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Source link: http://archive.mises.org/8983/did-the-fed-or-asian-saving-cause-the-housing-bubble/

Did the Fed, or Asian Saving, Cause the Housing Bubble?

November 19, 2008 by

Just about the only good thing to come out of the housing bubble is that many financial analysts are coming to see the virtue of the Austrian theory of the business cycle. Specifically, though Greenspan did his best to blame deregulation and foreigners who saved too much, many people now think that the Maestro’s ultra-low interest rates in the wake of the dot-com crash may very well have sowed the seeds for our current crisis. FULL ARTICLE


greg November 19, 2008 at 8:57 am

I love it, economist talking about housing and don’t know what end of the hammer to hold.
Having built homes for the last 22 years, I have seen these ups and downs come and go. This last one was easy to see coming and that is why I stopped building specs in 2004 and currently don’t hold a single spec. What did I see?
Basically, you must realize that real estate is a bad short term investment. When I saw people buying houses at retail and flipping them for a profit, I knew that would not last and it signals the end is near. To invest in real estate you must realize that it is a commodity and you must buy it at wholesale, modify it (subdivide, build on it or change zoning) and sell it for a reasonable profit. It is like buying an ounce of gold, designing and building a ring.
Now the Case-Shiller index. The development of these types of indexes and the huge amount of funds that was invested into funds related to them did more about drawing investors into this flipping craze. And one of the reasons I stopped building specs was the development of uptrend “W” in the chart. The second bottom of the “W” signaled the end was near.
I could go on about where foriegn savings was coming from, demand for mortgage backed securities, short selling, commodity speculation and the rise in the Fed funds rate with little or no effect on long term rates. But I would be typing all day. But all of those monday morning quarterbacks debating the causes don’t really understand and could never play the game.

Jonathan November 19, 2008 at 9:46 am

We ought to note that the Fed wasn’t the only central bank keeping rates below their natural rate. The remarkable rally in the Yen and to some extent Swiss Franc with the dollar recently, as debt is unwound (meaning a bid for the currency in which the debt was taken) indicates there were many culprits. The irony for Japan is that their policy helped reinflate, but not in their own economy as intended.

John Reed November 19, 2008 at 10:06 am

I admit to becomming confused as I try to understand all the factors that resulted in the current mess. Nevertheless, the argument that “excess foreign savings” had some impact seems plausible. If low interest rates were part of the cause, and if foreigners were buying up huge amounts of Treasury obligations, would not that high demand tend to push the interest rates on those obligations down?
I certainly have the impression that the Fed was favoring low interest rates and acting in a way to facilitate them, but weren’t the market forces I cited (assumed) above a major causal factor in the low rates?

Dr Duncan Druhl November 19, 2008 at 10:14 am

It is actually rather simple when you look at Greenspan. You have to ask for whom he is working. To determine this, it is probably necessary to ask who owns the firm which he runs. The answer to that is half a dozen New York banks that are mostly US, but some only so in name and corporation details. No, this isn’t an old conspiracy nut theory – it is simple fact. The organisation for which Greenspan worked was always and still is a private bank for all intents and purposes.

So, the question really is: did Greenspan perform his job well for his boss(es)? I suspect that answer is yes.

peter helbich November 19, 2008 at 10:46 am

this is vienna austria. where it all began.
mozart , menger, mises, hayek etc

send this theorem to all your friends and spread it in the internet.

its the mathematical proof of the austrian school of economics

regards peter helbich

Chris November 19, 2008 at 11:08 am

How does an article, on mises.org, which says the following…:

“Naturally, just because the global-savings-glut hypothesis has some trouble fitting the facts, that doesn’t mean we should completely throw it out. After all, this is macroeconomics, not quantum physics. There’s no such thing as a controlled experiment in the realm of the social sciences, especially when we’re talking about global outcomes.”

proceed to avoid all discussion of the theory behind the actual global savings hypothesis, and move on from the hypothesis after only examining evidence (which, by the way, was not even presented in the paper in question)? Wouldn’t it be more… Austrian to point out theoretical flaws in the framework of the hypothesis itself? Is there any article anywhere where this is done?

greg November 19, 2008 at 11:40 am

Here is a challenge to all to apply their economic knowledge:
When do you see housing turn up?

William Rader November 19, 2008 at 12:02 pm


My natural inclination would be to say when the demand for housing exceeds the rate of new housing construction after the housing market equilibrates. However, there appear to be a number of variables to consider here: foreclosures: number of houses foreclosed upon, number of house in foreclosure, number of houses that will be foreclosed upon, sales of foreclosed properties; the future costs of construction materials; the ability of consumers to save for down payments on houses; the preference for consumers to rent rather than to buy; etc.

Sorry, Greg,I know this sounds like a cop out, but I just can’t get past these variables.

Miklos Hollender November 19, 2008 at 12:50 pm

“Just about the only good thing to come out of the housing bubble is that many financial analysts are coming to see the virtue of the Austrian theory of the business cycle.”

Don’t worry, they’ll forget it instantly at the next upturn.

greg November 19, 2008 at 12:59 pm

Thanks for your response and it sums up a point I want to make, there are too many variables to pin this question down. Just like there were more variables that led to the downturn than just Fed action. Getting off the tunnel vision highway could help us all.

To help you out on the variables consider the following:
1. The majority of foreclosures are in 4 markets in the US.
2. Demand for housing (rental and owned) in the US is 1.2 million units per year based on population growth and replacement.
3. Future cost of construction will remain low as lumber futures during the boom years was close to $500 per 1000 BF, now that number is $200.
4. We just registered the largest number of births in the US which signals a baby boom and a shift in housing requirements.
5. Rental cost are increasing with the increase in demand. Plus these units cost base have expanded which puts upward pressure on rents.

These are just a few of the variables builders should look at to make the decision to jump in. The problem builders face is that it takes 6 months to plan and build a house for sale and in a business where margins are slim, timing is everything. The only saving grace a builder has is that if he makes a wrong choice, he is in at a wholesale price and can sell the product at cost to get out fast and try again. Those that bought at retail don’t have that luxury.

A. Viirlaid November 19, 2008 at 1:03 pm

Thank you Robert Murphy.

I have always thought that the presentation of the Savings-Glut Theory was just a little TOO convenient and self-serving for both the FED and the government. Others have also posited that it was a phony shield behind which they could conveniently hide the actions of their intellectually-bankrupt (and morally-bankrupt) policies.

A few weeks ago I posted an entry that summarized my thinking.

I agree with your analysis but I would like to add the fact that China follows a very, very, dirty “dirty-float” policy with its own currency. It controls its currency as if it were a war-time strategy and has very tight exchange controls — some have even said that this IS a war-time strategy. That China sees itself as if at war with the West, economically-speaking.

Countries that profess to have a freely-convertible currency rarely do nowadays. But China does not even pretend to have this. It does not allow conversion without its oversight.

My entry has to do with the Greenspan “conundrum” — namely, why did long-term prevailing interest rates stay so low.

The answer IMHO is that since nothing like a gold-based or rules-based system prevents some countries from converting their money into American currency, they will do it, if it serves their political and economic interests.

My entry follows:

Another very germane thing that will also affect how long the recession lasts is whether the authorities recognize, finally, what the so-call Greenspan ‘conundrum’ really consisted of.

Bernanke amongst others thought that there was a real savings boom in the developing nations. He thought this was why long term interest rates stayed so low. He thought that this explained Alan Greenspan’s ‘conundrum”.

This type of analysis borders on financial eccentricity.

Because it is deliberate manipulation by foreign governments and their Central Banks that is hurting America — it is not some harmless ‘saving’ done by poor peasants. This indeed even fed into Greenspan’s decision to ignore the housing boom, at least that part that was facilitated by low long-term interest rates.

The explanation IMO is very simple, as is the mechanism.

Countries like China buy from their exporters those foreign-currency surpluses these exporters don’t need for purchasing foreign goods (commodities for manufacturing, etc.).

But China’s government (and Central Bank) does this buying with newly-printed Chinese paper money. China does this because otherwise its own currency would be driven up in value.

This seems to be initially a good idea. China keeps its currency from appreciating, thus further facilitating its takeover of the world’s manufacturing. It can continue to sell its goods very cheaply, keeping its economy humming. In the long run, it will prove to be a house of cards and will come back to grievously harm China’s economy and people.

This is inevitable with such manipulation of paper money currencies. A system backed by gold-based or other rules-based money-issuance would make such manipulation less likely. As would an international agreement to never again go down such a road.

The Chinese exporting companies need Chinese currency to pay local wages, and to deal within the Chinese economy for some Chinese goods and services, obviously.

After China buys the foreign currency from its exporters (mostly U.S. dollars) it sends these monies to purchase Treasury Bonds in the respective countries (most especially the United States).

There is no savings “glut”.

This is a manipulation of economic normality. It is a way to ‘fix the game’.

The surplus would normally drive up the value of the Chinese currency if China did not print phony paper money with which to purchase the American dollars.

In that case, America would be in some reasonable position to sell its own goods to China. But with the Chinese interventionist manipulation, American sellers of goods don’t stand a chance. They are effectively blockaded from doing ANY meaningful business in China. They have been ‘shanghaied’.

That is part of the reason why American long-term interest rates were so low for so long.

This partly explains the Housing Bubble.

Just ask yourself some questions — is it normal to have interest rates so low for so long, for savers, as they have been in the recent past? Do you really believe the overall inflation statistics? Why have you not personally been incentivized to save more over the last 15 years?

I am not suggesting that all of this is China’s intentional design — although for sure, China’s intelligence agencies are certainly aware of this — and most certainly are not unhappy with the newfound leverage that China has over America given how much China has become America’s creditor.

Some of the low-priced goods coming from China have indeed kept the overall ‘basket of household goods’ type inflation index low. But it was wrong to focus on this portion of the inflation rate.

Housing, college tuitions, medical care, commodities (until the bust started), etc. all were screaming “inflation is HERE”!

Normally this type of inflation would have driven interest rates higher — and savings rates would thus have normally gone up — and lending activity down. We would not have been ‘zombie-consumers’ for quite as long as we were. We would not have gotten quite as deep into the current mess.

But the fact that ‘normality’ was shanghaied allowed all of us to become zombie-consumers. We did not have any incentive to SAVE. What’s the point if your bank gives you 2%, in other words a negative ‘real rate’? You would be stupid to save if you could buy more cheaply now then next year.

That is the end of my original entry.

My point is that without a self-regulating (worldwide, internationally-accepted and -monitored) money-system, we are subject to all kinds of distortions and manipulations.

These are very real ‘offences’ against what the normal money-system would do, and how the economy would and should respond — BTW, we haven’t had any semblance of ‘normality’ IMHO since 1913 when the FED was established.

My example is but one. Your examples are just as real. As are the many other ones raised by your colleagues on the mises.org site.

Thank you.

Larry N. Martin November 19, 2008 at 1:04 pm

Having built homes for the last 22 years, I have seen these ups and downs come and go. This last one was easy to see coming and that is why I stopped building specs in 2004 and currently don’t hold a single spec.
Congratulations on your perspicacity, Greg, but what about all the other home builders? ;-)

Inquisitor November 19, 2008 at 1:20 pm

Interesting analysis Viirlaid. So are you basically saying this policy of China’s is complementary to the Fed’s own monetary expansion policies?

John November 19, 2008 at 1:23 pm

I always rely on Okam’s razor or the KISS theory. It all started with the Government creating too much money that could not be absorbed into the system. Increasing the governmental economy by about 40% is too much for any country to handle. Its like a person who maxs out all their credit cards. And poor Alan had to get rid of all that money, so rates were lowered, loans were given to anyone who could speak and walk, like a fire sale it all had to go. Well it did and here we are. You got us into a nice fix Georgie.

joebhed November 19, 2008 at 1:30 pm

central government planner backatcha.

Of course the answer is the FED, and the deregulation of the entire international investment banking sphere.

But that FED, in case you didn’t see who was paying Greenspan, and every other FED employee’s payroll, is NOT the government and has nothing to do with the government.
They don’t work for the government.
We long ago, in one of our premier privatization efforts, turned all monetary policy in this country over to a private banking cartel.
Yes they are called the FED and the private central banking authority for the USA.
But, they are NOT the government.
I know y’all know that.
But it wasn’t so much the agency(FED) that caused the policy(low interest rates) that caused the financial crisis that began as the subprime crisis that is now emanating upwards through other levels of the housing market.
Rather, it is the essential structure of the private monetary system(debt-money) that caused the need for another bubble in order to extinguish a sizeable portion of the debt that has been created in a centralization/contraction phase, which has in turn taken the asset-inflation in housing and turned it on its ear.
ALL the rest were just bets on bets on bets that the thing would fail, or not, or when.
Get ready for the rest of the ride.
Monetary reform now.

A. Viirlaid November 19, 2008 at 2:22 pm

I think Inquisitor, you may be right.

I am confident that there was no explicit arrangement between the FED and China’s communist party-run government. I will explain why in a moment.

But this ‘arrangement’ certainly was convenient for both sides.

The FED got to inflate “price-inflation worry-free” at home.

China got to do a lot of ‘goosing’ of its own economy.

So the arrangement seemed valuable for both parties — for a while anyway.

Along with that, the dictatorship in China — which in no way represents the Chinese people — has gained economic leverage over the freedom-loving country of America and her people. China has been America’s primary external lender for some time. I think the amounts run into the trillions.

This gives the leaders in China some political influence over Washington also, IMO. This is implicit, and is never spoken of.

This is why I think the FED, or at least our current money-system arrangement, has done a lot of harm to the United States. The FED was a patsy. It did not foresee the harm that was being done.

Of course the FED is not the whole money-system. But it does exercise oversight. And it should have the political and economic interests of America in its mandate. When it sees future potential difficulties, its job is to raise the alarm.

China can use phony printed paper currency (its own) as a way to snare America into its political orbit —– this is not right.

Of course, in the old gold-based system of years past, the West could never have bought as much (on credit) because we would have run out of gold to pay for all of our excesses. China’s currency would have appreciated. The system itself would have helped to balance the accounts — the inflows and outflows.

The system would have prevented China from manipulating its own currency because they would have been required to maintain their own currency’s value AGAINST gold. Without that control mechanism, China can pretty much print as much paper money as it wants — and in turn buy U.S. currency (the surplus portion) from its own exporters. Voilà — total control!

Today we can so much more easily get into trouble — China has become our Pay-Day Loan outlet. Except we have run out of pay-days.

The ironic thing is that China may have miscalculated — it may suffer far more harm than America. Its own economic achievements — the part based on the phony printed money — will prove to be illusory. China has done no small harm to itself and its own people.

Peter van Haaren November 19, 2008 at 3:28 pm

Many financial journalists “who are now coming to see the virtue of the Austrian theory”? I believe nothing of this. The great economic stars arising from the subprime crisis are Minsky and his followers. Go to SSRN; they´re writing one article, paper, comment after another… Where are the Austians?

Glen November 19, 2008 at 3:46 pm

The defense of Greenspan reminds me of a case study we had in b-school. The head of the company overclocks his plant and equipment but makes numbers that has never been seen. When his protege takes over, the company begins to spiral into bankruptcy. The stockholders cry about the great retired CEO and the new directors still believe in his management style. You are hired as a consultant to fix this mess, what do you do?

Eric November 19, 2008 at 6:58 pm

Two questions, and 2 answers.

1. Where’d all the money come from to make those home loans, especially how more was needed as home prices soared?

2. Is the FED really private?


1. More houses were built and before the bust were selling at very high prices.

Where did all the money come from to spend on these houses. Nobody was selling stocks to get the money. They weren’t sucking the money out of other loan areas that went suffering for cash to loan.

So, where did all this money come from? The only reasonable answer was by increasing the money supply through central bank credit manipulations.

And AFAIK, the way they decide how much money to inject (out of thin air) is to set some arbitrary rate of interest as a target and if this causes demand for loans to increase, the central bank creates new money and then spends it. The money they inject eventually finds its way into banks which now have larger reserves and so can make more loans. This continues until the interest rate targets are achieved.


2. Is the FED private? Or is it government.

Well, that depends on your definition of government. If you like Harry Browne’s one word definition (as I do) then government is simply FORCE. However, I like to make it even clearer with 2 more words, so

Government = Non-defensive legalized force.

We may legally use force in defense, but government can use aggressive, initiated, offensive force. It merely needs to pass a law.

This is the only attribute of government which is unique and thus different from private organizations.

Does the FED use legal force? Yes. Is it in self defense? No. Can private organizations legally do what the FED does? No.

By this definition, the FED is not private, but is a government entity, although it directly aids private entities.

Using this definition of government gets to the nitty gritty of the matter. Little else is important.

As Harry would say, the government does have some fringe competitors, such as the Mafia. But by pinpointing the issue of force, he has made it possible to say that any organization that operates legally using force as its main tool is either the government or an entity that has control of the government – and I see little difference there.

Brian Macker November 19, 2008 at 8:10 pm

I went over to that Marginal Revolution blog and I tell you I haven’t read so many idiotic economic articles and ridiculous comments on economics in my life.

This one on the liquidity trap is particularly stupid.

Ted Berthelote November 19, 2008 at 8:52 pm

Cato has been purchased by Leviathan, so what do you expect from Henderson?

Jay Aren November 19, 2008 at 11:45 pm

Looking at the graph titled “A savings glut, not an investment drought” that shows savings versus investment as a % of GDP, it would seem to me that the important factor is the difference between savings and investment.

Indeed, I believe Setser’s argument is exactly this: the growth in savings minus domestic investment means that the developing / emerging countries had more money to invest overseas.

To quote: “However the rise in the emerging world’s savings was so large that the emerging world could investment more ‘at home’ and still have plenty left over to lend to the US and Europe. That meets my definition of a ‘glut.’ “

Jeremy November 20, 2008 at 1:10 am

“The ironic thing is that China may have miscalculated — it may suffer far more harm than America. Its own economic achievements — the part based on the phony printed money — will prove to be illusory. China has done no small harm to itself and its own people.”

The part based on the phony printed money?

China had to produce those things it shipped to America in exchange for depreciating slips of paper. To do so, it had to first save and accumulate capital.

When the phony American demand finally disappears for good (once China becomes a net seller of treasuries), all of that capital will still be there. Sure, a good bit of it will be malinvestments geared toward the US consumer, but it will still be there even after its companies go bankrupt – others will buy it up and still be able to use it for other purposes.

So China has gone through a period of great savings and capital accumulation. It will stop shipping products to America and will instead send them to people who can buy them with real goods (or sell them internally to consumers with a strengthening currency versus the dollar) – that means that China will be wealthier.

The US, on the other hand, has consumed more of its capital base (percentage wise) than at any time since the Great Depression, and we may outdo even that based on the idiotic policies currently being followed.

You still think China will be hit harder than the US in the coming years?

newson November 20, 2008 at 1:31 am

to dr murphy:
why bother arguing with h&h over bank reserves? karlsson has done a good job explaining their utter irrelevance (http://stefanmikarlsson.blogspot.com/2008/04/myths-about-monetary-base-and-bank.html).

charles hatch explains how reserve requirements have been de-fanged through sweep arrangements.

Inquisitor November 20, 2008 at 3:25 am

A Viirlaid, I think we more or less agree then.

Peter van Haaren I think all Murphy meant is the increased attention some financial analysts and articles have been giving the ABCT.

TokyoTom November 20, 2008 at 4:07 am

Bob, when you talk about the failures of the rating agencies, I hope you also have in mind the perverse incentives in the market:

- rating agencies are paid by debt-issuers who want the best rating possible, not by investors, as David Zetland noted yesterday – http://aguanomics.com/2008/11/fixing-credit-rating-agencies.html – and

- and the demand for ratings isn’t driven so much by investors desires to manage risk as by regulations that restrict the assets that regulated entities may purchase and that mandate they hold varying amounts of capital based on the ratings of their assets.

As a result, the whole rating system is perverted.

I guess the government needs to regulate the rating agencies now.

ktibuk November 20, 2008 at 4:44 am

“I guess the government needs to regulate the rating agencies now.”

The government has been regulating the rating agencies and that is the problem.

There are laws requiring that you work and get a good rating from specific established rating agencies. There is no free competition amongst them. You can not go and choose any agency for your stocks or bonds. You have to choose amongst the “7 chosen ones” in the US


ktibuk November 20, 2008 at 4:50 am

A. Viirlaid is right but this isn’t just about US and China.

Since the dollar is the reserve currency of the world, every other CB in the world inflated using the FED created dollars.

It is like fractional reserve banking, where every other CB has reserve requirement to keep dollars and for each dollar they can inflate their own currency even more.

This is bigger than 1929 because the inflation of the dollars screwed up the capital structure of the whole world not just US or even Chinas.

With this much inflation all over the world it is almost impossible to say what is real saving and what is inflation. And that is the main problem isn’t it?

Kurmudjin November 20, 2008 at 8:20 am

Thank you Dr. Murphy.

Once again you have clarified what was undecipherable. Just when I was ready to give up and blame it all on animal spirits!

Larry N. Martin November 20, 2008 at 10:52 am

“Animal spirits”, Kurmudjin? No, it’s the fault of “irrational exuberance”!

A. Viirlaid November 20, 2008 at 11:13 am

ktibuk is right IMHO.

China is only the most egregious (recent) example of the manipulative practice of subsidizing these exporting countries’ export sectors with “goosed-up” local economies using currency controls. And using “dirty-float”exchange controls…

And using import restrictions — whether “dirty” or legal. And using ownership “sharing” arrangements where local companies get the technical skills and trade knowledge, and jobs and manufacturing secrets from the offshore investing countries — most often America. That’s when their “industrial espionage” spies are not getting those secrets for them.

How many times have you read of an American being laid off who then has to earn his or her layoff “bonus” by training the offshore worker who is taking that job. But we have always been told that we need to compete better, more intelligently. On a level playing field, that makes sense.

We are to blame somewhat of course — we have allowed such offshore countries to fatten us up — we don’t save — we buy on credit. We also have gotten used to having cheaper goods come to us from offshore where quality is comparable… and Wal-Mart is our enforcer for that quality in a lot of cases. And maybe we have gotten a little lazy on the innovation side as well.

But there is a cost to that convenience of lower prices. Where the level playing field does not exist, our workers suffer. While I believe in (fair) free trade, and am a fiscal and financial conservative, I cannot see how destroying middle class jobs does us any good.

It is my position that the U.S. Treasuries (later purchased by these countries for the surplus U.S. dollars they have “earned”) are thereby accumulated by these other CB-s and their governments in a “dirty” and unfair manner.

The resulting imbalances are enormous. There has been some small justification for keeping such reserves, but only within reason. The exporting countries claim that otherwise there can be runs on their own currency. That offshore investors can repatriate “hot money” and cause their economies to suffer. That these surpluses are just “buffer” amounts to protest their own interests. To mitigate problems when hot money (especially the reserve American money) wants to go home.

Japan has followed a similar policy for years. I think that Japan is now in a dilemma partly of its own making. So imbalances do cause problems. If the U.S. cannot buy from Japan and China, and (as it appears) those countries are not YET ready to decouple themselves from American trade, so as to survive with trade amongst each other, then, yes, some of their difficulties are indeed homegrown.

An argument is often made (by those countries) that they are “only building up” their export sectors and one day, soon, they will “normalize” their control of their currency rates — and that they will “normalize” their trade with America. I’m still waiting for that “normalization” day in the case of Japan. Sure as they get richer they import a lot from us. But don’t think for one moment that they do not very critically watch to ensure that they always continue to run surpluses with us.

To Jeremy — thank you. I am not an expert on China. But what I have read leads me to believe that there are ENORMOUS malinvestments. Empty condos. Soon, many more empty factories. I once read that something like 70% of ALL Chinese jobs are totally dependent on the export sector. And today, China itself is losing jobs to Vietnam, which relative to China, is playing the same game — initially with even cheaper labor.

One good article (if it is not now “access protected for subscribers”) can be found at http://www.theglobeandmail.com/servlet/story/LAC.20081108.STBUYSIDE08/TPStory/TPBusiness/

This article in the Globe and Mail, by AVNER MANDELMAN from November 8, 2008, states among other things:
“Despite the [very small] town’s size, it sported dozens of condo towers and a posh hotel. And so, to celebrate the completion of the project, the Canadians went to dinner at the hotel’s restaurant with the local bigwig (the son of an army general), who, by the way, also owned the hotel and condos.
“They were the only diners present – the hotel was empty and dark, the condos emptier and darker. But there were lots of staff members, and during dinner the bigwig kept complaining that the Beijing bank that lent him the construction money was suddenly demanding interest. The cheek! How could one keep restive peasants employed if one had to pay interest?
“My e-mailer noted wryly that all over China there are many such empty hotels and condos – and factories too – built with loans to the well-connected and intended to maintain employment, but also (allegedly) to allow loyal bigwigs to enrich themselves.
“The economic value of such enterprises is, of course, zip, yet the “loans” are carried on the books of Chinese banks as good ones – just like U.S. mortgages to shirtless Joes and Janes were carried on Freddie Mac’s and Fannie Mae’s books before the mortgage corporations blew up. And, yes, just like loans to Sony or Sumitomo were carried by Japanese banks in the 1990s before the Japanese economy blew up.
“And, similarly again, just as everyone in Congress knew that Freddie and Fannie would soon come to grief – or just as everyone in Japan in the ’90s knew that most corporate loans were unpayable – the same is known in today’s China. Yet most China bulls in the West maintain that the country’s growth has merely slowed temporarily and will soon resume.
“Will it? Not according to my informants. China, they insist, is like Japan of the ’90s times three; it is Nortel writ large, maybe even Russia before the 1988 upheaval. You think this is extreme? Think again. Just last week Chinese Premier Wen Jiabao finally admitted that slow growth could risk “social stability.” Slow growth? How about no growth? Or even negative growth? It’s coming, and here’s why.
“You see, China, like Nortel and Japan and Soviet Russia, has been selling most things below true cost – which is the direct cost of production plus the cost of capital – and thus lost money on much of what it produced, and so destroyed much of its capital. A company that does so must eventually lay off workers and go bust. China, in my opinion, now faces similar risks, which Mr. Wen finally admitted.”

Bob V November 20, 2008 at 2:45 pm

Concerning China & savings, agreement with A. Viirlaid can be found at:


Jay Aren November 20, 2008 at 4:00 pm

I disagree with A. Viirlaid on several points.

First, by keeping its currency cheap relative to the dollar (and hence other currencies), China is basically giving the U.S. cheaper goods at the cost of its workers and poorer citizens. Their wages and savings are not worth as much as they would be if China allowed a truly floating exchange rate – imports are more expensive and domestic goods don’t face competitive pricing pressures from imports.

Second, if unemployment increases in the U.S. due to loss of jobs to China and other emerging markets, this should drive down U.S. wages. As wages decrease, businesses will hire more workers. In addition, cheaper labor makes it possible for new businesses to come into existence, as their costs are less. Yes, there would be an adjustment period, but in the end, the U.S. benefits – cheaper goods from abroad, cheaper domestic goods, and new products and services from new businesses.

TokyoTom November 20, 2008 at 9:35 pm

ktibuk, the government formally introduced only a limited regulation of the rating agencies in 2006. The regulation had its beginning in the regulation of the asset and capital of regulated agencies, which remains the principal problem.

Of course what we can now expect to see is a further expansion of government regulation, including more extensive reguilation of the rating agencies, to “cure” the problems created initially by FDIC deposit insurance.

A. Viirlaid November 20, 2008 at 11:06 pm

Thanks Bob V — I owe you one! I HAVE bookmarked that link into my personal favorites.

And I also owe (Professor) John Succo and Mike Shedlock.

How, in light of their tour de force (back in December 2006), can Bernanke continue with his “Global Savings Glut” fiasco of an “explanation” for low interest rates?
This amounts to Doctor-of-Federal-Reserve malpractice!

Now I can more easily understand why Dr. Bernanke persists with his “lessons learned” from the Great Depression. At least he is consistent — consistently wrong.

He thinks the poor people in the Great Depression did not spend enough because they somehow knew that a dollar next year would be worth more than this year (=price deflation). He believes that he can force aggregate spending UP à la Zimbabwe with dollar depreciation (monetary inflation). He believes that those once-again-forced-into-buying consumers will then buy the ‘right things’ like cars, houses, furniture, appliances (and keep GM etc. in business) — instead of buying freeze-dried food, underground bunkers, guns, tillers, seed stock, fertilizer, home generators and wind turbines and solar arrays, and toilet paper.

Mike Shedlock’s post is a wonderfully lucid exposition of the problem.

AND it was written well BEFORE this imbroglio we find ourselves in.

I would STRONGLY urge all our posters to read that one article.

The fact is that this is MANIPULATION. Yes, it is not explicitly agreed to ahead of time by the FED and its Asian (and other) trading-partner counterparts, but it is “MONIPULATION” — sorry, could not resist — just the same, that leads to hugely damaging imbalances (from the Austrian point of view, and from the point of view of Reality Herself).

John Succo clarifies Ben Stein’s muddled take on this “glut”.

Dr. Succo also points out the flaw in thinking that this process is cost-free. Because it is not. He points out the future-coming (back then) correction in both the debt and derivatives markets.

Let’s repeat one more time for Dr. Bernanke’s benefit — there are NO POOR PEASANTS in China or anywhere else that are causing a SAVINGS GLUT. Most certainly not a glut of savings that then flows back into America.

It is the CB-s in those countries that are printing local paper money with which to buy up surplus U.S. dollars and then using those dollars to buy U.S. Treasuries. Got IT? If not, please read the last few sentences OUT LOUD in front of the mirror at least 10 times — I guarantee that you will then GET IT!

And then repeat to yourself 10 more times in front of your mirror after your shower the following few phrases:

“It is the fiat (debt-paper) currencies that all countries today operate with that is causing all of my freakin’ (and our) problems.”


“In the absence of any supervisory-role played by an impartial arbiter like gold — or by any similarly-equivalent role played by some international, supranational, overriding controlling body of rules, mechanisms, and institutions — we will NOT be able to PREVENT this maelstrom of events from happening AGAIN!”

I can just see poor Ben running down the street (naked) yelling “By God, I’ve GOT IT! — EUREKA! EUREKA!”

Cheers to all, I’ve certainly enjoyed the exchanges.

A. Viirlaid November 20, 2008 at 11:45 pm

Sorry Jay Aren, I did not reply to your entry.

You first wrote:

“First, by keeping its currency cheap relative to the dollar (and hence other currencies), China is basically giving the U.S. cheaper goods at the cost of its workers and poorer citizens. Their wages and savings are not worth as much as they would be if China allowed a truly floating exchange rate – imports are more expensive and domestic goods don’t face competitive pricing pressures from imports.”

Agree 100% with the above comment. My point was that without allowing ‘normal’ real-time adjustments to trading-partner currency exchange rates — or use of a one-common worldwide currency [scary] — one side can take advantage of the other, perhaps even to the extent of harm to BOTH parties.
And perhaps, as we seem to be seeing today, to the extent of a worldwide financial meltdown. The Money System is breaking down. The signals the system used to give as guidance are pointing south when they should point north. This is a compass gone awry.
You properly point out that this is at a very real cost to the Chinese workers — no argument there. If it serves the “greater good” of China (in her masters’ opinions) what of those poor workers? Does the ruling class care?

But it is also at a very real cost to America’s manufacturing infrastructure and to America’s workers. No Chery car company worker being paid 80 cents an hour is overpaid — but no American auto sector worker who used to make wages (including benefits) 2 orders of magnitude greater than that Chinese wage is going to long be able to compete. Once the Western plants are dismantled, who will rebuild them — even if Chinese wages, artificially suppressed until then — are subsequently allowed to rise?

Secondly, you wrote:

“Second, if unemployment increases in the U.S. due to loss of jobs to China and other emerging markets, this should drive down U.S. wages. As wages decrease, businesses will hire more workers. In addition, cheaper labor makes it possible for new businesses to come into existence, as their costs are less. Yes, there would be an adjustment period, but in the end, the U.S. benefits – cheaper goods from abroad, cheaper domestic goods, and new products and services from new businesses.”

This is the same as your first point, from a different perspective. I don’t disagree with your observations, as before, since there is nothing materially incorrect in your statement IMHO.

The problem is this. Would all this evolve within a real money system (for sake of argument use some hypothetical gold-based system, or one-world currency system) then there would be no unnecessary disruption or “adjustment period” as you refer to it.
Yes, the various economies would gradually approach each other over time, in their respective performances, with each using their own national skills and relative advantages to bring novel and great goods and services at the best prices to market.

But what happens today? We are living through a major crash. This is not an adjustment that I think can be considered good or desirable. It is wasteful, needlessly disruptive, and harmful to all people.

This is the part of what might have happened [gradually] anyway that we don’t need. We do not need not only American auto workers to be unemployed, but Chinese ones as well.

This was a completely accidental, avoidable, and unnecessary recession-depression. This was madness.

Jay Aren November 21, 2008 at 12:00 am

It seems our positions are much closer than I originally thought – I apologize if I did not read your previous comment correctly.

“This was a completely accidental, avoidable, and unnecessary recession-depression. This was madness”

I agree 100%. By nature I tend to be suspect of the “savings glut’ theory, but I can’t claim to fully understand all the factors at play and therefore hesitate to make any firm statement one way or the other.

My understanding of the anti-savings glut argument is this:
1. The Fed lowered interest rates below the natural rate
2. With the “extra” dollars, U.S. consumers went on a buying spree that included significant purchases of Chinese goods
3. In addition, U.S. investors poured money into China
4. To offset these inflows of dollars in order to keep their currency cheap relative to the dollar, the Chinese gov’t printed RMB to purchase dollars from Chinese businesses.
5. The Chinese gov’t then used these dollars to buy U.S. bonds, thus in a round-about way helping the U.S. Fed in its low interest rate policy.

Is this accurate?

Gu Si Fang November 21, 2008 at 1:55 am

Thank you for this excellent post. It provides graphs, data and correlations which should be quite convincing for a mainstream approach. But what would an austrian economic reasoning look like if applied to a hypothetical savings glut?

The reason I ask this is that emerging economies did have a growing savings rate during the boom. The effects of these savings were mixed up with opposite fluctuations in developed countries. Yet it would be nice to know what a real savings glut in emerging countries-alone-would have done.

If there were an unanticipated change in savings vs consumption preferences of emerging economies-or in their natural interest rate-, what would the consequences be, ceteris paribus? Have proponents of the global savings glut theory offered such a narrative?

In fact, I am puzzled by the idea that if our friendly Chinese neighbours decide to save more, this can cause malinvestments for us and for them. Unless markets are totally blind, and incapable of correct expectations and even incapable of reacting to a change in preferences, I don’t see how it could cause such a crisis.

ktibuk November 21, 2008 at 5:19 am

Tokyo Tom, I am not just talking about internal regulations of rating agencies. The main problem lies in government creating a cartel and forcing people to use only th,s cartel of licensed agencies. Then the incentives get mixed up.

It is like government licensing just 7 auto repair companies and forbidding anybody to use any other repair shop. Government doesn’t need to regulate how these repair shops operate to hurt the free market.

It is exactly like Mises said. Every intervention causes a problem and that problem begs another intervention. Until you get full blown socialism.

Brian Macker November 23, 2008 at 10:13 am

”That meets my definition of a ‘glut.’ “

Says the grasshopper to the ant.

A. Viirlaid November 24, 2008 at 9:28 am

Jay Aren, thank you!

Your synopsis is very good IMHO!

Sad to say, as a result of this “MONEYPULATION” the pain on Main is only just starting.

As The Daily Reckoning wrote: “This is a Balance Sheet Recession”. Assets go down in value, but debts stay the same, or even go up.

Given future-accumulating interest, debts get bigger.

With price and wage deflation (or just plain LOSS of wages), the dollars that are needed in the future, to be used to pay back the debt, will also be “dearer”.

Those dearer dollars would buy more goods in the marketplace.

But they will only pay off the same old amount of debt that was accumulated in the “good times”.

Johan November 30, 2008 at 6:07 pm

If Greenspan held the target rate below the market rate, how come the balance sheet of the Fed did not expand?

How come the housing bubble is global if it was Greenspan’s fault?

A. Viirlaid March 18, 2009 at 2:40 pm

Hi Johan,

It did expand.

But lately more than ever!

Its expansion IMO now will prove to be utterly catastrophic!

A.Viirlaid June 5, 2009 at 12:01 am

Hi again Johan,

I did not respond to your second question:

“How come the housing bubble is global if it was Greenspan’s fault?”

It is not entirely global, but for sake of argument let’s say that it happened in more than 1 country. Your question BTW is similar to those who point out that the Housing Boom did not happen equally across all states in America — which is true. But that observation in no way frees Alan Greenspan from his culpability for the boom and subsequent bust.

To your point however, for example, certainly there are indications of housing booms in Ireland, Spain, and the U.K.

First there was IMO the same type of philosophical approach followed by other central bankers, most notably in the U.K. — there was none of the old “protect the value of the currency” mentality left. After all, we live in a world where the bywords are Expediency, Consequentialism, Ignorance, and Betrayal of Trust.

The other factor at play is that, until recently anyway, the U.S. currency has been a reserve currency that allowed U.S. central bank activity to influence the activities of other central banks and other economies.

When the Fed inflated he money supply and thus debased the American currency, the Chinese and Japanese (as just 2 examples) had to do the same thing — otherwise they jeopardized their own export-oriented economies.

And similarly with many other world economies — it was a ‘race to the bottom’ because if your country’s central bank did not print its own currency as quickly as the FED was printing U.S. greenbacks, your particular country’s currency would naturally appreciate against the other relatively more-quickly depreciating currencies. And so your country’s economy would be seen to possibly suffer just because your central bank was not as morally and intellectually bankrupt as the Federal Reserve was.

But most certainly, the housing boom (in the ROW = Rest of the World) was not caused by any “Savings Glut” where poor Chinese peasants, who typically save 40% of their income, should be blamed.

And even if Greenspan could not DIRECTLY be found culpable for the problems in other countries, the meetings that all the G-7, G-8, G-20, and so on, have year after year — and which are intended to “coordinate” a lot of macroeconomic “managerial activity” even if those managers have no good idea of whether what they are doing is helpful or harmful — would go a long way to explaining how such money-destroying ‘coordination’ spreads across the globe.

A. Viirlaid June 9, 2009 at 10:45 am

Hi Johan,

A great article on Mises.Org just got posted that pertains to your question.

Please see http://mises.org/daily/3499

This explains how similar ‘techniques’ were used in other places to cause housing booms. It was not just in the U.K. and in America.

This one was in Iceland.

And the article shows nicely how Central Bank policies were inextricably linked, fatally-so, even though none of them were enacted consciously or intentionally with any harm in mind.

Notice especially the focus of the article on capital misallocation (i.e., malinvestments), moral hazard, enticement of people to borrow to the hilt to buy houses, and the sad (implicit) participation of the Bank of Japan (again another central bank) in the creation of below-market cost of capital “money” which directly enabled the tragedy to unfold in Iceland.

None of these practices will stop until and unless Central Banks understand the harm they do with their manipulation of money. There is no cost-free way to obtain a free lunch. And yet the heads of Central Banks on the whole are oblivious to this seemingly obvious truth.

Their respective governments must come to an agreement to not allow any type of “beggar thy neighbour” policies that they currently tolerate from their respective Central Banks.

George Selgin June 12, 2010 at 3:19 pm

Could everyone please, I mean PLEASE, stop writing FED? It isn’t an acronym, for goodness sake–it doesn’t stand for Fiat Emitting Disaster or something like that. It’s just an abbreviation of Federal. Got that?

Thanks for your attention. And oh yes: nice article, Bob.

Gene Callahan August 17, 2010 at 3:05 pm

Good point, GEORGE!

(GEORGE *is* an acronym, btw, for General Entrepreneurial Ordinally Rational Generating Economist.)

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