Monday, December 13, 2004

The heavy lifting of global rebalancing -- as Stephen Roach likes to call it -- will not be done by a falling dollar. I mentioned this for the first time about a month ago in discussing a recent paper by Maurice Obstfeld and Kenneth Rogoff on the US current account deficit. There these deans of American economics note that
even very large autonomous exchange rate movements will not go far toward closing a current account gap of the magnitude presently observed in the case of the United States. The lion's share of the adjustment has to come from saving and productivity shocks that help equilibrate global net saving levels, and that imply dollar change largely as a by-product
Stephen Roach gets in on the game today as well.
First, the United States is unlikely to export its way out of its trade quagmire by a currency-induced improvement in competitiveness . . . Second, the only real hope for meaningful improvement on the trade front over the next several years is on the import side of the equation; given the secular shift of rising import penetration into the US, that would undoubtedly require a protracted slowing of US domestic demand growth.
The truth hurts, especially to, shall we say, "those of a more sunny disposition" hoping for a relatively painless pathway out of the current predicament via a global demand boom far outstripping growth in US demand. The long and short of it is that the US imports too much. It is simply not reasonable to expect US exports to grow 50% faster than imports -- which must happen if the trade balance is to merely stabilize, much less decline -- especially in light of the shrunken US manufacturing base and the country's waning agricultural production.

For Roach, the only hope is higher real US interest rates. Of course, it's hard to get any lower than we are now. The federal funds rate currently stands at 2.0% while PCE inflation is (in October) at 2.4% and CPI inflation is 3.2%. That's a pretty serious negative real interest rate. But if real interest rates are going to rise significantly enough to spur a revival in US personal savings, how high will they need to go? I suspect a lot higher than a nominal rate of 4% -- and that's a long long way from where we are today.

The boys' club at Morgan Stanely kicked around a few other ideas last Friday on how to reduce US consumption. Their favorites were [1] cutting the US budget; [2] cutting Social Security benefits; and [3] a consumption tax. All three of these projects are being crafted to wipe out the US working class. But the people who benefitted least from the excesses of the last ten years are now supposed to pay the majority of the costs in cleaning up its post-party messes? Throwing the US back to the 19th century seems to be on everybody's agenda.

General Glut's long-standing interest now gets piqued: will this simply invite another deflation scare? The world is already awash in excess production, and what little inflation there is has been spurred by the overstretched American consumer. When that consumer returns to a more 'normal' shape and cuts overall demand, combined with the dollar continuing to weaken in real terms (through falling nominally as well as through higher US inflation vis-a-vis Japan and Europe), what exists to fend off falling global demand? And more importantly what exists to fend of the popping of asset bubbles (e.g. housing) and a debt-deflation spiral?

The short answer would seem to be: central banks dramatically lowering interest rates. After all, that's how we got out of the immediate messes created by the 1997 East Asian financial crisis as well as the 2000 US stock market bubble pop. Yet lower real interest rates in the US are precisely what the world doesn't need in the medium-term for sure.

If capital is going to play 19th century politics, whether in its robber baron (Bush administration) or its Rothschild (Morgan Stanley) idiom, the US working class needs to brush up on its 19th century tactics as well.

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