Beyond The U.S.: Currencies, China and India

So, what’s happening in the global economy? Let’s start with the weak dollar. As Fed policy tilts toward loosening, the already weak dollar hits a 15-year low, and is less than 2% from an all time low. The carry trade currencies, the yen and the Swiss franc, rallied the most during the dollar sell-off. (Here’s a good summary article on the carry trade.)

It’s not that foreigners are fleeing the dollar (unlike this article), though Treasuries are getting less attractive, because the dollar-based investments must be bought by someone. That doesn’t mean the exchange rates don’t shift down in the process, though, and exports seem to be improving because of the weaker dollar. Also, the idea that China would try to ruin the US through selling all of their dollar-based reserves is unlikely, though not impossible. China is too big of a holder to sell without driving the dollar down massively, which would force down the value of their remaining holdings, and harm their ability to export to the US.

Besides, what would they trade into? The US has the largest, most diverse debt markets in the world. One reason why the US is the world’s reserve currency, despite all of its flaws, is that there is no other economy with a currency capable of filling the role. Perhaps this article should have been titled, “Why isn’t the dollar falling more?” because the dollar has been falling, yet there are some things good about the dollar, and the US economy.

China is bumping up against the boundaries of its economy’s current capacity. With few additional young laborers, wage rates are rising. Inflation is now at a 10-year high. That’s leading the government to tighten monetary policy. Beyond that, it is raising the prices of their exports, which slowly forces inflation into the US and other trading partners.

India is facing similar difficulties. Wages are rising rapidly, amid rapid real growth, putting pressure on interest rates to rise. In one sense, this is what you get for taking back US assets in exchange for selling goods and services to the US. So long as your labor pool appears inexhaustible, you can avoid inflation at home, because you aren’t paying new workers much. But when workers become more scarce, the absence of imported goods for those workers to buy means that there will be inflation. Also, excess dollar reserves often produce excess credit, if the central bank allows the money supply to grow from the dollar reserves, which can lead to credit-induced inflation.

Final quick notes:

• Doesn’t look like the ECB, or any other major developed country central bank will tighten anytime soon. India and China are different here.
• As for Japan, if the credit crunch isn’t enough, GDP shrank recently. No tightening likely there.
• For average people planning on retirement, a declining dollar will hurt a little, but not a lot. It will add to inflation, and perhaps raise US interest rates, harming bond returns in the short run. Also, for those with no foreign investments, a declining dollar means foregone returns.

In summary, we are in a situation where the dollar is likely to remain weak. If currency calm returns, the carry-trade currencies will do badly, but if volatility picks up, the opposite will happen. (I can make a case either way.) China and India are on fire, and the developed nations are largely on ice. We are living in interesting times; in the long run, the development of the poorer areas of the world will be a big plus, particularly for US agriculture and resource extraction industries, but there will be bumps along the way. Keep your positions flexible enough to be able to benefit from volatility; I sense we are entering a more volatile period.

Comments

[Quaker]

America is a near bankrupt country with an ineffecient labor force and an old population. All the readings from the Good News Bible in the world won't change that. Go into any retail store. These kids are border line useless.

I live in a farm area and there's the biggest labor shortage in our history. Farm input costs are exploding. Wheat, Canola, Corn, Rice, Soybeans, are all up between 50 and 150% YOY. Farms are paying $12 to $20 an hour to Mexicans who are being ushered out of the country. Muck land in this area is up 600% in ten years. The price of onions has tripled. Milk is up 80%. I paid $7.50 for a gallon of milk and a pound of butter yesterday. That was $4 a year ago. We have 30 million less arable acres than we had in America in 1950. The same people who used prime farmland for houses are using corn for cars.

Next week, the fed will cut rates in the face of rip roaring inflation. Inflation WITH food and energy is running 4.5% annualized, according to these geniuses. This is WITH massive hedonic adjustments. When the Fed stuffed 200bn in overnight repo's into the system two weeks ago, gold went up $60. The world can't continue to absorb this hurricane blasts of money.

I live in an area where the population hasn't changed in 20 years. In the last 5 years, they added 1.4 million square feet of retail space. We have customers but no employees? How does that work? The government in printing money and giving it away! The demographics are insane. Americans are older, fatter and less healthy and they carry more debt? Aren't you supposed to reduce your debt when you get old. I have a friend who is 75 and just got a 15 year mortgage ON A SUMMER HOME.

Now the dollar is playing pin ball. It races from place to place trying to find a dafe haven. Americans have become horrible credit risks. Bill Gross sells out of CP and the stock market goes up? This isn't investing, it's the World Poker Tour.

[Brian Croner]

When I talk about the economy, I use real-world examples, too. I read the headlines, but I come up with stuff that sounds the same as what you just said, here. I see what I see. It doesn't add up. My opinion the nation is in more economic trouble than economists generally broadcast. I see something looming that the world hasn't experienced yet. It's looking like a recession, but I read an article yesterday that said this isn't like 1989 again (referring to Greenspan's statement). I see something lurking on the horizon, and as far as what it is, I'm surprisingly fortunate not to have kids or dependents of any kind right now. The real world is not doing well.

[Quaker]

I agree. One major problem is a HUGE percentage of business leaders live in lala land. They make salaries and live in neighborhoods that resemble Disneyland in a very real sense.

One thing that troubles me, both in economics but especially with Mr. Bush is this belief that life is a state of mind. It's as if we can simply will things into existence.

Nobody wants to use the word recession, as if somehow 3% gdp shrinkage is the end of the world. I share office space with a large law firm. They could literally work 24 hours a day 7 days a week processing bankruptcys. They can't add staff fast enough. The girl next to me has 44 in process. That's ONE person.

About 1/3 of their house closing are being shut out of financing.

I suspect that after 30 years of liberal arts education with an emphasis on social science and away from math the average person is an innumerate boob. In fact, I'm sure that's the case. Innumerate people making key financing decisions?

[Billy T2]

You asked:
"what would they trade into? The US has the largest, most diverse debt markets in the world."
Answer:
Real assets (ownership of companies and raw materials etc.)

Sovern Funds are rapidly growing because central banks have lost purchasing power by holding US treasury PAPER. (Dollar dropping more than interest paid.)

[dougeng]

I would be great to be able to go to work, without headhunters breaking into your home and casing you. Otherwise you would just have to work from home. Something was grossly wrong with our great system.