The
Buck Stops
What’s all this I’m reading about the
dollar, then?
My newspaper says that America is teetering on the edge
of a catastrophe so big that nobody even dares to talk about
it. They say that US consumers are spending their way right
into economic disaster, and that the rest of us are going
to have to bail them out when reality finally hits home.
And that the dollar is going to get a real bashing if we
refuse – maybe a 25% drop if things get really bad?
I’m hearing people say that the euro is structurally
undervalued by 15% and that there’s a wall of money
about to head back across the Atlantic. Can it be true?
And what would it mean for Europe?
Well, it depends who you ask. Talk to a US economist and
he’ll tell you that this whole business is being recklessly
overplayed by the foreign press. America’s fine economic
growth in the last six months is all the proof we should
ever need that the US is the most powerful, resilient economic
force in the world. And that everybody who complains about
it is simply jealous.
Ask a European, however, and you’ll get a different
story. The US has become so heavily addicted to a steady
influx of foreign investment capital that it doesn’t
even know that the problem is there any more. Even the huge
$450 bn current account deficit is only part of the regular
fix that Wall Street needs to retain its semblance of normality
– but if the Europeans ever withdrew even a little
part of their cash and pulled it back into European investments,
the effect would be enough to start a stampede that would
eventually make the very foundations of the world economy
tremble.
OK, OK, I’m trembling. What actually happens if the
Europeans repatriate their money?
Bad things. First, US corporations are going to find it
much harder to raise the money they need for their new projects,
because so far most of their new liquidity has come from
foreign investors, and not from US investors, who are currently
spending maybe 10 per cent more than they earn. Even before
the uncertain patch hit the US equity markets last year,
it was being estimated that private US investors were reducing
their portfolios by 5-8 per cent a year and spending it
in the malls.
Secondly, equities will drop steeply. With nobody left to
fund the US equity markets, the only way is down. Then,
once the US workforce realises that its stocks and savings
are worth much less than it thought, it will inevitably
start reining in its consumer spending. Which would be disastrous
for US businesses, to put it mildly. We’d see the start
of a spiral that could turn exceedingly nasty.
But the third worry is the biggest one. With all that foreign
cash gone, the likelihood is that the dollar will plummet,
and that US bank rates will have to rise even though the
consumer economy is quite fragile and heavily in debt. This
would undermine the bond markets in no small fashion - which
would be especially unfortunate since the government would
simultaneously have to make huge new issues to cover its
liabilities. All in all, the negative impact on the dollar
would compound itself in ways that hardly bear thinking
about.
I’m not feeling any better. So how much foreign
money is coming into the US?
Nobody really knows, but if you guessed in the region of
a trillion dollars a year you’d be in the right ballpark.
To start with, there needs to be enough to cover the current
account deficit, which is heading for $450 bn a year. Then
there are the government bond issues, a large proportion
of which are being bought by foreign institutions. And the
corporate bonds. And the CDs….
Whoa! A trillion dollars? That’s $3,000 a year for
every US consumer?
Yep. Or 8 per cent of Gross Domestic Product if you prefer.
That’s the current gap between America’s production
and its consumption. Indeed, at a rough guess it’ll
grow by another $1,000 this year. Can you really blame the
foreigners if they get just a little restless about the
continuing logic of bankrolling all those spending sprees
on Main Street?
So what’s so great about Europe then?
Well, for one thing it has a fundamentally more balanced
economic scene. Sure, economic growth in the US hasn’t
been that bad (2.5 per cent GDP growth is forecast this
year), and the most recent figures show that America’s
retail sales are quite bizarrely strong – total year-on-year
sales were up about 7.5 per cent in April. But that’s
where US analysts part company with their foreign counterparts.
For US observers it proves that America is in good heart
– but for foreigners it just confirms the impression
that US consumers aren’t even interested in balancing
their incomes with their outgoings. Instead, they’re
irresponsibly shoving the problem further and further into
the distance.
Now compare this with Europe’s situation. Its private
consumption levels are holding up reasonably well (up about
3 per cent this year), but the sales figures are very much
more in keeping with the underlying state of the European
economy, which is forecast to grow by 1.5 per cent this
year and by 2.5 per cent next year.
Certainly, European unemployment (5.1 per cent in Britain,
8.4 per cent in the euro area) is rather worse than in America,
where joblessness is currently around 6.5 per cent. But
do we really need to spell out to you how many US jobs are
effectively being paid for with European money? And with
European political sentiment now moving back toward the
right wing, would it be surprising if conservative economics
started to make people ask why they shouldn’t be spending
their money on their own economies rather than the American
one?
Spoken like a true European. But if the US crashes, won’t
Europe suffer terribly as well?
Yes indeed, the traditional consensus is that we’re
all going to be in big trouble if the US market goes down.
Conventional wisdom says that any major downturn in the
US market is inevitably translated into a similar crisis
in all the other developed-country markets.
First the US will be forced to start scaling back its imports
from other countries; then that loss of business will hammer
their own manufacturing industries so badly that they’ll
soon start to develop major crises of their own; and then
finally the rising levels of industrial unemployment will
start to affect their consumer sales while also making it
hard for their companies to raise more money. In short,
the US domino effect will rattle its destructive way through
every level of European society, leaving no-one unharmed.
Anybody thinking of removing his money from America needs
to take this grave possibility into account.
So it’s a case of moral hazard, then? Uncle Sam
owes us so much that we daren’t let him get into difficulty?
You could put it like that. But maybe we should look
at a few facts before we panic. Things have changed quite
a lot since the 1980s, which was the last time that a problem
in the US became an automatic stock market disaster for
everybody else. For one thing, we now have the Single Market
in Europe, which means that European Union countries are
less dependent on non-EU exports. Nowadays intra-EU trade
accounts for almost 90 per cent of all their cross-border
transactions.
At the same time, the harmonisation of European business
law is making a big difference to the economic integration
of continental Europe. The Single Market in particular has
made Europe a lot more capable of co-ordinating both its
regional and its business strategies in ways that have improved
efficiency immensely.
For another thing, those equity overvaluations in the States
are really in a different league from anything we’ve
seen in recent decades. In late May the S&P Industrial
was running a price/earnings ratio of 66, compared with
22 for the FTSE 100in London, 15 for the usual French and
German indices and 16 for Spain and Austria. And can it
be a coincidence that the much-derided euro is now the world’s
favourite currency for new corporate bond issues from all
over the world? After all, you know what they say about
bond investors. They have a much better grasp of the long-term
issues than the rest of us.
You don’t sound as gloomy as I expected.
Perhaps we don’t need to be, for reasons we’ll
explore in a minute. But first we ought to pinpoint one
area of concern. Germany is the one European country that
may really feel the pressure from a weaker dollar. Its manufacturing
industries (Siemens, Volkswagen, DaimlerChrysler, Bayer
and the rest) tend to be unusually heavily dependent on
US sales. Besides, Germany isn’t exactly in a healthy
situation anyway at present, because its economy is still
struggling. Its costs are high, its ability to compete with
cheaper euro-zone competitors is in doubt, its government
borrowing is excessive, and it has an election coming up
this autumn where unemployment is going to be the number
one issue.
Whoa again, aren’t you saying that the locomotive
of Europe could be running out of steam? Surely that would
be disastrous for the whole European bloc?
It wouldn’t be good for Germany, that’s for sure.
And there are bound to be some knock-on effects for every
European country if the worst happens. But France, Italy
and Spain will feel the impact very much less directly than
Germany. This is not just because their sales to the States
are in the region of 6 per cent of their total exports (compared
with 9-10 per cent for Germany) – it’s also because
they’re directly in competition with Germany for the
internal European export market, which could well mean that
they actually stand to benefit from Germany’s discomfort.
The main worry would be if Frankfurt’s fiscal troubles
drove it to adopt drastic overspending measures that would
undermine the strength of the euro.
Isn’t that bad enough to be going on with? Won’t
any kind of uncertainty in the euro zone drive investment
money away from the EU?
You’re forgetting something important. Unfortunately
for them, the money market men don’t have the option
of taking their money right out of the currency nexus and
sitting on it until conditions start to improve. Providing
that they don’t all rush out to buy gold bullion, then
we can safely say that all their money will always be invested
in one major world currency or another. A weak dollar would
simply mean that these people would have to go out and find
some other currency that wasn’t weakening so fast.
The euro does not need to be perfect – just less bad
than the dollar.
That’s why there’s a better-than-even chance that
any negative impact on Europe’s fundamental development
would be offset at least temporarily by a healthy inward
flow of investment cash from across the Atlantic.
I
can’t believe you’re saying this. Do you really
think that a big inrush of money into the European stock
markets is an adequate compensation for a downturn in Europe’s
manufacturing fundamentals? Surely the equity rush will
just put money into investors’ pockets, whereas the
industrial downturn will hammer the underlying companies
who do all the work? Isn’t that a bit lopsided?
Yes, absolutely. But here’s a funny thing. For practically
all of the 1990s, the US economy was pulling exactly the
same crazy stunt on the Europeans. The money that flowed
into American equities in the 1990s didn’t benefit
US businesses at all, except in those rare instances where
US companies were able to tap into the corporate bond markets
on the back of their higher share prices. There were some
good reasons for the money influx, of course (new technology
and a strong consumer economy), but there was also an unwillingness
to recognise the reality of the situation, which was that
in domestic terms the US economic boom wasn’t paying
for itself. And when the influx of foreign cash eventually
went too far, it left US businesses ludicrously overvalued
and without any real incentive to shape up and get competitive.
That’s partly where the protectionist pressure for
US import tariffs is coming from now.
So
you’re suggesting that it won’t be an altogether
bad thing for the global economic balance if some of the
foreign money comes back to Europe. Because, in the long
term, the right place for money to be is the place where
wealth is being generated - and not necessarily where it’s
being spent?
Goodness, we’re getting somewhere at last. Commonsense
will triumph eventually. Pass it on.
