Good new Boeckh Letter out on growing instability worldwide. After being rightly bullish on risk assets for the last year, the authors have become unnerved by growing signs that surplus countries (e.g., China, Germany, etc.) aren’t allowing deficit countries (e.g., U.S., U.K., etc.) to adjust, with dire implications for trade, sovereign debt, and the stability of the dollar.

Some choice quotes:

The most egregious offender is mercantilist China Inc., with its enormously undervalued exchange rate, loan subsidies to exporters and a variety of other import restricting / export subsidizing policies. Its dramatic foreign exchange reserve growth in recent years reflects these policies. The resulting addition to Chinese liquidity feeds real estate bubbles (but not yet the stock market in this cycle). China does try to sterilize the monetary effects of reserve accumulation but it is not easy to do on a sustainable basis.

Effectively, the surplus countries are stealing growth from the deficit countries and not allowing them to adjust to external and internal disequilibrium. In the U.S., this can be seen most clearly by the simultaneous rise in the savings rate, the trade deficit and the deterioration in labor market data. When the natural forces of the adjustment process to economic disequilibrium are blocked, political tension must necessarily increase. In an election year, you can expect vulnerable politicians to act.

Options, we have options, but mostly unpalatable:

The third option is for the U.S. to opt for non-market solutions—tit-for-tat mercantilism—to boost domestic demand and employment at the expense of foreigners. Trade protection can be employed via competitive devaluation, tariffs, non-tariff trade restrictions, etc. It was last tried in the 1930s when surplus countries didn’t allow deficit countries to adjust. It would be a far more dangerous option now because the U.S. is a large foreign debtor. The U.S. has net liabilities of over $3.5 trillion, most of which are held in short-term instruments by central banks who could try to dump them in retaliation. The international monetary system is seriously flawed as it was in the 1930s, although there is the important difference that domestic money supplies are not rigidly linked to central bank holdings of gold or foreign exchange assets. Nonetheless, great instability with the major reserve asset of the world—dollars—would be catastrophic.

[-]

View full post on Paul Kedrosky’s Infectious Greed

Related posts:

1. Measuring the Trilemma (with Special Reference to China)
2. China won’t Finance US Debt; We Hate You…you are devaluing your Dollar! Hyperinflation Collapse?
3. Should China Dump Dollars for Commodities? What about the “Nuclear Option” of Dumping Treasuries? Can Global Trade Collapse?
4. Conference: China in the Global Economy
5. Talk of Trade Wars with China, Tariffs, and Currency Manipulation Move to Forefront; US Trade Imbalance – Whose Fault is It?