The US Dollar

[Tex -USMC- 0]

It's premium content from The Economist, but here's the link anyway: http://www.economist.com/agenda/displayStory.cfm?story_id=3524771

Quote[/b] ]Plumbing the depths

Dec 30th 2004

From The Economist Global Agenda

The dollar has hit another record low against the euro. It is set for further falls against major currencies in the coming year, even though American interest rates will rise

FORECASTING exchange rates, warns Alan Greenspan, the chairman of the Federal Reserve, has a success rate no better than calling the toss of a coin. But the dollar keeps coming up tails. At the start of 2004, holders of America’s currency had to part with $1.25 to buy a euro. At year’s end, they must fork out nearly 12 cents more. In New York trading on Thursday December 30th, it cost almost $1.37 to buy a euro—a record low for the greenback for the sixth consecutive trading session.

The cause of the dollar’s decline is hardly a mystery: private investors have become less eager to finance America’s huge current-account deficit. The deficit widened slightly in the third quarter of 2004, to a record $165 billion, or 5.6% of GDP in that period.

These record deficits are adding to America’s foreign debts at an alarming rate. But as yet, America still earns more from its foreign assets than it pays on its foreign liabilities. That is about to change. As interest rates rise, refinancing America’s debt will become more costly. Goldman Sachs forecasts that net foreign-investment income is likely to shift to a sizeable deficit during 2005, growing thereafter. The investment bank estimates that, if America’s current-account deficit remains steady as a share of GDP and interest rates average 5% in future, net foreign debt-service payments will reach 4% of GDP by 2020—a significant drag on American living standards.

To avoid shelling out such large sums to foreigners, America will, ultimately, have to rely more on its own savings and less on savings imported from abroad. The country as a whole saved just 1.7% of national income in the first nine months of 2004. Households saved just 0.7%.

The dollar’s decline may force America to embrace thrift, argues Goldman Sachs. As the dollar falls, foreigners will demand more American goods. This will put pressure on America’s manufacturers, which are already operating at 78% of capacity. As supply is stretched, inflationary pressures will build. The Federal Reserve will raise interest rates, curbing domestic demand, and thus creating room for an export boom. The higher interest rates will thus promote the saving America has so sorely lacked.

This process has barely begun. Over the past two years, the dollar has lost almost 23% against the euro. But it has shed less than 13% against a broader basket of currencies (see chart), and it has not lost a cent against China’s yuan. As a matter of official policy, the Chinese currency has remained within a tight range around 8.28 to the dollar for the past decade. Forecasting the intentions of China’s policymakers may actually be harder than calling a toin coss. But many are trying. Offshore markets, for example, allow speculators to make a bet on the value of the yuan in 12 months time. At the moment, punters reckon you will get just 7.8 of them for your dollar this time next year.

Against the yen, the dollar is actually slightly stronger than it was in late November. The Bank of Japan has not intervened in the foreign-exchange markets since March, but the threat to do so remains. Japan’s finance minister, Sadakazu Tanigaki, gave warning this week that his country’s authorities would monitor foreign-exchange markets over the New Year holiday, a time when trading is thin and official buying can make a big difference.

If Japan’s finger is on the trigger, the European Central Bank (ECB) seems prepared to sit on its hands. Jean-Claude Trichet, president of the ECB, has lived with strong currencies before. As president of France’s central bank in the years before euro entry, he was dubbed “the ayatollah of the franc fort†for his unflinching support of a strong national currency. Indeed, for much of 1995, a weighted basket of the franc and the 11 other currencies that formed the euro was worth almost as much against the dollar as it is now.

In his press conferences, Mr Trichet has made it clear that recent rises in the single currency are unwelcome. But he has dwelt at greater length on the danger of rises in energy prices. His chief duty, as he sees it, is to convince firms and workers that inflation will remain well contained, despite the oil price spike of the autumn. It is a confidence game: if he can convince them an inflation spiral won’t happen, then it won’t. The strong euro will actually add to his credibility, by curbing the price of imports.

Besides, the hard men of hard money believe that weak currencies make life too easy for firms and politicians. Devaluing the currency provides an unsatisfying alternative to deregulating and restructuring the economy. An overvalued currency, on the other hand, leaves uncompetitive firms and tentative politicians with “no place to hideâ€, as Eric Chaney of Morgan Stanley puts it. They must reform or perish.

“You cannot devalue your way to prosperity,†says John Snow, America’s treasury secretary, somewhat hypocritically. The year to come may reveal whether Europe can revalue its way to the same end.

The point is that, while Econ101 tells you that devaluing a currency will increase exports and shore up the current account deficit, the reality of the situation dictates that when the currency in question is the bulwark of the world economy, the implications of weakening the currency for the sake of shoring up an ever-widening gap in the account balance are, to put it mildly, serious. How this will all end, whether it be a recession in the US or worldwide economic armageddon, remains to be seen. It does bear monitoring, however.

[denoir 0]

The markets will adjust as they always do. OPEC & Co will do what Asia now is doing - switch to the Euro. Investments in US industry will drop off. America will be transformed from a strong consumer to a strong producer of various low-tech crap that does not require external investments. The world will compensate for the loss of the American market with emerging markets such as China.

That's the bad case scenario. Such a transition will hurt as hell. The American economy is the second largest in the world and its downfall would hurt many econmies around the world - and primarlily the European one.

A second perhaps slightly better version, albeit very improbable is that US manages to pull it off. In theory a balancing act could function where through increased imports from the US, the EU and others would pay off the US deficit. A secondary effect would be that European products would be too expensive for the US markets, and by that reducing the trade gap and killing off a bunch of competitors. This would also severely fuck over the Asian markets and industry.

That scenario however assumes that the world will just bend over and take it voluntary. That won't happen. More likely is retaliatory sanctions. In short slap on taxes on goods from the US to an amount proportional to the losses due to the currency differential. And without the world's largest market for export, it would hurt more than it is worth it.

Personally, I'd like to see a strong show of support for the dollar. I'd like a 1:1 ratio to the Euro. Unfortunatly it seeems like 2:1 is more likely.

[Tex -USMC- 0]

The American economy is the second largest in the world

You like saying that, don't you?

The silver lining I see is this: the fact that this is a lose-lose situation could encourage governments to act in a slightly more rational manner than they normally do, because minimizing losses in the looming market adjustment is the best they can hope for. The problem is that America's economy is a freight train heading toward a rail bridge that was washed out 5 years ago.

edit:

Quote[/b] ]Personally, I'd like to see a strong show of support for the dollar. I'd like a 1:1 ratio to the Euro. Unfortunatly it seeems like 2:1 is more likely.

You're angling for the title of first European continentalist, aren't you?

[denoir 0]

@ Jan. 01 2005,13:02)]

The American economy is the second largest in the world

You like saying that, don't you?  

I love saying that

Quote[/b] ]The silver lining I see is this: the fact that this is a lose-lose situation could encourage governments to act in a slightly more rational manner than they normally do, because minimizing losses in the looming market adjustment is the best they can hope for. The problem is that America's economy is a freight train heading toward rail bridge that was washed out 5 years ago.

I hope so, there seems to be unfortunately a complete lack of will to organize something. When the Euro was dropping during the first year after its official introduction, banks and govenrments bought shitloads of the currency, which stabilized it. I'm not quite sure why, but there seems to be no interest in doing the same thing to salvage the dollar. Instead they seem to be worried that this is more of a permanent situation - and they're doing the safe thing - getting rid of their USD reserves. That's Asia for the most part. Europe is advocating an intervention, but apparently not strongly enough. One thing what the EU managed to do is to get OPEC to stop mentioning that they might switch to the Euro.

As for America, John Snow has made the its position very clear: America's deficit is as much the world's problem as it is Americas. In short, they're pretty happy with the way things are going and in a true Bushesque manner they don't really care about the long-term implications of it.

[Messiah 2]

To be cruely honest, this just seems to me like America's bad business dealings, corporation fraud (enron etc) and alot of its dirty laundry in terms of commerce and finance is being aired and its all catching up with them...

[Leveler 0]

Maybe the guys who voted bush should read more the economist... Oh and happy new year to everyone.

[Apollo 0]

Granted ,it's not only the fault of GW Bush that created this bad economic situation ,While Clinton could boast with a nice budget surpluss it must be said that woon when Bush came to power the IT bubble bursted in a scenario that could have well been predicted (halfway 2001 ,even i managed to predict that bust in 2000) ,and while Bush his tax cut's were primarily benificial to the wealthier classes in the end he had to pull em trough more towards the middle classes by pressure.Not all bad what he did from an economical point of view ,even from such a point of view giving up on Kyoto and support for drilling in certain protected nature enviroment was economicly sound ,though not very morally.

Afcourse Bush his war in Iraq is a big factor ,it's costs slammed that hughe deficit ,and the political factor's of that conflict might put a drag on the American economy for some more time as America is pressed to bear the costs of the continuing Iraqi insurgency.

In the end though ,Bush has always found his staunchers supporters in the big bussiness sector at home ,and clearly the supported bush again this year's ellection.While the situation might be lose-lose for the west ,the American industry moghul is probably happy'r ,and this lose-lose situatioon still benifit's his own pocket.

And yes ,happy newyear unto you all.

[benu 1]

Well, it's not too good for the european economy either, but as a european citizen it has never been as cheap to order stuff from the usa

[Supah 0]

Well, it's not too good for the european economy either, but as a european citizen it has never been as cheap to order stuff from the usa  

Cheap pizza

But more seriously, it might also be the time for EU companies to acquire some american companies. I would think a favorable exchange rate for currency would make that easier. Or doesnt it work that way?

[Tex -USMC- 0]

To be cruely honest, this just seems to me like America's bad business dealings, corporation fraud (enron etc) and alot of its dirty laundry in terms of commerce and finance is being aired and its all catching up with them...

All that has very little to do with the fact that the devaluation of the dollar has been a purposeful move on the part of the Fed- the reason is that our current account deficit (trade imbalance), while always high, has gotten worrisome. The only way to correct that imbalance is to attract foreign investment- in fact, foreign investment was largely responsible for America's economic recovery in 2001-2002, moreso than the tax cuts ever were; we have the impending decision to weaken the dollar to thank for that. The problem is that policymakers are either unwilling or unable to correct the trend, now that it is no longer advantageous.

[denoir 0]

@ Jan. 02 2005,00:58)]The only way to correct that imbalance is to attract foreign investment- in fact, foreign investment was largely responsible for America's economic recovery in 2001-2002, moreso than the tax cuts ever were; we have the impending decision to weaken the dollar to thank for that. The problem is that policymakers are either unwilling or unable to correct the trend, now that it is no longer advantageous.

On the contrary, I'd say. What you need is people to buy the products that you export - and that's what you'll get for a weak dollar.

Foreign investments on the other hand will severely drop as nobody wants to invest companies that are based on a weak currency.

Weak dollar (from a US perspective):

Positive: Increased exports and a stronger market position relative your competitors.

Negative: Less foreign investments, inflation and weaker puchasing power globally.

[Tex -USMC- 0]

On the contrary, I'd say. What you need is people to buy the products that you export - and that's what you'll get for a weak dollar.

Foreign investments on the other hand will severely drop as nobody wants to invest companies that are based on a weak currency.

Weak dollar (from a US perspective):

Positive: Increased exports and a stronger market position relative your competitors.

Negative: Less foreign investments, inflation and weaker puchasing power globally.

Not necessarily. Though investing in a country with a weak currency isn't attractive on that particular set of parameters, the relative weakening of the currency increases a foreign investor's purchasing power and essentially gets them more bang for their buck- why do you think that our decreased purchasing power wouldn't translate into relative adjustments for our competitors? In the case of America, that's the only way to close the current account deficit significantly, because we simply do not make enough stuff anymore for exports to do the job on their own. At any rate, the tendency of a weak currency increasing foreign investment will only continue insofar as the investors expect the currency to strengthen in the relatively near future. That's something the dollar has shown a distinct unlikelihood of doing lately.

[denoir 0]

Indeed. Oh well, you still have a strong labour market, a strong industry and an interested domestic market.

Europe is the one in the real economic dire straits in the medium term. We have some serious structural problems ("Eurosclerosis") that we don't know how to solve yet.

There are a few core developments:

[*] Market saturation. People are simply not buying as much industrial products as they can. There's simply no interest. For instance many European families choose to buy only one car although they could afford several. The reason for that is that just owning a bunch of stuff is not a status symbol any more. People are more interested in the environmental impact of it for instance etc Indirectly, the social layering is being restructured as well, where simple material wealth means much less.

[*] Industrial automation. Unlike America, industrial labour is expensive and less people are willing to work in industry. In addition we have very protective labour laws and regulations. The very clear trend is a technological solution. If you look at a General Motors plant in the US, you'll see lots of people working there to assemble cars. In Europe you'll see robots doing the same task. In America it's cheaper with people, in Europe it's not.

[*] Strong social security and good working conditions. People in Europe demand complete social protection, a strong  and free healthcare, education etc That costs a shitload of money. In addition labour laws are very strict and people want protection in that area. In many EU countries, the number of standard work hours per day has been reduced from the traditional 8h to as low as 6h. Obviously people like that, and again, that costs a shitload of money.

[*] Foreign production. Lots of industrial production and even R&D is moving to cheaper countries, such as India.

These developments are very incompatible with traditional industrial captialism. We're at a border right now, moving away from the industrial society the same way we some 150 years ago moved away from the agricultural society. In Sweden for instance in  1850 some 90% of the population worked in agriculture. Today it's less than 2%. The rest moved on to the industry and today we're facing the next step, but we don't really have a clue what it will be and how the transition will be done.

It seems that the next step will be a cultural production, knowledge production and stuff like that. The industrial sector will be marginalized, just like the agricultural was. And while this change is certainly natural and good, we're in for a rough ride. Remeber what happened after the industrial revolution - the complete exploitation of workers which in turn led to communism etc.. There's no reason to expect any less problems in this step. And our demographic problems arn't exactly helping.

America on the other hand has a strong labour market, weak social security and a very willing market. So you'll be fine for a while at least. And when you reach the point where we are, you'll be able to draw experiences from our development.

[Tex -USMC- 0]