Brad Setser

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You know, there are safe havens that do not have a current account deficit of $1 trillion …

by Brad Setser
May 25, 2006

Incidentally, I am not the only one who thinks that the US current account deficit is heading toward a trillion.   The OECD now forecasts $965b current account deficit in 2006 (7.2% of GDP), and $1070b in 2007 (7.6% of GDP) — rather than link to the full report, with the actual numbers, I’ll just link to the summary.   Justin Lahart of the Wall Street Journal reports that the April ports data suggests strong imports and not-so-strong exports, which supports this forecast. And, given the pending surge in net US interest payments as the interest rate on US external debt rises from 3.4% (2005) to something closer to 5.5%, it seems likely to me that the US current account deficit will be above $1 trillion for a long time.  Barring a very hard landing.

Still, David Altig notes that the US remains a safe haven in times of stress.  David Altig asks “where else would you go?”    Actually, he puts it in a slightly more colorful way.

To anyone waiting for the greenback slaughter, I have one question: If, heaven forbid, the global economy goes south, who ya gonna call?

He asks, I answer.

If the global economy goes south because of an oil supply shock, I would run into the Canadian dollar and the Norwegian krone.  I would even rather hold the Russian ruble than the US dollar.  Putin isn’t the nicest guy, but Russia is now a substantial net creditor – and with oil at $70 Russia is adding about $150b to its reserves a year.  I kid not — Russia's reserves have been rising by $5b a week recently. Its external fundamentals are solid.  And I doubt the central bank will be able to resist nominal ruble appreciation forever.

I would also prefer the euro and even the yen to the dollar.  Both Japan and Europe have more energy efficient economies than the US (yep, energy intensity is a structural problem).   Oil exporters want to spend their windfall on European goods, not American goods.   And if oil gets higher, Americans will want to import more Japanese energy-saving technology (hybrids).   But I realize that the euro/ yen over dollar call is a bit more conversial – Peter Garber of Deutsche Bank thinks the dollar would rally in the event of a big oil supply interruption.   Lots of petrodollars would need a home.  My botton line though is simple: in the face of a shock that increases the current account deficits of all oil importers, I wouldn’t want to hold the currency of the oil importer with the biggest deficit.

If the global economy goes south because of a global demand shock and oil falls, Canada, Norway and Russia aren’t the obvious safe havens.   But Asia still looks pretty good to.   Read Bill Gross – he is kind of good at these things.  Asia exports savings – unlike the US.   It imports a ton of oil, so if oil prices fall, Asia’s current account surplus would rise.   Of course, Asia also exports a lot of things – and if US demand growth slows, that would also hurt.  But net/ net I suspect that the impact of slower growth in exports is offset by lower import prices.  And if oil falls because of a global demand slump, US interest rates would likely fall, reducing the interest rate differentials that now favor the US.   

Afterall, a slump in global demand would probably stem in the first instance from a slump in US demand.  The US has been the engine driving global demand – and thus is the biggest potential source of trouble.

And particularly if German consumers start to act a bit more like Spanish consumers (i.e. start spending), the euro also looks like a better safe haven than the US.   Europe doesn’t have a big external deficit that it would need to finance during a downturn, when it is offering international investors a low interest rate.   And unlike the US, Europe is building up its stock of dark matter, not drawing it down.   The eurozone probably took in at least $150b from the central banks of the emerging world, and rather than using the funds to finance big external deficits, it used the flows to finance European foreign direct investment abroad.

Altig and others would probably say I am underestimated the United States strengths.  

But I say that they may be underestimating the problems created by running a current account deficit that exceeds your goods exports.   OK, I should throw in service exports.  But the US is running a 7% of GDP trade and transfers deficit off an export base that is only a bit over 10% with a dollar that is weak against the euro and with global demand for capital goods – the kind of thing the US makes – quite high.  The United States core external fundamentals are not so hot.   The US needs a gradual fall in the dollar that reduces its trade deficit slowly (and increases the value of US assets abroad) to stabilize its external debt at 60% of US GDP, and stabilize US net interest payments at something like 3% of GDP. 

A run into the dollar that pushes the dollar up would imply a trade and transfers deficit of 8 or 9% — and a currnet account deficit of 10 or 11% as interest payments rise.   That doesn’t sound like safe haven to me.  

It also implies a bigger future depreciation of the dollar and a US net external debt level that maybe stabilizes at 80% of US GDP.

Stephen – current account deficits really don’t matter – Kirchner, and lots of others, would say I am underestimating demand for US assets – and the United States skill at creating assets.

I concede that the US is good at selling debt to the People’s Bank of China.   But I would argue that Kirchner and others underestimate the long-term risks associated with depending on the central banks of nice places like China, Saudi Arabia and Russia – along with Japan’s version of day (carry) traders – for financing.  

The smart money betting on the US is betting – I think – that if private demand for US assets falters, central banks will step in.   The US is too big for China and Japan to let it fail (sort of like Russia was too nuclear too fail?).   That may be right.   Central banks so far have stepped up their purchases when the dollar is under pressure – and, as Ted Truman and Anna Wong nicely demonstrate, central banks also bought more dollars and fewer euros when  the dollar is under pressure in 2004, and then relatively speaking more euros in 2005 when the euro was under pressure.   That is the opposite of diversification.   They could act that way in the future too.  Or they could decide that there are limits to the number of dollars they want to hold …    

I recently read that US investors – mutual fund investors – put $20b into emerging markets in 2005, and $30b into emerging markets in the early part of 2006.   Those kind of flows – plus additional hedge fund flows – bid up thin markets big time.  The withdrawal of those funds, in turn, pushed lots of the same market down over the past two weeks.

But relative to the flows the US needs, $20b – or even $30b – is chump change.

China added $20b to its reserves a month in 2005.   And in the first quarter of 2006.  it probably will be more in the second quarter.  In a month, China provides about as much financing to the US as US investors put into all emerging economies in 2005.

The $30b that US investors dumped on emerging markets in 2006 less than what Russia and Saudi Arabia now add to their reserves in month.    Russian reserves are going up by about $20b a month.   Some of that is valuation changes, some may be capital inflows.   But most comes from selling oil and gas.  Saudi Arabia hasn’t released data for April or early May, but it doesn’t take a genius to guess how much it is now raking in.   Bill Gates has nothing on Saudi royal family.  Hell, with only $80b in 2005 profits, the big (western) oil companies have nothing on the Saudis.


  • Posted by kz

    4Q GDP growth was revised up to 5.3% from 4.8%. But the expectation was 5.8 or even 6.

    Initial jobless claims was 329. Last week, it was 369 because of the incident in Puerto Rico. Lehman thought it will fall to 310, but no. It was the highest since mid-October last year.

    Continuing claims also up from 2382 to 2420. Help wanted Index down to 35 from 38.

    Tomorrow there will be PCE coming out.

    Source: Bloomberg

  • Posted by FR

    This is a question that has been bothering me for a long time, and I’m pleased that you have addressed it. Frankly, though, you haven’t convinced me. I’m not capable of crunching or even eyeballing the numbers as you do, but it hardly seems likely to me that any other capital market or combination thereof is capable of absorbing the annual US trillion Dollar deficits. Norway, Canada, Swissy, etc may be big enough to provide safe havens for private capital, but nowhere near big enough if central banks of surplus countries decide they want to try another reserve currency. Indeed, where else can they go? I hope you can convince me. those who are mismanaging the US Dollar certainly deserve their comeuppance.

  • Posted by Dave Chiang

    Has anyone noticed the rising price of precious metal recently? Across world history, those who bought gold and silver preserved all of their wealth as their currency and economy took a dump, and they actually ended up with a fortune in gold. Actually it’s not the metal that’s going up, it’s the US dollar going down. Investors are losing faith in the fiat-currency US Dollar mismanaged by a Federal Reserve that continually expands the US money supply to finance record deficits.

  • Posted by bsetser

    FR — if you are China’s reserve manager, you are boxed in any case by your peg — but you also have too look at the other big liquid markets — i.e. yens, euros maybe pounds. I suspect the same is true for the Saudis.

    One alternative to buying us assets is to buy real goods … more mercedes and boeings, fewer t-bills.

  • Posted by Guest

    Brad – thought provoking, as ever. I have had a question rattling around in my head and would be interested in your thoughts…

    * The US is in debt up to its eyeballs
    * Foreigners continue to bankroll the US
    * The dollar will fall, and foreigners will see their dollar holdings shrink dramatically in value
    * Once the currency falls, the US will become a more competitive exporter

    While it can’t easily be quantified, one of the US’s clear competitive advantages is the flexibility of its business environment. When there is a dollar to be earned, the barrier to starting a company to earn it is almost zero. Similarly, if the company isn’t profitable, the US freely allows that company to migrate work elsewhere or shut the business down.
    While there have been a lot of changes in the last ten years, I think it is inarguable that the US remains more flexible than anywhere else in this regard.

    So what are the odds that a significant shift in the value of the dollar causes a massive shift in the current account deficit? If Intel, Motorola, and Cisco see that the cost advantage of Asian manufacturing declines by 30%, why wouldn’t they repatriate jobs just as quickly as they have been exported? What is the likelihood of the flood operating in reverse?

  • Posted by kz

    Brad, I’m not convinced either.

    Your argument for Norwegian Krone, Russian Ruble and Canadian Dollar is fine. We are already seeing a bit of preview of that. But when the global economy completely slows, I think the majority will still turn to the US Treasury or the USD after all. If they understand the macroeconomic severity today as you do, maybe they’ll take your advice. But if not, I think they’ll still cling to their unreasonable faith in the US and the USD.

    The credibility of Euro or JPY are short-lived. You know this better than I do. ECB cares more about its exchange rate than its interest rate. If European countries economic growth slows, and oil price falls, why should ECB raise its rate?

    JPY’s recovery will not last. My colleagues in Japan tell me all kinds of bad news about Japan. Simply put, Japanese 30 years ago were determined to overcome the US, as if to say, “We lost the war, so we’ll win in economics!” Today, spoiled Japanese youth have no motivation whatsoever. Plus, they make no kids.

    The US with better immigrant policy, higer fertility rate and the advantages the USD possesses, I still don’t see the USD falling too sharply (I do see it falling though).

  • Posted by Charlie

    One of the things the US has going for it is it has a government that can be trusted to honor its commitments. I know there’s a lot of blather on this blog about how the US is going to default, but, let’s be real, it’s not going to default on its debts. Since their debts are denominated in USD all they have to do is create USD to pay off the principal and interest. Plus, the US has laws that are enforced to protect against investor fraud. When investing in third world countries, if someone embezzles your investment, what can you do? I personally don’t feel safe investing in Russia or China. It’s not like the governments of these countries need to be worry about bad press losing an election for them. China clearly is very stubborn about giving in or even listening to anyone outside of China (probably inside China too). The gov’t does what it wants and complaining about or questioning their actions is futile.

    Actually it’s not the metal that’s going up, it’s the US dollar going down.
    Metals, and almost every commodity have gone up in value. Not just in USD terms, but in the terms of every currency. This isn’t a sign of investors losing faith in USD; This is what happens when inflation expectations are high.

    Across world history, those who bought gold and silver preserved all of their wealth as their currency and economy took a dump, and they actually ended up with a fortune in gold.
    Sometimes it works, sometimes it doesn’t. Not any different than any other investment. Gold and Silver have had bear markets where investors lost their shirt. I suspect we’ll be in one of those bear markets pretty soon since they always seem to follow bubbles.

    Be sure to keep us all posted on the latest from safehaven.

  • Posted by FTX

    “But I say that they may be underestimating the problems created by running a current account deficit that exceeds your goods exports.”

    Even with the caveat about service exports, that sentence should give anyone pause for thought.

    One (minor) data point that stands out in the Truman/Wong paper is Canada in the currency composition table (Table 3). The dollar accounted for 77% of Canada’s foreign exchange reserves in 2000, and fell (mainly in ’01 and ’02) to only 47% of reserves in 2004.

    Canada’s roughly 50-50 euro/dollar split of reserves seems a more ‘natural’ basket these days (for an economy whose currency isn’t pegged to the USD).

    One problem that must always be borne in mind with the euro is the issue of monetary union without political union. I believe we’ve yet to experience the full strains of this. Ironically, the sort of decline you predict for the dollar may be the catalyst.

  • Posted by steve kyle

    The question posed is a flight to quality and your answer is Russia and Norway? I dont know about that. If we are talking about a major fright in the markets then it might be a good idea to be in a larger steadier asset with a lot more inertia behind it. Given that you have two alternative scenarios (oil up and oil down) and euros look OK in both of them then that is the place to be. We really could go either way on oil – Either some wacko in the Persian Gulf bombs something or some wacko in Washington does the honors and the price goes up. Or, nobody bombs anything and there is a recession coupled with lots of new product coming on line and the price goes down. Either story is plausible and we dont know which it will be – So dont hang your hat on RUSSIA for God’s sake. At least not unless you have one hell of a lot more tolerance for risk than I do.

  • Posted by Dave Chiang

    Reply to Charlie,

    Americans like you need an economic reality check. The United States Economy goes deeper and deeper in debt to the world. Americans invade foreign countries in the belief that they are spreading freedom and democracy by creating enemies all over the globe, and depend on lending from China to pay for it. In fact, the entire US Bubble economy now depends on the savings of poor Chinese to keep it from falling apart. Americans overconsume far more than they earn. The difference is made up by the kindness of foreigners – the Chinese whose “supposed” savings glut is recycled into McMansions, gas-guzzler SUV’s, and flat-screen TVs all over the United States.


  • Posted by Guest

    I think kz hit the nail on the head. No other markets exist that are liquid enough to absorb USD flows. The money is permanently trapped in the US.

    David Chiang – I know you are a committed propagandist, but the Asian Times, Safehaven, James Kunstler liberal/leftist meme is getting a little old. Let’s make a deal. You stop posting here and we’ll all go visit those websites once a week to find out what you think.

  • Posted by Dave Chiang

    Reply to Guest,

    Perhaps I have missed the point completely so please answer several questions for me.

    1. Why is is good for United States run such huge trade deficits with the entire world?

    2. Why is is good for democracy to launch costly military invasions of Iraq and Iran?

    3. Do foreign Muslim countries actually want to be invaded and taken over by the US?

    4. If China is a terrible threat, why does the US government borrow hundred of billions of dollars from them?


  • Posted by DF

    That post was really funny. A nice one.

  • Posted by bsetser

    steve k.

    yep, if the economy tanks b/c of a supply interruption, i go for quality. which in that case is oil. particularly oil that does have to flow through the straights of hormutz (sorry about the spelling) to get to global markets. thin markets don’t bother here — more money chasing the krone = stronger krone … (sort of kidding, it only works if you get in first).

    too bad edward hugh is too busy with his blog to argue that the eurozone cann’t handle the inflows. i fully realize that a stronger euro would put a lot of pressure on some parts of the eurozone (just as the strong $ v. Asia puts pressure on Ohio … ) and that eurozone growth isn’t super strong.

    but if a global slump leads to an equalization of US/ Euro and yen interest rates … a big assumption — or it if leads US rates to fall further and faster than the other big currencies, i would prefer to hold the currency of countries that have smaller deficits/ surplus to that of the US. i don’t like the dynamics of raising $1 trillion at 1% … OK, if might not be $1 trillion if oil tanks (the demand shock) and interest rates fall (limiting the growth in US net interest payments), but it will still be a big number.

    And if a generalized flight out of risk turns into a flight back home, that hurts the US too — it needs continued big inflows of other folks savings. It isn’t enough for US money to come home. The US needs big flows from people who don’t want to keep their savings at home.

    Eurozone is fairly big and fairly liquid. Tis true that an Italian bond isn’t quite a German bond. But recently, the markets have traded as if they are very close substitutes (maybe too close). i don’t find the US is the only big and liquid market argument all that persuasive. Right now, the US treasury market is arguably too small for China’s reserves, so it has been pushed into other markets (there is some pull too). And if Germany ever learned how to gear up its housing stock like the rest of the world, it could start exporting a lot of financial assets (just as the US exports a ton of Mortgage backed securities)

  • Posted by Charlie

    Dave Chiang,
    As has been posted by many, time and again, you’re the one in need a reality check.

    If China is a terrible threat, why does the US government borrow hundred of billions of dollars from them?
    The US governement doesn’t borrow from the chinese. The chinese buy US debt on their own. It’s not like the US gov’t fills out a loan application with the chinese central bank.

    the entire US Bubble economy now depends on the savings of poor Chinese to keep it from falling apart. … The difference is made up by the kindness of foreigners – the Chinese whose “supposed” savings glut is recycled into McMansions, gas-guzzler SUV’s, and flat-screen TVs all over the United States.
    Do you really believe the chinese, who are world reknowned for a history of domestic civil rights violations, are engaged in their present practices with the US out of kindness? The chinese are the ones who are driving the present situtation with their dollar pegging. The US is asking them to stop their pegging and USD debt purchases. The chinese are the ones who are keeping things the way they are. According to your own words, they do this to keep their economy stable. If you’re mad at poor chinese savings going to the US, blame the chinse gov’t. They’re the ones responsible. Not Americans like me in need an economic reality check.. Also, what do you mean by “supposed” savings glut? Are you saying the chinese don’t actually have excess savings? Are you saying they’re like americans and are accumulating debt instead of savings?

    Since your response has now spread into politics, it’s clearer than ever that you just don’t like america or americans. It’s OK with me. A lot of people agree with you.

    NOTE: Setser edited this comment to remove a line at the end that I felt was inappropriate. No other changes were made.

  • Posted by Dave Chiang

    Sure Charlie. The Chinese force the US government to sell debt to them. If you believe that, I can sell the Brooklyn bridge to you. The economic solution is simple for Americans: just stop selling debt securities. Learn to live within your budget.


  • Posted by Charlie

    Dave Chiang,
    You just don’t get it.

    Maybe this analogy will help you understand…
    If I go to the store and buy a dozen apples. The store isn’t forcing me to buy them, nor am I forcing the store to sell them to me. They simply offer them for sale and I buy them. By the same token, the US gov’t isn’t forcing the chinese to buy their debt, nor are the chinese forcing the US gov’t to sell it it to them. Do you get it? I can’t reduce this to a simpler explanation, so if you don’t get it, well, then you never will and I’ll stop trying to explain it to you.

  • Posted by bsetser

    Charlie —

    “Go back to X” is never called for.

  • Posted by bsetser

    Charlie wrote that the US can always be trusted to keep its commitments.

    If you ignore the time when the US unilaterally eliminated a link to gold after it devalued the $ v. gold in the 30s, that is true.

    But I would also note in that context that the US has never committed to maintain the external purchasing power of the dollar. indeed, the fed has more or less said that it won’t do so, and it will direct US monetary policy as US domestic conditions. If that calls for a $ decline, no problem. The Fed’s scenario for a soft landing hinges of $ depreciation, shift from non-tradables to tradables and no impact on long-term uS rates.

    That is very far from a commitment to maintain the $’s purchasing power.

  • Posted by Dave Chiang

    Federal Reserve Monetary Policy Failure

    For too long, the Federal Reserve has tolerated monetary and credit excess. The Global Economic markets are signaling a prelude for the next financial crisis: a collapsing dollar, spiking Gold price, surging crude oil, and rising global bond yields. Slashing interest rates, and inciting more Credit and liquidity will only be counter-productive to maintaing the stability of the US Economy. The Dollar Liquidity Bubble represents the combination of massive Current Account Deficits and speculative finance that is inundating the entire financial world, and there is no way short of a major US economic crisis to put the situation back under control.

  • Posted by OldVet

    I agree more with David Chiang than not – the American Fed can do little to affect longterm interest rates as long as the Executive Branch lends and our creditors buy our Treasuries in such quantities as at present. There may be some way to measure auction prices for different Treasuries under different assumptions of how much cash foreign CB’s want to recycle into US debt. Or how little. So effectively my point is that our interest rates are effectively controlled on the auction block by foreigners at the present time.

    That said, the Executive branch has many ways to skin the current cat, from selective tariffs to raise money, rather than issuing bonds, to talking the dollar down, to embargoes, to taxing interest income earned by CB’s, – just imagine all the tools available. It’s up the to Executive Branch to use those tools, or we continue with huges excess consumption as we are. Having the US dollar fall is an indespensable part to the adjustment of the US to globalization and the current imbalances.

    Private industry seems willing and able – according to BP and to Ford – to get the US onto track for the hydrogen economy. Don’t bother telling me we can’t do it – look at the alternative today. Look at all the many things this country can do, including crash education programs in science and physics and biology, to stimulate the growth of new industries to absorb future workers. We still have a flexible economy, as remarked above, if we goose it.

  • Posted by Joseph Wang

    Charlie: The RMB peg is dead. Since 7/22, the RMB has appreciated about 3-4% and the PBC has made it obvious that they will keep appreciating. One can argue about how much and how fast the PBC should or will appreciate, but the peg is dead. Also, complaining about the peg seems to be yesterday’s news in Washington. The other thing is that the Chinese bureaucracy is surprisingly open to outside ideas and influence. I know of a lot of people (particularly in finance) that are “panda huggers” to various degrees because Chinese officials listen carefully to them and act on their ideas.

    As far as the US finance agenda, there are three issues that US Treasury has tried to get China to do. 1) revalue the RMB 2) open the financial markets to US investment and 3) increase domestic consumption. There is some pushback on 1), but 2) and 3) are like pushing on an open door.

    Also, the definition of “borrow” is getting money with the expectation that the money is going to be repaid. The US is borrowing huge amounts of money from China. China is willing to lend, but anytime you borrow money, it comes with strings attached, and the degree to which US borrowing of Chinese money has radically changed US foreign policy toward China is one of the untold stories of the last three years. “Panda huggers” (like myself) don’t talk about it loudly because they think the change is a good thing. “Dragon slayers” don’t like to talk about it because they really don’t want the public to know how much a China containment policy is going to cost (literally), and how much the war in Iraq is being financed by China.

    (One cool statistic is that in 2005, China spent more money financing the US military (US$100 billion) than it did financing the Chinese military (US$30-US$90 billion).)

    Guest: The jobs won’t come back with a 30% RMB revaluation because 1) the cost differential is a lot higher than 30% and 2) if you change the US-RMB exchange rate and China does become uncompetitive then those jobs will just move to someplace else. The toughest negotiations China had in getting into WTO weren’t with the US, they were with Mexico, and a moments thought should let you figure out why.

  • Posted by Guest

    Brad says the Chinese could be spending more of their dollars on real goods. Why would they not spend more on oil reserves? I know they are building theirs up, but why not build them up even more. I would think oil in reserve would be one of the best investments around. Instead of keeping a three months’ supply or whatever, why not a year’s supply?

  • Posted by psh

    Interesting book by historian Charles Maier with Larry Summers looking over his shoulder, complete with Setseresque plunging graphs. Kind of stratospheric. But it points out that prewar Britain could maintain a rentier economy because it had extreme income inequality and ingrained norms of class deference. Concentrated as their wealth was, it was easier to deploy (1913 NIIP 10% of GDP). [And a secure elite was not so prone to pee it away competing for status.]

    [N.B. 2, 4, 6, 8, simplify, exaggerate!] So how to overcome our handicaps here in the US? Populist cracker ideology, celebrity, and debt to mask impoverishment of displaced working stiffs. Patriotic holy-rolling witchhunts to obscure creation of transnational elites as you roll back civil liberties to perpetuate a ruling class at home, hierarchical subordination being critical for this kind of international organization. How does it work, now that we’re broke? Asia is willing to hold our monopoly money because they get ‘social capital;’ we’re giving them what used to be our working or middle class life. Now what? He doesn’t say. Maybe cuz it’s obvious: devaluation and elite capital flight, which comes back later to snap up cheap nontraded goods and services, again at the expense of the patriotic home-biased proles. So this remarkable economy, it’s only incidentally American, and it sure as hell ain’t your economy, if you’re not sucking the Federal tit and seeking rents.

    Not that there’s anything wrong with that.

  • Posted by Guest

    “(One cool statistic is that in 2005, China spent more money financing the US military (US$100 billion) than it did financing the Chinese military (US$30-US$90 billion).”

    is there any chance China also has interests – like oil, some of it possibly in Iraq and Iran – that it wants the U.S. to protect?

    And just generally, aren’t many of those expensive American homes, cars and TVs owned by wealthy Chinese-Americans? Not inferring there’s anything wrong with that, or that all wealthy Americans, no matter ‘where they come from’, don’t care about America’s poor.

    Sorry, but anyone who has been, or is the offspring of anyone who has been a victim of genocide would be chilled by many of David’s remarks. The very sad reality is that David may be provoking anti-Chinese sentiment by repeatedly expressing his pro-China, anti-American, presumably self-hating views – as he seems to be an American, given that he says he lives in New York City – a very expensive place.

  • Posted by Mr PPP

    I have to weigh in here – the Krone is overvalued by about 55% – based on PPP, anyway. More than any other currency. They do have that oil, tho. The Canadian dollar is only overvalued by 5% so it doesn’t look too bad. I know PPP doesn’t count in short run but it should exert an ongoing tug.

    Even USA Today is starting to recognize the imbalances: “The long-term economic health of the United States is threatened by $53 trillion in government debts and liabilities that start to come due in four years when baby boomers begin to retire.”

    Maybe some of this news will help crack the “Populist cracker ideology” USA Today notes: “To pay the obligations of federal, state and local government: All federal taxes would have to double immediately and permanently” etc.

    It does grab your attention … at least for a minute or two. So how do we open an account in Krones?

  • Posted by Joseph Wang

    Guest: Anyone who takes the opinions of a member of group X, and then becomes anti-X has some pretty serious issues. Different Chinese believe different things as do different Americans, and David Chiang has never claimed to be representative of Chinese or the Chinese government.

    I hate the term pro/anti – Chinese or American since it turns useful policy debates and discussions into useless arguments over loyalty and identity. Also the label is pretty useless since just because someone is pro or anti-X or Y doesn’t mean that they are wrong.

  • Posted by Guest

    Dave Chiang, I agree with you for the most part (average Americans will soon suffer for their profligate ways), however, to say, or even imply, that the Chinese fund our excessiveness out of “kindness” was your most misguided comment to date. I can understand if that was a slip of the tongue (or pen), but if you really believe that, you better re-educate yourself on economic incentives. There are no altruistic investments in this situation.

  • Posted by FTX

    psh – That’s the most cynical one-paragraph summary of contemporary bread and circuses that I’ve seen. Sadly, it rings depressingly true.

    PPP – This is the one issue that makes it hard for me to imagine the dollar falling substantially against the euro and GBP. I can completely see the logic of Brad’s arguments for dollar depreciation, so my objection is purely emotive.

    Quite simply, whenever I visit the US, almost everything seems markedly cheaper compared to the UK. Hotel accommodation, car hire, autos, gasoline, food, clothing, electrical goods, computers. Even real estate, despite the US ‘boom’. The one thing that stands out as being considerably more pricey is table wine – in restaurants a very average bottle can cost more than the meal itself.

    Ignoring cities such as New York and London, I wonder how many US visitors to the UK and Europe think it’s particularly expensive over here (I know we have VAT, but the difference is greater than that, and various US states have sales taxes too). Were it not for the punitive import duties that are currently applied, there would be enormous direct sourcing of goods from the US by UK consumers, despite the shipping charges.

    Are Asian goods being dumped in the US, or are Europeans being ripped off?

  • Posted by Guest

    Well this American thinks the UK is extremely expensive. I go to Portugal almost every year for several months and fly there via London. I don’t stay in the UK one minute more than necessary because of the cost of hotels in London. Portugal, or rather Lisbon, on the other hand is not so expensive since the economy is in the doldrums and hotels give very big discounts. You can get a room (normally priced at 150-160 euros or more) in a four star hotel in Lisbon for less than $100 a night because of them. So Europe varies, in spite of the common currency.

  • Posted by Guest

    I might have added that I have Portuguese friends who say it pays to come to the US with empty suitcases, buy lots of clothing, and fly back to Portugal. Still money ahead.

  • Posted by Iasius

    The eurozone has a trade deficit with the USA plus the countries pegging to the dollar. If you only look at the entire “dollarzone” the USD seems to be overvalued versus the euro.

    Also, the fact that prices are generally higher in Europe is not that surprising given the differences in consumption taxes. That becomes even more pronounced if you consider that prices in the USA are generally posted without sales tax and VAT is usually included in the price in Europe.

  • Posted by Joshua

    “Also the label is pretty useless since just because someone is pro or anti-X or Y doesn’t mean that they are wrong.”

    Joseph Goebbels in a speech he gave in late 1938 made exactly the same point when defending the anti-Semitism of the German government.

    “Anyone who takes the opinions of a member of group X, and then becomes anti-X has some pretty serious issues. Different Chinese believe different things as do different Americans, and David Chiang has never claimed to be representative of Chinese or the Chinese government. ”

    In principle I would naturally agree, but sadly it’s not the way things work. The world is stuffed full of people (quite possibly a majority) who will judge all Chinese by what David Chiang says. He should tone down his strident anti-American rhetoric for the sake of his Chinese brothers and sisters if not for himself.

  • Posted by Guest

    One problem that must always be borne in mind with the euro is the issue of monetary union without political union. I believe we’ve yet to experience the full strains of this. Ironically, the sort of decline you predict for the dollar may be the catalyst.

    In my opinion, the real test for the euro will come when the Italian government runs out of other options, and needs to do a sovereign default.

  • Posted by Dave Chiang

    Reply to Joshua,

    The American people are in deep, deep trouble, not because of what I say, but because of the enormous financial imbalances in the US Economy. There’s such an unwillingness by Americans to confront the dilemmas that I find deeply troubling. Americans are in deep denial, unwilling to accept that they are going to have to change the way they live for their own good. That means kicking the credit card borrowing and consumption binge that is bankrupting the nation. That means investment in education, human capital, high technology research, and Industrial production.


  • Posted by OldVet

    Dave Chiang, my sentiments exactly. Speaking as an American. Tough love is still love, and indulgence of weak and insipid practices is not. I actually fought for America in a war long ago, and still love this crazy country, but picking scapegoats is not the answer to the huge economic imbalances that we are all worried about. I’ve picked enough scapegoats to know, mea culpa. Our military wastes $300 billiion of it’s $400 billion budget on war and military junk, IMO. The FDIC and Fed could establish new reserve requirements for banks that would squeeze off excess private sector consumption without picking on China, and do it tomorrow morning.

    Guest, the Italian situation is coming to a boil – you can’t make shoes and furniture without a falling currency in this day and age. If Italians want to make stuff that sells cheap, why not? Isn’t that a free market choice? The ebb and flow of economic progress would mean that asset purchases would pump new money into Italy, in the medium term, and maybe even increase productivity. It’s not a one way bet that Italy would be worse off.

  • Posted by Guest

    Joseph, correct me if I’m wrong, but it is my impression that being ‘Chinese’, and staying on that ingenious global network, built and bonded in part by language, is very important to many of the wealthy Chinese who live outside of China. Not to say this system is unique. Many survivors of repressive regimes have developed unique crossborder networks which have enabled them to selectively rebuild the asset and power bases they need to survive – very well. Given some of the comments made on this blog, was wondering if it might be concluded that China’s poor, and perhaps America’s poor, at least in part, may be subsidizing the wealthy Chinese – at home and abroad.

    But my question to you was – is it possible that ‘China’ may benefit from ‘U.S’. military spending and protection in many ways – along with other nations who rely on imports to fulfill their growing energy needs? If the ‘U.S.’ pulls out of Iraq, what or who will finance the infrastructure development that guarantees the peaceful, equitable, efficient processing and distribution of the petroleum required to fill the world’s energy needs?

    “…Mr Putin reassured the EU that he would not jeopardise energy supplies to Europe by redirecting resources to China…”,,1783359,00.html

    Brad – still think a massive accounting problem has to be solved…

  • Posted by Joseph Wang


    It’s not clear what are you are trying to say here. Are are saying that I’m Gobbels? Are you saying that I’m using the same logic as Gobbels? Are you saying that the Chinese government is so evil/brutal that anyone that has anything good to say about it (like myself) is morally suspect?

    In his later years, Hitler was a vegetarian. That doesn’t mean all vegetarians are evil or morally suspect.

    In general, I really don’t believe that people should hide their beliefs for public relations purposes. A lot of “getting something useful done” involves trying to figure out what people really think and feel (not merely what they say they think and feel), and having people tone things done makes that job much harder.

    Besides, he might be right…..

  • Posted by HK

    Discussions have deviated from an economic issue of which currencies are safe havens to an emotional issue of pro/anti American arguments. We should better come back to the original economic issue.

    My tentative conclusion here is that there is probably no universal safe haven anymore. When terroist attacks ocurred in New York and Washington, the dollar declined. When the US attacked Iraq, the dollar recovered. If the US attacks Iran, however, the dollar may depreciate and oil prices may soar. In the last couple of weeks, when emerging market stocks plunged, the dollar recovered against those currencies, but not much against the euro and the yen.

    Depending on the particular nature of crisis, the dollar may be sold or bought.

  • Posted by Guest

    I wonder what would have happened to China in the second half of the 20th Century if the US had ceded the Pacific Rim to the Japanese? If my history is correct, things weren’t going so smoothly between China and Japan in 1940. I think we can all imagine what a long term Japanese occupation of China would have looked like. The death and destruction would have been of Holocaust proportions or higher. “USD hegemony” certainly looks benign in comparison. Your thoughts, Comrade Chiang?

  • Posted by Joseph Wang

    Guest: The dynamics of “being Chinese” is very complex and there is no way to give a one paragraph description of it. The short answer is that “Chinese” tend to think in terms of networks and not in boxes (as do Japanese).

    As far as whether the poor are subsidizing the rich. That’s really a complicated question that I haven’t quite figured out yet. The basic issue is that I’m looking at the way that the money is flowing, and I haven’t convinced myself that there is a “better” set of flows.

    For example, huge amounts of money have been flowing from “poor China” to “rich United States.” I haven’t been able to convince myself that the world would be better off if that flow hadn’t happened. The basic question is this. The money right now is being used to finance someone’s MacMansion.

    What’s a “better” use of that money? If you answer “build a school for poor kids in Gansu” I’d agree with you, but you just kept the money in China, and you didn’t change some things, then the money probably would have ended up in some corrupt local officials pocket, which would in my mind be a “worse” use than financing a MacMansion. The owner of the MacMansion is going to pay the money back and he or she is probably did something social useful to get the money.

    As far as military spending. It’s pretty clear to me that China *does* benefit a huge amount from US military spending (i.e. keeping shipping lanes open and maintaining general peace and stability in the world).

    The only major reason China has for objecting to a strong US military is Taiwan, and that issue is very rapidly being settled. Beijing, Washington, and the Kuomintang are basically on the same page here, and Chen Shui-Bian has totally self-destructed.

  • Posted by Dave Chiang

    Reply To Guest,

    For the record, it was really the Russian Red Army that liberated most of Europe from the Nazis and China from the Japanese. It is hardly ever reported by American media that the Russian people suffered 20 million dead from World War II. The largest tanks battles in World War II were between the Germans and Russians with over 1 million German troops killed at the Battle of Stalingrad alone. After defeating Germany, over 20 heavy Russian T-39 Tank divisions were redeployed destroying the Japanese military across Northern China.


  • Posted by Joseph Wang

    The other thing is that role of China and the US also figures into interservice rivalries.

    The interesting thing is that the most anti-China people in the US military and the most anti-US people in the Chinese military are in the Navy. This sort of makes sense, since if the US and China get along, this means much small budgets for the Navy on both sides, and if you spend all your days trying to figure out how to fight someone, they start to look scary.

    What’s really funny (and it’s funny because I don’t think anything bad will happen, otherwise it would be horrific) is how the anti-China people in the US Navy quote the anti-US people in the Chinese Navy to demonstrate how much of a threat China to the US is which gives quotes that the anti-US people in the PLAN use to demonstrate how much of a threat the US is to China.

    Now, I find it absolutely hilarious. A few years ago, when it wasn’t clear that something bad wouldn’t happen, it was scary.

    At the same time, all of the Army types are looking at this shaking their heads.

    The basic choice that the United States has to make as far as military investment is whether it wants to fight bin-Laden and Middle Eastern terrorism (i.e. the Army) or whether it wants to fight China (i.e. the Navy). It doesn’t have the money to do both. If you put it in those terms, then the policy alternatives by the China hawks look absurd (i.e. pull out of Iraq to fight China?????)

  • Posted by Dave Chiang

    Dollar hegemony eliminates US default risk

    Because of dollar hegemony, a peculiar phenomenon of the US dollar, a fiat currency, assuming the role of a key reserve currency for international trade and finance, US government securities do not carry default risks, as the United States can print dollars at will with little short-term penalty. The only risk US government securities carry is inflation, a prospect that the Federal Reserve, its central bank, can control through interest-rate policy. High Fed Funds rates can reduce dollar inflation under normal circumstances, unless the economy is plagued by a debt bubble, in which case high Fed Funds rates can actually add to inflation.

    Government securities of other nations denominated in US dollars carry default risks, as these governments cannot print dollars. Even government securities denominated in local currencies that are freely convertible carry default risks because the foreign-exchange market limits the ability of these governments to print their own local currencies relative to the size of their foreign-exchange holdings. In that sense, dollar hegemony has reduced all freely convertible and free-floating currencies to the status of derivatives of the dollar.

    The governments of such currencies have forfeited their monetary sovereignty with which to manage their economies. The currencies of these nations no longer derive their value only from the strength of their economies, but also from the value of the dollar, rising or falling against the dollar as a benchmark.

    The Federal Reserve of the US has become a super-national monetary authority through dollar hegemony, framing policies that prioritize the needs of the United States, from which the prosperity of the rest of the world must derive. This is why, after the abandonment of the Bretton Woods fixed-exchange-rates regime based on a gold-backed dollar, the US has been pushing a global floating-exchange-rates regime based on a fiat dollar in order to impose dollar hegemony on world finance.

    – Asia Times

  • Posted by Guest

    David Chiang,

    As usual, you are incoherent when not cutting and pasting quotes from safehaven and Stephen Roach. I raised the role of the US in the Pacific theater of WW2 and you respond by discussing the Russian role in the European theater of WW2. Your comment that the Russian Army liberated the Chinese from the Japanese is laughable. The Soviets didn’t declare war on Japan until August of 1945, weeks before Hiroshima and Nagasaki. By this time Japan was a thoroughly beaten nation, which was solely a result of US action. The US had virtually no assistance at any time in this theater from the British or Russians. Stalin cynically entered a war that was already over in order to grab territory for the Soviet Union. David, you set a new low for yourself with those comments.

  • Posted by EthanJ


    doesn’t the choice of a haven depend on what you’re looking to be safe from? If you’re worried about a major oil shock – i.e., a sudden political-military problem with uncertain outcomes, then a flight to strength and quality in the $US makes some sense, at least for money fleeing from emerging markets and unstable (oil-rich) autocracies. If uncertainty increases rapidly, even “safe” investments are more risky, and investors try to shield themselves from that risk by heading for stability.

    People looking for a “safe haven” are thus most risk-averse of investors. They also seem to be very shortsighted – flight is a short-term reaction to rapid or volatile events, those that threaten immediate large-scale losses of 10%, 20%, 30% or more. Against that potential, losing a few points to inflation, slower growth, long-term currency decline, or other structural problems is trivial. Once the money is safe and the situtation clarifies, there will be ample opportunities to make new plans.

    An oil shock might have serious long-term economic consequences for the US – and indeed, those consequences might be much worse than for the more insulated economies of Europe and Japan, where high gas taxes reduce the impact of sharp oil-price rises. But any ensuing recession or adjustment would take a while to appear – long enough so that haven-seekers can see what develops following the initial shock and adopt new strategies.

  • Posted by mao

    Your point about Russia in Europe is valid. You are very misinformed in the Pacific though….Russia did not even declare war/ lift a finger in the Pacific until 1945…the war was over!!!

  • Posted by Charlie

    Sorry about the post. I won’t happen again.

    I give up on David. He has his views and nothing will change them.

    But I would also note in that context that the US has never committed to maintain the external purchasing power of the dollar. indeed, the fed has more or less said that it won’t do so, and it will direct US monetary policy as US domestic conditions. If that calls for a $ decline, no problem. The Fed’s scenario for a soft landing hinges of $ depreciation, shift from non-tradables to tradables and no impact on long-term uS rates.

    That is very far from a commitment to maintain the $’s purchasing power.
    I agree. My point was that when investing in third world countries, there’s an added risk of political instability that isn’t likely to occur in the US. Many of these countries may have solid economies, but, political instability can destroy an investment or wipe out a currency.

    (One cool statistic is that in 2005, China spent more money financing the US military (US$100 billion) than it did financing the Chinese military (US$30-US$90 billion).)
    I don’t know how you concluded this. I agree the chinese bought a lot of US gov’t debt, but you have no way of knowing how the money was allocated. I could state with equal confidence that the chinese funded $100 billion of highway projects or education.

  • Posted by ndk

    You know, there are also safe havens that aren’t running a -1.6% personal savings rate.


  • Posted by Dave Chiang

    To Guest,

    The WWII historical record show that the Russians were at war with the Japanese Army in 1939 along China’s nothern border. It is simply incorrect that the Russian entered the war against Japan in 1945.

    ” In November 1939, while Hitler was busy conquering Poland, the Japanese were fighting battles against Soviet forces along the Manchurian-Soviet border. The world took little notice of how well the Soviet forces performed. The Japanese lost 50,000 dead and wounded – five times greater than Soviet losses. ”


  • Posted by mao

    The Soviets did not “liberate” anything in the Pacific until 1945 after the a-bomb was dropped on Japan.
    You shame your people and family by destroying your crediblity on this site.

  • Posted by Guest

    One of the reasons Marshall favored using the atom bomb on Japan was his knowledge that the Russians had shifted powerful military forces to Siberia preliminary to invading Manchuria. He hoped to forestall this. Atom bombs were dropped on August 6 and 9 and on the 9th the Russians invaded Manchuria against very weak Japanese resistance. The Russian invasion continued for the next week or so and guaranteed Russia control of most of Manchuria by the time the fighting had ceased.

  • Posted by bsetser

    Ethan J —

    fair point. but if oil prices surge, I would want to hold the currency of countries that produce oil. not necessarily the currencies of countries that import oil. and particularly not the currency of a country with a large non-oil trade deficit, a big oil import bill and a very low market share in the markets of the big oil producers …

  • Posted by Guest

    Yes, it is fair to argue that the relocation of Russian troops to Asia precipitated the decision to drop the A-bombs. It is also fair to argue that the quick Russian success was an important factor in the Japanese decision to surrender when they did. In this sense, the Russian invasion may have been responsible for saving many lives by shortening the war. Nonetheless, no serious person would ever argue that the Pacific War wasn’t won solely by the Americans. Thus, China owes its liberaton from the Japanese to the United States.

    I would never take anything away from the heroic Soviet and British sacrifice in Europe during WW2. It can be argued, however, that they would have never survived the Nazi campaign if they had not received substantial material support from the United States in their darkest hour of need. Much of this took place well before Pearl Harbor. These supplies were shipped with great sacrifice through the Uboat infested North Sea and overland through Iran. Also, the North African and Italian campaigns were designed to pin down as many Nazi divisions as possible in order to help the Russians before the DDay expedition was ready. In addition, the mere threat of the French coastal landing kept many more Nazi divisions away from the Eastern front. Without active American participation, it is very unlikely either Britain or the Soviets would have overcome Hitler. If you would like to learn more about these events, I highly recommend Winston Churchill’s Nobel Prize winning “Memoirs of the Second World War”.

  • Posted by gillies

    “The basic choice that the United States has to make as far as military investment is whether it wants to fight bin-Laden and Middle Eastern terrorism (i.e. the Army) or whether it wants to fight China (i.e. the Navy). It doesn’t have the money to do both.”

    it doesn’t have the money to do either. but the choice is no longer made by ‘the united states.’ the choice is made by those able to syphon the odd trillion through ‘the enterprise’ – the defence budget – without accountability, because they are able to use part of it to subvert the political process to their own agenda. 9/11 was a great naval victory. did you think that the banner ‘mission accomplished’ referred to iraq ? if you have no clue what i am talking about – time to review and overhaul your usual sources of information.

  • Posted by Guest

    “Are Asian goods being dumped in the US, or are Europeans being ripped off?”

    In an unofficial way, yes. I think a certain amount of Chinese manufactures are produced below cost (and, incidentally, creating more bad loans). When China/US trade inevitably cools and we have our hard/soft landing, this unofficial dumping may end and help increase prices.

    By the way, have we reached consensus on the safe haven yet. The Krone seems overvalued, Canadian banks seem to be sitting on questionable MBS, … maybe farmland in North Dakota?

  • Posted by Guest

    That brings me back to my comments about liquidity. It is ridiculous to talk about Scandanavian or Canadian investments as an alternative to the US. They can work out for small investors and some large investors, but if we are talking about a wholesale flight from the USD, the fixed income, FX and equity markets of those countries would explode. Even if you were to assume that people could get in, as a very large investor you also have to have a plan for how you are going to get out of something. Canadian capital markets are very unattractive from this perspective.

  • Posted by LP

    I’m kind of tired of hearing about the low American savings rate. If anybody in the world had access to such low-interest loans, they would add to their home/buy a new car (on loan)/buy some new things too. The very ppl complaining about Americans’ low savings rate are the people financing it.

    Despite this, I *do* agree that the rate is dismal, and that Americans should be saving instead of spending to such a ridiculous degree, but in many ways I think it’s more human than it is American.

    re: where to put your money, Canada feels safe but I don’t have any real evidence to support that (and it seems like others on the board disagree on Canada, anyway). As for putting money in oil-producers, sure that’s a good plan if you’re positive on an oil surge, and it’s only short-term gain that you’re looking for.

  • Posted by Derkar


    While you are discussing where, under the circumstances, safe havens are, international investors have already found the most appealing one. It is gold. Its prices have soared recently.

    As Alan Greenspan once remarked: “Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody.”

    Jill Leyland of the World Gold Council gives an even more straightforward account: “It is seen as the safe haven people turn to in times of doubt. Because gold is nobody’s liability, so if you have gold, nobody can take it away from you and no government can reduce the value of gold in the sense that they can, for example, be responsible for a fall in the value of their own currencies through inappropriate economic policies.”


  • Posted by madphycom

    “JPY’s recovery will not last. My colleagues in Japan tell me all kinds of bad news about Japan. Simply put, Japanese 30 years ago were determined to overcome the US, as if to say, “We lost the war, so we’ll win in economics!” Today, spoiled Japanese youth have no motivation whatsoever. Plus, they make no kids.”

    kz –

    I dont know who you talk to in Japan, but this is the prevailing wisdom there, NOT the truth. The reality you see when you actually speak to these kids and actually spend time “on the street” is fantastically different. There is generation now in Japan that is both financially capable and see the world close to how it actually is; in fact, like in the United States it would seem that it is the baby boomers in Japan that have a somewhat mistaken view of the world, and of the younger generations.

    I rarely see bright futures – but in Japan I do. Asset prices are reasonable, the cost of living has become more reasonable, they sit on a huge currency reserve and their economy is much less dependent on oil. And the lack of dependence is structural; looking at current oil consumption does not let you know that IF there ever was a supply shock, Japan would be able to without too much difficulty cut a lot of oil use pretty quickly without causing dramatic effects in the economy. The same cannot be said for the United States, where in most parts of the country you MUST drive to get to work, logistics relies critically on highways and trucks, and no alternative to fuel intensive transport is readily available.

    I see a few things happening in Japan going forward that is likely to be a boon – first, I see a great transfer of wealth from the older generations to the younger generations. Japan has accumulated a lot of wealth and the wealth is fairly well distributed, to the point that many banks even have quippy booklets about inheritances, and they’re NOT about taxes. I have never seen a similar booklet in the United States – namely because most people do not inherit too much wealth. I’m sure they exist in the offices of major wealth management firms and tax law firms – but I havent had the pleasure of going to those places.

    This wealth is now being used for not so much; it is sitting in a bank getting miserly returns. I think that once the younger generation gets a hold of this wealth, the likely effect is to spur both more aggressive investments, both domestically and overseas to find good return opportunities; and a boom in small business ventures. Forget Japan as a stogy place with stodgy companies – all of them started small; the Japanese are people too and a generation of kids who are somewhat freed from work but looking for good returns are probably just what the country needs in order to spur innovation.

    There are risks of course – but the ones you highlighted are myths held dear by the older generation who view their sacrafices and intelligence a bit too highly. The younger generation has their fair share of idiots and idle people – every society does; but it is also the generation most open to and most likely to change Japan into a completely different force.

    They, nor the world, has probably realized this; but as long as Japan can manage with the peaceful rise of China and the Rest of Asia, the future for the country is much better IMO than the future for the United States.

  • Posted by a

    ” …would also prefer the euro…” I’d have to agree with many of the others criticizing this comment. One of the reasons why the euro softened in 2005 vs the dollar is that the political risk with the euro, with the French no vote, came to the fore.

    This political risk will probably grow, rather than weaken, with time. The Europeans can’t think of a way out of their political problems. So long as times are good, they will be able to muddle through. But once there is a hard recession, there is quite likely to be some kind of crisis. The value of dollars may be inflated away, but at the end of the day, 50 cents out of 100 is better than holding worthless currency of a country which doesn’t even exist.

    The euro may strengthen vs the dollar in the medium-term. I certainly hope so, I have plenty of them sitting in a bank account… But strengthening will unleash corrective forces – higher unemployment in Euroland, more attacks on ECB independence – which will then undermine euro strength.