Sunday, November 7, 2004
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The reason the dollar has managed to stay as strong as it has -- despite the combination of large trade deficits and low interest rates -- is that Asian central banks have been buying up greenbacks.
The big question that watchers of global finance have been asking in recent years is: what happens when the Asian central banks stop buying dollars?
Steve Johnson and Andrew Balls of the Financial Times suggest that we're about to find out:
Brad DeLong has further thoughts on the matter.
UPDATE: Do check out the Institute for International Economics web site as well -- papers by Fred Bergsten, Catherine Mann, Morris Goldstein, and John Williamson address various aspects of the U.S. curent account deficit.
ANOTHER UPDATE: DeLong says I'm oversimplifying things:
Well, yes... except that the external pressures on a country to stop buying a foreign currency in order to prevent currency appreciation are much weaker than the external pressures on a country to stop selling a foreign currency in order to prevent currency depreciations. My guess is that (b) doesn't take place until there's some sign that (a) is about to happen.
LAST UPDATE: Some of the commenters are wondering what the big deal is, since, "the value of the dollar remains about 10% ABOVE where it was during the halcyon days of Bill Clinton."
The answer is, possibly, nothing. If the dollar slowly depreciates by about 20-30% over the next year, there's no reason for concern. And the administration deserves some credit for talking down the dollar while preventing a precipitous fall. The question is whether this will continue as Asian central banks stop buying the dollar in such large quantities.posted by Dan on 11.07.04 at 11:54 PM
Although Americans might not have voted their pocketbooks, non-American entities appear to be voting their pocketbooks. The question is what the Bush administration will do once the dollar begins its rapid decline. The administration's benign neglect has been sustainable only prior to the "voting" in the currency market.posted by: Moonhawk on 11.07.04 at 11:54 PM [permalink]
Time to buy dollars?
The sky is not falling.
But this is great news for American manufacturing.posted by: Mark Buehner on 11.07.04 at 11:54 PM [permalink]
A paranoid thought -- is currency speculator George Soros taking his revenge? Any way to know?posted by: Appalled Moderate on 11.07.04 at 11:54 PM [permalink]
Something that Barron's mentioned over the weekend struck me as interesting. During the Reagan era, foriegners were willing to deploy capital in the US because assets were undervalued. That isn't the case any more. Both real estate and financial assets are certainly not substantially undervalued.
AM -- Soros has largely shut down his hedge funds, I believe. Very little chance he's doing this. Buffett, on the other hand, has made a huge bet against the dollar.
I'm thinking of increasing my unhedged holdings abroad.posted by: erg on 11.07.04 at 11:54 PM [permalink]
Nobody has mentioned what a strong Euro is going to do to Europe's already stagnant economies.posted by: Mark Buehner on 11.07.04 at 11:54 PM [permalink]
Mark said, But this is great news for American manufacturing.
This is great news for american manufacturing that doesn't depend on foreign imports such as oil.
Here's the thing -- when oil goes to $200/bbl it doesn't just mean we can't afford to import much. In a quasi-free market, oil is fungible and domestic oil producers will sell to the highest bidder. Most of the domestic production would also go overseas.
This would not be good news for anybody trying to do business in the USA.posted by: J Thomas on 11.07.04 at 11:54 PM [permalink]
I really, really hope we don't have a financial melt down. On the other hand, I really want to see Glenn, Hugh, NRO, The Weekly Standard, and all the other nut cases spin this and blame it on Clinton, Kerry, the democrats, and libearl abortionists. Its going to be pure comic gold. Maybe even wroth the cost to my pocketbook.posted by: Jor on 11.07.04 at 11:54 PM [permalink]
What we need is more faith in this faith based currency poilcy.posted by: Waffle on 11.07.04 at 11:54 PM [permalink]
Jor, I doubt they'd blame democrats. The democrats are already crushed.
More likely they'd blame france, china, russia, and the UN and likely blame japan and south korea for failing to fight hard enough on our side.
I'm not sure where it goes from there. Withdraw from the UN? Start a draft to be ready to fight our worldwide enemies?
They wouldn't try to say it's anything but a disaster. They couldn't usefully blame democrats and they sure wouldn't blame themselves. Iran and north korea aren't big enough. So it would have to be the other foreign enemies, who have been secretly opposed to us all along but are only now ready to take direct action.
They couldn't surrender, so they'd have to fight. Start by repudiating the debt? Trade sanctions? Certainly block oil exports except to our best friends. When we can't be the high bidders we need to keep US oil for ourselves rather than sell it for foreign exchange -- except the foreign exchange we need more than we need oil.
Probably we'd need to invade somebody but I can't offhand think who. France doesn't have any oil.
The reality would surely be a lot weirder, but I'm not very good at imagining how.
J Thomas...There is plenty of US manufacturing that doesn't depend in a major way on oil. Steel, for instance--integrated steel mills burn coal directly, and minimills burn it indirectly, in the form of electricity mostly generated from coal. It seems possible that a lower dollar could be a net plus for American manufacturers, particularly those at the base of the value chain.posted by: David Foster on 11.07.04 at 11:54 PM [permalink]
If we are in a crunch for oil, Europe must be on its deathbed. Even with a stronger Euro, the massive taxation on petroleum in most European countries more than makes up the difference. Asia has its own problems with a lack of modern infastructure. Look for run away inflation on the horizon in China.
Oil has been expensive for Europeans for *decades*. Their economies have adapted (smaller cars, more mass transit, more nuclear power, ...). Ours have not. Not that we can't adjust, but it will hurt economically and take time. And, for that matter, last I heard Europeans were not seeing rising oil prices - the price of oil in Euros has been flat for quite some time.posted by: Ravi on 11.07.04 at 11:54 PM [permalink]
I wish Oldman still commented here regularly.posted by: fling93 on 11.07.04 at 11:54 PM [permalink]
I caught an interview with Lee Kwan Yew, the former prime minister of Singapore a couple of weeks back. His advice: make sure that Mandarin Chinese is a part of your child's curriculum, if they plan to be in business. They're going to need it.posted by: haydar on 11.07.04 at 11:54 PM [permalink]
Has anyone (particularly our blogster) read Lester Thurow's "Fortune favors the bold"? He talks a lot about the current-account issue, and the possibilities of a hard vs. soft "landing" for the dollar. The issue concerns me a lot. It seems that it wouldn't take much for investors to lose confidence in the dollar. While foreign governments may feel the need to prop it up, they may not be able to if there's a big run by investors.posted by: Andrew Steele on 11.07.04 at 11:54 PM [permalink]
The sky is falling! The sky is falling! The... oh wait, hold on, did someone mention that the trade weighted value of the dollar is still significantly above 1997?
So let me get this straight, the value of the dollar ramins about 10% ABOVE where it was during the halcyon days of Bill Clinton. But somehow we are now on the brink of The Great Depression The Sequel?
I understand why Brad DeLong wants to pump out this crap, but why does Dan Drezner? I suppose it is some kind of ex post facto justification for his vote...posted by: Al on 11.07.04 at 11:54 PM [permalink]
Visit my site, www.thecapitalwire.com and scroll down to my 11/5 post on the employment report and its implications on the dollar.posted by: Uday Karmarkar on 11.07.04 at 11:54 PM [permalink]
Interestingly, Matthew Yglesias points out a Reuters article saying that we hit "a nine-year low on a trade-weighted index".
I'm not sure which index it refers to - I suppose the "Major Currencies" index referenced in the Fed press release to which I linked. Nonetheless, I recall that Bill Clinton was President nine years ago too. And somehow even at this value of the dollar (and lower!), we still survived.
How much lower can the dollar fall without any disastrous effect on our economy? I have no idea, but seeing as how everyone survived the dollar 25%-30% above the 1997 levels, I'm not sure why we couldn't survive the dollar being significantly below 1997 as well. And, at least as to the "Broad" index I pointed out, we're not even close yet.posted by: Al on 11.07.04 at 11:54 PM [permalink]
India and Russia have reportedly been selling US assets, as well as petrodollar-rich Middle Eastern investors.
What's the latest quote on a petro-dollar rich Middle Eastern investor?posted by: Bernard Yomtov on 11.07.04 at 11:54 PM [permalink]
Al...you can't look at the dollar/foreign exchange on an absolute basis. It doesn't work that way. It's on a relative basis. The dollar is at multi-year lows relative to other currencies.
And yes, severe global capital imbalances put the dollar in a very precarious position. But this doesn't necessarily call for a financial day of reckoning. It all depends on HOW the dollar corrects (the velocity at which it corrects).posted by: Uday Karmarkar on 11.07.04 at 11:54 PM [permalink]
Well let's be serious. Regular Americans (me included) don't fully, or even nearly, understand this stuff. It's fine to say "Don't worry about the dollar," but you can't say there's no risk at all. And, most Americans simply don't know about the risk, whether it's big or small, and don't incorporate it into their electoral calculus, or into the way they live their lives.
This stuff is happening outside the universe of the "regular person." Bloggers, journalists, and academics can argue until they're blue in the face, but this may not be relevant to the real world.
The dollar must fall, let's hope it's softly.posted by: Andrew Steele on 11.07.04 at 11:54 PM [permalink]
Uday Karmarkar - huh? Did you look at the Fed press release to which I linked? The dollar is still at a significantly higher level than 1997 when compared to to a broad index of our major trading partners' currencies.posted by: Al on 11.07.04 at 11:54 PM [permalink]
David Foster said, There is plenty of US manufacturing that doesn't depend in a major way on oil. Steel, for instance--integrated steel mills burn coal directly, and minimills burn it indirectly, in the form of electricity mostly generated from coal. It seems possible that a lower dollar could be a net plus for American manufacturers, particularly those at the base of the value chain.
Yes. In the medium run it's even OK if they use a lot of oil. Sell for hard currency and you can afford oil, with confirmed foreign contracts upi can get loans. This approach has been working for the third world all along. Build extractive industries that sell exports. Build transportation networks that center around getting the goods to the ports. Internal trade doesn't seem very important, what's clearly important is to bring in hard currencies.
There could be a lot of turbulence while we adapted to a third-world economy.
But all that is supposing that the dollar got devalued rather suddenly, and then it stayed down. It isn't clear that would happen. If, say, the chinese tried to make it happen and nobody important opposed them except the USA, then it might. If foreign-owned or operated businesses in the USA suddenly got clumsy, that would make things worse. If we got a lot of social instability that would make it harder to recover economically. (The violence and graft in the early years of the XSSR clearly made it harder for them to build a decent system.) We have a whole lot of foreign-born engineers, and if very many of them decided things looked bad here and they went home that would be another problem.
It looks plausible to me we *might* have some big problem, but it doesn't look inevitable to me that it would happen within the next 4 years. If you dig a hole in soft dirt and you keep digging it deeper then it's predictable that sometime it will fall in on you. But it isn't especially predictable when it will fall in.
Your wish is my command.
The answer is that Europe will do the same thing that we did. They will let other countries denominate the Euro to buy oil, and use the trade deficit to float their equities market starting a huge investment rush. If we did it why can't they?
Like Greenspan's plan is order to try to do Europe what Japan did to us. The problem is that our interest rates are capital flow sensitive. Given a depreciation of the dollar against other currencies, the Federal Reserve would have to decide between inflation and higher interest rates.
That would be likely where America would see the hurt the most - the higher central bank interest rates needed to prevent hyperinflation. Quite possibly we're talking about 80's levels of interest rates. This would cause a lot of bankruptcies, shut down liquidity-credit injections into the economy, and start a formal recession.
With higher interest rates the second way that this would affect ordinary Amerians is that the debt service in the Federal Budget would double or triple in a short amount of time since our national debt is held in short term notes.
In a few years the Federal debt service could increase by somewhere from half a trillion to near a trillion dollars a year depending on increases from our historically low interest rate schedule currently.
The crunch in Federal spending would require drastic budget austerity to dig ourselves out of this worsening the recession, or it would require flagrant debt default causing capital flight. This is assuming the Fed doesn't just go the hyperinflation route.
Therefore interest rates and the expected increase in debt service to the government budget are probably the flash points you want to watch.posted by: oldman on 11.07.04 at 11:54 PM [permalink]
J Thomas...I used steel as an example of an industry that might benefit from a lower dollar, even given high oil prices...but there are other, very different industries, that would likely also benefit. Software, for instance...the falling dollar would make their prices more competitive on global markets, while oil is not an important input to this industry.
Also, I would think internal trade would become more rather than less important in this scenario, since domestic manufacturing would gain in price competitiveness relative to imports.posted by: David Foster on 11.07.04 at 11:54 PM [permalink]
There is plenty of US manufacturing that doesn't depend in a major way on oil. Steel, for instance--integrated steel mills burn coal directly, and minimills burn it indirectly, in the form of electricity mostly generated from coal.
And the coal gets to the steel mill how exactly? I do believe it gets there in these things called "trucks" which not coincidentally also deliver the raw iron to the mill, and then transport the finished steel to other places.
We live in a petrochemically-based economy. Don't try to pretend that there's any industry that doesn't have its manufacturing and transport costs raised significantly when the price of oil goes up, because such an animal doesn't exist yet.posted by: Magook on 11.07.04 at 11:54 PM [permalink]
Magook, steel facilities tend to have railroad and waterway connections precisely because it's so stupid to move lots of heavy stuff by truck. Of course our locomotives are diesel now but they don't have to be; given the capital we could replace them with steam engines or some newer coal-based engines.
Failing that, even if oil becomes something we generally can't afford, primary exporters *will* be able to afford it. If they can compete on international markets then they'll have hard currencies to buy oil. If they can't make a profit exporting after they pay for their oil then they might as well shut down. It would lead to an economy dominated by exports. Just as, say, senegal and guinea trade mostly with europe and not each other, the same could happen to georgia and alabama. Why invest in markets that can only pay dollars, when you can get real money?
We could build a much less-petrochemically-based economy, given sufficient time and money. Jimmy Carter tried to get us to do that, and failed. We haven't put the time and money into it, and now we may have to do it on the cheap.
I seem to recall seeing some input reports that showed that energy prices constituted less than 5% for US manufacturers. If that number is true, (and I believe it is) then even a steep rise in the price of oil would not offset the advantages of a lower dollar to US manufacturers -- or service providers, for that matter. What scares me is the mortgage bubble. I bought my first house recently, and was pressured by my mortgage broker to take out an interest only loan. Apparently it's pretty common. I thought about it for a couple of days and then got the shivers and went for the 30 year fixed. I thought about the dark arts of international economics, and remembered enough from classes for the following scenario: Dollar falls, interest rates rise. Rising Interest rates mean a fall in demand for housing (unlike the 80s, just about everyone who can afford a house has bought one, and rising interest rates choke off new entrants to the market). So housing prices drop pretty steeply to meet the lowered demand. Now you have lots of people on ARMs or interest only loans that are looking at being in the hole for 90K at their current loan. They can't sell, and maybe they don't want to be paying 40% above market for housing. So they declare banko and walk away, leaving lots and lots of housing stock in the arms of Fannie Mae, which auctions it off, dropping housing prices still lower, to the point where guys like me feeling smug in my 30 year fixed have an asset that I'm paying 30% more than it's worth, given the lower prices. The follow on effects to the construction industry (which is a pretty significant chunk of GDP, last I heard) make things yet more unpleasant.posted by: amaxen on 11.07.04 at 11:54 PM [permalink]
er, by the above, I meant 5% of costs per unit of output, on average.posted by: amaxen on 11.07.04 at 11:54 PM [permalink]
A falling dollar helps exporters IF the supply-manufacturing-market chain exists almost entirely in the country where the currency devaluation is going on. The export price effectively fall as labor costs and whatnot effectively fall. (Which has its own negative repercussions.) If your the supply part of the manufacturing chain comes from somewhere else (platinum comes from South Africa fer instance, tantalum from the Congo) or you are assembling parts manufactured elsewhere, then your costs go up. If you pass that on, then your prices rise, negating the benefits. And import prices rise which hurts your labor. You don't net anything out of it. Of course, our labor costs have NOT been falling relative to Japan, SK, and China. Which is why the trade deficit hasn't closed up during the previous dollar value falls.
'Global economic integration' is going to depend on a reasonably stable currency.
Unfortunately, we have depleted our ability to adjust to recessions. We're deep in debt, taxes are low and falling, interest rates are low, and our equities markets (aka our very own bubble) de facto depend on foreign currencies.
Import prices have been the last holdout against general inflation. If those prices start going up, we're going to have general inflation, which tends to feed on itself. And inflation tends to discourage investment. If overseas investors stop pumping in money, then stock and bond prices should (correctly) fall, which discourages investment further. Which means we have to start cutting somewhere. Which means the deficit. Except that is part of the support we have been using to prop up the economy.
In 1997, we were not in this position, so a dollar fall didn't hurt nearly so much. After all, total stock market valuation versus GDP was lower at that point that it has been at any time since.
if oil price goes up 1000%, price of microsoft office will go up perhaps 0.01%. think about it.
Don't tell me; let me guess --- you voted for Bush didn't you?
Mr. Maynard i am European and you're are wrong. In last 10 years Europe was growing at half of US.
Right now the good economies in Europe are some Scandinavian, British (they're income was 2/3 of French in end of 70's and now it is better than them) Irish, some Eastern countries. France, Germany are in trouble.posted by: lucklucky on 11.07.04 at 11:54 PM [permalink]
By looking at the trade weighted dollar you are missing the point. The problem is the Euro, and China is not buying Euros. Moreover, the Chinese currency is not in the trade weighted dollar. Asian central banks buying dollars is forcing the entire adjustment onto the Euro.posted by: spencer on 11.07.04 at 11:54 PM [permalink]
Mr. Maynard i am European and you're are wrong. In last 10 years Europe was growing at half of US.
How does that stack up against differing population growth rates?posted by: Brittain33 on 11.07.04 at 11:54 PM [permalink]
It seems to me that those export driven Countries, like Japan and China, have more to fear from a falling dollar than the US does. Who's going to buy all their stuff?posted by: Lurker on 11.07.04 at 11:54 PM [permalink]
Brittain33 probably the same but i dont know the answer to your question, someone could say that more population could mean even bigger unemployment rate, or?(they arent necessarely exclusive) a little better grow level.
Lurker thats a good point.posted by: lucklucky on 11.07.04 at 11:54 PM [permalink]
French viewposted by: lucklucky on 11.07.04 at 11:54 PM [permalink]
Magook....iron ore and coal get to steel mills via a combination of water transport and rail. Trucks are not generally used for these operations: water transport and rail are far more energy-efficient for bulk commodities. When steel is exported (as a lot of it is these days) it generally goes to the port via rail and thence via ship. Sure, petroleum prices have *some* impact on steel-manufacturing costs, but it is very minor compared to the impact on an industry like plastics or chemicals.posted by: David Foster on 11.07.04 at 11:54 PM [permalink]
But in the end, isnt the falling dollar a normal economic "correction", however painful, in response to certain economic practices?
Wasn't this or some other falling dollar scenario reasonably foreseeable given the amount of public and private debt being racked up by the US?posted by: Panu on 11.07.04 at 11:54 PM [permalink]
Moreover, the Chinese currency is not in the trade weighted dollar.
Yes, it is. Look again at the link I posted.
What I find fairly hilarious is the talk of hyperinflation (or, just slightly less hilarious, 1970's style inflation). Wasn't it just a couple of months ago that Paul Krugman was warning us all about DEFLATION?
Yeah, yeah, I know, hyperinflation, deflation, what's the difference? As long as there is some wild-ass prediction with which to bash Bush.posted by: Al on 11.07.04 at 11:54 PM [permalink]
Somebody mentioned how Europe has 'adjusted' to significantly higher oil prices, assuming this means they have more flexibility to absorb further increases in problematic. We're also forgetting the natural brakes US demand has built into it. We by far are the biggest consumers of petroleum, and much of that is 'elective' in the sense that American will pay X amount of dollars to drive their single passenger cars all over the country. If gasoline hits 4$ a gallon, that whole dynamic will change instantly. Cross country road trips cancelled, car pooling, buses and trains, etc. There is a huge amount of elasticity built into US gasoline demands that simple hasnt presented itself yet because quite simply Americans have been spoiled by _radically_ low gasoline prices (name me something else you can buy a gallon of for 2 bucks, even water is becoming competative [a gallon of Jack Daniels costs ya 50 bucks or so]). Neither Europe nor Asia have that kind of demand elasticity built in to such an extent.posted by: Mark Buehner on 11.07.04 at 11:54 PM [permalink]
place your betsposted by: w on 11.07.04 at 11:54 PM [permalink]
posted by: Andrew on 11.07.04 at 11:54 PM [permalink]
I know jack about international finance and such markets. What I do know is every year since I've been old enough to pay attention, some idiot has made money by publishing a book claiming the sky was falling, the next great depression was just around the corner, and the west coast of the USA was about to fall into the Pacific, so we should all buy soon-to-be-oceanfront land in Arizona. Different idiot every year, different details, but the "big financial meltdown" is always a part of it.
Looks like Krugman will be the idiot for 2005. I hear he's taking time off to write a new book....posted by: ubu on 11.07.04 at 11:54 PM [permalink]
Different idiot every year
That's not true. Krugman took it in 2002, 2003, and 2004...posted by: Al on 11.07.04 at 11:54 PM [permalink]
none of you are commenting on why the dollar is headed for a possible free fall...we have a much bigger debt now and it is only going to get bigger. this was not the case during the clinton years.posted by: joe on 11.07.04 at 11:54 PM [permalink]
P wrote, "if oil price goes up 1000%, price of microsoft office will go up perhaps 0.01%. think about it."
Let's say Microsoft Office costs go up 0.01%. What *price* will Microsoft charge?
If they charge the same price in dollars then the rest of the world gets a great deal. Microsoft however brings in much less foreign exchange than it used to, assuming sales don't greatly rise due to the low price.
If Microsoft charges what the market will bear in europe, then Microsoft makes out very well but will be priced out of the american market. Unless they manage special ways to differentiate their market that let them sell cheap in the USA and expensive elsewhere. They were looking at that sort of thing some but as far as I heard didn't get very far because they didn't really care about, say, pricing their products to sell in the greek market. They knew there was a whole lot of piracy but it would be a lot of work to arrange to sell cheap enough to cut into the piracy, and they wouldn't get much revenue for it.
I suppose they could use that approach here. Let americans pirate Microsoft products and ignore it since it's only dollars and the foreign cash flow would be much more important.
Trade Gap Narrows Thanks to Weak Dollar
posted by: Panu on 11.07.04 at 11:54 PM [permalink]
"They will let other countries denominate the Euro to buy oil,"
I went searching in the magazine databases for articles on the dollar/euro oil pricing issue.
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