Steve Blitz's  Instablog

Fed Chairman Ben Bernanke spoke today on "Asia and the Global Financial Crisis" at the Federal Reserve Bank of San Francisco’s Conference on Asia and the Global Financial Crisis, Santa Barbara, California. This call for balanced growth policies in Asia has been made before by Bernanke, Geithner, Summers and others. The call appears to be falling on deaf ears as far as Asian exporters are concerned. Here are some excerpts from today's Bloomberg News article "Won Crushes Yen as Dollar Substitute in Asian Rally" --

Asian central banks are running out of ammunition to fight their currencies’ biggest rally since 1998, paving the way for South Korea, Taiwan, Indonesia, Thailand and India to help lead foreign-exchange performance next year. . . . . . . . The currencies are rising even as policy makers sell them, amassing record reserves on concern that too much appreciation will slow export-driven recoveries. . . . . . . . . . he central banks now find themselves in a conundrum. They can let inflation accelerate as they flood their economies with local currencies sold for foreign cash. Or they can raise interest rates to keep prices in check and become even more attractive as carry-trade investors use money from countries with lower borrowing costs to buy Asian financial assets. Taking funds from the U.S. and Japan, with benchmark rates of 0.25 percent or less, to buy won, rupees and rupiah, with rates between 2 percent and 6.5 percent, has produced an annualized carry trade return of 36 percent since Feb. 20 -- the most ever for that length of time, Bloomberg data show. Some governments are trying to soak up the local cash they’re printing by selling short-term local-currency debt, a process known as sterilization, but there aren’t enough buyers for the bills to finish the job.

. . . “Korea is paying the most” for its currency’s strength, said Mirza Baig, a Singapore-based foreign-exchange analyst at Deutsche Bank. “The pace of intervention, based on reserves accumulation, is very high, so that shows the currency is massively undervalued. Inflation is creeping up while money supply also looks high, and this leads to concerns about asset price bubbles.”. . . China, which amassed a record $178 billion in new reserves in the second quarter, has effectively pegged the yuan to the dollar since July 2008 and probably will keep it there until mid-2010, according to the median of 26 forecasts in a Bloomberg survey. The currency is seen strengthening 2.5 percent to 6.66 per dollar in 2010 and 6.20 in 2011, from 6.83 as of Oct. 16. . . . . . . After letting the yuan appreciate almost 18 percent in the three years to July 2008, China has kept it in check to help exporters weather the global recession. Shipments abroad fell a less-than-forecast 15 percent in September. . . .

With this in mind, here is what the Fed Chairman said --

. . . . . In Asia, as in the rest of the world, the provision of adequate short-term stimulus must not be allowed to detract from longer-term goals, such as the amelioration of excessive global imbalances or ongoing structural reforms to increase productivity and support balanced and sustainable growth. . . . . . . . In particular, trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distort the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term.To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows .  . . .  . . . . As the global economy recovers and trade volumes rebound, however, global imbalances may reassert themselves.  As national leaders have emphasized in recent meetings of the G-20, policymakers around the world must guard against such an outcome. . . . .

To help these nations understand that their unilateral policies have adverse global implications of which they can also be victims, Bernanke noted several times how the collapse in U.S. demand severly hurt Asia's economies. He ended his talk by saying --

Indeed, the financial crisis has starkly demonstrated the extent to which the fortunes of the United States, Asia, and the rest of the global economy are intertwined.  These powerful economic linkages, as well as the importance of both the United States and Asia in the global economy, underscore the need for consultation and cooperation in addressing common issues and concerns. Our shared stakes in the prospects of the global economy bring with them a heightened responsibility to work together to maintain those prospects. I am optimistic that the United States and Asia will rise to the challenge and address in a mutually beneficial fashion the range of issues confronting the global economy.

Looking at the article and the speech it is hard to see how the Fed Chairman's optimism is resting on anything more than a wing and a prayer. In my article last Friday, "Capacity Utilization, Fed Policy, Oil and China -- One Big Gordian Knot", I noted that policy is in a legitimately tough spot as it balances a still problematic banking system and huge excess capacity with the possibility of inflation imported through rising oil and commodity prices.

The possibility of higher commodity prices is more probability as Asian nations sustain overly expansionary policies by keeping their currencies cheap to the dollar in the face of large and growing trade surpluses. Of course most of these Asian countries act as they do because of fear of a repeat of the 1990s when strong global demand for their currencies recklessly swamped their capital markets and distorted prices. As demand waned, we got the Asia currency crisis of 1997.

As for importing inflation, worrying about inflation today is like sitting in a freezing cold apartment in the dead of winter wearing several coats and sweaters and only worrying about the bathing suit you need to buy if you can afford to take a summer beach vacation.

Commodities are still cheap and U.S. interest rates will stay lower longer than the market expects.

The production and capacity numbers released this morning indicate that the recession likely ended in June. But it is just as important, if not more so, is to recognize that the reported 70.45% capacity utilization rate only just reaches the 70.93% low of the 1981-82 recession (the previous worst economic crisis since the Depression). The importance of this indicator owes to the Fed’s historic consideration of capacity utilization as the best real time indicator of economic activity (see the working paper “Improving Real-Time Estimates of the Output Gap” by Thomas Trimbur). From the official end of the past two recessions it took the Fed 38 and 32 months respectively before the first increase in the funds rate (see chart). The timing, of course, depends on how fast spare capacity is taken up. After the 2001 recession it took 32 months for capacity utilization to go from 73.53% to only 77.74%.

The "cash-for-clunkers" program has been the subject of more negative comments and bad puns than anything an administration has put out for a long long time. Most of the comments have focused on the program's inevitable failure to permanently raise the level of spending for autos and/or anything else. By extension, the reaction is that Obamanomics is a complete bust. Political rage absent of thought to other possibilities is not the best way to go through life, unless your goal is to get crankier as you get older. The chart below plots out auto industry inventories, sales, and the inventory/sales ratio.The cash for clunkers program moved the auto industry out of depression and into recession at an extraordinarily rapid pace. This saved a lot of investors, public and private, a lot of money,

We can see now that the program was never really intended to be a permanent boost to sales, I think even Larry Summers and Ben Bernanke knew that. The cash for clunkers trade was meant to alleviate an extraordinary overhang of unsold cars under which an entire industry was about to collapse. Normal recession metrics for sales, inventories, and production are now in play and they will be for some time but the government accomplished what it set out to do -- saving an industry and giving it the time to do what's necessary to save itself short-term and for the long haul. It will be a while before we know whether the auto industry finally gets it right, but at least they now have the time to figure it out.