Foreign Exchange Outlook : The US may have lost some of the shine off its FIFO standing by having dithered a little, with
Paulson changing his mind about direct investment in banks instead of just buying paper, now that the UK led the way with a big 3-part plan pretty much accepted by the rest of the world. What the US has that the
ECB does not have is the ability to support the corporate world directly by buying/backstopping commercial paper. Other central banks have to keep the banks funded and hope they lend to the players in the real economy. Cold, hard cash is always nicer than hope in a panic.
On the whole, the US has better recuperative powers than other economies, so the FIFO story is not gone and forgotten. And the US has some problems that other economies do not have, namely Detroit and a discouraged consumer who is two-thirds of the economy.
Germany, to take an example, can stimulate exports with subsidies and tax breaks. The US doesn’t have that option—does it? Don’t ever think this is not a competition. It is certainly viewed as a competition in Europe, if not in Washington. We laughed until it hurt upon reading the first report that the combined European rescue plan is $1.4 trillion, exactly double the US number. You can just imagine those guys sitting around saying “That’ll show ‘em who has guts.” (The
dollar amount of the combined European plans keeps changing in each report, but it’s true that it’s roughly double.)
As for the inevitable recession, pundits are now saying that the probability of a Depression has receded to a low level now that governments have acted (and the stock market voted them good guys again, at least for a day). Business Week says the recession will likely be long but mild. Past recessions since the War lasted 10.4 months, cut 2% from GDP from peak to trough, and unemployment rose about 3%. It’s interesting that inflation (ex food and oil) always falls in a recession. In retrospect, the NBER will probably date the current recession from Dec 2007. If it runs 16 months to April next year, that would put it on a par with the recessions in 1973-75 and 1981-82. If we consider what was going on in the world during those earlier recessions, especially the oil crisis in 1973 (and subsequent floating of the dollar), maybe what’s happening now is not that much more of a shock. After all,
Warren Buffett was not the only doom-sayer. Plenty of people, including new Nobel laureate Krugman, said the
housing bubble could have disastrous consequences. So let’s say the US loses 2%--we would still have growth around 1.5% by the middle of next year. Europe will be lucky to get 1%.
We’re not so sure that this recession is not different in some qualitative ways even if in the end the economic data puts it in the same class as other recessions. For one thing, the moral dimension is far bigger, broader and deeper.
Individuals behaved badly.
Banks and mortgage brokers behaved badly. Investment managers behaved badly, buying pie-in-the-sky stories from quants. Governments and their regulators behaved badly. The Fed behaved badly, if you accept that Greenspan’s Randian fantasies overruled common sense. If you cut interest rates to 1%, you need to take other steps, chiefly regulatory, to avoid abuse. How can the Rand/Greenspan libertarians not see that avarice is a powerful and anti-social thing? It’s not healthy for a society that so many people turned a blind eye to lying on mortgage applications and mortgage approvals. Subprime may be only a small portion of the overall problem but it’s a pernicious disease. In the old Soviet Union, there was a joke that “
the workers pretend to work and the state pretends to pay them.” In the US, we have a similar joke—“
we pretend we are rich and the banks and brokers pretend to believe us.”
Now the US faces a moral dilemma of the highest order—the government will decide which financial institutions will survive and which will not. Capitalism is not supposed to work this way, but that’s not even the main point. This is how we’re doing it for the sake of expediency, so let’s accept it for a moment. The question then becomes HOW will the government decide who survives and who does not? The opportunities for fraud, corruption, error and injustice are nearly endless.
The other moral component is the punishment to be meted out to the miscreants. In Europe, executive heads are going to roll-that has been the sentiment all along and was featured in German FinMin Steinbrueck’s 8-point list of prerequisites for rescue plans. So far we have heard that the
Royal Bank of Scotland CEO was given his walking papers, with no golden parachute.
TreasSec Paulson has said he disapproves of government dictating executive pay, but these are not normal circumstances. He who pays the piper gets to call the tune, right? And it’s not just jettisoning the top executives. The public is pounding on the table for some of these guys to go to jail, certainly not to be allowed to stay in their jobs at high pay. Presumably we can spare them with over 100,000 former financial sector workers on the street and a great sector consolidation about to begin. Alas, we fear that the only charge available will be “stupidity” and you can’t send a guy to jail for that (can you?). When it comes to the moral outrage issue, it looks like the British and Europeans have a firmer grasp on the concept of the social contract that says people fortunate enough to rise to wealth and high social status are duty-bound not be to greedy cads.
But back in the real world of money flows, we need to note two developments. The first is that bond yields everywhere will be rising as governments issue new paper to fund the bailouts. Even if the US, UK and Europe engage in additional
interest rate cuts on the very short end, the yield curve must steepen as new paper comes along. This is also a competition for the world’s savings, and as we know, the world’s biggest savers reside in Japan, China and other emerging markets. What about Middle East sovereign funds? We are getting silence on that front.
Panic and blood on the street always causes hot money flows. Market News reports a fascinating development, that during Sept, capital flowed out of China. “
Foreign exchange reserves hit a new record of $1.906 trillion at the end of September, up about $98 billion from the $1.808 trillion at the end of the first half. But a monthly breakdown of the quarterly increase suggests an estimated $20 billion to 25 billion left China in September, according to Stone & McCarthy…. The $21.4 billion increase in September --much smaller than the combined $29.3 billion trade surplus and $6.64 billion foreign direct investment during that month -- could raise the spectre of capital outflows, rather than the inflows that the government has long been concerned with.”
Exactly whose money is this? It could be private individuals, including wealthy Chinese and some living outside the country, who expected the crisis to spread to China, or it could be corporate money going home in the Western credit crunch. Remember, there’s a lot of Japanese money in the Chinese stock market, too. In a related matter, some analysts say the
dollar exchange rate could be the beneficiary of repatriation flows for the same reason. How much money does (say) GM or GE have in China?
We expect the
dollar exchange rate to seesaw early in the week as we await the market’s judgment on the various bailout plans. So far analysts are impressed by the Europeans lacking the institutional infrastructure to create a clear and coordinated master plan. We say this is wrong. It is a huge plan when all the pieces are put together and there is no reason it won’t work just as well (if not better) than a eurozone-wide plan. And the US plan to be announced in more detail today has many potential pitfalls. The dollar could dive a lot early in the week, especially if oil rallies as it appears likely to do. But by the end of the week, if real confidence is restored, the
US dollar can come back on the FIFO growth story. We hate to say it, but we must watch the stock market as the symbol of sentiment.
Bye for now
Barbara Rockefeller -
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