2005 March 22 Tuesday
John Maudlin And Stephen Roach See Dollar Declines Against East Asia
John Maudlin thinks East Asian central bank demand for additional US sovereign debt is going to come to an end.
"Prime Minister Koizumi of Japan said his country 'in general' needed to consider diversifying its foreign currency reserves, the world's largest. 'I think it's necessary to diversify the investment destinations' of foreign reserves, Koizumi said. 'At the same time, we have to make a judgment in general, considering what's profitable and what's stable.' This is a big step for Japan, as they have generally always talked about their reserves as a monetary policy tool, rather than a financial investment. With $820 billion now at stake it is clear that the government is concerned about their returns, and the returns of dollar assets to a global investor have recently been ugly. If Japan is going to start moving $820 billion dollars around, it is inevitable that others will try to get ahead of them." (Bridgewater)
Immediately, Japanese Ministry of Finance officials began to either outright deny Koizumi's statement or suggest that the press did not understand the clear intentions of his words. But understand this, if the dollar were to drop 15% against other Asian currencies, while Japan fought to maintain their dollar yen ratio above Y100 to the dollar, Japan would lose over $100 billion in purchasing power. That is not small potatoes. Koizumi recognizes this and also recognizes the serious strain that their government deficits and huge debts have on their economy. Koizumi was clearly stating that losing $100 billion is not going to be politically acceptable.
As I said a few weeks ago, the dollar is going to become the Old Maid. It is going to start being passed around from country to country in an effort to lessen the impact of a falling dollar in the local economy.
At some point East Asian policy makers are going to accept that they can't keep propping up their currencies against the dollar.
Morgan Stanley chief economist Stephen Roach also thinks the US trade deficit and the East Asian holdings of US debt have both gotten so large that East Asian central banks are going to start looking for ways to minimize their losses when the dollar inevitably declines against their currencies.
And so the US must then run massive and ever-widening current account deficits to attract that foreign capital. And ever-widening it is: America’s broadest measure of its external shortfall was just reported to have hit an all-time record of 6.3% of GDP in 4Q04 -- an astonishing 1.8 percentage point deterioration from the 4.5% deficit a year-earlier in 4Q03. Not only is this a record current-account deficit for the US, but it is also a record financing burden for the rest of the world. Based on the annualized current account deficit of slightly more than $750 billion in the final period of 2004, America now requires an average of $2.9 billion of capital inflows each and every business day to keep the magic going.
Roach says the foreign buyers of US Treasuries are on the verge of deciding that adding ever larger quantities of US Treasuries to their portfolios is too bad of an investment to continue buying much longer.
The Washington spin is that foreigners can’t get enough of dollar-denominated assets and the returns they offer in an otherwise return-starved world. Don’t kid yourself. This rush of foreign capital is not about private investors plunging back into US assets. It is a conscious policy move on the part of foreign central banks. The US Treasury data do not accurately reflect the obvious -- an extraordinary build-up of dollar-denominated official foreign exchange reserves held by the world’s monetary authorities. By our estimates (based on IMF data), total reserves increased by about $700 billion from year-end 2003 to year-end 2004. Assuming that the dollar share of such holdings held steady at around 70% (an official BIS estimate as of late 2003), that implies an increase of nearly $500 billion in dollar-denominated holdings of the world’s central banks -- confirming that foreign central banks financed about 75% of America’s current account deficit last year. That policy-driven financing is a bold effort on the part of foreign central banks to keep their currencies from rising and defer what could be an otherwise painfully classic US current account adjustment -- complete with a further decline in the dollar and sharply higher US interest rates. The resulting subsidy to US interest rates -- and the asset-driven consumption that engenders -- goes a long way in cushioning the blows of stagnant real wages and surging oil prices that might have otherwise clobbered the American consumer.
But the message from overseas is that this game is just about over. One by one, Asian central banks -- America’s financiers at the margin -- have dropped the not-so-subtle hint that they are saturated with dollar-denominated assets. From Korea and Japan to China and India -- not to dismiss Malaysia, Hong Kong, and Singapore -- there is a growing protest to massive dollar overweights in official reserve portfolios.
Andy Xie, also of Morgan Stanley but stationed in Hong Kong, says property bubbles in the United States and China can not go on indefinitely.
What may occur soon is another scare, in my view. Property bubbles support demand in the US and China. Until property prices begin to decline in New York and Shanghai, the game is not over.
Household real estate values in the US increased by $2 trillion or 13.4% in 2004 compared to $1.4 trillion or 10.5% in 2003. US personal consumption rose by $505 billion in 2004. On the surface, the balance sheet of the US household sector is much stronger than one year ago due to asset inflation. As long as property prices keep appreciating at the current pace, why should the US consumer stop spending and start saving?
Strong US consumption has kept China’s exports strong. Hot money continues to pour into China. China is not investing all the money that it has. The surplus liquidity in the banking system is very high. China’s property sector continues to expand rapidly. Over the past three years, property prices have doubled in major cities in the Yangtze Delta region and increased by 60% in most provincial capital cities. The sales of new properties reached 7.4% of GDP from 4.7% three years ago and 2.1% in 1997. New property projects have been growing at 15% per annum in square meters in the past three years. The properties under construction, when completed, are worth more than one-third of GDP at current prices. As most developers expect double-digit price increases, the inventory-carrying profit is expected to exceed 3% of GDP per annum. The profits of S&P 500 companies are only 3.5% of the US’s GDP. This is why the investment desire is so strong in China.
The problem with the US property bubble is that it is making people think they are worth more and therefore they are more eager to spend money than they ought to be. By purchasing such large quantities of US Treasuries East Asian central bankers have created large distortions in American market's demand for capital, housing, and consumer goods. When East Asian central banks slow or stop their US Treasury bond buying spree interest rates in the US will rise and that will put a big crimp into US housing prices. Prices of imports will rise while at the same time foreign demand for US products combined with a shift of US demand from foreign to local goods will create additional inflationary pressures. The coming decline of the East Asian demand for US debt will therefore likely trigger an inflationary recession.
I believe the term used in the late 1970's was stagflation. Double digit interest and inflation and high unemployment rate in places other than the oil producing areas.
But,on the bright side, won't a dollar deevaluation make our exports cheaper and domestic consummer goods more competitive to imports. Would a more realistic dollar to Asian currency be in the best interests of our economy? I don't know, just asking.
U.S. dollar devaluation will reduce the value of foreign dollar holdings since it will drive up interest rates (and thus prices) in the U.S.
The problem is compounded by the following:
1) Like the stockmarket equities in the late 90's, everyone is deluded that real estate prices will go up forever. Call it irrational exuberance II. Like equities, the longer the bubble goes, the harder the fall when it comes, as it must. Simple law of economic gravity, what goes up must come down. Why people delude themselves that any particular thing that they happen to be into is exempt from this is beyond my conprehension. Chalk this one up top our buddy Alan Greenspan, who created this bubble in the first place.
2) We have inflation. Of course the FED (under Greenspan) does not call it inflation because, golee, its not in the core CPI, but we have inflation. See, Alan Greenspan "redefined" inflation several times in the 90's. The first time was in '93. He said that since products get better quality over time because of technological improvement, that the then CPI over estimated inflation. This is a crock because defining such improvements in quality is very subjective, which Greenspan admitted at the time. So, with this adjustment, the CPI and, therefor, the inflation figures that the government issues also becomes subjective.
Later, Greenspan redefined the CPI again because, afterall, when the price of a particular thing goes up, people shop around for a substitute. Of course, the notion that we shop around for a substitute is because the price of the original thing went up in the first place never occured to them.
So now, thanks to our body Alan Greenspan, we no longer have an objective measure of inflation. We have twaddle and handwaving instead, whereas the prices of everything from cinema tickets to groceries keep going up and up.
3) Thirdly, we have our buddy Dubya in the while house, supposedly from the party of fiscal responsibility, who has gone on a spending binge that would make Teddy Kennedy and Tip O'neill (remember him?) proud.
The problem started with Clit-man and Greenspan. We had a sluggish recovery in the early 90's and I suspect that Greenspan decided to "re-define" inflation in 1993, mainly to keep Clit-man from replacing him and to make his own job easier. Clit-man, being the corrupt shit that he is, went along with this so that the economy would get an artificial boost that he could take credit for.
Later, as the economy grew, Clinton denied the funding that the SEC needed to enforce the securities regulations to keep the large companies from cooking their books. It is no accident that Clinton got lots of corporate donations in 1996. As payback, SEC enforcement became even laxer. The result is the whole acounting scandal that a significant percentage of corporate America indulged in the late 90's. The acounting shenanagans created much of the equitie bubble of the late 90's. The other part of it was Greenspan's decicion in 1998 to furthur increase the bubble rather than reining it in (like he was supposed to). He did this in two ways: He bailed out that hedge fund and he lowered rather than raised interest rate, both of these in 1998. This resulted in a clearly unsustainable 1920's style bubble, which finally collapsed in 2000-2001. Of course, Clinton went along for the ride.
There is another tend which occured in the 1990's which is not often discussed in the business media. That is the rise of the influence of HR, finance, marcom, and other "staff" functions within corporate America. This is especially clear when you go to look for a job in say the semiconductor or other technical fields. In the 80's and early 90's, you were likely to talk to the actual hiring manager. That is, if you were interviewing for a sales position, you would talk to and get interviewed by a sales manager. If you were interviewing for an engineering position, you would talk to and get interviewed by an engineer or an engineering manager. The only time you dealt with HR people is when you git hired and you met with them to get your holiday and medical benefits squared away.
Today, HR is directly involved in the hiring process. You have HR "professionals", few of who have ever worked as an engineer or sales person, who make the decision about who gets hired or not. There was a comment made a few years ago that if some of the founders of the whole semiconductor/IT industry (people like Bill Gates and others) were to apply for jobs under anonymous psuedonames, that many of them could not even get a job in the industry. This shows the parasitical nature of HR and "staff" bureaucracy.
If I ever become the American "fuhrer", the HR and other "staff" people in corporate America will be the first to go to the camps.
I see scientific instrumentation start ups staffed with people who worked as management consultants. In the "old days" (the 80's), a scientific instrumentation start-up would be staffed with people who had made or sold such instrumentation before, ir who at least had the engineering knowledge to design and make such instrumentation or who could sell it.
This was the situation as of 2001. Then came 9/11 and our buddy Dubya gets converted to the crusading empire.
Did you know that Dubya has yet to veto a single spending bill sent to him? We no longer have a major political party in this country that is committed to limited government and fiscal responsibility. Like Nixon in the 70's, the old parasitism of Nelson Rockefeller and the big spending republicans has risen from the swamp like the smelly thing that it is.
We had a chance in the early 90's. We had a recession that appropriately corrected the excesses of the 80's. Like any "rational" recession, prices declined somewhat, especially real estate. Corporations and entire industries were restructuring, becoming lean mean and competitive and cutting out the dead weight. The country was poised for long term stable growth by 1993 or so. Clinton and Greenspan threw that all away for short term benefit and personal agrandizement. Then, we get Dubya, who has more moral back bone than Clinton ever had, but is too stupid and ignorant to understand economics.
So, here we are now. Just in time for the baby boomers to retire, grow old, and sink the economy.
You know, maybe I should move to Singapore and start a business there.
One of the scary parts here is that the savers and taxpayers of the countries, such as Japan, which are financing our wildly irrational binge of borrowing from foreign central banks, are starting to realize how badly they are being rooked. They are having their life savings replaced, by their central banks, with what, by now, is the equivalent of Argentina bonds, with no reasonable prospect of repayment.
Folks, the dollar isn't going much of anywhere, and here's why.
Communist China is, apparently, still determined to keep it deliberately cheap currency, so as to wipe out its East Asian competitors (our allies, BTW, and that's no accident) and damage several U.S. industries. In order to maintain that currency, it must depress the demand for its own currency and prop up demand for the dollar. So it will keep buying U.S. securities.
The ChiComs are doing this for their own interests, and none of them are good. But destroying the dollar is not one of them; it's still far to useful for the cadres.
The solution is to slap a currency corrective tarriff on every Communist import. That will, at least, counteract the currency manipulation.
I saw the dollar lose more than half of its value in the late 1980s; no one batted an eyelash back then. What matters is the fundamentals of the American economy. Not to say those fundamentals are good, but that's what's important, not the currency value.
D.J. McGuire: I was stationed in Germany as a member of the USAF during 1973 when the dollar deevaluated against the German mark dropping from 3.26 marks to 1.65 marks in a matter of months. Made it tough to survive on an already high cost of living German economy.
I don't know what caused the deevalustion against the mark but do know the dollar stayed relatively staticagainst the French and Swiss currencies.
Upon return to the USA in 1977 I saw double digit inflation and the highest interest rate in my young adult life! I always thought that just maybe the deevaluation of the dollar might have had something to do with the stagflation.