Monday, March 9, 2009

New York Times: A Rising Dollar Lifts the U.S. But Adds to the Crisis Abroad

Warning: wonkish currency talk ahead. For many of us who have been waiting for this awful era to arrive, a quite surprising development has occurred. The belief shares by many was as the epicenter (and indeed cause) of the global financial crisis, the US (and its currency) would be punished. However, the damage we caused has been so systematic with contagion like events occurring across the globe - in a quite sinister development the US dollar has SURGED higher as a flight to safety play. I will admit, I got this one completely wrong myself. In no time in history (that I can recall) has a country whose financial system has been imploding have investors run INTO their currency. But we are a blessed nation - having so destroyed the global financial system, the U.S. is seen as the best of a sorry lot.

And currency is all about RELATIVITY.... relative to the horrid conditions elsewhere the U.S. is considered the best of the worst. The Japanese yen is based on an export economy in the middle of a global trade implosion and the Euro is based on a multitude of countries with different objectives. In fact Japan just reported its first current account deficit in 13 years. All other currencies, even the more stable, are relatively small in size so hence cannot provide the same liquidity even if they are based on more stable economies. Further, I do believe we are going through a deflationary period and by definition as capital is destroyed each remaining increment of capital is therefore valued more.

Until this episode the dollar had been on a downfall almost the entire decade of the 2000s, I'd point to many of our long term national policies as a culprit - but one could point fingers at many reasons. The irony is once the world stabilizes (not any time soon) this flight to safety will reverse, and my belief is the dollar is destined to resume its downward projection - so if you are looking to travel abroad to take advantage of the dollar strength; try to book that vacation in the next 12-24 months. With all the liabilities the country already had, plus all the ones we are adding to the national ledger each month - we are going to be printing new dollars like they are going out of style for a generation or two. (which devalues all the other dollars in the system) To continue to attract capital to this country post the Great Recession, interest rates will surge higher, which will impair the country in a multitude of ways. In fact, if I were the US government I'd be issuing 40, 50, heck 100 year bonds. The interest rates we are paying to borrow are near criminal... take advantage of it. In 5 years you will see why....

For many years the weak dollar, while hurting US consumers by (a) making imports more expensive and (b) not allowing us to travel to many countries without losing an arm and a leg ... has been an absolute boon to our multinational corporations. While a weak dollar makes imports more expensive, it makes exports much more cheap. So our exporters thrived while European just last summer were balking at how the strong Euro was absolutely smashing their exporters (see Airbus v Boeing for example). Now - very quickly - the tables have turned. But the strong dollar is a drag on our multinationals earnings... yet another reason profits are sagging.

Via the New York Times
  • As the world is seized with anxiety in the face of a spreading financial crisis, the one place having a considerably easier time attracting money is, perversely enough, the same place that started much of the trouble: the United States.
  • American investors are ditching foreign ventures and bringing their dollars home, entrusting them to the supposed bedrock safety of United States government bonds. And China continues to buy staggering quantities of American debt.
  • These actions are lifting the value of the dollar and providing the Obama administration with a crucial infusion of financing as it directs trillions of dollars toward rescuing banks and stimulating the economy, enabling the government to pay for these efforts without lifting interest rates.
  • .... the tilt of money toward the United States appears to be exacerbating the crisis elsewhere. The pursuit of capital suddenly seems like a zero sum game. A dollar invested by foreign central banks and investors in American government bonds is a dollar that is not available to Eastern European countries desperately seeking to refinance debt. It is a dollar that cannot reach Africa, where many countries are struggling with the loss of aid and foreign investment.
  • Virtually all of the low-income countries are in very serious trouble,” said Eswar Prasad, a former official at the International Monetary Fund and a senior fellow at the Brookings Institution, the liberal-leaning research organization in Washington. He went on: “This is the third wave of the financial crisis. Low-income countries are getting hit very hard. The flow of private capital to the emerging market has dried up.”
  • Private money invested in so-called emerging countries plunged from $928 billion in 2007 to $466 billion last year and is likely to fall to $165 billion this year, according to the Institute of International Finance.
  • In the United States, investments by foreigners have slowed markedly. But as Americans eschew foreign deals and keep their dollars at home, and as foreign central banks — especially China — buy Treasury bills, the United States is absorbing money that used to be scattered around the globe. And that is making money tighter elsewhere in the world.
  • The most immediate crisis appears to be in Eastern Europe, where investors borrowed exuberantly in foreign currencies — notably the euro and the Swiss franc — using those funds to build office towers and factories. Their debts are growing as their currencies decline in value, leading to bank losses and requiring government bailouts along with aid from the I.M.F.. “Eastern Europe looks incredibly similar to Asia in the 1990s,” said Brad Setser, an economist at the Council on Foreign Relations in New York.
  • In a report released Sunday, the World Bank predicted that the global economy would shrink in 2009 for the first time in more than half a century and forecast that global trade would decline for the first time since the early 1980s. (welcome to reality World Bank... you're too rosy predictions are finally starting to see the light)
  • “Depreciation isn’t enough now to offset the global contraction,” said Mr. Setser, noting that export powers like Japan, Korea, Taiwan and Brazil have had rapid declines in sales in recent months. “Everybody’s looking vulnerable. All commodity exporters are potentially subject to currency crises.
  • Fears are growing that a much broader group of countries will plunge into trouble. Mr. Prasad’s list of potential danger zones includes Vietnam, the Philippines, Malaysia and Indonesia, as well as Pakistan and Ecuador.
  • Debt collapses are going to wreak havoc with exchange rates,” Mr. Rogoff predicted. “A lot of countries in Europe are already on the brink of default.
  • Because worries are deeper nearly everywhere else, the United States and the dollar have essentially benefited from the worldwide panic. In the last year, the dollar has risen 13 percent against major foreign currencies after adjusting for inflation, according to Federal Reserve data. “It’s a huge safe haven effect,” said William R. Cline, a senior fellow at the Peterson Institute for International Economics in Washington. “The basic assumption that people are making is that the U.S. government will never default on its debt.” (long time readers will know I disagree - one day we will turn full Banana Republic and default on at least a portion of our debt; we do not have political will as a nation to say no or make hard decisions - so we will continue to "promise" things we cannot pay for until the rest of the world stops financing us - but that's a story for another era)
  • In ordinary times, the rise of the dollar would provoke American worries that it would crimp exports by making goods more expensive on world markets. But for American policy makers, what matters now is attracting enough buyers of American debt to finance the rescue plans, and if the dollar must rise along the way, that is a cost worth paying. (translation - who the heck cares about our companies, we need money flowing into the country to bail out company after company and finance more promises we cannot afford; keep the shells rotating until someday someone realizes there is nothing underneath them - this is our ultimate KICK THE CAN DOWN THE ROAD policy - the crisis you are seeing today is just the warmup gig for the "end game" whether it be in 10 years or 20) “The fact that we can still borrow at lower interest rates is saving us from much more severe adjustments,” Mr. Rogoff said. “We’re really still staring down an abyss.”

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