There Is No Easy Way

There is a lengthy, dense, and, honestly rather opaque piece at RealClearMarkets that goes a long way towards explaining the economic fix we’re in, at least from a macroeconomic standpoint. Here’s a sample:

This week it was revealed what I had long suspected, namely that the Chinese central bank had been forced into a form of deception that reveals the folly of “devaluation” rhetoric. Local Chinese banks had been “selling” spot “dollars” in August at the behest of the PBOC who were issuing forwards for the back end of that “trade.” This is almost classic response to a wholesale “dollar” run, as has been practiced time and again, most recently in Brazil.

The idea is simple enough even if it follows along far more complex tactical deployment. In general terms, private “dollar” markets were disrupted (the run) which then led the PBOC to three unappealing options of varying danger. First, the central bank could actively supply “dollars” itself in various forms, which is what the PBOC had clearly been doing for some time before the break (essentially pegging the CNY/USD to no variability for five months). Second, they could do nothing and allow rollover defaults in the local and offshore eurodollar markets. Or they could widen the trading band of renminbi/dollar exchange in order for the private, onshore “dollar” market in China to bid for liquidity at whatever cost. They chose the last option after being exhausted and beaten by the first, which proves the seriousness of the malady itself.

His prediction is actually rather bleak:

Japan is working on its third straight “lost decade” with the US and Europe closing in on completion of each their first. That is an enormous amount of unnecessary waste, especially when properly viewed under terms of compounding. Wholesale money may have been, and may remain, dauntingly complex and often counterintuitive but not so much as to have been impossibly excluded and ignored. The financial epidemic is of the wholesale strain. Health and recovery lie there, and no QE or interest rate control can reach it now as the clock continues to tick.

or, said another way, there’s a good chance that global economic doldrums will persist for the rest of my life. I agree with much of what he writes and his analysis will come as no surprise to some of the readers here.

I don’t think that macroeconomics explains all of our problems, however. While I agree that central banks’ policies have weakened our economy, they’re not alone. I think that microeconomics needs to be taken into account as well. We just import too much of what we consume to have a really robust economy and central banks’ policies are not only aggravating that but making it necessary. The policy solution is to do whatever is necessary to change that and, given those central banks’ policies, that may be pretty severe. It’s no wonder that the Powers-That-Be are resisting change with all their might. They like things as they’ve been.

One final word on China. As I’ve predicted all along, China has followed Russia’s lead. The economy of Stalin’s Russia was the envy of the world in the 1930s but it was a house built on sand. It prospered by moving relatively unproductive labor resources from agriculture to manufacturing, just as China has done. The difference between Stalin’s Russia and China of 1979-2005 is that China managed to accomplish that while increasing agricultural productivity. China’s agricultural productivity stopped increasing about a decade ago, a sure sign that they were nearing the end of the road for that particular strategy. And here we are.

The question that should keep the heads of Western governments and companies up at night is just what will China do now? The Chinese people might just put up with rising unemployment and slower improvements in their standards of living. Or they might push back. In twenty years China might be much as it is now or it might be a cluster of warring provinces. The only things we can do here are watch and try to mitigate our risks.