AI
Monday, February 14, 2005 11:12:01 AM
*** U.S. debt: Watch out for the domino effect ***
U.S. debt: Watch out for the domino effect
Daniel Altman
International Herald Tribune
February 12, 2005
With Interest
How long will foreigners continue to finance the debts of America's government and corporate sectors? Some forecasters have said that the country is heading for a credit crunch, brought on by doubts about its economic prospects and fears of ballooning federal deficits. But others see no reason for concern. To them, the United States has become a special case in the global economy's textbook.
Among the worriers is Ashraf Laidi, the chief currency analyst at MG Financial Group, a foreign exchange trading firm in New York. In his view, foreign central banks and other investors will soon decide that buying dollar-denominated assets to prop up the value of the dollar is a losing battle.
"All of these banks have been incurring big-time losses on their dollar holdings," Laidi said. For him, the main countries to watch are China and Japan.
"Because the Japanese are holding as much as $715 billion in U.S. Treasuries, they cannot continue to bulk up," he said. "They are largely exposed to the decline of the dollar and its impact on their portfolio."
Like any good investor, Laidi asserted, the Japanese will soon seek to diversify. "Japan is looking for a gradual way out of this overconcentration of dollar holdings, without disrupting the market."
China, too, will have to diversify its holdings if it decides to loosen its currency's firm link to the dollar - a move toward revaluation that Laidi called "inevitable." When that happens, he said, investors will take their cue. "You are going to see a domino effect, from the world monetary authorities, to the traders, to market sentiment, to overall investment in the U.S."
In other words, central banks will sell their dollar-denominated assets (or not buy as many), and the dollar's value will fall. Then foreign investors in the United States will see their returns plummet and take their money elsewhere.
At least, that's one possibility.
Edward Yardeni, the chief investment strategist at Oak Associates, a fund manager in Akron, Ohio, sees things differently. "Why would the Japanese and Chinese change the rules of the game when the main reason they've been buying the dollar is to support it?" he asked. "Why would they suddenly let the dollar go into a free fall?"
Yardeni hearkened back to the 1980s, when, he said, American companies feared that Japanese private investors would lose their lust for American assets in the wake of big trade deficits and budget deficits. In the end, they didn't. "I don't know why there's a perception that there's going to be an endgame here," he said.
From Yardeni's perspective, the United States is becoming a unique case in economic history. As the world's main economic superpower and biggest export market, its purchases support the economies of countries around the globe. Those countries plow the resulting wealth back into the United States, where they can earn a safe return - often a much safer one than they could find at home. The trade deficit grows, foreign inflows of money match it, and everybody's happy.
Though Yardeni doesn't expect this pattern to continue forever, he said it probably can for several more years. But with time, he prophesied, other economies will provide more demand for exports and more safe homes for money. As that process moves forward, the pressure will come off the United States. "As the rest of the world becomes more prosperous, I think you'll see a more balanced trade situation," Yardeni said.
That's a rosy scenario, to be sure, but Yardeni said he's losing patience with the "currency calamity crowd," his name for people who keep predicting the end of the financial world. "The pessimists have been getting a lot of press, but if you look at their forecasting records in the past couple of years, they're just dead wrong."
Well, a very influential name has just joined that crowd. Olivier Blanchard, a professor of economics at the Massachusetts Institute of Technology, released a draft paper last month that foresees trouble ahead. Written with his colleague, Filipa Sa, and Francesco Giavazzi of the Luigi Bocconi Commercial University in Milan, the paper argues that bigger inflows of foreign money are in the interest of neither Asian central banks nor the American economy itself.
"A further shift in investors' preferences towards dollar assets would provide only temporary relief for the dollar," the economists wrote. "It would lead to an initial appreciation, but the accompanying loss of competitiveness would speed up the accumulation of foreign debt. The long run value of the dollar would be even lower."
The three authors also foresaw an adjustment of central banks' portfolios sooner rather than later. "The longer the Chinese wait to diversify their reserves, the larger the eventual appreciation of the renminbi," they wrote. As a higher value for the renminbi, also known as the yuan, could hurt Chinese exports, the benefits of quick action are clear.
China seems to have picked up on this. Fan Gang, the director of the National Economic Research Institute, China Reform Foundation, said at the World Economic Forum in Davos, Switzerland, that his government viewed the dollar as "no longer a stable currency" and expected its decline to continue.
No one is willing to say precisely when these things will happen, of course. At the moment, the American economy is growing steadily, and the dollar's recent gains against the euro and other currencies have allayed some traders' fears. Yardeni attributed those gains to private investors showing confidence in the economy.
Rising short-term interest rates, care of the Federal Reserve, could also be behind the gains. Yet Blanchard and his collaborators asserted that rates in general needed to fall, not rise, to stabilize the dollar.
Such turnarounds can be fleeting anyway, as holders of the euro found during its long initial slide. If Laidi is right, the markets may just be waiting for the right catalyst for calamity.
http://www.iht.com/bin/print_ipub.php?file=/articles/2005/02/11/business/wbmarket12.html
U.S. debt: Watch out for the domino effect
Daniel Altman
International Herald Tribune
February 12, 2005
With Interest
How long will foreigners continue to finance the debts of America's government and corporate sectors? Some forecasters have said that the country is heading for a credit crunch, brought on by doubts about its economic prospects and fears of ballooning federal deficits. But others see no reason for concern. To them, the United States has become a special case in the global economy's textbook.
Among the worriers is Ashraf Laidi, the chief currency analyst at MG Financial Group, a foreign exchange trading firm in New York. In his view, foreign central banks and other investors will soon decide that buying dollar-denominated assets to prop up the value of the dollar is a losing battle.
"All of these banks have been incurring big-time losses on their dollar holdings," Laidi said. For him, the main countries to watch are China and Japan.
"Because the Japanese are holding as much as $715 billion in U.S. Treasuries, they cannot continue to bulk up," he said. "They are largely exposed to the decline of the dollar and its impact on their portfolio."
Like any good investor, Laidi asserted, the Japanese will soon seek to diversify. "Japan is looking for a gradual way out of this overconcentration of dollar holdings, without disrupting the market."
China, too, will have to diversify its holdings if it decides to loosen its currency's firm link to the dollar - a move toward revaluation that Laidi called "inevitable." When that happens, he said, investors will take their cue. "You are going to see a domino effect, from the world monetary authorities, to the traders, to market sentiment, to overall investment in the U.S."
In other words, central banks will sell their dollar-denominated assets (or not buy as many), and the dollar's value will fall. Then foreign investors in the United States will see their returns plummet and take their money elsewhere.
At least, that's one possibility.
Edward Yardeni, the chief investment strategist at Oak Associates, a fund manager in Akron, Ohio, sees things differently. "Why would the Japanese and Chinese change the rules of the game when the main reason they've been buying the dollar is to support it?" he asked. "Why would they suddenly let the dollar go into a free fall?"
Yardeni hearkened back to the 1980s, when, he said, American companies feared that Japanese private investors would lose their lust for American assets in the wake of big trade deficits and budget deficits. In the end, they didn't. "I don't know why there's a perception that there's going to be an endgame here," he said.
From Yardeni's perspective, the United States is becoming a unique case in economic history. As the world's main economic superpower and biggest export market, its purchases support the economies of countries around the globe. Those countries plow the resulting wealth back into the United States, where they can earn a safe return - often a much safer one than they could find at home. The trade deficit grows, foreign inflows of money match it, and everybody's happy.
Though Yardeni doesn't expect this pattern to continue forever, he said it probably can for several more years. But with time, he prophesied, other economies will provide more demand for exports and more safe homes for money. As that process moves forward, the pressure will come off the United States. "As the rest of the world becomes more prosperous, I think you'll see a more balanced trade situation," Yardeni said.
That's a rosy scenario, to be sure, but Yardeni said he's losing patience with the "currency calamity crowd," his name for people who keep predicting the end of the financial world. "The pessimists have been getting a lot of press, but if you look at their forecasting records in the past couple of years, they're just dead wrong."
Well, a very influential name has just joined that crowd. Olivier Blanchard, a professor of economics at the Massachusetts Institute of Technology, released a draft paper last month that foresees trouble ahead. Written with his colleague, Filipa Sa, and Francesco Giavazzi of the Luigi Bocconi Commercial University in Milan, the paper argues that bigger inflows of foreign money are in the interest of neither Asian central banks nor the American economy itself.
"A further shift in investors' preferences towards dollar assets would provide only temporary relief for the dollar," the economists wrote. "It would lead to an initial appreciation, but the accompanying loss of competitiveness would speed up the accumulation of foreign debt. The long run value of the dollar would be even lower."
The three authors also foresaw an adjustment of central banks' portfolios sooner rather than later. "The longer the Chinese wait to diversify their reserves, the larger the eventual appreciation of the renminbi," they wrote. As a higher value for the renminbi, also known as the yuan, could hurt Chinese exports, the benefits of quick action are clear.
China seems to have picked up on this. Fan Gang, the director of the National Economic Research Institute, China Reform Foundation, said at the World Economic Forum in Davos, Switzerland, that his government viewed the dollar as "no longer a stable currency" and expected its decline to continue.
No one is willing to say precisely when these things will happen, of course. At the moment, the American economy is growing steadily, and the dollar's recent gains against the euro and other currencies have allayed some traders' fears. Yardeni attributed those gains to private investors showing confidence in the economy.
Rising short-term interest rates, care of the Federal Reserve, could also be behind the gains. Yet Blanchard and his collaborators asserted that rates in general needed to fall, not rise, to stabilize the dollar.
Such turnarounds can be fleeting anyway, as holders of the euro found during its long initial slide. If Laidi is right, the markets may just be waiting for the right catalyst for calamity.
http://www.iht.com/bin/print_ipub.php?file=/articles/2005/02/11/business/wbmarket12.html
Dan 
Join the InvestorsHub Community
Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.
