Left Flank

On the heels of reading about how it's rough out there, and feeling fairly optimistic...

None of this is exactly cheerful, but it is not disastrous, either. Particular problems, like the monoline insurers, should be dealt with by particular remedies, not the warm bath of monetary policy. It is early days, but one choice for Mr Dinallo would be to corral their worst risks in a «bad bank», leaving the rest intact—and more tightly regulated.

As to decoupling, although the rest of the world remains somewhat vulnerable to America's troubles, most rich economies are in a slightly better shape than the United States, and most emerging ones are better able to withstand an American downturn than they were (see article). Many have plenty of reserves and flexible exchange rates, making a rerun of the 1997-98 crises unlikely. Many are growing nicely on the back of rising domestic demand and regional trade links. And many have strong budget positions, leaving room for fiscal loosening to offset weakening exports.

American policymakers also have tools to cushion—if not forestall—the downturn. Lower interest rates may not stop house prices falling, nor will they prevent banks from tightening their lending standards. But monetary policy can still stimulate the economy, as lower rates boost banks' profitability, bring down firms' borrowing costs and improve indebted consumers' cash flow (see article). Equally, fiscal policy will be a prop. Of course, President Bush promised too much when he suggested that a stimulus package would keep the economy «healthy». But Congress is rushing the $150 billion package through, and, even if it takes a while to reach firms and consumers, it will give the economy a boost.

Taken together, the signs from the world economy are troubling. The credit binge will not unwind quickly or gently. Asset prices will fall. But central bankers and regulators have the tools to stop a downturn from becoming a slump, so long as they use them sensibly. Reacting to market panic with panicky rate cuts is likely to make things worse rather than better. The Fed should always be the calm centre of a financial storm.

...I had to read James Fallows' answering the $1.4 Trillion Question (an informative essay worth reading):

What might poke a giant hole in that logic? Not necessarily a titanic struggle over the future of Taiwan. A simple mistake, for one thing. Another speech by Cheng Siwei—perhaps in response to a provocation by Lou Dobbs. A rumor that the oil economies are moving out of dollars for good, setting their prices in euros. Leaked suggestions that the Chinese government is hoping to buy Intel, leading to angry denunciations on the Capitol floor, leading to news that the Chinese will sit out the next Treasury auction. As many world tragedies have been caused by miscalculation as by malice.

Or pent-up political tensions, on all sides. China's lopsided growth—ahead in exports, behind in schooling, the environment, and everything else—makes the country socially less stable as it grows richer. Meanwhile, its expansion disrupts industries and provokes tensions in the rest of the world. The billions of dollars China pumps into the United States each week strangely seem to make it harder rather than easier for Americans to face their own structural problems. One day, something snaps. Suppose the CIC makes another bad bet—not another Blackstone but another WorldCom, with billions of dollars of Chinese people's assets irretrievably wiped out. They will need someone to blame, and Americans, for their part, are already primed to blame China back.

So, the shock comes. Does it inevitably cause a cataclysm? No one can know until it's too late. The important question to ask about the U.S.–China relationship, the economist Eswar Prasad, of Cornell, recently wrote in a paper about financial imbalances, is whether it has «enough flexibility to withstand and recover from large shocks, either internal or external.» He suggested that the contained tensions were so great that the answer could be no.

Today's American system values upheaval; it's been a while since we've seen too much of it. But Americans who lived through the Depression knew the pain real disruption can bring. Today's Chinese, looking back on their country's last century, know, too. With a lack of tragic imagination, Americans have drifted into an arrangement that is comfortable while it lasts, and could last for a while more. But not much longer.

Years ago, the Chinese might have averted today's pressures by choosing a slower and more balanced approach to growth. If they had it to do over again, I suspect they would in fact choose just the same path—they have gained so much, including the assets they can use to do what they have left undone, whenever the government chooses to spend them. The same is not true, I suspect, for the United States, which might have chosen a very different path: less reliance on China's subsidies, more reliance on paying as we go. But it's a little late for those thoughts now. What's left is to prepare for what we find at the end of the path we have taken.

I've spent so many years as a deficit hawk, I'm actually quite brain-tied right now. Fallows compares the current PRC-US financial relationship to the nuclear stalemate between the Soviet Union and the US during the Cold War. Well, there are still nukes around the world, and proliferation seems a certain probability. There's little hope that the US budget deficit, given Fallows' analogy, will disappear either. 50 years of this financial terror, it seems!

Nothing follows right now...