two major bone-head policy mistakes in just a few days by the President and his staff
... that Bob Rubin very likely would have prevented - just the kind of stuff that the U.S. does not need right now in terms of destabilizing our economy.
From my macro economic 'bible', "The Economist" ...
Releasing America’s Oil Reserves
MOLOTOV cocktails, tear gas, burned-out cars, dozens of
wounded protesters and police: for a few hours on September
26th, the scenes in Prague, the lucky venue for this year’s
annual meetings of the IMF and World Bank, were as ugly as
any doomster had predicted. Some 11,000 police, in full riot
gear, faced perhaps 10,000 angry protesters from around
Europe.
Among them were German socialists, Norwegian communists,
French Christian leftists, Spanish anarchists, Greek union
members, greens from all over, British anti-vivisectionists in pink cocktail dresses, a naked Swiss man, and a black labrador of unknown origin carrying a (small) banner railing against the “International Misery Fund”—but almost no Czechs. An assault on the bridge leading to the congress centre was fended off by police. And, as usual, a McDonald’s restaurant was wrecked.
Apart from the publicity, it is unclear what the protesters
hoped to achieve. For one thing, they chose the wrong target: if there are villains, they are not the Bank and Fund, but their rich-country shareholders. For another, they picked the wrong day: most of the work was done before the meetings began, especially by G7 ministers meeting in the German embassy on September 23rd. Most ministers and bankers were already leaving Prague by September 26th.
During the scheduled, protester-soothing, discussions of how
to make globalisation “work for all”, not much of substance
happened. There was little further progress on forgiving the
debts of the poorest countries: a Canadian proposal for a
moratorium on debt repayments was ignored. Perhaps to
compensate for this, James Wolfensohn, head of the World
Bank, went around averring that he was sympathetic to the
plight of the poor and understood the protesters; he even
embraced Bono, a travelling rock star crusading for debt relief.
Crude decisions
Arguably, however, the biggest decisions of all occurred
before anybody even got to Prague. And these should have
delighted the anti-market protesters, for they were government intervention to change prices that they considered “unreasonable” in two key markets: for oil and foreign exchange.
America’s decision to release 30m barrels from its Strategic
Petroleum Reserve (see article) was welcomed by
everybody—including, apparently, the American treasury
secretary, Larry Summers, even though he had previously
argued against it. “Oil prices are the largest cloud in the
relatively blue sky of the global economy,” he noted at a press conference after the G7 meeting.
Less uniform was the welcome for intervention in the
foreign-exchange markets. America joined other big central
banks to shore up Europe’s single currency, the euro, which
had shed 30% of its value against the dollar since its launch in January 1999. Over the weekend, G7 finance ministers and central bankers hinted at further intervention. Wim Duisenberg, boss of the European Central Bank, thundered that “the instrument of intervention is in our arsenal,” and that the euro had fallen “beyond what the fundamentals justify.” He even expressed hope of seeing an “orderly reversal” in the euro’s fall.
Yet, official statements aside, Mr Summers for one seemed
uncomfortable about intervention. His repetition of the mantra that a strong dollar was in American interests confused the markets. Intervention is jargon for buying, in this case, euros, lowering the value of the dollar—not the most obvious way of keeping it strong. Small wonder that Mr Summers’s official comments in Prague were cautiously worded. America took part in the intervention only because the Europeans had, for the first time since the euro was created, asked them. It amounted, in short, to a rescue for an old friend.
From the point of view of transatlantic amity, this is an
admirably altruistic use of American funds. Whether it is in
America’s economic interests is another matter—particularly if it works, which few such currency interventions do. But there is an outside chance that it might, especially since markets were caught on the hop. That is why it is worth asking what America is doing. For a weak dollar is surely the last thing that it needs just at the moment.
Mr Summers strongly denied one potential self-interested
motive for a weaker dollar: to help the American stockmarket
by improving the prospects of leading multinationals such as
Intel, McDonald’s, and Gillette, whose dollar profits from
Europe have suffered from the weak euro. His denial rings
true, for currency intervention would be unlikely to shore up the overall market. Even if investors responded to the prospect of improved profits, such benefits would surely be far outweighed by the risks to the stockmarket from a weaker
dollar.
Why so? European investors have been heavy buyers of American shares, and bonds, attracted not just by the
country’s economic prospects, but also by the strong dollar.
Their purchases have helped to drive the euro down and the
dollar up. Since the launch of the euro, according to Merrill Lynch, net inflows of capital into America from the euro area have been $261 billion—over 4% of the euro area’s
GDP—with half going into the stockmarket. If the dollar were
to start falling, these investors would earn less attractive
returns and might become increasingly concerned about
investing in dollar assets. That might in turn mean that both share and bond prices would fall.
Any such fall would probably drive the dollar even lower,
triggering further outward capital flows. Michael Hartnett, an economist at Merrill Lynch, thinks that the effects on the corporate-bond market would be particularly severe. This
would make it harder for companies to raise fresh capital, and so lead to a sharp reduction in the corporate investment that has been driving America’s recent economic boom.
Then there is the question of inflation. By making imports
cheap, the strong dollar has helped to keep American
consumer-price inflation down (though not, it turns out, as
low as it seemed, thanks to a double-counting of quality
improvements that the government owned up to this week). A
weaker dollar would push up inflation (now running at some
3.4%), shaking the current confidence in the markets that the Fed’s interest-rate-raising blitz is over.
A weaker dollar might also threaten to slow world economic
growth, which is currently forecast to reach a remarkable
4.7% this year. Much of that growth is expected to come from
Europe and Japan; but a lot of the expansion in these
economies has of late come from exports to America. If a
wimpy greenback meant fewer purchases of foreign products
by American consumers, domestic consumption in Europe and
Japan might not rise by enough to take up the slack.
All in all, Mr Summers is playing with fire by doing anything to suggest that his support for a strong dollar is even slightly equivocal. Some market folk think he is less commited than his predecessor, Robert Rubin. Worse, many economists think the dollar is overvalued, and vulnerable, not least because of America’s huge and growing current-account deficit. Market sentiment can turn on a dime, and the foreign-exchange market is notorious for overshooting when it changes its mind. Rather than worry about a weak euro, Mr Summers might do well to contemplate the real possibility of a weak dollar. It may be closer than he thinks. |
