Most convincing, perhaps was a graphic analysis by Michael Rosenberg, Deutsche Bank's Head of foreign exchange research. He showed that the dollar's movements tend to go in cycles, of about 5-7 years in duration, with periods of dollar strength being accompanied by exceptional strength in the U.S. economy and periods of dollar weakness being accompanied by either excessive Federal Reserve creation of money, or excessive U.S. balance of payments deficits or (as currently) both. He pointed out that the U.S. balance of payments deficit, currently at $500 billion per annum just under 5 percent of gross domestic product, was still headed on a sharp upward trend, if only because imports are now half again as large as exports, so a similar percentage increase in both imports and exports produces a widening trade gap. Deutsche Bank's forecast for the U.S. balance of payments in 2004 is a deficit of $610 billion, almost 6 percent of GDP. This is far larger than the previous record deficit, around 3.5 percent of GDP in the mid 1980s.
Rosenberg believes that the dollar is currently in the early stages of a down cycle, with on a trade weighted basis around 10 percent of an eventual 30 percent drop completed. So far, most of the drop has been against the euro, and Rosenberg expects this to continue, with the euro topping out at around $1.40-$1.50 (other participants also expect the euro to reach $1.50.) The Japanese government has bought over $50 billion of Treasury bills since January in order to keep the yen stable against the dollar. However, Rosenberg expects the yen to share in the general strength against the dollar going forward, strengthening from its current level of Y117=$1 to around Y110=$1. The third stage of the dollar decline will involve the Chinese renminbi, which is currently pegged to the dollar and therefore causing considerable trade distortions in the Asia Pacific region, even though on a global basis Chinese trade is only just in surplus. However, a revaluation of the renminbi against the dollar, even if it were to continue to decline against the euro, would be a very difficult decision for the Chinese government, which has only recently taken office, and hence can be expected to be moderate in extent (possibly accomplished simply by a widening of the renminbi's current trading bands) and delayed at least into 2004.
Kenneth Rogoff, director of the Research Department at the International Monetary Fund, stated that the U.S. net debt position (foreign debts, at current prices minus foreign assets, revalued to current prices) was now around 25 percent of gross domestic product, as high as at the peak of U.S. capital-importing development in the nineteenth century. He projects that the U.S.'s net debt position will reach 40 percent of GDP by 2007, which is well above Mexico's net debt at the time of the 1982 and 1994 crises, higher than Brazil's currently and comparable with Argentina's at the time of its 2001-02 meltdown. Nevertheless there have been successful countries with higher net debts; in particular New Zealand currently (70 percent) and Ireland around 1990 both had higher net debts than 40 percent of GDP.
Rogoff also made the important point that the composition of the financing inflows to the U.S., financing the payments deficit, has changed. Until 1999, at which point the deficit was around 3-4 percent of GDP, funds inflows were largely largely investment in productive U.S. assets and stocks, particularly during the dot-com boom. More recently, U.S. savings rates have fallen still further in comparison to the rest of the world, and foreign funds flows have entered the U.S. to fill the gap, but have been invested largely in more passive assets such as Treasury securities. One advantage of this, from the U.S. point of view, is that the returns to foreigners, particularly Asian central banks, on their U.S. holdings are relatively low, whereas the returns to U.S. owners of foreign assets, primarily direct corporate investments abroad, are very much higher, so the net service cost of the U.S. net debt position is very low, if it is even positive.
As I pointed out in questions, with the U.S. federal deficit now approaching $500 billion, the country is essentially sucking in 5 percent of GDP per annum in net foreign flows each year, and pouring it down a rat hole. This is unlikely to lead to anything good in the long run. Conversely, the late 1990's, when the country was sucking in $300-400 billion a year to invest in worthless dot-coms and overvalued telecom, were a halcyon period for the U.S. economy's relations with the world; the entire country was behaving like a Wall Street bucket shop! The difference, for those worrying about this analogy, is that debt, Federal or otherwise, must be repaid, whereas equity -- overvalued or phantasmagoric -- somebody (management, employees, stock brokers or suppliers of the myth-creating companies) gets to keep.
The meeting concluded with a presentation by economist Allan Meltzer. He pointed out that foreign holdings of dollar reserves have increased at a rate of 8.5 percent per annum, to $1.8 trillion, over the last 30 years, so that the U.S. would need to run a payments deficit of $150 billion simply to supply this foreign demand. In May 2003, for example, $110 billion of U.S. assets were bought by foreigners, representing over twice the payments deficit for the month -- this may account for some of the strength in Treasury bond and U.S. equity markets during the month.
Meltzer does not however agree with Fed Chairman Alan Greenspan's recent warnings about deflation -- "what economic textbook has he been reading?" Instead, with money creation having been so high for so long, and the dollar being structurally weak, Meltzer believes that the U.S. will have "the highest inflation in the developed world in the next few years."
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