|
Economic Armageddon
One seldom sees such a sober US bashing in economic circles: Andy Xie – Asia Should Sell Treasuries Now
The US has been binging beyond its means since 1999. In 1999 and 2000, the new economy hype sucked the rest of the world into buying US tech assets. Asian portfolio investors now hold worthless NASDAQ stocks and European MNCs own many US tech companies that have heavy debts but weakening revenues.
After the tech burst, Mr. Greenspan cut interest rates aggressively, causing US treasury yields to fall to around 4% from 6%. The bond market rally sucked in foreign buyers, who supported US consumption and the dollar.
As treasury yields have bottomed out, the US now wants to devalue the dollar (which would be to the cost of foreigners who hold trillions of dollars of US financial assets) to create jobs to sustain its consumption. I see the weak dollar policy as simply another way to get foreigners to subsidize US spending.
Xie goes on asking Asia’s central banks to sell their treasuries and keep the Dollars in cash. US yields would rally, the Fed would have to raise rates, inflation would raise and the over consumption via borrowing would stop. He continues:
The US should have seen a recession following the tech burst. However, it shied from this, and has since been juggling to sustain demand growth. When this juggling act falters, a recession will occur anyway.
Andy Xie’s boss, Stephen Roach, also thinks this is inevitable: Economic `Armageddon’ predicted
Press were not allowed into the meetings. But the Herald has obtained a copy of Roach’s presentation. A stunned source who was at one meeting said, “it struck me how extreme he was – much more, it seemed to me, than in public.”
Roach sees a 30 percent chance of a slump soon and a 60 percent chance that “we’ll muddle through for a while and delay the eventual armageddon.”
The chance we’ll get through OK: one in 10. Maybe.
Consuming on borrowed Dollars and than to devalue the Dollar to have to pay back less is not a friendly behaviour. Asia should recognize this and follow Xie’s advice.
On the hopeful side an economic Armageddon may keep some radical Christian nuts away from causing a physical one in the Middle East. At least they should have trouble to finance it. Now that would be a real positve result.
Originally appearing in the FT:
The Dollar Is In Trouble
By Peter Bernstein
The dollar is in trouble, but it has been in trouble before. Perhaps the past holds the solution everyone seeks.
On September 22 1985, the ministers of finance and governors of the central banks of France, Germany, Japan, the UK and the US signed an accord at the Plaza Hotel in New York City. It stated that signatories “were of the view that recent shifts in fundamental economic conditions among their countries, together with policy commitments for the future, have not been reflected fully in exchange markets…In view of the present and prospective changes in the fundamentals, some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to co-operate more closely to encourage this when to do so would be helpful.”
Over the next two years, the dollar dropped by 30 per cent and America’s deficit on current account began shrinking. By 1991, the current account was just about in balance. A neat job, elegantly executed.
Could we replay the Plaza Accord today? The case would be difficult to make. Aside from enormous differences in the magnitude of the economic problem, the political setting bears no resemblance to 1985. At that time, the ministers and governors who gathered at the Plaza were old pals, used to finding solutions to common problems. The western powers and Japan dominated the world, and everybody else genuflected before them. Today, the picture is far more complex.
On the economic side, the scale of the problem is daunting. The rapidly expanding US current account deficit is now more than 5 per cent of gross domestic product, as against only 2 per cent in 1985. Furthermore, the small surplus of 1991 was also the consequence of a recession in the US that curtailed the flow of imports even as exports kept rising – but the US slipped right back into the red as soon as recovery got under way. Helped by a 25 per cent appreciation in the dollar between 1991 and 2001, the current account deficit has been climbing ever since. In 1985, foreign official assets in the US were a fraction of what they are today; since the end of 2002, growth in official holdings has amounted to more than $450bn. In 1986, the price of oil dropped by 50 per cent; today, the concerns are just the opposite.
In many parts of the world, economic growth is excessively dependent on exports, which depend on a strong dollar. On the US side, the authorities welcome the willingness of exporting nations to finance America’s appetite for imports, as it helps finance the federal government’s bulging deficit.
But, as Herb Stein, the late economist, put it: “If something can’t go on forever, it won’t.” Private capital inflows into the US are already shrinking. There is a point at which one or central bank or other will cry “Enough already!” and the house of cards will fall in. Indeed, China has already begun diversifying its foreign exchange reserves into other currencies and investments. Protectionist pressures are developing within the US, which – to borrow the Plaza Accord’s words – “if not resisted, could lead to mutually destructive retaliation with serious damage to the world economy”. At the same time, Americans are creating a setup for foreign nations to blackmail them over unpopular US policies by threatening to cease accumulating dollars, thus prompting the dreaded crisis.
There is, however, a vested interest around the world that firmly opposes “some further orderly appreciation of the main non-dollar currencies against the dollar”. Many countries are hooked on exports rather than domestic demand as the engine of growth. Accumulating US government securities in such copious amounts is not exactly comfortable, but appreciation of their currencies against the dollar would be even more uncomfortable, as it would deprive them of their main economic stimulant. The important exception is China, which appears to be laying the groundwork for an eventual appreciation of the renminbi against the dollar.
Nevertheless, as Stein reminds us, the current situation cannot go on forever. The worst solution would be to yield to protectionist pressures in the US, which would immediately invite retaliation abroad. The optimal solution is a replay of the Plaza Accord – an orderly appreciation of the main non-dollar currencies against the dollar, which is a more generalised method of curtailing America’s appetite for imports while spurring the development of domestic sources of growth in the rest of the world. Without such an accord, the outlook for an orderly dollar devaluation is dim.
Posted by: Pat | Nov 23 2004 19:18 utc | 3
From John Mauldin’s Investor’s Insight:
The Chinese Currency Conundrum
There is a growing international call for China to revalue their currency. Much of the speculation about the Chinese revaluing the Renminbi focuses on the large trade deficit they have with the United States. If they buy all the dollars from the various Chinese companies who sell to the US, giving them Chinese currency, it is inflationary and can spark a bubble, which would result in a crash, much like the Asian crisis of 1997-98.
But that’s not really the case anymore. China is running a deficit with many of its other trading partners. In fact, it is now running a small negative trading balance as a nation. They are simply recycling our dollars to other countries. Further, they have been using some of their past surplus at least in part to buy euros, as their central bank’s holdings of non-US assets has risen by $100 billion in the last four years. This has probably been one of the hidden factors in the euro’s rise. (BCA Research)
Given that the Chinese will only act in a manner which will benefit them and at a time which they will determine, what can we guess about the timing of when they will allow their currency to float?
First, they have to allow their currency to float by 2007, assuming they will live up to the document they signed when they entered the World Trade Organization, and I assume they will. But waiting until the last minute does not make sense. They, like all other central banks, like slow and steady.
If the Japanese are truly signaling that they are willing to let the yen rise, which will mean the rest of Asia is likely to follow, I would speculate (and that is all this is) from all the sources I have read, that the Chinese will allow their currency to float in a measured way. They will initially allow the currency to float within a certain range and gradually broaden that range.
They are taking the steps they need to be taking to start such a process. We are beginning to see some verbal movement from their financial leaders as well as practical steps. Take note that this has been done after the election so as to not be seen as meddling in US politics, or worse, to seem like they were bowing to US pressure.
Who Really Controls the Dollar?
Roach is right. The dollar is going to be devalued. Whether it is in a crash or a controlled downward glide path is not in the hands of the US or the Fed. So, let the games begin. We will see if there is a coordinated movement to allow the dollar to drift down, especially in Asia. Such an effort would be a major policy shift for Asian central banks.
The irony is that it is foreign central banks that have far more interest in the value of the dollar, and far more control over it. Secretary Snow can talk all he wants about a strong dollar (and he once again did yesterday). The Fed and the Bush Administration will do nothing. They clearly want and need a lower dollar.
The Things That Go Bump in My Worry Closet
OK, the dollar is going to go lower. As I pointed out a few weeks ago, that is not the end of the world, unless you want to vacation in France. The dollar dropped over 30% and then rose in the 80’s and 90’s without great upheaval. So far, other than our European trips and products costing more, there has been little adjustment on the part of America. In a growing economy, rising interest rates and a falling dollar is something we can deal with.
Remember the old western movies, where the trusted scout leans over to the captain and says, “It’s quiet. It’s TOO quiet.” This is usually just before a 1,000 Apaches come screaming over the hill. I get this eerie sense that it is too quiet.
I worry about what happens as the dollar drops and we do not have a growing economy. The Index of Leading Economic Indicators has now fallen for five straight months. Usually, but not always, that means a recession. The index fell for five months in 1995, but the conditions then and now were different. Our debt levels were nowhere near as high, interest rates and inflation were still on the demise and budget deficits were shrinking.
Oil, while likely to retreat somewhat in price, is likely to stay uncomfortably high, at least until a world recession reduces demand. It is a drag on the economy. The fact that long term interest rates have not risen much seems to suggest to me that the bond market is telling us things are weaker than we think.
As I noted last week, I do not think earnings will be anywhere close to the forecasts currently made by analysts. In fact, they have not been as good across the board as the numbers might indicate. Bill King writes:
“…the energy sector is contributing much of the increase in S&P 500 earnings y/y and the sector has a much lower PE (~13) than the S&P 500. Ergo, investors are placing a higher multiple on the index due to the energy earnings for which they have little enthusiasm.
“As usual, an examination of the details shows the situation is even more dramatic. The energy production sector and the energy equipment sector produced $5.95B of the $13.03819B increase in earnings for the S&P 500 in Q3 y/y. S&P earnings growth is 11.9% y/y. Ex-energy earnings the growth is 6.45%.
“Inflation impacts S&P earnings. Metals contributed $1.486B and Tobacco $3.120B (inelastic demand, assume little unit growth; it was -$837B Q3 ’03, so the change is ~$4B y/y) of the y/y earnings increase. Add these to energy and we get $10.556B. Ex-these sectors, S&P earnings growth becomes 2.26% y/y.
“Let’s look at two more inelastic demand sectors – healthcare and pharmaceuticals. Healthcare provider earnings increased 67.7% or $1.68B y/y. Pharmaceutical earnings increased 34.5% or $2.8856. If we add these sectors to the sectors mentioned above, the earnings gain is over $1B more than the total earnings gain in the S&P 500 y/y. The aggregate of all other sectors had lower earnings y/y… Ironically the above mentioned sectors have low PE’s because investors don’t think the earnings are stable.
“The multiple expansion of an aggregate due to the increased earnings of a much lower PE component is a principal that fueled the blow-off top in the late ’60s to the long bull market that commenced in 1949.”
Earnings disappointments are typically a trigger for the beginning of a bear market. A retreating stock market and a slowing economy, coupled with rising rates is not good.
I worry that we will enter the next recession too soon – before the Fed has time to “reload” its conventional recession fighting weapons and with the dollar in clear retreat.
Why the Dollar May Rise
Now, after all that, let me tell you why we could see the dollar rise in the near term. Everybody (well, most everybody) and their dog expect to see the dollar fall. That is the way the bets have been made. But when “everybody” is on the same side of the trade, there is no one on the other side, and you can get some violent corrections. While the trend may still be there, we could see a nasty “adjustment” or two. Indeed, if the central banks of the world actually do coordinate a gradual fall in the dollar, expect to see them “reverse” policy from time to time, just to jerk the chains of the speculators and hedge funds. If you play this market, expect volatility and lots of it.
For those who want to invest in foreign currencies, I would point you to Everbank (www.everbank.com) in St. Louis. You can buy an FDIC insured CD in almost any currency. Call Chuck Butler at 800-926-4922 and tell him I sent you. (Note: Everbank is a sponsor of my publisher.)
Posted by: Pat | Nov 23 2004 19:52 utc | 5
|
