November 22, 2007
The falling dollar: possible political ramifications
I recently wrote a column on the political consequences of $100 oil, which drew quite successfully (I thought) on an earlier discusssion on this blog. So I would like to repeat the experiment.
There is no shortage of analysis of the global economic consequences of the falling dollar. But what about the global strategic consequences? Over the long term, a feeble currency is usually both a symbol and a cause of national decline. I’m not sure you can yet read anything too profound into the current movements in the currency markets, although Hugo Chavez is doing his best.
Still, even in the here-and-now, I think there could be political ramifications to the falling dollar. Off the top-of-my-head, here are four possibilities:
1) Americans feel humiliated and anxious - It cannot be nice for New Yorkers to have lots of chavvy Brits and Europeans, staggering around their shops, chortling about how cheap everything is. And those Americans who travel are experiencing severe sticker shock in Europe. People feel all macho about their currencies. The Germans used to love the strong D-mark. The Brits felt that the slide in sterling reflected their decline as a nation. Will similar concerns spread in the US?
2) Foreign companies buy up the US - One thing that could spread national anxiety in America would be a few foreign bids for high-profile American assets: the Rockefeller centre, Universal Studios etc…Particularly if those bids were from the Chinese or the Gulf Arabs.
3) It is more expensive to project American power - All those American military bases overseas need supporting. And a lot of those costs cannot be borne in dollars. American aid budgets will be relatively smaller this year. The American economy will be a smaller share of the world economy, and the American market will feel a little less important.
4) American debt will become less attractive to hold - This is the big one. What happens if the Chinese or other Asians or the Arabs buy less American debt? Theoretically, they have the Americans by the balls. (I think one can say that on a blog?) But, they also have themselves by the balls. Too rapid a withdrawal from the dollar will cause a further fall in the currency, forcing down the value of their own foreign reserves, which are largely held in dollars.
Those are my four points. What other political consequences of a falling dollar should we be thinking about? And what should I be reading?
Each of these trends has been underway for awhile, but in cautious pencil for most observers. The FT is inking them not just through your blog, but through numerous commentaries and reports this week.
One that has not been observed concerns the US army of expatriates, most living on COLA indices, that now oocupies the most charming spots in Europe (with some dispersed elsewhere). The year 2000 US census, I read somewhere, cited 3 million non-military taxpayers living abroad (without representation). Recent articles have estimated the number today at 7-to-8 million. (Hard numbes will be welcome, but I trust also challenged.)
Bilan, the Suisse-Romand business weekly, ran an article the week after the Blocher-dominated elections about the rise in US companies that are basing global activities and legal entities in Switzerland. It paints a picture of a new and troubling immigrant class, one which requires segregated schools, too many SUVs, women who need careers, and, increasingly, opportunities to stay–forever.
These expats are close to their companies’ performance data and have seen the writing on the wall. More importantly, they have long seen the tangible difference in quality of life and the happiness of their children, who do not require security personnel to go to-and-from.
According to Bilan, they are not good Swiss taxpayers. Companies negotiate preferential deals, where neither the enterprise nor its expats pay their fair share for the services and air they consume. Companies have strategically underestimated both the number of local jobs they will create and the number of expats they bring.
It would please me to see Herr Blocher put the light on this new breed of linquistically impaired nomadic consumers. I doubt he will, as he drew heavily on direct and indirect support from this new 27th canton. He also likes to lunch and dine with them.
When will shareholders challenge their management teams on their expatriate needs and practices. It is well known to be a bit of a clubby game in the ageing US Bigcos. Numerous consultancies make relatively high fees in serving it. The US expats are hardly an invisible lot, and they may be more culturally destabilising than Turks, Russians or Africans.
The article focuses on three companies that have recently expanded their bases in Switzerland: Google in Berne; eBay in Zürich; and Philip Morris in Vaud/Lausanne. I can show you a better list.
The Swiss still do business quite well and not many deals have slipped notice there. For more fun, look at the story in Belgium.
How will the falling dollar affect 1) expats and 2) the old war-horse US multinationals? Is it possible the benefits of their respective “diversification” strategies have already paid off these past several months? What is really going on with their tax status in their host countries? Are they still a gift horse?
Posted by: WCM | November 22nd, 2007 at 7:24 pm | Report this commentRent payments on leases on property in Poland, which were formerly indexed to the USD, are now moving towards EUR indexation. I don’t know how widespread the practice is, but it could have a political dimension, as Easterners begin to feel more European.
I would look into the widespread possibilities for all sorts of disruption from un-pegging and de-indexation effects around the world. All sorts of transactions, which were formerly carried in USD - petroleum immediately springs to mind, of course - but also local transactions as in the above property example. A fall in the dollar’s cachet must certainly lead to a fall in America’s ’soft’ power, no matter how implicit the effect.
Posted by: RCS | November 22nd, 2007 at 7:31 pm | Report this commentGermany keeps the biggest Trade surplus of the World ($257 billion) in spite of the rising Euro…but we must take into account thanks precisely to the EURO there is a fixed exchange rate with over 450 million people around the World (including the CFA area in Africa and those nations which participate in ERM II like Denmark)
Japan also kept a permanent surplus during the 90s in spite of the rising Yen…and that, plus a permanent Budget Defict which has taken their Public Debt to over 160% of GDP, avoided Japan from falling into Recession, or even full Depression.
Both Germany and Japan offer high quality goods which in America mostly can be found just in the military field (a consequence of being part of a militarised society like the American where 25% of the Budget is spent on Defense, War and Weapons)…
Of course, there is another field which will profit from that: Agriculture, farmers, food industry…but that brings competition with Third World nations.
Is it the same a falling USD in 2007 as in 1997?
There are two differences:
a) Euro
b) China
The Euro didn´t exist by then so there was not a reliable competitor for capital.
China didn´t exist by then (on a degree we can watch today holding $800 billion in reserves)
If it is true there are constant travels from the US Treasure to Beijing begging the chinese not to change their USD reserves into a basket of currencies including basically the EURO (something inevitable) as i ve read in FT then it is evident US capacity for political pressure is eroding.
And we can imagine how strong must be the pressure to the U.K. Of course we know Murdoch advised Blair and Brown not to join the EUROZONE, but the political, economic, military pressure against Britain from the USA must be much, much worse than we can imagine (Matin Fieldstein was aware about that fact 10 years ago)
The Bank of England is a member of the European System of Central Banks (ESCB) and Britain is part of the European Union, which means a Customs Union with another 430 million Europeans…
About the EURO Britain´s official position was “wait and see” 1. if it goes ahead in schedule (as it did) and 2. if it is a success or a failure (and was a success)
So right now, being part of the ESCB, having a British as member of the Executive Board of the Euroepan Central Bank is a goal, not openly, but a clear goal from any UK Government…but they suffer constant, evident and growing political pressure from the U.S. because that would mean a transfer of the World´s HUB of capital from America to Europe for the first time in one century as the EUROZONE would have a GDP at current USD $3 Tr. bigger than the American and at PPP $1 Tr. bigger…
What would be the implications of the transfer of the HUB? An increasing difficulty for America to finance her Defense Agenda on a similar degree we had seen during the last decades.
Posted by: Enrique Costas Mira | November 22nd, 2007 at 8:49 pm | Report this commentI don’t think Americans would care if Rockefeller Center or Universal Studios got bought out by foreigners. Why? Because it’s happened before.
The Japanese bought Rockefeller Center in the early 90s, while Viviendi bought Universal in the 90s too.
Viviendi, went it went through financial problems, sold the majority of it’s interest in Universal to General Electric, and now it’s NBC Universal.
As for the dollar falling so low, it’s not necessarily bad for all Americans, or good for all Europeans. It means that with a high Euro, European manufacturered items are more expensive than American manufactured items. American manufactured items are getting cheaper, and American manufacturers are saying business is booming.
The US government could prop up the dollar if they want to. They will not, as they’re using as a way to reduce and eliminate our trade deficiet.
So if Americans can’t shop around in Europe, from this rational, good. It means they spend the money here in the US. If that means more European tourists come to NY to shop at bargain prices, well, NY businesses will not complain. They need the money more than ever now, with the US entering a slowdown due to the subprime mortage/housing market mess.
Posted by: Justin | November 22nd, 2007 at 8:54 pm | Report this commentJustin’s observations have been right for other downturns. The thinking now seems to be that the US has not hit a bump going up the hill, but that its right rear wheel has slipped from the pavement while trying to off-road a high pass.
Posted by: WCM | November 22nd, 2007 at 9:07 pm | Report this comment.
Hmmmm ! here it goes
- 1 New Yorkers as all big cities resident see tourists as fowls to be plucked , the plumpness of their wallets is a plus , The one’s who might mind are mid west tourists finding themselves downgraded .
-2 No big deal , foreigners have been buying american stuff for ever ( remember the petrodollard , then the yen kings )
usually it end as point 1 above ,the tourists get badly done over by the locals , universal must have been sold as often as the brooklin bridge ,
-3 The high cost of projecting power might possibly concentrate the mind of the U.S. government on where , when , how and why power projection is needed , war is notorious for being a ruinous activity at least since gunpowder got used !
it’s a truism to state than diplomacy is the shadow of might , it’s also a damn sight cheaper !
-4 The U.S. debt has gone above any reasonable limit and has become the credit card of the administration , the Chinese and U.S. treasury are dancing a slow tango with each caught by the short and curlies , as for the Saudis plight , no sympathy there , their asset depreciation should be considerred a taxe on stupidity
.
Posted by: jeannick Guerin | November 22nd, 2007 at 9:25 pm | Report this commentThe US economy is the central pillar of the global economic system and despite growing claims of a decoupling away from this, there is little to indicate that much has changed. Europeans claims that they have diversified by exporting as much to Asia now are just delusions: in many cases they export the very capital equipment which is used to produce goods subsequently exported to the US. What mystifies me is why so many constituencies around the world are lining up to applaud the decline of the dollar as part of a perceived decline of the American Empire. Without any viable alternative world growth locomotive, a true collpase of the dollar is everyone’s worst nightmare (even Hugo Chavez!).
Posted by: Charlie Welsh | November 23rd, 2007 at 2:34 am | Report this commentI walk by groups of Europeans, Brits, French and Spaniards every day in Midtown Manhattan. They don’t bother me a bit, they are all welcome to New York. I do wander why they go shopping in the most expensive stores where plenty of middle class Americans never step in but that’s their business. I would be bothered if Rockefeller Center gets bought by the Britons, after all if the Russians buy up half of London, the Brits will need a new place to hang around.
Posted by: New York Joe | November 23rd, 2007 at 3:59 am | Report this commentIn answer to Gideon Rachman’s question about what he should be reading concerning the falling US dollar, one book I intend to read if I can find a copy is “As The Money Kept Rolling In” by Washington Post reporter Paul Blustein, about the 2001 economic collapse brought about by wasteful government spending in Argentina, a country which, unlike the US, did not have to support a military establishment that extends throughout the globe (reviewed by Alan Beattie, FT, February 17, 2005). Argentina yesterday, America today?
Posted by: Roger Algase | November 23rd, 2007 at 4:32 am | Report this commentMy above comment should have ended: “Argentina yesterday, America tomorrow?” Mr. Rachman might also want to put “The Sorrows Of Empire” by Chalmers Johnson on his reading list.
Posted by: Roger Algase | November 23rd, 2007 at 5:19 am | Report this commentQuoting from the FT:
“China keeps the currency composition of its reserves a state secret, but some analysts believe that more than two-thirds are probably still held in dollars.”
I’d like to make a slightly contrarian observation here:
I find it curious that the fate of the US dollar now appears to be in the hands of China, which is ruled with an iron hand by the direct heirs of Mao Tse-Tung who insist that they are still Marxist-Leninist.
John Lennon sang mockingly in “Revolution”,
“But if you go carrying pictures of Chairman Mao, you ain’t gonna make it with anyone anyhow”.
However, if you look carefully you’ll find that Mao’s picture is on all the Chinese money right at this very moment, so I guess that makes about a billion people “carrying pictures of Chairman Mao”.
I have been reading Sun Tzu and Mao for many years and frankly I smell a rat. I’m afraid we may have made what Stalin would have called “a serious mistake”. To quote another moldy classic, Lenin always said that a capitalist would sell you the rope on Friday to hang him with on Sunday, just to make a profit on Sunday. Perhaps we are about to have our “contradictions” accelerated.
I can’t really remember what my petard is, but I think we may have been hoisted by one.
Posted by: David Seaton | November 23rd, 2007 at 8:29 am | Report this commentThe fact is that the US is still the biggest economy in the world and as far as I know is projected to remain there.
If it deserves to retain that position - which I believe it does - then sooner or later there will be a reaction to where we are now. The most likely? Recession in the US. And unless there has been serious decoupling of the global economy, when the motor stalls, the car stops. So when America stops spending, factories in China close, the oil price drops and a host of other consequences occur. Assuming the US does tip into recession - whether a significant growth recession (ie two quarters of below target growth) or a full recession - the government will look to create more jobs at home, the economy will be stimulated, the deficits will be cut, the dollar will strengthen and so the cycle starts again.
One factor which you haven’t mentioned is the effect of sovereign wealth funds. Forgive me if I am incorrect, but it was Japanese banks and other non-state entities which did most of the spending the last time around - not the Japanese government, a markedly more US friendly entity than some of the governments currently looking to spend trillions of dollars through these funds - trillions of dollars incidentally that are now loaded onto US / western home owners. This will be a significant factor I believe in the rise of protectionist policies and could put a serious stick in the spokes of the globalisation bicycle.
But there are also huge national pension schemes - in Norway and France for example - which are similar to the sovereign wealth funds in their investment objectives, but which have a totally different significance which perhaps reflect the reality of the demographic changes taking place around the globe. The fact is that the US has a much healthier demographic profile than any of its potential rivals - the EU, Russia, China or Japan. I think this will be a key factor in deciding who will be top dog this century.
Personally I think this is a short term blip that we will recognised as such in the coming decades.
Posted by: AYC | November 23rd, 2007 at 9:24 am | Report this commentTo answer your question “what should I be reading?” I recommend the book “Empire of Debt”. I think the authors got the point a while ago…
Posted by: A. Magan, Spain | November 23rd, 2007 at 9:24 am | Report this commentInteresting topic. Yet I’m afraid as usual it’s coming too late. Of course, forecasting exchange rates is a mug’s game, but if I’m right, we’re bound to see a period of renewed strength of the USD. Virtually all the technical indicators are in oversold territory and let us not forget that many US funds and corporate will want to bring back some foreign profits hence will boost the USD.
That said the post’s point is probably still valid longer term. But to attempt answering the questions one need to understand the de facto world up to now - ie a world where the USD was effectively a gold standard. The birth of the Euro and the rise of emerging markets (whose economies are mostly built around exporting goods & commodities and whose currency is pegged to the USD or at least artificially made cheap to the USD and as a consequence those economies have been hoarding USD at an extraordinarily rate) have challenged the USD dominance.
The Americans have never really cared about the value of the USD - it was up to everyone else to bother/worry/adapty (hence the famous “it’s our currency but your problem). To a large extent, this is what the US authorities (Treasury & Fed) are still doing but they have (or are or will soon) realised that the value of the USD does indeed matter. Letting the USD fall and inflation increase worked in the past in reducing national debt without hurting the economy too much. But this time, the US is facing an international backlash and while in the 70’s and 80’s one had to have mainly USD as reserves, now there’s the EUR. A fair bit of EUR/USD recent strength had more to do with EUR buying than USD selling. End result is the same (last night new all time high of 1.4965) but it’s indicating that the USD us undershooting and the EUR is probably overbought.
As for the specific points raised in the post:
US tourists tend to spend more than other nationalities mainly because if you only get 2wks paid holidays you better blow the budget - that’ll still happen but of course, as London is witnessing less tourists will travel. For London or Paris, it doesn’t matter because they are being replaced by hordes of Indians and Chinese tourists.
For the US economy, it’s not such a big deal: many commodities are denominated in USD (which is prob why most have been booming), then many goods are imported from countries whose currency is pegged to the USD hence the retail price will hardly move. Of course, BMWs, Porsches, Louis Vuitton bags will become more expensive but most European exports to the US tend to be luxury goods, or precision engineering, basically things with high added value that hardly noone can manufacture. (witness the delay of the latest boeing due to a lack of a special kind of screws - which, if I’m not mistaken were made by an italian firm)
As for Euro firms buying US assets, I agree with most posts: it wont happen!!! Level of cross-border M&A is not correlated with exchange rates. In any case, if you’re based in the Eurozone and buy a US firm on the basis of a depperciating currency, you will have depreciating earnings from the US assets - not a great deal. On top of this, Americans (and Brits) are the best in the world at selling businesses. They can spot the top of a market better than most (see Sam Zell’s sall of his property company to Blackstone - or Blackstone very own part sale to China!!! - not a great investment for the Chinese). They did just that with the Japanese in the 80’s and the Europeans in the mid-90’s (witness Vivendi of course, but also Daimler!!!! - lost more than USD50bn on Chrysler in 10 yrs!!!!)
Some investors are awash with cash - in that situation that’s when you overpay because all financial analysis goes through the window. Debt repayments bring discipline - which is essential to succeed in making the right investments.
Of course, the marco problem in today’s global economy is that fast growing economies do not let their currency appreciate like they should. Faster growing economies have appreciating rates - that’s basic economic theory. But when the 25% of world GDP that are growing the fastest decide that they will keep their currencies artificially undervalued you then have massive imbalances - with an undervalued USD and an overvalued EUR.
And my final thought is that one ought to read up on history a little bit. The chapters on Bretton Woods particularly.
Posted by: fxtrader | November 23rd, 2007 at 11:31 am | Report this commentThe sort of currency brutal swings (to use Trichet’s sentence) have been extraordinary this year - in many ways unrelated to the relative strength of economies.
If currency imbalances continue the way they are, I’d expect vocal calls to start thinking about a global currency stabilisation system - in effect a new Bretton Woods. The political implications of this would be dramatic: if we stuck such a deal now, the US would be a junior partner, with the Eurozone, China and opec (including Brazil) at the top table.
http://www.ft.com/cms/s/0/1b848ae2-993a-11dc-bb45-0000779fd2ac.html?nclick_check=1
As can be seen from the above front page news (at least in FT.com), not all consequence of the weak dollar are negative for America. If Airbus’s life is threatened by the low dollar, that means immense opportunity for Boeing. The same thing will be replicated across many industries.
Best,
P
Posted by: Pacifist | November 23rd, 2007 at 12:07 pm | Report this commentTo FX Trader and anyone who may know.
Is there any research showing how much of the weakness of the Greenback is merely due to the existence of the Euro (hence the ability of investment funds and governments to hold reserves in something other than Dollars)?
Best,
P
Posted by: Pacifist | November 23rd, 2007 at 12:31 pm | Report this commentMr Rachman,
Your arguments have focused inordinately on the bruising to the American ego that further declines in the dollar would provoke. Citizens of hegemonies tend to have over-sized egos that could do with a little deflating once in a while. I would be more concerned with global balance of power. The two most significant consequences are that the dollar falls from its position as the currency of reserve and currency of account and that there is a global shift in relative prices, which in turn have strategic and geopolitical consequences.
The first consequence is that the dollar is replaced as a reserve currency and currency of account: I have seen some developments recently that would support the thesis that the declining dollar is encouraging a shift to trading and holding assets in euros. In the Hubei province in China shipbuilding projects that four months ago were being contracted in dollars are now being contracted in euros. Eastern Europe switched to denominating real estate in euros a while back reflecting the political developments (joining the EU) and the investor base in the region (predominantly European). More recently countries such as Turkey and Russia, with a less compelling political or financial reasons, are also switching to euros for real estate transactions. This is not motivated by political reasons, but like Gisele Bundchen, the individuals committing to future prices and payments are fearful of losing out from further dollar depreciation.
But what power does issuing the world’s currency of account and reserve currency confer? Would it make a difference if we were all transacting in Samoan Tala or Argentinian pesos? The big loser is the US government who is losing out on future Seignorage revenues. For the last 50 odd years people around the world were more than happy to “pay” the US government for the services of maintaining a stable currency of account by accepting that the value of their dollar would depreciate at about 2% a year but not much more of less than that. People did not want to use the Argentinean peso because they did not trust the Argentinean government (who had a track record of allowing their currency to inflate) and people could not use the Samoan tala because the Samoan government would not let it out of the country. The US kindly offered the people of the world a freely exchangeable and stable currency and reaped the Seignorage revenues in return. In the 1970s when the US government reneged on their part of the bargain to maintain stability the rest of the world did not have much choice of an alternative currency but that is not the case today with the emergence of the euro. The US government is the big loser and the European governments are the big winners. This is arguably how it should be, as the ECB is rewarded for its focus on inflation and prudent monetary management. A little bit of competition in the market for currency of account is no bad thing if it puts pressure on central banks to keep inflation low.
If some capital goods such ships and real estate have begun to be priced in euros, will commodities and other traded goods follow suit? Quite possibly. There has been a lot of huffing and puffing about switching oil prices to euros. With freely exchangeable currencies it doesn’t really matter what currency symbol comes before the number. Oil is priced everyone can just pay at a whatever exchange rate prevails on the day. The impact of pricing oil in dollars is that reserves of oil and the wealth of oil producers are also held in dollars. If there was a switch from pricing traded goods in the world from dollars, there would also be a switch from holding dollar-denominated assets, which would dump a lot of dollars onto the market and push down the currency even further in a vicious cycle. Oil wealth has been accumulating in dollars since the 1970s and the Chinese have managed to accumulate quite a lot in the last ten years. That is one hell of a big unwinding. The oil producers and Asian exporters would most certainly have the US by the balls as you put it. It is possible that foreigners will snap up US assets on the cheap as you suggested, but if these foreigners think that the dollar is going to fall further they will probably wait until they think the dollar has bottomed out and that could be a while off yet.
The second big consequence of a declining dollar is the global shift in relative prices. European goods are becoming more expensive and Europeans are seeing their purchasing power increase at the expense of pressure on their exports. The contrary is true for Americans and the large part of the world that is pegged to the dollar. For governments of countries with a dollar peg, there will be pressure to either move away from a pure dollar peg to a basket of currencies better reflect trading partners, or peg to a single currency or even free-float. Asia, with its more diversified trading partners will more likely go this route and it is possible that we will see Asians currencies de-pegging from the dollar. The consequence for Americans is that they will feel poorer. After the prolonged spending binge of the American consumer there is some correction due on that front. It is likely that Americans will disengage somewhat from international trade as imports become more expensive. The US is a large enough market to support itself to an extent and Americans may become more self-sufficient economically and may become more isolationist politically. But the one thing Americans cannot import is energy and that alone will force it to remain engaged with the world.
You didn’t mention much about the impact on European egos? Should I infer that French farmers and German plumbers will be less anxious now that they can take pride in their strong currency? Germans were proud of their D-mark, but for a long period after the war they few other national symbols to take pride in. Americans on the other hand are not short of national symbols to take pride in so they can afford to let one slip to the Germans. As for the impact on the American ego, Americans have been feeling anxious ever since 2001. Arguably these bouts of anxiety (and paranoia) are a part of the American psyche (I am thinking of the Salem witch trials and McCarthyism). I quite frankly don’t care if Americans feel less important, humiliated or anxious unless it seriously affects consumer spending. Many people think that Americans are a little too pompous and self-important and that a correction is in order. I would really not be too concerned that Americans cannot project as much military power. They have not been doing too good a job of it recently. I believe that the Europeans will steep up to the mark on that and start doing their fair share of spending for world defence if the alternative is to allow the Chinese to do it. With all their new Seignourage revenues and increased purchasing power, they can probably afford it.
Posted by: Collins | November 23rd, 2007 at 12:48 pm | Report this commentA very weak USD probably will slow the brain- draining to the US.
Posted by: H Shen | November 23rd, 2007 at 12:58 pm | Report this commentGideon, Collins just wrote your column for you.
Posted by: David Seaton | November 23rd, 2007 at 1:04 pm | Report this commentP,
Interesting point - problem is FX trading is not centralised. So comprehensive data is hard to come across. The BIS puts out a great report (every 3 yrs though).
Usually you look at indirect indicators to gauge the appetite for currencies. One is of course the central banks reserves. But of course, that doesn’t tend to be transparent, especially for emerging markets. Another one is bond issuance - which is pretty interesting and has seen a massive rise in EUR denominated issuance. Of course, European companies represent a big chunk of that total but what is interesting is that many US firms and emerging market firms have decided to issue in EUR. (my guess is that the ECB is seen as a better inflation fighter (inflation targetting) than the FED (which is trying to addres that point - see recent “communications” changes) and hence holding EUR bonds are less likely to be eroded by creeping inflation)
But to clarify, I think the current (ie last couple weeks and probably the next couple weeks) has more to do with Euro buying than USD selling. But overall, USD weakness is independent from the EUR existence - clearly the budget deficit matters. (the tax law allowing US corp to bring back foreign earnings helped hiding USD weakness for a while)
Posted by: fxtrader | November 23rd, 2007 at 1:23 pm | Report this commentAnd then of course, the US economy is ahead of the cycle - in the sense it’s been suffering first, getting rate cuts (which depress USD) etc.. but I’d expect rate cuts to hit the UK in 1H08 and probably the Eurozone in 2H08 as the slowdown starts to bite. Also, I don’t buy at all the “decoupling” argument that emerging markets can go humming along regardless of what’s going on in the US and Europe. This is the latest Investment banks’s idea and it frankly doesnt wash. Globalisation makes economies more interdependent not less! In any case, the argument that the US doesn’t matter anymore for the world economy now that BRIC is here is nonsensical. Everybody’s talking up to the media emerging markets because it’s the “sexy” bit a bit like companies talked up their online strategies in 99/00. The reality is that for most companies, emerging market is a tiny share of sales (granted growingg fast) and even less of profits. (Because one thing they dont say is that selling in China, for example, is much less profitable!)
So the US will have a consumer led recession and it needs to - US consumers have been borrowing enormously to keep spending - soon or later you got to start paying back that debt. The USD’s pricing is discounting a US recession. The rest of the world might not get into recession - but many economies will experience a slowdown - some probably a very significant one.
Oh - and I’m just remembering one v important political fallout: we’ll see a few financial crisis - some eastern european countries are close to imploding, their EUR peg is creating negative real interest rates which is in turn boosting assets valuations to crazy levels - not a recipe for macro stability…
I would say that’s a significant risk to generate anti-EU sentiment - Britain’s exit of the ERM in 92 was very damagin for the EU’s standing in the UK - interest rate shot up, and most blame Europe for it.
Collins - I think you are little too optimistic if you think the Europeans will step up to the mark “for world defence”, by which I assume you mean raise the level of their defence expenditure to allow them to fill any vacuum left as America withdraws on itself? The main argument against this is the demographic one. Older populations requiring increasing levels of health spending and correspondingly fewer children of fighting age (the key here is fewer sons per family not total numbers by population) do not augur well for those hoping for increased levels of European defence spending to challenge the US and China. Would the Europeans even have the will to take care of their backyard should there be a new Balkans war? They hardly did a bang up job last time, did they? Could you honestly expect them to project power further afield? The Germans aren’t even allowed to fly at night in Afghanistan!
The reality is, that given the long lead times in developing weapons systems and building platforms (think aircraft carriers or the F-22 Raptor), the Europeans have to step up to the mark now, not tomorrow.
Btw, I think you are scraping the barrel a little if you have to illustrate your point about US paranoia with the Salem witch trial. Hardly national paranoia was it? And the same thing happened in England - ever hear of the Pendle witches or the witchfinder general? Not really in the same league as Stalin’s slaughter of the kulaks, is it?
Posted by: AYC | November 23rd, 2007 at 1:35 pm | Report this commentFX, you are right, the Trade balances of the Baltics is really frightening and the only consequence will be postponing Euro entry.
On the other side the determination of the Government of Denmark led by Rasmussento join the Eurozone is obvious and welcome after years in ERM II.
Denmark joining the Eurozone, plus Finland which is alraedy a founding member state, would send a clear signal to Sweden…
Posted by: Enrique | November 23rd, 2007 at 1:41 pm | Report this commentAYC, we don´t have to do America´s work in Defense. After all the Commander in Chief of SACEUR is not a European but an American, and the US is occupying a lot of space in Europe with dozens of military bases (about 40) paying a ridiculous rent for it or not a rent at all (as happens with US Occupation bases in Germany and Italy) YOU HAVE TO PAY because you are in our land occupying our territory. So don´t beg as for money.
Posted by: Enrique | November 23rd, 2007 at 1:46 pm | Report this commentEnrique, couple of quick points. As previously explained, I’m a British citizen, born and bred. Secondly, the US bases bring in a lot of money to the local economies - reference the manager of the Quarterdeck restaurant in Hong Kong. How much money would have gone into the local economy? Story is here:
Posted by: AYC | November 23rd, 2007 at 1:59 pm | Report this commenthttp://www.ft.com/cms/s/0/41f203a0-985c-11dc-8ca7-0000779fd2ac.html
From today’s IHT
“Japanese shift cash out of U.S. investments”
http://iht.com/bin/printfriendly.php?id=8447197
I think perhaps the major effect of a US recession would be that the world might not really be much affected by it; another chapter in the ongoing story of “The Emperor’s New Clothes,” that began with the war in Iraq.
Posted by: David Seaton | November 23rd, 2007 at 1:59 pm | Report this commentDavid, so Japanese invest in “Australian Government bonds”…but it is Australia an emerging market?
Even if Australia, above all the Northern Territory and Queensland, is part of what can be denominated Greater China´s economic area (Darwin is an Australasian town with much potential for growth) I don´t think of Australia as an emerging market.
Australia, like South Korea, Singapore, Taiwan or Japan are mature markets. The advantage of Australia over the other markets is a population growth of 1% plus an incredible source for commodities Greater China needs.
But as an emerging market Hawaii, California, Washington, Oregon, British Columbia and Alaska (a total of 53 million people in the Pacific Coast of North America, almost as much as the U.K. and with a similar GDP) are as much “emerging” as Australia (21 million people)
Another region to take increasingly advantage of Greater China is the Russian Federation´s Far East (7 million people) with Vladivostok as its center, but for growth they need the integration of North and South Korea with a market economy in Pyongyiang at least like the one they have in China´s Heilongjiang (Harbin)…
Posted by: Enrique | November 23rd, 2007 at 3:14 pm | Report this commentDear Mr Rachman,
your colleague Mr Wolf has written about the great unwinding. There are many aspects to the shrinking value of the dollar.
Is it going to be the beginning which will end the lead of the US super power? I am not certain about this because most countries are still in deep dependency to the US and will therefore co-ordinate their actions to minimise losses, as you said.
It will be important to see how the Chinese are going to decide on what to do with their extreme amounts of dollars. If they will find a clear way out of the dollar catch the world could face a dramatic acceleration of the unwinding which would be called a downfall later on. But who would want a downfall?
Another scenario would be the opening of another war on Iran which would catapult oil prices up and destabilize the world security resulting in unpredictable market situations. Not to mention the costs.
Would an economic downfall be followed in a political downfall and would it be a peaceful process like the downfall of the former USSR? Or will there be explosions like those of a dying star? In the long run, I guess that the world does not want a dominating power anymore. One could say that the US has done its job and now the children have grown out of it to create a new world economy based on ‘real’ value and not on vulnerable currency. But what is real value in this world? Gold has done its time it can not keep up with the volumes which are around. How about creating an institution to control major currencies? The dollar is loosing the lead, good this way! Upcoming nations like China and Europe have to be on equal levels for the sake of fair trade, if such thing exists.
Best regards
Hans MIttendorf
Posted by: Hans Mittendorf | November 23rd, 2007 at 3:34 pm | Report this commentGood analysis here for the most part. For the first time, I’ve copied a couple of the posts (Collins and fxtrader) to ponder later.
David Hale’s piece in today’s FT illustrates why this is different than the experiences of the 70s, 80s and 90s.
Gillian Tett’s piece confirms the sort of talk I’ve heard the past few days out of the non-plussed corners of the Gulf. What are the options? Certainly there is hesitation about jumping in and bailing out the US as they did in 1991 or with the Japanese before that. No one wants the US to become the Brazil of the 21st century, a possibility, but the financial map is dramatically different than it was 20 or even 10 years ago.
For more than two years, I’ve seen major contracts/transactions priced in euros or with strategic dollar-hedges built in. Expectations of a long siege of the dollar have been largely accepted, but, I would tend to agree with others here that the lows are likely within sight. The phrase most often heard has been that the US is living on other people’s money. Despite short-run rises in exports, they lack the infrastrusture to jump back into key export sectors to sustain this trend during a recession or a onger term adjustment.
With 25 years’ experience walking the halls of big banks and enterprises on all continents but two, the biggest change I have noted is in the outlooks of corporate board members. Their scepticism about binding ties to US interests has been on the table for more than three years. Private discussions amongst this group have been cautious-to-critical of US policy making, which had been out of scope for the better part of two generations. Few are feeling any surprise in the reports they are reading today.
Perhaps the FT can try to obtain some candid readings from this august group.
Posted by: WCM | November 23rd, 2007 at 5:23 pm | Report this commentThe dollar will probably continue to fall as America’s financial institutions struggle to remain solvent. The NewsVisual article on Freddie Mac http://www.newsvisual.com/newsvisual/2007/11/knowledge-map-s.html talks about the company’s plan to issue $5 billion in preferred stock in order to raise capital the company requires to offset its huge losses in the subprime market.
Posted by: Bill | November 23rd, 2007 at 11:26 pm | Report this commentPosters who have mentioned the advantages involved in being the owner of the world reserve currency have pointed to the seignorage percentage (inflation tax). They may also have mentioned the millions of green dollars that never return to the U.S. Federal Reserve for redemption. But no has mentioned the enormous downside of being the reserve provider: I refer to the ability of that country to avoid all the usual consequences of irresponsible fiscal policies. When any non-reserve country government refuses to balance its budget, the consequences in rising interest rates and falling exchange rate are quick to follow. Not so with the reserve supplier. The result is that politicians can follow the path of least resisitance, lower taxes and increase spending at an accelerating rate, as the U.S. is doing.
Posted by: Robert Molineaux | November 25th, 2007 at 3:58 am | Report this commentWould any other potential reserve supplier resist this temptation? Japan is the only country which has proven to be persistantly frugal in the face of prosperity, but even there the government runs enormous deficits to encourage growth. It is becoming increasingly apparent that, as others have suggested, there needs to be a new Bretton Woods conference on the scale and seriousness of the original, to devise and/or strengthen a supernational authority to stabilise trade and exchange rates. The European Community has demonstrated that this can be done regionally. It now must be done globally.
How can the USA reduce its $9 Trillion debt AND pay the WW2 baby boomers pensions that are just about ready for the first wave of payments? On top of the crazy defence budget. The government is like a teenager with a unlimited credit card its getting close to payback time.
I have read quite alot of information regarding the US$ being replaced with the ‘AMERO’ I used to think of it as a bit of fiction but it seems like the USAs only way out now. Next 12/18 months will be interesting.
Posted by: Douglas Reid | November 25th, 2007 at 10:58 am | Report this commentThe dollar’s weakness will not last forever, and threats of diversifying into euros may put needed pressure on the U.S. to strengthen its currency. However, the price of high price of oil will remain high long after the dollar rebounds. The US dollar will rebound… but WHEN will it rebound?… that is the important question that needs an answer. It is an interesting geo-political dynanmic and it is having US econ and global econ repercussions. However, there are forces/reasons here to consider that something very disturbing economically could happen…which could in turn result in unforseen political scenarios coming to the fore.
Posted by: Lisa-Helene Lawson | November 25th, 2007 at 9:02 pm | Report this commentOh Yes, GR,…and You MUST read “THE BLACK SWAN” by Nassim Nicholas Taleb…I am really disappointes it did not get FT Business Book of the Year…it’s a pity people have so little imagination these days…
Posted by: Lisa-Helene Lawson | November 25th, 2007 at 9:20 pm | Report this commentMost people tend to conform to the mainstream view. Right now: the USD is dead, long live pretty much any other currency.
The USD should have fallen much earlier given the increasing massive trade deficit that really started getting out of control in 03/04. Yet, a fortunately timed tax relief on foreign earnings and extraordinarily high purchases of USD-denominated assets boosted the demand for USD and hence delayed the needed fall of the USD. At current levels, the deficit is already reducing (exports have performed well). Now the US slowdown will help further by reducing US consumers appetite for expensive foreign goods.
Posted by: fxtrader | November 26th, 2007 at 2:03 pm | Report this commentSo, I believe the USD is close to rebounding. Late last week (admitedly in thin trading with US thanksgiving and Japanese holiday), the EUR/USD hit very breifly 1.4965 - another all time high, yet it crashed to 1.4800 less than 10 hrs later. I’d say it was more technical (Stop orders being triggered, that sort of things). And my view is that at this level traders are a bit more cautious to go long because we all know that the pullbacks from highs can be very very violent.
Anyway, I agree the USD is not anymore what Gold was in the old Bretton woods but as the incumbent standard it still matters hugely, not only because the US is the world’s largest economy but also because the US has the most developed capital markets (no matter all the non-sense about London Vs NYC) meaning it’s leading in the market capitalisation stakes (I can’t seriously include China’s - the numbers might be high, but it’s artificial) and in the size of assets under managements.
In finance (don’t want to generalise for everything else), once media is backing a particular view, it takes a canny and shrewed investor to take the contrarian view… (of course timing is key) That’s because a trend needs not only to be apparent but also impressive/extraordinay for the media to take interest - which means it’s usually a top. If anything indicates exhuberance or herd behaviour is the media milage the story of Gisele Bundchen’s preference for Euro contracts attracted.
Some short seller investors are scrutinizing the media for “profile pieces” - usually glowing articles about how well companies are doing - as a research criteria to find targets to sell. It’s a “hype detector” of some sort. If you consider that a few months prior to going bankrupt, Enron was praised on the front page of Forbes. (if i remember correctly, they were arguing that Enron was on the verge of becoming the world’s largest company!)
Euro versus Dollar
Some contrarian factors to consider:
1- EU has a rapidly aging population that will translate into a much higher dependency ratio, pension costs and government financial burden than the US.
2- EU countries, such as France, have far higher debt-to-GDP burdens than the US, especially when estimates of unfunded pension liabilities for government employees are included.
3- Some EU countries with high birth rate Muslim populations will be challenged to integrate those populations and generate employment for them.
4- US still maintains a significant lead in productivity growth, research and product innovation.
5- US has significantly higher relative returns on capital; and,
6- Dollar weakness has already stimulated US export growth.
(see, e.g., GaveKal research)
Net, net, the dollar may not be in long-term decline versus the euro.
As for the mood of Americans, the “average” American travels to the Grand Canyon not overseas (most Americans do not have passports) and is much more concerned with maintaining her job (employment is the key factor determining the mood of the US consumer), the cost of her mortgage, and the price of food and gas. These “average” Americans also are against the war in Iraq and the current President (who has a 28% popularity rating), and don’t want America to serve as the world’s police force.
Finally, Venezuela, Iran and Russia all are selling dollars as they earn them from oil profits but the rest of the world (especially the PRC) has every reason to not further depress the dollar. They cannot easily diversify out of their dollar debt holdings without suffering large losses and their economies are dependent on the US for their own health and growth (the US economy provided an over 30% contribution to world GDP growth over the last 5 years and the PRC’s economy will be a mess if there is a prolonged economic downturn in the US).
Posted by: kc | November 26th, 2007 at 4:02 pm | Report this commentkc
kc,
item 1…how about the unfunded medical cost in the US?
3-) That is unfounded, based mainly on paranoia generated in the US. In fact the vast majority of the Muslims integrate very well into the economy and their high birthrate is a partial mitigation to problem 1. Moreover, you could posit the same problem about Latinos in the US.
4-) Yes for now but will it last?
5-)
A-) Will it look the same after the current asset bubble is deflated?
B-) How do the returns look for the foreign investor in US assets?
Your final paragraph about China (and the likes of Saudi Arabia) holding too much of US IOU’s and not wanting to do anything to reduce their value further, is very true. They can’t back out easily but, absent an adjustment soon, they cannot hold on to a depreciating asset forever. They may not dump the dollar but they may stop adding to their pile. Who will be buying the future US trasury bonds?
Best,
P
Posted by: Pacifist | November 26th, 2007 at 4:50 pm | Report this commentDear P,
Posted by: kc | November 26th, 2007 at 5:01 pm | Report this comment1- This is apples to apples.
3- My view here is derived mainly from the European media (eg, Le Monde, Der Spiegel and Neue Zuercher Zeitung). I don’t want to over-emphasize this as I don’t have deep direct knowledge. As for Latinos, they share a common religious heritage with the other major US ethnic groups that includes a belief in separation between state and religion.
Finally, the Saudis and the PRC have to do business with the US and therefore will be buying US securities as long as there is a trade imbalance.
Best,kc
Hi kc,
1-) Not sure if the too problems aren’t the same “fruit”.
3-) I do live in Europe and in London which has been caricatured as “Londonistan”. The point about Muslims in Europe is that they mainly came here because they preferred it to what was going on back home and are hardly likely to wish to turn Europe into S Asia or the Middle East.
The rejectionist minority are very very tiny indeed. They are basically a policing problem and beyond the costs of that, they are not an economic threat.
As for trade imbalance, what is to stop PRC / Saudi conveting their Dollar earnings into other currenies as they go along?
P
Posted by: Pacifist | November 26th, 2007 at 5:18 pm | Report this commentHi, P:
Posted by: kc | November 26th, 2007 at 5:29 pm | Report this comment1- No, the US does have much more favorable projected demographics than the EU in connection with the aging of the work population.
3- I defer to your direct experience and analysis.
As for the PRC and Saudi Arabia, it is in their interest to continue to finance and support the US. A weak dollar can impact the price of gas and the Saudis want the American consumer to stay addicted to gas (not seeking to save as they did in reaction to high gas prices during the 1970s — an experience the oil ministry does not want to replicate) and the PRC wants the US consumer to continue to buy, buy, buy (which cannot happen without a financing source).
Best,kc
Dear kc,
That last point about China fascinates me. I wish I could find a shopkeeper who wants to keeping selling to me and lend me greater and greater amounts to buy from him without any intention on his part to call in the debt.
Maybe I should become an American?
Best,
P
Posted by: Pacifist | November 26th, 2007 at 5:51 pm | Report this commentDear P,
Posted by: kc | November 26th, 2007 at 5:58 pm | Report this comment1- The analogy is not apposite. In any case, though, you would achieve the personal objective you are seeking by filling out a US credit card application.
2- I’m sure your citizenship would be welcomed. American needs all the intelligent, open-minded, thinking, and critical citizens it can get.
Best,
kc
Dear kc,
Thank you for your kind words, although you gave 4 reasons why my citizenship application would be rejected
Good night,
P
Posted by: Pacifist | November 26th, 2007 at 6:04 pm | Report this commentDear Mr. Rachman,
In response to your question, I would suggest you add Ghemawat’s “Redefining Global Strategy” to your reading list. Currency markets are global. Business is not. At least not nearly to the extent we may think it is. Politically, this means leaders and regulators ought to appeal for calm, rather than stoke mass hysteria.
Though Ghemawat addresses his argument to managers charting global strategies, entreating them to pay attention to heterogeneity and cultural differences, there are important political ramifications. Most FDI (Ghemawat calculates around 80-90% if memory serves) remains inward. Currency fluctuations do have certain short term impacts, but I don’t think this is a cause for alarm - as has already been pointed out in rather colourful terms, all the key players have each other and themselves by the balls. So what’s the worry? I guess this stuff sells papers, though I don’t see why it should.
The world is not flat as some believe, it is spiky and heterogeneous. Currencies fluctuate, sometimes wildly, but business flows do not have the same volatility on an aggregated level. I’m less worried about currencies or the stability of global business, and far more concerned by politicians and central bankers mounting arguments for short term fixes which could actually do the real damage.
America’s response to their currency up until now has been the right one. Do nothing, or very little. Their rather obvious economic and military mistakes have been elsewhere, with commensurate impact to their psyche. But if we keep talking about the sky falling down, then politically, there might well be a situation. As fxtrader put it, it might all end in a new stabilisation framework with the US forced off the high table. Something tells me the Americans wouldn’t take that very well, and I would worry about what unpredictable response might follow. And that is the political risk.
Kind regards,
Posted by: F Alvi | November 26th, 2007 at 11:50 pm | Report this commentF Alvi
http://blogs.ft.com/wolfforum/2007/11/wake-up-to-the.html#comments
The comments made by Ricardo Hausmann are quite interesting. I had some of the same questions too!
P
Posted by: Pacifist | November 27th, 2007 at 4:24 pm | Report this commentAm having another thought on this: what if the fall of the USD (longer term - ie 5-20yrs) continues steadily? (a few rebounds as I’m expecting soon, but downwards all the same) Then, clearly large holders of USD will have opportunities (those rebounds) to trade away their USD, eventually ending up with a much smaller USD exposure, possibly even something negligible, say similar to today’s holdings of GBP or JPY.
Posted by: fxtrader | November 27th, 2007 at 7:37 pm | Report this commentClearly, this scenario implies a dwindling of the US economy relative to the rest of the world. (the Fed’s recent revised down estimates of the US optimal growth trend is much smaller than previously thought)
The end result (admitedly a doomsday scenario - yet, all outcomes including both best & worst must be considered as possible) is a default of the US government, unable to refinance its debt as USD bond buyers once burnt, shy away.
Of course, this isn’t very rigourus and based on linear projections of current trends assuming nothing can be changed - still when one borrows and parties like there’s no tomorrow, one either needs to pay back the debt or ends up bankrupt. Clearly what’s applicable to individuals is clearly not the same for countries. So maybe no default, but what about an IMF loan?
A default seems highly unlikely in the near term, as the Saudis and Chinese are unwilling to risk their current status quos. A return of US exuberance is even less likely. The American Century is ending. Some serious analysts have predicted US society to slowly move towards something closer to an economic mirror image of Brazil. Such a prediction was printed in an op-ed in the FT at least two years ago. The persistent denial that anythings is wrong in the US, the softness of economic productivity, and the arrogance of the failed that dominates the ethernet today suggest a less than bright future.
Posted by: WCM | November 27th, 2007 at 11:56 pm | Report this commentI agree with you, WCM, the “arrogance of the failed” suggests a “less than bright future”. But isn’t the choice here one of managed decline on one side (Paul Kennedy’s argument) or upheavals and major dislocation on the other? Yes, the economics of the falling dollar may not be default inducing, but what about the political ramifications (Gideon’s original question) of an America even more defensive than it already is? I think it may be in the collective interest to put on kid gloves when dealing with the US as they come to terms with the loss of prestige that is popularly associated with a declining currency.
Remember the last superpower that got its comeuppance?
Kind regards,
Posted by: F Alvi | November 28th, 2007 at 10:59 pm | Report this comment