Wednesday, November 29, 2006

The US economy

The dollar is looking extremely weak at present. It has lost 30% of its value against both the Euro and the Pound in the last four years. Meanwhile, the mainstay of the US economy, the housing market has entered a slump phase (a British property slump is also now widely predicted, but its hard to see how in places like London and Manchester where the boom boometh still). There will be the usual consumer pick-me-up on the back of an ever weaker dollar thanks to consumer tourists and locals chasing down cheaper imports (it looks like the 2 dollar = 1 pound is just about to be broken again). However, it is hard to see what is going to turn things around in the States.

China is now producing cars that retail at US$5000 with leather seats and a/c. How would the US car market ever recover? (Answer: it won't. RIP GM). Huge tracts of the American economy have lost their competitive advantage, forever. At some point in the near future, an ever weaker dollar will surely look like an unattractive currency to purchase for other nation's foreign reserves. Exporting in mega-volumes to America's malls will surely reach a tipping point, whereby the forex received in exchange depreciates beyond a certain point and reduces profit margins, especially as these narrowing margins are compared with other emerging consumer markets open up around the world (where margins are going in the other direction), and as US consumer credit slowly dries up in line with a property fall.

I'm far from being even an amateur economist: but why would you (in the role of a Central Bank chief) keep precious foreign reserves held in a currency that is increasingly devalued and unstable? Meanwhile, the OECD is making noises that the other big global economies - China and Europe specifically - have almost reached the point whereby when America sneezes, only America catches the cold. Perhaps only a war economy can reverse the trend Stateside? Trouble is, the neo-cons have just lost their power-base and there are too many resource-heavy flash points in the Middle East already. The 21st century might not be an American Project after all, even if all the smartest guys in the room are American. I don't see a way out for the US economy as it is, as the health-dependency of the rest of the world on the US ever so slowly starts to recede.

All the above are just my simple thoughts. I'd be happy to hear someone with more understanding of these things paint a different scenario..


Anonymous,  4:17 am  

I agree that the U.S economy is facing serious challenges from the Euro and the Pounds. Also there is the threat from China in the form of cheap goods and even cheaper method of production. However, U.S economy is not going down the way you pointed out. For starters, the dollar is still the world’s dominant currency, thanks to petrodollars. Two-thirds of the world’s currency reserves are kept in dollar, because oil importers pay in dollars and oil exporters keep their reserves in the currency they are paid in. In fact, the entire global oil trade is conducted in dollars and that means that everyone needs to keep dollars (the reason why the Nigerian reserves are in dollars). Am not trying to undermine the threat the Euro poses to dollar. In fact the Euro has established itself as the second most important currency in world’s financial market and accounts for one quarter of the global market. But the fact that Oil is still traded in dollars means that for now….the US and its economy is still on top

Anonymous,  6:21 am  

All the above are just my simple thoughts.

Couldn't have said it better myself, Jeremy. Attaboy.

Jeremy 7:45 am  

Ok right then Fred - no argument, the US economy will do fine, just like the global climate abi? Which one of us lives in a simplified universe?

To the first commentor - that's part of the point: will the use of dollars for oil trading be replaced by Euros, and if so, when and under what conditions? This was one component of the real reason I understand why Saddam had to be removed - he was just about to switch Iraqi oil trading to Euros, which would have prompted a domino effect across all oil-producing nations. A switch like this would be catastrophic for the dollar, ending the last layer of currency protectionism the US economy has, leaving the greenback fully vulnerable to the brutally disloyal powers of the global currency markets.

Anonymous,  10:14 am  

...and cmc conveniently forgot that the Iranians have shown the way by changing their reserves and preferred trading currency from Dollars to Euro?

Venezuela is set to follow. Had it not been for the loss of Capitol Hill, the drums of war against Iran would have been going up a notch by now...

Anonymous,  11:44 am  

To answer your question Jeremy, I don’t think the euro will replace dollars (at least not in the foreseeable future). However, the U.S has shown that it is willing to do anything to protect its interest and that includes pre-emptive strike (am not saying that US will invade E.U countries. It just shows how far they are willing to go.) Furthermore, the UK is still using pounds sterling and does not want to switch to Euro. I believe that if and when the UK switches to Euro that will be it for dollar as it will make the euro 50% stronger than dollar (currently, the euro is 25% stronger). And that will be the last hurdle that breaks the horse’s back but this time the horse will be the U.S economy. Besides, the fact that the EU imports 60% of OPEC oil makes more sense if the oil is traded in Euro.

Anonymous,  4:36 pm  

You, J. You live in the simplified universe, socialist.

The US economy will do fine. For one reason only: Americans.

Don't mean to burst your masturbatory fantasy bubble, doc, sorry.

Just keep yanking yer pecker long enough, don't worry, America will soon sink.

Anonymous,  7:27 pm  

Nice train of thought you guys have here. Monetary economics is much more complex than all of this though.
With respect to the money held in reserves, the magnitude of the shock and after shock of corrective policies, is sometimes as important as the immediate considerations. The free market vs interventionist argument is not resolved and will never be resolved because there is no right or wrong.
With respect to the value of the dollar, the media often assumes that a strong currency is an objective of monetary policy. This is not always so. In a nutshell, there is more to it than meets the eye.

Anonymous,  10:33 pm  

"I agree that the U.S economy is facing serious challenges from the Euro and the Pounds"

the u.s economy is not slowing down because of the euro or pounds!
its just slowing down on its own cant compete they are felling the pinch of the chinese

bush is planning to build a massive library though maybe the cowboy can learn something atlast!

Atala Wala Wala 4:47 am  


I think the dollar has been slipping all this while because of the perception that forex traders have that America's economy hasn't been particularly well handled (and they're right - how do you go from a budget surplus six years ago to a stonking great deficit?).

It's also true that large swathes of American manufacturing industry will continue to disappear as production costs in China and elsewhere become lower.

But I don't think that this is the end of the road of America's economic pre-eminence yet (with a couple of caveats). First of all, as you've noted already, a weak dollar has the effect of boosting America's competitive advantage so that it's easier for it to export goods and harder for countries like to export goods to it. So that will help to some extent to spur its economy. Hopefully also, a more fiscally responsible government will take over in a few years and restore some sanity to public finances (perhaps helped by a phased withdrawal from Iraq).

Secondly, even though manufacturing is moving abroad, the ideas behind the manufactured products still largely originate in America. America still has a culture which encourages entrepreneurship and innovation, so it is likely that new idea-based industries will be created to replace the old ones that are dying out.

However, America still needs a good educational system to create the entrepreneurs to thrive in this kind of culture (or if it can't create them, it needs to be able to import them from the rest of the world). The problem is that I don't know that America's education system is that great - and there are signs that America wants to limit the inflow of talented immigrants as well with all the anti-immigration feeling that's all the rage there right now.

Lastly, I don't think that countries will stop denominating sales of goods in dollars overnight, even if America's economy is looking a bit shaky now. This is because I don't think that people see the weakness as terminal - why shift if things will improve soon? Of course it would be a different matter if there really was no relief in sight.

snazzy 3:10 pm  

since everyone is feeling very economically minded I might as well put in my two cents, though I basically agree with omodudu.

Here is the thing about fx, about 90% of the market is speculation and as such is not driven by what you would call fundamentals. So a weaker dollar is based more on fx traders perceptions of the US economic outlook rather than its actual outlook, and most fx risk that affects actual businesses is hedged anyway.

Second no one annointed the dollar as the currency of last reserve, it became such because it was the currency of the largest, most stable economy. Now the euro was created in part to change this. There is no consensus on whether it will or it won't but here is the thing; It might matter to the Fed as it makes money of printing money, or it might matter to the govt as a matter of posturing, but it doesn't matter for most Americans as they don't export or import anything. That is the most important thing because the import/export share of American GDP is not that big compared to say China or Japan. Besides all those people like Lou Dobbs who are complaining about imports will have less to complain about cos their prices will go up.

Here is the thing, the same Americans that are complaining about a weaker dollar, are the ones that are complaining that the yuan should be allowed to appreciate (they want the dollar to get weaker against the chinese currency).

Last thing, caring about a strong currency in a relatively free floating system is like caring about getting a six pack when you are training for a marathon. I mean it is nice to have (cos it looks good) but not really important to performance. Look at the Japanese (before the deflation era,) they lived off a weak currency in the 80's.

Through these eyes 5:48 pm  

Nice write up. America's saving grace now that we are in the midst of a housing market consolidation (i won't term it as a recession or "slump" as you put it) is the AMERICAN STOCK MARKET. The Dow in the past month just broke it's ALL TIME HIGH that was achieved during the peak of the tech boom of 2000. Money is currently being transfered by institutional investors from real estate to the American stock market and corporations and consumers invested with 401k's and the like will witness eye-popping profits pretty soon. The next boom is predicted to occur during the last leg of this decade and peak around the turn of the decade (2010-ish).

As far as the dollar, it will recover soon. The democrats have taken over the senate and house will the White House, come 2008. The democrats are good at balancing the budget and decreasing debt as Clinton did during his term in office. If Senator Clinton wins (she is currently considering a presidential run) we have a good chance of achieving this soon.

This is my 2 cents. Again, thanks for bringing this up. It shows you are well read and are up to date with world affairs.

Through these eyes 6:02 pm  

One more thing, I read a short while back on financial news that the Bush administration is purposely letting the dollar to depreciate short-term, so as to jumpstart our economy. So the falling dollar is a calculated move to achieve some specific end results in mind and furthermore boost our economy.

I totally second ata wala wala's comment.

BTW, I'm thrilled to see we have some highly-educated and strong minded individuals on this blog. Great analysis guys!

Anonymous,  8:46 pm  

The American dollar may look that way right now (i.e "weak" and "depreciating" compared to the EURO), but I dare say that America is one of, if not at the top list of the smartest countries in the world. One important fact, disregarding the dollar status, is that America is hiding its oil reserves and sucking the oil reserves of other oil-producing countries like Nigeria. So basically, I'm thinking the plan is that when all these other countries have been sucked high and dry by the U.S, then the U.S can establish its AUTOCRACY (and all the other countries will come and bow down to the king of the universe). What position would the dollar absorb after all of that? I'm thinking it would be worth a gold-mine!

Anonymous,  5:50 pm  

Interesting thoughts and to a degree it is correct. The US dollar will rebound in 08 when a new administration is elected. the war really hurt the US economy. ( Help big companies Halliburton and Oil companies) But The US strength lies in research and development where new economie will flourish such as green energy and wind power.

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