The Dollar and the Fed still rule
With the world turning inward, we should recognize that countries are beholden to the US dollar more so than ever before. A mere hint of a shift in Fed policy sends shivers, up and down, the boulevards of most countries’ financial districts. While the US may no longer be the super economy it once was, having eased from controlling 40% of world GDP, to now controlling about 23% of world GDP, the dollar is still the superpower currency. In the last 600 years, there has been one mega currency in each century. The dollar has been Number One since it succeeded the Pound Sterling about a century ago and there is no rival in sight. In the last fifteen years, foreign currency reserves value rose from $3 trillion dollars to $11 trillion. Nearly two-thirds of those reserves are held in U.S. dollars. 90% of all trade, world-wide, is conducted in dollars. The dollar has never been more influential and the financial hegemony of the U.S. has never been greater.
Domestically, despite comments to the contrary, the American economy is flourishing. Unemployment is only 4.9%, newly created jobs increase by nearly 150,000 monthly, consumer confidence is strong, and new homes sales are higher than 2008. The second quarter growth rate was strong. Most of all the Fed did not bump up rates. Why? Inflation is barely 0.9%. Price rises will pick up as the effect of cheap oil and the strong dollar dissipate. Core inflation is 1.6% and wages are being pushed higher. The Fed, I believe is finding it hard to tell how loose monetary policy actually is. Several factors are holding down the natural rate: weak productivity growth. In 2000s, productivity averaged 2.9%. Since 2008, it has been 0.9%. Another culprit- Attention Sociopath Trump! – is being caused by an ageing workforce and population. We NEED the immigrants Trump is so eager to throw out of and to wall out of our country. Markets, too, seem to expect low rates to continue. However the strength of the consumer means there is a chance of a rate rise this year.
The economy will improve via two things: innovation and productivity, which are interlocked. It seems that all of the products that make our lives better were not around 30 years ago. And secondly, what is really important is gains in productivity. Back 100 years farms were producing 30 bushels of corn per acre. Now they’re producing 160 bushels of corn per acre, and of course, it takes fewer people to do it. Productivity is the name of the game.
Fed grew more confident as near-term risks diminished and held rates steady, but opened the door for a rate rise later in the year, perhaps as late as December. Hiring bounced from 10,000 in May to over 287,000 in June.
American producer prices rose 0.5% month-on-month in June, the biggest gain in a year, and above expectations. Rising costs for energy and services, and the fading effect of the strong dollar, were the main causes. Now energy prices are falling like stones with little prospect of strength. In another sign of the economy’s strength, unemployment benefit claims held steady at a seasonally adjusted 254,000, rather than increasing as expected.
In a more connected world, there is more value in the infrastructure that joins us- roads and routes than borders that divide us. Deconstructing barriers via digital technology and flows of investment are the first steps towards realizing the potential of a connected world.
We have accepted the assumption that the world of our children would be a place of fewer borders and lower barriers to the movement of goods and people. Not long ago, walls were literally brought down, with the promise that global progress and prosperity would henceforth be marked by openness.
Sadly, that is not how things are trending now, and the consequence is troubling for those of us who believe that the most powerful cure for war and economic stagnation is direct exchanges between people around trade and ideas.
The latest signal of rising barriers is the England’s Brexit from the European Union. Though not necessarily a done deal, it is perilously close to happening.
An enthusiasm for erecting barriers is evident elsewhere, too. Donald Trump wants to build a wall along the border with Mexico, and Hillary Clinton came out against a free-trade deal whose formulation she once supported.
Consumer spending has been the main engine of growth in the U.S. for the past few years and is the case now, but that engine appears to have run slower than it has in the past. Retail sales for February were flat, fell 0.4% in January and March sales grew 1.7%. One big reason for March’s weak overall reading was a drop in auto sales which tumbled 2.1% in March and is still not showing much life. Auto sales continue to be disappointing, advancing only 0.1% last month.
American households have benefited from relatively cheaper gasoline and an improving labor market for more than a year. But wages have been growing only slowly, other measures of the economy have been mixed, and financial markets have been volatile in the last six months of 2016.
The present acrimonious political discourse is polluting our normal American ‘Can Do’ mentality. The sooner we find representatives worthy of our expectations, the better. Any suggestions are welcome. I keep reading that historically, there examples of an even worse environment, I am horrified of looking at the prospect of having to discover if this is true.
The tug of war between the Fed trying to force rates higher and the rest of the world trying to fight off recession continues with no let-up in sight. The US economy grew at 2.4%, faster year end 2015 than thought. The consumer is spending with home-buying especially rosy. But corporate earnings, with the fall in oil prices, have some challenges not just domestically, but also internationally. The global nature of financial markets and the dollar’s critical role within them requires the Fed to go slowly. Its planned additional hikes might well tip America and much of the rest of the world into recession. Even as household wealth grows on strong new job creation, ongoing struggle in Europe and Japan and the slowdown in China have limited how fast US activity can move. Raising interest rates well above the global level may be inviting destabilizing financial flows and an economy choking rise in the dollar. The Fed should tolerate rising inflation, it is preferable to imploding portfolios and risking a recession.
The Bizarre rise of “Trumpism” is frightening. The rest of the world thinks he and his supporters are mad. What, must he and they be smoking?
What might a Trump economy look like?
He makes up policy as he goes along, departing from party orthodoxy. He insults our largest trading partner, China, calling them ‘currency manipulators’. And he wants to force them to eliminate ‘illegal’ export subsidies. He will ‘force’ Mexico to pay for the improbable wall he proposes to build on the border of Mexico, despite the President of that country saying, “No way Jose.”
On taxes he wants sweeping cuts, higher standard deductions, lower dividend and capital gains taxes, and he wants to cut corporate taxes to 15%.
While most economists say such a program would lead to a huge increase in the federal deficit, Trump claims lower taxes will stimulate the economy. Meanwhile, he also calls for a balanced budget that will require huge spending cuts.
He is also going to beef up the military and spend more on Veterans and immigration controls. He claims that he will save $300 billion on Medicare. How he will accomplish this, as usual, he is short on details.
Funding his tax cuts would require unimaginable spending reductions. His program is unimaginable as it is improbable.
How does a demagogic opportunist exploit a divided country? How did Hitler come to power in Germany or Mussolini in Italy? Watching Donald Trump’s fashion show, I am beginning to suspect, or fear I understand. The danger is that the electorate becomes de-sensitized to his absurd outbursts. Trump must be taken on by one electable candidate and the contenders know which is best placed to complete this task. It is time for several of them to fall on their swords.
Though the US economy seems to be a brightish light on the horizon, there seems to be a growing fear that the rich world’s weapons against economic weakness no longer work. Despite central banks’ efforts recoveries are weak, and few on the ground, and inflation is low. For all the cheap money sloshing around, growth in bank credit has been dismal. More can be done but central banks will need help from governments. It’s time for politicians to join the fight alongside central bankers. Public spending could be financed directly by printing money; Wage and prices could be mandated through government incomes policies; while this involves risks, waiting raises the specter of having to rely on extreme action. Multi years Infrastructure projects to fix bridges, roads, and buildings would add predictability to worker expectations. Deregulation would also help. Cut the red tape. Zoning laws are barriers to new projects and tax codes are too complicated. America remains the world’s indispensable economy, dominating the brightest, brainiest and most complex parts of the human endeavor. Its capacity to influence will linger and even strengthen though its economic weight as a percentage of world trade declines. The growing gap between its economic weight and its power will cause instability and conflict if not handled properly. Given its present political atmosphere, expectations are dimming. America’s grip on the global economy helps organize, provide access, enrich bosses and annoys the rest of the world. And here comes China.
The migrant crisis sweeping Europe is likely to get worse before it improves. Tempers on all sides are shortening. Head of the Bank of England has dampened expectations of an interest rate rise this year. Meanwhile Euro Zone business activity fell to a one year low, suggesting a slower rate of expansion; the service sector also fell implying first-quarter growth in the bloc would be less than 0.3%. Having said all that, Europeans can seem miserable; its produced writers and philosophers that are downbeat. Paradoxically, Europeans are happiest, today, than they were since the financial crisis of 2008. The only metric consistently correlated with European happiness is relative income. The more it rises, the happier people become. Where they live is also important. Not Northern Europeans are uniformly happier than Southern or Eastern Europeans. Good governance seems to be the main factor.
Brexit is a danger to its economy. It will imperil Britain’s security and its clout. Brexit also would deal a heavy blow to Europe. Uncoupling the fifth largest economy in the world from its biggest market is no joke. Brexit would also deal a pretty heavy blow to Europe’s security. Britain is its fifth largest defense spender. The new EU and the West would be weaker. Let’s hope the British voters think carefully on June 23rd.
Asia countries are competing to modernize their military, now accounting for almost half of the global market for big weapons- nearly twice that of the Middle East and four times that of Europe. The largest importers are India, China, Australia, Pakistan Vietnam and South Korea. Unquestionably, China’s recent assertiveness, seeming simply to be taking what it thinks is its own, underlies this trend. Even if China were not filling in the sea so enthusiastically, its military build-up would not go unnoticed, and reacted to. Nearly 30 % of world trade passes through the South China Sea. China’s behavior there, of late, evidences disdain for international laws, laws which they themselves signed in 2002. Such behavior scares its neighbors and heightens the danger of conflict and justifies why America should continue to assert freedom of navigation and overflight. Net result is to drive China’s neighbors closer to America, and to suppliers of heavy weaponry. China’s excessive industrial capacity harms its economy and riles its trading partners. It should embark on some form of consolidation by closing down older capacity.
Either we validate the financial asset prices and growth faster, or we slip into a global recession with financial disorder. If only central banks would step back and allow economies to determine their own futures. The irony is that the economy has healed, but it is not unfettered. The Fed may be able to get one more rate rise to hold, but no more. We must expect high volatility especially in the currency markets. Business conditions are much more positive than stock markets suggest.
The Fed is now in a very uncomfortable position, which could easily become much more difficult still. This is the risk in hiking rates before economic conditions demanded it. When both interest rates and inflation are very low, there is unlimited room to increase rates in response to an unexpected surge in inflation to a rate will above the target. And under those circumstances it is very hard to react in time and with adequate force to any unexpected weak economic performance.
Europe is looking into the jaws of a recession. Stronger downside risks, including China’s change of growth model, lower commodity prices, and “asynchronous” monetary policy around the world prompted the International Monetary Fund (IMF) to lower its global growth outlook, The IMF pared its global growth forecast to 3.4% in 2016, a decline of 0.2% from the agency’s prior estimate in October. The world faces weaker growth. Fewer jobs are being created around the world and there will be countries that will struggle, particularly those suffering from the double downside risk, which is the trade relationship with China slowing down and lower commodity prices. This will affect some of the emerging market economies and low income countries that are vastly commodity export dependent.
The chaos created by the mass migration from turmoil in Syria to Europe has European economies examining closely their ability to absorb these masses. Many are acting to curb the intake.
Global economic growth disappointed once again because of the poor performance by emerging economies. Exotic assets did badly, showing a negative 17% return. Latin America dropped 32%. High yield bonds also lost money. Commodities fell by 26%. Euro-zone and Japanese were better off, in local currencies, but against the dollar, they also suffered. Corporate profits are likely to have fallen 3.5%. Investors are cautious about 2016 because China’s economy is the biggest cause of concern.
The Federal Reserve hiked interest rates between 0.25 and 0.50 percent while openly allowing that it is up to the market to make the increase stick. This is first rise in nearly a decade, signaling faith that the U.S. economy had largely overcome the wounds of the 2007-2009 financial crises. The Fed confidently considers the labor market improved and inflation will rise to its 2 percent objective. This was a tentative beginning to a gradual tightening cycle and will be carefully monitored.
The median projected target interest rate for 2016 remained 1.375 percent, implying four quarter-point rate hikes next year.
The impact on business and household borrowing costs is unclear. One of the issues policymakers will watch closely in coming days is how long-term mortgage rates, consumer loans and other forms of credit react to a rate hike meant not to slow an economic recovery, but nurse monetary policy back to a more normal footing.
Growth in total business fixed investment has slowed, mainly because of the dramatic fall in oil prices and plunge in fracking and related investments. In the US, the economic distress in the “oil patch” is offset by the huge benefits to the rest of the country from lower fuel prices. But among OPEC and other oil producers, the setbacks are liable to have serious political as well as economic repercussions. In recent years, much has been accomplished in the US to deal with the “too big to fail” dilemma. Most large banks and other significant financial institutions have shrunk and will shrink further, while their equity positions have strengthened and continues so. Their retreat from the credit market has created space for nonbank institutions to grow, especially in the making and packaging of loans, many of which are commodity-based. The resulting hedge funds, private equity partnerships, internet lenders, and so on, are owned by (mostly) rich people who have skin in the game. So they have greater incentive and are better equipped to avoid losses. But these sophisticated investors also are more likely than holders of mutual funds or bank deposits to withdraw funds or hedge their positions when markets turn turbulent. In sum, nonbanks, like banks, are also subject to runs that can become infectious, resembling what happened in 2008. And such spasms, as recent experience demonstrates, are more prevalent in high-frequency trading markets.
While individual investors and taxpayers are better sheltered than before, the macro-economy may be at greater risk. Should there be a financial embolism, the Federal Reserve’s power to intervene has recently been curtailed by new rules linked to the Dodd-Frank overhaul, and the willingness of Congress to authorize fiscal assistance to financiers is probably lower than ever.
Although Europe may benefit from lower fuel prices, the outlook there is especially grim. Local chauvinism, inflamed by huge immigration from culturally non-Western areas, is superimposed on deeper problems of population aging and decline. (In notable contrast with many other industrial countries facing similar demographic problems, the new Japanese budget includes funds for child nurseries and senior service centers, in the hope this will permit adult relatives to remain at work.) The greater exchange-rate uncertainty introduced by last week’s events — a falling euro has been the main channel through which the ECB’s policies were supporting the euro zone economy — will further dampens private investment plans. The same probably holds true for longer-range investment plans by US firms, many of which are, or wish to be, multi-national. More broadly, the political stability, personal safety, and orderly financial environments needed to promote long-term investment are under assault in much of the world including, albeit to a lesser extent, the US.
Just when we thought we were free of monetary crisis, we get pulled back into one; this time it is the emerging markets. Ten years after the US housing bubble collapse and six years after Greece dragged the Euro zone to the brink, a third installment in the emerging markets is unfolding. This bust will hit harder than people expect, weakening the world economy even as the US Fed, threatens to raise interest rates.
This cycle began with capital flooding across borders in search of disappearing yield. Bubbles turned to busts, the flow changed directions, flowing from rich markets to poorer ones. Debt in the emerging markets has risen 150% of GDP in 2009 to 195% presently. Slower growth in China and weak commodity markets, along with the approach of higher rates in the US sets the world up for a sobering horizon. The coming reckoning will hurt three groups: The prolonged hangovers, such as South Korea and Singapore with enormous current account surpluses, that are kicking the can up the road. All this saps growth and puts off the threat of a severe crisis; the imprudent borrowers which lack the means to bail out their sufferers. Brazil, Malaysia, Turkey rely on foreign capital, have high debt to income ratios, high current account deficits, high inflation and foreign denominated debts. It is important not to overstate the gloom. Nominal wages in the US have just begun to rise at a healthy rate. Europe is having its best year of growth since 2011. Europe’s open economy is most exposed to the cooling emerging world. The US has a more acute problem: The divergence in US domestic monetary policy and that of the rest of the world. The fear is that any Upward pressure on the dollar, will hurt exports and hurt earnings. Waves of capital will invariably seek out the American consumer as the borrower of last resort.
The Euro Zone has been reporting underwhelming GDP growth of late. Germany grew at 1.8%, but its quarterly rate slowed, while France narrowly beat expectations and growth in Italy continued to slow. The Euro hit a seven-month low against the dollar and the yen on the hope that the ECB will introduce more stimulus. More easing would highlight the economy’s divergence with the US, which is promising a rise in rates.
China’s home price index rose for the time in more than a year. New home prices increased by a mere 0.1%, but at least it was upward. This ends a 13 month of steady dropping prices. This seems to be good news but the improvements in the economy are lopsided, in favor of State Owned Enterprises.
Japan, the other Asian powerhouse returned to recession when its economy sank by an annualized 0.8%, a much deeper contraction than the 0.2% that was expected. With China slow growing and low oil prices could prompt further stimulus.
The new game for the US will involve tough diplomacy and the occasional judicious application of force.
Nobody should wonder that America’s pre-eminence is being contested. After the Soviet collapse the absolute global supremacy of the United States sometimes began to seem normal. In fact, its dominance reached such heights only because Russia was reeling and China was still emerging from the chaos and depredations that had so diminished it in the 20th century. Even today, America remains the only country able to project power right across the globe.
There is nevertheless reason to worry. The reassertion of Russian power spells trouble. It has already led to the annexation of Crimea and the invasion of eastern Ukraine—both breaches of the very same international law that Mr. Putin says he upholds in Syria. President Obama, takes comfort from Russia’s weak economy and the emigration of some of its best people. But a declining nuclear-armed former superpower can cause a lot of harm.
Relations between China and America are more important—and even harder to manage. For the sake of peace and prosperity, the two must be able to work together. And yet their dealings are inevitably plagued by rivalry and mistrust. Because every transaction risks becoming a test of which one calls the shots, antagonism is never far below the surface.
American foreign policy has not yet adjusted to this contested world. For the past three presidents, policy has chiefly involved the export of American values—although, to the countries on the receiving end, that sometimes felt like an imposition. The idea was that countries would inevitably gravitate towards democracy, markets and human rights. Optimists thought that even China was heading in that direction.
Still worth it
That notion has suffered, first in Iraq and Afghanistan and now the wider Middle East. Liberation has not brought stability. Democracy has not taken root. Mr. Obama has seemed to conclude that America should pull back. In Libya he led from behind; in Syria he has held off. As a result, he has ceded Russia the initiative in the Middle East for the first time since the 1970s.
All those, who still see democracy and markets as the route to peace and prosperity hope that America will be more willing to lead. Mr. Obama’s wish that other countries should share responsibility for the system of international law and human rights will work only if our country sets the agenda and takes the initiative—as it did with Iran’s nuclear program. The new game will involve tough diplomacy and the occasional judicious application of force.
America still has resources other powers lack. Foremost is its web of alliances, including NATO. Whereas Mr. Obama sometimes behaves as if alliances are transactional, they need solid foundations. America’s military power is unmatched, but it is hindered by pork-barrel politics and automatic cuts mandated by Congress. These policies spring from the biggest brake on American leadership: dysfunctional politics in Washington. That is not just a poor advertisement for democracy; it also stymies America’s interest. In the new game it is something that the United States—and the world—can ill afford.
Pause, Think, Trump: Our Mighty Woman of the Torch’s tablet reads, “Give me your tired, your poor, your huddled masses yearning to breathe free…I light my lamp beside the open door.”
Rather than limiting immigrants, we should be welcoming them, let them in and let them earn. Europe and North America are among the richest most stable, peaceful places on Earth. We should admit that we have standards of compassion that obligates us morally if not legally, to grant safe harbor to all comers. With Hungary, some elements of Germany and Sweden, channeling their inner Donald Trump, barriers are being erected, as inhumane as they are absurd.
We need fresh, eager people to work; yes, new immigrants! For selfish reasons the welcome mat should be out. Our labor force is ageing and will soon begin to shrink. We need fresh blood to add to the pension contributions to pay the already or about to be retired workers. Clearly screening of immigrants must be done, but again It should be done firmly and correctly and for the correct reasons. Around the world, studies have consistently shown that immigrants are more likely to start businesses than natives, and less likely to commit serious crimes and are net contributors to the public purse. The fear that immigrants will poach jobs or drag down wages is also misplaced. They most often bring complementary skills, ideas and connections. They tend to raise the wages of native born overall. They become more productive and their wages rise accordingly. While monitoring should be stepped up, we need to assimilate, not alienate. Let them in and let them work. Just as America has done in the past, we should dump ‘Trumpism’.
The US is humming along quite nicely. Market levels reflect a much more buoyant economy than actual numbers deserve, however. Consumer spending is weaker than in over a year. Third quarter GDP may be lower than hoped. Though the Fed decided not to raise rates, Fed Chairman Yellen says a rate hike is still likely by year end. She also does not think the US will suffer from a global slowdown in growth and she will wind down stimulus measures.
The IMF said it was alarmed over the slowing on global growth and has encouraged G20 to implement polices to boost growth.
Manufacturing and services continue slow throughout the zone. Germany is perking up as is the UK, elsewhere in the Zone, things are quiet to gloomy. Despite the slowdown in September however, overall growth numbers are highest since 2011. Germany was perking up until VW, the World’s largest car maker admits it was fiddling the American regulations on emissions requirements. Everything changes, putting its future and a good many others under its banner in unforeseeable directions.
China’s government has lost credibility having bungled its devaluation of the yuan and by trying to prop up SOEs. Its goals are not clear and its policy is filled with contradictions. Its manufacturing surprisingly hit a six year low, industrial companies are reporting a drop of 8-9% in profits. China also suffered its tenth consecutive decline in trade and is suffering from weak demand generally. Any illusion of a gradual slowdown is gone. The slowdown in China has the potential to significantly dampen demand for oil. US crude has now been in decline for eight consecutive weeks, the longest streak since 1986.
Meanwhile, Japan is flirting with a recession, producer prices are falling and its economy contracted 1.6% annualized. Also of note is the recent laws Japan’s Diet (Congress) passed to allow Japan’s Defense Force to help Americans and its allies even if Japan is not under attack. China is not happy, reminding Japan of its brutality in WWII, but ignores its own (China’s) ambitious efforts in the South China Sea and those of its own revitalized military.