Vikram Saxena

Long Term Treasury Yields Likely to Rise, Pressuring Dollar Lower

All the green shoots being sighted are unlikely to grow into trees, if the longer term interest rates continue their upward march. Unless Ben does a Greenspan, and encourages people to use ARMs, the Fed efforts to re-capitalize US consumers via cheaper rates on fixed rate mortgages will be in serious jeopardy if this spurt continues. Long bond yields tend to move in big spurts and the current spurt has taken the yield on the 10 year up by more than 70 bp since the low reached after the Fed's quantitative easing announcement in March. This trend will "Round-Up" the green shoots if not arrested.

Inflation and the Declining Dollar

The emergence of the Euro as a viable alternative to the US Dollar has made the US not the only 'big country' around. Since the Euro is controlled be a large number of countries with different foreign policy objectives, it is seen as relatively immune to foreign policy based uncertainty. Since 9/11 US foreign policy has scared a number of countries which are big exporter of raw materials. These countries now convert their US Dollars to Euros right away; they are afraid that the US will use the US Dollar as a foreign policy tool (e.g. freezing assets held in the US).

The large federal budget shortfall, the trade gap and the low saving rate all require the rest of the world to buy our dollars. When there was no other alternative we could get away with it. However, the party is going to end, and it is doing so now as many other currencies now emerge; apart from the Euro, the currencies of the commodity producing countries like Australia and Brazil will continue to show strength.

The US has enjoyed very high wage rates and commodities form a very small percentage of its economy. In a globalized world this mismatch can not last forever. US wages will have to harmonize with the rest of the world, and the contribution of the commodities to the overall economy will gradually come in line with the rest of the world.

The only way we can maintain our lead in wages is by increasing productivity. That requires investment in fundamental engineering and science which will ensure that we drive the next big waves of high-value technological products. Our scientific base is our unique advantage and we need to invest to stengthen that to maintain our lead in real wages. Unfortunately the past two decades have seen private sector investments in fundamental research dwindle. With the compelling cause of the Cold War also not around, government spending too has not kept pace. We need to re-evaluate our priorities and keep up the investment in fundamental research. Kudos to Gov. Arnold who recognizes the value of high-tech and is trying his best to ensure that California remains the high-tech hub.