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December 08, 2004

I'm an economic girlie-man

In his speech at the Republican National Convention, Arnold Schwarzenegger said, "To those critics who are so pessimistic about our economy, I say: 'Don't be economic girlie-men!'". But I am, and have been for some time. Optimism is great and is necessary for economic growth, but a willful blindness to reality can make a bad situation much worse. I've been expecting a big shake-up in the global economy, and now think I see the first signs of it's arrival: the steady drift lower of the US dollar.

My reasoning has always been ideological rather than based on some trendy economic theory. I think having governments mucking around in markets is a bad idea. And what's been going on for the last ten years is governments messing around in the foreign exchange and credit markets. Bigtime.

The Asian governments have been soaking up US dollars from the currency markets to keep their currencies low, thus keeping their exporters busy. The policy hasn't really kept Japan out of the doldrums, but it's kept the pedal to the floor in China and boosted places like South Korea and India. All those dollars held by the Asians have gone back to America to be loaned out, creating low interest rates and bottomless credit. This has contributed to a real estate bubble, a negligable savings rate, and a massively indebted population (and government).

Few problems are yet seen in the commonly quoted economic metrics. But because it takes ever increasing amounts of cash to maintain this artificial situation, it will eventually have to end. And when it does, it won't happen gradually. I really don't think a 'soft landing' on this one is possible. The amounts of American bonds held by Asian governments and corporations is a truly staggering, preposterous sum. When the great cash-out starts -- when traders conclude that a significant portion of the Asian governments can no longer keep the game going -- there'll be a rush to the exits. The US dollar will tank hard, and interest rates and inflation will shoot up. And if you don't want to believe the word of an unemployed blogger, take the word of brilliant Morgan Stanley economist Stephen Roach:

Our updated foreign exchange forecast now calls for a sharp depreciation of the dollar over the next six months. Relative to the dollar, we are now forecasting a 1.37 euro and a 95 yen by mid-2005 -- about 15% higher than our previous forecast and levels that could well put significant further downside pressure on externally-dependent European and Japanese economies. Moreover, given America’s record current account deficit, together with the huge dollar overweight in official foreign exchange reserve portfolios -- close to a 70% share of dollar-denominated assets versus America’s 30% share in world GDP -- the possibility of a flight out of dollars can hardly be ruled out.
He goes on to say that the only thing that will avert this financial earthquake would be a concerted effort by the major economies to increase their amount of intervention in these markets -- which will only delay the eventual reckoning and make it worse.

Stephen Roach works for a big financial services company, so he can't run around in circles flapping his arms in panic. But I can.


The end is nigh! Buy gold! Stock up on canned goods!

(Okay, I'm stretching it a little. But be warned...)

Posted by Bruce Gottfred at December 8, 2004 10:37 PM | TrackBack
Comments

And what of Canada? I noticed from the Bank of Canada's web site the other day that the value of their foreign currency reserves was "up" - in US dollar terms, but what they didn't tell you was that their value in Canadian dollars had dropped by a few billion dollars in just a two week period.

Even more important than the currency reserves, our whole economy is practically nailed to the butt of the American economy. We'll sell them lots of forest products, minerals, cars, etc. while they're on a borrowing and spending binge, but then what?

I check the Stats Canada economic indicators every few weeks, and Canadians' personal savings rate is practically zero - bouncing around 0.5% to 1.5%. I wonder to whom Canadian baby boomers think that they will sell their houses in a few years when they all start worrying about their retirement at the same time.

Then again, why save money when David Dodge is determined to wipe out your savings with low interest rates and high inflation? I mean real inflation, not the phoney CPI that Stats Canada comes up with.

Buy gold, indeed.

Posted by: Justzumgai at December 8, 2004 11:53 PM

It's hard to figure out how any big shake-up will affect Canadians. In one sense, as you said, we have many of the same problems as the Americans. But in another, we are still in many ways a commodity country, and as such we still will have goods to sell. So our currency won't be as heavily trounced as the US dollar will.

But with our major trading partner in a severe economic crisis, we're definitely going to hurt too.

Posted by: Bruce Gottfred at December 9, 2004 11:37 AM

The depreciation in the value of the U.S. dollar versus the euro has, to date, been quite orderly and "soft" in fact it might just be enough to help straighten up the U.S. currenct account deficit a tad. Europe is in the hot seat right now, because growth (if any) has been luckluster at best and the decline in the U.S. is going to make it harder for them. That said I don't think they are going to try and boost the dollar, that's as you say delaying the inevitable and quite costly at the same time. A slowdown in Asian growth, especially a cooling by China, will go a long way to taking further pressure off the U.S. dollar and countering a lot of the imbalances. I'm not sure the end is nigh, it's tricky but I'd say so far we're on track for a nice touchdown. Canada is sitting pretty, our commodites are varied: grains, metals and wood and there will always be some demand. In fact, as the U.S. dollar slides, and our fiscal position stays strong I thing we're on track for a dollar above the U.S. again, and that's going to be interesing because the crutch of a weak C$ has been relied on for too long by Canadian companies, which will now have to boost efficiency considerably.

Posted by: Andrew at December 9, 2004 08:43 PM
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