Broken Greenbacks and Foreign Aches April 26, 2007
Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst and editor of the website GlobalMacroScope.
As we pointed out in our February contribution, America has been masterful at exporting the pain of falling dollars and failing policies. She has been adept at transferring the short term costs of trade and savings shortfalls as well. This occurs because our external assets are held in other nations’ local currencies. Our liabilities, endlessly growing, are in US Dollars. Pain is being felt in the Gulf States, East Asia and Europe. Oil exporters earn devalued dollars in currencies linked to the greenback. East Asia sits atop a scandalously underperforming Everest of dollar reserves absorbing ever more at a rising pace. China now possesses $1.2Trillion in reserves on the back of increases of $137billion in 1Q2007. Russia has just announced plans to invest and diversify its growing reserve holdings. Europe faces export difficulties, a likely decline in American tourism and decreased cost competitiveness as the dollar falls and money seeking return pushes up the Euro. The greenback has given up a trade weighted 30% of its value since 2002. The developing world, emerging markets, have benefited from new found interest and faith. So has America, as these nations have retired billions in net outstanding liabilities. Where else can one lend? The USA seems to be the answer.
The housing meltdown is accelerating and there is more to come. The nasty April 24, 2007 March report from the National Association of Realtors shows a 9.5% decline in existing single family home sales and inventory rising ahead of the essential spring/summer selling season. We have gone from frothy to frosty. This further pressures dollars. The extent and duration of downward economic pressure is sure to increase the likelihood of Fed rate cuts. This is exactly the “painted into a corner” scenario we feared and discussed as the Fed cut rates and left them low so very long. The Fed is left to choose between further Dollar weakness and interest rate relief required by the masses. The Fed will have to try to thread this needle. As they do, bet on tumult in currency and assets markets.
American equity indexes have soared. Europe’s indexes have done better in percentage terms, and much better if adjusted for currency performance. Emerging market bonds have done well and swoons have proved buying opportunities of late. Here too, non-US indexes are out performers and would be more dramatically so with true floating currencies. China’s voracious demand places a rising floor under the many commodities it imports, not least metals and oil. This can be seen in China’s trade deficit with many primary exporters. We are still the consumption end of the line for too much of what emerging market raw materials and industrial exporters offer. They must lend to sell, and they have. Their cost to lending is measured in sub-par absolute returns, and their assumption of increasingly painful US dollar currency risk. Thus, the cost of subsidizing America is rising. This is occurring as the American economy slows.
One must begin to fear that the rest of the world will realize what leading American firms already have; future growth and opportunity is offshore. Adjustment risks are growing. This occurs not because we are more integrated, but because of how we have been integrating and specializing. Protectionism is not the answer and would result in real pain, real fast. System risk arises from specialization between borrowers/lenders, makers/buyers. This is not the efficiency enhancing specialization that Adam Smith and David Ricardo espoused! The 2007 IMF Global Financial Stability Report details the world’s 2006 exporters and importers of capital. Four leading exporters (China, Japan, Germany and Singapore) export 37% of the globe’s capital. Six leading oil exporters (Russia, Saudi Arabia, Kuwait, UAE, Algeria and Venezuela) exported 29.3% of the world’s capital in 2006. The US accounted for 64% of the capital imported in 2006! The US was 4.7% of world population and 20% of world GDP in 2006. America’s $856.7billion 2006 deficit in balance of payments on current account represented 152% of the total shortfall of the world’s “advanced” economies. Our $765.3 billion negative balance on goods and service trade lies at the heart of the present global specialization problem. This system of integration and specialization is dangerous and long-term inefficient.
Attention has shifted away from the structural problems as market performance has been strong and corporate earnings robust. Record breaking corporate profits, strong consumer spending and asset appreciation have produced GDP growth and a sense of things on track. These developments are largely fueled by the global structural imbalance and speak to US macroeconomic dependence on our specialized place in the global economy. This is long term unhealthy. Corporate earnings, decelerating, are strong on lower than average wage and tax bills. This has not produced the usual problems as consumers and government agencies are happy to borrow and spend. The world lends. Falling dollars and growing opportunities to manufacture, design, sell and invest offshore are helping many firms. Falling dollars increase the value of foreign earnings. Private Equity binge buying and massive stock repurchasing is reducing the supply of equities. This lifts indexes. Of course much of these shares will be sold back to the public and buybacks float with decelerating earnings. Foreign buying and easy low cost leverage also assist in the process. This, and the lowered cost of US assets in foreign currency terms, attracts buyers to our equity markets.
Taken together, all this suggests that our proofs of economic strength are largely pleasant symptoms of an unsustainable global economic position. This has been true for some time and does not have to unwind soon or violently.
The relatively smooth recent period could have been used to improve our structural economic health. Instead we have been euphoric about the most beneficial symptoms of our ailing global economic position. So far broken greenbacks and policies have mostly caused foreign aches and pains.
