Adam brings up some Tyler Cowen predictions from 2005. Of particular importance, I think, is this one:

2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.

Adam doesn’t list them but the prediction above goes hand-in-golve with these two

1. I would think that Asian central banks, by buying U.S. dollars, have been driving a massive distortion of real exchange and interest rates

5. I would think that the U.S. economy is due for a dollar plunge, and a massive sectoral shift toward exports.  Furthermore I would think it will not handle such an unexpected shock very well

One of the key facts about the last crisis is that manufacturing and construction employment moved in opposite directions.

FRED Graph

That’s quite distinct from their normal pattern of moving in the same direction. Indeed, it’s a big part of why the mid-2000s boom was so odd and so weak employment wise.

This is important because it means it doesn’t quite make sense that what happened here was action by the Fed. If the Fed were printing too many dollars it would drive down both interest rates and the value of the dollar. This would increase construction and manufacturing.

However, what’s happened is that interest rates were low while the dollar was high. That means that someone must be buying lots of US bonds with some other currency they are printing. The obvious culprit is the Bank of China.

However, if this thing is going to come to an end because of the unsustainability of this relationship then we should expect a rapid unwinding of the BOC’s position. This would mean a collapsing dollar and rising US interest rates.

But, that’s not exactly how the burst happened.

FRED Graph

The dollar soared and US bond yields collapsed.

This is why I think neither the Fed nor the Bank of China can claim this crisis. It was creature of Wall Street and of financial innovation that didn’t go as planned.

Advertisements