Thursday, July 23, 2009
Wednesday, July 22, 2009
Market Direction
Since late May the dollar has traded in a limited four figure range against the euro - limited and a bit odd. Good American economic news pushes the dollar down; bad news returns it to favor.
May Non Farm Payrolls, unexpectedly positive, gave the dollar a fainting spell. The June numbers, worse than predicted, revived the greenback. Retail sales figures and consumer confidence have gradually returned from oblivion and the value of the dollar ebbed as they rose.
Risk aversion is the standard explanation. Risk capital, or perhaps it is better to name it capital that is averse to risk, is sequestered in Treasury bills and other dollar denominated safe investments when the economic environment looks, well, risky. The demand for these dollar assets pushes the US currency higher as foreign denominated capital enters the currency markets and is converted to dollars. When economic risk is judged to diminish these funds suddenly pour back out of US Treasuries seeking higher returns. Since those returns are often overseas the dollars are changed for foreign assets and the dollar sinks.
This mechanistic and simplified logic may suffice to explain the weak pro and anti-dollar moves that have played back and forth in the currency since late May. But a larger question looms. Why hasn’t the dollar benefited from the improvement in the US economy? Currency markets, like equities and futures, are discounting machines. They trade now for where their participants think that currencies, stocks or commodities will be at some point in the near future.
The US economic situation compares favorably with that of any of its major currency trading partners. The financial panic has long since dissipated. The banking system is not going to collapse. Present inflation is benign, whatever the real or imagined fears for 2011 and beyond. The Federal Reserve has restrained its essay into overt monetization. At the last FOMC meeting the Reserve Board declined to add to the $300 billion already allotted for Treasury purchases. Perhaps most informative on Fed thinking, the M2 money supply, long neglected, has leveled and even declined a little in May. Last fall and spring as the crisis escalated M2 had jumped at historically unprecedented rates as the Fed pumped liquidity into the economy. But now it seems the Fed has drawn back from the money glut and that can only help to contain future inflation.
One year ago the US unemployment rate was 5.5 %, it is now 9.5%. While such numbers are a serious hardship for workers and businesses they are also a sign of the flexibility of the US labor market. Because American firms operate under relatively few restrictions they are free to use labor as they see fit. US firms can restructure and redeploy resources to meet actual demand. When growth returns US firms are often in a better financial condition to rehire. US unemployment rises faster in a recession but it also falls faster and to a lower level under economic growth. Compare the US employment situation to that of the European Monetary Union (EMU).
EMU unemployment has risen from 7.4% a year ago to 9.5% in June, half the amount of the US increase. In Europe it is far harder for firms to eliminate workers and doing so is far more costly. Thus when the recovery begins there are fewer empty places to fill. Companies remain wedded to resource deployment designed for the last expansion with no guarantee that the new cycle will ask for the same product mix. In comparison US firms are able to meet the new economic situation with a far more flexible outlook.
Many secondary US economic indicators have improved substantially in the past months. Housing is stable, purchasing managers indices have recovered and consumer confidence and retail sales are on the mend. This is not to say that the recession is ended or even ending. But that as a comparative lesson the US is arguably in better shape for recovery than its European competitors. When this improved economic situation is joined to the historical ability of the US economy to work its way out of trouble faster and with more emphasis than any other industrialized economy we have to ask again: Why has the dollar declined?
The answer may lie in Washington and the political and economic agenda of the Obama administration. Currency markets are making their own discount judgments on the potential economic effect of the two major initiatives of the administration: the climate change bill and the creation of a government health service.
Irrespective of the political and policy aims of the two pieces of legislation, and aside from any opinion on the social and environmental desirability of their stated goals, there is no doubt that both will impose huge economic costs on the US economy. For the climate bill the intention is to apply a proper cost to carbon output. The legislation is designed to impose huge new taxes on any users of carbon. Since almost every consumer or industrial product uses carbon somewhere in the production cycle the economic costs will stretch across the entire economy.
The health service bill cannot be funded without raising taxes and will likely incur large additional deficit spending as well. Few economists advise raising taxes in a recession. A further increase in the already vast Federal deficit could well squeeze out much of credit needed for the private economy and raise the cost of credit for all. Both bills, if passed in present form, seem destined to restrict US economic growth and retard recovery from the recession.
American equities have had a strong recent surge as the passage of these bills has become more problematic. The currency markets will soon notice. If the climate bill fails and the universal health care provision is watered down or put off until next year then restraints on the dollar will fall away and it will follow equities higher.
Joseph Trevisani
May Non Farm Payrolls, unexpectedly positive, gave the dollar a fainting spell. The June numbers, worse than predicted, revived the greenback. Retail sales figures and consumer confidence have gradually returned from oblivion and the value of the dollar ebbed as they rose.
Risk aversion is the standard explanation. Risk capital, or perhaps it is better to name it capital that is averse to risk, is sequestered in Treasury bills and other dollar denominated safe investments when the economic environment looks, well, risky. The demand for these dollar assets pushes the US currency higher as foreign denominated capital enters the currency markets and is converted to dollars. When economic risk is judged to diminish these funds suddenly pour back out of US Treasuries seeking higher returns. Since those returns are often overseas the dollars are changed for foreign assets and the dollar sinks.
This mechanistic and simplified logic may suffice to explain the weak pro and anti-dollar moves that have played back and forth in the currency since late May. But a larger question looms. Why hasn’t the dollar benefited from the improvement in the US economy? Currency markets, like equities and futures, are discounting machines. They trade now for where their participants think that currencies, stocks or commodities will be at some point in the near future.
The US economic situation compares favorably with that of any of its major currency trading partners. The financial panic has long since dissipated. The banking system is not going to collapse. Present inflation is benign, whatever the real or imagined fears for 2011 and beyond. The Federal Reserve has restrained its essay into overt monetization. At the last FOMC meeting the Reserve Board declined to add to the $300 billion already allotted for Treasury purchases. Perhaps most informative on Fed thinking, the M2 money supply, long neglected, has leveled and even declined a little in May. Last fall and spring as the crisis escalated M2 had jumped at historically unprecedented rates as the Fed pumped liquidity into the economy. But now it seems the Fed has drawn back from the money glut and that can only help to contain future inflation.
One year ago the US unemployment rate was 5.5 %, it is now 9.5%. While such numbers are a serious hardship for workers and businesses they are also a sign of the flexibility of the US labor market. Because American firms operate under relatively few restrictions they are free to use labor as they see fit. US firms can restructure and redeploy resources to meet actual demand. When growth returns US firms are often in a better financial condition to rehire. US unemployment rises faster in a recession but it also falls faster and to a lower level under economic growth. Compare the US employment situation to that of the European Monetary Union (EMU).
EMU unemployment has risen from 7.4% a year ago to 9.5% in June, half the amount of the US increase. In Europe it is far harder for firms to eliminate workers and doing so is far more costly. Thus when the recovery begins there are fewer empty places to fill. Companies remain wedded to resource deployment designed for the last expansion with no guarantee that the new cycle will ask for the same product mix. In comparison US firms are able to meet the new economic situation with a far more flexible outlook.
Many secondary US economic indicators have improved substantially in the past months. Housing is stable, purchasing managers indices have recovered and consumer confidence and retail sales are on the mend. This is not to say that the recession is ended or even ending. But that as a comparative lesson the US is arguably in better shape for recovery than its European competitors. When this improved economic situation is joined to the historical ability of the US economy to work its way out of trouble faster and with more emphasis than any other industrialized economy we have to ask again: Why has the dollar declined?
The answer may lie in Washington and the political and economic agenda of the Obama administration. Currency markets are making their own discount judgments on the potential economic effect of the two major initiatives of the administration: the climate change bill and the creation of a government health service.
Irrespective of the political and policy aims of the two pieces of legislation, and aside from any opinion on the social and environmental desirability of their stated goals, there is no doubt that both will impose huge economic costs on the US economy. For the climate bill the intention is to apply a proper cost to carbon output. The legislation is designed to impose huge new taxes on any users of carbon. Since almost every consumer or industrial product uses carbon somewhere in the production cycle the economic costs will stretch across the entire economy.
The health service bill cannot be funded without raising taxes and will likely incur large additional deficit spending as well. Few economists advise raising taxes in a recession. A further increase in the already vast Federal deficit could well squeeze out much of credit needed for the private economy and raise the cost of credit for all. Both bills, if passed in present form, seem destined to restrict US economic growth and retard recovery from the recession.
American equities have had a strong recent surge as the passage of these bills has become more problematic. The currency markets will soon notice. If the climate bill fails and the universal health care provision is watered down or put off until next year then restraints on the dollar will fall away and it will follow equities higher.
Joseph Trevisani
Wednesday, July 15, 2009
Market Direction
The origin of the Group of Eight was an invitation from French President Valery Giscard d’Estaing in 1975 to six of the major World War Two combatants to meet at Rambouillet in France. Leaders from West Germany, Great Britain, Italy, the United States, Japan and France attended that first meeting. The impetus to the summit, if not the sole topic, was the first post war economic challenge to the west, the 1973 OPEC oil embargo. In 1976 Canada was invited to join and the group stayed at seven until 1997 when Russia formally became a member.
Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.
Why relate this history? The nations of the Second World War consensus that have dominated the world for 60 years are close to bankrupt. Their foreign bankers are now calling the shots; those who pay decide the future.
The abandonment of the climate change issue at the G-8 meeting is an example. Though the global warming agenda is a major part of the domestic political positions of President Obama, Chancellor Merkel, Prime Minister Brown and President Sarkozy the issue was removed from G-8 consideration because China, India and others would not go along. This is perhaps a foretaste of what will happen on every topic in which China and the other BRIC (Brazil, Russia, India, and China) countries have an interest.
China, Russia and India have been very public with their concerns for the long term value of the US Dollar and critical of the effect of American deficit spending. In April, China’s holding of US Treasuries fell for the first time in eleven months. The amount was small, $4 billion and partially offset by a small gain in Hong Kong. But in the charged atmosphere of today’s international economics and in light of US funding needs, the drop was widely noted. From April 2008 until March 2009 the Chinese Government had been steadily acquiring Treasuries; its holding had increased from $502.0 to $767.9, a jump of 53%.
China has also moved to increase the supply and demand for the yuan as an alternative to the dollar by starting limited trade settlement in its currency. On July 6th some firms in five Chinese cities were allowed to begin settling transactions in yuan with companies from Hong Kong, Macau and the ASEAN countries. Non-Chinese banks will be able to obtain yuan from mainland institutions to finance trade.
The Peoples Bank of China (PBOC) has also formulated currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. The PBOC will render yuan to their central banks as needed to pay for imports if these countries are short of the currency.
These moves by the Chinese authorities will not establish the yuan as an international reserve currency. But they will shift some of the trade demand for dollars to yuan. Offered the choice what Asian trading partner of China would not want to remove the volatile and increasingly questioned dollar from their financial equation? The logic is simple and efficient. Why hold reserves in dollars for your China trade and bear the currency risk? Yuan reserves reduce the need for dollars and reduce dollar currency risk.
China has emerged as the engine of growth in Asia and Asian countries are looking to China for the health of their own economies. If yuan settlement becomes the policy of the Chinese Government what trading partner will want to go against Beijing’s wishes and opt for dollar settlement? Considering the size of China’s foreign trade the potential drop in dollar demand could be substantial.
Until now it has been in China's interest to keep the yuan undervalued for trade competition. Since last summer China has effectively re-pegged the yuan to the dollar after three years of gradual appreciation. But that is likely to be a temporary expedient. If China is serious about using the yuan in trade and in permitting outside players, non Chinese players, to hold and store value in yuan, an essential component of a reserve currency, what better way than to resume a gradual appreciation of the currency? For an exporter in Vietnam or Thailand or even Australia, Japan or New Zealand would not an appreciating yuan be a far better option for your China trade capital than the dollar?
Chinese national interest will determine Beijing’s economic policy. But the time is fast approaching when safeguarding her economic development will be far better served by a strong and convertible currency than by a weak yuan priced for export. A strong dollar has been one of Washington’s most effective foreign policy tools for more than 50 years; that fact is not unknown in the Chinese capital.
Joseph Trevisani
Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.
Why relate this history? The nations of the Second World War consensus that have dominated the world for 60 years are close to bankrupt. Their foreign bankers are now calling the shots; those who pay decide the future.
The abandonment of the climate change issue at the G-8 meeting is an example. Though the global warming agenda is a major part of the domestic political positions of President Obama, Chancellor Merkel, Prime Minister Brown and President Sarkozy the issue was removed from G-8 consideration because China, India and others would not go along. This is perhaps a foretaste of what will happen on every topic in which China and the other BRIC (Brazil, Russia, India, and China) countries have an interest.
China, Russia and India have been very public with their concerns for the long term value of the US Dollar and critical of the effect of American deficit spending. In April, China’s holding of US Treasuries fell for the first time in eleven months. The amount was small, $4 billion and partially offset by a small gain in Hong Kong. But in the charged atmosphere of today’s international economics and in light of US funding needs, the drop was widely noted. From April 2008 until March 2009 the Chinese Government had been steadily acquiring Treasuries; its holding had increased from $502.0 to $767.9, a jump of 53%.
China has also moved to increase the supply and demand for the yuan as an alternative to the dollar by starting limited trade settlement in its currency. On July 6th some firms in five Chinese cities were allowed to begin settling transactions in yuan with companies from Hong Kong, Macau and the ASEAN countries. Non-Chinese banks will be able to obtain yuan from mainland institutions to finance trade.
The Peoples Bank of China (PBOC) has also formulated currency swap agreements with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. The PBOC will render yuan to their central banks as needed to pay for imports if these countries are short of the currency.
These moves by the Chinese authorities will not establish the yuan as an international reserve currency. But they will shift some of the trade demand for dollars to yuan. Offered the choice what Asian trading partner of China would not want to remove the volatile and increasingly questioned dollar from their financial equation? The logic is simple and efficient. Why hold reserves in dollars for your China trade and bear the currency risk? Yuan reserves reduce the need for dollars and reduce dollar currency risk.
China has emerged as the engine of growth in Asia and Asian countries are looking to China for the health of their own economies. If yuan settlement becomes the policy of the Chinese Government what trading partner will want to go against Beijing’s wishes and opt for dollar settlement? Considering the size of China’s foreign trade the potential drop in dollar demand could be substantial.
Until now it has been in China's interest to keep the yuan undervalued for trade competition. Since last summer China has effectively re-pegged the yuan to the dollar after three years of gradual appreciation. But that is likely to be a temporary expedient. If China is serious about using the yuan in trade and in permitting outside players, non Chinese players, to hold and store value in yuan, an essential component of a reserve currency, what better way than to resume a gradual appreciation of the currency? For an exporter in Vietnam or Thailand or even Australia, Japan or New Zealand would not an appreciating yuan be a far better option for your China trade capital than the dollar?
Chinese national interest will determine Beijing’s economic policy. But the time is fast approaching when safeguarding her economic development will be far better served by a strong and convertible currency than by a weak yuan priced for export. A strong dollar has been one of Washington’s most effective foreign policy tools for more than 50 years; that fact is not unknown in the Chinese capital.
Joseph Trevisani
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