Is the dollar’s decline over?
The Economist put the dollar on its cover this week. The Economist’s cover is usually a lagging, not a leading, indicator: it signals that the dollar already has fallen significantly, and sometimes indicates that it is poised for a rebound.
Perhaps more importantly, a long-standing dollar bear – Goldman’s Jim O’Neill – now expects that dollar to rebound against the euro. Bo Nielsen of Bloomberg reports:
"It's fallen a long, long way … I personally think that a year from today the dollar will be quite a bit stronger."
Morgan Stanley’s Stephen Jen presumably has a similar view — Morgan Stanley’s forecast for the dollar at the end 2008 is 1.35.
And – as Felix hints – I am also starting to wonder if the dollar has already fallen by as much as it is going to fall against the euro.
I have long believed that a fall in the dollar’s real value was a necessary part of a broader adjustment needed to bring the United States’ trade deficit – and the United States need for external financing — down. And I have long argued that unprecedented intervention to support the dollar (in order to keep other currencies from rising) by the world’s central banks has impeded this correction, storing up problems for the future.
Those basic views haven’t changed. But it also hard to deny that the dollar already has moved substantially against the euro. At 1.45-1.50, the US trade deficit with Europe should fall quite quickly, especially if Europe continues to grow even as the US slows. The US bilateral balance with Europe has already started to improve in a rather big way.
There is even evidence of a bit of a J-curve effect in the q3 data – the rise in US imports from Europe in dollar terms likely reflects a rise in the dollar price of US imports far more than an increase in the volume of imported goods.
The dollar’s fall v the euro also gives US manufactures an advantage over European producers in third party markets. Ask Airbus. US airlines aren’t buying many planes period, so Boeing’s recent success has come entirely from exports. If currently under-employed American financial engineers can retool – and if US firms start to invest more in production in the US – the US might even be able to challenge Germany in some segments of the high-end engineering market.
Bottom line: the dollar has fallen enough against the euro to encourage a needed adjustment. The “structural” argument for the dollar to fall v the euro is gone. With time, the US deficit with Europe should disappear. The argument for further falls in the dollar is now in large part cyclical — a slowing US economy and falling US rates. A loss of confidence in US financial engineering and the risk that some big holders of dollars may stop buying and start selling also plays a part.
That said, reserve managers should at least pause before buying into euros at current levels. Russia had the right idea – it increased its euro allocation back in early 2006. But anyone trying to follow Russia’s example has to ask if they are going to be buying euros at the euro’s peak. The dollar probably won’t retain its current dominance in central bank reserves, but now may not be the right time for long-term investors to buy European currencies.
But too much of the talk about the dollar focuses entirely on the dollar-euro. The dollar-euro is important, but it isn't the only currency pair that matters. The US has a lot more investment in Europe than Asia, but it imports far more from Asia than from Europe.
And while the dollar has fallen significantly v a range of European currencies over the past several year, it has yet to fall by much against most Asian currencies. A lot of emerging Asian currencies have sat out (thanks in large part to central bank intervention) the dollar’s recent slide. If you compare the cumulative depreciation of the dollar against the euro since the end of say 2000 v the cumulative depreciation of the dollar v. the yuan since 2000, there is no comparison.
My conclusion: the dollar’s fall isn’t over even if the dollar’s fall v. the euro may be.
It seems a bit churlish to pick up on one small item that I disagreed with in the Economist’s extensive analysis of the dollar this week, especially when I agree with nearly all of the leader. But one aside in the article analyzing the dollar’s slide jumped out at me:
“As a rule, central banks cannot intervene to determine exchange rates.”
That seems a bit too strong.
The GCC central banks clearly set their exchange rate by pegging to the dollar. I would argue that a central bank – the People’s Bank of China – determines one of the most important exchange rates in the world: the dollar –RMB. Indeed, absent the rather herculean efforts by the PBoC to hold its pace of reserve growth down (the October number – a roughly $20b increase, with around $10b coming from valuation gains — is too low to be credible), China's central bank would need to buy around $40b in the market to keep the RMB from rising. The Ruble-dollar sure seems to be set by the Bank of Russia, and the Reserve Bank of India keeps a close watch on the rupee-dollar (especially when there is pressure for rupee appreciation). Brazil seems to be intervening again as well – though Brazil’s central bank isn’t as obviously defending a certain level as the other three.
The BRICs are kind of important. They are going to add $800b to their combined reserves this year. And presumably they are doing so to determine the value of their exchange rates against the dollar, and influence the value of exchange rates against the euro. I would consequently argue that the exchange rate between the BRICs and the US and Europe is primarily determined by central banks.
The argument in the Economist's analysis article – in context — was referring to the euro/dollar not the BRIC-dollar exchange rate.
And the conventional wisdom among central banks is that limited intervention by the ECB and the Fed has at best a marginal impact on the value of a generally floating exchange rate. If the US Fed sells euro-denominated bonds to buy dollars, the general argument would be that this would have no real effect on either the price of euro-denominated bonds or the euro-dollar. Private agents would sell some of their dollar-denominated bonds to buy the euro-denominated bonds the Fed is selling.
The same logic also applies to the sale of dollars for euros by emerging market central banks. The increased bid for euros and euro-denominated bonds should be offset by an increase in private sales of euros and euro-denominated bonds, as private actors shift into dollars. This is why Alan Greenspan argues in his book that a huge swing in the composition of say China’s reserves would have a modest impact on both the euro-dollar exchange rate and the price of US bonds. (For a primer on the economics literature, see Menzie Chinn at Econbrowser)
I am not sure I fully believe this argument in its strongest form.
Nor is it obvious that many in the market believe it. There is a strong sense that increased central bank buying of euros – whether because they are “diversifying” or because they have to sell more dollars and buy more euros just to keep the euro’s share in their portfolio constant as their reserves grow at an exceptional rate – is one cause of the euro’s strength and dollar’s weakness. See Dr. Jen a few weeks ago.
Indeed the Economist’s leader hints that big swings in the composition of the emerging world’s reserves could matter. That presumably is why the Economist’s leader calls on emerging market central bankers to hold on to their existing dollars even as they allow their currencies to appreciate at a faster rate against the dollar.
These economies [those now pegging to the dollar] need to allow their currencies to rise, both to curb inflation and encourage the rebalancing of the global economy. Appreciation would mean that these countries accumulated new dollar reserves at a slower pace. That in turn would lead to a loss of the dollar's pre-eminence and the emergence of other reserve currencies: there is no rule to say you can have only one reserve currency. But this need not—and in today's febrile environment must not—mean dumping existing dollar reserves. That would impose a far higher cost on everyone, including the dumpers.
The history of international co-operation on currencies is patchy. But China and the oil-rich Gulf states have ample reason to play their part in an orderly decline of the dollar's dominance. Despite the opprobrium heaped on them, the Chinese do not want to see the Fed's hands tied by a dollar crisis; nor do they want to see the euro zone, one of their best markets, slow sharply; and they have little interest in the external value of their existing dollar reserves plunging.
Indeed, the Economist's analysis article makes a similar point a few lines before arguing that central bank intervention has little impact.
“A crash might be averted if China holds fast too, because it recognises how self-defeating dumping dollars would be to such a large owner of American assets.”
If central banks intervention – including a large portfolio reallocation by a large central bank – didn’t matter, there would be little need to call on China and others not to dump their dollar reserves. The market would happily sell euros for dollars and the adjustment in central banks portfolio would have little enduring impact …
I think most people would agree that the BRIC central banks do determine their own exchange rates. And there is at least a possibility that their portfolio choices also influence euro-dollar exchange rate. I personally would bet that the portfolio choices of a set of actors whose assets are growing at a $1 trillion annual pace has at least some impact on a range of financial variables.
One line in an Economist article – particularly one line in an article embedded in an issue that includes a leader that I quite liked – hardly merits this kind of attention.
But I wanted to draw out a tension between two different views, both of which are commonly expressed.
One view holds that in today’s huge global markets, central banks are too small to matter much – and that all central bank intervention can do is send a signal to the market.
Another view argues that central banks have now become so big that their actions now can dominate even big markets ….
China shrugs off EU calls to revalue yuan, blaming crisis on cheap dollar
http://www.guardian.co.uk/business/2007/nov/29/china
European leaders worried about the rise of the euro against the Chinese yuan would be better advised to go to the real source of the problem: the United States and the “excessive devaluation” of the dollar.
That was the blunt message from China’s prime minister Wen Jiabao, speaking to EU leaders at the end of a summit in the Great Hall of the People on Tiananmen Square, after being pressed to revalue the Chinese currency.
Despite reports that China would revalue or realign the yuan against the dollar next month, Wen said that there was little he could do about the fact that the Chinese currency had gained 11.9% against the greenback since mid-2005 but fallen against the euro by 8%.
It remained clear that the EU still fails to understand fully the policy attitudes of China’s leadership as it grapples with 11.5% growth and promotes employment at all costs.
China Rebuffs European Call to Hasten Yuan’s Gains
http://www.bloomberg.com/apps/news?pid=20601080&sid=a17KDcZBssc4&refer=asia
Nov. 29 (Bloomberg) — Chinese Premier Wen Jiabao snubbed a European plea for the yuan to appreciate faster against the euro after two days of talks in Beijing.
“China obviously doesn’t see the yuan’s decline against the euro as its problem,” said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi Ltd. in London. “It is not going to be rushed into any increased appreciation and hurt its own growth.”
Wen pledged a currency policy of “gradualism”. Wen said the US dollar’s weakness explained the euro’s surge.
Hi Brad, I wonder what you have to say about this…
http://www.bloomberg.com/apps/news?pid=20601083&sid=agTVg9VIRYp4&refer=currency
Gulf States Can’t Cut Inflation With Currencies, Citi, HSBC Say
“Revaluation wouldn’t be a cure for inflation,” said Simon Williams, an economist at HSBC in Dubai. It will only provide temporary relief to the “symptoms,” he said.
“As the primary cause of such inflationary pressures in the GCC is oil, not the U.S. dollar, neither a euro peg nor a basket peg would be an obviously superior regime compared to a U.S. dollar peg,”
I disagree with Simon Williams. High oil is contributing to inflation (b/c it finances more spending and more investment locally), but if the currency can appreciate enough against the currencies of its trading partners, the inflationary impact of the increase in local activity financed by higher oil revenues is offset by the deflationary impact of a stronger currency. pegging to the euro won’t solve the problem, but a big appreciation would.
and incidentally, the reason why higher oil prices are inflationary is that it finances more spending and investment; if the entire oil windfall is saved — no inflation. that suggests another equilibrium — a lower spending/ lower investment, lower inflatino and higher savings (i.e. bigger sov. wealth funds) equilibrium. but i don’t see why equilibrium is desirable — even if it would make the current exchange rate regime consistent with a lower level of inflation.
The US Dollar will plunge further since it is loud and clear Helicopter Ben doesn’t care about the monetary value of the dollar. – Dave C.
Recent comments by Fed Chairman Ben Bernanke and vice chair Donald Kohn indicate a rate cut is likely on Dec. 11.
http://money.cnn.com/2007/11/30/news/economy/fed_outlook/index.htm?postversion=2007113013
Wall Street has heard signals loud and clear that a cut is coming. First, Fed Vice Chairman Donald Kohn said on Wednesday that the central bank needed to be “nimble,” and then on Thursday night Fed chair Ben Bernanke, speaking before a business group in Charlotte, N.C., indicated that the Fed will stay “alert” and “flexible.”
“Bernanke gave the markets an early Christmas gift last night in Charlotte. If there were any doubts about a rate cut, they are now gone. He wrapped it up, stamped it and sent it in the mail,” said John Norris, managing director of Oakworth Capital, a private bank based in Birmingham, Ala.
Good point about the internal inconsistency of the Economist, Brad!
Whoever thinks the problems with the dollar are cyclical and not structural is an ostrich with the head buried in the sand. TRILLIONS of debts, TRILLIONS being spent, TRILLIONS unaccounted for, TRILLIONS being printed, TRILLIONS unreconciled. Come on, raise rates and let’s see if the dollar can appreciate 5 or 10 cents. That would be a sign that the dollar has some sort of a bottom. I personally think the U.S. dollar valuation has no bottom.
http://www.safehaven.com/article-8915.htm
When the Federal Reserve embarked on its rate-cutting journey in August, it might as well have set alight a few US Dollar bills on national television. Let there be no doubt; by slashing interest-rates in the face of a sinking Dollar, the Federal Reserve has made it absolutely clear that it does not care about the health of its currency. It is more interested in creating more inflation and giving the illusion of prosperity through even higher asset-prices. Whilst this is a tragedy for Americans, it is also an opportunity if you can invest your capital in appropriate assets and currencies.
To add to the Dollar’s woes, it is estimated that approximately US$1 trillion worth of US Dollar holdings will be reallocated to other currencies over the next half decade. This development should weaken the US Dollar further, especially against the Asian and Latin American currencies.
I maintain my position that the US Dollar is in a lengthy bear-market which will see its value erode considerably against the “emerging” currencies and the currencies of the commodity-producing nations. In summary, get rid of your US Dollars by either buying tangible assets or switching to more favourable currencies in Asia, Canada, New Zealand Dollar and Australia.
The ring of too big to fail echoes and echoes and echoes…but is anyone listening to the other end of US Treas Sect. plea? The notion that somehow presto rate cut fixes this decades long slow motion trainwreck just goes to show what happens in public private partnerships (Wall Street/Gov’t). This looks more and more like the mid ’20s and it will end badly. “Hope is not a good hedge” – someone said this
A gulf revaluation is not an a prior solution to inflation. If the Gulf countries de-peg a la China, i.e. in a manner specifically designed to have no macroeconomic impact, it then becomes a tautology that the inflation situation will not improve.
Rather, it is the mechanism that is the key item for the GCC countries. Paltry revaluation, with its implicit promise of more down the road, merely encourages capital inflow which inflates the domestic money supply (and by extension, CPI) even further. China has found this to its cost.
A maxi-reval would eliminate much if not all hot money inflow, and indeed would likely encourage a hot money outflow, raising domestic interest rates. This is more or less what the doctor ordered for countries like the UAE and Qatar.
On another level, of course, a revaluation will help inflation through second round effects. Foreign workers in the UAE have been striking because of the reduced value of their remittances back to the subcontinent, and a segment of that group has recently won 20% wage gains. THAT is inherently inflationary.
A reval could potentially keep a lid on further wage pressure, and by extension domestically-generated inflation.
What the Economist and many other observers (though not, of course, Brad) seem to miss is that BRICS don’t need to diversify to have a large market impact on the dollar; at recent rates of reserve accrual (eg over the past year or so) , even maintaining portfolio benchmark weights, including valuation gains, leaves a very large market footprint. When one consider the investment and consumption activities of the Gulf countries as well, that footprint is even bigger.
I never believed that the China PBoC would be buying US Dollars through London intermediaries. – Dave C.
Gulf Arab State Petrodollar recycling supporting US Dollar, not China PBoC Central Bank
http://www.financialsense.com/Market/wrapup.htm
Over the past six months, China, Japan, South Korea, and Taiwan have been net sellers of $65 billion of US Treasuries. However, the Arab Oil kingdoms have picked up the slack, boosting their holdings of US Treasuries, thru their agents in London, and providing the dollar with vital life support. Holdings of US Treasuries from the United Kingdom have soared by $205 billion from a year ago, allowing Asian central banks to scale down their exposure to US bonds in an orderly fashion.
The Arab Oil kingdoms are plowing petro-dollars into US Treasuries, but are also facing the same quagmire that’s entrapping China — an inevitable devaluation of their pegged currencies versus the US dollar.
Now, Washington is asking the Saudi king for more big favors — maintain the Saudi riyal peg to the dollar at all costs, and start pumping more oil this winter, to keep prices from climbing above $100/barrel. But keeping the dollar peg intact threatens the Saudi kingdom will hyper inflation and social unrest. Pumping more oil endangers budding relations with Iran, and could trigger a sharp downturn in the Saudi stock market, which is just starting to recover from a brutal 60% correction.
The Bernanke Fed is printing worthless paper currency in exchange for OPEC’s oil is right on target, and fully understood by the political leaders who control 75% of the world’s proven oil reserves. The Federal Reserve has allowed the MZM money supply to expand by $850 billion this year, up 13% from a year ago. The broader US M3 money supply is 15.8% higher, its fastest in history, monetizing the prices of crude oil and gold, key hedges against inflation, to all-time highs.
Loonie has been a swan dive recently.
Precursor?
Warning Signs?
—————
Subprime read “deadbeat”
Loans
SIV’s
CDO’s
RMBS’s
ABCP
Major Corporate leaders ousted
Major leaders retire
Heightened insider stock sales
Little M&A activity
Little IPO activity, many withdrawn
Free fall in Equities stopped by unknown, unseen forces
High Libor Spreads
Dollar Devaluation
Huge Drop in ABX index
Govt. Intervention in free market contracts
Large swath purchasing by foreigners of hard assets
Tremendous volatility in markets
Fed cuts despite high inflation
Rush to quality and safe havens
Inverted yield curve
Credit Market Lock-up
Desperate asset sales or stock issues to obtain cash or capital
Loss of confidence
Huge rise in price of commodities
Consumer & Governmental Debt in multiples over GDP
Foreclosures
Runs on Banks and Fund managers
Lack of any meaningful coverage of distresses on major networks
Artificial Rallies in seriously diseased business sectors
Speculation
Expensive overseas wars without exit strategy
Massive deficits without accountability
Political Intrigue
It all adds up, don’t let them deceive you that these aren’t real. There can’t be anymore kicking the can down the road. It’s time, there has never been a more perfect storm of correlating evils, take your own precautions.
macro man — good point; the impact of a revaluation in the gulf on inflation hinges on doing a “real” revaluation and not doing a set of mini-moves that invite speculation and hot money inflows along the way. the risk of hot money inflows fueling domestic liquidity is particularly large given the limited sterilization instruments in the gulf (not much of a gov. bond market), tho i guess CB bills and reserve requirements can always be used …
DC — the available data suggests that the Asian central banks have been shifting toward treasuries not shifting away from the dollar. tho there are enough gaps in the data that i cannot be totally sure for China. it is also likely that a large share of the Treasuries that appear to have been built up in London in the treasury data are actually held by China.
Brad,
How big share does the euro have in Russian FX reserve?
@40% last I checked. I think all reserves are around 40/10/50 (eur/ gbp/ usd). stabilization fund is 10/45/45. there is a small yen position as well now that likely came at the expense of the dollar share. these shares are for end 06 — i have looked closely at the 07 data for tell tale signs of change. Russia more or less told us its shares for mid to late 06 in the ft this spring, and the share of the stabilization fund is disclosed publicly.
just to be clear the stabilization fund is 45/10/45 using the same order of the currencies I used first (eur/gbp/ usd)
I can believe that the dollar’s slide against the Euro might be slowing somewhat or even halting– I just doubt that the dollar is ever going to recover much in the foreseeable future. I’d surmise we’ll see resistance repeatedly anytime the dollar gets up to around 1.4 against the Euro, with big dollar-holders among the central banks (aka the CCB and BOJ) happily taking the opportunity with each temporarily dollar climb, to progressively rid themselves of their dollars in waves, cutting their losses.
The Chinese especially have been burned severely by having accumulated so much US Treasury paper that’s now depreciating, as have the Japanese. There were prior warnings of this in the early part of the decade and I suppose, the Chinese did do some dollar divestment (in favor presumably of Euros) back in 2005 when the dollar had some gains, but not nearly enough.
So the Chinese are now paying an enormous price for accumulating such a dollar hoard as that hoard plummets in value– the US economic problems, war costs, snowballing debt are eating into American economic markers, but due to the effective dollar pegs and securities purchases undertaken by the Chinese and the Gulf Oil States, the USA can effectively make the Chinese and Arabs pay for US debt blunders and budget overstretch by exporting inflation and currency depreciation to the dollar-pegging countries. China has, what, about 10% inflation now, with oil prices becoming crippling? And poor Qatar and UAE– real inflation of, what, 15%? If the ME countries are stupid enough to stay with the dollar peg into 2008, the progressive hyperinflation there will probably provoke general strikes, riots and other generalized ugliness pretty soon.
I was in China recently (can speak OK Mandarin), and the fury against the USA was almost palpable. It’s that kind of raw anger that a dupe feels toward a con-artist after the dupe realizes the extent to which he’s been conned out of his money. In this case, hundreds of billions of dollars due to the disastrous practice of putting seemingly all the Chinese savings eggs into the dollar basket rather than diversifying. I still wonder why the Chinese exposed themselves to such risk from overconcentration of assets– of course the USA has the most liquid markets to absorb Chinese savings, but couldn’t they have dumped a bigger fraction into other sinks? Into Euros, yen, oil (all those dollars in the stash can buy a lot of black gold), other commodities, or just pumping the money into Chinese internal infrastructure and development? Why throw so many eggs into potentially worthless US Treasury Securities? An old friend in Guangdong suggested that it was maybe an overcompensation from the Communist days, with the zeal for capitalism leading to a misplaced uber-faith in the supposed leader of capitalism in North America. Except that the central banks failed to diversify into other capitalist markets. (With the greater orientation toward the Eurozone perhaps, seems like the Chinese were signing up for German courses in droves, just like they did for Russian or English before. And German with a thick Chinese accent sounds, well… unique.)
After several hits like this and the USA’s still spiraling debt, my guess is that China realizes it has to exit the dollar as judiciously as possible, and will use the dollar mini-jumps as an exit ramp. I’d guess the Chinese could also cut their losses somewhat by using the dollar hoard to build up oil reserves, or maybe transfer into yen– IIRC somebody else suggested that, and the dollar-to-yen transfer maybe another rescue for the Chinese reserves, since an appreciating yen could then allow further transfers into things like Euros and commodities.
Capital is a coward. Therefore it will take the path of least resistance toward profits.
“Is the dollar decline over?”
For a while probably yes. But moreso, a decline of the Euro and Pound has begun as thier custodians contemplate just how to deal with the stagflation starting to clearly assert itself in their data. Euroland and UK focus has shifted from the dollar and US mortgage market implosions to more local issues such as bank solvency, credit market siezure impacting the broader economy, about to collapse housing RE values, the black hole that is commercial property, massive CC debt, the toxic paper mountain at home , inflation , slower growth etc… The one way dollar bet isnt so clear now, hence the covering.
But much more dollar pain is set to come. Ultimately the chainsaw Ben will take to IR’s will drive immense sentiment away from dollar assets as the US financial system faces the spectre of insolvency- front and centre. That is inescapable. So there is a respite for the dollar here which gives people a chance to adjust their defences for the bloodbath to come.
Chinese style reval
Kuwait Weakens Dinar Reference Rate 0.05% Against Dollar
http://www.bloomberg.com/apps/news?pid=20601116&sid=aKS34DsLsgWw&refer=africa
“central banks have now become so big that their actions now can dominate even big markets” – as if their decision-makers operate ‘independently’ from the ‘big markets’ (define) and visa versa.
if what really matters is USD vs. not only oil, but metals, other commodities and commodity indexes http://economist.com/daily/columns/marketview/displaystory.cfm?story_id=10198668
and another big market dominated by the US, IP, which we might assume to be priced in USD.
US Debt and Reciprocal Money Expansion;
Quantum Fractal Analysis predicted the recent change in the US Dollar’s valuational direction relative other European currencies.
This holiday will see a 300 billion or so US dollar increase in the American (and global) economy – a good percentage of those billions as credit card debt. Whether it is deficit spending for the Iraqi oil fields from the empty US social security lock box, buying holiday Chinese Snow Baby eqivalents on credit cards against personal future earnings, or too good to be true deals on 500,000 dollar homes unsupportable by American wage and cost of living inflation realities- deficit spending against furure earnings and tax collections – will temporarily, very temporariy at this point – push the economy on a very overstretched long string and likewise temporarily expand the money supply. The summation money and credit growth is exactly reflected in the daily growth and decay quantum valuation fractals and the summation of the evolving quantum fractal patterns of competing debt, equity, and commodity investment entities. Even the currencies follow the precise fractal growth and decay patterns found in The Economic Fractalist’ relative to each other’s valuations. The recent fractally predicted change in the valuational direction of the dollar – on the new blog ‘Lammert’ – against other world currencies is both a currency fractal saturation phenomena and can be qualitatively explained by the fact that most of the world’s debt is denominated in US dollars. The fractal saturation area of the Swiss Franc, Euro, and British pound is timed precisely when massive repayment is being called due by lenders and those indebted must sell other currency holdings (and gold) to gain dollars to repay that debt. The non US currency saturation area is also timed with the 11-14 week area of equity devolution – after which the dollar will have much more equity purchasing power. For the composite equities lowly New Century holds the secret of devolution. Observe the evolving New Century fractal pattern. On 30 November New Century closed down over 16 percent at 2 pennies even. (Both the 19 July 2007 and 11 October 2007 Wilshire highs were precisely predicted by saturation quantum fractal analysis.)
Colin — good points. I am very concerned that Chinese anger at their large (but not hidden) losses will be directed at the US (for not maintaining the dollar’s value) rather than at China’s leaders (Who adopted a currency regime that required that they over pay for dollars to hold their own currency down and thus take losses). the US has consistently maintained that China should appreciate more, which would mean buying fewer dollars at the bottom. China’s leaders have argued that they have a sovereign right to take large losses in pursuit of their chosen currency regime …
I also agree that at some level there are a lot of central banks who would be large dollar sellers. Whether that is 1.40 or 1.30 I don’t know.
I think Colin’s view of the Chinese loosing a lot on their dollar reserves is wrong. I agree with jye, the Chinese fellow, who a few weeks ago wrote here that those reserve dollars are a way of buying economic power. As he estimated, if current trends were to continue, by 2020 China would reach the level of US GDP, at the expense of 2 trillion USD. Would it worth it? Jye says yes. I agree. And I don’t even think that this is lost money. If the grandchildren or grand-grandchildren of the current generation will buy american goods in the USA on that money, competing with the american consumers, then there is no loss at all.
And concerning the anger of the people: Jye wrote that in recent years the real wages went up strongly, another fellow living in China wrote recently here, that people don’t care much about reserves and things like that, they care about buying cars and washing machines, etc.
I like to think about the Chinese dollar reserves as a gift from the current generation to their grandchildren (and if they will spend this money on american goods, then it won’t loose its value more than the american consumers loose their purchasing power). And what kind of gift the current american generation will leave for their grandchildren? Mostly debt. Which one is wiser?
I think it is far the best thing the Chinese can do is to continue the present crawling peg as long as they can. They have to fight inflation, of course, but big appreciation is not the only way to do that. Maybe they should block the influx of hot money more efficiently.
The current crawling peg gives and will give China an enormous competitive advantage. Compared to last year, this year its export to the USA, EU, India, and Russia are up by 15, 30, 60, and 80%, respectively.
The question is will rich Americans sell Dollars?
Nothing suggests that China wants instability, or that Japan wants instability, or that Gulf nations want to really break with the United States.
So while defunding by central banks is a real issue, it is much less of an issue compared to how US financial wealth reacts; if they feel that the US Dollar is no longer worth holding, the torrent out of the US will be unstoppable.
Any data on this Brad?
I think a distinction should be made between losses on dollar reserves due to currency movements and inflation. The US have never undertaken to maintain the exchange value of the dollar, but they do at least claim to care about its internal purchasing power. China cannot complain if the dollar depreciates as interest rates are cut in a slump, but would have every right to feel aggrieved if the US allows higher inflation to ease its debt burden. I fear that the Chinese have a lesson to learn that more experienced reserves managers already know – “no-one ever made money by overestimating the integrity of the Fed”.
“…In the 1980s, Mr. Pei says, few corrupt officials stole more than one million yuan ($135,000). Now, even lowest-level officials routinely steal “tens of millions of yuans.” All in all, Mr. Pei says, corrupt government officials steal 3 per cent of the country’s $10-trillion (U.S.) economy, or $300-billion [annually?]… But these numbers do not include many other kinds of corruption…” http://www.globeinvestor.com/servlet/story/RTGAM.20071128.wrreynolds28/GIStory/
Fascinating to hear that more Chinese are learning German. Just like at football (soccer to US readers), the Germans do not overestimate their own ability (no house price boom) and make the hard choices (recovering competitiveness through wage restraint and maintaining product quality), and come through ahead after being doubted. I hope that next week, the ECB will be true to its Bundesbank model and do what maintaining credibility requires in the face of well above target inflation and money supply growth – raise euro interest rates!
“…Luigi is a Chinese businessman from Wenzhou. He calls himself Luigi because it’s easier for Italians to remember… He prefers not to reveal his real, Chinese name. It would be bad for business… Luigi spent the next two years working as a forced laborer, hemming pants 18 hours a day and earning €500 ($635) a month under the table, ten times the average worker’s wage in China. His new life began after he had sent €10,000 to his family, allowing them to pay off the human trafficking operation that had brought him to Italy…” http://www.spiegel.de/international/spiegel/0,1518,435703,00.html
DC: It remained clear that the EU still fails to understand fully the policy attitudes of China’s leadership as it grapples with 11.5% growth and promotes employment at all costs.
It is not a matter of “failing” to understand …
Everybody defends their own interest. I cannot see why the EU should feel the burder of China’s development.
Rebel — you wrote:
China “would have every right to feel aggrieved if the US allows higher inflation to ease its debt burden”
Inflation reduces your internal debt burden. Domestic creditors see the buying power of the dollars they lent out eroded. But it doesn’t necessarily hurt external creditors — at least not those looking at their holdings of dollars as a way of preserving their local purchasing power, not their purchasing power in the US (I’ll grant you that if you buy a ten your treasury noting to buy as many us goods in ten years as now, you would be disappointed).
Consider the gulf. Suppose I hold gulf currencies as an investment. I am neither better or worse off if gulf inflation takes off. my dinars buy fewer goods, but they still buy the same number of dollars. I would only be worse off if the inflation leads to a real appreciation that leads to a nominal depreciation in the future (first generation currency crisis model style, for em finance geeks). I would be better off if the gulf lets its currency rise in nominal terms to try to contain inflation.
Now China may be worried about the future ability of its dollar claims to purchase US goods — i.e. it built up dollars today in anticipation of its need to purchase us goods and services in the future — and thus may care about us inflation. but if it cares about the external value of the $ — whether the ability of a dollar to purchase euros (read european goods) or natural resources (oil) or even other asian currencies and goods, it should worry more about changes in the dollar’s external value.
and given the PboC and even more so the CIC’s financing structure (RMB liabilities/ $ assets) it has to worry about the dollar’s value v the RMB — that in some sense matters far more than anything else.
China in a financial sense would be best off if the necessary (in my view) real depreciation of the dollar v china comes from us deflation (or slower inflation in the us in china, so long as inflation in china doesn’t push up the pboc’s rmb funding costs) rather than rmb appreciation. so in that sense you are right — the more the us inflates (leading the $ to appreciate in real terms), the more it likely will need to depreciate in nominal terms v the rmb …
but i would still argue that your analysis understates the impact of nominal exchange rate changes for an external investor. i do agree though that the only policy commitment the us has made is to keep domestic inflation stable, not to keep the dollar’s external value stable. the “Strong dollar” policy never meant monetary policy would be used to stabilize the dollar. never. certainly not in the clinton administration.
Warning Signs?
—————
Subprime read “deadbeat”
Loans
SIV’s
CDO’s
RMBS’s
ABCP
Major Corporate leaders ousted
Major leaders retire
Heightened insider stock sales
Little M&A activity
Little IPO activity, many withdrawn
Free fall in Equities stopped by unknown, unseen forces
High Libor Spreads
Dollar Devaluation
Huge Drop in ABX index
Govt. Intervention in free market contracts
Large swath purchasing by foreigners of hard assets
Tremendous volatility in markets
Fed cuts despite high inflation
Rush to quality and safe havens
Inverted yield curve
Credit Market Lock-up
Desperate asset sales or stock issues to obtain cash or capital
Loss of confidence
Huge rise in price of commodities
Consumer & Governmental Debt in multiples over GDP
Foreclosures
Runs on Banks and Fund managers
Lack of any meaningful coverage of distresses on major networks
Artificial Rallies in seriously diseased business sectors
Speculation
Expensive overseas wars without exit strategy
Massive deficits without accountability
Political Intrigue
Off balance sheet calculations; holding all good in one bag, all bad in another
Near future liquidation of over $300 billion in SIV’s with
Robert Prechter, of Elliot Wave International, showed in a Bloomberg interview November 27, 2007, that the Federal funds rate closely tracks the three month Treasury Bill yield. The correlation appears so close as to be virtually identical.
Needless to say, the three month T-Bill yield fell to 2.9%.
(Link to Bloomberg video: http://search.bloomberg.com/search?q=robert+prechter&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date%3AD%3AS%3Ad1&submit.x=0&submit.y=0&submit=submit)
Brad,
Thanks for your expanded explanation! I suppose in simple terms what I am saying is that:
dollar depreciation due to decreasing “hegemony”: no grounds for complaint
“excess” dollar depreciation due to surprise inflation without interest compensation: complaint justified
“…In 1994, in Central Bank of Denver v. First Interstate Bank of Denver, a closely divided Supreme Court ruled that secondary participants (such as auditors and investment bankers) could not be held liable by investors for “aiding and abetting” securities fraud…” http://www.legalaffairs.org/issues/November-December-2003/review_coffee_novdec03.msp
“…None of the major North American or European banks have quantified their hedged exposure, or disclosed their relationships with various insurers and other counterparties… This lack of information has been a boon for hedge funds, many of which have filled the void by issuing dire predictions about potential losses and simultaneously shorting bank shares…” http://www.globeinvestor.com/servlet/story/RTGAM.20071130.wrcibc30/GIStory/
“Democrats are collecting more than two-thirds of the campaign donations from employees of the biggest hedge funds and buyout firms, as the party taps into one of Wall Street’s fastest-growing sources of wealth…” http://www.bloomberg.com/apps/news?pid=20601070&sid=abPcaWGJlFwo&refer=home
I have more sympathy for Euroland’s problem with the weak renminbi, since, unlike the US, Europe cannot stop the Chinese buying dollar assets, and do not directly benefit from the cheap capital inflow. However, Euroland’s reserves, and the ECB’s reserves in particular, are arguably on the low side, and the dollar does look cheap to me, so maybe a bit of ECB intervention (rigorously sterilised, in view of my remark above) would be reasonable.
RE, a LOT of Euroland’s net portfolio inflow of €400 bio-odd so far this year has come from sovereign or quasi-soveriegn sources. Like the US, Europe hasn’t asked for this inflow, but let’s not kid ourselves that Europe hasn’t benefited from it, albeit not to the same absolute degree.
how can we be talking about halt in dollar’s fall with central banks adding so much reserves. These are purely debt that must be repaid. reserve accumulation is not capitalism itself. Greatest irony is that china is buying dollar to prop up a weak currency and investing in so called safe asset- US assets denominated in dollars.
capital must used to produce maximum profit with absolute safety not invested in rubbish
PRC is getting more Euro denominated trade surpluses. Does that mean the PBoC could buy more Euros even if they are not dumping dollars? More Euro holdings could be viewed as a necessary hedge because of the exploding volume of trade with Europe, discounting valuation concerns.
Brad, that was a very intersting post. However, you didn’t mention the effect on the dollar if commodities such as oil are no longer traded in dollars alone, but instead a basket of currencies. It seems to me that this would also cause the dollar to depreciate, much like it would as a result of currently pegged currencies becoming unpegged.
Could you share your thoughts on that possible outcome? Is that not also a looming threat to the dollar?
Any entity buying the dollar or trying to sustain it today is doing so for its own interest not because it is a valid and safe investment. The fact remains there are trillions of assets held in the U.S. by foreign entities that are being devalued along with the currency. There also are export economies trying to obtain relief and need a stronger dollar. Therefore to say the U.S. dollar is safe is like saying playing with a rattlesnake is safe. It’s just not the case any longer.
Nicolas- will so called export economies ever disappear?
“European leaders worried about the rise of the euro against the Chinese yuan would be better advised to go to the real source of the problem: the United States and the “excessive devaluation” of the dollar.”
they have done. in snooker this is the shot ‘off the cushion’. the europeans do not like to threaten or cajole america. they do not like the euro at $1.50 either. so they grumble at china. all the players know that china has only followed the dollar down, so this is an indirect shot at u s policy. those who can read the diplomatic language seem to have phoned in their euro sell / dollar buy orders orders straight away.
.
dollar hegemony is the financial policy of the house of saud. a democratic election in saudi arabia would focus minds.
.
macroman — i would presume that Europe’s financial sector (which now does a booming business intermediating between global demand for safe european assets and eastern europe’s growing financing need)/ those owning european financial assets have benefited far more from large portfolio inflows into the eurozone ($600b/ euro 400b = big, and maybe $300-400b comes from sovereigns … ) than say workers at airbus. the same issues that arise in the us about the distribution of the benefits also apply to europe.
brooks — so long as oil moves up (in $ terms) when the dollar goes down, it already acts as thought it is pegged to a basket of currencies. tho in practice oil has appreciated against almost any basket, not just v the dollar. At the end of the day, oil exporters will get paid in a real currency, not a basket — tho if some pay in $, some in euros and some in yen, the net result is similar. Iran already gets paid in euros/ yen. Shifting the currency of denomination influences demand for transactional balances.
but at the end of the day, the currency oil is sold in matters far less — in my view — that the currency the oil exporters opt to use to denominate their financial assets. That is why I agree with Gillies about the Saudis even though I am not one who believes in an orchestrated Saudi-US plot to sustain dollar hegemony. The Saudis are certainly very wed to the dollar: they don’t just defend dollar pricing but have most of their financial assets in dollars and are the gulf state most inclined to keep the peg to the dollar.
and the fact that they hold their assets in dollars (Tho offshore, mostly with london fund managers i suspect) means that they support the dollar. If the Saudis joined some other gulf states in diversifying away from the $, i would expect to see a bit more pressure on the $. of course, that would also mean more pressure on the GCC’s peg to the $.
bottom line, in my view, what the Gulf does with its money (and watch their currency regime, which currently limits how much they money they can move out of dollars so long as they care about the value of their own currency) matters far more than whether or not oil is priced in dollars.
Gillies — I agree with your second point more than your first point. I tend to think the policy decisions of China’s government are now far more responsible for the world’s imbalances than the policy decisions of the US government. European policy makers understand the United States currency policy. Or at least they should: it is pretty close to their currency policy — namely directing monetary policy at domestic conditions. China didn’t have to follow the dollar down/ tie its monetary policy to the US. Indeed, you can make a strong case that domestic chinese conditions argue that the rmb should be appreciating by more than the euro v the dollar.
but you are right that one consequence of the United States growing financial dependence on the Gulf — one overlooked by i-banks looking for fees from the next deal — is that the United States own financial health increasingly depends on the portfolio choices of a group of aging Gulf monarchs. Tis hard to push your unelected banker to become a democrat.
Moreover, democratic elections risk electing a government with a rather different asset allocation that now observed in the Gulf. I would bet that any democratically elected government in the Gulf would have a much lower share of the state’s financial wealth in US dollars and a much lower share of their wealth in private equity/ hedge funds than the Gulf monarchies do now.
What about UK finances of The City? The economist:
The City of London’s tumble
At the start of this decade, the financial sector–banking and securities, insurance and specialist services like shipbroking–made up 5.5% of national output; by 2004 that share had jumped to 8.3%. Over the same period manufacturing dwindled from 17.9% to 14.1%. The financial sector’s expansion has continued apace: by 2006 it made up 9.4% of the economy, according to provisional official estimates.
(…)
The recent City-led expansion of finance in Britain has meant that a sector worth almost a tenth of the economy has been responsible for 30% of overall GDP growth over the past three years.
(…)
In the past decade Britain’s financial sector has contributed about 30% of all corporation-tax revenues. For all the attention devoted to how some escape their fair share of taxes, the taxman has also reaped handsome returns from the City’s high fliers, who make up many of the top 1% of earners contributing 22% of income-tax receipts. The fiscal dividend has been vital in paying for Labour’s big public-spending increases.
(…)
It has come to seem, for many people, a sort of laboratory in which a rawer, less-cohesive Britain is emerging; a crowded, hustling place of vaulting earnings for the rich and of widening income disparities, which drains talent and wealth from the rest of the country.
Despite these fears, those who cheer as the City falters, will be wrong. The gains from London’s position as a global financial hub, a source of envy to other countries, outweigh the losses. Every economy needs an engine-room: better one manned by bankers than none at all.
MM: Is it that rosy? Aren’t they preparing a hard-landing?
Brad, in your general posts about europe, is The City inside euro-zone or dollar-zone, playing cards with sterling, of course?
In ordinary countries, a woman is pregnant or it’s not.
Any light about UK’s pregnancy? Or she goes Tony Blair-style to the wall, with one leg in USA and the other in europe, leg open to to the world?
Thanks.
“…economists, like accountants, are artists. They have a tendency to paint what their patrons, who pay them, want to see…” http://www.nytimes.com/2007/12/02/business/02every.html?_r=1&ref=business&oref=slogin
“…Gulf states may focus on financials for their relationship to oil prices. In the past, when oil prices declined, so did inflation and interest rates and financial stocks did well… suggesting the buying of financial assets is a diversification strategy…” http://www.guardian.co.uk/feedarticle?id=7114215
“Investment funds from the Middle East and Asia have invested an estimated $37bn in shares of western financial companies this year…” http://ftalphaville.ft.com/blog/2007/11/28/9217/mideast-asian-swfs-put-37bn-in-financials/
“…oil dropping $10 has contributed to a breathtaking turnaround in equities, bonds, and the greenback… This weekend, everyone will be eyeing what the UAE does on their currency to see if they reval or de-peg. Market continues to buy Euros on dips on the belief that a de-peg will bring a torrent of Euro buying from the Middle East…” http://www.bmocm.com/publications/fxcom/busch/
“…Dr. Brad Setser, a currency analyst at RGE Monitor [??]…” http://www.nytimes.com/2007/12/02/business/02view.html?ref=business
“i-banks looking for fees from the next deal”
“…Funds and fund managers that don’t share their results weren’t considered for the ranking. The large funds for which we lacked sufficient data included Citigroup Alternative Investments LLC, DE Shaw & Co., Farallon Capital Management LLC and SAC Capital Advisors LLC. Our list of best-paid managers came from a universe of 620 individuals who run about 2,000 U.S. and non-U.S. hedge funds with assets of at least $100 million…” http://www.bloomberg.com/apps/news?pid=20601109&sid=a4hrcYrY655M&refer=home
Western hypocrisy on the Chinese yuan
I’ve always wondered why so many people could not see the reason behind the Western countries’ almost manic desire to have China raise the value of the yuan.
Whatever criticism one may have towards the chinese government, monetary management is certainly not one of them. They have masterfully insulated their currency from the great world banks’ (soon to be joined by 3-4 Chinese banks) manipulations.
Remember how a few years ago there were so many articles in the Western press about the imminent collapse of the Chinese banking system because they carried so much debt? As long as China was exporting like they were and its economy was growing like it was, I, personally, did not see the problem. It was simply a transitionary process. Plus the fact that the government had enough cash on hand to help them on the way to healthy operations.
The large Western banks, just like the large Chinese banks, do not operate in a vacuum. They are often the tools used by governments to obtain certain results. The World Bank, and some of its clones, is nothing more or less than Western powers’ attempt to control the rest of the world economically and to make it march to their dictates. Have you ever heard, or read, about a country becoming rich by submitting to World Bank rules? Usually, it has been quite the opposite.
China realized, after the last major monetary crisis, that it was imperative that it insulate its currency, to whatever degree possible, from the Western ones, primarily the dollar. By the way, pegging the value of your currency to the dollar does not appear to be much of an insulationist policy. However, in the short run it is brilliant.
So, now we have, for a while already, been seeing the pathetic spectacle of Western countries crying that the value of China’s currency is too low and that it needs to be valued upwards. Have you often heard such a ridiculous argument? I can not remember the Western block using it very often for their own currencies. Except, of course, when it politically and economically benefitted them and it was to the detriment of less economically powerful countries.
In essence, Westerners want to be given the economic tools to dominate China, to control it, to make sure the economic roles will not be reversed. One way to control is to have a currency’s value determined by friendly banks and their agents (Forex people).
They are scared stiff that power, in every way, will shift to the East and, for right now, China in particular. After all, when Eastern countries start to climb the wealth ladder, in all probability this means that Western populations will have to make do with less. That is, if you believe that earth’s resources are limited.
And when governments get scared they will go to extraordinary lengths to protect their interests. The results are usually conflict.
Macro Man — “Like the US, Europe hasn’t asked for this inflow..”
If the US does not want this inflow, then why don’t they issue less treasury bonds or buy back the old ones?
Good post as always.
Whenever you hear talk about governments getting rid of their dollars, you know we’re close to a bottom in the dollar. You won’t find worse traders than governments!
For example, do you remember when gold was below $300 an ounce earlier this decade, and all the European governments made a pact to sell their gold? The European governments all sold their gold at the bottom of its bear market. They wish they hadn’t sold now.
What do we hear today? The OPEC countries and some Asian countries are talking about selling their US$ reserves or dropping their “pegs” to the dollar. To me, this talk of governments selling is like government selling of gold; it tells me we’re much closer to a bottom than a top in the dollar.
Yaser
Forgot to add in my post above: I’m not expecting US$ to bottom and finish it’s downward trajectory, except in the short-term for the reason I alluded to above. Yaser
The dollar will continue to devalue just enough to enable the US to welsh out on most of its debt obligation. That’s the only way we can get out of the mess we’ve made, since there aren’t nearly enough real assets to cover the debts and no one trusts our IOUs anymore.