They’re calling The Oughts a Lost Decade. Yet how could that possibly be? The experts keep telling me a weak dollar brings prosperity. But look at this chart from Carpe Diem:
Ed Yardeni expounds:
I’m not sure, but it seems to me that the dollar is the best of a dodgy breed. The Old World nations–Europe, Japan, and the United States–have rapidly aging populations. Their outlays on social welfare are rising faster than their GDPs. Their dependency ratios–the number of retired persons supported by each worker–are taking off. This suggests to me that the dollar, the euro, the pound, and the yen (DEPY) might all continue to be good shorts relative to gold. (See Figure 5 in our Gold chart book linked below.) Gold is widely viewed as a hedge against inflation. More broadly, it is a hedge against out-of-control debt-financed government spending.
The currencies of the New World should also continue to outperform those of the Old World. While the economies of the Old World are likely to stagnate as a result of the expansion of their social welfare states, the economies of the New World are likely to continue to rapidly improve their standards of living. The proliferation of free trade and globalization should continue to boost prosperity in the emerging economies of Asia, Africa, the Middle East, and Latin America. As discussed below, China is leading this charge and pushing up commodity prices. Australia, Canada, South Korea, and Taiwan are included in my New World paradigm.
My pal Felix Salmon makes a good point about the dollar and Dubai. The greenback initially slid on the news. But isn’t the greenback supposed to be a safe haven. Felix opines as follows:
Needless to say, this isn’t exactly a classic risk-aversion reaction: when the markets are really scared, they tend to flee to the safety of the dollar, rather than to the Japanese yen. So my feeling is that this — along with the relatively modest stock-market reaction in New York this morning — counts as a sign that Dubai really isn’t all that bad: it shows that markets are trading the news, rather than panicking.
On the other hand, it’s clearly not good news that a severe-if-not-life-threatening shock such as this one sends the dollar down rather than up. The immense fiscal cost of the financial crisis has hurt the dollar’s standing as the global reserve currency, and if I were at Treasury right now I’d be very concerned about this reaction. Not that there’s much Treasury can do about it.
I spent all morning at a Senate Budget Committee hearing looking at how to create a special commission that would devise a plan to fix America’s long-term budget shortfall. This would be like the base-closing commission where a panel — made up mostly of senators and congressman — would submit a plan to Congress that would have to be voted on — up or down, no amendments.
Among the economists and budget experts who testfied — Douglas Holtz-Eakin, Maya MacGuineas, David Walker and Willam Galston — there was widespread agreement that a) commission is a good idea, b) ObamaCare does little to change the long-run fiscal outlook for the better, c) we may be approaching the point where global financial markets rebel as American profligacy, d) Obama will have to break his campaign promise and sharply raise middle-class taxes (in addition to healthcare taxes, of course).
But it would be my guess that Team Obama is more worried today about rising unemployment than rising deficits.
If the Reserve Bank of India’s directors had any doubts about the wisdom of buying 200 tonnes of IMF gold — and likely dumping some U.S. Treasuries in the process — they had only to watch last weekend’s legislative activities on Capitol Hill. The proceedings provided plenty of reassurance that the move was a smart play.
Nothing in the healthcare reform bill that passed the House of Representatives should give investors in dollar-denominated assets any confidence that U.S. policymakers are serious about tackling the government’s structural budget deficit.
And if the dollar’s gradual decline hastens dangerously, deficit fears might well be the catalyst.
Yes, the healthcare plan does slightly trim the 10-year budget deficit from where it would be otherwise. But America’s long-term entitlement problems are such that healthcare reform needs to cut long-term health costs substantially rather than just being “deficit neutral”.
Even worse, to believe in even the modest claims of deficit neutrality, one has to also possess faith that some $500 billion in 10-year Medicare cuts will really happen. That is a monstrously tall order when Congress is working feverishly to restore those cuts in legislative side deals.
Another way the House proposes to pay for reform is through a 5.4 percent income surtax on wealthier Americans and small businesses.
Like America’s alternative minimum tax, this surtax is not indexed for inflation. So every year, the levy will affect more and more taxpayers. Unless, of course, Congress passes a temporary fix every year, as it does with the AMT. Such a move would protect the middle class, but it would also make expanded healthcare coverage a fiscal fiasco.
The House plan will surely be altered by whatever the Senate passes, assuming the Senate is able to pass anything. But the House bill is still a disturbing sign that fiscal rectitude is a low priority for at least half of the legislative branch.
Higher gold prices seem to go hand in hand with bad U.S. economic policy, be it the higher inflation of the Carter years or the budget busting of the Bush II years. And surging gold prices may be giving a thumbs down to Washington economic policy this time as well
Perhaps the real reason Gordon Brown suggested a securities transaction tax was to tamp down on currency speculation that driven down global currencies vs. gold. Willam Rees-Mogg explains:
At St Andrews, Gordon Brown unexpectedly advocated the adoption of a global Tobin tax. He was immediately repudiated by Timothy Geithner, the US Treasury Secretary, and by Dominique Strauss-Kahn, the head of the IMF. The proposed global Tobin tax has the support of Oxfam and of some left-wing economists, but without American support, it does not have the least chance of being adopted.
The Swedes experimented with a national transaction tax in the 1980s. It did not work because bankers avoided paying tax by transferring transactions to markets in which it was not imposed. The tax had to be abandoned in the early 1990s. This negative history must have been known to Mr Brown; perhaps the clumsiness of his diplomacy reflects the pressure he is feeling.
In Britain, there is an urgent need for a new tax base. One can take almost any very large figure as the sum needed to balance the budget. At some point, Britain will have to raise taxes and cut expenditure. It is hard to see where this additional revenue can be found.
No doubt it would be helpful to Mr Brown if the other governments of the world would join him in policing a worldwide transaction tax on the banks. Britain would be a major beneficiary. Like the US, Britain has a combination of very large bank debts with a very large budget deficit. As a response to the recession, large sums of money have been injected into these economies. That has eroded global confidence in the pound and dollar.
If there is no Tobin tax, it will be difficult to rebuild confidence in these currencies, and the Tobin tax is not going to happen, if only because it would not work. Two factors emerge. Gold will be a stronger reserve currency than paper, and the market will increasingly decide national policies. “You can’t buck the market”, whether in taxes, in dollars or in gold.
The great Andy Busch of BMO Capital Markets sees some problems down the road:
It’s called carry, but not like currency carry. As most know, banks can fund themselves at 0.1%-0.25% as the Federal Reserve keeps Fed Funds at 0.0%-0.25%. Then banks are incentivized to find the safest, highest return they can with this cash.
Then where is this cheap money going? Why back to the US Treasury! Banks earn a somewhat risk free return on their cheap money from the Fed by purchasing US Treasury securities.
But there’s one more big incentive for banks to do this carry trade. If they buy something other than Treasury securities, they have to set aside a percentage of the assets value based on the risk weighted asset rating. This carry is only limited by what regulators will allow the bank’s leverage ratios to reach.
As the world looks to see how the massive US Treasury auctions are going, don’t be fooled into thinking that the US government can easily fund itself because the markets have confidence in defect reduction down the road. As the economy recovers and the business environment shifts, this bank-Treasury carry trade incentive will be reduced as the Fed raises interest rates and the cost of funding the carry goes up.
Therefore, the appetite for US government securities will be reduced as well and we’ll get a much better view of how the world feels about the US massive fiscal deficit.
Allan Meltzer on deficits and the dollar:
The administration admits to about $1 trillion budget deficits per year, on average, for the next 10 years. That’s clearly an underestimate, because it counts on the projected $200 billion to $300 billion of projected reductions in Medicare spending that will not be realized. And who can believe that the projected increase in state spending for Medicaid can be paid by the states, or that payments to doctors will be reduced by about 25%?
While Chinese government purchases of U.S. debt may delay a dollar and debt crisis, they also delay any effective program to reduce the size of that crisis. It is far better to begin containing the problem before the U.S. blows a hole in the dollar and starts another downturn.
A weak economy is a poor time to reduce current government spending or raise tax rates, but we don’t require draconian immediate changes. We do need a fully specified, multi-year program to restore fiscal probity by reducing spending, and a budget rule that limits the size and frequency of deficits. The plan should be announced in a rousing speech by the president. The emphasis should be on reducing government spending.
Me: This could be just like in 2004 when President Bush ordered the Marines to take Fallujah right after the election. Maybe right after the 2010 midterms, Obama will announced a VAT.
This paper make a great case for blaming the Great Recession on the massive influx of cheap labor (and the continued weak yuan) into the global economy. Bad decisions on Wall Street didn’t help, but they are not the root cause:
The common wisdom is that cheap money and lax supervision of financial institutions led
to this financial crisis, and solving that crisis will take us out of the recession. In our view,
the financial crisis is just the symptom. The fundamental cause of the crisis is the huge
labor supply shock the world has experienced, not the glut in liquidity in money supply.
In what follows we argue that this huge and rapid increase in developed world’s labor
supply, triggered by geo-political events and technological innovations, is the major underlying
force that is affecting world events today. The inability of existing financial and legal
institutions in the US and abroad to cope with the events set off by this force is the reason for
the current great recession: The inability of emerging economies to absorb savings through
domestic investment and consumption caused by inadequate national financial markets and
difficulties in enforcing financial contracts through the legal system; the currency controls
motivated by immediate national objectives; the inability of the US economy to adjust to
the perverse incentives caused by huge moneys inflow leading to a break down of checks
and balances at various financial institutions, set the stage for the great recession. The
financial crisis was the first symptom.
The great Andy Busch of BMO Capital Markets effortlessly explains the link between the current anemic state of the dollar and America’s terrible fiscal situation:
The US fiscal deficit remains the major concern for US dollar reserve
holders and the situation is not improving. Granted, the peak of new
Treasury issuance occurred in August. However, there is no sign from
Washington that spending will be under control any time soon.
This is why you have seen this week US Treasury Secretary Geithner and
Federal Reserve Chairman Ben Bernanke all warn that the US fiscal
deficit must come down or risk disaster. They know that the US dollar
is weakening due to this red ink. 2009 fiscal deficit was an astounding
$1.4 trillion as spending increased from $3.0 trillion to $3.5 trillion
while tax revenue fell from $2.5 trillion to $2.1 trillion. The debt is
now at $12 trillion and is expected to grow by another $9 trillion over
the next decade.
Without any changes to health care, the CBO estimates spending for
Medicaid and Medicare is expected to grow $700 billion over the next
decade. With health care legislation conservatively estimated to add
another $900 billion to the deficit, the numbers are spiraling out of
control. Actually that phrase doesn’t do the situation justice. Maybe
the trailer for the movie 2012 is more appropriate.
Most disturbing is the combined level of federal, state, and local
government spending. According to the OECD, this totals up to 42% of
U.S. gross domestic product. Think about it: 4 out of every 10 dollars
of everything produce in this country is channeled through governments.
Quick poll: who thinks this is the most efficient way to run an
The point is that the US has embarked on a glide path of spending that
is making the currency weak and US dollar reserve holders knees weak,
too. The Federal Reserve appears to be the only one left in the
government who can do something about it by raising rates. With
unemployment expected to continue upwards, this is not expected to
This means that in the short term, the only change to the downward
direction for the US dollar has to come from outside the country. So
far, Brazil and Canada have acted. In the long term, the US has to act
to change spending or rates. Unfortunately, Congress is likely to
actually increase spending while the Federal Reserve is unlikely to
Therefore, the US dollar is likely to remain weak for a long period of time.