Anna Fedec's  Instablog

The United States government has spend trillions of dollars in order to weather the financial crisis. In one hand, the massive fiscal and monetary stimulus has been stimulating the world’s largest economy. But on the other hand it is also likely to undermine long-term growth prospects as the nation will have to take the burden of rising federal deficit and national debt.

Indeed, the national debt has recently reached $12 trillion and with the current pace of growth will probably overpass the overall size of the economy as measured by Gross Domestic Product.



Moreover, the federal deficit has hit an all time high of $1.42 trillion in 2009; more than tripling the 2008 figure. So, it’s possible that a large deficit and national debt may crowd out the positive effects of monetary and fiscal stimulus because it is likely that sooner or later the federal government will need to increase taxes to cover the deficit which in turn may dampen consumer spending and business investments. Also, so far there is little competition for US Treasuries as safe haven assets but with a rising national debt, questions over its sustainability will start to be raised. This will drive yields up and push up real interest rates which will make credit less available for businesses and individuals. Higher interest rates will also make national debt more expensive.

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Last week, Brazil announced the implementation of a 2% tax on capital inflows for fixed income and equities. Apparently, this decision was intended to prevent a bubble in the Bovespa and stop the Brazilian real for appreciating any further.



However, although there is more and more discussion about the damaging effect of high/low exchange rates it is unlikely that any significant coordinated action will take place in the near future.

Indeed, some countries are recovering faster than others from the global recession. In one hand, in places like Japan, European Union, Brazil and Switzerland, a high exchange rate is damaging exports; on the other hand, the ongoing weakness in the dollar is making harder for the US government to keep borrowing money from abroad to stimulate the economy.

However, besides Brazil only Switzerland has attempted to influence the exchange rate without any good results. In fact, we haven’t see any significant improvement nor in the exports neither in the consumer price index. Moreover, since March, when the intervention took place, Swiss Franc appreciated 15% against US dollar and 2% against Euro. So, “the tax action” in Brazil is unlikely to bring any effect on the Real as the main factor behind currency appreciation is not demand for Brazilian stocks but the state of Brazilian economy, which emerged from slowdown much faster than other countries.

Surprisingly, Japan, the world’s fourth largest exporter which was badly hit by dwindling global demand and high the value of the Yen haven’t attempted any devaluation. The problem here is that Japan is the world’s the third largest economy and any change on their exchange rate policy can easily trigger a trade war with the United States or China. This is the so called domino-effect and its consequences can be disastrous for the world economy.

Looking further, the coordinated exchange rate action is quite unlikely because it requires a change in the monetary policy. For example, in the campaign to support the euro in 2000, interest rates in the Euro Area fell more slowly than elsewhere, causing interest-rate differences to move in favor of the euro and creating demand for euro denominated assets. This kind of action is now needed to boost value of the US Dollar. But because the United States is still trying to boost credit availability to fight with a severe recession the Fed will be unable to raise interest rates in the next year.

'Disclosure: No positions'

Although recent data is signaling that the worst for the US economy may be over, the current pace of growth may not be sustainable.



First, the poor condition of the labor market is likely to start having an impact on growth in the form of lower consumer spending. Second, the ongoing weakness in the dollar will eventually make it harder for the US government to keep borrowing money from abroad to stimulate the economy.

Indeed, there are more and more good news coming for the US economy and it is expected that growth may reach as much as 3% in the second half of 2009. In fact, in September industrial production recorded the third consecutive monthly increase and inventories continued to shrink. Moreover, retails sales has grown in August and September even excluding vehicle sales. More importantly, it seems the housing market, probably the biggest cause for the recent financial crisis, has reached the bottom and housing starts and existing home sales have bounced higher.

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During the last few months, commodity linked currencies, have seen an unprecedented rise in their exchange rate against the dollar. For instance, the Australian Dollar and the Brazilian Real are among those currencies that gained the most. But can those currencies sustain its current levels?

Australian Dollar May be Boosted by Carry Trade

So far this year Australian dollar has appreciated 26% against the US dollar. Among many factors weighing on the recent strength of Aussie is a rise in commodity prices and a real improvement in terms of trade. Australia relies on row materials for about 60% of its exports and the price of coal, iron ore and gold has risen substantially over the last few months. Moreover, the Australian economy weathered the global downturn pretty well and hasn’t recorded a year over year GDP decline like many countries. Indeed, a cautious monetary policy and a big fiscal stimulus helped offset the loss of exports and made Australia one of a few countries with prospect of sustainable recovery in the near term. Looking further, the recent increase in interest rate to 3.25% will attract carry trade investors and drive the currency even higher.

Brazilian Economy is Recovering so is the Real

The Brazilian Real reached a 13-month high against US dollar, rising 32 percent since the beginning of the year. And although a remarkable increase in commodity prices contributed to its rally, a rebound in global risk appetite has been leading factor in the appreciation. In fact, in the beginning of global recession, the withdrawal of foreign capital and lost of income from exports weighted on the county economy and the Real. But with several government measures, including tax and interest rate cuts aiming at boosting credit supply and domestic demand, the Brazilian economy has been recovering bringing back the foreign investors interest and much needed capital.

long BZF, EWZ

The Japanese yen spiked to an eight-month high against the US dollar on September 28. However, the stronger than expected pace of yen appreciation is causing some internal conflicts in the ruling DPJ party. In one hand, the new Japanese government favors a strong currency. However, the new Minister of Finance Hirohisa Fujii was recently forced to backtrack on earlier comments that he wanted to avoid currency intervention.

Indeed, the Democratic Party of Japan wants to stimulate growth by increasing household disposable income instead of subsidizing Japanese companies. Moreover, in their perspective, a strong yen makes imports become cheaper, and the party thinks a strong yen is essential in stimulating purchasing power if growth is to come from personal consumption.

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This week, leaders of the Group of 20 leading nations are meeting in Pittsburg. This meeting is happening the third time in less than a year and the agenda is expected to include calls for bigger financial markets regulations, global intervention to trim down trade imbalances and further discussion over protectionism. But with so many different interests in the same table will the major economies have the ability to solve some important issues?

Indeed, the United States government priority is the reduction of global imbalances. And President Barack Obama wants G20 nations to commit on boosting consumption in exporting countries while encouraging debt laden nations to save more. This sounds like a good idea but is very difficult to make the Chinese to spend more and Americans to save more.

Germany and France’s agenda is quite different. They want to focus on financial regulations asking for changes in banker’s compensation rather than higher capital requirements for banks. In fact, German Chancellor Angela Merkel, almost accused the US and the UK of turning back on the issues of financial market regulation by putting the spotlight on the export oriented economic policies of Germany and China.

In our opinion, the G20 needs to focus only one issue, protectionism. Indeed, during the last G20 meeting in Washington all leaders declared to reject protectionism and implementation of new barriers to investment or to trade in goods and services. However, since then every government has been bending or breaking international rules on subsidies and import barriers to protect jobs. To make things even worst, on the eve of the Pittsburgh summit, US raised tariffs on Chinese tires, prompting Chinese to pledged dumping and subsidy probes of chicken and auto products from the US.

'Disclosure: No positions'