The Federal Reserve Board is meeting to decide whether or not to raise interest rates. The costs and benefits of its decision, whichever way it goes, will fall to a large degree along international borders.
Most of the data favoring a rate hike are domestic. The U.S. economy is growing, moderately but steadily (especially after data revisions). Unemployment has fallen to the level generally regarded as full employment. Jobs growth continues, not at a blistering pace but indicative of continued expansion. Inflation is very low, but if you strip out energy and food prices (which are volatile), the rest of the price structure is pretty close to the Fed's 2% target.
Most of the data arguing against a rate hike is from overseas. Chinese stocks have been volatile and China's growth is slowing. Europe's and Japan's economies are barely growing. Emerging nations and commodities producing nations are on the ropes, with many facing shrinking economies. The Greek debt crisis has temporarily simmered down, but the most recent "resolution" was just another kick of the can down the road. So we can be confident that a Greek default will loom anon, and we'll have to revisit familiar angst. A rate increase will strengthen the dollar, which will possibly exacerbate these international problems.
Much of foreign anxiety stems from the fact that the dollar is the international medium of exchange. The entire world uses the dollar in numerous trade and cross-border transactions. The Fed's monetary policy unavoidably affects people in distant lands. A rate hike may help the domestic economy by easing asset distortions and increasing certainty (and desperately desired income for savers). It is likely to have a negative impact overseas. No wonder the IMF and other voices reflecting foreign perspectives argue against a rate hike.
What will the Fed do? Most likely, not even the Fed knows before its meeting. We've been told that its decision is data dependent. What we don't know is how it weighs and balances the data. What data receive greater consideration? What data are downplayed? What thought is given to the effect of the Fed's decision on foreign relations? Central banking is distinct from diplomacy, but the Fed can't ignore foreign concerns. A rate hike will produce smiles and frowns, mostly on different sides of the border. After World War II, America became the pre-eminent economic power in the world, and it cannot now avoid the consequences of its dominance.
Showing posts with label U.S. dollar. Show all posts
Showing posts with label U.S. dollar. Show all posts
Tuesday, September 15, 2015
Monday, October 10, 2011
Barack Obama's Lucky Breaks
Barack Obama is a lucky man. Even as the economy idles in neutral and his ratings sink, good things keep happening to him.
Lucky Dollar. Europe's debt crisis is getting worse--a Belgian bank was just nationalized, which means more liabilities for Belgian taxpayers. The dollar remains attractive and capital is flowing into high quality dollar denominated assets. Interest rates remain low but the strengthened dollar prevents a flood of capital out of the U.S.
Bad Guys Can't Hide. U.S. counterinsurgency forces have successfully dealt with bin Laden and Awlaki. Although this is mostly the result of patient, painstaking intelligence work, there's an element of luck in these successes and Obama has been very lucky in the war against terrorism.
Occupy Wall Street. This largely spontaneous protest movement provides the Democrats with an opportunity to organize a counterweight to the Tea Party. In his typically cautious style, Obama waited three weeks before speaking favorably of the Occupiers. The protests give him an opportunity. He's lost most of the popular groundswell that got him elected in 2008, and Occupy Wall Street let's him recover some of his losses. Not all Occupiers like Obama. But not all Tea Partiers like the Republicans and that didn't prevent the Republicans from co-opting the Tea Party movement.
Stock Market Loves Big Government. Ignore what Wall Street says and watch what it does. Today, the Dow Jones Industrial Average rallied some 330 points on vague promises by France and Germany to do something or other to support their banks. Also heartening for stocks was Belgium's nationalization of a sovereign debt-laden bank, Dexia and, Belgium's, France's and Luxembourg's guarantees of some 90 billion Euros of Dexia's future borrowings (which presumably would be used to pay existing creditors off). In other words, losses that would have fallen on financial market participants will now fall on European taxpayers. If you're a banker, you gotta love that. Since Obama's principal policy options at this point are one variant of big government or another, he's lucky to have a stock market that will cheer his every policy success.
Lucky Dollar. Europe's debt crisis is getting worse--a Belgian bank was just nationalized, which means more liabilities for Belgian taxpayers. The dollar remains attractive and capital is flowing into high quality dollar denominated assets. Interest rates remain low but the strengthened dollar prevents a flood of capital out of the U.S.
Bad Guys Can't Hide. U.S. counterinsurgency forces have successfully dealt with bin Laden and Awlaki. Although this is mostly the result of patient, painstaking intelligence work, there's an element of luck in these successes and Obama has been very lucky in the war against terrorism.
Occupy Wall Street. This largely spontaneous protest movement provides the Democrats with an opportunity to organize a counterweight to the Tea Party. In his typically cautious style, Obama waited three weeks before speaking favorably of the Occupiers. The protests give him an opportunity. He's lost most of the popular groundswell that got him elected in 2008, and Occupy Wall Street let's him recover some of his losses. Not all Occupiers like Obama. But not all Tea Partiers like the Republicans and that didn't prevent the Republicans from co-opting the Tea Party movement.
Stock Market Loves Big Government. Ignore what Wall Street says and watch what it does. Today, the Dow Jones Industrial Average rallied some 330 points on vague promises by France and Germany to do something or other to support their banks. Also heartening for stocks was Belgium's nationalization of a sovereign debt-laden bank, Dexia and, Belgium's, France's and Luxembourg's guarantees of some 90 billion Euros of Dexia's future borrowings (which presumably would be used to pay existing creditors off). In other words, losses that would have fallen on financial market participants will now fall on European taxpayers. If you're a banker, you gotta love that. Since Obama's principal policy options at this point are one variant of big government or another, he's lucky to have a stock market that will cheer his every policy success.
Tuesday, May 3, 2011
Is the Federal Reserve Following Germany's Example?
Germany is Europe's economic engine. Its recent recession wasn't Great, like America's. Its unemployment levels didn't rise as sharply as America's. It has a trade surplus and a strong manufacturing sector at the core of its economy. Considering that West Germany had to absorb moribund formerly Communist East Germany during the past 20 years, one has to wonder how the Germans did it.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Tuesday, March 8, 2011
Will the Arab Revolution Topple the Dollar?
As unrest in the Arab world has grown over the past few weeks, the dollar has fallen in value. That would seem anomalous, since the dollar has served for decades as a safe haven in times of crisis. But investors apparently have noticed that the U.S. is unbalanced: too much in the way of imports, not enough in the way of exports, and a growing federal deficit that is likely to punish holders of U.S. Treasury securities if it isn't brought under control.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
Sunday, January 30, 2011
Champion Cellists on the Move
This past week, Davos chattered as Egypt burned. Stock markets shuddered, and high ranking government officials worldwide issued statements and proclamations that were promptly ignored in the streets of Cairo. Hedge funds shorting oil were clobbered when petroleum prices surged, and the dollar rose as it took on its customary role as a refuge in times of crisis. The Euro, too close to the restiveness, fell back. None of this was entertaining.
More entertaining are the live performances by some champion cellists. They don't merely play notes. They squiggle, squirm, grin, frown, look around, roll their eyes and hug the instrument. Here are four of the finest, each playing the rousing third movement of Haydn's Cello Concerto No. 1.
Yo Yo Ma seems to scan the balconies for good-looking women. He must have seen some, because he delivers an inspired performance. http://www.youtube.com/watch?v=-S8pW74t2QQ&feature=related.
Han Na Chang, a Korean prodigy who has blossomed into one of the world's best cellists, bounces, frowns, purses her lips, puffs up her cheeks, and grins from coast to coast. She is one happy cellist. http://www.youtube.com/watch?v=-aoUxKfHS9I&feature=related.
Julian Lloyd Webber, brother of impressario Andrew Lloyd Webber, is one of the doyennes of Britain's cellist community. Here he is, in vaguely Medieval costume, playing brilliantly while flicking some lint off his left hand and occasionally flashing the whites of his eyes. http://www.youtube.com/watch?v=13GHrPNJzNQ&feature=related.
Mstislav Rostropovich demonstrates, however, that one need not squiggle all over the stage to play masterfully. He simply hugs the instrument, juts his jaw, and delivers a performance worthy of a maestro. http://www.youtube.com/watch?v=Vo113j8sQRE&feature=related.
More entertaining are the live performances by some champion cellists. They don't merely play notes. They squiggle, squirm, grin, frown, look around, roll their eyes and hug the instrument. Here are four of the finest, each playing the rousing third movement of Haydn's Cello Concerto No. 1.
Yo Yo Ma seems to scan the balconies for good-looking women. He must have seen some, because he delivers an inspired performance. http://www.youtube.com/watch?v=-S8pW74t2QQ&feature=related.
Han Na Chang, a Korean prodigy who has blossomed into one of the world's best cellists, bounces, frowns, purses her lips, puffs up her cheeks, and grins from coast to coast. She is one happy cellist. http://www.youtube.com/watch?v=-aoUxKfHS9I&feature=related.
Julian Lloyd Webber, brother of impressario Andrew Lloyd Webber, is one of the doyennes of Britain's cellist community. Here he is, in vaguely Medieval costume, playing brilliantly while flicking some lint off his left hand and occasionally flashing the whites of his eyes. http://www.youtube.com/watch?v=13GHrPNJzNQ&feature=related.
Mstislav Rostropovich demonstrates, however, that one need not squiggle all over the stage to play masterfully. He simply hugs the instrument, juts his jaw, and delivers a performance worthy of a maestro. http://www.youtube.com/watch?v=Vo113j8sQRE&feature=related.
Sunday, December 12, 2010
Still Searching for the Gold Standard
Contrary to popular belief, the gold standard lives on. Not as a linkage of paper currency to a precious metal, but as the human search for certainty in the value of currency. And the results today are as convoluted as earlier experiences with the gold standard.
The gold standard--making a unit of a paper currency convertible into a fixed amount of gold--was used first and foremost to provide assurance against uncontrolled printing of money and the inflation that could follow. Such inflation could be created by whoever issued the paper money--be it a bank or a government--and gold convertibility was seen as stabilizing the value of the currency.
Gold, however, doesn't ensure absolute certainty of value. When large amounts of gold become available (from mining or other sources), price inflation can result. The Spanish conquest of much of Central and South America in the 1500s resulted in massive amounts of Aztec and Incan gold and silver flowing to Spain. Price inflation followed, even though Spain used gold and silver currency.
Gold as a reserve for paper currencies has not always provided a foundation for stability. In the 1930s, central banks protecting the gold standard acted too conservatively to combat the growing economic depression. In doing so, they may have aggravated the deflation that resulted from the stock market crash and accompanying economic downturn, which in turn hindered recovery from the depression. Eventually, the U.S. and other nations had to devalue their currencies to help foster recovery. What happened here was that the nation issuing the currency had gone into a depression and the real world value of its currency had correspondingly fallen. The conversion value of its currency into gold had not changed, so the currency was overvalued and deflation ensued. Ultimately, the gold standard did not prevent paper currencies from falling in value because paper currencies takes their true value from the economic strength of the issuing nation.
Gold can serve as a currency because people think it's valuable and accept it as a medium of exchange. The same is true for anything people accept as valuable--tobacco, cotton, deer skins, beaver pelts, sea shells, and American cigarettes all have served as currency at various times and in various places.
People want their currency to be stable. It doesn't really matter what is used as currency. Most currency today consists of electronic entries in computer systems. But people believe these little bits and bytes of data have value, so they accept them as a medium of exchange.
What hasn't changed from the days of the traditional gold standard is the desire for certainty. And that's the problem. The Euro bloc, in which 16 nations have adopted the Euro as a common currency, is simply a reincarnation of the gold standard. By adopting the same currency, issued by a central bank that supposedly must limit its responsibilities to maintaining the value of that currency, the Euro bloc nations hope for an island of stability in the raging seas of the currency markets. But these nations can't reach Avalon unless all members row their oars together and pull their own weight. That hasn't been happening and the ship is foundering.
China and other nations that link the values of their currencies to the U.S. dollar also seek to create a latter day gold standard. Although now a distant memory, there was a time (the 1970s and 1980s) when the dollar was seen in some parts of the world as rock solid. In the Soviet Union and Communist China, U.S. currency was coveted and hoarded, while local currencies were regarded with suspicion and disdain (China has a long history of currency inflation). As China integrated market forces into its economy, it linked its currency to the dollar, not as an export weapon so much as an anchor against inflation. Some Latin American nations that struggled with inflation did the same thing at various times. (Most notable among these were Argentina and Mexico.)
China's dollar link was crucial to its ability to grow. It removed the risks of currency fluctuations, encouraging American businesses to invest in China. The Chinese very much wanted American investment in order to obtain American know how and technology. The intellectual capital gained by China from American (and other foreign) investment leveraged its rate of growth. On its own, China could never have achieved prosperity as quickly as it did.
Of course, as China grew, its currency became more valuable in relation to the dollar and China's dollar link conferred an exporting advantage that is now essential to its economic model. Despite increasing inflation and foreign political pressure, the Chinese want to protect their exporters, because they don't have internal markets to substitute for the export markets they would lose from a stronger yuan. To combat inflation, the Chinese have employed alternatives, such as higher reserve requirements for their banks, price controls, consumer subsidies and sales from state food reserves (the latter a tradition from the days of dynastic China).
Americans shouldn't think that their own government isn't implicated in China's search for a contemporary gold standard. The U.S. government was for a time quiescent about China's exchange rate policies in order to encourage China to ally itself with America against the Soviets, and to open up China to U.S. investment. Moreover, the inflow of inexpensive Chinese goods has helped keep inflation low in America, which in turn permitted low interest rates and booming real estate values. Okay, so not everything turned out wonderfully, but the 2008 financial crisis wasn't the fault of the Chinese. Indeed, they lost money investing in American mortgage-backed securities.
In spite of the financial turmoil of the past three years, Europeans and Asians still cling to their gold standards, looking for certainty in the value of currencies. Gold standards can have short term benefits. Long term, economic conditions change and so do currency values. The squabbles of the Euro bloc over bailouts, quantitative easing, haircuts for creditors and the growing disquiet of German taxpayers, are a struggle over who will bear the costs of maintaining Europe's latter day gold standard. China's accumulation of a vast hoard of U.S. debt securities (and their attendant investment risks), along with the fiscal costs of consumer subsidies and state-owned food stocks, are China's costs of maintaining its 21st Century gold standard.
The gold standard protects savers, investors and creditors. Pure fiat currencies tend to favor borrowers and spenders. Thus creditor nations prefer a gold standard. Borrowing nations argue for free-floating currency rates. A gold standard doesn't necessarily favor exporters--they are better off or not depending on where the exchange or conversion rate is set. The Euro bloc includes both creditor nations and borrowing nations; hence the conflicts that may yet cause the Euro to collapse. The dollar bloc similarly includes creditor nations and borrowing nations; its tensions, too, are palpable.
Ultimately, there is no permanent gold standard or other absolute reservoir of value. The never-ending quest for certainty is trumped by the incessant process of change, mutation and evolution in the economy. (See http://blogger.uncleleosden.com/2010/06/what-if-economy-is-creature.html.) But the process of human advancement can be said to be a long struggle for certainty. Deliverance from the vicissitudes of hunting and gathering, the extremes of the weather, the unpredictability of farming, the dangers of aggressive peoples, the horrors of plagues and other deadly illnesses, the volatility of the business cycle, and the capriciousness of financial markets all underlie the imperative for human advancement. All the bug-eyed, rifle-cleaning, ridge-dwelling, fringe group wackos panting for the gold standard can wipe the drool from the sides of their mouths and rest easy. It's alive and kicking, and will continue to bedevil central banks, high ranking government officials, policy makers, business executives, and the rest of us as far into the future as one can see.
The gold standard--making a unit of a paper currency convertible into a fixed amount of gold--was used first and foremost to provide assurance against uncontrolled printing of money and the inflation that could follow. Such inflation could be created by whoever issued the paper money--be it a bank or a government--and gold convertibility was seen as stabilizing the value of the currency.
Gold, however, doesn't ensure absolute certainty of value. When large amounts of gold become available (from mining or other sources), price inflation can result. The Spanish conquest of much of Central and South America in the 1500s resulted in massive amounts of Aztec and Incan gold and silver flowing to Spain. Price inflation followed, even though Spain used gold and silver currency.
Gold as a reserve for paper currencies has not always provided a foundation for stability. In the 1930s, central banks protecting the gold standard acted too conservatively to combat the growing economic depression. In doing so, they may have aggravated the deflation that resulted from the stock market crash and accompanying economic downturn, which in turn hindered recovery from the depression. Eventually, the U.S. and other nations had to devalue their currencies to help foster recovery. What happened here was that the nation issuing the currency had gone into a depression and the real world value of its currency had correspondingly fallen. The conversion value of its currency into gold had not changed, so the currency was overvalued and deflation ensued. Ultimately, the gold standard did not prevent paper currencies from falling in value because paper currencies takes their true value from the economic strength of the issuing nation.
Gold can serve as a currency because people think it's valuable and accept it as a medium of exchange. The same is true for anything people accept as valuable--tobacco, cotton, deer skins, beaver pelts, sea shells, and American cigarettes all have served as currency at various times and in various places.
People want their currency to be stable. It doesn't really matter what is used as currency. Most currency today consists of electronic entries in computer systems. But people believe these little bits and bytes of data have value, so they accept them as a medium of exchange.
What hasn't changed from the days of the traditional gold standard is the desire for certainty. And that's the problem. The Euro bloc, in which 16 nations have adopted the Euro as a common currency, is simply a reincarnation of the gold standard. By adopting the same currency, issued by a central bank that supposedly must limit its responsibilities to maintaining the value of that currency, the Euro bloc nations hope for an island of stability in the raging seas of the currency markets. But these nations can't reach Avalon unless all members row their oars together and pull their own weight. That hasn't been happening and the ship is foundering.
China and other nations that link the values of their currencies to the U.S. dollar also seek to create a latter day gold standard. Although now a distant memory, there was a time (the 1970s and 1980s) when the dollar was seen in some parts of the world as rock solid. In the Soviet Union and Communist China, U.S. currency was coveted and hoarded, while local currencies were regarded with suspicion and disdain (China has a long history of currency inflation). As China integrated market forces into its economy, it linked its currency to the dollar, not as an export weapon so much as an anchor against inflation. Some Latin American nations that struggled with inflation did the same thing at various times. (Most notable among these were Argentina and Mexico.)
China's dollar link was crucial to its ability to grow. It removed the risks of currency fluctuations, encouraging American businesses to invest in China. The Chinese very much wanted American investment in order to obtain American know how and technology. The intellectual capital gained by China from American (and other foreign) investment leveraged its rate of growth. On its own, China could never have achieved prosperity as quickly as it did.
Of course, as China grew, its currency became more valuable in relation to the dollar and China's dollar link conferred an exporting advantage that is now essential to its economic model. Despite increasing inflation and foreign political pressure, the Chinese want to protect their exporters, because they don't have internal markets to substitute for the export markets they would lose from a stronger yuan. To combat inflation, the Chinese have employed alternatives, such as higher reserve requirements for their banks, price controls, consumer subsidies and sales from state food reserves (the latter a tradition from the days of dynastic China).
Americans shouldn't think that their own government isn't implicated in China's search for a contemporary gold standard. The U.S. government was for a time quiescent about China's exchange rate policies in order to encourage China to ally itself with America against the Soviets, and to open up China to U.S. investment. Moreover, the inflow of inexpensive Chinese goods has helped keep inflation low in America, which in turn permitted low interest rates and booming real estate values. Okay, so not everything turned out wonderfully, but the 2008 financial crisis wasn't the fault of the Chinese. Indeed, they lost money investing in American mortgage-backed securities.
In spite of the financial turmoil of the past three years, Europeans and Asians still cling to their gold standards, looking for certainty in the value of currencies. Gold standards can have short term benefits. Long term, economic conditions change and so do currency values. The squabbles of the Euro bloc over bailouts, quantitative easing, haircuts for creditors and the growing disquiet of German taxpayers, are a struggle over who will bear the costs of maintaining Europe's latter day gold standard. China's accumulation of a vast hoard of U.S. debt securities (and their attendant investment risks), along with the fiscal costs of consumer subsidies and state-owned food stocks, are China's costs of maintaining its 21st Century gold standard.
The gold standard protects savers, investors and creditors. Pure fiat currencies tend to favor borrowers and spenders. Thus creditor nations prefer a gold standard. Borrowing nations argue for free-floating currency rates. A gold standard doesn't necessarily favor exporters--they are better off or not depending on where the exchange or conversion rate is set. The Euro bloc includes both creditor nations and borrowing nations; hence the conflicts that may yet cause the Euro to collapse. The dollar bloc similarly includes creditor nations and borrowing nations; its tensions, too, are palpable.
Ultimately, there is no permanent gold standard or other absolute reservoir of value. The never-ending quest for certainty is trumped by the incessant process of change, mutation and evolution in the economy. (See http://blogger.uncleleosden.com/2010/06/what-if-economy-is-creature.html.) But the process of human advancement can be said to be a long struggle for certainty. Deliverance from the vicissitudes of hunting and gathering, the extremes of the weather, the unpredictability of farming, the dangers of aggressive peoples, the horrors of plagues and other deadly illnesses, the volatility of the business cycle, and the capriciousness of financial markets all underlie the imperative for human advancement. All the bug-eyed, rifle-cleaning, ridge-dwelling, fringe group wackos panting for the gold standard can wipe the drool from the sides of their mouths and rest easy. It's alive and kicking, and will continue to bedevil central banks, high ranking government officials, policy makers, business executives, and the rest of us as far into the future as one can see.
Tuesday, September 14, 2010
Japan's Yen Intervention: A Trade Skirmish?
The Japanese central bank has unilaterally stepped into the currency markets and bought U.S. dollars in an effort to lower the value of the yen and push up the dollar. It appears to have increased the dollar by about 1%. In economic terms, this intervention is similar to a 1% across-the-board tariff on all U.S. goods imported into Japan. Conversely, it creates a 1% price cut on all Japanese goods imported into the U.S.
While American consumers wouldn't mind a 1% price cut, this intervention could export some of Japan's unemployment to the U.S. American workers making products that compete with now cheaper Japanese goods may face a greater risk of layoffs and reduced income.
The Japanese government apparently had hoped for international support for its intervention. It got none. Everyone's hurting and no one wants to take someone else's unemployment.
There was no public reaction from the U.S. government to the Japanese intervention. A 1% shift in currency valuations is small from a medium to long term perspective, and could easily shift back within a few days from now in today's volatile currency markets. The U.S Treasury has its hands full squabbling with the Chinese about the valuation of the yuan, and probably doesn't want to fight on two fronts simultaneously.
The yen is rising because it's becoming more valuable. One reason is that the Chinese government has been buying yen denominated assets in order to diversify away from the dollar. The Chinese are killing two birds because this diversification is also likely to weaken the dollar. Because the Chinese yuan is still essentially tied to the dollar, when the dollar sinks, so does the yuan. The Chinese tack allows them to maintain approximate parity with the dollar while gaining a trade advantage over the Japanese.
By intervening, the Japanese central bank is in effect riposting with a two birds with one stone tactic of its own. Pushing the dollar up also pushes up the yuan against the yen, thereby recovering some of the trade advantage the Chinese have gotten lately.
Next week, the Federal Reserve will meet again and perhaps give more guidance on the extent of the quantitative easing (read, printing of money) it has in mind for the foreseeable future. The more the Fed quantitatively eases, the lower the dollar will fall in the currency markets. The Japanese may perceive this as aimed at them, even though it isn't. They might respond with more intervention.
With economies around the world slowing and governments too leveraged for much more stimulus spending, currency manipulations are a deceptively cheap and easy way to improve a nation's prospects. The problem is that one nation's gains come at the expense of other nations. When they all start to maneuver their currencies around, they wittingly or unwittingly form a circular firing squad aiming inward. Things weren't pretty when that happened in the 1930s and they wouldn't be pretty if it happened again.
While American consumers wouldn't mind a 1% price cut, this intervention could export some of Japan's unemployment to the U.S. American workers making products that compete with now cheaper Japanese goods may face a greater risk of layoffs and reduced income.
The Japanese government apparently had hoped for international support for its intervention. It got none. Everyone's hurting and no one wants to take someone else's unemployment.
There was no public reaction from the U.S. government to the Japanese intervention. A 1% shift in currency valuations is small from a medium to long term perspective, and could easily shift back within a few days from now in today's volatile currency markets. The U.S Treasury has its hands full squabbling with the Chinese about the valuation of the yuan, and probably doesn't want to fight on two fronts simultaneously.
The yen is rising because it's becoming more valuable. One reason is that the Chinese government has been buying yen denominated assets in order to diversify away from the dollar. The Chinese are killing two birds because this diversification is also likely to weaken the dollar. Because the Chinese yuan is still essentially tied to the dollar, when the dollar sinks, so does the yuan. The Chinese tack allows them to maintain approximate parity with the dollar while gaining a trade advantage over the Japanese.
By intervening, the Japanese central bank is in effect riposting with a two birds with one stone tactic of its own. Pushing the dollar up also pushes up the yuan against the yen, thereby recovering some of the trade advantage the Chinese have gotten lately.
Next week, the Federal Reserve will meet again and perhaps give more guidance on the extent of the quantitative easing (read, printing of money) it has in mind for the foreseeable future. The more the Fed quantitatively eases, the lower the dollar will fall in the currency markets. The Japanese may perceive this as aimed at them, even though it isn't. They might respond with more intervention.
With economies around the world slowing and governments too leveraged for much more stimulus spending, currency manipulations are a deceptively cheap and easy way to improve a nation's prospects. The problem is that one nation's gains come at the expense of other nations. When they all start to maneuver their currencies around, they wittingly or unwittingly form a circular firing squad aiming inward. Things weren't pretty when that happened in the 1930s and they wouldn't be pretty if it happened again.
Monday, July 19, 2010
Warning from Weird Financial Markets
The financial markets are getting weird (as if they weren't already). Interest rates for mortgages are at or near all-time lows, but home buying interest is dropping. Stocks are trading in tandem with each other more than ever, seemingly in disregard of the fortunes of individual companies. The dollar and U.S. Treasury securities have improbably rallied, in spite of already low interest rates. When markets behave strangely, it's prudent to check if any canaries have stopped chirping.
The decline in home buying interest stems from two factors: (a) the end of the $8,000 first time buyers credit (and $6,500 repeat buyer's credit), and (b) the large quantities of foreclosed homes and homes with defaulting mortgages sitting in bank inventories. Buyers know that home prices are likely to stagnate or drop, because banks will have to offload their moribund inventory eventually. There's no point rushing to buy now. Lower interest rates may reduce monthly payments, but buyers have learned that monthly payments aren't the only problem. They realize that a loss of equity can be devastating. Something like a quarter to a third of all homes with mortgages are now underwater. Whether the owners of those homes can still afford the monthly payments is becoming a less important question than whether a strategic default makes sense.
Today's stock markets are dominated by powerful hedge funds and other institutional traders. Many use high speed trading strategies. These big boys frequently trade the stock market as if it were a commodity. The notion of stocks as ownership of a piece of a continuing business enterprise is becoming outdated as computerized trading techniques treat the stock market like a bulk commodity to buy or sell alongside oil, copper and pork bellies. Individual investors see their modest portfolios gyrating for no reasons relating to the companies they hold. It's tough to ride a bicycle among tractor trailers, and lots of Moms and Pops are stepping back from the chaos.
The dollar and the U.S. Treasuries rallies were flights to safety at a time when the European Union seemed about to fall apart. It's still shaky, and may get shakier if there's a lot of grade curving on the bank stress test results to be announced this week or next. That the dollar would be seen as a safe haven in a time when the U.S. economy's running on flat tires doesn't bode well.
The markets are mispricing assets. Real estate prices are too high to compensate buyers for the risks of the inventory dump that's coming. But a host of government subsidies, policies and programs buffers home prices from market forces. So buyers hold back, reluctant to pay a non-market price.
Stock prices are too high to compensate individual investors for the stomach churning volatility created by the big boys. But the stock markets today are of, by and for big traders. Volatility is profitable for the short term, high speed strategies many of they employ. These big dogs don't care which way the market moves as long as it moves somewhere because they can't make a profit if prices don't change. Small investors are removing liquidity from the market and finding tranquility in bank CDs.
The dollar and U.S. Treasury securities are issued by a politically unified nation (okay, so bipartisanship ended about 2.04 seconds after Barack Obama was sworn in as President, but compared to Europe the U.S. is as solid as a rock). The Euro is backed by a loose confederation of separate nations that are devoted to passing the buck to someone else. The financial markets undervalued the dollar, not adequately factoring in the value of political cohesiveness. But a rising dollar impairs America's ability to increase exports, foreclosing one path to economic recovery.
Then, there is the biggest market dysfunction of all. For over one and a half years, the Federal Reserve has held short term interest rates to near zero. Bank profits have rebounded sharply but the stimulative effect of this policy has been disappointing. Banks aren't lending. They invest excess reserves in U.S. Treasury securities, mortgage backed debt guaranteed by the U.S. Treasury, and accounts at Federal Reserve banks (in effect, investing in the federal government). The credit markets for banks now operate smoothly. But the credit markets for everyone else are discombobulated. This massive dysfunction remains an enormous barrier to recovery.
While the reasons for these problems vary from market to market, they each impede America's long term economic prospects. Their simultaneity only exacerbates things. When so many important markets are mispricing assets and discouraging participants, canaries may fall quiet.
The decline in home buying interest stems from two factors: (a) the end of the $8,000 first time buyers credit (and $6,500 repeat buyer's credit), and (b) the large quantities of foreclosed homes and homes with defaulting mortgages sitting in bank inventories. Buyers know that home prices are likely to stagnate or drop, because banks will have to offload their moribund inventory eventually. There's no point rushing to buy now. Lower interest rates may reduce monthly payments, but buyers have learned that monthly payments aren't the only problem. They realize that a loss of equity can be devastating. Something like a quarter to a third of all homes with mortgages are now underwater. Whether the owners of those homes can still afford the monthly payments is becoming a less important question than whether a strategic default makes sense.
Today's stock markets are dominated by powerful hedge funds and other institutional traders. Many use high speed trading strategies. These big boys frequently trade the stock market as if it were a commodity. The notion of stocks as ownership of a piece of a continuing business enterprise is becoming outdated as computerized trading techniques treat the stock market like a bulk commodity to buy or sell alongside oil, copper and pork bellies. Individual investors see their modest portfolios gyrating for no reasons relating to the companies they hold. It's tough to ride a bicycle among tractor trailers, and lots of Moms and Pops are stepping back from the chaos.
The dollar and the U.S. Treasuries rallies were flights to safety at a time when the European Union seemed about to fall apart. It's still shaky, and may get shakier if there's a lot of grade curving on the bank stress test results to be announced this week or next. That the dollar would be seen as a safe haven in a time when the U.S. economy's running on flat tires doesn't bode well.
The markets are mispricing assets. Real estate prices are too high to compensate buyers for the risks of the inventory dump that's coming. But a host of government subsidies, policies and programs buffers home prices from market forces. So buyers hold back, reluctant to pay a non-market price.
Stock prices are too high to compensate individual investors for the stomach churning volatility created by the big boys. But the stock markets today are of, by and for big traders. Volatility is profitable for the short term, high speed strategies many of they employ. These big dogs don't care which way the market moves as long as it moves somewhere because they can't make a profit if prices don't change. Small investors are removing liquidity from the market and finding tranquility in bank CDs.
The dollar and U.S. Treasury securities are issued by a politically unified nation (okay, so bipartisanship ended about 2.04 seconds after Barack Obama was sworn in as President, but compared to Europe the U.S. is as solid as a rock). The Euro is backed by a loose confederation of separate nations that are devoted to passing the buck to someone else. The financial markets undervalued the dollar, not adequately factoring in the value of political cohesiveness. But a rising dollar impairs America's ability to increase exports, foreclosing one path to economic recovery.
Then, there is the biggest market dysfunction of all. For over one and a half years, the Federal Reserve has held short term interest rates to near zero. Bank profits have rebounded sharply but the stimulative effect of this policy has been disappointing. Banks aren't lending. They invest excess reserves in U.S. Treasury securities, mortgage backed debt guaranteed by the U.S. Treasury, and accounts at Federal Reserve banks (in effect, investing in the federal government). The credit markets for banks now operate smoothly. But the credit markets for everyone else are discombobulated. This massive dysfunction remains an enormous barrier to recovery.
While the reasons for these problems vary from market to market, they each impede America's long term economic prospects. Their simultaneity only exacerbates things. When so many important markets are mispricing assets and discouraging participants, canaries may fall quiet.
Thursday, July 1, 2010
How the Chinese Yuan Re-valuation Will Affect the U.S. Real Estate Market
The re-valuation of the yuan recently announced by the Chinese government has implications for the balance of trade, capital flows into China, and political relations between the U.S. and the People's Republic. What seems to have gone unnoticed is the consequence of this re-valuation for the U.S. real estate market.
As the dollar falls in relation to the yuan, it will make less and less sense for the Chinese to lend to America. They would need interest rates that covered not only lending costs and risks, but also currency risk in an environment where the yuan will almost surely rise. Current low U.S. mortgage rates, a boon to buyers who are financially qualified, are like cold pizza to lenders. And the Federal Reserve appears dead set on keeping interest rates low, lower and even lower. During much of the past decade or so, the Chinese were big buyers of American mortgage-backed investments. The mortgage crisis cooled their jets big time. Even though the secondary market for mortgages today consists almost entirely of U.S. government guaranteed investments, currency risks will make the flow of funds from China less unpredictable. It's true that Europe and the Euro don't, at the moment, provide China with attractive alternatives to the dollar. But China is working on boosting domestic demand and building an internally focused economy. Over time, it will demand fewer dollars and Euros, and provide less real estate financing in the States.
The excess inventory from foreclosures, short sales and the like will be a drag on the real estate market for years. The shrinkage of foreign credit due to the falling dollar will add to the stagnation. We'd better hope the falling dollar gives U.S. exports one helluva jump start, because it will probably tighten up an already parsimonious mortgage market.
As the dollar falls in relation to the yuan, it will make less and less sense for the Chinese to lend to America. They would need interest rates that covered not only lending costs and risks, but also currency risk in an environment where the yuan will almost surely rise. Current low U.S. mortgage rates, a boon to buyers who are financially qualified, are like cold pizza to lenders. And the Federal Reserve appears dead set on keeping interest rates low, lower and even lower. During much of the past decade or so, the Chinese were big buyers of American mortgage-backed investments. The mortgage crisis cooled their jets big time. Even though the secondary market for mortgages today consists almost entirely of U.S. government guaranteed investments, currency risks will make the flow of funds from China less unpredictable. It's true that Europe and the Euro don't, at the moment, provide China with attractive alternatives to the dollar. But China is working on boosting domestic demand and building an internally focused economy. Over time, it will demand fewer dollars and Euros, and provide less real estate financing in the States.
The excess inventory from foreclosures, short sales and the like will be a drag on the real estate market for years. The shrinkage of foreign credit due to the falling dollar will add to the stagnation. We'd better hope the falling dollar gives U.S. exports one helluva jump start, because it will probably tighten up an already parsimonious mortgage market.
Wednesday, February 10, 2010
The Nine Lives of the Dollar
With feline quickness, the dollar has again pulled out of its latest nosedive. Greeks came bearing gifts, in the form of a Euro bloc debt crisis, and investors worldwide suddenly found the greenback in their hearts. Two and a half months ago, the dollar was trading at more than $1.51 per Euro. Today, it closed below $1.38 per Euro. That's close to a 10% gain (approaching 50% on an annualized basis). We're not suggesting that you jump into the currency markets. But if you're an American, your passbook savings account just enjoyed a pop in Euro terms.
Late last year, many predicted the imminent transfer of the dollar to hospice care. These days, the dollar is dancing up a storm in swanky nightspots with an endless stream of partners. There's nothing like a good old fashioned financial crisis to put the pep back in the greenback's step.
The Chairman and governors of the Federal Reserve Board are probably sleeping better, as a strong dollar portends lower inflationary risk and widens their latitude to continue monetary accommodation. The administration is likely breathing more easily, since a strong dollar attracts capital to the mountains of Treasury securities that will have to be sold soon to finance the burgeoning federal deficit. Exporters are not pleased. But reality is that the government sector of the economy is more important these days than the private sector. Although that's a very big long term problem, no more than three or four people in America are focused on the long term, while the unemployed and everyone else are wondering about today, tomorrow and next week.
Wall Street is pleased, if only because the recent volatility of currencies and the stock market, and divergence in the bond markets (corporate debt is down, Treasuries are up), provide profit opportunities. Big money is made by the big banks when asset prices soar and swoop, and churn the stomachs of investors. Volatility creates trading opportunities for returns above long term market averages. In order to cash in on these trading opportunities, the big banks have to convince you, dear reader, to be a short term investor who trades in and out. That gives them commission income and market making profits. Fastidious, disciplined long term investors who know that .300 hitters hit a lot of singles and not so many home runs, and therefore don't trade a lot, are not ideal customers for the Street, even if they impudently become personally prosperous. (See http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.)
Legend tells us there are risks when Greeks come bearing gifts. A bailout for Greece is reportedly in the works. If so, the burden will fall mostly on Germany, the economic engine of the European Union. France will contribute a high five but not too much money. The Dutch will frown and dourly push a few Euros into the pot. The Germans will probably insist on stiff terms for Greek fiscal reform, and pretend not to hear sardonic asides about jack boots, Panzers, and aspirations for continental domination. The Euro bloc bailout will probably feel ragged, begrudged and fraught with political risk (such as rejection by the Greek government due to internal opposition). Other financially troubled nations in Europe may also look to Bonn for a bailout. The burdens of bailouts could slow down Europe's recovery, which might in turn hinder America's recovery. The dollar may yet again lose its shine.
Late last year, many predicted the imminent transfer of the dollar to hospice care. These days, the dollar is dancing up a storm in swanky nightspots with an endless stream of partners. There's nothing like a good old fashioned financial crisis to put the pep back in the greenback's step.
The Chairman and governors of the Federal Reserve Board are probably sleeping better, as a strong dollar portends lower inflationary risk and widens their latitude to continue monetary accommodation. The administration is likely breathing more easily, since a strong dollar attracts capital to the mountains of Treasury securities that will have to be sold soon to finance the burgeoning federal deficit. Exporters are not pleased. But reality is that the government sector of the economy is more important these days than the private sector. Although that's a very big long term problem, no more than three or four people in America are focused on the long term, while the unemployed and everyone else are wondering about today, tomorrow and next week.
Wall Street is pleased, if only because the recent volatility of currencies and the stock market, and divergence in the bond markets (corporate debt is down, Treasuries are up), provide profit opportunities. Big money is made by the big banks when asset prices soar and swoop, and churn the stomachs of investors. Volatility creates trading opportunities for returns above long term market averages. In order to cash in on these trading opportunities, the big banks have to convince you, dear reader, to be a short term investor who trades in and out. That gives them commission income and market making profits. Fastidious, disciplined long term investors who know that .300 hitters hit a lot of singles and not so many home runs, and therefore don't trade a lot, are not ideal customers for the Street, even if they impudently become personally prosperous. (See http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.)
Legend tells us there are risks when Greeks come bearing gifts. A bailout for Greece is reportedly in the works. If so, the burden will fall mostly on Germany, the economic engine of the European Union. France will contribute a high five but not too much money. The Dutch will frown and dourly push a few Euros into the pot. The Germans will probably insist on stiff terms for Greek fiscal reform, and pretend not to hear sardonic asides about jack boots, Panzers, and aspirations for continental domination. The Euro bloc bailout will probably feel ragged, begrudged and fraught with political risk (such as rejection by the Greek government due to internal opposition). Other financially troubled nations in Europe may also look to Bonn for a bailout. The burdens of bailouts could slow down Europe's recovery, which might in turn hinder America's recovery. The dollar may yet again lose its shine.
Wednesday, October 21, 2009
The Cart-Horse Problem of the Currency Debate
The blogosphere and op ed pages are filling up with calls to arms over the recent decline of the dollar. Predictions of the imminent collapse of American civilization abound. Gold sales boom.
Although the value of the dollar is very important, it is the result, not the cause, of our economic problems. A currency becomes strong when the nation issuing it is economically strong. A currency weakens when the issuing nation's economy weakens. The strong currencies today--the Japanese yen and the Chinese yuan--got that way because Japan and China became manufacturing powerhouses. Both nations try like heck to keep their currencies weak in order to bolster exports. Over the long course of time, they have failed. Their currencies have inexorably strengthened as their economies have strengthened. The Japanese yen has tripled its value in the last 30 years. The Chinese yuan probably would be considerably higher than its current value, as well, if it were freely tradeable--the Chinese government does not allow full convertibility of the yuan in order to constrain the outflow of capital from China.
Conversely, the dollar has fallen as the U.S. has shifted from being a manufacturing powerhouse to a binge consumer living off the equity of its real estate. The American way of life in recent years was possible only because foreigners were willing to buy dollar-denominated debt, in effect lending us the money for $5 lattes, $3,000 wide-screen TVs, luxury nameplates on all three cars in the driveway, and a house twice as large as the one we grew up in. When things fell apart, the entire nation became like a person with 22 credit cards and $230,000 of consumer debt, looking for a bailout.
A weakening nation cannot, through government intervention, preserve or increase the value of its currency. Calls to the Treasury or the Fed to intervene in currency markets or raise interest rates in order to support the dollar are misguided. The last major economic power to try something like that--Great Britain in September 1992--was blown up by a wolf pack of hedge funds that shorted the pound in the direction it would have eventually gone anyway. It's doubtful that any collection of hedge funds, however large and well-leveraged, could blow up the dollar. But the other major economic powers of the world can. And, gradually, they are, with talk of repricing oil in a basket of other currencies and gradual reallocation of central bank bond portfolios away from the dollar.
There is a way to save the dollar. That would be to institute government policies to bolster the manufacturing capabilities of the U.S. economy. America has a long and illustrious history as a manufacturing powerhouse, and does not inevitably have a dark future in that regard. It also does not have to rely on exports to support a manufacturing sector, since the American consumer, although currently down in the dumps, will probably rise from the ashes if given half a chance (i.e., a full-time job) and a little more reasonably priced credit. But the Federal Reserve, with its all for the banks and none for anyone else distortion of the Robin Hood tale, offers only sermons but not solutions. And the Obama administration's stimulus package has been unfocused and diffuse. A nation cannot spend or consume its way to economic health. It must be able to make things that other people will pay good money for. This should be the goal of government economic policy.
Although the value of the dollar is very important, it is the result, not the cause, of our economic problems. A currency becomes strong when the nation issuing it is economically strong. A currency weakens when the issuing nation's economy weakens. The strong currencies today--the Japanese yen and the Chinese yuan--got that way because Japan and China became manufacturing powerhouses. Both nations try like heck to keep their currencies weak in order to bolster exports. Over the long course of time, they have failed. Their currencies have inexorably strengthened as their economies have strengthened. The Japanese yen has tripled its value in the last 30 years. The Chinese yuan probably would be considerably higher than its current value, as well, if it were freely tradeable--the Chinese government does not allow full convertibility of the yuan in order to constrain the outflow of capital from China.
Conversely, the dollar has fallen as the U.S. has shifted from being a manufacturing powerhouse to a binge consumer living off the equity of its real estate. The American way of life in recent years was possible only because foreigners were willing to buy dollar-denominated debt, in effect lending us the money for $5 lattes, $3,000 wide-screen TVs, luxury nameplates on all three cars in the driveway, and a house twice as large as the one we grew up in. When things fell apart, the entire nation became like a person with 22 credit cards and $230,000 of consumer debt, looking for a bailout.
A weakening nation cannot, through government intervention, preserve or increase the value of its currency. Calls to the Treasury or the Fed to intervene in currency markets or raise interest rates in order to support the dollar are misguided. The last major economic power to try something like that--Great Britain in September 1992--was blown up by a wolf pack of hedge funds that shorted the pound in the direction it would have eventually gone anyway. It's doubtful that any collection of hedge funds, however large and well-leveraged, could blow up the dollar. But the other major economic powers of the world can. And, gradually, they are, with talk of repricing oil in a basket of other currencies and gradual reallocation of central bank bond portfolios away from the dollar.
There is a way to save the dollar. That would be to institute government policies to bolster the manufacturing capabilities of the U.S. economy. America has a long and illustrious history as a manufacturing powerhouse, and does not inevitably have a dark future in that regard. It also does not have to rely on exports to support a manufacturing sector, since the American consumer, although currently down in the dumps, will probably rise from the ashes if given half a chance (i.e., a full-time job) and a little more reasonably priced credit. But the Federal Reserve, with its all for the banks and none for anyone else distortion of the Robin Hood tale, offers only sermons but not solutions. And the Obama administration's stimulus package has been unfocused and diffuse. A nation cannot spend or consume its way to economic health. It must be able to make things that other people will pay good money for. This should be the goal of government economic policy.
Sunday, February 8, 2009
Benefits of a Strong Dollar
Over the past year, the dollar has risen sharply against Europe's currencies and the Canadian dollar. Although it has weakened against the Japanese yen, that has had less impact because the U.S., comparatively speaking, doesn't import as much from Japan than it did, say, 30 years ago. Many and perhaps most countries sliding into recession would like to weaken their currencies, because then they can try to export their way out of their problems. The U.S. cannot, for practical purposes, weaken the dollar. The Fed has already lowered short term interest rates to an effective rate of zero. And it's been printing truckloads of money as part of the financial system bailout, without any obvious impact on the value of the dollar.
The dollar is strong because of market forces. Other nations' economies are fading faster than the U.S. economy (if you would believe it). Capital is fleeing to the dollar, because it remains the safest haven available. Even though we can't export our way out of our problems, we receive countervailing benefits from a strong dollar.
Oil prices, which are denominated in dollars, have fallen as the dollar has risen. This price drop directly boosts consumer incomes, at the expense, in some cases, of people who harbor ill-will toward the United States. Better that they should provide a stimulus now than the U.S. taxpayer.
Federal Reserve monetary policy is made much easier. Ordinarily, lowering interest rates weakens a nation's currency while exacerbating inflation, and encourages capital flight. But the strong dollar has done much to stop the acceleration of inflation that, as recently as six months ago, was a major potential complication to the Fed's strategy. Chairman Ben Bernanke is a very lucky central banker. If we are going to have a central bank, we want a lucky one.
The federal deficit is easier to finance with a strong dollar. Much, if not most, of the Obama administration stimulus and bank bailout packages will have to be financed with money from overseas. A strong dollar provides reassurance to foreign investors. The U.S. should be able borrow at lower interest rates.
International commerce operates more smoothly with a strong dollar. The dollar is the world's reserve currency and is used more than any other currency for international trade. Commerce benefits from a strong, stable currency. One need only look back at pre-Civil War America for times when there was no permanent national paper currency. There was tremendous demand for a medium of exchange, however, and a variety of things served as currency, including tobacco, deer and other animal skins (whence the term "buck"), pieces of Spanish coins (the origin of "quarter," which resulted when a Spanish doubloon was cut into four equal sized pieces), and promissory notes issued by state banks, private banks and even individuals. It's not an accident that the U.S. experienced its greatest industrial growth after the permanent adoption of federally issued paper currency. International commerce, which must remain vigorous in order to facilitate a recovery, would struggle if there were no readily accepted transnational currency.
However, before we congratulate ourselves on the might of the dollar, let's remember that our current good fortune results from market forces. The past two years have abundantly demonstrated the market is tempestuous even on good days, and what it giveth it can easily taketh away. With the government about to borrow a trillion or more, and the Fed printing another trillion or more, the market could turn tail and flee the dollar in a New York minute. The music you hear in the background isn't "Columbia, the Gem of the Ocean." It's Carly Simon's "You're So Vain."
The dollar is strong because of market forces. Other nations' economies are fading faster than the U.S. economy (if you would believe it). Capital is fleeing to the dollar, because it remains the safest haven available. Even though we can't export our way out of our problems, we receive countervailing benefits from a strong dollar.
Oil prices, which are denominated in dollars, have fallen as the dollar has risen. This price drop directly boosts consumer incomes, at the expense, in some cases, of people who harbor ill-will toward the United States. Better that they should provide a stimulus now than the U.S. taxpayer.
Federal Reserve monetary policy is made much easier. Ordinarily, lowering interest rates weakens a nation's currency while exacerbating inflation, and encourages capital flight. But the strong dollar has done much to stop the acceleration of inflation that, as recently as six months ago, was a major potential complication to the Fed's strategy. Chairman Ben Bernanke is a very lucky central banker. If we are going to have a central bank, we want a lucky one.
The federal deficit is easier to finance with a strong dollar. Much, if not most, of the Obama administration stimulus and bank bailout packages will have to be financed with money from overseas. A strong dollar provides reassurance to foreign investors. The U.S. should be able borrow at lower interest rates.
International commerce operates more smoothly with a strong dollar. The dollar is the world's reserve currency and is used more than any other currency for international trade. Commerce benefits from a strong, stable currency. One need only look back at pre-Civil War America for times when there was no permanent national paper currency. There was tremendous demand for a medium of exchange, however, and a variety of things served as currency, including tobacco, deer and other animal skins (whence the term "buck"), pieces of Spanish coins (the origin of "quarter," which resulted when a Spanish doubloon was cut into four equal sized pieces), and promissory notes issued by state banks, private banks and even individuals. It's not an accident that the U.S. experienced its greatest industrial growth after the permanent adoption of federally issued paper currency. International commerce, which must remain vigorous in order to facilitate a recovery, would struggle if there were no readily accepted transnational currency.
However, before we congratulate ourselves on the might of the dollar, let's remember that our current good fortune results from market forces. The past two years have abundantly demonstrated the market is tempestuous even on good days, and what it giveth it can easily taketh away. With the government about to borrow a trillion or more, and the Fed printing another trillion or more, the market could turn tail and flee the dollar in a New York minute. The music you hear in the background isn't "Columbia, the Gem of the Ocean." It's Carly Simon's "You're So Vain."
Monday, December 17, 2007
A Tale of Two Currencies
Today, the world has two principal currencies. One, the Euro, is the officially adopted currency of the 13 countries of the Eurozone, which includes of most of the economic powers of Europe. The other, the U.S. dollar, is the officially adopted currency in six nations (the U.S., Panama, El Salvador, Ecuador, East Timor and certain Pacific islands). It is also officially or not quite officially pegged to certain other currencies, which in effect makes it a de facto currency of the pegging nation (such as China, Hong Kong, Macau, and Saudi Arabia). Although China has officially delinked the yuan from the dollar, it unofficially maintains currency parity, allowing the yuan to drift up ever so slightly from time to time without disrupting its fundamental relationship to the dollar.
We all know that the dollar has been falling and the Euro rising. Hordes of European tourists flood Manhattan, Florida, dude ranches and upscale shopping venues nationwide. Canadians lose their customary restraint whenever they cross the border and approach a mall. Fashion models demand payment in Euros.
Foreign and American investors are allocating more capital to non-dollar denominated investments. The foreign capital that is coming into the U.S. is being used to buy pieces of crown jewels of the American financial system. America continues to attract foreign investment, only at greater cost.
Short to medium term, foreign financial markets will probably provide returns that are as good or better than the U.S. financial markets. Foreign economies are less burdened by the losses emanating from the U.S. mortgage mess, and will probably grow faster. The U.S. economy may or may not fall into a recession, but it will surely slow down and bring corporate profit growth down with it.
But long term, bet on the dollar. Why?
Because the greatest economic potential remains in the dollar zone nations. With Germany, France and Italy at the lead, the Eurozone consists primarily of mature, highly structured economies with substantial social welfare systems. They have short work weeks and generous amounts of vacation time. Innovation and risk-taking are not greatly encouraged. Their cultures are highly developed and continental--meaning they indulge in a condescending cynicism that sometimes makes Americans feel inferior, but ultimately saps Europe of economic vitality.
The two principal nations of the dollar zone are the U.S. and China. Although politically quite different, they are economically almost two parts of the same nation. Numerous U.S. manufacturing and retailing companies rely heavily on Chinese suppliers. The U.S. government's budget deficit is financed to a significant degree by the central bank of China. Low American inflation rates and the flood of inexpensive consumer goods we have today are attributable in large part to America's economic ties to China. China's new found prosperity is heavily dependent on sales to America.
America is a nation of dreamers. Founded by immigrants, its aspirational qualities form the core of American culture. The American dream, and the gosh, golly enthusiasm of American tinkerers and entrepreneurs, continue to be vital.
The Chinese, too, are a nation of dreamers. Traditionally, dynastic China provided young, talented boys--including those from humble families--with the opportunity to advance by taking a series of imperial examinations. Those that were successful were given educational opportunities, and, ultimately, university professorships and high ranking government positions. Thus, the talented and ambitious could advance and confer the benefits of their abilities on the nation as a whole.
The Communist Chinese government, in making its turn toward capitalism, funneled these ambitions toward commercial endeavor. Chinese entrepreneurs responded with vigor, producing the economic juggernaut we see today.
The common tendency of Americans and Chinese to dream, aspire, and indulge ambition is probably one of the main reasons for the economic partnership of the two nations. While many third world nations can provide low cost labor, few peoples try as hard as the Chinese to win and please customers. There have been some stumbles along the way, most recently with some poorly manufactured toys. But Americans and Chinese find that they often work well together. And, given the interconnections between their economies, they have a strong interest in continuing to work together. Whatever it may say, the central bank of China will maintain close parity between the yuan and the dollar.
America is the center of high tech innovation. Nothing happening anywhere else in the world is about to change that. The best computer hardware and software is American. The ubiquitous Internet, an innovation that allows mass, simultaneous communication, could only have been made in the U.S.A. The core of technological knowledge here is an ocean compared to ponds in other nations.
China has become a manufacturing giant. Its engineers are becoming skilled at applied engineering, although they need to derive most of their inspiration from technological advances in other countries. The dollar-based economies of both nations links them together tightly, and they cannot (and would not want to) go their separate ways. Moreover, their aspirational qualities and drive will lead to more innovation and risk taking, qualities that will enhance productivity and economic growth.
In centuries past, nations became wealthy by building empires. The military aggression that required is no longer possible today. The Eurozone nations have tried to become wealthy by lowering trade barriers and currency translation costs. But you can build only so much wealth by cutting expenses. Ultimately, the wealth of nations now comes from technological advancement and risk taking. This is where the dollar zone nations have the distinct advantage.
The nation's and the world's economies, as we are now learning with the mortgage mess and credit crunch, move in cycles. No amount of overly clever financial engineering changes that basic fact. At some points of the cycle, conservative economies like the Eurozone will have the advantage, just as Japan had the advantage in the 1980s. But the long term advantage rests with the dreamers and schemers, the plungers and gamblers, the max-out-your-credit card entrepreneurs. For your long run investments, bet on the dollar.
Crime News: the rising popularity of pink penitentiaries. http://www.wtop.com/?nid=456&sid=1310999.
We all know that the dollar has been falling and the Euro rising. Hordes of European tourists flood Manhattan, Florida, dude ranches and upscale shopping venues nationwide. Canadians lose their customary restraint whenever they cross the border and approach a mall. Fashion models demand payment in Euros.
Foreign and American investors are allocating more capital to non-dollar denominated investments. The foreign capital that is coming into the U.S. is being used to buy pieces of crown jewels of the American financial system. America continues to attract foreign investment, only at greater cost.
Short to medium term, foreign financial markets will probably provide returns that are as good or better than the U.S. financial markets. Foreign economies are less burdened by the losses emanating from the U.S. mortgage mess, and will probably grow faster. The U.S. economy may or may not fall into a recession, but it will surely slow down and bring corporate profit growth down with it.
But long term, bet on the dollar. Why?
Because the greatest economic potential remains in the dollar zone nations. With Germany, France and Italy at the lead, the Eurozone consists primarily of mature, highly structured economies with substantial social welfare systems. They have short work weeks and generous amounts of vacation time. Innovation and risk-taking are not greatly encouraged. Their cultures are highly developed and continental--meaning they indulge in a condescending cynicism that sometimes makes Americans feel inferior, but ultimately saps Europe of economic vitality.
The two principal nations of the dollar zone are the U.S. and China. Although politically quite different, they are economically almost two parts of the same nation. Numerous U.S. manufacturing and retailing companies rely heavily on Chinese suppliers. The U.S. government's budget deficit is financed to a significant degree by the central bank of China. Low American inflation rates and the flood of inexpensive consumer goods we have today are attributable in large part to America's economic ties to China. China's new found prosperity is heavily dependent on sales to America.
America is a nation of dreamers. Founded by immigrants, its aspirational qualities form the core of American culture. The American dream, and the gosh, golly enthusiasm of American tinkerers and entrepreneurs, continue to be vital.
The Chinese, too, are a nation of dreamers. Traditionally, dynastic China provided young, talented boys--including those from humble families--with the opportunity to advance by taking a series of imperial examinations. Those that were successful were given educational opportunities, and, ultimately, university professorships and high ranking government positions. Thus, the talented and ambitious could advance and confer the benefits of their abilities on the nation as a whole.
The Communist Chinese government, in making its turn toward capitalism, funneled these ambitions toward commercial endeavor. Chinese entrepreneurs responded with vigor, producing the economic juggernaut we see today.
The common tendency of Americans and Chinese to dream, aspire, and indulge ambition is probably one of the main reasons for the economic partnership of the two nations. While many third world nations can provide low cost labor, few peoples try as hard as the Chinese to win and please customers. There have been some stumbles along the way, most recently with some poorly manufactured toys. But Americans and Chinese find that they often work well together. And, given the interconnections between their economies, they have a strong interest in continuing to work together. Whatever it may say, the central bank of China will maintain close parity between the yuan and the dollar.
America is the center of high tech innovation. Nothing happening anywhere else in the world is about to change that. The best computer hardware and software is American. The ubiquitous Internet, an innovation that allows mass, simultaneous communication, could only have been made in the U.S.A. The core of technological knowledge here is an ocean compared to ponds in other nations.
China has become a manufacturing giant. Its engineers are becoming skilled at applied engineering, although they need to derive most of their inspiration from technological advances in other countries. The dollar-based economies of both nations links them together tightly, and they cannot (and would not want to) go their separate ways. Moreover, their aspirational qualities and drive will lead to more innovation and risk taking, qualities that will enhance productivity and economic growth.
In centuries past, nations became wealthy by building empires. The military aggression that required is no longer possible today. The Eurozone nations have tried to become wealthy by lowering trade barriers and currency translation costs. But you can build only so much wealth by cutting expenses. Ultimately, the wealth of nations now comes from technological advancement and risk taking. This is where the dollar zone nations have the distinct advantage.
The nation's and the world's economies, as we are now learning with the mortgage mess and credit crunch, move in cycles. No amount of overly clever financial engineering changes that basic fact. At some points of the cycle, conservative economies like the Eurozone will have the advantage, just as Japan had the advantage in the 1980s. But the long term advantage rests with the dreamers and schemers, the plungers and gamblers, the max-out-your-credit card entrepreneurs. For your long run investments, bet on the dollar.
Crime News: the rising popularity of pink penitentiaries. http://www.wtop.com/?nid=456&sid=1310999.
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