From the March 27, 2009 San Francisco Examiner
March 27, 2009
by Irwin Stelzer
Barack Obama heads into the G-20 meeting in London next week having been told by his top advisers that the US economy is showing signs of recovery.
New home sales rose by 4.7 percent last month, applications for mortgages are soaring in response to low mortgage rates, and durable goods sales increased last month. A few brave souls think the real economy might lead the financial sector out of recession, rather than the other way around.
The President also travels to London confident that his decision to push for a budget that splatters trillions in red ink across the government's ledgers won't depreciate the dollar or trigger inflation.
He is sticking with his plan to borrow trillions to fund both his stimulus package and his wish list -- extending health care coverage to 50 million more Americans, constructing a "smart" grid powered by renewable energy, and improving access to superior education from kindergarten through college.
The Chinese, whom Treasury Secretary Timothy Geithner is counting on to buy all of the IOUs he will be peddling, are not so sure that all that borrowing won't drive down the dollar.
After Chinese Premier Wen Jiabao announced that he is "a little bit worried" that U.S. deficits as far ahead as the eye can see means he will be paid back in depreciated dollars, Zhou Xiaochuan, Governor of the People's Bank of China, went further.
He put forward a plan that would replace the dollar as the world's main reserve currency with a quasi-currency managed by the International Monetary Fund.
Obama was quick to turn thumbs down on any such move, and sources in foreign embassies tell me that the Chinese were merely flexing their muscles.
They feel under-represented in international economic forums and institutions such as the International Monetary Fund, and know that the G-20 will be asking them to make a major contribution to the IMF to increase its ability to cope with the current recession and future financial crises. So Wen is hinting that China will pay the piper only if it is allowed to call the policy tune.
The President also heads for London confident that the plan announced by Geithner to set up public-private partnerships to take "toxic assets" -- renamed "legacy assets" -- off the books of the banks will further ease the credit markets. But the investors I talk to are frightened by the populist backlash against the bonuses paid to some A.I.G. executives.
So, after originally fanning populist flames, Obama decided to tone down his rhetoric. He now is urging Congress not to make policy in anger, and to support programs to get the banks functioning again.
Geithner says his plan will protect investors against ex-post attacks on their profits. But the private-sector players still worry that they might end up under the klieg lights in a congressional hearing room, or with busloads of protestors on their doorsteps. How many will be scared off won't be known until the plan swings into action in about a month.
The Geithner plan is running into another potential problem: "I don't see how they are going to get the banks to sell," an executive at a large bank told the press.
Banks value these assets on their books at something like 90 cents on the dollar -- and are likely to be offered perhaps half that for some, and as little as 30 cents on the dollar for others.
If they sell, the banks would have to record the resulting losses on their books, reducing their ability to pass the "stress tests" now being run by the Treasury to determine whether they can withstand a worsening of the recession. Any bank that fails the stress test might be subject to a government takeover.
As would any financial institution if the President is given the authority he is seeking to have the Treasury, in consultation with the Federal Reserve Board, take over any troubled institution that poses systemic risk to the entire financial system -- think Lehman Brothers.
Meanwhile, a new thought has dawned on the policy makers who will assemble in London on Thursday. Only America and China, dubbed in private a G-2, can create a sensible new world economic order, one in which China relies less on exports, and we rely less on borrowing to pay for those goods.
Optimists are convinced a deal to rebalance world trade can and will be done between the existing and the emerging super-powers. Let's hope so.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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