From this morning's Wall Street Journal:
WSJ.com - Capital: Every year for the past several, the U.S. has imported ever more than it exported... financ[ing] these purchases by borrowing more from China, Japan and other thrifty countries. How long can this go on? As long as foreigners are willing to lend.... How long is that? No one knows. Furrowed-brow economists have been warning for years of an imminent, market-rattling, recession-provoking crisis: a plunging dollar, sinking stocks and soaring U.S. interest rates when foreigners decide to put their money elsewhere. These econo-worriers have been wrong -- so far.
But there are fresh warnings. After a brief respite, the dollar is sinking against the euro and yen.... The next president... can't count on continuing what amounts to "low-cost finance for America at a time when savings are low" coupled with "strong exports for those who are providing the finance," as Harvard University President Lawrence Summers put it... the current-account deficit... now is at a record 5.4% of gross domestic product. Even when the U.S. was a capital-hungry developing economy in the late 19th century, the deficit never topped 4%.
The "why worry?" school sees the flood of foreign money as a sign of American strength: The U.S. is a country that capital is trying to get into.... That argument was more comforting in the 1990s, when the U.S. borrowed to invest in machinery, computers and software, hoping those investments would produce profits and exports that would pay off the debts. After the investment bubble burst in 2000, the U.S. kept borrowing and saved less. Foreign money now finances health care and housing, which are hard to export, as well as America's imported-oil habit. It also would be comforting if private global investors were putting money in the U.S. But more and more of it comes from Asian central banks, parking huge dollar reserves in U.S. Treasury debt. Holding $1.2 trillion in U.S. Treasury debt gives China, Japan and other governments good reason not to pull the plug on the U.S....
If a president sought a pre-emptive strategy -- instead of waiting for markets to attack or foreigners to keep money home -- what would his economists prescribe? [C]onsume less and save more.... The rest of the world must consume more, particularly stuff made in the U.S.A.
The easiest way for the U.S. to save more is for the government to borrow less. But the U.S. isn't going to raise taxes and cut spending enough to solve the problem.... An alternative fix is for the dollar to weaken enough to make imports prohibitively expensive to Americans and U.S. exports irresistible to foreigners.... [T]he cure could be nearly as painful as the averted crisis. It would take a huge dollar move -- a decline of at least 20%, and maybe 40%, against all trading partners, economists Maurice Obstfeld and Kenneth Rogoff estimate. A 30% decline in the dollar against major currencies but not China's would shrink the U.S. current-account deficit by 1.4 percentage points of GDP, the Organization for Economic Cooperation and Development projects. And it would hurt. Global growth would slow, the Federal Reserve would boost short-term interest rates by three full percentage points to resist inflation....
"The global economy is more vulnerable today than it seemed four years ago, when it already looked worrisome," Mr. Rogoff says. "If the current account closes up under relatively benign circumstances, then the effects may not be too traumatic"... The only hope is a little of everything and a lot of luck. Cut the U.S. budget deficit to raise U.S. savings, while encouraging Americans to save more. Get China and other Asian economies to let their currencies strengthen so the dollar can slide, convincing them that the alternative risks inflation in their economies and a global market crash that will hurt them, too. Persuade central banks in Japan and Europe to keep rates low enough for their consumers to pick up some of the slack as the U.S. saves more.
The day after the election would be a good time to start.
Once again, there is a huge puzzle here. We academic economists all see a large forthcoming decline in the dollar. But financial markets don't--or, rather, holders of dollar-denominated assets don't appear to want to be compensated for bearing the risk of the substantial dollar decline sometime over the next decade that we economists read written on the wall by the course of the U.S. current account deficit.
And monetary policymakers? I cannot tell. They seem to be split. I'm told that X makes "a pretty persuasive case that the U.S. current account deficit will fall with a substantial period of very low consumption growth" and dollar decline, as happened in the late 1980s. In the 1980s the falling dollar was not accompanied by (much) higher U.S. interest rates--for reasons we don't understand. Y is deeply puzzled by the failure of financial markets to have already priced the likely fall in the U.S. current account deficit and the value of the dollar. Z, W, and V believe that, as in the 1980s, the U.S. current-account adjustment is likely to be prolonged and "smooth." And U is quietly freaking out.
Posted by DeLong at October 28, 2004 09:54 AM | TrackBackWhy worry?
Its the old story of the company store:
The people arrive in the town dassled by all the nice stuff in the company store. The store owner says, "Sure you can have these nice things - And get this - you don't even have to pay me (now)"
Later its: "Oh you don't have cash. Hmmm... I 've got it! you can work it off!"
Except the real crime is that we aren't going to work it off -- our kids are.
Posted by: Michael Carroll at October 28, 2004 10:07 AMdaZZled that is.
Posted by: Michael Carroll at October 28, 2004 10:09 AMWell, I'm not an economist, so I have no clue. I do know that the chances of a relatively benign, 1980's style adjustment are probably greatly enhanced by a Kerry victory next Tuesday. Common sense tells us that this is yet another policy that W would manage to screw up completely.
Posted by: flory at October 28, 2004 10:25 AMAsian central banks have been propping the Dollar through purchase of Treasuries at fantastic rates to insure the American Consumer market. This will be discontinued in the coming year, no matter who is President, as these Asian nations face inflationary pressures from rising Consumer expectation within their own countries. Will the Dollar devalue? Good Question.
Reinstitution of Business and Corporate taxes to rates existent in 1998 will strengthen the Dollar against foreign currencies. Canceling the Bush Tax Cuts for the Wealthy, as Kerry plans, will not save the Dollar--it will devalue 30%(I would say 50%, but I already scare people). The reelection of Bush will mean a $5 trillion Federal Budget by Y2007, as the Dollar will devalue to the rank of the Mexican Peso. lgl
Posted by: lgl at October 28, 2004 04:29 PMAsian central banks have been propping the Dollar through purchase of Treasuries at fantastic rates to insure the American Consumer market. This will be discontinued in the coming year, no matter who is President, as these Asian nations face inflationary pressures from rising Consumer expectation within their own countries. Will the Dollar devalue? Good Question.
Reinstitution of Business and Corporate taxes to rates existent in 1998 will strengthen the Dollar against foreign currencies. Canceling the Bush Tax Cuts for the Wealthy, as Kerry plans, will not save the Dollar--it will devalue 30%(I would say 50%, but I already scare people). The reelection of Bush will mean a $5 trillion Federal Budget by Y2007, as the Dollar will devalue to the rank of the Mexican Peso. lgl
Posted by: lgl at October 28, 2004 04:33 PMHasn't the euro/dollar rate gone from something like 1.35 euros/dollar to .80 euros/dollar in the last 2 or so years. Isn't that a pretty substantial devaluation already?
Posted by: John Casey at October 28, 2004 04:53 PM>
Now Brad teases us with a blog à clef. . .
Last week I asked one likely Y whether she agreed with her colleague Mr. McTeer's comment about the unidirectional prospects for the dollar. Naturally she dodged the question -- and further, professed to have no opinion on the subject!
Does it make sense to have Fed people sworn to silence on policy regarding the exchange value of the currency?
Posted by: Bob at October 28, 2004 07:22 PMI think what you are describing is pretty typical investor behavior. Aren't most investors more likely to hold until the investment is absolutely untenable--say, until a default on California state bonds--, and then bail en masse, sending the dollar through a series of huge jumps, tending drastically lower? That's what makes bubbles, no? And a few investors will make piles, proving that is is possible to time the market if you are really sharp and have nerves of steel, and most will lose their shirts. I...don't see what there is to be surprised about here. There's reason for concern and I would very much like to see more sensible US trade, currency, and monetary policy, sure, but surely there's nothing new here?
Or am I an ignorant outsider?
Posted by: Randolph Fritz at October 28, 2004 09:52 PMrefinance mortgage
Posted by: refinance mortgage at October 29, 2004 03:41 AMI would like to tighten up the puzzle a bit.
The question is not how the current account balance is being financed today. Central bank intervention is the answer to that. The question is why profit-seeking speculators do not overwhelm the central banks by selling dollar assets in sufficient volume to drive forward dollar exchange rates down to levels that would (if realized) stabilize the balance of payments.
I think the answer to this question involves a theme that has been recurring in recent years. The force of stabilizing speculators is weaker than -- and habitat effects are stronger than -- neoclassical economists instinctively assume.
I don't know why this is the case, as there seems to be know shortage of prop desks or hedge funds around the world. But we see its effect or lack of effect in many places. On the run Treasury trade at a reliable premium to off the runs, with arbitrage forces affecting only the repo rates. Swap spreads move in and out in response to corporate and mortgage-player hedging and other purely supply/demand effects. Changes in longer-dated implied volatility are driven more by mortgage supply and the relative importance of the GSE bid than by considerations about realized vol. And now this dollar puzzle.
Part of the issue here may be that financial market paricipants are not as smart of as convinced in their views as Dr. Delong. Most of the folks I know don't contemplate imaginary numbers for fun or calculate the arc of a sunset and the shadows cast by it. Instead, they are bogged down in ephemera like "resistance" and are always careful not to "overthink" an issue. The notion that they have the conviction and patience to wait out the BoJ or PBoC is probably false. Maybe George Soros could do it, but he is too busy saving the USA to trash its currency. Or maybe he realizes he just got lucky breaking the BoE that time.
Regarding the article, why does the journalist suggest that dollar depreciation and a decline of domestic absorption are ALTERNATIVES. Clearly, the two work together. A dollar decline will be required to accommodate the trade improvement implied by a rise of national savings relative to investment. Or vice versa. This seems fairly straightforward, but I have never seen a journalist get it right.
I think what he meant to say is that the dollar landing will be softer on the USA if the ex-ante movement is on the domestic side, that is, if Americans try to improve their financial balances before the rest of the world tries to slow its capital inflow (at prevailing asset prices). That might not be pretty. It would level a temporary hit to US living standards, but it would beat the hell out of a foreign lenders' strike triggering the dreaded hard landing. Interestingly (to me anyway), it would generate downward pressure on the dollar AND interest rates.
I find it strange that even the big thinkers on this issue like Ken Rogoff have trouble getting their head around the notion that the interest rates might actually fall during the adjustment if the FIRST MOVERS are domestic. They see dollar weakness and higher rates as joined at the hip. But the alternative mix is at least conceivable, having been the established trend for about three years now.
Posted by: Gerard MacDonell at October 29, 2004 05:17 AMThis is another fine mess you free traders and capital movers have gotten us into. Thanks a lot.
Posted by: la at October 29, 2004 08:28 AMThe Economist this week published some research into the US twin deficits that are said to threaten the global economy.
It's not good news for any currenciy that is subject to heavy political manipulation. The study suggests that there is now a haven for Asian money other than the dollar - it is the euro. Although the discipline in the eurozone is starting to break down, the currency risk for the euro is still very much less than the dollar. "In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar—and the fall-out in other financial markets—could well be larger." http://www.economist.com/finance/displaystory.cfm?story_id=3329902
But if the object of the game is to minimise currency risk, surely an even safer haven for international investors is gold? On the other hand, national democracy is the way to go - voters might want policies that maximise currency risk.
See democracy.
"I find it strange that even the big thinkers on this issue like Ken Rogoff have trouble getting their head around the notion that the interest rates might actually fall during the adjustment if the FIRST MOVERS are domestic."
Sorry to be dense, Gerard, but could you explain how that works?
Posted by: Curious at October 29, 2004 09:51 AM"We academic economists all see a large forthcoming decline in the dollar. But financial markets don't-"
Sounds like a money making opportunity for these academic economists. Wonder how many are putting their money where their mouths are?
Posted by: PM at October 29, 2004 10:28 AM"The question is why profit-seeking speculators do not overwhelm the central banks by selling dollar assets in sufficient volume to drive forward dollar exchange rates down to levels that would (if realized) stabilize the balance of payments."
There is no advantage to them to do so; they are hoping to make killings by timing the market.
Posted by: Randolph Fritz at October 29, 2004 11:46 AMWhy is it that "holders of dollar-denominated assets don't appear to want to be compensated for bearing the risk of the substantial dollar decline?"
This will probably sound like a black helicopter theory to most. I think this is all tied to Peak Oil.
Japan and US governments understand Peak Oil. Japan props up the US economy by purchasing US treasuries, while keeping the Yen reasonably weak. In return, their economy which is 99% dependent upon energy imports, secures those supplies via the US military forces which occupy territory holding the richest energy supplies in the world. Japan can live with the long term currency risk, but not the immediate-term problem of energy dependency in a post Hubbert-Peak world.
Unfortunately it's not going as well as planned and energy prices are rising nonetheless. Via the petrodollar, foreigners pay higher prices for energy when the USDX is strong. Sometime in 2005 expect them to run out of fingers to plug the dike, and let the dollar fall, in order to pay lower relative prices for energy (China and Japan).
The other scenario would be demand destruction via a world recession or some form of engineered fall in demand -- a theory I will not even begin to elaborate on because it makes me ill just thinking about it.
If you understand Peak Oil, the world suddenly begins to make sense in an Occam's Razor kind of way.
IJ, as for a strategy to avoid the devaluation, I'm into precious metals and foreign bond funds such as Templeton Global (ticker GIM). It pays 5% and in just a few weeks my capital appreciation is already 3%. There are also a number of foreign currency CDs at everbank.com which pay about 3% annualized yield on a 3 month. They are FDIC insured, except for the currency risk ;)
Posted by: whocanitbenow at October 29, 2004 03:56 PM"refinance mortage"
Near on-topic spam? Good grief!
Posted by: Randolph Fritz at October 29, 2004 04:11 PMCurious: You are hardly dense. The intuition for thinking about things in ex-ante terms is hardly natural. And there is a 49% chance I am wrong anyway. Hell, I ain't George Bush! I have to figure this stuff for myself and am not inerrant.
But I figure that if Americans decide that they want to borrow less before foreigners decide they want to lend less, then interest rates here will fall or at least rise less than would otherwise be the case. But if the story starts with the premise that the trade deficit and the S-I gap are going to narrow, then the dollar falls regardless of who the first mover is.
I hope this clears up your self-said confusion. The next course of treatment is 5,000 words or maybe some references. Plus, as I said, I may be wrong. Thanks for asking.
Posted by: Gerard MacDonell at October 29, 2004 06:28 PM"The question is why profit-seeking speculators do not overwhelm the central banks ..."
Overwhelming the central bank of an Asian nation is fundamentally an undertaking an order of magnitude more difficult than overwhelming the Bank of England, just as overwhelming Okinawa in WWII was an order of magnitude more difficult for the U.S. than overwhelming Singapore was for the Japanese. Asian power elites are ready, willing and able to defend their turf with a tenacity and ruthlessness unimaginable to the Western mind. Had Singapore been defended the way Okinawa was, the Japanese offensive would have failed.
The Bank of Japan expended more than $300 billion last year to keep the dollar up, and has governmental authorization to spend a trillion more. Scaled to GDP, that's as if the U.S. government had spent $600 billion on currency intervention, with an authorization to spend $2 trillion more.
Might that trillion-dollar bulge under the BOJ's armpit be some reason for the speculators to be reluctant in challenging it?
Posted by: jm at October 30, 2004 12:00 AMGerard, thanks for clearing that up for an amateur like myself, it makes sense. With American household savings grinding the bottom of the seabed last month at 0.4%, maybe borrowers really will be the ones to freak out first.
"Near on-topic spam? Good grief!"
Heh... that f-ing bit of spam has appeared so many times, it reminds me of the old saying - even a broken clock is right twice a day.
Posted by: Curious at October 30, 2004 07:24 PMhttp://www.ny.frb.org/research/current_issues/ci10-10/ci10-10.html
or in pdf at
http://www.ny.frb.org/research/current_issues/ci10-10.pdf