Posts Tagged ‘China. RMB’

An ultimatum game of ichi-go ichi-e

There was an opportunity, one meeting at Osaka for world leaders at the recent G20 summit. A valuable starting point for the policy-makers, faced with a menu of economic theories, is trust in each other and a new inter-disciplinary approach with an emphasis on ethics and economics. Climate change, migration and displacement, IoT and 5G, global income inequality, household mortgage debt, value of drinking water and food shortages present a grand ethical challenge. In 2015 we asked has economics become an illusion? An era of wistful economics:

Taylor Principle

This time, however, global economic policy should be less about money supply and demand, less about central banks modelling and the private sector and more about the strategic interaction between these ethical challenges.  There is an urgent need for coordinated action to stimulate the global economy with fiscal and monetary measures. The EU is fragmenting. Whither the Euro? Today, Federal debt is projected to jump to a record 144% of US GDP by 2049. There is a debt mountain in China reported at 250% debt-to-GDP. As the Scylla of the Taylor principle (of high interest rates when there is high inflation and low interest rates when unemployment is high) causes a modelling whirlpool with the Charybdis of the Ramsey approach to optimal monetary taxation, the appropriateness of an ethical fiscal policy as a stabilisation tool may calm the waters. So, more fiscal stimulus is required.


On a macro level, world politics is more about China’s transition to greater exchange rate flexibility and the internationalisation of the Chinese RMB. We had presented on this point in Shanghai in 2012. It’s a long game. In other words, RMB v US$ is an infinite game of playing the game not a finite game of first mover advantage. . A weaker RMB would probably mean a stronger US dollar and vice versa. We are reminded of Japan’s exit from its dollar peg in 1971 as today the game is one of reserve currency competition, whether or not the US dollar is destined to lose its standing as the preeminent international currency to Sterling, the Euro or the RMB. Trade wars, competitive devaluations, Brexit, military conflict create sudden disruptions to growth at a moment in time.

Productivity Bonus

As a countermove we become risk-averse on currency fluctuations. But there is a curved ball from the EU and the US regulators as their antitrust focus on big tech. Based on the presumption of a negative effect on competition it relies wholly on an attack on monopoly rents as a reward to innovators. Nonetheless, shareholders and investors and pension funds gain too. However, if the model builders could adapt the McKenzie model of classical general equilibrium theory so that technology is available to any company who can supply the resources required, ultimately, by happenstance, competition and innovation will coalesce into a productivity bonus. Big tech and technology could then be viewed as a way to escape classical monopoly by innovating to compete. To do so would require the equivalent of the 1919 Colgate doctrine for big tech, facilitating the introduction of new technology by allowing each of the big tech companies to decide, on its own, with whom to do business. They exercise discretion on innovation and technology; we, as onsumers,  decide. Our behaviour, after all, is less measured by prices, supply and demand but more influenced by small changes in innovation and technology over shorter time periods.

Onsumers & Complexity

Albeit, our policy advisers and central bankers are less likely to ever move away from the standard Ricardian DGSE models of economic analysis. There is a sunk cost to the modelling.  A key assumption in this model is that households like you and I are a homogeneous family of infinitely lived individuals. Really? This is 2019 and a more realistic and heuristic approach would address the fact that individual’s behaviour changes over shorter time periods with innovation and technology. Our well-ordered lives bring the occasional disturbance that can be characterized by an unmanageable degree of complexity. In our real world, we as onsumers, for example, shopping online, continue to bid against ourselves in the search for the best algorithmic deal.  In practical terms we do not behave as hyper-rational beings. At every G20 there is a risk-bucket and world leaders may get a chance to try again at another meeting; at this G20 there was one chance to try: ichi-go ichi-e. The ethical challenges of climate change, mortgage debt, migration and displacement, IoT and 5G, global income inequality, value of drinking water and food shortages all collapse into a generalized ultimatum game in which we as players must agree or we all get nothing.

Drifting into a debt-recession trap

The despondency that has attached itself to the financial crisis is ‘taking shadows from the reality of things’. Dante would not approve. Europe is drifting into a prolonged recession as policy-makers worry about inflationary expectations and competitive devaluations. Households hope to be delivered from this agonizing crisis.  Are there solutions? The following is a grand narrative of policy options, contingent on a managed exchange rate regime, an idea first aired in the Letters to Editor page of the Financial Times in 2009. G20 has not acted. They meet in Mexico – maybe recent Yen, RMB, Euro, Sterling, Swiss Franc and US Dollar movements may persuade them to look at the role of exchange rate fluctuations ‘midst this financial crisis as Europe drifts into a debt-recession trap.

Drifting into a recession

There is a palpable sense of despair and hopelessness, a lack of demand yet inflationary expectations have become embedded in the policy-maker’s crystal ball. The real economy of households and companies is shrinking in a vacuous cycle of intermittent growth as rising bond prices and lower yields improve the real economy of the investor. Banks, the exogenous factor in the policy-makers’ macro-economic models, still fail to understand that job creation, time-to-build technologies and innovations require a flow of credit. Personal balance sheets are moving into safe harbours, given the wealth destruction that has occurred in the property and equity markets and will continue for the foreseeable future. Anybody who can is saving, more are spending less. Welcome to the debt-recession trap.

Household balance sheets

Recovery must be centred on the household balance sheet; however, household budget patterns are unpredictable. Current decisions depend on expectations of what future policies will be. This is a conditioned response for households in a debt-recession trap. The mismatch between policy-maker and reality creates a short period – a phenomenon that households imagine if they change demand and spend more the other households will neither keep demand unchanged (so all increase demand and prices go up) nor continue to keep their behaviour unchanged (so bargains become available to the first mover) if they alter their behaviour. How each household responds depends on how each believes the other will respond. The result is demand is less, output is less and the recession is prolonged.

In the interim, households have adjustment costs – no interest income from government bonds, no dividend income from company-issued equities and minimal after-tax spend so unlike in the macro-economic models of our Central Banks, households are not seeking to maximise the concave single-period utility function subject to a budget constraint wherein the present value of consumption equals the present value of disposable income. Savings, for example, in a debt-recession trap signal to policy-makers that rational householders are experiencing low levels of expenditure in the present period due to the short-period phenomenon thus reducing the marginal utility of expenditure in future periods. So there should be a greater willingness to spend when the personal balance sheet are restructured.

Policy prescription: reduce income taxation to increase after-tax spend

QE and the US Dollar

During the Great Depression banks restructured their balance sheets; reduced loans in absolute and relative terms and invested (mainly) in government bonds. Isn’t this happening today? The ECB/Bundesbank believes that purchasing government bonds is tantamount to monetising government debt, thus leading to high inflation or a loss to the ECB on a government default. Paradoxically pre-crisis banks were turning government bonds from across the Euro zone into cash at the ECB, as governments borrowed and the banks relied on short-term funding. So really, all Central Banks – the Fed, BoE, BoJ and even ‘the outright monetary transactions’ policy at the ECB/Bundesbank facilitate the buying of government bonds – so why the mystery?

The Fed signals less worry about inflation through QE and the printing of money. Lowering interest rates may be devaluing the dollar but it is facilitating increased US export competitiveness. Central Banks that want to support their currencies are willing to increase interest rates. The Fed does not. The US dollar has been captured by Fed announcements. It is widely accepted that QE has contributed to a weak US dollar.

Exchange rates

When Timothy Geithner described China as ‘a currency manipulator’ in 2009 the exchange rate became politicised. More recently, Jens Weidmann, President of the Bundesbank, expressed concern about Central Banks’ efforts to revive exports by facilitating competitive devaluations. Did he have the Fed in mind?  Music to the ears of Brazilian Finance Minister Guido Mantega, who first signalled the ‘currency wars’ in 2010 as Brazil worried about an overvalued real. Its current account deficit is now contributing to a reduction in its economic growth. And the new PM of Japan, Mr Abe has had an impact on the Yen’s exchange rate pushing it from 78 per US dollar to 89 as he asked the Bank of Japan to double its inflation target to 2% – and to buy government bonds until that target is met.

Policy prescription: looser monetary policy and higher inflation targets

China and the Yuan/RMB

Elsewhere we had argued that Yuan appreciation will not and cannot solve the Sino-US trade imbalance. China in time, will, we had argued then, move to a more flexible exchange rate regime but at its own pace. It could occur during the 12th Five-Year-Plan 2011-2015 as economic growth in China becomes less reliant on export-led growth. By 2015 China trade and FDI flows will have moved away from US and Europe and more towards what we had described as the ASLEEP economies We agree with Professor Subramanian at the Peterson Institute for International Economics that the RMB could displace the US dollar as the leading reserve currency in the next decade. Trading nations and TNCs are already diversifying into RMB – being able to trade in RMB reduces transaction costs and mitigates currency risks for exporters. Liquidity from China could relieve any inflationary pressures in trading economies.

Solution Template

Many trading nations are considering a looser monetary policy combined with a higher inflation target – it presents an optimal policy and an escape hatch in a debt-recession trap. An inflationary bias in the conduct of monetary policy might be optimal if inflation shocks can lead to (welfare enhancing) increases in output. Albeit, any comparative statics exercise emanating from policy-makers’ models should be interpreted with great caution. A looser monetary policy could drive their respective currencies lower but any hope of sustained growth will be frustrated by a beggar-my-neighbour policy of competitive devaluations in the race to win the greater share of increased exports.

As previously outlined, a period of managed exchange rates may be required under the auspices of G7, and ultimately G20. Europe, specifically, and the G20 trading nations more generally, need to manage their monetary and fiscal policies within a managed exchange rate regime in order to escape the debt-recession trap.

Policy prescription: managed exchange rate regime to align world currency fluctuations.

Rational households and companies may have ‘parked’ demand and production, delayed in the anticipation of an inflationary period with looser monetary policy and competitive devaluations. If their expectations were managed within a managed exchange rate regime then there could be some hope that the real economy may improve as the worlds’ trading nations together plan an exit from the financial crisis. ENDS/PatrickMcNutt

EU as ‘off-shore’ hub for RMB

The search for a financial engineering solution in the EU is taking its toll on the European economy, creating a debt-deflation cycle that will suppress EU demand into the future and relegate the relative importance of the Euro as a credible currency in the global markets. EU policy makers should play the game not to lose – that is they should champion a resolution of the EU crisis linked with the internalization of RMB and currency misalignments into a managed exchange rate regime – in order to bring greater stability to world financial markets.

One likely scenario is the internationalization of the RMB by providing an off-shore hub for RMB in Frankfurt; such a solution must include fiscal union and the political will to march forward as a United States of Europe. It will be a long term objective. It could provide part of a solution to the EU debt crisis. Such a strategy would warrant the creation of an EU-China bond reversed engineered by China and thus outside the domain of the EU political hegemony.

It is the only rational institutional response within the democratic deficit of the European treaties is a response that provides for the EFSF ‘walking forward’ as a conduit bank for the ECB providing a package of catastrophic bonds to refinance defaulting sovereign states. Some of the arguments in ‘dark strategy’ – vide Chapter 7 of my book Game Embedded Strategy – wherein one player in a game influences the belief system of another player, EU policy-makers need to visualize today the outcome of their action tomorrow. To adapt Bob Dylan – so much older then (we should be) younger than that now’. This ‘thief of Nature’ strategy, providing an ‘off-shore’ hub for the RMB, should prevail because the time is now or never for EU as an economy, for Europeans and for the Euro as an international reserve currency in a global economy.