Thursday, December 03, 2009
Strong and Weak Money
Vietnam recently decided to depreciate their currency, the dong, by 5%, raising concerns throughout Asia about the possibility of competitive currency depreciations. Vietnam has a strong export sector, which is facing heavy competition from other Asian producers, including China and Thailand. If labor costs cannot go lower, if productivity cannot be raised, why not make Vietnam’s exports cheaper by simply making the dong worth less, meaning a dollar or Euro goes further than it did before.
The contradiction of Asia is that every country wants their currency to be strong and weak at the same time. Strong currencies are viewed as stable, and attract investment. Yet weak currencies allow the country to export goods that seem cheap in other countries.
How will China respond to this move? They might like to depreciate the Yuan, which has strengthened 17% against the dollar since 2002. After all, that would make their exports more competitive with Vietnam’s exports. China has been marked by a very slow and consistent approach to foreign exchange. There do not seem to be any sudden changes when it comes to policy about the value of the Yuan. It’s been assumed by most observers that the strategy is simply to capture the American market with low prices (which they know we can’t resist).
China’s goal may be far more ambitious: to create a new global reserve currency. Could the Chinese Yuan be a contender for that illustrious role? Such a possibility seems unfathomable. The natural contender to the dollar is clearly the Euro, the currency of the world’s largest trading economy, the Eurozone. After the Euro perhaps is the Yen. But China’s growth is far more vigorous than that of the Eurozone or Japan. Investors of all kinds want to get in on China’s growing markets, exchanging Euros or dollars for Yuan, which steadily pushes up the value of the Yuan. Since the Yuan is stable (and in fact, standing behind it is the largest currency reserve the world has ever seen), investors have faith it will keep its value.
What does China do with it’s growing foreign exchange surplus? It’s much more than they need to stabilize the Yuan’s value. They buy assets of real value: gold, copper, rare earth elements, stocks, real estate, and of course, government bonds, many of them US Treasurys. As long as China’s growth continues to be vigorous, the Chinese economy will draw in more and more outside capital. The lion’s share of the world’s Foreign Direct Investment is in the Eurozone, but utilized FDI in China has increased 10% a year since 1999, on average.
It’s unclear whether China’s goal can succeed. But they seem to be pursuing it with some vigor, and if they cannot be the world’s reserve currency, they can at least be part of a few key currencies, finally accepted as a great industrialized power. It seems increasingly clear that the US dollar will lose its spot on that list, particularly with the recent decision to commit even more troops to Afghanistan, which will add billions to the US fiscal hole.
The contradiction of Asia is that every country wants their currency to be strong and weak at the same time. Strong currencies are viewed as stable, and attract investment. Yet weak currencies allow the country to export goods that seem cheap in other countries.
How will China respond to this move? They might like to depreciate the Yuan, which has strengthened 17% against the dollar since 2002. After all, that would make their exports more competitive with Vietnam’s exports. China has been marked by a very slow and consistent approach to foreign exchange. There do not seem to be any sudden changes when it comes to policy about the value of the Yuan. It’s been assumed by most observers that the strategy is simply to capture the American market with low prices (which they know we can’t resist).
China’s goal may be far more ambitious: to create a new global reserve currency. Could the Chinese Yuan be a contender for that illustrious role? Such a possibility seems unfathomable. The natural contender to the dollar is clearly the Euro, the currency of the world’s largest trading economy, the Eurozone. After the Euro perhaps is the Yen. But China’s growth is far more vigorous than that of the Eurozone or Japan. Investors of all kinds want to get in on China’s growing markets, exchanging Euros or dollars for Yuan, which steadily pushes up the value of the Yuan. Since the Yuan is stable (and in fact, standing behind it is the largest currency reserve the world has ever seen), investors have faith it will keep its value.
What does China do with it’s growing foreign exchange surplus? It’s much more than they need to stabilize the Yuan’s value. They buy assets of real value: gold, copper, rare earth elements, stocks, real estate, and of course, government bonds, many of them US Treasurys. As long as China’s growth continues to be vigorous, the Chinese economy will draw in more and more outside capital. The lion’s share of the world’s Foreign Direct Investment is in the Eurozone, but utilized FDI in China has increased 10% a year since 1999, on average.
It’s unclear whether China’s goal can succeed. But they seem to be pursuing it with some vigor, and if they cannot be the world’s reserve currency, they can at least be part of a few key currencies, finally accepted as a great industrialized power. It seems increasingly clear that the US dollar will lose its spot on that list, particularly with the recent decision to commit even more troops to Afghanistan, which will add billions to the US fiscal hole.
Wednesday, December 02, 2009
A Very Interesting Animation: Empires Decline
Look at this fascinating visualization of the decline of the great imperial powers of the 19th and 20th centuries. Who might be next, I wonder?
Visualizing empires decline from Pedro M Cruz on Vimeo.
Monday, November 30, 2009
Holiday Spending and the Fed
The veil of illusion that says the dollar has value is being torn away.
Last week’s “Saturday Night Live” had an actor playing President Obama giving a press conference with an actor playing China’s President Hu Jintao, who repeatedly reminded Obama that the US owes China a lot of money. At one point, Hu asks, “Do I look like Mrs. Obama?”, answering the question soon after with: “Then why you try to make sex with me like I was Mrs. Obama!”
Some things can be said in a joke that can’t be said with a straight face.
>
Imagine telling someone back in 1989 that in twenty years China would be the world’s emerging power, and the US would be running to China to ask for more money to plug its enormous deficits, while reassuring China that its money is secure, and politely asking China to respect copyright rules and ensure free internet access (which China will politely ignore).
So where will we be in twenty years from now? The dollar will be discredited, a shell of its previous value, no longer a reserve asset. The world will want currencies backed with real assets, not fiat paper which can be printed at will with the touch of a keystroke.
In the US, anger is rising about the massive financial bailouts engineered by the Fed and the Treasury, which so far have not caused any reduction in unemployment or real economic stimulus. Perhaps this sentiment is why Rep. Ron Paul’s amendment to audit the Fed has passed a vote in committee and is gathering support in both houses of Congress. In a surprise move, Rep Barney Frank delayed a vote on the bill until after the Thanksgiving recess.
Why does the Fed oppose being audited so vociferously? Bernanke says he doesn’t want the Fed to be too influenced by short-term politics, but it’s hard to see how the current veil of secrecy prevents politics from entering into the Fed’s deliberations. The country ought to know what the Fed is doing (or was doing, as the bill calls for the release of information only with a 6 month lag).
Early reports on Black Friday, the largest single shopping day in the US, indicate a very small increase in spending over last year of 0.5%. Strangely enough, articles on Black Friday never seem to adjust sales figures for inflation. Given that the CPI rose 0.5% in the last two months, it’s more accurate to say that spending is flat or declining in real terms. We’ll have more details on the numbers in a few days, but the trend toward more frugal spending is still in force. Even if an increase is recorded, we have to keep in mind that retailers are offering massive discounts, which may pull sales to Black Friday at the expense of other days. We’d also do well to recall what products are being discounted: mostly electronics, which are rarely produced in the US. Increases in retail spending on imported goods puts the US economy in a deeper hole. We need to come to balance, and that won’t happen because of an unsustainable surge in retail spending, but rather will be due to growth in the productive sectors of the economy.
Last week’s “Saturday Night Live” had an actor playing President Obama giving a press conference with an actor playing China’s President Hu Jintao, who repeatedly reminded Obama that the US owes China a lot of money. At one point, Hu asks, “Do I look like Mrs. Obama?”, answering the question soon after with: “Then why you try to make sex with me like I was Mrs. Obama!”
Some things can be said in a joke that can’t be said with a straight face.
>
Imagine telling someone back in 1989 that in twenty years China would be the world’s emerging power, and the US would be running to China to ask for more money to plug its enormous deficits, while reassuring China that its money is secure, and politely asking China to respect copyright rules and ensure free internet access (which China will politely ignore).
So where will we be in twenty years from now? The dollar will be discredited, a shell of its previous value, no longer a reserve asset. The world will want currencies backed with real assets, not fiat paper which can be printed at will with the touch of a keystroke.
In the US, anger is rising about the massive financial bailouts engineered by the Fed and the Treasury, which so far have not caused any reduction in unemployment or real economic stimulus. Perhaps this sentiment is why Rep. Ron Paul’s amendment to audit the Fed has passed a vote in committee and is gathering support in both houses of Congress. In a surprise move, Rep Barney Frank delayed a vote on the bill until after the Thanksgiving recess.
Why does the Fed oppose being audited so vociferously? Bernanke says he doesn’t want the Fed to be too influenced by short-term politics, but it’s hard to see how the current veil of secrecy prevents politics from entering into the Fed’s deliberations. The country ought to know what the Fed is doing (or was doing, as the bill calls for the release of information only with a 6 month lag).
Early reports on Black Friday, the largest single shopping day in the US, indicate a very small increase in spending over last year of 0.5%. Strangely enough, articles on Black Friday never seem to adjust sales figures for inflation. Given that the CPI rose 0.5% in the last two months, it’s more accurate to say that spending is flat or declining in real terms. We’ll have more details on the numbers in a few days, but the trend toward more frugal spending is still in force. Even if an increase is recorded, we have to keep in mind that retailers are offering massive discounts, which may pull sales to Black Friday at the expense of other days. We’d also do well to recall what products are being discounted: mostly electronics, which are rarely produced in the US. Increases in retail spending on imported goods puts the US economy in a deeper hole. We need to come to balance, and that won’t happen because of an unsustainable surge in retail spending, but rather will be due to growth in the productive sectors of the economy.
Thursday, November 19, 2009
What Exactly Would a Stronger Yuan Do for the US Economy?
Obama’s trip to China was mostly photo-ops and talk about the importance of trade. The one topic on which Obama spoke sharply was the need for China to allow the Yuan (officially called the Renmimbi) to strengthen against the dollar. Many analysts are criticizing the Chinese government for ‘manipulating’ the Yuan, keeping it too low relative to other Asian currencies. Paul Krugman, perhaps the best-known economist in the US, calls it ‘outrageous’, and accuses China of making its export-oriented neighbors poorer through unfair currency manipulation. Leaving aside the obvious point that all currencies are manipulated—in a world of fiat currencies, no item of intrinsic value stands behind the dollar or the Yuan—let’s explore the question of how the US might benefit from an strengthening of the Yuan.
Back in 2005, the World Bank estimated the Yuan to be undervalued by 10%, based on purchasing power parity. Other economic analyses have concluded an undervaluation of 20 to 25%. Let’s take the upper end of the these estimates and assume the Yuan is undervalued by 25%, and that China, acting for the good of the world, allows the Yuan to appreciate 25% against the dollar. What would that do for the US economy?
The most obvious and immediate effect would be an increase in prices. Consumer price theory tells us that that increases in exogenous costs such as tariffs are not fully reflected in final prices, but the cost is shared by producer and consumer depending on the elasticity of demand. The increase in prices directly translates into increased prices for consumer goods, for apparel, electronic goods, raw materials, food items, etc. It’s hard to see how that rise in prices would benefit American households, who are feeling the effects of 10.2% unemployment and falling home prices. It’s more likely that increased consumer prices would bring significant hardship.
In theory, an appreciation of the Yuan should narrow the trade deficit between the US and China. But it’s likely that the trade deficit won’t fall much (if at all), because consumers driven by low prices are likely to select goods from other low cost producers (Thailand, South Korea, the Phillipines, or India, for example).
Would an appreciation of the Yuan cause an increase in American employment? It’s hard to see how. There aren’t many US industries that are in direct price competition with Chinese exporters. Overall, the US economy is in a process of shifting back toward productive activity (including manufacturing), but such a shift is the product of many structural economic forces, not simply the relative value of the Yuan and the dollar.
As Obama urged China to allow the Yuan appreciate, Zhou Xiaochuan, the head of China’s central bank, fired back that the US needs to get its fiscal deficits under control and raise interest rates. Zhou is clearly correct that currency manipulation (in whatever direction) cannot help the US economy out of its malaise. Only fundamental economic changes can do that. But cutting the deficit in this economy will require massive spending cuts, while raising interest rates will cut off the monetary stimulus, no doubt deepening the recession.
If only it were as easy as blaming China.
Back in 2005, the World Bank estimated the Yuan to be undervalued by 10%, based on purchasing power parity. Other economic analyses have concluded an undervaluation of 20 to 25%. Let’s take the upper end of the these estimates and assume the Yuan is undervalued by 25%, and that China, acting for the good of the world, allows the Yuan to appreciate 25% against the dollar. What would that do for the US economy?
The most obvious and immediate effect would be an increase in prices. Consumer price theory tells us that that increases in exogenous costs such as tariffs are not fully reflected in final prices, but the cost is shared by producer and consumer depending on the elasticity of demand. The increase in prices directly translates into increased prices for consumer goods, for apparel, electronic goods, raw materials, food items, etc. It’s hard to see how that rise in prices would benefit American households, who are feeling the effects of 10.2% unemployment and falling home prices. It’s more likely that increased consumer prices would bring significant hardship.
In theory, an appreciation of the Yuan should narrow the trade deficit between the US and China. But it’s likely that the trade deficit won’t fall much (if at all), because consumers driven by low prices are likely to select goods from other low cost producers (Thailand, South Korea, the Phillipines, or India, for example).
Would an appreciation of the Yuan cause an increase in American employment? It’s hard to see how. There aren’t many US industries that are in direct price competition with Chinese exporters. Overall, the US economy is in a process of shifting back toward productive activity (including manufacturing), but such a shift is the product of many structural economic forces, not simply the relative value of the Yuan and the dollar.
As Obama urged China to allow the Yuan appreciate, Zhou Xiaochuan, the head of China’s central bank, fired back that the US needs to get its fiscal deficits under control and raise interest rates. Zhou is clearly correct that currency manipulation (in whatever direction) cannot help the US economy out of its malaise. Only fundamental economic changes can do that. But cutting the deficit in this economy will require massive spending cuts, while raising interest rates will cut off the monetary stimulus, no doubt deepening the recession.
If only it were as easy as blaming China.
Thursday, November 12, 2009
Cash-for-clunkers, Dollars-for-dishwashers, and Other Government Consumption Stimulus Ideas
The news of the week is rising auto sales in the US, stimulated by the Federal program called ‘cash-for-clunkers’ where you trade in fuel-inefficient car for a more efficient one, and get thousands of dollars from the government. The program has been such a ‘success’ that it has made lawmakers think of other possible ways to stimulate consumer spending, such as the dollars-for-dishwashers program, which gives $300 mil in federal rebates for new appliance purchases. Of course, a larger version of this same theme is the new-home purchase credit. All these efforts are attempts to stimulate consumer spending, and all go in exactly the wrong direction.
Why should we be trying to stimulate consumption? We ought to be attempting to stimulate saving and investment, for these are the keys to long-term prosperity. Perhaps the most pernicious economic fallacy is revealed in the oft-repeated phrase: ‘consumption spending is the driver of the economy’. Before one can consume, one must produce. The best way to stimulate production would be to allow market competition to determine interest rates, and to eschew the pro-cyclical tendencies and distortions of fractional reserve banking. During the Panic of 2008, money destruction took place even as the Fed cut interest rates, because banks restricted their lending faster than the Fed created liquidity.
Banks had good reason to restrict lending; they were over-exposed to bad loans, their balance sheets crammed with assets of dubious value. Bank reserves shot from $44 bil to $800 bil in a year, going from less than 1% of deposits to over 10%. At the same time, lending fell (although there was massive borrowing from the Fed by banks to increase their reserves).
All parties in the economy, from the government, to corporations, to households, must reduce their debt, or ‘de-leverage’. Consumers see the wisdom in this, recognizing the frailty of their situation when they live paycheck-to-paycheck, without any cushion of savings, while debts steadily mount. The government cannot reverse the process of de-leveraging. When it tries, it loses credibility. We still remember the spectacle of Fed chairman Alan Greenspan urging consumers to take on adjustable rate mortgages. The best that can be done is to allow de-leveraging to proceed swiftly. And let’s look on the bright side; while many businesses will fail, most will survive, and they will be stronger for it, because the market, given time, rewards prudence at the same time as it punishes foolish risks.
Gold Prices Continue to Climb
So far in 2009, the S&P 500 is up 21%, while gold is up nearly 25%. Gold and stocks have been moving in tandem for much of the year, an unusual situation, to say the least.
The rising stock market has been one of the few bright spots of the economy. While it’s difficult to say what causes short-term movements in stock prices, the year’s increases in the stock market is probably not connected to the performance of the economy, actual or perceived.
I say this because the rally has not been driven by outside events. At the low of the market, in March 9, 2009, the sentiment was bleak. Analysts who had previously been known as solid bulls began to say, “the sky is falling!” News since then has been solidly bad, with continuing job losses, rising unemployment, trade deficits, budget deficits, and a rising disillusionment with the Obama Administration. Now sentiment has reversed; everywhere the talk is of green shoots and growth; all experts agree: the recession is over. They point to the performance of the stock market and the recent rise in GDP (mostly driven by debt-funded government consumption).
It seems more likely that the rally is a correction of the long slide in stock prices that took the Dow down 7500 points over a period of about 17 months. The nature of markets is action and reaction, movement followed by countervailing movement. The stock rally of 2009 is simply a long counter-movement, where the market recoups a portion of its losses. The general rule to look for is a counter-movement of 50%, though it may be as large as 75%. The former has basically been achieved. That means extreme caution is warranted about future market moves. Indeed, it seems to me that the sentiment has become so uniformly bullish that the only possibility is a sharp downward movement, even an eventual violation of the lows of March 2009. This possibility is not driven by sentiment alone, but by the fundamentals of a weak economy coupled with the multiple threats to the dollar’s reserve currency status.
Right now it seems unthinkable to nearly all observers that the dollar could be displaced. That alone should give us pause. The last two years have been a time when most observers have been disastrously wrong. Most did not foresee the crash of October 2008. Most did not foresee the rapid downturn of February 2009, nor the rally that began in March. Early in 2009, when oil prices dove to below $40, most analysts predicted they would stay there; instead, they doubled within the year, in the face of worsening economic deterioration.
Yet India’s purchase of 200 tonnes of gold from the IMF at near-record prices shows that nations are increasingly distrustful of the dollar. Individual investors should take note.
Where are all the posts?
Well, my writing activity has really fallen off over the last few months. But I have been writing for the Borsen-Kourier, just not posting it on the blog. I know, very lazy... so what I'm going to do is go backwards, and post the articles I've written over the last couple of months on the day I wrote them. (I won't make any changes to make myself look more prescient!)
Thursday, November 05, 2009
US GDP Swings to Growth
For the first time during this recession, US GDP is registering solid growth of 3.5% for Q3 of 2009.
Declining businesses inventories played a large role, but much of the growth was caused by increases in consumption spending: 40% of the increase in consumption was cars, driven by the cash-for-clunkers program, and another big slice was new home construction, driven by the $8,000 first time home buyer credit.
Those of us who were skeptical about these Federal programs to prop up consumption, may now be shown the rising GDP numbers as proof that these kind of government actions work. Well, yes, they work. But at what cost, and for how long? When the government borrows in order to give money to home buyers and car buyers, not only is that a dubious redistribution of resources, it causes a distortion in prices and in perceived demand. It causes sales from the future to happen in the present, inflating both automakers’ view of demand for cars and homebuilders’ view of demand for new homes.
It’s painfully obvious that the government cannot keep borrowing in order to funnel money toward consumption. When it ceases to do so, growth will fall, perhaps to negative territory.
Federal spending was up sharply, though state and local spending fell, due to declining revenues. States have a budget constraint that the Federal government doesn’t have.
Though the weakness in the dollar pushed up exports by 14.7%, imports increased by 16.4%, underscoring Americans’ addiction to low-priced foreign goods. The tendency to buy imports is true for cars as well as clothing and electronics: an often-overlooked feature of cash-for-clunkers was the fact that people often bought Hondas and Toyotas, which helps to stimulate Japan’s economy more than the US (with the exception of those Hondas and Toyotas produced in the US).
The Obama Administration claims the $160 billion that has been spent (of the $787 billion stimulus bill) has created or saved 640,329 jobs. Do the math: that’s $249,000 per job. That seems a bit expensive to me. For that price, we could’ve given 3.2 million Americans $50,000. Of course, the number of jobs ‘created or saved’ is already a bit dubious. Could it be that the government agencies who received stimulus funds had an incentive to say more jobs were ‘saved’ then actually was the case, to secure future stimulus funding? The Bureau of Labor Statistics doesn’t have a category for jobs saved, but it does have a category for net job creation, which has been massively negative for nearly 2 years, adding up to a total number of jobs lost of over 7.2 million. Given that the Bush administration also did a stimulus of $170 bil in Feb 2008, if $330 bil gives us only 640,329 jobs, how much would have to be spent to give us 7.2 million jobs? The answer is a staggering $3.6 trillion.
The reality is that the massive stimulus efforts have produced only small numbers of jobs, which have been swamped by the restructuring occurring throughout the economy. But such restructuring is necessary and unavoidable, and should be allowed to happen quickly rather than being dragged out through massive government consumption schemes.
Wednesday, October 28, 2009
Downsizing and Consolidation
The American household continues the path of downsizing and consolidation. Electricity usage, which hardly ever declines, has fallen 2.3% in the US since August 2008, reflecting mostly the decrease in industrial output.
Rents have been dropping, as vacancy rates rise. This is perhaps an odd finding: shouldn’t the tightening of credit mean fewer people can buy homes, channeling more demand into the rental market? Similarly, shouldn’t rising foreclosures push more people into the rental market? It seems that these forces were overwhelmed by the drop in household income caused by the recession, and the resultant tendency to live more frugally.
Some condo developers expected the baby boomer generation to consolidate and move to smaller spaces in urban centers as they retired, but because home prices fell, they haven’t really done so. They can’t sell their homes at the price they think the homes are worth. There hasn’t been a movement away from suburbs en masse (in fact, there isn’t much moving at all: moving rates are the lowest they’ve been since 1948, when the Census Bureau began tracking them) though the preference for smaller homes seems to be increasing over the last 2 years. But that is probably a counter-reaction to the excesses of enormous McMansions, with their costly heating and electricity bills.
One hot trend is the tiny home. Several home builders are bucking the trend and moving toward very small homes. Often modular or mounted on trailers, tiny homes are less than 300 sq ft. People are going small for financial reasons, but also because of concerns over the environment and the impact of consumption. Large homes seem to engender large collections of things.
How does all this saving and decreased consumption affect the economy?
Keynes called it ‘the paradox of thrift’. Though saving is good for individuals, it can be bad for society, because it moves society to an equilibrium of lower spending, which Keynes considered the driver of economic growth. Here is where I part ways with Mr Keynes. Investment is the driver of economic growth, not spending, and higher rates of savings allow us to achieve higher rates of investment. But that won’t happen until businesses clean up their balance sheets and eliminate debt. That process will require some inefficient and overleveraged firms to enter bankruptcy. The sooner they do so, the quicker they can emerge and the sooner the economy can recover.
Individuals are curtailing their spending because that seems the smart thing to do, given the circumstances. My guess is that we’ll find a silver lining in this, for even though consumption is likely to grow more slowly in the coming years, we may be taking a path that is more sustainable.
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