Posted on 10/04/2004 7:05:29 AM PDT by shrinkermd
The U.S. current-account deficit reached 5.7 percent of GDP in the second quarter of 2004. Yet the dollar remains at a relatively high value: less than 20 percent below its early 2001 highs and more than 10 percent higher in real terms than in the early to mid-1990`s.
As the current-account deficit rose over the past half-decade, international economists have lined up to predict doom: returns on assets invested in the United States are relatively low, so at some point - probably all at once - holders of dollar-denominated securities will realize that the risk of suffering a major crash in value is not being adequately compensated. Once portfolio investors start selling their dollar-denominated securities, a stampede will follow, causing the dollar`s value to crash and triggering the first major global financial crisis of the 21st century.
Fred Bergsten of the Institute for International Economics calls this situation "a disaster in the making." How far will the dollar have to fall? The first historical rule of thumb is 10 percent on the dollar for each percent of GDP`s worth of unsustainable current-account deficit. The second historical rule of thumb is that currencies on the decline tend to overshoot: near the bottom, international currency speculators require a substantial risk premium out of the fear that the currency crash might trigger something even worse.
So, when will this promised dollar collapse and crisis come? Bergsten says, "Soon."
But Bergsten is probably wrong about that. The late Rudiger Dornbusch - who used to write this column - used to say that unsustainable situations lasted longer than economists who believed in market rationality and equilibrium could imagine possible. They then tended to collapse more quickly than anyone could believe. In his view, currency overvaluations go through five stages:
First, short-term speculators seeking higher returns, or investors overanxious for safety, drive a currency`s value to unsustainable levels.
Second, trend-chasers keep buying because the returns have been so good in the recent past, thus pushing the overvaluation to a height and duration that orthodox economists cannot explain.
Third, highly intelligent economists, puzzled by the duration of the overvaluation, evolve theories of why things are different this time, and why this time the overvaluation is perhaps sustainable after all.
Fourth, market bulls, encouraged by theories of a "new economy" that justify the extraordinarily good returns seen in the recent past, keep buying and keep the currency suspended above economic fundamentals even longer.
Fifth, the supply of eager purchasers and trend-chasing investors comes to an end, producing a crash that resembles the collapse of a Ponzi scheme.
In the past six months, the current round of the dollar cycle entered stage three. Louis Uchitelle of the New York Times quotes the highly intelligent Catherine Mann commenting on the "co-dependent relationship between the United States and its trading partners," which might "last for quite some time," because "the United States and its main trading partners have a vested interest in the status quo."
Japan, China, and other export-oriented East Asian economies are indeed eager to keep the value of the dollar relatively high, and their central banks have piled up close to $2 trillion in dollar-denominated assets. China`s government regards the threat of capital losses on its dollar-denominated securities as less important than the need to maintain near-full employment in coastal manufacturing cities like Shanghai. After all, the ruling communist oligarchs have grown accustomed to a comfortable lifestyle. The last thing they want is mass unemployment and urban unrest to call their positions into question.
But if international currency speculators get the scent of near-inevitable profits from an ongoing dollar decline in their nostrils, all Asian central banks together will not be able to keep the dollar high. Only the Federal Reserve can do that - and the Federal Reserve is very unlikely to sacrifice the jobs of American workers on the altar of the strong dollar.
There may yet be a soft landing, whether slow or fast: during the last major dollar cycle, between 1985 and 1987, the dollar fell by 40 percent without ever causing panic, major bankruptcies, or a demand by investors for a substantial dollar risk premium to compensate them for holding assets denominated in a declining currency. But the historical rule of thumb is that the chances of a fast, hard landing have now surpassed 25 percent, and continue to climb.
J. Bradford DeLong is a professor of economics at the University of California at Berkeley and was assistant U.S. Treasury secretary during the Clinton presidency. - Ed.
Copyright: Project Syndicate
2004.10.05
¨Ï Copyright 2002~2004 Digital Korea Herald. All rights reserved
Who cares? A weak dollar helps the trade balance. It would destroy China and everyone else dependant on exports to the United States.
So, plastic crud one buys at Wal-Mart would be expensive for a year. So would clothes.
Food is from the US. We wouldn't starve.
We'd tough it out.
And we'd export a lot of mfg. goods, which would help the rust belt.
But if international currency speculators get the scent of near-inevitable profits from an ongoing dollar decline in their nostrils, all Asian central banks together will not be able to keep the dollar high. Only the Federal Reserve can do that - and the Federal Reserve is very unlikely to sacrifice the jobs of American workers on the altar of the strong dollar.
If I remember correctly (it's been a while since I had time to go back through the numbers), Japan has reserved $1 trillion dollars worth of yen (with $350 billion worth of yen in cash money at the Bank of Japan) to carry out just that defense. So far, despite some dabbling by the hedge funds, they haven't been able to push the yen into the sub-100 range.
Maybe some group will be able to out-trade the Bank of Japan on this, but so far they haven't pulled it off -- in fact, I have heard that some have come out with their hands singed from trying.
If they do eventually manage to pull it off, it could make Soros breaking of the Bank of England look like small potatoes indeed. Not because they hurt the Japanese directly -- believe me, increasing the value of the Japanese huge dollar reserves isn't going to harm them directly -- but it will slow their exports to us, which are an important component of their economy.
Ultimately, a dollar only has value when spent or invested in its country of origin. All US dollars must eventually come home.
Time to offload all politicans who supported 'NAFTA' one-way trade agreements before America has to carry around money in wheelbarrows.
Soros and Buffet attacked the dollar over a year ago, if they held they broke even at best. It's been one of their main motivations for the sudden politics interest.
I know they will never even attempt to contemplate this, but I've always wondered.
Assuming the American dollar really is 'over valued', could I interest you into trading US dollars for say, Panamanian Balboas? It said right there in the article: "when will this promised dollar collapse and crisis come? Bergsten says, 'Soon' " so it must be true.
This is what happens when we base the value of the dollar on the promise of a politician instead of the value of gold.
As for US industry, well considering we shipped the very machines to China and anyone who thinks China will ever let you ship them back needs to lay off the crack pipe.
ping
1. Oil currently has a massive "fear" factor built in. It will quickly drop to $28-32 in the next six months. So even if the price doubles, will be about where we are now.
2. What bases? You mean the ones in Germany that we need to leave? While some incidental services may increase in relative cost (say Kraft services for food or somesuch), the bulk of the cost are: (1) real estate, which is taken care of (free or long-term lease) and (2) soldier salaries, which are, and will remain, in US dollars at the same rate. So they have to shop at the PX. Happens.
3. Lower dollars mean more foreign investment because stuff is cheap here, including stocks. So this is just wrong.
Devaluation of currency (and inflation for that matter) to debtors is also a good thing -- it's like owing less and owning more.
Yes, idiots who have adjustible rates mortgages and credit card debt will get popped, but I don't care, they're idiots. I have a fixed rate mortage and no credit card debt.
4. I am sceptical of the "most companies have" deliverable proposition. Exports would be up dramatically, which helps all levels of mfg.
BUT, more importantly, we are a service economy. For example, programmer services now done in India would come back to the US.
Food for thought: Venuzuala will probably stabilize with the leftists, worst case scenario they go into civil war. US should have interviened to remove Chevaz when he was first "removed", opportunity lost.
Nigeria is going to be in a civil war, regardless. Sudan's oil regions are already in civil war. Democracy in Iraq might have the opposite effect in Saudi Arabia and the other Gulf States as the nut jobs might move up their take over schedule and cause a chain of similar revolutions (whether or not they succeed is to be seen but disruption is guarenteed). If there is revolution in Iran, I hope it is fast, otherwise more disruptions.
Either way, China's continued massive suckup of all raw resources will guarentee that oil prices stay high. Russian oil is heading either to Europe, China or Japan. Notta to the US. Mexico is a hope. ANWAR is barely a band-aid, only 5% of our daily consumption.
As for our bases, yes the ones in Germany, Italy, England, soon Poland, Bulgaria, the ones in Bosnia, Kosovo, Iraq, Afghanistan, Japan, S.Korea, etc will all get a lot more expensive. Most of the support on those posts are paid for to local civilians. Also, the COLA will have to be massively adjusted in order for families living off post and shopping off post to keep from going bankrupt. Even the gasoline is already subsidized in Europe and Japan. All this adds up quickly.
3. Lower dollars mean more foreign investment because stuff is cheap here, including stocks. So this is just wrong
Yes and no. If the risk of default is up, and with a collapsing dollar it will be, and interest rates are low, then you would have to be an idiot to invest. There has been threat already of lowering the US credit rating from AAA to AA, this is a massive move and would require a major rise in interest rates to offset. All of which affects the debt almost every american is sinking in. Also affects the large percentage of our taxes already heading to pay off interests.
Devaluation of currency (and inflation for that matter) to debtors is also a good thing -- it's like owing less and owning more
Only if it is at a controlled rate. Run away inflation is not good. Major devaluation is not good. More money chasing fewer goods, which in turn causes less production not more. Harken back to Carter and 18% inflation, how well off was America then? When your debt also means less, banks charge higher interest to recoup. This cuts into business growth, further slowing things down. A collapse of the banking system from lack of liquidity of its debts would be disasterous.
4. I am sceptical of the "most companies have" deliverable proposition. Exports would be up dramatically, which helps all levels of mfg
Only in the long run, in the short run, volumes are often set. Also, supplies of raw materials or parts imported are also contractually set, so this hurts, especially when buying in euros and having to convert, or yen. Further, how will you start new production right off? First you have to make new machinery since much of the heavy stuff (like textiles) is sitting in China or other places and they will not let you take it out.
There's been lotsa chatter about the "fear" factor in oil pricing, but another way to look at it is that it's the same price as the 1980's plus inflation. It may jump on a USD deval, but not for long/not too much.
The PRC is already unloading USD assets, purchasing oil leaseholds in Canada--and yes they will retain manufacturing, partly because the yuan is fixed at 8x the dollar. I don't know if the rupee is fixed on the dollar.
Long-term US exports will go up as a USD deval makes our goods cheaper overseas (except in PRChina.)
Short term it will be a hell of a mess for a while. And yes, rates will jump.
The MOST remarked-upon situation is the bond's strength, effectively keeping rates low. Few can figure out why, although Japan and PRC laid off the last Treasury offering (last week) only buying 3% of the sale. Rates did pop a bit on that sale...
I just don't see the dollar "collapsing." Taking a huge hit --- possible. Taking a healthly drop, probable.
Regarding the other posters talking about gold --- if the economy gets so bad gold is a serious investment, skip gold, and go straight to canned goods and shotgun shells.
Gold is over hyped. Besides, if anything like Roosevelt happens again, they'll just collect up all your gold.
Not if you have enough shotgun shells, although MY preference is .30-06 plus a handy-dandy 9mm
I think you're right. The "terror risk premium" built into the cost of oil (the US stock market as well I guess) will go down over time. After we take Fallujah, oil will drop. After Iraq has it's first elections in January, oil will DRAMATICALLY drop.
Fundamental Tax Reform that shifts much of the tax burden from savings/investment to consumption is enacted (which is what the president wants), we will need less foreign debt financing. If Capital Gains and corproate taxes are dramatically reduced, which is also possible, more investment will pour into the US. More goods will be produced in the US because the cost of doing business will be lower.
So why are we so worried about oil prices now? After all, the cost of oil in Gold shot up 130% in 1999, and experienced a nearly 300% climb from the beginning of 1999 to the end of 2000, almost quadrupling.
So have recent oil spikes really that bad? Considering that it's less than doubled in 18 months, I'm not too concerned.
btttttttttttt
it won't touch China - their currency has an artificial peg.
we'll be paying $4 for gasoline if this happens.
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