Posted on 05/04/2003 7:43:46 AM PDT by Chipata
Economic view: Europe's force de frappe
The US now owes France and Germany no favours. It may not be openly vindictive but it is not going to help them
By Hamish McRae
04 May 2003
The dollar is going to get weaker. What then? To say the dollar's present slide has some way further to go is hardly controversial, for it is the mainstream view of the financial markets. Whether this will turn out to be right or not is, of course, another matter, but let's assume for the time being that it is so. A typical profile for this decline, at least against the euro, is shown in the first graph above. This suggests that the fall of the dollar will carry it beyond its €1.15 (80p) level at the beginning of 1999, when the euro was launched, to something like €1.25 by the middle of next year.
If that turns out to be right – and once financial markets get their teeth into an idea, they tend to push it onwards for a long time – there will be a string of consequences for the rest of the world.
First, and most obviously, a super-competitive dollar will be bad news for the eurozone. It may also be bad-ish news for the UK, though that depends on the extent to which sterling can maintain a mid-Atlantic status, moving some of the way with the dollar but not all.
For the eurozone, and particularly for Germany, the situation would be very grave. The fringe eurozone countries could still manage to maintain growth. This is partly because several of them (such as Ireland and Spain) entered the eurozone with an undervalued currency and partly because they can generate domestic growth. But Germany (and to a lesser extent France and Italy) find it hard to boost domestic demand, leaving them open to price competition in export markets. Last year, the only part of the German economy that delivered growth was exports – domestic demand actually fell – so a more competitive dollar would be serious indeed.
But this is only a first order effect. There is every likelihood that this will be another year when US demand rises faster than European or Japanese demand. The likely result of that is the US current account deficit, far from narrowing, may actually widen further. HSBC estimates that it might reach 6 per cent of GDP (see next graph). Were that to happen there would be a danger of the slide becoming very serious indeed. I don't think you need to predict a crisis of confidence in the entire US economy to be aware that it would lead to global trade disruption.
When the dollar rose to unsustainable levels in 1985 and world trade was threatened, such fears led to the Plaza Pact, so-called because it was signed at the Plaza Hotel in New York, between the G5 nations (as they were in those days). Their main central banks agreed to intervene to curb the rise. But it would be hard today to assemble a similar coalition of those willing to support the dollar, were it to fall too low. For a start, global economic co-operation is going to be harder in the wake of the Iraq bust-up. And in any case it would suit the US administration, whatever it might say, to have a more competitive currency. Fears of inflation have given way to fears of deflation. While it is far too early to think in terms of a series of competitive devaluations, as took place in the 1930s, the fact remains that in a period of slow global growth, it helps to be able to corner a few more exports by being able to undercut competitors.
Remember that the general concern about devaluation – that it leads to imported inflation – becomes much less significant in a time of global price stability, even deflation. Meanwhile, the already low inflation in Germany (third graph) could quickly slip into deflation.
This leads to a more general concern. International co-operation is going to be much tougher to orchestrate in the coming months. Self-interest would suggest that we should all continue with the multilateral approach that has governed international trade and payments since the Second World War. But that has been sustained by mutual concessions.
The US now owes France and Germany no favours and while I cannot see it being openly vindictive in its trading relations, it is not going to help countries that have behaved in this way. There will be an economic price to pay; it is naïve to think otherwise. The weaker dollar has to be seen in this context.
So what will happen to sterling? The problem there is that the whole debate is stalled until the result of the Treasury's five tests are published. Assuming they produce a "not yet" verdict, the markets will have to decide whether sterling is fundamentally part of the dollar bloc or the euro bloc. Past performance suggests that it tends to be halfway between, sometimes siding with one, sometimes with the other. On balance over the past two decades it probably has inclined a bit more towards the dollar, but in recent months we have been closer to the euro. A "not yet" decision would push us back towards the dollar.
If this is right you could see quite a weak pound against the euro. We would go back to having holidays in Florida because it was cheaper than Spain. The Eurostar trains to Paris would be even emptier than they are now. Our exports to Europe would become much more competitive and there would start to be European opposition to sterling joining the euro.
Currencies overshoot. In a rational world they would move in much narrower bands and we would create ways of resisting their wilder fluctuations. But we do not live in a rational world. I personally do not think the dollar fall will get out of hand but if it were to fall to €1.25 or beyond, it would do grave damage to the European recovery. And I do not see the Americans worrying much about that.
I'm just waiting to see Joschka Fisher become the head of a new EU foreign office once the red-green coalition collapses. That will drive even bigger wedges into the already evident faultlines in Europe...
In a world dominated by free market economies, "rational" would be the apt description. But when a few exercise much power, as they do in ALL major economic powers in existence, there is no rationality - just reaction, deeply flawed forecasting, and poor planning, with an eye toward maintaining that power.
Why? Oil is priced in US dollars. Natural Gas is supplied locally in USD as well. They each have their own independant market dynamics that cause price fluctuations, but the exchange rate of the USD vs. another currency isn't one of those factors. Now if crude oil suddenly switched to trading on a Euro basis, then we'd have a problem.
Higher prices for imports, which we have become dependent upon.
We can do without luxury cars and French wines and cheeses. There are plenty of good alternatives. By far, the imports that we are most dependent upon, the ones that REALLY keep our consumer goods prices down, are Chinese. Since their currency is pegged to the USD, we should see no change in the price of those consumer goods.
American made goods, by contrast, become much more affordable in foreign markets. So it can be a great opportunity to increase our exports.
In fact, for someone with strong Euros that wants to invest in stock, the US stock markets become a very good buying opportunity. We could see a good amount of those strong Euros and other currencies buying into and bolstering our stock market.
The drooping greenback is starting to get investors jittery.
By Justin Lahart, CNN/Money Senior Writer
NEW YORK (CNN/Money) - In just a week, the Treasury Department is going to unveil a new $20 bill that's going to use, ahem, a "subtle background color". What the color is going to be is a state secret, but the way things are going for the U.S. dollar lately, the appropriate hue for the Jackson is going to be red.
The red... we mean greenback keeps dropping and in some investing circles this is causing increasing alarm. Thursday, the buck fell to new four-year lows against the euro (really the "synthetic euro", because the currency hadn't even been introduced yet four years ago). Meanwhile, the Dollar Index, which shows how the dollar is faring against a basket of major currencies, has fallen 9.2 percent this year.
So why is this a problem for the market? Put yourself in the shoes of a European portfolio manager (ooh, nice tassels), hanging out in some cafe drinking an espresso and looking over your portfolio. Let's say you're an investing genius, and you bought U.S. stocks on Oct. 9, when they closed at their lowest level in over five years. Since then, the S&P 500 has risen 18 percent.
But in the same period, the dollar has slipped a bit over 13 percent against the euro. Add it all up and in local currency terms you've made just about 2.5 percent on your U.S. stock investment. Ugh.
Of course most global portfolio managers aren't geniuses. They are, by definition, just average. The U.S. market has not been nearly as kind to them lately as you'd think if you just glanced at the major indexes and, given a widely held belief that the dollar has further to fall, many may be considering pulling money out of the U.S. assets. Or maybe they are pulling money out of the United States, and that's why the dollar is drooping.
All of which leads us to the nightmare scenario. It comes up every few years, and it goes like this: All those global portfolio managers, worried about the hits they're taking from the dollar, are going to start selling U.S. assets which is going to: A) send U.S. stocks lower and B) further damage the dollar. Which is only going to make the global investors (and U.S. ones) more twitchy, and beget more selling. Which will beget more selling. Pretty soon you have a massive rush to exit U.S. assets, and a global financial catastrophe.
Pretty scary, right? If it's any consolation, there have always been people who worry investors are going to rush out of the United States. They point out that the United States' has a huge current account deficit, meaning that, on net, foreigners own far more U.S. assets than U.S. investors own foreign assets. Eventually, the argument goes, the foreigners are going to want to repatriate their money -- and if the dollar is falling badly, they may want to repatriate it in a hurry.
Like other disaster scenarios that people get worked up about -- Y2K, Skylab -- the big, bad dollar drop has never happened. The problem, however, is that when these dollar worries surface, stocks often see a period of weakness.
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