Thursday :: Nov 25, 2004

The Economy yet again

by soccerdad

I know I know another damn post on the economy. Well it is an important issue to all of us. Eventually, I might actually understand most of the macroeconomics. Today’s post is from an article by Jack Crooks in the Asia Times. It’s a good article and I would urge all to read it. It had some nice graphs which helped my understanding.

First he summarizes the major problem, the imbalance in the US economy and the world’s economy. As we know the US is a consumption, import driven economy with no savings. The Asian economies are export, savings driven economies. One way to bring the economies more into balance is to allow the dollar to go lower. Here’s a warning that despite the decline in the dollar we’ve seen lately, the situation may et worse before it gets better.

The problem is, despite calls for a lower dollar to help close the current account gap, it's poised to get worse before it improves. Here's why, says Morgan Stanley economist Richard Berner: 1) Import of goods, services and income is 40% bigger than exports. And this ratio is on the rise again. 2) Higher US interest rates will increase debt payments to foreign debt holders. 3) Iraq war and redevelopment. 4) Slowdown in global growth, especially in Asia. 5) Soaring cost of imported oil.

So this means that despite a decrease in the value of the dollar the US will need to borrow more money in the near future. The problem as we have discussed before is that the Asian banks have been carrying us by buying our notes. Will they continue? They can’t forever. As the dollar declines the holdings of the central banks decrease in value. But is it likely that anyone will do something soon?

Dr Jiang Ruiping, director of international economics at the China Foreign Affairs University, pointed out the following as a warning to the US in an article titled "Crisis looms due to weaker dollar" in the China Daily newspaper:
· Since China holds huge amounts of dollar-denominated foreign-exchange reserves, the authorities should consider taking prompt measures to ward off possible risks.
· Given the deteriorating relations between the US and the Arab world, quite a few Middle Eastern oil-exporting countries have begun to increase the proportion of euro in international settlements. Russia is reportedly going to follow suit.
· About two-thirds of the reserve [Chinese] is dominated by the dollar. As the dollar goes down, China will suffer great financial losses.
· The low earning rate of US treasury bonds, only 2% - much lower than investment in domestic projects - could cost China's capital dearly ... If the bubble bursts, China will suffer serious losses.
· To ward off foreign-exchange risks, China needs to readjust the current foreign-exchange holding structure, increasing the proportion of euro in its forex reserves.
· Considering the improving Sino-Japanese trade relations, more yen may also become an option.
· China could also encourage its enterprises to "go global" to weaken its dependence on US treasury bonds.
· Using US assets to increase the strategic resource reserves, such as oil reserves, could be another alternative.

He explains the theory behind how a falling dollar is supposed to rebalance the economies.
Here is how a coordinated decline in the US dollar is supposed to rebalance an unbalanced world:

1) A global agreement to let the dollar fall (explicit or implicit) leads to:
(i) Gradual increase in US interest rates
(ii) Dampening of US consumer demand
(iii) Increased domestic savings, reducing the dependence on foreign funds
(iv) Making US bonds more attractive for new buyers to help maintain capital flows to US.
2) A weaker dollar pressures European and Asian exports by:
(i) Forcing them to focus on domestic demand compensating for lower exports and decline in US consumer demand
(ii) Increasing US exports and reduces global trade tensions
3) Ultimately leading to improvement in the US current account and more productive use of surpluses in Europe and Asia.

Mr. Crooks goes into some detail explaining why their needs to be coordinated effort to min the effects of the falling dollar on all parties. But will all parties cooperate?
Its worth taking the time to read the whole article.

soccerdad :: 8:05 PM :: Comments (2) :: Digg It!