Joan, the Euro is also having an impact on the US$. Today from Stephen Roach....
Stephen Roach --
The first thing I did when I arrived in
Frankfurt this week was to get
some euros. There’s nothing like the look and
feel of newly minted
coins -- especially of a currency that
heretofore existed only on our
screens. When I emptied my pocket at the end of
the day, it was not
too difficult to separate the euros from my
American currency. Shiny
and sleek, they stood in sharp contrast to the
worn and wrinkled
greenbacks. My mind started racing.
I have long felt the strong dollar is an
accident waiting to happen. If
anything, my conviction is deepening. The
reason: America’s external
imbalance has plunged into the danger zone and
is about to get worse.
The current-account deficit -- the broadest
measure of any nation’s
international financial position -- hit a record
4.6% of nominal GDP in
late 2000. That was more than a full percentage
point wider than the
previous record deficit of 3.5% hit in late
1986. While the deficit
narrowed a bit in 3Q01 (to 3.7%), that was an
aberration traceable
largely to foreign insurance payments associated
with the destruction of
the World Trade Center. The bad news is that the
current-account deficit
appears set to get a good deal worse in the
years ahead. Our baseline
scenario for the US economy has America’s
external shortfall rising to
the astronomical 6.2% share of GDP by late 2003.
Such a deficit would
bear an eerie resemblance to those that plagued
a pre-crisis Asia in the
mid-1990s.
This is a stunning and worrisome development for
a US economy in
recession. Normally, cyclical downturns are just
what the doctor orders
for current-account deficit economies. The
resulting slowdown of
domestic demand produces a concomitant reduction
in imports, whereas
resilience elsewhere in the world allows exports
to keep on expanding.
That’s exactly the way it worked in the
recessions of the mid-1970s, the
early 1980s, and again in the early 1990s -- as
the business cycle
transformed external deficits into balance. Not
so this time. The
synchronicity of this world recession has
prevented such an outcome.
With the rest of the world marching quickly to
the beat of the US
economy, exports plunged by 11.5% (in real
terms) over the four
quarters of 2001. And with a relatively
contained shortfall in domestic
demand, imports were down an estimated 6% over
the same period.
With the dollar value of imports of goods and
services fully one-third
larger than exports, the normal cyclical math of
the current-account
adjustment simply doesn’t add up; it would have
taken a much larger
reduction in imports -- or an even greater
export offset -- to take the
external gap toward balance.
This same math -- a by-product of the so-called
current-account legacy
effect -- produces the even more dire outcome of
our recovery scenario.
The value of imports is simply too large to
allow the likely rebound in
exports to put a dent in the external imbalance.
Nor does America’s
high import propensity help matters any. Our
baseline case for 2003
calls for export growth (13.9%) to be more than
50% faster than import
growth (9.0%). And yet because imports are so
much larger than
exports, the current-account gap is still
projected to go from 4.9% of
GDP in 2002 to 6.1% in 2003.
This would leave America more dependent than
ever on foreign capital
to finance the ongoing operations of the US
economy. The capital
account is, of course, the flip side of the
balance of payments. And if
our baseline estimates come to pass, the United
States will have to
attract some $664 billion of foreign capital in
2003 in order to finance
its current-account deficit. That’s nearly $2
billion per day, close to
double the daily financing requirements in 2001
(about $1.1 billion per
day). Therein lies the great conundrum for the
heretofore Teflon-like
dollar. History is utterly devoid of examples
when such a massive
external financing requirement did not result in
a sharp depreciation of
the currency and/or a concession in the price of
other assets -- namely
stocks or bonds.
There is, of course, another outcome to this
sorry state of affairs -- a
current-account adjustment that comes through
the currency and/or the
business cycle. A soft landing in the dollar --
a drop of some 10-15%
per year -- would not do the trick, in my view.
The lags are simply too
long between trade flows and such muted shifts
in foreign exchange
rates. Even a hard landing in the dollar --
perhaps double the
depreciation of the soft-landing -- would have a
limited impact in a
short and mild recession. By contrast, a deeper
and longer cyclical
downturn would take a much greater toll on
domestic demand -- and
the import content of such purchases. Needless
to say, a double-dip
recession would come in quite handy in that
respect. In my opinion,
however, only by putting the two outcomes
together -- a harder landing
in both the dollar and the real economy -- would
it be possible for
America to come to grips with its seemingly
intractable current-account
deficit.
Such a scenario is dismissed out of hand by
policy makers and
investors alike. It’s a nightmare that few want
to face. There must be
an easier way out. Since the dollar hasn’t
fallen yet, it seems most
believe that the current account has simply lost
its potency in shaping
the relative prices set in foreign exchange
markets. With the benefit of
hindsight, we all know what has finessed the
current-account-financing
problem in recent years. It’s capital flows,
stupid. The world has been
more than eager to buy a piece of America’s New
Economy prowess and
its related ability to deliver superior returns
on dollar-denominated
assets. Nearly two years after the popping of
the Nasdaq bubble, this
legacy endures -- either out of hope or a
seeming lack of investable
alternatives elsewhere in the world. Whatever
the reason, a dollar that
has resisted the tine-honored pressures of an
ever-widening
current-account deficit is now thought to be
perfectly capable of
performing that high-wire act over and over
again. Sadly, this is
precisely the same logic that rationalized the
Nasdaq bubble -- that is,
until it popped. A new theory has been concocted
to explain away a
fundamental disconnect. My new euro coins are
looking shinier by the
minute.
morganstanley.com |
