Wednesday, December 03, 2008

Global Rebalancing-wont exchange rate achieve it?

Yves Smith has another excellent post on problems with Keynesian response to the crisis. She quotes Tom Ferguson on how Keynes would have chose global rebalancing as a key solution. There is merit in old Keynesian approach when there is increase debt repayment capability in the future. Currently, US needs jobs and work, but thanks to weird gloabal policies it has neither. So it is dependant on "investor-like" income generation - i.e. through capital appreciation and investment. This, to me, is pushing the ignorant risk-averse citizens along a high-risk cutting edge finance path. This is unfair to US citizens who are not aware how long it will take to repay the stimulus. And dont even think you can print your way out of it! Thus the global rebalancing solution seems only way out. But, as Yves Smith points out, there are hurdles.

I dont see any reason why exchange rate realignment + concerted international financial regulation cannot solve this problem.

Global banking regulation needs reform and Shiller has also highlighted this his new book (I just saw the interview - waiting for the book). There is something fundamentally wrong with accounting policies that let banks lower capital requirements based on "perceived" asset price increases. The same regulation also creates holes in balance sheets as asset prices falls. This regulation needs to be suspended for sometime - (upside suspension), banks be forced to take all the write-downs marking the assets to agreed upon prices (lets call them steady state prices) - and then made to raise capital enough to sustain them.

Secondly exchange rate realignment is absolutely must. I have been harping about this on this blog comments for long now. US must become producer and China and surplus countries must become consumers. Without this there is no resolution of this crisis.

Finally, there is likely to be a diplomatic war to protect and isolate the consumers an keep the consumer to itself. Such a trading barrier game will be detrimental to global prospects and will decrease the total pie. If a big ship(US and EU) is sinking - one way is to protect your resuce boat - or save the ship. Former saves you comfortably but leaves the world with just a boat! and latter is difficult but the Ship stays so we are better off.