An unannounced but evidently coordinated effort to arrest or at least slow the fall of the dollar is underway. The Financial Times indicated that Asian central banks were aggressive dollar buyers on Thursday, but the information came via currency traders rather than an official pronouncement. Thailand, Malaysia and Taiwan made substantial purchases; Hong Kong and Singapore also intervened today. The action may also have a secondary objective of rejiggering their currency values versus China’s, since China repegged the renminbi against the dollar.
However, these efforts were seen by traders as merely an attempt to control the fall in the dollar rather than halt it. And other markets responded to the dollar weakness. Oil prices rose nearly $3 today, gold hit a new high in dollar terms, and copper and tin spiked upward. The dollar is strengthening overnight on Bernanke’s empty promise that the central bank will raise rates when the economy recovers.
The dollar’s weakness exposes a series of dilemmas and a lack of obvious remedies. Normally, a country experiencing a financial crisis takes measures to depreciate its currency so it can use an export boom to help pull itself out of its economic mess. However, Paul Krugman, among others, have pointed out that trade has collapsed, so even if one were to break glass and trash currency, it isn’t as effective a solution as it would normally be. And even if that approach might work, with so many countries affected by the crisis, it’s too easy for currency depreciation to lead to beggar-thy-neighbor competitive devaulations.
Although the US keeps mouthing its “strong dollar” assurances, many observers believe that the Obama Administration is content to let the dollar slide because the resulting inflation will help erode the value of debt and more robust exports will help growth. But that seems a trifle optimistic. First, some economists, such as Jim Hamilton, argue that it was the commodity price runup of early 2008 that pushed over-indebted consumers over the edge. Commodities inflation, when it inures to the benefit of foreign producers, is not a boon to the US. Second, the US has ceded a lot of manufacturing industries. How long would the dollar have to stay weak for the US to repatriate significant amount of, say, furniture and shoe fabrication? These are two industries where some incumbents insist the US could remained competitive in high-end and even some mid-level manufacturing (offshoring was driven not just by cost savings but also by a desire to please Wall Street analysts). It takes time to establish operations and hire and train staff. No one is going to make investments like that unless they are confident the dollar will remain comparatively weak.
Third, rising inflation is not a panacea. While it reduces the value of debt currently outstanding, it also makes it costly to sell new debt (unless the borrower is convinced inflation will rise even higher). Even if the principal will be paid back in depreciating dollars, the cost of debt service rises with higher interest. And having lived through the inflation-ridden bond markets of the early 1980s, no one wanted to be borrowing then. Reasonable credit quality companies were facing 15+% coupons.
Even before we get to anything resembling that level of interest rate, the Fed and Treasury have a big bind. Higher domestic inflation means higher interest rates. Higher interest rates mean higher mortgage rates. That kills housing. Higher interest rates also means all those private equity owned companies that are stuffed up to their eyeballs in debt and need to refi between now and 2013 find it more costly. Many will not survive higher debt service. Big bankruptcies and related job losses are not too good for economic recovery. The Treasury has also gotten addicted to super low interest rates (and if my correspondents are correct and the average maturity of Treasury debt has shortened, the US is more exposed to interest rate increases than it might otherwise be). In other words, even a modest increase in rates could have a much nastier economic impact than conventional wisdom assumes.
And we have another possibility. At the G20, the US started to take up the “we want to be an exporter when we grow up” theme. Ahem, so who is going to be the net consumer if the US gives up that role? Now I will be the first to concede that having a world where more countries had robust consumer sectors and were less export dependent would be a much better arrangement, but getting there is at least a 10 year, probably more like a 20 year transition. Yet the powers that be here are acting as if the US can beef up its exports and get to a net neutral or a net exporter position much sooner. So was that unannounced Asian intervention benign, or was it a bit of a warning shot, that the rest of the world reluctantly accepts that the dollar probably needs to be cheaper, but will only let that go so far?
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I’m not sure how much to equate “weak dollar” and “inflation”. Just did a quick search on VoxEU for the phrase pass-through and came up with a Blinder piece “Oil Shocks Redux” that looks at some angles.
My main question would be the extent to which the US is a services economy, not the one I grew up in back in Pittsburgh before the phrases “oil shock” and “rust belt” had been coined.
Also, I suspect manufacturing could be built up rather quickly given that machines/robots do most of the work. I wouldn’t expect a tremendous number of jobs to be created, but demand could be met maybe quicker than you seem to think.
Anyway, I was working on a comment about the dollar. Here’s David Malpass in the WSJ today, on “The Weak Dollar Threat”.
“The more the dollar devalued against the yen in the 1970s and ’80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity.”
Japan’s capital market, along with the rest of its economy, was notoriously closed to foreign participation during this era. The central authorities did, however, engineer a huge home-grown asset bubble in the wake of London’s Big Bang.
In “Devil Take The Hindmost”, Edward Chancellor notes that “many manufacturing companies which raised capital during the late 1980s used the proceeds to build overseas factories in order to circumvent the problems caused by the appreciation of the yen.” (p. 292).
Malpass again: “China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability.”
The only “stability” of the Chinese currency is its peg to the USD. That’s the very same dollar which Malpass claims is being weakened not as a result of market forces such as the unwind of the flight to safety or the demise of the world’s consumer of last resort, but by “Washington’s current economic program.”
I’m with Buiter and those calling for “global rebalancing”.
Um, where exactly was Malpas in the 1970s and 1980s? US trade was not in a serious deficit in the 1970s. And the dollar was not terribly strong then. The dollar fell 50% in gold terms when the US went off Bretton Woods. I do not have the foggiest idea where he gets his currency history.
The dollar was massively strong in the early 1980s, and that was when the US moved into substantial trade deficits. They became so large that the non-interventionist Reagan-era US entered into the Plaza accord, a coordinated action to drive the dollar down against the yen, against which it had a particularly large bi-lateral deficit.
US imports from Japan did drop considerably, in fact, this is one of the big reason Japan engineered its bubble (this was BoJ policy, believe it or not, to create a wealth effect and stimulate domestic spending to compensate for the loss of exports as a result of the strengthening of the yen). But the Japanese did not buy US imports. The reason was “structural” deficits. The Japanese think all foreign products are inferior (I worked for the Japanese then and can attest this is true, and not just PR) plus they did have weirdo licensing, labeling and other requirements that also made it hard for importers (that is, they had clever non-tariff restrictions). But that really was a US-Japan issue, the Japanese were masters of that game, and also have particularly xenophobic consumers.
As for being able to start up factories quickly, my father did manufacturing startups in a capital intensive industry. With all due respect, you are dreaming. You have to acquire land, get permits, do design and feasibility studies, contract to have the plant designed, negotiate with vendors, shake down operations, etc. This is not like opening a restaurant or retail store. This is a minimum three year cycle to get going. You might kid yourself you can do it in 24-28 months, but nothing goes fully according to plan and it easily takes three years. That means you have to have some confidence where the world will be in three years going forward for at least the next four after that.
And if you read the post, I did not disagree with global rebalancing, in fact, I have called it for quite some time. But for the US to pretend we can suddenly become a net exporter is somewhere between wishful thinking and delusional. It will take economies like India and China time to move from an investment/export driven model to one with more consumer demand. To imagine that that will take anything less than a decade is unrealistic.
Amen, Yves. The people who think we will become competitive in manufacturing simply because the dollar drops must think that the pond will freeze over the minute the temperature drops below 32 F.
I think it is possible to conclude there no net change in the US position because of a devaluation. Since the dollar is the reserve currency, both imports and exports feel the same effect from any deval/reval. A devaluation reduces both the value of imports and exports simultaneously.
For most currencies, devaluation increases the prices of imports in the domestic market, and reduces the costs of exports to foreign markets. This does not occur with a reserve currency. Both change in the same direction – prices of imports fall and so do the costs of exports, when measured in other currencies.
In other words, trade itself is devalued.
What then occurs is that the profitability of trade is increased as a whole as the result of a devaluation. The profitability of exports is increased, but the costs of imports, to the extent it enters into domestic production, is lowered as well.
We should probably see fatter profits as a result of this move.
We must reconsider our support for the WTO. We are on the short end of non-tariff barriers not really dealt with in WTO.
This is not Smoot-Hartley but a realistic critique of the WTO.
We are much better off with the chain of bilateral trade agreements done under Bush (I don’t believe I wrote that!)
Obama’s Nobel prize will, I fear, increase his world-savior complex at the expense of nitty gritty needs of his country.
If I am right (above) you will see more aggressive free trade propaganda…This is a “heads I win, tails you lose” proposition for the US.
in the asian thursday daily session the dollar performed as follows:
– fell against the euro 1 cent (-0.68%)
– fell against the yen 0.6 yen (-0.67%)
– gained against the gbp 0.5 cent (+0.31%)
– fell against aud 1.4 cent (-1.57%)
– fell against chf 0.5 centime (-0.49%)
so much for this trader’s folklore.
It says the intervention failed, or only worked against the currencies involved. Official intervention is often seen as a sign of weakness. Traders love to bet against central banks.
http://www.oanda.com/convert/fxhistory
all three mentioned currencies appreciated slightly against the usd. in fact their daily moves were smaller than their bid/ask spreads(!!!). non-majors are usually quite volatile (2-3% daily). the very fact that the FT author does not cite any numbers hints at some confused causation link that he is trying to establish.
it is impossible for a central bank to fail in the depreciation of its own currency because all FX in its own banking system is less than the local currency. on the other hand, attempts to stem the decline of a local currency usually fail.
and do NOT rely on currency commentary from bloomberg either, their asian currency team is plain horrible. i personally only regard reuters/thomson currency commentary.
Phew!!
If the currency system we have, that is dollar as reserve is really in trouble, and structurally that’s where we are, but if it is now immediate, well… phew!!
It would be fun to go on about Japan as I lived there as a consumer for many years. I think East Asia has taught the world a lot about non-tariff restrictions and those lessons are likely to be applied in interesting ways.
At the time it was a US-Japan issue because there was an EU but no Euro. If I recall correctly, The Economist often bitched about Europe standing on the sidelines while the US floundered about.
So long as China pegs to the dollar and the Euro floats (and endures), we’ve got a different game.
I have no expertise in manufacturing but based on what I think I know of tech and brown-field sites, it could fire up pretty quick if entrepreneurs believed they could compete at home. And when I read between the lines in a story like this I say, why not start at 10% tariff today and run it up another 10% every six months for a couple of years?
You are entirely correct in the original post: “No one is going to make investments like that unless they are confident the dollar will remain comparatively weak.”
You are correct, Germany was the other big worry then, but (and I’d need to look at data) the Japanese surpluses were bigger than the German, and my dim recollection is by quite a lot.
I have to say the Japanese prejudice is not entirely unfounded. Their consumers really are tough. I did not spend as much time there as you probably did, but you get used to the high service standards, plus some of the overmanning masquereading as service (the white gloved lady greeters).
I’m not certain the sort of high tech manufacture you are thinking of adds up to a lot of domestic value added, but we may be thinking of very different types of end products.
When the bloated supperation of speculation in the US burst in August 07, the powers that be could hope to do successfully one of two things: save the banking system, or save the currency. Instead, they did a third thing and tried to save asset prices. Now, this is now surprise, Reinhart and Rogoff together with most any other historical analysis shows that this is what the powers that be typically try to do if they have any latitude at all. Because said weensy sparklers o’ powers that be are tied and tied utterly to the controllers of assets so priced, and so can get their heads around no other course.
In the US, this attempt to support asset prices was pursued by shoving a great mass of ‘nothingaire’ under said prices in the form of guarantees and Fed-float, followed by the Treasury issuing massive debt that it has no revenue stream to support. This has served to obscure the tumble of asset prices more than to support them. Said strategy has _not_ saved the banking system. Rather, it has postponed into the mid-term the rot, debt, unprofitability, general incontinence, and overall zombieness of the major players while the FDIC runs out its shop knocking little zombitties on the head. But what said ‘third thing’ was certain to to is to trash the currency.
So far we have a moderately orderly decline of the dollar. Not pretty, but really not reversible. And all of the problems which come with that, many salient among them which Yves lists in this post, are baked in; near inevitable. Having shoved toxic vapor out the door, there is no counter move those shrunken, drunken powers that be can do to effectivley support the dollar. Given our public debt, privated debt, and structural marcescence in the banking system that’s the way it goes. It only goes slower because we are bigger than others who have gone this way, and the world has few options to make it go fast; except the mutally assured destruction of dumping the dollar, and nobody has pushed the latter button. And seriously, I doubt that anyone _will_ dump the dollar. They will only step away from the splash pattern on the pavement once the decline and fall is an established fact. Assuredly, other major trading nations will not turn to ‘a basket of currencies;’ that strategy just doesn’t hold profit, but such is another tale.
So the dollar goes the way of all pustulent flesh, that was a given when Paul and Georgie and Larry and Timmy decided to prop up the assets of their cronies and employers. That ‘intervention’ by the nations mentioned yesterday? Well for one thing, all those countries _combined_ are far to small to move the dollar in any direction. To me, their action appears entirely defensive, to burn those speculating on the appreciation of those particular currencies and so to brake if not possibly reverse their own currency rises against the mortifying $. Japan and China can defend their slots, but the small ones have to try market jolts; not a pleasant option.
And such fabulating regarding the ‘recovery of US exports,’ I don’t even take it as hot air and spin, it’s nothing, to me. Ramp up takes time, it takes product, it takes, well, _investment_. Anyone see any manufacturers stepping up to that idea? Not; so very NOT. Believe it when someone puts money behind it. Until then it’s purest wishfulfillment and Demo blather to labor not even meant to dry upon the placards to which it has been hurriedly imprinted. This was in Pittsburgh after all. Phoney-talk, just like the Phoney Recovery. Talk to buy time while more commitments are made to asset prices which refuse to walk again in the shoes they once wore.
When strangeness makes its rounds upon the battlefield one may assume one of two positions, the fetal position, laugh like a henna uncontrollably, maybe 3, the pie hole mouth position.
skippy..um mm now which one should I choose?
PS great stuff RK can’t stop laughing, cheers!
I want to thank Yves for the posting and add a thank RK for your added commentary.
It is not going to be pretty when the music stops.
It seems clear to me that the answer is to let the US dollar drop and as a result manufacturing will come back to the US. The point about exports is a red herring. The US is sitting on top of the world’s largest proven reserves of high-performance, ready-and-willing consumers — its own population. A first step in redressing the global imbalances is for the dollar to drop and as a result imports into the US would drop along with the currency. This drop in imports would be compensated by an increase in US manufacturing for the home market. Only years later after the rate of imports has decreased sufficiently would the US have to worry about beefing up its actual exports.
Obviously the price of raw materials would rise and as a result the US would actually have to start conserving energy. All those posh shops in NYC might have to actually close their doors in the summer so that the air conditioning system doesn’t have to try to cool the sidewalk.
This is the only way employment is ever coming back to the US. Continuing Chi-merica is only going to result in higher unemployment and more bubbles to try to cover up this fact.
Wal-Mart is now the buyer for a tremendous amount of retail spending, I know lawyers who advise clients against doing business with Wal-Mart precisely because they are dreadful (they beat vendors down horribly). The Wal-Mart factor is a curious barrier to domestic manufacturers.
Interesting. The folklore used to be that while Wally World was a harsh negotiator with suppliers, demanding constant price reductions and ready to change suppliers if a rival could offer the slightest price advantage, if nothing else WalMart paid on time, fairly and in full.
Of course, at one time WalMart also trumpeted “buy American!” and I don’t think we are in much danger of that today.
“The Wal-Mart factor is a curious barrier to domestic manufacturers.”
I agree but if the dollar collapsed this might change. You would still need retail players like Wal-Mart, the only difference is they would be selling American-made junk instead of Chinese trinkets.
The key point that I was trying to make is that there are really three parts to any balance of trade equation: imports, exports, and interior trade (made in America and sold in America). Let’s imagine for example the current balance of trade is (and I’m just making these numbers up as an example) 50% import, 30% interior trade, and 20% export. It is quite possible if the dollar dropped that the US economy could swing into balance (20% import, 60% interior trade, and 20% export) without increasing exports.
I did consulting engineering work for Wal-Mart as they were expanding in the late 1980s and early 1990s. They were actually a very good client. They knew exactly what they wanted and why. Their RFPs were the most specific, logical, and defined that I have ever gotten from a client.
You needed to sharpen your pencil to win the work but they were very fair once you won the work and did a good job. They had high, but clear, expectations, so sloppy engineers and construction contractors did not survive long but good ones got repeat work.
Invoices that were in line with the accepted proposal and for work that was done properly were paid in 30 days without question so the AR staff never needed to call them.
They were actually quite profitable to work for because you didn’t get into endless loops about vague things, so you could make good money if you knew what you were doing and were efficient.
believe it or not, the u.s. manufacturing sector is quite competitive domestically.
i will give you the most blatant exampe: 3 pairs of locally made cotton crew socks at a NC gas station next to I-95 go for $3. 3 pairs of the same crew socks at the adjacent walmart go for $6. but walmart would not carry those locally knitted socks because their profit margin will be much smaller and this particular mobil gas station simply does not have the customer traffic to cannibalize the walmart market share. why would walmart settle for $0.33 per pair profit local manufacturing when they can make at least $1.5 per pair on imports??? they have already squeezed the competition and everyone knows they are the cheapest place in town to shop at.
corporate profit margins, not country competitiveness, is what drives jobs outside of the u.s.
We really need a relatively clean way to export or kill off a lot of superfluous workers who will never be employed (initially or again). Only then will we catch a glimpse of the that light at the end of the tunnel.
I see no way that we could EVER become an export economy. Our costs of living, even reduced to today’s level, is still far above too many other countries.
Normally, a country experiencing a financial crisis takes measures to depreciate its currency so it can use an export boom to help pull itself out of its economic mess.
So where was the export boom in the US from 2001-2008 as the dollar weakened?
There was no export boom. Instead there was an outsourcing boom.
The dot com bust was not a financial crisis. Look at Sweden, Finland, and Norway in the early 1990s, or Iceland now. The currency depreciation was significant and speedy.
Many European companies did shift production to the US as the Euro rose higher. The problem was that US jobs were being lost to Asia at an even faster rate since the dollar did not start to depreciate against the Chinese Yuan unitl 2005 and then only in a limited fashion.
The financial mess is looking to me more and more like the equivalent of Hurricane Katrina: the thing that caused most of the damage wasn’t the hurricane itself, but the system of levees that were there to protect NO. Instead of protecting it, it ended up exacerbating the situation and turning it into a disaster.
In the same vein, having the USD as the world’s reserve currency was a way for the US to enjoy a lot of benefits of international trade, and enjoying a lazier debt policy than all the other countries in the world, but now it seems to be trapping them in a corner. The US can’t let the dollar devalue, otherwise it makes the case of removing the US as the reserve currency even stronger. An unstable dollar will make the case for China, Saudi Arabia, et al. to try to usurp it, and if that happens, all the benefits that they have enjoyed will come back to haunt them.
If the US no longer is the reserve currency, will the US have to issue debt in other denominations? Will the weight of the US’s debt finally affect investors’ feeling about purchasing US treasuries?
On the other hand, the US can’t afford to keep their dollar strong. I believe their decades of financial mismanagement are finally going to roost, and even though Jim Rogers has been wrong since the 80s, I believe this may finally be the time when things turn on the US and it suffers a tremendous financial struggle.
But the US
I’ve said it before and I’ll say it again. Rebalancing must come from China. Building an industrial economy for 1300 million people on the back of an already saturated 300 million consumer market and cheap energy was never going to work. And Yves, Wal-Mart beats them up too. The Chinese have made investments that we never would have.
What we have done is out-source, off-shore and restructure our multi-nationals to survive in that mercantilist atmosphere. We have structured them horizontal, like Wal-Mart and like Dell, where production is no longer an integral component of the business, but can be sourced from multiple vendors like any other commodity. And we play them off against each other. China against Viet Nam. Japan against Korea. Michigan against Tennessee. It would seem much easier to reposition those Chinese manufacturers to supply their own domestic market than to rebuild a US manufacturing industry. And we must hope there will be openings for the things we still continue to produce – medical technology, pollution abatement equipment, etc.
Furthermore, a lower dollar will not bring that production back. It’s not just a question of lead times. It requires investment. US banks will not have the stomach for it. Capital will be found wanting. It will require Chinese investment. Chinese savings may continue to go into govt. debt, but it will not be going into corporate debt. Can we leverage that ourselves like we did in housing? I would think not.
What a lower dollar can do is wreck the Wal-Mart model too. The savings realized by reducing the labor component of production still further is off-set by the increases in costs of energy (transportation) and infrastructure. A cheap dollar makes it impossible to maintain even that. The result is a breakdown in global trade. Shortages of the most common materials. And inflation.
I don’t think there is any intent to rebalance trade with China.
Is it possible the dollar weakness does not improve the US trade position, but to forces other nations to lower their export prices to the US.
To put this out there more completely: In Marxian economics, allowing the dollar to weaken would force Chinese producers to lower their prices still further. Such a situation would make it possible for the US to generate a greater amount of surplus value relative to imported costs.
This would be a possible route to restoring profitablity in the US economy by devaluing imports.
Of course, no one on here is a Marxist economist, but the same conclusion could be reached within mainstream economic theory as well.
The fact remains that there is no other free currency in this world in better shape to take on the duties of a reserve currency. Then yen and the euro are viable, but each is plagued by problems at least as great as our own. Notions of an international currency backed by the dictatorial regimes of the world are laughable. You may as well employ foxes to build henhouses.
I believe it is being conveniently forgotten that this is a global crisis, simply because the damage has hit first – and been most acknowledged – in this country. I think it is very conceivable that, in several years’ time, near-sighted commentators will be commending our government for being the first to balloon deficits, while there was still capital available globally to borrow. At least respect the possibility that this may not be the end of the dollar’s demise, but only the beginning of the end. Or the end of the beginning.
Certainly this infatuation with Asia strikes me as absurd. Chinese politicians must be the most effective in the world. Their most outrageous economic “figures” are unquestioningly accepted. Not only have they discovered how to export to themselves, but they are expected to, by dictat, create a consumer economy from an export economy within one year, two tops. They will float the stock exchanges, the unemployed, and the rather exhaustive prison populations. One of the most abusive, restrictive, bureaucratic, cronyist regimes in the world will lead us out of this crisis to a brave new world. Gather hands, everyone.
You must admit that it’s a strange world where the villains are expected to save us. Three centuries and our ideal of statehood has not advanced beyond Louis XIV. I look forward to his remains being exhumed and canonized.
Agree about the yen & euro and especially so about an international currency. But the fact that there is nothing to take the place of the dollar as a transactional currency doesn’t preclude the possibility of a dollar collapse.
But it’s not just an absurd infatuation with Asia. China is the center of gravity on earth. And I recognize how difficult, ne impossible, it will be for them to create a consumer economy. But I insist that it will be found easier for them to do that than for the US to borrow still more money to prop up an unsustainable consumer economy that produces little. To think the Chinese will agree to continue to work and save to purchase those unredeemable assets of declining value is what strikes me as absurd. In the end this is a struggle for the Keynesian economics that you promote.
Yves,
This is unrelated, but would you consider posting a review of Michael Moore’s new film, Capitalism, A Love Story?
I thought it was his best work to date, not only from a documentary point of view, but it also had humor and some very emotional moments as well.
Vinny G.
I agree with Vinny about Moore’s “Capitalism”. I went in expecting to be disappointed by a “let’s bash the rich bankers” movie, and happily discovered that he gets at something far more fundamental and important.
Not sure I agree with his conclusion, but I can’t deny what he talks about is vital to be reflecting on.
In M. Moore’s new film I personally liked the fact that he made the film a more personal experience than his previous films. For example, shwing how foreclosure or job loss affected individuals on a personal level was nice.
I also liked the fact he covered the “private prisons” topics, although I thought in a somewhat shallow manner. I worked as a shrink for the USDoJ and I saw this type of corruption going on there at unbelievable scales. Judges sit on the boards of directors of these private prisons, hugely inflating sentences for profit purposes. I saw many, many people serving multiple life sentences without parole for a first offense drug charge or for assault and battery. Most of them were black people or illegal aliens and most of those judges were from Texas. I have seen the monster from within and what I saw scared the crap out of me. My hope is that this crisis will bring this whole system down. Any system that feeds off its own members needs to be vanquished, just like that Catholic Bishop stated in the film.
Vinny
As long as the US has a chronic structural trade deficit, there will be long term downward pressure on the dollar. Asian countries are just buying time in these interventions.
what is the name of all the country in asia