Zeev ... a few thoughts on the US and world economy. What do you think?
1. China, Japan and the rest of Asia are exporting incredibly large quantities of underpriced goods to the US. Principal causes are an overvalued USD and an undervalued Yen and Renmindi.
Trade imbalances are increasing almost geometrically, and have become real issues for Asia and the US.
Large trade surpluses with the US have been historically viewed favorably by Asia. However, as the value of the USD declines, and the US Treasury market becomes viewed as more and more fragile (by Asians), their perceptions and strategies are changing.
Oil prices are paid in USDs world wide. With the USD continuing to decline, oil prices have increased significantly to countries whose currencies are linked to the USD.
Asia is financing massive quantities of low cost exports to the US. They take those excess reserves of USDs and purchase US Treasuries. This helps long term US Treasury Yields stay low, which in turn helps the US consumer continue buying Chinese imports, whether Americans have to go further in debt or not to do it.
If the Chinese do not allow their currency to float against other currencies (especially the USD), and if the Japanese do not allow the value of the Yen/USD to rise significantly, the appetite of US consumers for low priced goods from Asia will continue to grow.
At some point Asia (especially China and Japan) has to decide when is enough too much. If the value of the USD continues to fall, Asia’s hoard of USDs will continue to lose value. And if long-term US Treasury Yields continue to rise (as it seems they must), Asia’s large investment in US Treasuries will continue to lose value as US Treasury prices fall.
2. Europe (and the Euro) are in a very different situation.
The quickly rising Euro/USD is a problem for the Euro in terms of exports to both the US and Asia. It is making their goods and services non-competitive in world markets. It also increases the probability that they will retaliate eventually against Asia in terms of import tariffs.
So far, almost the entire decline in value of the USD has been at the expense of the Euro. This is nonsensical, as the huge trade imbalance of the US is with Asia, not Europe.
3. The US has the most negative or problematical imbalances, but not very much control or power in recommending or dictating solutions. This is unique in modern American history.
Although the increasingly large US Federal Deficit is a problem, I would argue that it is a marginal issue right now … at least in the sense of the argument I am trying to make here, so let’s put it to one side for now.
Consumer and household debt in the US are dangerously out of balance. That is the main reason the Fed is increasing short term interest rates so slowly. The other reasons are (1) the US labor market is improving too slowly, and (2) US corporations are not spending their huge cash balances to expand their businesses.
It seems that the US is hoping that a continuous and slowly declining USD will raise US inflation slowly enough that employment will continue to improve and that corporations will accelerate capital spending. And at the same time, they hope that neither China or Japan will precipitate a US Treasury crisis by slowing their purchase of US Treasuries or actually selling a bunch of them.
Hoping the USD will continue to fall gradually without a US Treasury crisis is obviously America’s wish. But doing it without accelerating US Treasury Yields is a dream in my mind.
A US Treasury crisis is a possibility at some point, maybe sooner than later. Asia may decide by themselves to force a crisis if they view it as advantageous to themselves compared to alternative strategies.
4. What do I think will happen?
The US seems unsure of what it wants to accomplish and how to get what it wants. Lobbying China to let the Renmindi float may well cause more problems for the US than solutions, especially in the short term. It could easily lead to quick drop in the value of the USD and a corresponding sharp increase in US Treasury Yields.
What is very interesting is that the US has made itself vulnerable to Asian political pressures on US foreign policy. For example, US policy for Taiwan could be undermined.
I have to believe that the Bush administration clearly recognizes that the only way out of this economic quagmire is a moderate to serious recession in America. And getting it out of the way early in Mr Bush’s next term would seem to be a priority.
The biggest economic decisions that effect our future will be made in Asia. The US has forfeited its economic power to Asia as a result of the US being so overwhelmingly in debt to them. Thank you, Mr Greenspan!
Not that Asian choices are easy ones. They are not. If they set off a US Treasury crisis in the US, they will get badly hurt.
On the other hand, what are they to do? … continue to purchase larger and larger amounts of US Treasuries that are losing value with a declining USD?
Will China force the US to rebalance the American economy by selling enough US Treasuries to cause the yield on the 10 Year Treasury up to 6.00% or even 7.00%. This will hurt Asian economies, but they are going to get hurt anyhow, so they may want to do it on their own terms.
Or will China let their currency float (gradually) which will also cause a further and significant drop in value of the USD, and higher US Treasury Yields in America.
America seems totally unable to set the economic forces in motion so that the American economy can rebalance and heal.
Asia has to do it, and I think they will. A US Treasury crisis in the US by selling US Treasuries (and not floating the Chinese currency) seems to be the best of bad choices for China.
Market Data 
Markets 
AI
