« Go Hawks! | Main | More on the current account »
January 1, 2005
Where's Waldo?
Remember that children's book from a few years back? You had to find the character "Waldo" among a sea of distracting images. In his recent book A Term at the Fed, Laurence Meyer describes Fed speeches as a "Where's Waldo?" exercise. If you've ever read one, you know what he means.
I like to do the same thing with news stories once in a while. Pick a "gloom and doom" story about some aspect of the economy and find something in it that could be used to make the case that things aren't so bad. The Economist is a good place to play that game these days. It's time for the weekly installment of the doomed dollar.
These record [current account] deficits are adding to America’s foreign debts at an alarming rate. But as yet, America still earns more from its foreign assets than it pays on its foreign liabilities. That is about to change. As interest rates rise, refinancing America’s debt will become more costly. Goldman Sachs forecasts that net foreign-investment income is likely to shift to a sizeable deficit during 2005, growing thereafter. The investment bank estimates that, if America’s current-account deficit remains steady as a share of GDP and interest rates average 5% in future, net foreign debt-service payments will reach 4% of GDP by 2020—a significant drag on American living standards.
No, that's not the "Where's Waldo?" paragraph. I just thought it was an interesting choice for a forecast scenario. Raise your hands all who think that today's current account deficit will remain steady as a share of GDP until 2020. Okay, moving on.
The dollar’s decline may force America to embrace thrift, argues Goldman Sachs. As the dollar falls, foreigners will demand more American goods. This will put pressure on America’s manufacturers, which are already operating at 78% of capacity. As supply is stretched, inflationary pressures will build. The Federal Reserve will raise interest rates, curbing domestic demand, and thus creating room for an export boom. The higher interest rates will thus promote the saving America has so sorely lacked.
I think I caught a glimpse of Waldo. 78% isn't exactly an all time high. See for yourself. And, of course, the writer seems to discount the possibility of supply increases over time (implication by omission). If you want to find a time when capacity utilization was at a pretty high level (almost 85%), go back to the beginning of 1995. Not exactly the strongest dollar in history. Interest rates had been going up the previous year and weren't quite finished rising. Personal saving had begun its fall. Yet, a lot of commentators regard 1995 as the early stage of a pretty good run. Hardly the end of the world.
Here's Waldo!
If Japan’s finger is on the trigger, the European Central Bank (ECB) seems prepared to sit on its hands. Jean-Claude Trichet, president of the ECB, has lived with strong currencies before. As president of France’s central bank in the years before euro entry, he was dubbed “the ayatollah of the franc fort” for his unflinching support of a strong national currency. Indeed, for much of 1995, a weighted basket of the franc and the 11 other currencies that formed the euro was worth almost as much against the dollar as it is now.
Indeed. 1995. Need I say more?
The next paragraph is good, but it goes downhill to the end.
In his press conferences, Mr Trichet has made it clear that recent rises in the single currency are unwelcome. But he has dwelt at greater length on the danger of rises in energy prices. His chief duty, as he sees it, is to convince firms and workers that inflation will remain well contained, despite the oil price spike of the autumn. It is a confidence game: if he can convince them an inflation spiral won’t happen, then it won’t. The strong euro will actually add to his credibility, by curbing the price of imports.
Yes.
Besides, the hard men of hard money believe that weak currencies make life too easy for firms and politicians. Devaluing the currency provides an unsatisfying alternative to deregulating and restructuring the economy. An overvalued currency, on the other hand, leaves uncompetitive firms and tentative politicians with “no place to hide”, as Eric Chaney of Morgan Stanley puts it. They must reform or perish.
Only if there is some commitment to the strong currency. So was this our problem at the end of the '90s? Uncompetitive exporters had to reform or perish? Tentative politicians had "no place to hide"? Discuss.
“You cannot devalue your way to prosperity,” says John Snow, America’s treasury secretary, somewhat hypocritically. The year to come may reveal whether Europe can revalue its way to the same end.
Somewhat hypocritically? Snow hasn't really "devalued" the dollar. The dollar has depreciated on the market, and we have (wisely) allowed that to happen. If I were a long term speculator (with a time horizon of 10 to 20 years), I'd say that last paragraph is just silly.
Posted by William Polley at January 1, 2005 11:23 PM
Trackback Pings
TrackBack URL for this entry:
http://www.williampolley.com/cgi-bin/mt-tb.cgi/21