12.29.08
Posted in China, Economic Analysis, Exchange Rates, Obama Administration, Trade Policy at 6:49 am by Administrator
The New York Time has been running an oustanding series entitled “The Reckoning” which explores the causes of the global economic crisis. I recommend the one published this week entitled “Chinese Savings Helped Inflate American Bubble” by Mark Landler. Landler pointed out how Chinese money (from the huge export surplus due to the fixed exchange rate policy) helped the US run a risky economic policy (sharply expansive fiscal policy fueled by large deficits at the same time as an expansive monetary policy from a low interest rate policy). The first to write about the phenomenon was a leading economist (guess who?). Landler starts off the article:
In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.
The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.
This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “we probably have little choice except to be patient.”
Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.
As I blogged previously, the US consumption binge was fueled with Chinese money. The trade policy of a fixed exchange rate allowed China to price its goods aggressively in the US markets. China however had to sterilize the inflationary effects of the export surplus by buying up the excess dollars. It then invested those dollars in Treasury securities, even though the Fed was keeping US rates low. (Other Asia export-oriented countries did similarly with their surpluses, although at a much smaller scale.)
The US made its share of economic mistakes as well. The Bush Administration started two wars without raising taxes, relaxed financial regulation and supervision and took advantage of the Alan Greenspan’s low interest rate policy. In the ensuing party, the banks gave away mortgages to just about anyone, causing a huge housing bubble. Unfortunately, US policy makers focused largely on the domestic US market, and thus they missed the “blinking red light.” The US inflation indicators excluded the wealth effects of higher stock indices and higher housing prices. Without those two components, inflation looked under control, especially in the consumer goods portion of the CPI where Chinese imports kept down prices. The little that US policy makers looked at international issues was with regard to the euro/dollar or yen/dollar relationship.
One lesson that has to be learned is the US is inextricably entwined in the world economy and that it no longer sets the agenda. It can play a leadership role if it chooses to participate in the game. The incoming Obama administration has the intellectual horsepower to make that mental shift. My New Year’s wish is that the Obama administration will formulate its economic policies with a global vision.
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09.29.08
Posted in China, Economic Analysis, Exchange Rates, Finance, Strategies at 2:47 am by Administrator
A number of months ago, I blogged about the interconnectedness of modern financial markets. The events of the last month have clearly demonstrated this.
We have to look back about a decade for the origins of the crisis which had its origins in the US policy to promote home ownership. In 1997, the US changed its rules on capital gains to allow individuals to avoid (on two properties no less) capital gains tax on less than $500,000. (Remember that the US allows a personal tax deduction on interest only for those associated with a home mortgage.) After that, banks and other lenders began liberalizing the documentation required to get home loans and lots of people qualified for loans that previously couldn’t. People do react to the economic incentives around them and the prices of houses in real terms began to soar — who couldn’t afford to be part of the great bonanza provided by Uncle Sam.
A second enabling factor was the huge fiscal deficit by the United States. George W. Bush decided to fight two global wars without a tax increase. The result was over a trillion dollars injected into the economy.
Next, the expansive fiscal policy was complemented by an accommodating monetary policy. From early 2001 when the tech downturn took place and accelerating after the 9/11 attacks, the Fed cut and maintained interest rates at very low levels. From their point of view, the Fed looked at domestic inflation and saw little impact, but did see a continuing weak economy. It continued its accommodating monetary policy into 2005-7.
Both the White House and Fed saw the positive impact of their policies in a steady US expansion. What they missed were the negative results. First, despite the grossly expansionary fiscal and monetary policies, there was little US inflation as measured by the CPI or WPI. Why — first of all housing prices were not included in the CPI — only rental prices as a proxy. Secondly, Washington didn’t look at the role of international markets. – specifically tradable versus non-tradable goods and services.
While US prices have not move dramatically over the past years, the subsets have. Internationally traded goods — like food, clothing and consumer goods — have shown little growth and in the case of electronics, prices have fallen. Why? Because as international trade barriers have fallen, cheaper international goods have flooded the US marketplace. The consumer has profited from lower prices. There have been negative effects for those workers in those industries who saw their jobs move overseas. Non-traded goods, like health care and education, soared since consumers had extra money in their pockets (often after having taken out second mortgages on their homes that suddenly were worth much more). And the non-traded good with the largest price increase — houses — were excluded from the index. In short, we exported part of the inflation (and at the same time lots of US jobs) and we were baffled at why education and health care continued to rise far faster than the CPI.
As Americans purchased more goods and services from overseas, the trade and current account deficits soared. Suddenly there were lots of US dollars flooding world currency markets. Here comes in the last element — normally, the rates of exchange would have corrected themselves by making dollars cheaper, pushing exports and decreasing imports. However during most of this time, China wanted to keep its exchange rate fixed to ensure continued export competitiveness. The Chinese were able to support the RMBI only by buying up the excess dollars, with which they bought US Treasury notes.
US home prices started turning down in late 2006 and accelerated this past year. As a result, many found their home prices less than the mortgage, causing defaults. That cascaded from the mortgage holders to the guarantors of the mortgages (Fannie Mae and Freddie Mac) to the investment banks (Bear Stearns, Lehman Brothers) to the insurers of the derivatives (AIG). At the same time, the Chinese government lost the capacity to control the influx of cash and resultant inflation. It has let the RMBI appreciate at a 15% per year rate and took severe measures to restrict the leverage of the Chinese banks. When the financial crisis hit in the US, the Chinese were also worried about buying US securities, accelerating the global credit crunch.
What’s the moral in this? Bad economic policy catches up with you. In this interconnected world, the results may be less easy to see, but the markets eventually punish excesses. So for all those who say Wall Street greed led to the collapse, you missed the essential elements. The bubble couldn’t have built up except for huge fiscal deficits, tax policy pumping up one sector, accommodating monetary policy and attempts internationally to fix exchange rates. Wall Street firms are supposed to be greedy — it’s the job of the politicians and ordinary citizens to make sure that this doesn’t happen.
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08.27.08
Posted in Economic Analysis, Exchange Rates, Finance, Government Resources at 3:43 am by Administrator
If you ever lived through a period of hyper-inflation, you know the effects on an economy. Savings are lost, basic necessities become scarce and credit disappears. Ending a period of high inflation always requires major contractionary policies, policies that inevitably hit the poor and weakest members of society the hardest.
I remember one time visiting in Brazil when the prices changed from the morning to afternoon. I was completely dumfounded by the currency — there were several varieties floating around and in one case the government just added six zeros to the old currency. One curious fact that I realized is that in high inflation economies, there are no coins. The metal in the coins rapidly becomes more valuable than the currency and bad money (cheap paper bills) drives out the good (copper or even aluminum).
The New York times reported this week about the crippling effects that inflation has had on Vietnam.
The country’s fledgling stock market, which had been booming a year ago, has fallen in volume by 95 percent and is at a virtual standstill.Squeezed on all sides, people are cutting back on food, limiting travel, looking for second jobs, delaying major purchases and waiting for the cost of a wedding to go down before marrying.
More importantly, the downturn has crushed hopes for a better life.
The mood in Vietnam, after years of upward mobility, is tense, said Kim N. B. Ninh, the Asia Foundation’s country representative. “I think people are pessimistic,” she said. “You sense a tougher environment, a more restricted environment, a more pessimistic environment. It’s a moment of turmoil, I think.”
So how does the international businessperson cope with the highly inflationary atmosphere? The answer to remember that “Cash is King.”
You certainly cannot extend credit in the local currency. You also have to check that your banks will continue to extend trade finance — if conditions worsen, even respected guarantee agencies like EXIMBANK will go off cover for a country.
All transactions have to be in a stable international reserve currency — usually the US dollar. Obviously a currency hedging strategy is useless with such volatility. But even be careful of contracts in dollars backed by dollar deposits from within the country. Argentines woke up in 2002 to find that their dollar deposits were frozen –even to pay for international contracts.
Lastly, rely on your customers to figure out how to handle the inflation and resulting foreign exchange problems. Frankly in the 1990s and early 2000’s the average taxi cab driver in Buenos Aires or Sao Paulo knew more about foreign exchange strategies that all but a handful of traders in London or New York. If you work with your established customers during the down times, they will remember you when the market stabilizes again. It always does return — the question is just how long until “again” arrives.
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06.11.08
Posted in China, Economic Analysis, Exchange Rates at 4:01 am by Administrator
The Bank of China again raised the amount of cash that banks must keep on hand. The reserve requirement limits the amount that a bank can on-lend. At its current level of 16.5%, a bank can lend out approximately six times the deposit base. Until mid-2003, the level was only 6%, allowing the banks to lend out 16 times the deposits. The authorities are trying to limit money supply (M1) growth and this rapid increase in the reserve requirements has done that. Interest rates (both lending and deposit) are up about 100 basis points although inflation remains a concern, particularly in the wake of skyrocketing prices for crude oil and other commodities.
Usually Central Banks regard changing reserve requirements as a sledgehammer approach to controlling inflation. Why did China pick this policy? The basic answer is that the continuing trade and current account surpluses are creating challenges in controlling the money supply. When a dollar comes in from an exporter, the Bank of China is required to convert it into yuan, thus increasing M1. With such a large and continuing surplus, the normal monetary policy controls (buying and selling of treasury notes) are overwhelmed. China has also been reluctant to use the other instrument of a major revaluation of the currency. (Note: the Peoples Bank of China has put the Yuan on a 15% percent annual appreciation course; nevertheless most observers believe that the currency continues to remain undervalued.)The change in reserve requirements is a much more blunt instrument and has effects of tightening credit, taking some wind out of the overheated economy. As noted in previous posts, watch out for major economic contractionary measures after the Olympics.
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02.14.08
Posted in Clean Technology, Exchange Rates, Strategies at 5:30 am by Administrator
GM posted this week a record loss of $722 million for last quarter. But digging into it further the loss was from the sagging North American operations where the company is rapdily losing market share to Toyota, Honda and other international manufacturers. For 2007, GM’s revenue was flat in North America compared to the 50% gain in Latin America and 20% growth in Asia Pacific. The company continues to lose automotive U.S. market share–falling from 23.6% in 2006 to 23.1% in 2007. GM barely held on to its title as the largest automaker in the world, beating Toyota by just 3,000 vehicles.
This result came at a time when the dollar was at record lows against the Euro and was relatively weak against the Yen. Yet international carmakers figured out how to cut prices of exports to the US. Most of the international auto makers also have operations in the US and they also managed to profit despite the rise in prices for imported components due the weaker dollar.
GM, like most US manufacturers, exports relatively few cars. It chose a strategy after the Second World War of having local assembly or manufacture. In fact, GM cars in Europe bear little resemblance to the ones produced in the US. There is some sourcing of parts from the US but most of the content is local.
Over the past two decades, GM and Ford international operations have been more efficient and profitable than the domestic counterparts. But it leaves the auto makers unable to take advantage of a weak dollar since they export little. On the other hand, when the dollar is strong, imports are more competitive.
The US automakers have vigorously fought the new high fuel efficiency standards. They now must retool to produce more efficient engines. The international manufacturers, particularly the Japanese, have already made the investments in clean technology.
GM has much to do with ”right-sizing” its domestic operations. It also faces challenges in “greening” its fleet. However, if the company loses such money in weak dollar environment, watch out if the dollar suddenly strenghens.
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01.26.08
Posted in Economic Analysis, Exchange Rates, Taxes & Tariffs at 12:31 am by Administrator
What was interesting about the tumult of the last week in global stock markets is that the concerns began in Asia about worries over the direction of the US economy. That led to Asian investors pulling out of US stocks and European investors followed suit. The US markets were closed on Monday but it was clear to the Fed and US Treasury Department officials that with the drop around the world, the US markets would face a tsunami of sell orders at opening bell. The Fed reacted quickly by cutting some rates by 3/4 of a point and the President and Congressional leaders advanced their timetable on a stimulus package. Was it enough? We’ll have to see but the markets are still clearly worried at week’s end. My personal opinion is that there are short term liquidity issues that the markets are reacting to and long term growth issues as the US consumer has cut back on spending due to changes in the mortgage market. The equity line of credit piggy bank, which financed most of the growth in consumer spending since 2002, has been broken. It’s going to take a while for the consumer to pay down debts to start consuming again.
But let’s think through the international business implications of the policy changes in Washington this past week. The cut in interest rates made short term financial investments in the US less attractive versus the Euro or Yen zones. That will keep the dollar weak, now at $1.46/Euro. That will be good for US exporters and for foreign tourism coming to the US. That will also make it more difficult for European countries to expand their economies via the traditional export markets. I would expect the ECB to also cut rates, even with the fears about inflation.
The economic stimulus package will also affect the other major trading partner of the US, namely China. With the Yuan tied to the dollar, the interest rate cut will have little effect. However with a larger percentage of US income being spent on imported goods (estimated to be 21% today versus 19% in 2001), the stimulus package will increase demand for goods from China and part of the stimulus package will leak out of the economy.
Bottom line — Weak dollar, boost for US exports to Euro-zone and boost for Chinese exports to US.
What is your opinion – post a comment!
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01.09.08
Posted in Economic Analysis, Exchange Rates at 5:34 am by Administrator
I found the article in the January 3 Economist entitled “An Old Chinese Myth” to be quite fascinating. It takes a contrarian view that increases in domestic demand, not the export surplus, have led to the economic boom in China.
Begin Quote: “MOST people suppose that China’s economic success depends on exporting cheap goods to the rich world. Headline figures show that China’s exports surged from 20% of GDP in 2001 to almost 40% in 2007, which seems to suggest not only that exports are the main driver of growth, but also that China’s economy would be hit much harder by an American downturn than it was during the previous recession in 2001. …If exports are measured correctly, however, they account for a surprisingly modest share of China’s economic growth…
“Jonathan Anderson, an economist at UBS, a bank, has tried to estimate exports in value-added terms by stripping out imported components, and then converting the remaining domestic content into value-added terms by subtracting inputs purchased from other domestic sectors.
“Once these adjustments are made, Mr Anderson reckons that the “true” export share is just under 10% of GDP. That makes China slightly more exposed to exports than Japan, but nowhere near as export-led as Taiwan or Singapore (which on January 2nd reported an unexpected contraction in GDP in the fourth quarter of 2007, thanks in part to weakness in export markets. Surveys suggest that one-third of manufacturing workers are in export-oriented sectors, which is equivalent to only 6% of the total workforce.”
I have a slightly different take on the process based on my experience in countries like Chile and Argentina which opened their markets to international trade in the 1980’s. An exchange-rate policy that favors exports at the beginning of the process is certainly an important first step. However, in my opinion, the key policy change is that by orienting the country to international trade, an economy can rapidly close the technology gap with the developed world. In doing so, productivity increases and domestic sectors that feed the export industry can also increase production. In a few years, countries that were laggards in technology because of self-imposed isolation can catch up to the most modern production techniques.
One of the issues that critics of globalization seize on is that income gaps widen during this process of modernization. This results from the above processes. The sectors that are open to international trade advance quickly, only limited by the pool of skilled workers, while traditional sectors lag. This is not the fault of globalization but rather a reflection of sectors where the economy has not kept up to date because of low skill levels. The answer is not to slow down globalization but rather to increase investments in education and infrastructure.
China has boomed not from low-wage exports or a “rigged ” exchange rate but rather by moving up the value chain. That in turn has allowed a good portion of the traded-sectors to grow rapidly. The challenge in China, as other economies have experienced, is to bring the non-traded sectors of the economy up to the same levels of productivity.
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12.12.07
Posted in Economic Analysis, Exchange Rates at 6:36 pm by Administrator
I recommend you read Steven Pearlstein’s article in today’s Washington Post. It reiterates a point in one of my earlier blogs that we are exporting the inflationary pressures of the excess demand from the large US deficit. That is sustainable only as long as China is willing to keep an fixed exchange rate and maintain sterilization operations to limit domestic Chinese inflationary pressures. As I noted last week, many analysts are expecting contractionary policies after the Olympics. Pearlstein put is very well in the on-line discussion this morning in the Post:
“Q: how long can nations such as China tie their currencies to the dollar? It seems to me that at some point, that strategy will backfire.
Steven Pearlstein: Well, there is a limit on how long they can do it, as we now see. Without getting into the details, let’s just say that all the market turmoil you are seeing is an indirect effect of their currency manipulation all these years with the currency of a large trading partner. It causes all sorts of other distortions in market economies and financial markets, and those distortions eventually cause problems that come home to roost. These may look like our problems at the moment, not China’s. But if you look more closely, you see that China’s economy is overheating, inflation is very high and rising, there are bubbles in its real estate market and its stock market, and things are looking a bit dicey for them as well. Because they are still a controlled economy, they think they can handle this and let the steam out gradually — they raised bank capital reserve requirements to 14.5 percent the other day, which is very very high in an attempt to slow growth in credit and money. But markets have a funny way of correcting indirectly what they are not allowed to correct directly. All of which is a longwinded way of saying that the peg can’t last much longer.”
What do you think? What would be the impacts on your business strategy?
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12.05.07
Posted in Economic Analysis, Exchange Rates, Strategies at 8:58 pm by Administrator
At the annual Business Climate Finance Outlook of the German American Business Association of California (www.gaba-network.org), Robert Prion of Citi Private Bank noted that his bank had lowered world economic growth estimates because of the US home mortgage crisis and because of an expected slowdown in China after the Olympics.
In China, the economy remains overheated, in part due to the dollar-pegged exchange rate. Because it is a non-reserve currency and is running a huge trade surplus, the Bank of China has had to undertake major sterilization operations to stop the money supply blowing up because of potential injections of dollars into the Chinese economy. The Chinese authorities have avoided taken the necessary adjustments (allowing the Yuan Renminbi to appreciate or significantly raising interest rates). (It should be noted that the government consolidated all credit decisions last week — a good first step.) However it appears that Beijing wants to wait until after Olympics to apply the brakes.
This is very reminiscent of what happened in Spain during their Olympic year of 1992. I was the economic attaché at the US Embassy during this period. The Spanish had pegged the peseta to the Deutsch Mark in the 1980’s and pumped up the economy with a major public works program to build infrastructure for the Olympics. (Spain was one of the fastest growing countries in the world in the 1980’s.) Shortly after the Olympics finished, Felipe Gonzalez took the necessary corrective actions, which led to his losing power to Aznar.
So in terms of strategy, my advice would to be to plan for a weaker Chinese market and an appreciation of the Renminbi.
What are your thoughts?
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11.30.07
Posted in Economic Analysis, Exchange Rates, Strategies at 5:03 am by Administrator
The economic laws of supply, demand, expectations and speculation work in the long run – it’s just that its sometime difficult to predict when the long run will occur. The mistakes of US economic policy over the past ten years (tax policy that gives incentives to spending over investing, large federal deficits, an energy policy that encourages petroleum imports, lax regulation of the mortgage market to name a few) have caught up with the US. We’re now facing a probable recession that will take several years to work through. One by-product is that the dollar has weakened substantially and it is part of the self-correcting nature of the markets. (The increase in exports helps expand the economy and jump start consumption.)
If your products are denominated in dollars, now is the time for your business to look at international markets. There are some short term profits that can be made solely on the basis of price and you can find those opportunities relatively easily. The mistake that many international business managers make is not following up on the low price “teasers” made possible by the favorable exchange rate. Take advantage of the opening by strengthening your international market presence: you should identify your customers, work as appropriate with distributors or local representatives and find ways to differentiate your produce/service from the competition in that market.
A recent study by the San Francisco Federal Reserve found that the export boom ended when the Fed raised interest rates as the economy matured. Thus, in your market strategy, use the opening to gain new markets and keep a close watch on the Fed’s interest rate policy (particularly the differential with the Euro rates). When the rates change direction, that is the time to work aggressively to keep the international markets.
You’ll find that if you can establish your product through weak and strong dollars, you will have a corporate strategy that will get allow you to weather weak domestic markets by expanding exports.
What is your stategy to take advantage of the weak dollar?
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