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THURSDAY, NOVEMBER 4, 2010 STRATFOR.COM Diary Archives
Washington's Warning Shot on the Currency Front
The U.S. economy is, somewhat cautiously, on the mend. We don’t mean to proclaim everything hunky-dory, but consumer spending is back up above the peak level of the last recession. Since consumer activity accounts for roughly 70 percent of the American economy — and at some $11 trillion, that American consumer market is more than the combined economies of China and Japan — it isn’t that big of a leap to say the American economy is at least moving forward, even if it isn’t firing on all cylinders.
“The United States holds both the only major consumer market showing signs of life and unfettered control of dollar policy.”
There are two veins of concern that branch from this. First, this lukewarm performance has now been the state of affairs for nearly a year (regular STRATFOR readers will recall that this situation is, in essence, what we described in our 2010 annual forecast). Americans like breakout and that simply hasn’t happened, ergo the malaise. Second, the United States is the only major advanced economy showing such signs of consumer recovery: Japan is mired in a stew of aging and deflation and is probably incapable of expanding its consumer spending for reasons that have nothing to do with its recession; southern Europe is sinking into a vat of debt that is dampening growth across the continent; and despite the much-mooted talk of the advanced developing world making up the difference, their combined consumer base is less than half that of the United States. It will take another generation of growth before they can be considered a major absorber of global exports — and that’s assuming you believe all the statistics.
In the meantime, basically all of the major economies are pushing to export to the United States, hoping that by maximizing their take of the global — which is to say, American — import market, they might be able to improve their chances of recovery. To this end, many countries are engaging in policies to maximize their chances of selling to the American market — in particular, the world’s second, third and fourth largest economies.
China maintains a de facto peg to the U.S. dollar to minimize currency risk and maximize reliability for their firms. True, Beijing had continually repegged the yuan higher bit by bit in recent months, but the yuan remains now roughly where it was four years ago. Add in that China funnels the savings of its citizens as loans to state corporations at subsidized rates and you have a country that could only consume more by transforming its entire financial system.
Japan faces the problem of demographics. Large numbers of aging (low consumption) citizens and very few young (high consumption) adults have cursed the traditionally export-oriented country with a strengthening currency (low consumption/imports and high exports lead to a stronger yen). No wonder the Japanese economy is approximately the same size in 2010 as it was in 1991. Consequently, Tokyo is unabashedly intervening in currency markets to drive the yen down and hopefully spur Japanese exports — and with them some sort of domestic revival.
Germany is in yet another situation. Situated at the heart of Europe, the only way Germany has ever been successful economically is to engage in massive projects that link the country’s disparate river systems and coastlines, with the autobahn perhaps serving as the most recognizable example. All this state-influenced investment provides Germany with not only a world-class infrastructure, but an extremely educated population and a top-notch industrial base. Modern Germany is by design an export juggernaut that favors investment over consumption. Luckily (for Berlin) many of its European partners’ debt problems are weighing down the euro, so German companies are getting a currency boost to their exports without Berlin having to engage in any currency manipulation strategies.
With economies No. 2, 3 and 4 all pushing for maximum exports, and import capacity weak at best, it should come as no surprise that the U.S. government is attempting to convince all the major states to agree to some sort of currency pact at the upcoming G-20 summit. Details are sketchy, but the bottom line is that Washington would like Germany, Japan and China — and many others — to publicly commit to refraining from currency manipulation, and let their currencies float to wherever the market will take them. To this point, such calls have largely fallen on deaf ears.
Then something interesting happened today. The U.S. Federal Reserve announced it would engage in a process called Quantitative Easing (QE), which in essence means printing currency and using the money to purchase assets that investors are shunning with the goal of stimulating economic activity. There are a number of reasons why a central bank might engage in QE, but none of them are conventional. For purposes of this discussion, there are really only two to consider. First, QE can be used as a sort of tool of last resort when tax cuts, deficit spending and interest rate policy are maxed out, as they arguably are for the United States. Second, large-scale QE can increase the money supply to a degree that it devalues the currency, a sort of semi-stealth means of driving the dollar lower.
Now, this batch of QE isn’t very big — “only” $600 billion over eight months. It is an amount that is not all that much larger than normal Fed operations for managing the money supply. It’s too small to have more than a marginal impact on either inflation or the value of the dollar. But the Fed manages the dollar, and the dollar is the only global currency. It is the currency that all commodities are bought and sold in, that two-thirds of global currency reserves are held in, and that everything coming in and out of the United States — still the world’s largest economy by a factor of three — is handled in.
None of America’s trading partners will think that this batch of QE is the beginning of a massive dollar devaluation — the change is simply too small for that. But it is a stark reminder that if it does come to an actual currency war, the United States holds both the only major consumer market showing signs of life and unfettered control of dollar policy. For states that have been tinkering with their currency policies, attempting to maximize their access to the American market, today’s QE announcement is a warning |
