Global Market Brief: Nov. 29, 2004
After bouncing around the week of Nov. 15, the dollar resumed its slide this
week, hitting record lows on a number of occasions as the currency staggered
downward. Reasons for a weak dollar have been discussed before, but we feel
compelled nonetheless to launch into a quick review.
First there is the trade deficit. Americans are importing more than they are
exporting to the tune of 6 percent of gross domestic product (GDP). So long
as that is the case, the U.S. currency will remain stable only as long as
foreigners are willing to lend the United States money. This results in
steady downward pressure on the dollar, with the risk that the dollar could
crash should foreign investors be spooked.
Second is the federal budget deficit, pushing 5 percent of GDP. As the
government spends more than it takes in, it must issue bonds in order to
raise funds. Those government bonds compete in the marketplace with all the
other financial instruments, such as stocks and corporate bonds. More
competitors mean higher premiums for people who hold cash. The result is
higher interest rates across the board, which will hand the U.S. economy
slower growth.
Between these two deficits, the United States is dependent on foreign
investors to supply around $3 billion a day in investment. Should that end,
the dollar would simply crash.
But that is not all.
Perhaps the biggest reason the dollar is so weak is that U.S. President
George W. Bush's administration likes it that way. The big dive in the U.S.
currency began in the run-up to the Iraq war when, diplomatically, events
were not going as well as Washington had expected. The resulting diplomatic
chaos proved so destabilizing that global growth came under threat.
For the Bush administration, unofficially driving down the dollar was a neat
fix. A weak dollar also simultaneously served the administration's domestic
economic and political agendas. Economically, a weak dollar would make U.S.
exports more competitive abroad. In addition to stabilizing U.S. growth in a
time of global instability, the Bush administration was already thinking
ahead to the 2004 elections. A booming export sector plus increased jobs in
the manufacturing sector equals re-election.
There also was a certain amount of payback involved. From 1990 to 2003,
Asian states regularly intervened in their currency markets in order to
export more to the United States. Even the Europeans were guilty of this to
a certain degree, preferring promoting exports to enacting politically dicey
(if long overdue) economic reforms. For the Bush administration, informally
weakening the dollar reminded all these states who they ultimately depended
upon economically at a time when he was seeking political submission. It is
notable that most Asian states not pegged to the U.S. currency ultimately
signed on to the politics of the Iraq war.
It also was something the Federal Reserve thought sound, as a weaker dollar
strengthened inflation. Normally that is a bad thing, but the Fed feared in
2003 the United States might slip into deflation. The last period of
significant deflation the U.S. suffered was the Great Depression. The Fed
considered mild inflationary pressure preferable to potentially repeating
the darkest chapter in U.S. economic history.
Even under the best of circumstances, these are three trends that show
little sign of rectifying themselves during the second Bush administration.
Americans are not going to stop purchasing foreign products. The federal
government, even under its most aggressive plans, will only be halving the
deficit in the next four years. The Bush administration sees no reason to
not take advantage of the tools it has to promote employment growth.
Nonetheless, Stratfor forecasts the dollar rising in 2005.
The first reason is the most basic. U.S. interest rates are at 2 percent,
making them equal to European Central Bank rates, and a full 2 percentage
points above Japan's. As the U.S. economy continues to grow (and its federal
budget deficit remains stubbornly high) inflationary pressures will build.
Far from the deflationary fears of 2003, inflation in the United States is
running about 0.2 percent per month, right about where it should be.
However, rates are still near historic lows. Therefore, over the next year,
the Fed will continue to hike rates as it has during the past few months to
keep inflation under control.
That is not happening, however, in Europe or Japan. Europe remains unwilling
to enact the labor reforms needed to unchain its economies and spark growth
because such reforms would radically alter -- if not dismantle -- the social
welfare state to which the European electorates have grown accustomed. EU
expansion to 10 new Central European and Mediterranean states in 2004
ensures that Europe ultimately will indeed move in that direction -- Western
Europeans do not want to see all their jobs move east to the newer,
lower-cost-of-production members -- but that will take time as European
policy takes years to debate and implement. For now, rates have to be kept
low to keep growth going.
A similar situation exists in Japan, where the key considerations are not
profitability or growth, but cash flow and market share. The Japanese
economic model requires strong social protections and maximum employment
regardless of the bottom line. That has led the government to lean on the
banks to provide loads of loans to the private sector in order to keep
everything running. The government also has spent more than $1 trillion of
its own money propping the economy because of slack domestic demand brought
about largely by deflation. That has left Japanese corporations and the
government with the largest debts in history, and any increase in interest
rates would bring the whole unsightly mess tumbling down.
So long as U.S. rates are higher than their European and Japanese
counterparts, money will flow from those economies into the U.S. economy.
There is more. The United States is also growing much faster than either
Japan or Europe. In part, this is courtesy of the weaker dollar and low
interest rates, but it has much more to do with the flexibility of the U.S.
financial and labor markets, which enabled the country to fully recover from
its 2001 recession a long time ago. Europe and Japan have not fully
recovered. In the third quarter of 2004, U.S. growth hit 3.7 percent, versus
0.3 percent for Europe and 0.1 percent for Japan.
Finally, Stratfor predicts that 2005 will see a new Asian crisis. The shape
and depth of the coming problems are difficult to divine, but consider this:
The Chinese banking system makes the Japanese banking system appear a
paragon of virtue. Where the Japanese economic model involves private firms
that actually produce items for sale, the Chinese model uses state-owned
enterprises (SOEs) largely as employment generators.
What will bring matters to a head is that in 2005 China will have to open
large tracts of its financial sector to foreign competition. That, in turn,
will force the government to do one of two things. First, it could simply
directly subsidize the SOEs -- a monumental task. Second, it could sell
portions of its banks to foreigners in order to inject a massive stimulus
into the sector and hopefully restructure it. The problem is that if
foreigners purchase a chunk of a company, they get to look at its books.
Either way, the financial alchemy that has maintained Chinese political
stability for the past generation is about to be exposed to the world at
large. Historically, whenever Asia has problems -- most recently
demonstrated by the 1997 Asian financial crisis -- investment flees for the
safe shores of the United States.
Which pushes the dollar up.
These three factors -- interest rate disparities, the growth disconnect and
a dawning Asian crisis -- tend to be short-term factors whose effects last
for months. Stratfor expects the dollar to find its footing within the next
three months, and then get a sharp boost when Asian problems begin to
dominate the headlines.
But in contrast, the twin deficits and the Bush administration's political
views of the dollar are much longer lasting. And they will certainly outlast
2005. Eventually European -- and, dare we say, Japanese -- interest rates
will have to rise, and while U.S. growth has outpaced Japanese and European
growth for most of the last 15 years, those two economies are capable of
growth themselves when the conditions are right.
Is the long-term trend for the dollar still pointing down? Certainly. But
2005 will witness a bump nonetheless.
- Stratfor 2004
After bouncing around the week of Nov. 15, the dollar resumed its slide this
week, hitting record lows on a number of occasions as the currency staggered
downward. Reasons for a weak dollar have been discussed before, but we feel
compelled nonetheless to launch into a quick review.
First there is the trade deficit. Americans are importing more than they are
exporting to the tune of 6 percent of gross domestic product (GDP). So long
as that is the case, the U.S. currency will remain stable only as long as
foreigners are willing to lend the United States money. This results in
steady downward pressure on the dollar, with the risk that the dollar could
crash should foreign investors be spooked.
Second is the federal budget deficit, pushing 5 percent of GDP. As the
government spends more than it takes in, it must issue bonds in order to
raise funds. Those government bonds compete in the marketplace with all the
other financial instruments, such as stocks and corporate bonds. More
competitors mean higher premiums for people who hold cash. The result is
higher interest rates across the board, which will hand the U.S. economy
slower growth.
Between these two deficits, the United States is dependent on foreign
investors to supply around $3 billion a day in investment. Should that end,
the dollar would simply crash.
But that is not all.
Perhaps the biggest reason the dollar is so weak is that U.S. President
George W. Bush's administration likes it that way. The big dive in the U.S.
currency began in the run-up to the Iraq war when, diplomatically, events
were not going as well as Washington had expected. The resulting diplomatic
chaos proved so destabilizing that global growth came under threat.
For the Bush administration, unofficially driving down the dollar was a neat
fix. A weak dollar also simultaneously served the administration's domestic
economic and political agendas. Economically, a weak dollar would make U.S.
exports more competitive abroad. In addition to stabilizing U.S. growth in a
time of global instability, the Bush administration was already thinking
ahead to the 2004 elections. A booming export sector plus increased jobs in
the manufacturing sector equals re-election.
There also was a certain amount of payback involved. From 1990 to 2003,
Asian states regularly intervened in their currency markets in order to
export more to the United States. Even the Europeans were guilty of this to
a certain degree, preferring promoting exports to enacting politically dicey
(if long overdue) economic reforms. For the Bush administration, informally
weakening the dollar reminded all these states who they ultimately depended
upon economically at a time when he was seeking political submission. It is
notable that most Asian states not pegged to the U.S. currency ultimately
signed on to the politics of the Iraq war.
It also was something the Federal Reserve thought sound, as a weaker dollar
strengthened inflation. Normally that is a bad thing, but the Fed feared in
2003 the United States might slip into deflation. The last period of
significant deflation the U.S. suffered was the Great Depression. The Fed
considered mild inflationary pressure preferable to potentially repeating
the darkest chapter in U.S. economic history.
Even under the best of circumstances, these are three trends that show
little sign of rectifying themselves during the second Bush administration.
Americans are not going to stop purchasing foreign products. The federal
government, even under its most aggressive plans, will only be halving the
deficit in the next four years. The Bush administration sees no reason to
not take advantage of the tools it has to promote employment growth.
Nonetheless, Stratfor forecasts the dollar rising in 2005.
The first reason is the most basic. U.S. interest rates are at 2 percent,
making them equal to European Central Bank rates, and a full 2 percentage
points above Japan's. As the U.S. economy continues to grow (and its federal
budget deficit remains stubbornly high) inflationary pressures will build.
Far from the deflationary fears of 2003, inflation in the United States is
running about 0.2 percent per month, right about where it should be.
However, rates are still near historic lows. Therefore, over the next year,
the Fed will continue to hike rates as it has during the past few months to
keep inflation under control.
That is not happening, however, in Europe or Japan. Europe remains unwilling
to enact the labor reforms needed to unchain its economies and spark growth
because such reforms would radically alter -- if not dismantle -- the social
welfare state to which the European electorates have grown accustomed. EU
expansion to 10 new Central European and Mediterranean states in 2004
ensures that Europe ultimately will indeed move in that direction -- Western
Europeans do not want to see all their jobs move east to the newer,
lower-cost-of-production members -- but that will take time as European
policy takes years to debate and implement. For now, rates have to be kept
low to keep growth going.
A similar situation exists in Japan, where the key considerations are not
profitability or growth, but cash flow and market share. The Japanese
economic model requires strong social protections and maximum employment
regardless of the bottom line. That has led the government to lean on the
banks to provide loads of loans to the private sector in order to keep
everything running. The government also has spent more than $1 trillion of
its own money propping the economy because of slack domestic demand brought
about largely by deflation. That has left Japanese corporations and the
government with the largest debts in history, and any increase in interest
rates would bring the whole unsightly mess tumbling down.
So long as U.S. rates are higher than their European and Japanese
counterparts, money will flow from those economies into the U.S. economy.
There is more. The United States is also growing much faster than either
Japan or Europe. In part, this is courtesy of the weaker dollar and low
interest rates, but it has much more to do with the flexibility of the U.S.
financial and labor markets, which enabled the country to fully recover from
its 2001 recession a long time ago. Europe and Japan have not fully
recovered. In the third quarter of 2004, U.S. growth hit 3.7 percent, versus
0.3 percent for Europe and 0.1 percent for Japan.
Finally, Stratfor predicts that 2005 will see a new Asian crisis. The shape
and depth of the coming problems are difficult to divine, but consider this:
The Chinese banking system makes the Japanese banking system appear a
paragon of virtue. Where the Japanese economic model involves private firms
that actually produce items for sale, the Chinese model uses state-owned
enterprises (SOEs) largely as employment generators.
What will bring matters to a head is that in 2005 China will have to open
large tracts of its financial sector to foreign competition. That, in turn,
will force the government to do one of two things. First, it could simply
directly subsidize the SOEs -- a monumental task. Second, it could sell
portions of its banks to foreigners in order to inject a massive stimulus
into the sector and hopefully restructure it. The problem is that if
foreigners purchase a chunk of a company, they get to look at its books.
Either way, the financial alchemy that has maintained Chinese political
stability for the past generation is about to be exposed to the world at
large. Historically, whenever Asia has problems -- most recently
demonstrated by the 1997 Asian financial crisis -- investment flees for the
safe shores of the United States.
Which pushes the dollar up.
These three factors -- interest rate disparities, the growth disconnect and
a dawning Asian crisis -- tend to be short-term factors whose effects last
for months. Stratfor expects the dollar to find its footing within the next
three months, and then get a sharp boost when Asian problems begin to
dominate the headlines.
But in contrast, the twin deficits and the Bush administration's political
views of the dollar are much longer lasting. And they will certainly outlast
2005. Eventually European -- and, dare we say, Japanese -- interest rates
will have to rise, and while U.S. growth has outpaced Japanese and European
growth for most of the last 15 years, those two economies are capable of
growth themselves when the conditions are right.
Is the long-term trend for the dollar still pointing down? Certainly. But
2005 will witness a bump nonetheless.
- Stratfor 2004