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Sunday, December 14, 2008
The rapid US dollar resurgence of the past couple of months is being felt in a number of very specific ways. Rory has been following this trend closely (see posts on USD resurgence, other currency stuff and the, er, "GreenPack.") so I won't spend too much time on the specifics. What I have been meaning to discuss is the significance of this shift in a broader context.
Japan, China and others have so many funds to lend because they have exceptionally high national savings rates, relatively low levels of spending (esp. China) and foreign currency reserves generated from trade surpluses. Since the US is the largest, safest, most open economy in the world, these excess foreign reserves have been pouring into their economy as low-yield investments. For instance, Japan holds about $1 trillion in US assets; China about $1.9 trillion. That means the US is indebted to these countries to the tune of several trillion dollars.
Fed Chairman Ben Bernanke has argued that this "savings glut" in developing countries is the main source of the imbalances. These precautionary savings have two problems. First, they provide low-yield return. For instance, China could take a portion of those nearly $2 trillion and invest it in their own country's education and infrastructure - this is in fact less of a savings glut than an "investment drought." Second, developing countries that rely on export surpluses are essentially relying on the United States to buy those exports. In short, the US must act as "consumer of last resort."
On the other side of the equation, the American economy has been saving almost nothing and accumulating debt like it's going out of style (this applies to other rich developed economies, but less so). This is partly because there was no need: cheap credit from abroad helped fuel equity bubbles in the late 1990s and the recent housing bubble - people were getting rich. But this system was only sustainable so long as American deficits continued to grow and American consumption continued to hold up the world economy.Fed Chairman Ben Bernanke has argued that this "savings glut" in developing countries is the main source of the imbalances. These precautionary savings have two problems. First, they provide low-yield return. For instance, China could take a portion of those nearly $2 trillion and invest it in their own country's education and infrastructure - this is in fact less of a savings glut than an "investment drought." Second, developing countries that rely on export surpluses are essentially relying on the United States to buy those exports. In short, the US must act as "consumer of last resort."
Some people have argued that this balancing act is (was) sustainable, but they are wrong. The real question is when and how will things re-balance themselves. There are two worries. First, that US deficits grow to the point where China & co lose faith in the dollar, dump their assets and cause a recession in the United States. I think that fear has always been overstated. To paraphrase the old banking addage: when you owe the Chinese government $100 million, you have a problem. When you owe the Chinese $1.9 trillion, they have a problem. If the US economy drops 10%, say, these Chinese-held assets will suffer enormous losses. So the fear of a "hard landing" caused by foreign investors was always problematic.
The second worry is that of a Sudden Stop: a slowdown in the US economy prevents them from acting as "consumer of last resort" and emerging markets are forced to readjust internally on short notice. This could also result in a "hard landing" for the economies involved - something to be avoided.
However, last week John Kemp pointed out that we no longer need to worry about which outcome it will be since the decision has been made for us:
The unfolding credit crisis is producing a deep recession, cutting U.S. demand for imports, and forcing the long-overdue adjustment in the trade deficit.He concludes:
With recession taking care of the current account deficit, financial crisis reducing gross capital outflows, and foreign official buyers continuing to support the Treasury market, the U.S. currency has been a strange beneficiary of the crisis. If the dollar’s earlier decline was a symptom of over-fast growth, its rise is a by-product of recession.That's all fine and good for the dollar, but what about everyone who was relying on US consumers to fuel growth? A hard landing is still a strong possibility in some parts of the world. Over the next few months we're going to find out just how capable some countries are at redirecting investment inwards and stimulating their own demand.
Further Reading: Patrick and I discuss China's counter-move of devaluing the yuan. Checkitout!
(Photo: Daylife)
