US monetary policy: right for the US, wrong for the dollar zone?
The US economy is faltering, at least a bit, on the back of the troubled housing market. Uncertainty surrounding the value of debts backed by subprime US mortgages has created more than a bit of turbulence in global markets. And particularly after the jobs data, the market expects the Fed to cut –
Indeed, there is a meaningful possibility that the Fed’s widely expected cut in September will be followed by a series of additional rate cuts. Dr. Hamilton has a wonderful summary of the current debate over the timing and pace of US rate cuts.
The dollar is – no surprise – once again weak relative to the other major currencies. At least part of the dollar’s August rally seems – at least to me – to have been tied to deleveraging (including deleveraging by European banks) rather than safe haven flows. Selling rubles and Asian equities to pay back borrowed dollars isn’t quite the same as seeking out the dollar because you expect it to rally in times of stress.
No matter. The US economy could benefit from a boost from the export side as it works through the excesses that emerged out of the housing boom over the past few years.
But the Fed doesn’t just set monetary policy for the US. It also sets monetary policy for all the countries that are pegged to the dollar (The Gulf) and heavily influences the monetary policy options available to countries that manage their currencies primarily against the dollar (China). And while a weaker dollar and lower rates are precisely what the US needs at this stake in its economic cycle, they aren’t obviously what the rest of the dollar zone needs.
Take the Gulf. Oil prices are still high. The Gulf countries would rater they stay high as well — they don't want to increase production as the global economy slows and repeat their mistake of the late 1990s.
Spending and investment are still adjusting upward. Kuwait, for example, spent less than expected in its fiscal 2006 because it couldn’t spend all the money allocated for capital improvement in the calendar year. But that spending will no doubt take place in 2007. A small fall in the oil price shouldn’t change this much: spending and investment decisions made over the past few years are now being implemented, and in the worst case scenario, the Gulf can finance its currently planned investment out of its existing assets rather than out its oil export revenue.
The result of higher spending and investment and a weaker currency: high rates of domestic inflation. Real rates are already negative in some Gulf states, and very low in others.
The last thing the Gulf needs is lower nominal rates and weaker dollar.
China is another case. It is also booming. CPI inflation is now rather high. Real rates are now negative, certainly for deposits and increasingly for loans. The PBoC generally has been tightening monetary policy – raising reserve requirements, raising China’s policy rates – not loosening monetary policy. China hasn’t exactly hesitated to grow on the back of strong net exports that stem in part from the RMB weakness against a broad range of currencies. But at this stage in its cycle, it also isn’t clear that even export-addicted China wants an even weaker RMB.
It is possible that the inconsistency between the monetary policy China needs and the monetary policy it will tend import from the US so long as it manages its exchange rate primarily against the dollar will be resolved by the “recoupling” of China’s economic cycle to that of the US. China shrugged off the US slowdown over the past year – in part because booming exports to commodity exporting regions and Europe more than offsetting a slowdown in the pace of growth in China’s exports to the US. However, if the US slump broadens – and particularly if US consumption growth falters, really pulling down the growth in Chinese exports to the US – China may not be as lucky.
On the other hand, if China’s economy has by now developed a strong momentum of its own – or if China can continue to explain the RMB’s weakness against the Europe to grow on the back of European demand (and the oil spending and investment boom) – China’s economy cycle may not follow that of the US.
No doubt that is the scenario China prefers.
But a booming China and slumping US does create a challenge for the PBoC, as the PBoC will likely be tightening (or on hold) as the Fed is cutting.
It would be interesting, intellectually speaking, to see if China’s capital controls – which Ma and McCauley of the BIS believe still are effective enough to provide China with a degree of monetary policy autonomy (hat tip, Menzie Chinn) – still work well enough to allow the PBoC to push the interest rate on Chinese bank deposit rates above the US fed funds rates ….
Irresponsible and Reckless Federal Reserve Monetary Policy
Analyst: Fed rate cut won’t help markets
Lower interest rates will not bring in money but instead send dollar into a tailspin, says Punk Ziegel banking analyst.
http://money.cnn.com/2007/09/10/markets/bc.apfn.liquidity.aheado.ap/index.htm
NEW YORK (AP) — A widely watched banking analyst said late Sunday the best solution to the crisis plaguing financial markets is to let cash-strapped borrowers default and their lenders go bankrupt, rather than slashing interest rates.
Punk Ziegel & Co. analyst Richard X. Bove wrote in a client report the hoped-for cut in interest rates this month will do nothing to bring money back into the U.S. financial markets. Instead, Bove said, lower interest rates will send the dollar into a tailspin and wreak havoc in the job market.
Bove cautioned that cutting rates will not lure investors back into troubled markets. Investors and banks already have the cash to buy risky loans and investments, he said. “There is no liquidity problem, but a serious crisis of confidence,” Bove said. In fact, cutting interest rates will only encourage investors to borrow dollars at the lower rate and bring the cash to places like Europe, Bove said.
“It is illogical to assume that holders of cash will have a strong desire to lend money at low rates in a currency that is declining in value when they can take these same funds and lend them at high rates in a currency that is gaining in value,” he said. “By lowering interest rates the Federal Reserve will not stimulate economic growth or create jobs. It will crash the currency, stimulate inflation, and weaken the economy and the job markets.”
Bove said the solution to this crisis is to allow people who cannot repay their debts to default and allow the companies that issued bad loans to fail.
From Bill Fleckenstein,
http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/BushBernankeAndABadBailout.aspx
Bailouts are being demanded and contemplated because we have become a bailout nation — as a consequence of all the bailouts sponsored by then-Fed Chairman Alan Greenspan.
I must admit that I have a hard time rationalizing how it is that stock bulls can be demanding a bailout with the market still up on the year, and with the Dow Jones Industrial Average ($INDU) barely off its all-time high. But getting it both ways is what Greenspan taught folks to expect.
The reason for the current crisis is the problem in the structured-credit market and mortgage loans that have gone bad. Notice I do not use the word “subprime.” It’s not just been subprime, just as it’s not been contained, all along.
Unfortunately, while the equity bubble left little debt in its wake — excluding the telecom sector — we now have millions of homeowners with too much debt and an unknown number of financial institutions that are holding the debt. This predicament is not dissimilar to the one Japan faced in the 1990s, which ultimately saw equity and real-estate prices decline 80% over a decade.
I just dont understand all the talk about the weak dollar. I am not an econommist to begin with so maybe someone can enlighten me on the topic. In my opinion the USD will strengthen to other currencies in the coming months, especially the Euro. I see it to 1,2OUSD/Euro by end of 2008. All US debt is in USD dollars which Fed has a monopoly to begin with. However, most of debt by other countries is in USD and I can see a huge amount of leverage and debt denominated in USD outside US and they will be having a very hard time to get USD to pay back this debt. (When you think about oil at 70USD in comparision with 20USD 5 years ago, it means that all oil dependent countries have been doing a lot of USD borrowing to pay for their oil at 70 just to keep their economies going). As this debt must be paid eventually I can see the value of USD going up - look what happend with subprime exposure in Europe, lots of European bank scrambling to by USD. I beleive the USD debt pain will be mostly borne by other countries than US.
Anonymous — most oil-importing emerging economies (china, for example) run current account surpluses and are net dollar lenders, not net dollar buyers. The main exception is eastern europe, but it has been taking on euro denominated external debt, not dollar denominated external debt.
and my personal opinion — one shared by the goldman fx team — is that the US ultimately has far more exposure to US subprime than Europe (tho Landesbanks had made a bad concentrated bet). More importantly, the US has to sell a lot of debt to the world to finance its external deficit, and if the world feels a lot of pain on the us debt it bought in 2005 and 2006 and early 2007, it may be less willing to buy additional US debt in 2008.
-Anon
“I see it to 1,2OUSD/Euro by end of 2008″
You’re joking, right?
“…In late August, the Dubai investment company Istithmar beat out the Fast Retailing Company, the Asian apparel retailer, with a $942.3 million bid for Barneys New York… The United States is considered one of the most transparent and stable markets in the world, even given the current credit shakeup…” http://www.nytimes.com/2007/09/09/realestate/commercial/09sqft.html?ref=business
Brad,
what about peak oil mentioned by Dr. James Hamilton
The dollar should not be turned into toilet paper. The U.S. government prints money like it’s water and has massive deficits. How wonderful that the exports are cheaper then why is everyone worried about a recession?
The dollar is anticipating rate cuts.
Rate cuts to bailout the hucksters and swindlers etc.
Brad,
What’s your view on the trade-off between the boost to consumption from rate cuts and cheaper credit — versus the risks to consumption from -a weaker dollar-driven- higher import costs (as $ weakness passes thru to prices) & higher market interest rates (if, as you anticipate, foreigners do become wary of UST’s, etc.).
I think the referenced tradeoff is key to the pace at which global imbalances finally unwind.
Can you say collusion??? Price Fixing??? Criminal maybe???
Banks in huddle over credit squeeze
Financial Times, September 9 2007 22:47, By David Wighton in New York and Jeremy Grant in Washington
The leading commercial and investment banks have been in private talks about how to account for losses in their leveraged lending and securities businesses due to the credit squeeze.
The discussions reflect concerns that the various banks could make very different judgments about the impact of the market turmoil.
Banks have a high degree of discretion about how to value the losses but top executives believe too much variation will undermine market confidence…
pass through generally has been modest, tho it might be higher for Asia than for Europe. imports are not all that high a share of US consumption (services in particular, imports share of goods is high), so my view is that the increase in import prices from a lower dollar/ impact on inflation is manageable. the gains to the “US centric” part of the economy outweigh the drag from higher import prices (and remember, higher import prices are price the us pays for stronger exports and the resulting boost to activity).
as for the fall in demand for treasuries, it really depends on how central banks behave. if they want to keep the dollar from falling by too much against their currencies, they will end up being the dollar’s buyer of last resort (and the source of treasury demand of last resort). there isn’t much evidence (yet) that they are willing to change their policies.
if those policies change tho all bets are off — the fall in policy rates might not produce much of a fall in long-term rates (for the same reason that the rise in policy rates had little impact on long-term rates).
that is why the choices of the dollar zone central banks matter — if they decide to really decouple from the us, they might act differently during this rate cutting cycle than they acted during the last one.
“…Speaking at last week’s conference in Frankfurt on the ECB and its watchers, Stephen Cecchetti of Brandeis University gave a detailed analysis of what he called a crisis of collateral.* Banks do not know what their collateral is worth during a liquidity squeeze as it is not marked to market. Since large parts of the market for structured finance products are over-the-counter…” http://www.ft.com/cms/s/0/a5394528-5f35-11dc-837c-0000779fd2ac.html
“Federal Reserve Bank of Philadelphia President Charles Plosser said there is an ‘underlying stability’ in the U.S. economy…”
Could you please tell us, Mr. Plosser, what that ‘underlying stability’ is?
The ONLY thing was Pushing Debt to households and nothing else. All the growth, and more, was accounted for by increased household debt.
It Is the Debt, Stupid! (That saved the economy during 2003-07 and will sink it during 2008-10).
Jas Jain
“…The disclosure of his stake comes after weeks of speculation… However, most of that speculation focused on large financial institutions, including perhaps a Chinese bank, rather than an individual investor… Mr Lewis is now the largest Bear shareholder, vaulting past Putnam Investments…” http://www.ft.com/cms/s/0/1af87cde-5fa4-11dc-b0fe-0000779fd2ac.html
Brad S. - “imports are not all that high a share of US consumption”
While true, that implies there are a lot of domestic suppliers with potential import competitors. If the price of potential imports rises, the domestic supplier may raise prices as the competitive pressure eases. In the end, the impact likely depends a lot on the degree of slack in the domestic economy, does it not?
re: “if they decide to really decouple from the us” - how would they do that?
“…Still, there’s agreement that global growth will suffer - even among some prominent Wall Street proponents of the theory that the rest of the world can “decouple” from the U.S., including Jim O’Neill, chief economist at Goldman Sachs Group Inc., and Stephen Jen, head of foreign-exchange research for Morgan Stanley…” http://bloomberg.com/apps/news?pid=20601109&sid=aEM9on7P5400&refer=home
“…Mr. Kingston said the cartel… must balance projections of a tight market in the next few months against concerns… “that a significant slowdown in demand could be around the corner.”…” http://www.globeinvestor.com/servlet/story/RTGAM.20070910.wopec0910/GIStory/
Hi Brad,
I think you’re pretty well managing to shape a possible USD path for the future.
I’ll summarize your views and try to merge them up with what part of the doctrine has said about the possible future USD correction.
“Selling rubles and Asian equities to pay back borrowed dollars isn’t quite the same as seeking out the dollar because you expect it to rally in times of stress” but it may account for a dollar quasi-appreciation at least on the short to medium run. Okay; however, some have argued (Krugman, 2006, ‘Will there be a Dollar crisis?’) that the Dollar eventually will collapse: what will the Russians and Asians do in such a case?
Now, if we assume true both your view and Krugman’s and merge them together we may conclude: Russia and Asia are being the “myopic” investors — or, in any case those who will suffer major losses.
Why not? after all, if they are buying Dollars it is probably because they have to (as you say, they have to pay back depositors), not because they prefer to. Moreover, they may not have read Krugman, or maybe they are assuming Kruman’s paper was “wrong”. However, they are still buying USD. Are they expecting a future Dollar correction?
Obstfeld and Rogoff say that a Dollar correction will have to happen, otherwise, (as you and prof Roubini said) the USA will eventually be insolvent. O-R said that the USD correction should come about 30% in real terms. Such correction may be triggered by the FED itself (if, assume, they cut rates of >50 bp), or (but I’m not too positive about it), by some Wile E. Coyote-like foreign investors who will eventually foresee the upcoming collapse.
I think such an argument explains the latest EUR increase against the Dollar (I don’t think EU banks needed many dollars to pay for the depositors, and on top of all the ECB has provided plenty of liquidity to stop some of the bank runs). After all, European investors and banks may be hedging for a future Dollar collapse and buying Euros.
China: it will not only be interesting to see what it will do with its monetary policy, but also whether the PBoC will manage to sell off the trillion-odd reserves while the Dollar will be collapsing without suffering big losses.
Bottom line: probably the worse off may turn out to be Europe once again if the Euro soars too high in case of a Dollar correction and if PBoC switches its reservews into Euros. This is an old scenario, but now that the Fed is seeming to be cutting rates, the Euro is seeming to remain strong and the PBoC is likely going to couple with Europe (this is what those at Morgan Stanley assume), it looks more and more probable.
Best
P.s. please feel free to vote on my “What will the FED do on Sep 18th” poll on (no ads):
http://thedailyeconomist.blogspot.com/
Bernardo
Fed policy may hurt vulnerable economies due to their linking their currency to the dollar, yes. But nobody lashed them to the mast, and they can untie themselves anytime they please.
“…At a banking conference last month, Gennady Melikyan, the central bank’s top supervisor, warned that some Russian banks “have stuffed their vaults to the maximum with loans in foreign currencies”. Mr Melikyan added that if the dollar continued to strengthen against the rouble “they could face certain difficulties”…” http://www.ft.com/cms/s/0/dc2c44dc-5fc5-11dc-b0fe-0000779fd2ac.html
The Fed needs to ease and will ease, substantially I firmly believe, not to bail out Wall Street but to make certain that weaker growth on Main Street does not morph into recession, which would carry serious debt-deflation consequences. It’s a risk management world: recession may be a low risk (though not as low as only a few months ago), but the consequences would be very severe. It’s a fat macroeconomic tail that the Fed must, and will, cut off.
- Pimco
Fed will ease 25 bp because its the choice with the minimum cost of being wrong.
PIMCO’s Paul McCulley says, “The Fed needs to ease and will ease,”. It appears that he and Richard Bove have diametrically opposing views about the pending Fed funds rate cut.
China Inflation Quickens to 10-Year-High 6.5 Percent
“In June 2007, the Renminbi Pressure Indicator (RPI) score rose 1.18 percent as China’s foreign exchange reserves increased to US$1.33 trillion, up 42 percent over last year…” http://www.milkeninstitute.org/chinaindicators/index.taf?page=rpi
Sept 10 - “Brazil’s stock market and currency sank on Monday, pushed lower by lingering concerns that the U.S. economy could be headed for a recession…” http://uk.reuters.com/article/oilRpt/idUKN1030543420070910
if one definition of a ‘non-US dollar zone’ might consist of countries which do not manage their exchange rates primarily against the USD, and their economies primarily against the ‘US economy’ - which counties might be on that list?
“Stock prices come tumbling down in the US, Europe and Asia, but Indian stock prices continue to climb, and the key indices are not far from their all-time highs. The financial and economic news gets from bad to worse in the United States… But Indian markets continue to bounce along, recovering by some 10 per cent from the trough it hit last month. Is it possible that the de-coupling thesis — which says that the Indian market will strike out on a different course from those in the west — is turning out to be true?…” http://www.business-standard.com/opinionanalysis/storypage.php?leftnm=lmnu5&subLeft=1&autono=297543&tab=r
if a broader range of factors determining the extent and nature of coupling should be considered:
“…China Security and Surveillance has been aggressively raising money in the United States… Traded on the over-the-counter bulletin board market while waiting for the beginning of trading on the New York Stock Exchange, the company has raised almost all of its money… in the United States… China Security and Surveillance has headquarters in Shenzhen, a high-tech manufacturing center in southeastern China, but two years ago it purchased a “shell” Delaware company with no operations but a listing on the American over-the-counter bulletin board market. It turned the Delaware company into its corporate parent. China Public Security, also with headquarters in Shenzhen, incorporated in Florida in the same way to obtain a listing on the over-the-counter bulletin board…” http://www.nytimes.com/2007/09/11/business/worldbusiness/11security.html?_r=1&hp&oref=slogin
whether NYC may decouple from the US economy: “…Switzerland is home to perhaps 40 or 50 hedge fund managers in a world of about 9,500 hedge funds — too few, according to the EBK, given Switzerland’s role as a hedge fund buyer. Many fund managers live and work in London or the New York area to profit from the favourable tax conditions and the deep pool of talent. Of the estimated $600 billion… invested in so-called funds of hedge funds, $200 billion comes from Switzerland, making it the world’s second-biggest hedge fund investor after the United States…” http://investing.reuters.co.uk/news/articleinvesting.aspx?rpc=401&type=hedgeFundsNews&storyID=2007-09-11T071826Z_01_NOA126258_RTRUKOC_0_SWISS-HEDGE.xml
“…Russian companies are raising money at the most favorable terms ever, thanks to rising prices for oil, natural gas and metals…. S&P lifted the country’s foreign-currency credit ratings nine times since the default to BBB+, or investment grade. Moody’s has it at Baa2, a level lower… Pimco is “overweight” on Russian debt…” http://www.bloomberg.com/apps/news?pid=20601109&sid=az2VhzZp50gg&refer=home
“…According to Deutsche Bank, the extent to which emerging markets currency movements can be explained by events in the US… is at an all-time high… Those hoping to diversify risks in emerging markets are likely to be disappointed… world equity and commodity prices appear increasingly to be moving together. Hence commodities, and commodity-related stocks, have sold off more than the stock market as a whole during the recent turmoil…” http://www.ft.com/cms/s/0/5e088466-5f35-11dc-837c-0000779fd2ac.html
old vet — fully agree, China and the Gulf tied themselves to this particular mast.
Bernardo — no way China sells. the issue is whether it can find a way to scale back the size of its dollar purchases from their current extraordinary level. And yes, the Wile E Coyote investors have been central banks — but so long as they keep buying, their won’t be a Wile E Coyote moment, and so far, they have kept buying. Betting on a change in policy has been a loser.
the rise in inflation recently suggests that china may be hitting the limits of its ability to sterilize –
PROTEST IRRESPONSIBLE FEDERAL RESERVE MONETARY POLICY ACTIONS
What incentive is there for savers to hold the US Dollar with the irresponsible Federal Reserve determined to destroy its monetary purchasing power value? Under political pressure from Wall Street for a “cheap” money monetary policy, the Federal Reserve debates a totally unjustified half-point cut of the benchmark interest rate on Sept 18. In protest of the imminent Federal Reserve decision to slash interest rates to well below the “real” rate of inflation, private investors of US bonds around the world should immediately dump the US dollar. Energy, Gold, and other Industrial commodity prices are at record prices and soaring higher. Whatever holdings of US dollars I personally hold in GNMA mortgage backed securities, I plan to unload by this coming weekend. I hope bondholders around the world will join me to protest the devaluation of their hard earned US dollars.
Federal Reserve to slash rates by either quarter or half percentage point
http://www.bloomberg.com/apps/news?pid=20601103&sid=aDt3MNXyVHfk&refer=us
The scope of remarks may reflect debate inside the central bank over whether to lower the benchmark interest rate on Sept. 18 by a quarter-percentage point, or a half-point as some investors expect, Fed watchers said.
The trouble with Chinese capital controls is that they are one way. There are effectively no capital controls to keep money from entering China, and all of the capital controls prevent money from leaving China. This made sense fifteen years ago. It makes no sense today.
The story of King Midas comes to mind…..
2fish — i strongly disagree with your comment. china has progressively tightened inflow controls in a host of ways over the past few years (notably controls on bank lending) and its controls on portfolio inflows are severe. that effectively keeps the big US and European banks from directly betting on the RMB — they cannot buy up Chinese gov. bonds, for example. Conversely nearly all the controls on outflows have been removed. my take on china’s current policy is that they have severe controls on inflows, but essentially no controls on outflows.
http://www.weedenco.com/welling/Downloads/2006/0804welling022106.pdf
As a result of current market conditions, what policies e.g monetary and fiscal should be put in place for 2008 year?