Dollar Merry-Go-Round -- by John Mauldin (Millennium Wave)
All this has profound implications for the dollar. One of the
hottest and most interesting current debates among economists is
about the value of the dollar. Dollar bulls say that the rest of the
world will continue to buy our stocks, bonds and assets. Why should
demand for the dollar change? They have been right for a long time,
as those who worry about our trade deficit have been wrong in
predicting a crash in the dollar. Why should the next few years be
any different than the past?
For the record, I have been bullish on the dollar for many years, up
until recently. What has made me change my mind?
The "current accounts deficit" is approaching critical mass. Think
of it this way. If you spend more than you make, you have to do
something to make up the difference. You can sell the furniture,
borrow money, hock the kids, get a second job and so on. If you do
nothing, you will soon be bankrupt.
On a macro scale, it is not much different for governments and
currencies. We are buying more products from overseas than we sell.
To make up the difference, foreigners have bought our companies
(called mergers and acquisitions or M&A), bought our stocks and
bonds and sometimes bought our currency (in the form of bonds and t-
bills).
Much of the M&A has been from Europe. This has been drying up at an
alarming rate in the past few months (see below). It is almost like
Europeans smell blood, and realize they will be able to get the US
assets cheaper in the future if the dollar drops.
The longer this stock market goes sideways, the less enthusiastic
the world will be with US equities. If you are not convinced the
dollar is going up, you will invest in your own currencies or in
Euros.
Morgan Stanley analysts Jen and Yilmaz point out that if the world
shifts from the current equity regime to a bond regime (their word)
that the dollar would go from being slightly over-valued to dropping
by as much as 15-20%.
In other words, if Bernstein and Arnot are right and investors are
going to become increasingly interested in the absolute returns,
then the dollar is at real risk.
And then one of my favorite analysts., Stephen Roach, weighs in with
these thought-provoking words:
"Never before has the United States commenced economic recovery with
a current-account gap totaling 4% of its GDP. (They predict it will
rise to 6% in 2003, although Fed studies show that when the trade
gap gets to 5%, serious problems will develop - JM) Given the high
level of import penetration now structurally embedded in the US
economy -- with goods imports at 30% of GDP in early 2002 -- another
stretch of US-led global growth will most assuredly result in a
significant further widening of the external shortfall.
"If such a massive external funding requirement doesn't lead to a
saturation of the foreign appetite for US assets, I'm not sure what
will. Just because America's external financing was manageable in
the 1990s doesn't mean it will be so as the as the ever-widening
current-account deficit now ups the ante on capital inflows.
Needless to say, that conclusion is in direct contradiction to that
of the capital-flow-driven justification of the Bush Administration.
"Interestingly enough, there are signs suggesting that this point of
saturation may now be at hand. As Joe Quinlan and Rebecca McCaughrin
have recently noted, the portfolio portion of capital inflows into
the United States has slowed dramatically in early 2002. Over the
first two months of this year, foreigners purchased just $27 billion
of dollar-denominated assets, a dramatic reduction from the $100
billion pace in the first two months of 2001.
"Meanwhile, foreign direct investment into the United States -- the
other major piece of the capital inflows equation -- has also slowed
dramatically. FDI into the US was $158 billion in 2001 -- only a
little more than half the $295 billion average pace of 1999 and
2000. Fully two-thirds of this slowdown is traceable to diminished
FDI activity from Europe; that's largely a reflection of a dramatic
downshift in the cross-border M&A cycle -- a trend that has
continued into the early months of 2002.
"I remain convinced that America's current-account deficit
represents a key point of tension for the US and global economy. It
is the crux of our "global decoupling" thesis -- that the world can
no longer afford to be dependent on the American growth engine as
the dominant source of economic growth. The coming US current-
account adjustment speaks of a new recipe for sustained global
growth -- a slower pace in the US, a speed-up elsewhere, and a
weaker dollar. The logic of the Bush Administration is flawed in the
sense that it relies on an ever-expanding stream of foreign inflows
into dollar-denominated assets. In this post-bubble era, that may
well turn out to be the ultimate in wishful thinking."
The dollar is headed down, and perhaps the beginning of the drop is
sooner than I had previously thought. You can open foreign
denominated CDs in the Euro or other currencies at Everbank right
here in the USA. This link will take you to their information page:
everbank.com
One of several things will have to happen over time. We will have to
decrease our purchase of foreign goods, although since so much is
manufactured overseas, this is not a short-term solution. Foreign
purchase equal to 30% of GDP is huge.
If the dollar drops, manufacturing and production will come back
into the country, as it will become cheaper to produce things here.
Just as we enjoy cheap foreign products, the drop in the dollar will
make our products cheaper in terms of foreign currencies, and so we
will sell more of them.
The US will still be the premier world economy for some time
(decades and decades) to come, and foreign companies will want to
have a presence here, and will buy our companies and assets, which
will help balance the current accounts deficit.
All these should keep the dollar from the crash that many predict,
but will not save it from the 20% drop that the Morgan Stanley
analysts predict. How soon will all this happen? I don't know, and
neither does anyone else. If I say in the next year or so, it is
just a guess, and that is my guess. Many analysts hazard a guess
which they call a prediction, in case they might be right. If they
are, they will remind you of the accuracy of their prediction. If
not, they assume you will forget.
-end- |
