The Great Debate

U.S., China and eating soup with a fork

Bernd Debusmann

Oct 29, 2010 10:35 EDT

-The opinions expressed are the author’s own-

Are economists the world over using an outdated tool to measure economic progress?

The question, long debated, is worth pondering again at a time when two economic giants, the United States and China, are sparring over trade, currency exchange rates and their roles in the global economy.

In the run-up to U.S. mid-term elections on November 2, politicians from both parties, for different reasons, blamed trade with China for American job losses. China responded with irritation and hit back by accusing the U.S. of “out of control” printing of dollars tantamount to an attack on China with imported inflation.

Measured by Gross Domestic Product (GDP), the United States tops the list of countries. China overtook Japan in August to become number two. Depending on whose forecasts you believe, China will overtake the United States in 2020, 2035 or 2040 and therefore turn the 21st century into the long-predicted Chinese Century. It’s becoming conventional wisdom that the United States will play a reduced role on the world stage.

Crystal ball gazers might do well to remember that long-range forecasts have often been wrong in the past. At the turn of the 20th century, eminent strategists predicted that Argentina would be a world power within 20 years. In the late 1980s, Japan was seen as the next economic leader, on the strength of supposedly unstoppable progress. Forecasters extrapolated from past GDP growth rates.

They are widely used to compare standards of living in one country with those in another but critics say GDP is too narrow to be a realistic indicator. Joseph Stiglitz, the Nobel-prize winning American economist, has complained that world leaders make a fetish out of it and suffer from GDP-obsession.

from The Great Debate UK:

A history lesson for lenders

Laurence Copeland

Jun 9, 2010 08:07 EDT

-Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.-

Anyone looking for a broader perspective on the events of the last three years could hardly do better than choose for bedtime reading “This Time is Different” by Carmen Reinhart and Kenneth Rogoff.

It is nothing less than a history of financial crises through the ages, starting in late medieval England and continuing via 15th and 16th century Spain and its New World colonies on to the teething problems of Britain’s banks in the industrial revolution and the upheavals of the 20th century, ending in 2008 with the bankruptcy of Lehman Brothers.

The emphasis throughout is on sovereign default. For many politicians, bankers and economists, it ought to read not just as a lesson, but as a severe rebuke, because its basic message is that there is nothing new under the sun and that financial history reads like a long catalogue of facts we have chosen to forget.

So, as the authors show, no country’s history is free of bank collapses, sovereign defaults and currency debasement in one form or another.

Many countries have been serial defaulters, and – surprise, surprise! – the recidivists include some of today’s shakiest sovereigns, notably Greece (which went bust several times in the first decade or two after it gained its independence in 1821, and has never in its history merited a good credit rating) and Spain, which after many defaults in the pre-industrial era seemed until relatively recently to have reformed.

from MacroScope:

Political economy and the euro

Mike Dolan

Feb 8, 2010 13:18 EST

The reality of  'political economy'  is something that irritates many economists -- the "purists", if you like. The political element is impossible to model;  it often flies in the face of  textbook economics;  and democratic decision-making and backroom horse trading can be notoriously difficult to predict and painfully slow.  And political economy is all pervasive in 2010 -- Barack Obama's proposals to rein in the banks is rooted in public outrage; reading China's monetary and currency policies is like Kremlinology; capital curbs being introduced in Brazil and elsewhere aim to prevent market overshoot; and British budgetary policies are becoming the political football ahead of this spring's UK election. The list is long, the outcomes uncertain, the market risk high.

But nowhere is this more apparent than in well-worn arguments over the validity and future of Europe's single currency -- the new milennium's posterchild for political economy.

For many, the euro simply should never have happened --  it thumbed a nose at the belief that all things good come from free financial markets; it removed monetary safety valves for member countries out of sync with their bigger neighbours and put the cart before the horse with monetary union ahead of fiscal policy integration. But the sheer political determination to finish the European's single market project, stop beggar-thy-neighbour currency devaluations and face down erratic currency trading meant the  currency was born and has thrived for 11 years.

Now the budgetary and bond market upheaval currently afflicting euro member Greece and stalking  Portugal, Ireland, Spain and Italy has reawakened the whole debate. "Will the euro survive?" seems a legitimate question once again.

Apart from financial analysts, Paul Krugman seems to have made his peace with the euro's existence but he still reckons it was a bad idea. Eric Maskin thinks financial markets are right to question the future of the single currency. And much is being made once again of Milton Friedman -- high priest of 20th century monetarism -- having reportedly said in 1998 that the euro would not survive the zone's first serious economic downturn.

But having an opinion about the euro is not the same as knowing whether it is going to survive. And this is what most annoys those who have money at stake. Plugging in a new set of variables into complex econometric equations is probably not going to get any of these experts closer what happens next. Hanging around the corridors of power in Brussels, Frankfurt, Berlin or Paris is likely to prove more fruitful.

In the 1990s, many financial strategists in London, Manhattan and elsewhere often confused what they thought should happen with what was likely to happen and got the call wrong on one of the most far-reaching monetary events of the century.

from The Great Debate UK:

Slow growth and deficit stem lure of dollar

Jane Foley

Oct 27, 2009 20:01 EDT

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The U.S. dollar may have found support this week but the USD index remains at a 14-month low.

The impact of the financial crisis in drawing buyers to the "safe-haven" dollar has in effect been almost cancelled out by the healing in risk appetite. The dollar looks to have re-embarked on the downtrend that had been in place for more than two years prior to the start of the financial crisis, only now the U.S. fundamentals have arguably deteriorated further.  

Slow growth and a hefty budget deficit are likely to hamper the attraction of the dollar for some time.  That said, there is a huge invested political interest in ensuring that any further declines in the dollar remain orderly.

The weakness of the dollar has already prompted some Asian countries such as South Korea and Taiwan to intervene in order to prevent the appreciation of their currencies impacting competiveness.  This action can be viewed as a protest against the renminbi-dollar peg and a guard against losing competitiveness to China.

As the euro rises against the dollar, it is also rising against the renminbi and -- spurred on by the actions of other Asian central banks -- the chances are that it will continue to appreciate against a host of other Asian currencies.

Since the start of last year, the euro has risen by 37 percent against the South Korean won.  In recent comments, French Finance Minister Christine Lagarde stressed that she did not want to see the euro bearing the brunt of the downward adjustment of the dollar. 

Getting ready for the dollar’s fall

Agnes Crane

Aug 20, 2009 07:37 EDT

It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.

Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.

But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.

Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.

“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.

Is the buck back?

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. The opinions expressed here are her own.

“The Buck is Back,” proclaimed a Wall Street Journal headline on Tuesday. But even if it is, and that’s a big if, a strong currency is a mixed blessing.

True, in spite of the financial crisis, over the past six weeks the dollar has strengthened substantially against the euro and the British pound, although Wednesday’s half percentage point Federal Reserve rate cut caused the dollar to slip. But the dollar has lost value relative to the Japanese yen.

What’s really happening is not that the dollar is strengthening on its merits, but that European currencies are weakening.

“For the dollar to depreciate, it has to depreciate against another currency. America isn’t looking great, but Europe is looking even worse,” explains American Enterprise Institute resident fellow Desmond Lachman.

Europe’s worsening economic problems — greater than America’s — are causing some investors and the army of regular foreign exchange speculators to prefer dollar assets, what foreign exchange traders call a “flight to quality.”

Approximately 40 percent of America’s subprime loans are held abroad; the British housing market is deteriorating; the British government is bailing out the City of London’s famed banking sector; and European banks hold risky investments in slowing Eastern European economies, especially Russia.