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My new piece is up over at Mises.org that discusses Asian savings and its purported role in the housing bubble. Bob Murphy has also written a good piece about the topic.

I’ve received some interesting feedback regarding the role currency exchanges played in this. One long-time contributor to Mises.org wrote me (it’s 3 paragraphs for those using an RSS reader):

the argument that is being made by the mainstream comes from people who believe in the paradox of thrift or some variety of underconsumption theories and other such nonsense, and who do not adopt austrian capital theory

we know that any amount of savings can be used to expand the capital structure, and that there can never be any such thing as a savings glut. the asian individuals and business firms that saved may at worst have wasted a lot of their savings but cannot be blamed for the crisis

however, I think that, if within the category of “Asians”, you include government in Asia that adopted mercantilist policies of fixing their currencies at below market levels, this put them in the position of running a permanent capital account deficit, which they chose to “invest” in the debt instruments of the US govt. without the mercantilist program, the US government (by which I include the GSEs) would not have found a buyer for its paper at such low rates of interest, interest rates would have gone much higher, much sooner, and the artificial boom would have been over maybe before it even started.

A number of other people commented about this as well in the blog section (Terry, DS, and Houseward).

While I agree with the bulk of the content stated in the email, I will quibble over the role Asian currencies played in the most recent bubble.

Floating

Following the Asian financial crisis, Korea was forced to float the Won (it fluctuated between 900 and 1400 when I lived there). The Japanese Yen was officially floated after Bretton Woods was abandoned in 1971 and the BoJ has attempted to defend certain price points. While it was initially pegged to bullion, the New Taiwanese Dollar has floated for years (it hovered around 32 when I lived there last year).

Soft-pegs

The Hong Kong Dollar used to float but is now “allowed” to fluctuate between 7.75-7.85 to the USD. The Singapore dollar used to be pegged to both the pound and USD and currently fluctuates based upon an undisclosed basket set of currencies. The Chinese Renminbi (Yuan) has maintained various pegs to the USD. For nearly ten years it was pegged at around 8.27 and since the summer of 2005, has appreciated to roughly 6.85 today.

Government action

In a libertarian world, no government would intervene in currencies. Money would simply be another industry managed by market forces. And despite government monopolies on money creation, market forces still determine exchange rates. See Rothbard and Selgin for more.

True enough, as suggested by the above email, the PRC has practiced some form of partial mercantilism that many mainstream economists note leads to an “imbalance.” This includes Paulson, Setser, Pettis and now even The Economist (none of whom condemned the “imbalance” five years ago…).

To their credit, both Hank Paulson and Tim Geithner have tried to get countries like China to float their currencies. And ironically, if China ever did so, it would be the dollar that gets hammered. This is because China artificially props up the USD. In fact, any country that maintains a dollar peg is basically propping up the USD.

And true enough, over the years Korea and Japan have both artificially “manipulated” their currencies by buying or selling dollars on the open market. In fact, in the last quarter of 2008, Korean monetary authorities spent billions of USD to defend the Won — to prevent it from hitting 1500 (it has sat around 1350 this week).

Unexpected Forex changes

At the opposite side of the aisle, one of the reasons Japan has been getting creamed at the macro level in exports is because the Yen has strengthened quite a bit in the past year. Car firms such as Honda and Toyota built margins based upon exchange rates that were way too high and as a consequence, have had huge loses. Even Nintendo’s profits were hit big time during the holiday sales season because of a strong yen.

But this all ignores the role the Fed has played since 1944 (or really, since its creation). Any currency pegged to it has to essentially mimic the monetary policy of the Fed — and not vice-versa. The Yuan is pegged to the dollar and if the Fed inflates or lower rates, so too does the PBoC. And it would be one thing if the Fed maintained a steady rate over the past 20 years, but as shown by this table, the rates have been anywhere and everywhere.

Or in other words, the Fed is peerless as a “manipulator.”

So yes, some central bankers (not just in Asia) probably have tried to “manipulate” their currencies to gain temporary competitive advantages in the export market. Some of them then have invested the “gains” or “profits” to purchase US treasuries. And because of the relatively high demand for US treasuries, interest rates across the board stayed low for many years.

It’s not me, it’s you

Yet, policy makers in both the Clinton and Bush administrations are trying to shirk the blame entirely as if they acted as responsible custodians of the foreign funds. None of OPECs members (collectively the 5th largest holder of US treasuries) forced the GSEs to hand out houses or forced Bush to throw money at wars — the poitical class had access to some artificially cheap money and blew it on really dumb things. That is something the establishment has yet to accept. And again, instead of paying back the trillions in debt, the Treasury department instead issued even more debt.

This cycle was entirely unsustainable in part because nothing productive was being built with the cheap interest rates — government housing in the exurbs, Harrier Jumpjets, Ford Excursions and silicon DD breasts aren’t really good at manufacturing goods to repay the debt. And thus Chinese Premier Wen Jiabao is (partially) correct in blaming the quagmire back where the dollar is printed and to the people (Americans) who benefited from the cheap money and who did jack squat with it.

Seen and unseen

The last sentence in the email is partially true as well. The Fed induced bubble(s) probably wouldn’t have lasted long if central banks in general had kept a steady, higher rate. And if Chinese central bankers had floated its currency 20 years ago (or pegged it to a metal), the middle class in China would be much larger and wealthier, because their purchasing power would have allowed them to buy the goods they make — and allowed them to import products from the US.

However, as a consequence, Americans probably would not have been able to buy as many electronic gadgets from Korea or China because they would have cost more. Oh and perhaps Americans would be living in roach motels and driving crappy cars made in the Rust Belt…

Who knows what the unseen alternatives are. If foreigners didn’t buy Treasury securities, the Fed might have bought the mortgage paper and Treasury bonds to surpress interest rates — something it is doing right now. So again, it’s hard for me to see how foreigners are largely to blame when the Fed has created bubbles independent of the actions of foreign savers.

Thus in a nutshell, by participating in the pegging system, Asians transfered their own gains in standard of living (purchasing power) to the US. Yet again, instead of thanking Mr. Miyagi and the Wang family for working so hard, the Jones’s and Bush’s blew the loaned money on exuberance — and are now bitching at Miyagi for helping them party. It is the same exuberance which the Fed and Team Obama are more than happy to try to reflate. Bupkis.

QED?

I think the above shows that while “adverse” currency rates contributed to and perhaps helped extend one particular bubble, they were not the root cause or the creator of it.

Be sure to read Judy Shelton’s “Stable Money Is the Key to Recovery” for a solution.

Recommended reading:
- “Trillion-Dollar Spree is Road to Ruin, not Rally” by Kevin Hassett
- “Bernanke Paints Himself Into a Corner” by Bob Murphy
- “Did the Fed Cause the Housing Bubble?” by Bob Murphy
- “Evidence that that Fed Caused the Housing Bubble” by Bob Murphy