More economic predictions, this from "The Financial Times." China sells us what we want for promises to pay sometime.
Lindybill@headhurt.com
Europe's challenge
Published: December 6 2003 4:00 | Last Updated: December 6 2003 4:00
Inch by inch, the dollar is losing ground against the euro. The latter is now worth $1.21 compared with the low of July 2001, when the single currency was worth just 84 cents. Currency traders have had a change of heart from the late-1990s, when they equated economic with currency strength. Back then, that meant a preference for the dollar, and the booming US economy, over the currencies of the pedestrian eurozone and moribund Japan.
After the brief recession of 2001, the US economy now looks as strong as ever. Although the non-farm payroll growth announced yesterday was a little disappointing, third-quarter growth in gross domestic product was a remarkable annualised 8.2 per cent. Consensus forecasts for 2004 see the US growing 4.2 per cent, compared with just 2 per cent for Japan and 1.8 per cent for the eurozone.
But this growth superiority is no longer doing the dollar any good. Instead, investors are focused on the US's ever-widening current account deficit: a shortfall that requires $1.5bn a day of foreign capital to finance it. Those investors are unlikely to be attracted by US yields; short-term interest rates are just 1 per cent (and negative in real terms) and the US 10-year Treasury bond yields a few basis points less than its German equivalent.
And once a currency slide begins, the incentives to hold it rapidly reduce. For a European investor, this year's 21.5 per cent rise in the US equity market translates into just a 5.6 per cent gain in euro terms, 25 percentage points behind the return from the German market.
Fortunately for the US, there are still some willing financiers of its current account deficit: the Asian central banks. They are keen to keep their currencies steady against the dollar so as to give their exporters a competitive boost. US demand keeps their factories busy. So they are happy to act rather like bourgeois merchants supplying the Victorian aristocracy - exchanging their goods for eventual promises to pay. At some stage, after their holdings of Treasury bonds have fallen sharply in value, the deal may start to pall but that stage may be years away.
The Asian reluctance to let currencies appreciate against the dollar puts more of the adjustment burden on the eurozone and on peripheral currencies such as sterling and the Australian dollar. In theory, that should allow the European Central Bank to cut interest rates. Such a move would head off the deflationary impact of a rising euro and play its part in rebalancing the global economy, reducing dependence on US domestic demand.
In practice, however, the ECB may be unwilling to play this role. It is already aggrieved at the failure of France and Germany to stick to the deficit terms of the stability and growth pact. And it seems to feel that the US current account deficit, being the result of US profligacy, is not Europe's problem to deal with.
For the moment, the boom in global trade is pulling the eurozone out of the mini-slump seen in the first half of the year. Export volumes are so strong that it matters little that European exporters are less competitive.
But it is not difficult to see where this delicate balancing act could go wrong. The Chinese economy could overheat, slowing the growth in global trade. Private investor reluctance to own US assets could push up Treasury bond yields, thereby applying the brakes to the US recovery. Faced with a rising currency and a slowing global economy, Europe could be caught in a very nasty squeeze.
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