Much to the surprise of numerous market players, the Swiss National Bank yesterday (Jan. 15, 2015) dropped its commitment to peg the Swiss franc at 1.20 to the Euro. The Swiss franc suddenly rose some 20% in value, a price shift that clobbered anyone betting the peg would hold. Losses have been sudden and very sharp. A major foreign exchange broker, FXCM, has received an emergency $300 million bailout loan from Leucadia National. Another forex broker, Alpari UK, has entered insolvency proceedings. A new Zealand broker, Excel Markets, has been knocked out of business.
The Swiss National Bank's reasons for abandoning the peg aren't very clear. But the abrupt demise of the peg is reminiscent of the UK's withdrawal of the British pound from the European Exchange Rate Mechanism in 1992, after a large hedge fund shorted over 10 billion pounds on September 16, 1992. The Bank of England was trying to fight market forces that dictated a lower valuation for the pound, and in the end couldn't win that fight.
A news story reports that in December 2014, there was a very large capital inflow into the Swiss franc, with some 34 billion francs being bought up. See http://www.cnbc.com/id/102343957. This is about 10 times the monthly average. One can wonder whether this flood of capital was the result of a calculated move by one or a few big market players. While there has for some months been a flight to safety resulting from the EU's economic slowdown (and the likely de facto devaluation in the near future of the Euro via ECB quantitative easing), Vladimir Putin's banditry in Ukraine, and the never-ending turmoil in the Middle East, December's inflow is so abruptly large than one cannot exclude the possibility that it was a move made by a few powerful players. And if it was, they would have profited handsomely from the Swiss franc's recent price rise.
Showing posts with label currency exchange rates. Show all posts
Showing posts with label currency exchange rates. Show all posts
Friday, January 16, 2015
Wednesday, February 6, 2013
Dow 14,000: So What?
What does Dow Jones Industrial Average at 14,000 mean? Not much, when you consider that it's to a large degree the product of the Fed's unremitting money printing policy. A "value" achieved through government policies, rather than market forces, has little intrinsic value. Witness the real estate markets of 2007-08: decades of government subsidies through the mortgage markets, tax laws and Federal Reserve monetary laxity puffed up home values until they exploded in our faces. Comparable subsidies (like quantitative easing) and more easy Fed money can do the same to financial assets.
Right now, retail money has started flowing into stocks again. That's deemed by many market pros to be a sign of an impending market peak. If you want to get in and out of the market--i.e., trade it as if it were an asset bubble--there may be some greater fools who would buy from you. That is, if you act quickly enough. But investor, beware. The Fed is making an enormous bet right now: that enough monetary stimulus will somehow revive the economy to the point that it will independently resume sustained growth and return to full employment. That such will occur is unusually uncertain. Aside from the fact that economic revival has been painfully slow even with all the printed money, one has the sneaking suspicion that the Fed has quietly placed a side bet that its easy money policy would push down the value of the dollar enough that America might export its way to prosperity. But other export-centric nations are fighting back. Japan has effectively undermined the independence of its central bank in order to push the yen down. China has stopped levitating the renminbi. And the Germans are starting to grouse audibly about the revival of the Euro. Currency wars tend to take on the look and feel of a circular firing squad, and the major economies of the world are charging their muskets.
Right now, retail money has started flowing into stocks again. That's deemed by many market pros to be a sign of an impending market peak. If you want to get in and out of the market--i.e., trade it as if it were an asset bubble--there may be some greater fools who would buy from you. That is, if you act quickly enough. But investor, beware. The Fed is making an enormous bet right now: that enough monetary stimulus will somehow revive the economy to the point that it will independently resume sustained growth and return to full employment. That such will occur is unusually uncertain. Aside from the fact that economic revival has been painfully slow even with all the printed money, one has the sneaking suspicion that the Fed has quietly placed a side bet that its easy money policy would push down the value of the dollar enough that America might export its way to prosperity. But other export-centric nations are fighting back. Japan has effectively undermined the independence of its central bank in order to push the yen down. China has stopped levitating the renminbi. And the Germans are starting to grouse audibly about the revival of the Euro. Currency wars tend to take on the look and feel of a circular firing squad, and the major economies of the world are charging their muskets.
Sunday, January 23, 2011
The Fed and Foreign Policy
The Fed's easy money policies have spurred inflation and rising real estate prices in China. China's informal link of the yuan to the dollar in effect imports U.S. monetary policy into China. Even though the slack in the U.S. economy from the Great Recession has held prices down here, the red hot Chinese economy reacted to excess liquidity by pushing up prices there.
The Chinese have a deep fear of inflation, having experienced far worse in their four millenia of existence as a civilization than anything Americans have seen. They're imposing monetary constraints, and even resorting to price controls. The Fed is meeting this Tuesday and Wednesday, and is expected to continue running its money printing press at full throttle. With its inflationary implications for the yuan, the Fed's current stance provides China a reason to de-link the yuan from the dollar. Once the yuan is de-linked, China can regain control of its own monetary policies.
The dissatisfaction of Chinese consumers with inflation has much more influence on Beijing's thinking than all the haranguing of the U.S. and European governments. Thus, the yuan is edging up in value, and is becoming more freely tradeable in international currency markets. Its continued rise against the dollar can be expected, albeit at a carefully managed rate. Among other things, a rising yuan makes it easier for China to buy oil and other commodities traded in dollars. Greater Chinese demand would push up the dollar-denominated price of those commodities.
This will be a mixed bag for America. As the yuan rises, U.S. exports to China may increase, creating jobs here. But a falling dollar also means a loss of buying power. America imports a lot from China, and as the yuan rises, those imports become more expensive. Cheaper substitutes may be available in some instances--Southeast and South Asia offer lower cost alternatives for manufacturing clothes. But the manufacture of high tech components that go into computers, cell phones, PDAs, tablet computers and what not can't easily be shifted to new suppliers. And rising oil and other commodities prices have obvious implications for American consumers. A rising yuan, bottom line, means falling wealth levels in America.
It may be that the Fed intends to engineer a drop in the dollar's value. That would be one way it can discharge its statutory mandate to foster full employment. America's wealth levels during the past decade were puffed up by the profligate borrowing that funded the nation's consumption. Debt-fueled "prosperity" can't go on indefinitely, and America's wealth was at risk for a fall.
As the dollar drops against the yuan, the Chinese government will take losses on its vast portfolio of dollar-denominated investments. It would likely be willing to take these losses in order to hold inflation in check and keep its citizens from becoming overly restive.
Many Americans would consider jobs for some of the unemployed at the expense of less buying power for all to be a fair trade. High unemployment has many social costs, ranging from increased government spending to discouraging consumption to familial distress and breakdowns. Fair or not, however, as the yuan rises, American living standards could be squeezed.
The Chinese have a deep fear of inflation, having experienced far worse in their four millenia of existence as a civilization than anything Americans have seen. They're imposing monetary constraints, and even resorting to price controls. The Fed is meeting this Tuesday and Wednesday, and is expected to continue running its money printing press at full throttle. With its inflationary implications for the yuan, the Fed's current stance provides China a reason to de-link the yuan from the dollar. Once the yuan is de-linked, China can regain control of its own monetary policies.
The dissatisfaction of Chinese consumers with inflation has much more influence on Beijing's thinking than all the haranguing of the U.S. and European governments. Thus, the yuan is edging up in value, and is becoming more freely tradeable in international currency markets. Its continued rise against the dollar can be expected, albeit at a carefully managed rate. Among other things, a rising yuan makes it easier for China to buy oil and other commodities traded in dollars. Greater Chinese demand would push up the dollar-denominated price of those commodities.
This will be a mixed bag for America. As the yuan rises, U.S. exports to China may increase, creating jobs here. But a falling dollar also means a loss of buying power. America imports a lot from China, and as the yuan rises, those imports become more expensive. Cheaper substitutes may be available in some instances--Southeast and South Asia offer lower cost alternatives for manufacturing clothes. But the manufacture of high tech components that go into computers, cell phones, PDAs, tablet computers and what not can't easily be shifted to new suppliers. And rising oil and other commodities prices have obvious implications for American consumers. A rising yuan, bottom line, means falling wealth levels in America.
It may be that the Fed intends to engineer a drop in the dollar's value. That would be one way it can discharge its statutory mandate to foster full employment. America's wealth levels during the past decade were puffed up by the profligate borrowing that funded the nation's consumption. Debt-fueled "prosperity" can't go on indefinitely, and America's wealth was at risk for a fall.
As the dollar drops against the yuan, the Chinese government will take losses on its vast portfolio of dollar-denominated investments. It would likely be willing to take these losses in order to hold inflation in check and keep its citizens from becoming overly restive.
Many Americans would consider jobs for some of the unemployed at the expense of less buying power for all to be a fair trade. High unemployment has many social costs, ranging from increased government spending to discouraging consumption to familial distress and breakdowns. Fair or not, however, as the yuan rises, American living standards could be squeezed.
Wednesday, January 12, 2011
Unintended Consequences of Monetary Policy
Today's news reported that China's foreign exchange reserves have risen to $2.85 trillion (yes, trillion, not billion), an increase of 20% over the past year. This is almost triple the next highest amount of foreign reserves held by a central bank (Japan, at $1.04 trillion). At the same time, China's trade balance narrowed over the past year. In other words, China's increased holdings of foreign reserves don't come from a net increase in exports.
Many commentators blame China's low exchange rate for the yuan, which it depresses in order to protect its exporters. But if net exports aren't increasing, something else is going on. A prime suspect is the carry trade, in which speculators borrow dollars made cheap by the Fed's easy money policies and convert them into yuan in order to profit from China's rising interest rates. The dichotomy in interest rates between China (high) and America (low) gives capital the incentive to flee the U.S. for higher returns in China. The fact that China has recently loosened trading restrictions in the yuan, allowing it to be traded in Hong Kong and now the U.S., only makes such capital flight easier. The Chinese central bank will levitate rates further in order to combat accelerating inflation in China, so the disparity with America will only increase.
China's high interest rate/low yuan exchange rate strategy exacerbates economic imbalance. The high rates will predictably draw in foreign capital, and the low exchange rate for the yuan will only aggravate the phenomenon by making it cheap in forex terms to buy high interest rate yuan obligations. But the Federal Reserve's easy money policy heightens incentives for speculators to invest the dollars it's printing in China rather than America. Such a capital outflow would help explain why inflation has been so low in the U.S., notwithstanding the Fed's 'round the clock money printing operation. Capital outflow detracts from whatever stimulus effect the Fed's quantitative easing program might have. Although unintended, QE is boosting China's forex reserves. The Chinese want to eat their cake and have it, too. So does the Fed, hoping that printing money will spur growth without inflation. But it isn't spurring much growth, and is producing inflation in China. That does nobody much good.
Monetary policy is heightening the imbalance between China and America. The Fed doesn't intend this, and the Chinese surely recognize the dangers as well. But China can't turn on a dime away from an export driven economy, and the Fed clearly will persist in QE come hell or high water. So we shouldn't expect things to change much in the foreseeable future.
Many commentators blame China's low exchange rate for the yuan, which it depresses in order to protect its exporters. But if net exports aren't increasing, something else is going on. A prime suspect is the carry trade, in which speculators borrow dollars made cheap by the Fed's easy money policies and convert them into yuan in order to profit from China's rising interest rates. The dichotomy in interest rates between China (high) and America (low) gives capital the incentive to flee the U.S. for higher returns in China. The fact that China has recently loosened trading restrictions in the yuan, allowing it to be traded in Hong Kong and now the U.S., only makes such capital flight easier. The Chinese central bank will levitate rates further in order to combat accelerating inflation in China, so the disparity with America will only increase.
China's high interest rate/low yuan exchange rate strategy exacerbates economic imbalance. The high rates will predictably draw in foreign capital, and the low exchange rate for the yuan will only aggravate the phenomenon by making it cheap in forex terms to buy high interest rate yuan obligations. But the Federal Reserve's easy money policy heightens incentives for speculators to invest the dollars it's printing in China rather than America. Such a capital outflow would help explain why inflation has been so low in the U.S., notwithstanding the Fed's 'round the clock money printing operation. Capital outflow detracts from whatever stimulus effect the Fed's quantitative easing program might have. Although unintended, QE is boosting China's forex reserves. The Chinese want to eat their cake and have it, too. So does the Fed, hoping that printing money will spur growth without inflation. But it isn't spurring much growth, and is producing inflation in China. That does nobody much good.
Monetary policy is heightening the imbalance between China and America. The Fed doesn't intend this, and the Chinese surely recognize the dangers as well. But China can't turn on a dime away from an export driven economy, and the Fed clearly will persist in QE come hell or high water. So we shouldn't expect things to change much in the foreseeable future.
Tuesday, October 19, 2010
So What the Heck is China Up To?
The Chinese central bank raised interest rates today, signaling a slowdown in the growth of China's economy. Financial markets in the rest of the world took the news badly. The U.S. markets dropped 1.5 %.
China's government moved to cool down a blistering economy, driven by fear of inflation and a bubble in its real estate market. Must be tough to have such problems--economic growth that's too fast, rapidly rising asset values. Oddly perhaps, these problems stem from the U.S. Federal Reserve's easy money monetary policy. Because the Chinese yuan is tied to the dollar at a more or less fixed exchange rate, U.S. monetary policy flows through to China and becomes China's de facto monetary policy. The flood of liquidity from the Fed has had limited stimulative effect in America because of the slack in the U.S. economy. But China's economy is much more taut and easy money makes things happen in China.
Just as America's monetary policy becomes China's, so does China's monetary policy become America's. The dollar rose in the currency markets, and interest rates in the U.S. Treasuries market moved up, seemingly in sympathy with the Chinese move.
Logically, if the Chinese government wanted better control over the Chinese economy, it would de-link the yuan from the dollar and rid China of the Fed's easy money policies. Why hasn't it? With all the international outcry over the relatively weak yuan, the Chinese would garner brownie points with many other nations if they did so. And Chinese manufacturers could probably cover much or all of the cost increases resulting from a rising yuan by squeezing more productivity out of their facilities and employees. The Japanese faced the same challenge with a rising yen in the 1970s and 1980s. They quite successfully increased productivity and protected their export industries.
While the Chinese central bank, unlike the U.S. Fed, does not issue statements explaining its actions, a glance at the tea leaves suggests an explanation. China holds trillions of dollars of investments denominated in dollars--U.S. Treasuries, mortgage-backed investments and other paper. De-linking the yuan from the dollar, and the resulting fall in the dollar, could impose hundreds of billions of dollars of investment losses on the Chinese. Even though China is no longer expanding its dollar exposure, and instead buying Euro denominated investments, it remains stuck in a bear hug with the dollar and must protect the value of the dollar. By raising its own interest rates, it raises the value of the dollar, offsetting some of the dollar's recent weakness.
The underlying source of all this angst, sturm and drang is China's trade surplus. Whether denominated in dollars, Euros or whatever, China maintains a large and persistent trade surplus with the rest of the world. By all indications, it intends to maintain this trade surplus, even though Chinese leaders pay lip service to the notion of increasing domestic consumption. Much of the outside world perceives China's trade surplus as economic aggression, and reciprocates with disapproval, at a minimum. But China, the world's oldest continuous civilization, hasn't survived 4,000 years by poking everyone else in the eye with a sharp stick. So what the heck are they up to?
China has a severe demographic problem. It doesn't have enough young people to support all the older Chinese who will be retiring in the next few decades. With an already enormous population of 1.3 billion relying on its limited resources, China can't add enough young people, either through births or immigration, to satisfy its needs. By saving enormous amounts of money denominated in key foreign currencies like the dollar and Euro, China acquires the ability to purchase resources from other nations to support its old folks. It can draw on the productive capacity of younger people elsewhere in the world by purchasing the goods they produce. Without a large stash of foreign currency, however, China could have a difficult time supporting its retirees through imports. It would have to export Chinese goods in order to acquire the necessary foreign exchange, and its ability to do so ten, twenty, thirty or more years from now is unpredictable. By stashing away foreign currency now, while it has a trade advantage, it builds up a reservoir on which to draw later.
What does this mean for the future? That America will be closely connected to China for a long time, and very possibly on terms not highly favorable to America. But the good news is that eventually, when China needs to import goods to support its elderly, it will logically look to spend many of its dollars in the country that issues them.
China's government moved to cool down a blistering economy, driven by fear of inflation and a bubble in its real estate market. Must be tough to have such problems--economic growth that's too fast, rapidly rising asset values. Oddly perhaps, these problems stem from the U.S. Federal Reserve's easy money monetary policy. Because the Chinese yuan is tied to the dollar at a more or less fixed exchange rate, U.S. monetary policy flows through to China and becomes China's de facto monetary policy. The flood of liquidity from the Fed has had limited stimulative effect in America because of the slack in the U.S. economy. But China's economy is much more taut and easy money makes things happen in China.
Just as America's monetary policy becomes China's, so does China's monetary policy become America's. The dollar rose in the currency markets, and interest rates in the U.S. Treasuries market moved up, seemingly in sympathy with the Chinese move.
Logically, if the Chinese government wanted better control over the Chinese economy, it would de-link the yuan from the dollar and rid China of the Fed's easy money policies. Why hasn't it? With all the international outcry over the relatively weak yuan, the Chinese would garner brownie points with many other nations if they did so. And Chinese manufacturers could probably cover much or all of the cost increases resulting from a rising yuan by squeezing more productivity out of their facilities and employees. The Japanese faced the same challenge with a rising yen in the 1970s and 1980s. They quite successfully increased productivity and protected their export industries.
While the Chinese central bank, unlike the U.S. Fed, does not issue statements explaining its actions, a glance at the tea leaves suggests an explanation. China holds trillions of dollars of investments denominated in dollars--U.S. Treasuries, mortgage-backed investments and other paper. De-linking the yuan from the dollar, and the resulting fall in the dollar, could impose hundreds of billions of dollars of investment losses on the Chinese. Even though China is no longer expanding its dollar exposure, and instead buying Euro denominated investments, it remains stuck in a bear hug with the dollar and must protect the value of the dollar. By raising its own interest rates, it raises the value of the dollar, offsetting some of the dollar's recent weakness.
The underlying source of all this angst, sturm and drang is China's trade surplus. Whether denominated in dollars, Euros or whatever, China maintains a large and persistent trade surplus with the rest of the world. By all indications, it intends to maintain this trade surplus, even though Chinese leaders pay lip service to the notion of increasing domestic consumption. Much of the outside world perceives China's trade surplus as economic aggression, and reciprocates with disapproval, at a minimum. But China, the world's oldest continuous civilization, hasn't survived 4,000 years by poking everyone else in the eye with a sharp stick. So what the heck are they up to?
China has a severe demographic problem. It doesn't have enough young people to support all the older Chinese who will be retiring in the next few decades. With an already enormous population of 1.3 billion relying on its limited resources, China can't add enough young people, either through births or immigration, to satisfy its needs. By saving enormous amounts of money denominated in key foreign currencies like the dollar and Euro, China acquires the ability to purchase resources from other nations to support its old folks. It can draw on the productive capacity of younger people elsewhere in the world by purchasing the goods they produce. Without a large stash of foreign currency, however, China could have a difficult time supporting its retirees through imports. It would have to export Chinese goods in order to acquire the necessary foreign exchange, and its ability to do so ten, twenty, thirty or more years from now is unpredictable. By stashing away foreign currency now, while it has a trade advantage, it builds up a reservoir on which to draw later.
What does this mean for the future? That America will be closely connected to China for a long time, and very possibly on terms not highly favorable to America. But the good news is that eventually, when China needs to import goods to support its elderly, it will logically look to spend many of its dollars in the country that issues them.
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.
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.
Friday, June 25, 2010
Winners and Losers from the Yuan Re-valuation
Winners
China cleverly announced its decision to permit its currency, the yuan, to float more widely and gradually move higher against the dollar shortly before the G-7 and G-20 meetings. It took away the biggest gripe other nations had about it, and leveraged its ability to lecture them about their failings. The Chinese, who are heavily invested in both dollar and Euro denominated assets, have much to say about the profligacy of the West, and much to gain if Western nations get their financial houses in order. The re-valuation was begun just as China is turning to building domestic consumer demand in order to lessen its dependence on exports to the West. It's no accident Chinese authorities didn't interfere when workers at Honda and Toyota plants in China went on strike. Higher wages in China will boost domestic demand. (Henry Ford did something similar in 1914 when he first began paying workers the then astonishing wage of $5 a day.)
China in the long term will win from the re-valuation of the yuan. Its manufacturers will seek to become more efficient and cost effective in order to preserve their export markets. Given China's indisputable prowess in manufacturing, expect many of them to succeed. The same thing happened with Japan. In the early 1970s, the yen traded at over 300 to the dollar. Despite various Japanese government measures to keep the yen down, it rose to the low 200s per dollar by the end of the 1970s. But Japan kept running a trade surplus with the U.S. because its manufacturers continued to improve (and in some cases move their factories to lower cost countries in Asia, but this still helped Japan maintain a surplus with America). In the 1980s, the yen stubbornly remained around the low 200s until a 1985 international agreement called the Plaza Accord led to its devaluation into the low 100s. Nevertheless, Japan's trade surplus with the U.S. remained sizable. It remains sizable to this day (over $44 billion in 2009), even though the yen now trades around 90 to the dollar. Japan's exporters still work hard to improve efficiency and quality. The Chinese will do the same, and their likely success will preserve many export markets. Efficiency improvements will also help them to seize market share in China's growing domestic markets, reducing opportunities for America and other nations to export to China.
Mexico and other low cost manufacturers will also win. America's now chastened consumers, who have rediscovered the virtues of saving, will resist higher prices. As China's prices rise, American retailers will seek out alternative inexpensive sources of supply. These will almost always be in other foreign nations with low labor costs.
Currency traders at big banks, hedge funds and elsewhere will have more opportunities with a more flexible yuan. Traders like volatility, because price movements, whether they are up or down, create larger profit opportunities than stable exchange rates. Big banks will also profit from selling derivatives products to hedge or speculate in the value of the yuan.
Losers
The United States could easily end up on the short end of the stick. A higher yuan will improve American industry's ability to export to China. But long term success is far from certain, as Chinese manufacturers will fight back by vigorously improving their capabilities. America's failure to achieve a trade balance with Japan after the yen more than tripled in value over 30 years is sobering. America needs to concentrate its resources on developing products and services other wealthy nations want to buy. Its last couple of decades of growth have been financed by foreigners purchasing American debt, and that's a trend that won't last. A big recent American innovation, social networking sites, may be fun, and popular overseas as well as here. But these sites are not noticeably profitable, and won't add much to our national income. Investment in basic research and development, bio tech and high tech should be favored. We don't need more financial engineering. We need more science-based engineering. Long term economic growth can't rest on the hoped-for continued escalation of real estate or any other asset. It should come from making things other people want to buy.
EU nations are also likely losers. The still unfolding sovereign debt crisis reveals that Western Europe, like America, used debt instead of productive capability to foster "prosperity." Europe is less innovative than America, and its prospects for growth are correspondingly lower. (EU per capita income is already about 30% lower than America's and Europeans should worry about whether or not that comparison will worsen.) As the rising yuan strengthens China, and American industry seeks to riposte, Europe will be caught in the cross-fire. Germany, with its famed discipline, might maintain relative parity. But the rest of Europe may have to rely increasingly on the quaintness of its tourist sites to pay the bills.
Political Winners
While we've been focusing on economics, the yuan re-valuation eases tensions between America and China, and makes it easier for them to work together on common problems. China wants to become wealthier and stronger. But it would not want America to become weaker. America is the world's police officer, and is taking the brunt of the load of dealing with international nut cases like North Korea's Communist government and the radicals in power in Iran. If the U.S. were to weaken and reduce its level of engagement in Asia, China would be stuck with a lot of nasty problems. The Chinese benefit economically from a prosperous South Korea, so they'd have the primary burden of constraining the loonies in Pyongyang, a job now largely performed by the U.S. troops on the 38th parallel. The Chinese would also have to greatly increase their involvement in the Middle East, a crucial source of petroleum for them and many of their Asian trading partners. The U.S., at great cost in lives and money, currently ensures a steady outflow of oil from the Middle East. And the U.S. war against Islamic radicalism in Afghanistan and elsewhere suits China's purposes. The same radicalism has seeped into the Muslim populations of Chinese Central Asia, creating unrest and occasional violence. The Chinese know they would become a primary target if America withdrew from the field of fire. America, in turn, needs China's cooperation with its many problems in Asia and elsewhere. Thus, both nations are political winners from the yuan re-valuation.
China cleverly announced its decision to permit its currency, the yuan, to float more widely and gradually move higher against the dollar shortly before the G-7 and G-20 meetings. It took away the biggest gripe other nations had about it, and leveraged its ability to lecture them about their failings. The Chinese, who are heavily invested in both dollar and Euro denominated assets, have much to say about the profligacy of the West, and much to gain if Western nations get their financial houses in order. The re-valuation was begun just as China is turning to building domestic consumer demand in order to lessen its dependence on exports to the West. It's no accident Chinese authorities didn't interfere when workers at Honda and Toyota plants in China went on strike. Higher wages in China will boost domestic demand. (Henry Ford did something similar in 1914 when he first began paying workers the then astonishing wage of $5 a day.)
China in the long term will win from the re-valuation of the yuan. Its manufacturers will seek to become more efficient and cost effective in order to preserve their export markets. Given China's indisputable prowess in manufacturing, expect many of them to succeed. The same thing happened with Japan. In the early 1970s, the yen traded at over 300 to the dollar. Despite various Japanese government measures to keep the yen down, it rose to the low 200s per dollar by the end of the 1970s. But Japan kept running a trade surplus with the U.S. because its manufacturers continued to improve (and in some cases move their factories to lower cost countries in Asia, but this still helped Japan maintain a surplus with America). In the 1980s, the yen stubbornly remained around the low 200s until a 1985 international agreement called the Plaza Accord led to its devaluation into the low 100s. Nevertheless, Japan's trade surplus with the U.S. remained sizable. It remains sizable to this day (over $44 billion in 2009), even though the yen now trades around 90 to the dollar. Japan's exporters still work hard to improve efficiency and quality. The Chinese will do the same, and their likely success will preserve many export markets. Efficiency improvements will also help them to seize market share in China's growing domestic markets, reducing opportunities for America and other nations to export to China.
Mexico and other low cost manufacturers will also win. America's now chastened consumers, who have rediscovered the virtues of saving, will resist higher prices. As China's prices rise, American retailers will seek out alternative inexpensive sources of supply. These will almost always be in other foreign nations with low labor costs.
Currency traders at big banks, hedge funds and elsewhere will have more opportunities with a more flexible yuan. Traders like volatility, because price movements, whether they are up or down, create larger profit opportunities than stable exchange rates. Big banks will also profit from selling derivatives products to hedge or speculate in the value of the yuan.
Losers
The United States could easily end up on the short end of the stick. A higher yuan will improve American industry's ability to export to China. But long term success is far from certain, as Chinese manufacturers will fight back by vigorously improving their capabilities. America's failure to achieve a trade balance with Japan after the yen more than tripled in value over 30 years is sobering. America needs to concentrate its resources on developing products and services other wealthy nations want to buy. Its last couple of decades of growth have been financed by foreigners purchasing American debt, and that's a trend that won't last. A big recent American innovation, social networking sites, may be fun, and popular overseas as well as here. But these sites are not noticeably profitable, and won't add much to our national income. Investment in basic research and development, bio tech and high tech should be favored. We don't need more financial engineering. We need more science-based engineering. Long term economic growth can't rest on the hoped-for continued escalation of real estate or any other asset. It should come from making things other people want to buy.
EU nations are also likely losers. The still unfolding sovereign debt crisis reveals that Western Europe, like America, used debt instead of productive capability to foster "prosperity." Europe is less innovative than America, and its prospects for growth are correspondingly lower. (EU per capita income is already about 30% lower than America's and Europeans should worry about whether or not that comparison will worsen.) As the rising yuan strengthens China, and American industry seeks to riposte, Europe will be caught in the cross-fire. Germany, with its famed discipline, might maintain relative parity. But the rest of Europe may have to rely increasingly on the quaintness of its tourist sites to pay the bills.
Political Winners
While we've been focusing on economics, the yuan re-valuation eases tensions between America and China, and makes it easier for them to work together on common problems. China wants to become wealthier and stronger. But it would not want America to become weaker. America is the world's police officer, and is taking the brunt of the load of dealing with international nut cases like North Korea's Communist government and the radicals in power in Iran. If the U.S. were to weaken and reduce its level of engagement in Asia, China would be stuck with a lot of nasty problems. The Chinese benefit economically from a prosperous South Korea, so they'd have the primary burden of constraining the loonies in Pyongyang, a job now largely performed by the U.S. troops on the 38th parallel. The Chinese would also have to greatly increase their involvement in the Middle East, a crucial source of petroleum for them and many of their Asian trading partners. The U.S., at great cost in lives and money, currently ensures a steady outflow of oil from the Middle East. And the U.S. war against Islamic radicalism in Afghanistan and elsewhere suits China's purposes. The same radicalism has seeped into the Muslim populations of Chinese Central Asia, creating unrest and occasional violence. The Chinese know they would become a primary target if America withdrew from the field of fire. America, in turn, needs China's cooperation with its many problems in Asia and elsewhere. Thus, both nations are political winners from the yuan re-valuation.
Tuesday, February 23, 2010
Greece, the Euro and the Currency Quandary
The following is entirely fictional.
Dour winter winds chilled the yard at the Butner, NC medium security facility. Inmates tried to exercise under the muddy gray overcast, their unprotected fingertips aching from lack of warmth. Jorge stepped around the weightlifting area and approached the older man seated on a bench.
“Hey, Bernie.”
“Hello, Jorge.”
“Bernie, I was wondering if I could get your advice on something.”
“Sure. What’s on your mind?”
“I got a chicken tamale for you, made the way you like. I figured it would help you think.”
“Oh, thanks so much, Jorge. My brain is firing up already.”
“Bernie, I got a prob . . . Well, my sister in Bogota has a problem.”
“What’s that?”
“She has some money, some U.S. dollars. And she’s trying to figure out what to do with them.”
“You mean, what to spend them on?”
“No. Like what to put them in.”
“You mean what to invest in--stocks and bonds?”
“No, I . . . she don’t like stocks and bonds because, you know, the big guys in New York, they got control over those markets. No one else knows what the stocks and bonds are really worth.”
“I understand that point. Uh, how much money does she have? I mean, depending on how much she has, you might be able to find special investments.”
“Bernie. . . Can you keep a secret?”
“Sure, Jorge. I’m very good at keeping things secret.”
“Okay, she has about ten million.”
“Ten million dollars? Holy cow. How did she get that much?”
Jorge paused and glanced around before speaking. “She . . . ah . . . found it on the sidewalk.”
Bernie smiled ever so slightly. “I guess that can happen. Investing such a large amount can be complicated. I mean . . . well, let me ask, is it in a bank account now?”
“No. Cash. Cash only. That’s the only way I do bus . . . , well, it was cash when she found it.”
“Investing that much cash would be complicated.”
“I . . . she can get it . . . how, you say, washed?”
“Laundered?”
“Yeah, that’s it. Laundered. You don’t have to worry about that Bernie. I can . . . she can take care of that. The problem is what to wash it into. That’s the hard part. I was thinking . . . I mean, for her. I was thinking for her that maybe we put them in Euros. The dollar isn’t so strong any more. And the Euro has gone up a lot. But then I hear that there’s a problem with Greece or some place, like they got too much debt or a lousy government budget, so the Euro is going down. What’s going on there, Bernie?”
“As I understand it, Greece and some other European countries borrowed a lot of money, and they’re having trouble paying it back. These debt problems make their economies grow slower. Because people think Europe's economy is weakening, its currency, the Euro, is worth less.”
“The TV was saying something like Greece or someone was hiding some of their problems. You know anything about that?”
“I gather that Greece and other European countries did these fancy deals called derivatives, which disguised some of their debt so they didn’t look so financially weak.”
Jorge frowned fiercely. “I don’t like that sneaky s___. A dude who pulls sneaky s___ on me is trying to f___ me. I don’t do no sneaky s___. When a guy tries to f___ me, I f___ him back. And, you know, I f___ him to his face, ‘cause I don’t f___ around.”
With well-practiced diffidence, Bernie glanced at Jorge, seeing eyes that could pierce steel. “I’ll bet you don’t, Jorge.”
“You can take my word on that, Bernie. I mean, you know that lying bastard that put me in this place, you know, he testify against me in court, saying I’m a narco trafficker, and the judge throw in me jail? When I get out . . . “ Jorge drew a finger across his throat.
Bernie practiced his diffidence some more. “I hope we get some warmer weather soon.”
Jorge threw back his bulky head and laughed thickly. “I like you, Bernie. You stay cool. Okay, so what we doing to do? I mean what do you think my sister should do? No Euros, ‘cause I don’t like that sneaky s___. How ‘bout the Japanese yen?”
“The yen has done pretty well overall, because Japan is basically a wealthy country and has a strong manufacturing sector that exports successfully. But the Japanese government is constantly trying to push the yen down because a weak currency helps their manufacturers export.”
Jorge thought about this for a moment. “You mean they f___ their own money?”
“Well, I don’t think they look at it that way. But you’re not far off the mark.”
“S___. Then, what’s a good thing to put the money into? I mean, I don’t want gold, ‘cause then I . . . my sister has to protect it, ‘cause there’s a lot of bad people that might try to steal it, and you know, someone might start shooting, and then s___ really starts to happen. “
“I agree, Jorge. Gold isn’t an optimal investment.”
“Then, what should I . . . my sister do?”
Bernie thought for a moment, and sighed. “Sometimes, Jorge, there aren’t any great investments. The markets fluctuate, and in a down cycle, you may just have to try to hang in there until things get better. Maybe it wouldn’t be a bad idea if . . . uh, your sister just held onto the dollars.”
Jorge frowned at the walls that would mark the limits of his freedom for years to come, and remained silent while a nearby sparrow chirped. Then, the edges of his lips lifted to betray his amusement. “So, is that how you pulled off that, what you call it . . . a party scheme?”
Bernie paused, and then said, “you mean a Ponzi scheme?”
“Yeah, that’s it. Ponzi scheme. That’s how you did it, right?”
“What do you mean?”
“You say the markets sometimes go down; not always up.”
“That’s correct.”
“So when you promised people whatever, ten or twelve percent steady, all the time, no bad times, they want believe it ‘cause otherwise they gotta deal with the market going up and down, and they don't like that. And then they give you their money.”
Bernie brooded before saying, “That about sums it up. I made it easy for them to give me their money and they made it easy for me to get it. We all took the easy way out. Legally, I’m the bad guy. But it’s easier to kill sheep than lions.”
Jorge took a deep breath, and said, “I ain’t no sheep. I had to work hard . . . I mean my sister had to look hard on the sidewalk for this money. We ain’t gonna put it where people pull sneaky s___ or these other people they f___ their own money. Maybe we just have to, like you say, hold the dollars for now.”
“I think that’s the right attitude, Jorge. Playing games with debt and currencies aren’t odds on winners. People who don’t look for the easy way out have better chances in the long run. You can take that from me.”
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.
Sunday, November 15, 2009
Currency Exchange Rates: Playing Musical Chairs with Fire
Currency exchange rates have been much in the news as President Obama makes his first visit to China. The dollar is sinking, and China has ensured that its yuan falls in tandem with the dollar. Other nations, disadvantaged by the drop in two of the most important currencies in the world, complain vociferously. The U.S. government proclaims a strong dollar policy, and then looks away as the dollar continues to fall. The Chinese government scolds the U.S. government, which lectures back.
The currency markets are different from other markets. They don't just consist of private buyers and sellers. Governments also get involved, and generally do so for political and macro-economic reasons. Since nothing is as unpredictable as politics, currency exchange rates can move in ways that seem seriously out of whack.
To make things worse, currency exchange fluctuations are, at best, a zero-sum game. One currency's gain comes at the expense of other currencies, and resulting trade imbalances have a similar effect on the nations issuing the currencies. Only today, it's worse than that. Two powerful nations--America and China--rely on policies that may produce near term gains for them but potential longer term losses for everyone. The currency markets may now be a negative sum game.
For decades, China has linked the yuan to the dollar. Thirty years ago, the rate was about 8 yuan to the dollar. Today, it's around 6.8 yuan to the dollar. By contrast, the Japanese yen has tripled in value against the dollar during the same time period. The yuan has never been fully convertible into other currencies, as China has sought to prevent the rapid inflows and outflows of foreign capital that have bedeviled the development of other Third World nations. Considering the devastation wreaked in Asia by the 1997-98 financial crisis, one would have to concede that the Chinese have a point. They aren't unvarnished capitalists, and won't allow markets to operate freely simply as a matter of principle. They utilize market forces pragmatically, mixing in government dictat whenever they believe Adam Smith's invisible hand may be a little shaky. By holding the the yuan relatively steady against the dollar, they ensure pricing stability for their exports to dollar bloc nations (i.e., nations that use the dollar or maintain currency stability against the dollar, including the U.S. and, at times, various nations in Latin America). Chinese manufacturers could largely ignore the complexities and costs of currency fluctuations and commit to low, fixed prices to buyers abroad.
China's fixed exchange rate did much to make China a dominant exporter. But it had to take a lot of dollars in exchange--ultimately trillions of dollars. These were mostly invested in U.S. Treasury securities and American mortgage-backed securities (on which the Chinese have already taken nasty losses resulting from the mortgage crisis). Now, as the dollar falls in value, China loses more money on these assets. Hence, China's scoldings to the U.S. government to get its house in order and prop up the greenback.
The U.S. government in turn has countered that China is itself responsible for this dilemma, having created the trade imbalance that resulted in its enormous dollar holdings. The U.S. government would have China restructure its economy to focus on domestic consumption, and reduce exports to take pressure off the dollar.
However, neither government is doing much to change the status quo. China's government has launched a major stimulus program to forestall economic slowdown, with much of its spending directed at building infrastructure. These are wise expenditures for a developing nation, but they do little to promote domestic consumption. The Chinese are among the world's most frugal people, because they have no other choice. China has no Social Security system. Most Chinese have no pensions; the pensions that exist are meager. The health insurance that was part of Communist China's iron rice bowl has disappeared along with sales of Chairman Mao's little red book. The Chinese save because it's the only way they can have health care and a half-way decent retirement. The Chinese government has done nothing to alter this dynamic. Since China needs about 8% economic growth every year simply to keep up with population growth, it has no choice except to keep exporting. And to do that, it has to keep its currency stable against the dollar.
The U.S. government has responded to America's economic crisis primarily by borrowing and printing dollars--shiploads of dollars. Pushed by the forces of a lot of supply and not so much demand, the dollar has not surprisingly fallen in value. Euro bloc nations have grumbled about the rise of the Euro, especially export-dependent Germany. Several smaller Asian exporting nations have recently been buying dollars in order to defend their currencies. Oil exporters, like Russia and the OPEC nations, have complained of losses in their holdings of dollar-denominated assets and hinted at pricing oil in a basket of currencies to free themselves of dollar risk. In short, the U.S. government's primary response to the economic crisis has imposed losses on the rest of the world.
The flood of the cheap money being pumped out by the Fed has fueled the "carry trade," in which speculators borrow dollars at extremely low interest rates, convert them into currencies where interest rates are higher (such as in much of Asia) and invest overseas for those higher returns. This outflow of dollars is stimulating economic activity in other nations, and appears to be creating asset bubbles in Asia. While other nations don't mind a touch of stimulus courtesy of the Fed, many in Asia have vivid and disturbing memories of the Asian financial crisis of 1997-98, when asset bubbles fueled by inflows of foreign capital burst painfully and caused severe recessions.
There is little sign that the U.S. government intends to pull its stimulus back. The Fed has made clear its intention to maintain zero interest rates as far into the future as one can foresee. The carry trade will expand and perhaps even explode--in a time of slow economic recovery, it's one of the very few ways to make fast money. China will complain and lecture, but won't change the exchange rate of the yuan by much, because it needs continued access to American markets. Other exporting nations will grumble and defend their currencies with little likelihood of long term success. Oil exporters and other holders of dollars (including China and Japan) will take more losses on their dollar reserves, as there is no other currency or asset into which they can easily transfer their wealth.
American and Chinese expediency have created dangerous dynamics in the world economy. America can win only if other nations continue to fund its gigantic deficits and tolerate its uncontrolled printing of dollars by taking losses as the dollar falls. China can win only if it continues to export to America and hope that other nations will help it fund America's deficits while they become more vulnerable to Chinese exports themselves. The rest of the world is scrambling to figure out how to limit its losses and avoid being blown up by carry trade asset bubbles. Everyone, one way or another, is trying to shift their economic problems to other nations, a process that won't have a happy ending. This is starting to look like a game of musical chairs where the limited number of chairs is diminishing and all could end up net losers. If, somehow, the people running these nations would stop playing a children's game.
The currency markets are different from other markets. They don't just consist of private buyers and sellers. Governments also get involved, and generally do so for political and macro-economic reasons. Since nothing is as unpredictable as politics, currency exchange rates can move in ways that seem seriously out of whack.
To make things worse, currency exchange fluctuations are, at best, a zero-sum game. One currency's gain comes at the expense of other currencies, and resulting trade imbalances have a similar effect on the nations issuing the currencies. Only today, it's worse than that. Two powerful nations--America and China--rely on policies that may produce near term gains for them but potential longer term losses for everyone. The currency markets may now be a negative sum game.
For decades, China has linked the yuan to the dollar. Thirty years ago, the rate was about 8 yuan to the dollar. Today, it's around 6.8 yuan to the dollar. By contrast, the Japanese yen has tripled in value against the dollar during the same time period. The yuan has never been fully convertible into other currencies, as China has sought to prevent the rapid inflows and outflows of foreign capital that have bedeviled the development of other Third World nations. Considering the devastation wreaked in Asia by the 1997-98 financial crisis, one would have to concede that the Chinese have a point. They aren't unvarnished capitalists, and won't allow markets to operate freely simply as a matter of principle. They utilize market forces pragmatically, mixing in government dictat whenever they believe Adam Smith's invisible hand may be a little shaky. By holding the the yuan relatively steady against the dollar, they ensure pricing stability for their exports to dollar bloc nations (i.e., nations that use the dollar or maintain currency stability against the dollar, including the U.S. and, at times, various nations in Latin America). Chinese manufacturers could largely ignore the complexities and costs of currency fluctuations and commit to low, fixed prices to buyers abroad.
China's fixed exchange rate did much to make China a dominant exporter. But it had to take a lot of dollars in exchange--ultimately trillions of dollars. These were mostly invested in U.S. Treasury securities and American mortgage-backed securities (on which the Chinese have already taken nasty losses resulting from the mortgage crisis). Now, as the dollar falls in value, China loses more money on these assets. Hence, China's scoldings to the U.S. government to get its house in order and prop up the greenback.
The U.S. government in turn has countered that China is itself responsible for this dilemma, having created the trade imbalance that resulted in its enormous dollar holdings. The U.S. government would have China restructure its economy to focus on domestic consumption, and reduce exports to take pressure off the dollar.
However, neither government is doing much to change the status quo. China's government has launched a major stimulus program to forestall economic slowdown, with much of its spending directed at building infrastructure. These are wise expenditures for a developing nation, but they do little to promote domestic consumption. The Chinese are among the world's most frugal people, because they have no other choice. China has no Social Security system. Most Chinese have no pensions; the pensions that exist are meager. The health insurance that was part of Communist China's iron rice bowl has disappeared along with sales of Chairman Mao's little red book. The Chinese save because it's the only way they can have health care and a half-way decent retirement. The Chinese government has done nothing to alter this dynamic. Since China needs about 8% economic growth every year simply to keep up with population growth, it has no choice except to keep exporting. And to do that, it has to keep its currency stable against the dollar.
The U.S. government has responded to America's economic crisis primarily by borrowing and printing dollars--shiploads of dollars. Pushed by the forces of a lot of supply and not so much demand, the dollar has not surprisingly fallen in value. Euro bloc nations have grumbled about the rise of the Euro, especially export-dependent Germany. Several smaller Asian exporting nations have recently been buying dollars in order to defend their currencies. Oil exporters, like Russia and the OPEC nations, have complained of losses in their holdings of dollar-denominated assets and hinted at pricing oil in a basket of currencies to free themselves of dollar risk. In short, the U.S. government's primary response to the economic crisis has imposed losses on the rest of the world.
The flood of the cheap money being pumped out by the Fed has fueled the "carry trade," in which speculators borrow dollars at extremely low interest rates, convert them into currencies where interest rates are higher (such as in much of Asia) and invest overseas for those higher returns. This outflow of dollars is stimulating economic activity in other nations, and appears to be creating asset bubbles in Asia. While other nations don't mind a touch of stimulus courtesy of the Fed, many in Asia have vivid and disturbing memories of the Asian financial crisis of 1997-98, when asset bubbles fueled by inflows of foreign capital burst painfully and caused severe recessions.
There is little sign that the U.S. government intends to pull its stimulus back. The Fed has made clear its intention to maintain zero interest rates as far into the future as one can foresee. The carry trade will expand and perhaps even explode--in a time of slow economic recovery, it's one of the very few ways to make fast money. China will complain and lecture, but won't change the exchange rate of the yuan by much, because it needs continued access to American markets. Other exporting nations will grumble and defend their currencies with little likelihood of long term success. Oil exporters and other holders of dollars (including China and Japan) will take more losses on their dollar reserves, as there is no other currency or asset into which they can easily transfer their wealth.
American and Chinese expediency have created dangerous dynamics in the world economy. America can win only if other nations continue to fund its gigantic deficits and tolerate its uncontrolled printing of dollars by taking losses as the dollar falls. China can win only if it continues to export to America and hope that other nations will help it fund America's deficits while they become more vulnerable to Chinese exports themselves. The rest of the world is scrambling to figure out how to limit its losses and avoid being blown up by carry trade asset bubbles. Everyone, one way or another, is trying to shift their economic problems to other nations, a process that won't have a happy ending. This is starting to look like a game of musical chairs where the limited number of chairs is diminishing and all could end up net losers. If, somehow, the people running these nations would stop playing a children's game.
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