No to revaluing the CNY

The US is trying to get the Chinese to up the CNY or RMB so that the Chinese will import more from the US (box 8).  This suggetion would not fly as it would put the Chinese into an unacceptably risky position. They have been unambiguously clear that China's contribution is to keep China stable and maintain its growth against their export markets shrinking.

Boxes 1, 2 and 3 is the story of fiscal stimuls taking over from exports. The longer term future is to shift more toward domestic consumption (box 4). If the CNY goes up (box 6) as per US wish and the Chinese chagrined no, going by recent history, money will rush into China worsening the asset bubbles already inflating there. The US hopes to get the Chinese hooked on their consumption habit? See the link between Box 5 and Box 4. In this scenario, the Chinese will find it affordable with super cheap money to buy more from the US and everyone. However the longer term consequences to China would be extremely negative. Kudos to the Chinese leaders astute leadership of their country.

USD carry trade

Box 1, 2 and 3 describe the US attempts to inflate its debt away. Since there are so many foreign holders of US assets, they especially China and Japan are forced to help pay the huge pile of US debt. Indeed we are living that attitude: The USD is my currency but your problem.

USD depreciation (box 3) opens up a massive opportunity for borrowing USD at near zero, even negative cost to buy non-US assets. This is driving up asset markets world wide (box 5). There is a reinforcing loop between Box 4 and Box 5. Massive assets bubbles are being inflated all over the world. They are unsustainable and will burst. As usual, too few people know when it will happen. Go bet the markets at your own risk.

As long as the USD is the reserve currency. The US will succeed at getting the rest of the world to help pay its humongous debt. US fiscal policies and consumer habits must change or she would just at the end of the road become utterly bankrupt and completely uncreditworthy.

Combining Nov 7 and Nov 9 NaviMaps

The NaviMap of November 7, "The Economic Recovery Process" is linked to today's, "Making Sense of Rising Gold Prices" via November 7 Box 9, "> USD weakness" to November 9 Box 3, "> selling USD".

The "The Economic Recovery Process" is the driving force behind "Making Sense of Rising Gold Prices" transmitting its influence via the USD price signal.

Making sense of rising Gold prices

Central banks have too much USD. As they diversify from it, USD weakens. The USD will find hopefully a high bottom because nobody is going to zero on the Dollar. The Americans will decide and the rest of the world will react accordingly. The more tough minded they are, the stronger the Dollar.

The Economic Recovery Process

You would have to double click on the NaviMap above to see a larger picture.

A few interesting features here.

Box 1 and Box 8
No free hand for the Americans to print money. It is difficult trying to strike a balance. If they could have push even more money into the economy, they can quickly reverse the rising rate of unemployment. This is too risky as foreigners might give up on the dollar. Krugman seems to have ignored this point.

Box 9, 10 and 12
This reinforcing loop on first look does not make sense. USD should in theory strengthen (box 9). The USD doesn't behave according to theory because it is a currency of safety. The USD is the worst reserve currency except for the rest as Soros pointed out.

Hopefully with more of Box 3 and Box 5 at a critical point, when the expected returns from USD assets become attractive again, the USD will strengthen (box 12)

"Too Big to Fail", "Too Big to take a Pay Cut"...

An article from the NYT, "Where Politics Don’t Belong" caused me to put my thoughts into this NaviMap. It discussed, "Too Big to Fail", i.e., Wall Street, and "Too Big to take a Pay Cut", i.e., the income of doctors.

If governments and here I am using the American one as the example, would to leave the markets to decide what is produced, sold then the government would be much smaller and has less to do. Since politicians need to win voters support, they must always find something to do to continue in office. This result in "more government" (box 1) which inevitably leads to messing with the functioning of the markets (box 2) so that the constituencies they they want to get support have an advantage over others (box 3). Note that this lead to a reinforcing loop.

Special interest influence the process of government for their benefit (box 4). The easiest is to provide money to help politicians win elections. Now another reinforcing loop, and this time between Box 3 and Box 4 enters the picture, which is the current state of affairs. Special interests have taken over the government.

Since no reinforcing loop can go on forever, the limits of growth eventually appears. This lead to Box 5 becoming critical, where  markets becomes increasingly distorted, inefficient and uncompetitive (box 6). Voters get fed up - this is the demoting influence of Box 6 on Box 3. If it hasn't happen already, it would as a matter of course.

Box 6 will compete with Box 4 for Box 3, but with Box 5 becoming more a reality, the underperforming economy eventually give Box 6 the upper hand and Box 4 is vanquished. This is all well and good except that I wonder if this can be achieved peacefully or if the economy could have deteriorated so badly by then for some nations that they just simply spiral down.

"Old Normal" vs "New Normal" - A simpler version

Related Post

Where do we go from here: "Old Normal" vs "New Normal"

Yesterday I posted a more complicated NaviMap and offered only a cryptic write up on it.

The NaviMap above was created before the one in yesterday's post. The most important boxes is this NaviMap is the reinforcing loop between Box 2 and Box 4a. Box 4a is in blue to suggest that at the time of creating this NaviMap and even now, it is an objective governments hope to achieve in their effort to shore up the financial system.

Similar to the NaviMap from my previous post, if Box 3 appears before the virtuous cycle between Box 2 and Box 4a materializes, then this would lead to the "New Normal". Box 2 and Box 4a represents the revival of the "Old Normal" when people were making money hand over fist.

Inflation (box 3) will force monetary authorities to rein in liquidity or completely lose credibility. They will do it regardless of the political costs.

Another scenario is the "Old Normal" would last briefly, acting as a big bear trap for many investors. Box 3 will appear and bring the party to a premature end heralding PIMCO's "New Normal".

Where do we go from here: "Old Normal" or "New Normal"

This NaviMap tells two stories. One, how overwhelming government funds were employed to rescue the near collapsing financial system and succeeded. Box 1, Box2, Box A. and Box B. The the story continues with Box 3. (increasing asset inflation) because once fear is driven out liquidity naturally seeks higher return.

Ideally policy makers are trying to achieve one or two virtuous loops of economic growth. This is the hope for reinforcing loop joining Box 2, 3, 4, 2 and/or 2, 3, 4, 5, 2. This is the return to the "old normal" as opposed to the low growth "new normal" PIMCO is planning to live with.

Most economists do not think it is possible to return to the old rate of economic growth any time soon. The hope of politicians is that the printed money would be successful at helping them grow out of their troubles. What is to prevent this from happening?

Firstly the amount of debt is just humongous. Secondly, the financial sector has gone far off the course from lubricating the wheels of commerce. Instead lot of bankers spend most of their time on how to obtain a bigger bonus, and how to pass the tab to someone else if things go wrong. That this misaligment of purposes can somehow end up achieving our socio-economic objectives defies imagination

If given the fairly narrow window of opportunity the two virtuous loops did not appear, then Box 7 will eventually appear. It will effectively abort any possibility for the virtuous loop. Central banks will be forced to drain the liquidity from the system the way Paul Volcker had done before. It would be an environment aptly described in PMICO's "new normal" scenario.

China: Towards the Rule of Law

"The Rule of Man" (box 1) is stuck in my mind after I read Zhao Ziyang's book, "Prisoner of the State".

Box 1 describes how China is ruled but to a less degree than when Deng was numero uno.

Note the reinforcing loop between Box 1 and Box 2. The Communist Party knows this is what keeps them in power. As no reinforcing loop can go on indefinitely, fairly early on Box 3 (Corruption) has been growing, which is a demoting influence on Box 2.

In this NaviMap we introduce Box 4 - Social Progress.

Because of Box 2 over the last 30 years, we can talk about Box 4 meaningfully today. However the antagonistic relationship between Box 3 and Box 4 has created a "Tug of War" situation over Box 4. This is feeding back to Box 1 as a promote and demote Box 1 influence.

The Chinese correctly believed that nothing can be done to get China out of its poverty and onto a development path without economic progress (box 2). A worsening corruption situation (box 3) must be managed within the latent strength of their ancient culture. Zhao Ziyang believed that pervasive corruption (box 3) would be temporary. Looking beyond, he had felt that the Rule of Man (box 1) is temporary. Eventually it would yield to the Rule of Law.

Rule of Law (box 5) is the destination that the Chinese wants to be at eventually.

Historically they have never succeeded at scoring a permanent victory over corruption. Why should it be different this time? They are hopeful because the days of the emperors and the paramount ruler are over. Now they have to figure out their own version of democracy. They cannot do this quickly. The pace is dictated by Box 3. and Box 2. Social Progress (box 4) is in the centre of this tug of war. The ride we can be sure has been and will continue to be very bumpy.

NaviMap now has a companion blog

This blog attempts to cover to much ground. I have started a related blog at http://virtuouscycles.blogspot.com/ which is more focused on understanding and owning the virtuous cycles around us. I welcome you to visit Virtuous Cycles.