-right. Developing economies really do have to focus on currency stability. And some of them have, but maybe not in the way people think. That's not me, at left, that's my Republican friend.

Okay, it's Karl Marx. But something old Karl would take note of these days is the growth in global dollar reserves - by which I mean the insanely large amount of dollars and dollar-denominated credit flowing from the U.S. to the rest of the world. It's immense. This guy Brad Setser from the Council on Foreign Relations wrote an important paper on it - got him onto CNBC. He seems like a nice fellow, too.




Woops! Sorry, that was rockabilly guitar genius Brian Setzer, not Geo-Economics Genius Brad Setser. Brad Setser's video may be have a smaller picture, but it has a hot woman and hotter economics in it. See below.


Foreign Funds

The video is an interesting debate. I find it a well-traveled path, but I would travel any path with her... Anyway...the point is that the numbers are enormous. Here is a nice highlight from Setser's paper that's getting him such press(.pdf):

"As Figure 7 demonstrates, the financing that emerging economy
governments have provided to the United States dwarfs the emergency
financing that the IMF provided to the emerging world in the
1990s.

Indeed, in 2007 alone, the estimated increase in the dollar reserves
of emerging economies was roughly thirty times larger than the financing
that the IMF provided to the emerging world in 1997–98.14
Table 1 illustrates this astonishing imbalance in a slightly different
way: The $30 billion in new capital that U.S. banks and broker-dealers
raised from sovereign funds in China, Singapore, and the Gulf states in
December 2007 and January 2008 is equal to the largest loan the IMF
extended to any emerging economy."

It's excellent, readable and informative stuff and I recommend it highly

Still this is the Internet, and here we quibble. It's just what we do. Note the implicit assumption of "outgunned". The idea is that not only have emerging markets done without IMF financing (net), but that these much-poorer countries have actually financed the United States to the tune of 30 times such financing. I'll spare you the table and give you the highlight that the emerging economies put more money into the Citigroup refinancing alone ($17.5 billion) than the nation of Turkey got from the IMF in the three years of its inflationary/financial crisis 1999-2001

So here's the question to Mr. Setser and to all of you: Does it really make sense that the emerging economies can spare 30x the the financing the IMF offers? Could these fast-growing, but poor, countries possibly afford to, in effect, give the United States of America more than $1.6 TRILLION dollars in financing out of the goodness of their hearts?

I believe their hearts are good, but India alone has accumulated over $300 billion in dollar reserves. Indians are generous people and some are quite ascetic and frugal, but that is just a lotta money.

Or did India - and these other countries - get something in return for their apparent largesse? From Reuters India:

India cbank sold $9.9 bln in currency market in July

Fri Sep 12, 2008 6:19pm IST

MUMBAI, Sept 12 (Reuters India) - India's central bank sold a gross $9.9 billion in currency market intervention in July, the highest on record, in a volatile month when the rupee hit a 15-month low but then later rose 1.1 percent on the dollar.

The central bank's monthly bulletin showed on Friday the monetary authority sold $6.32 billion on a net basis in July, trimming its net dollar purchases in 2008 to $13.24 billion.

The $9.9 billion gross is the most sold in a month by the Reserve Bank of India (RBI) since it began publishing its currency intervention figures in April 1995. It surpasses record dollar sales of almost $7 billion gross in June.

The rupee fell 7.4 percent in the first seven months of 2008, ending July at 42.57/58 per dollar , in a reversal of its fortunes in 2007 when strong foreign investment inflows drove it to 39.16, its highest in nearly a decade.

This year's fall accelerated sharply in July as crude touched a record above $147 a barrel, the trade deficit widened, and investment outflows weighed.

Traders say that in recent months and days the central bank has continued to support the rupee, which is now at its lowest in two years, has shed nearly 4 percent this month alone and lost 13.9 percent this year.

(Reporting by Anurag Joshi; Editing by Charlotte Cooper)

What this suggests about the relationship between the dollar and the rupee (or any emerging-markets currency) is not Gresham's Law: "bad coin drives out good" or the reverse (as is perhaps more often observed) but a situation where the "good coin" of the dollar and...if you'll excuse me...the "bad coin" of the rupee are made to be one in the same. With a positive flow of dollars behind it, the rupees is as good a coin as any. Everyone wants to be part of that unique dollar situation if they can be. Everyone wants the liquidity that comes from adding that unquestionable "goodness" to their currency.

Do government's decide this consciously? I don't think so. It's simply an evolutionary process. The world needs a standard of credit which is "risk free" and in buying what they perceive to be the closest thing to the thing they want, they make it so.

A virtuous cycle, but as we see with India, the dollars are now flowing out - quickly - and Gresham's Law may be reasserting itself to the disadvantage of the people of India. The learned at Harvard and The Economist proposed all sorts of wonderful solutions Indian inflation in April and I'm sure the large amount of empirical wrongness contained in their proposals will not dissuade them from making them again. But India needs better answers.

We may yet have to dig up Mr. Gresham and get him sorted.

May you live in interesting times