MInyan Mailbag: Cure All?
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Just what is the cure for the world economy?
On Friday Morgan Stanley's panel of experts seemed to agree on several things as follows:
1) Higher US interest rates and a lower US$ at the same time.
2) Increased consumption in Europe.
3) Reforms of structural problems and unions in Germany.
4) Increased consumption in Asia.
5) Decreased consumption in the US.
6) China to float the RMB.
Let's look at each solution in turn.
1) Higher US interest rates and a lower US$. Those are actually somewhat contradictory. Will higher US interest rates turn the tide in the US$? Perhaps and perhaps not. Does the US really want a higher US$ anyway? Will Greenspan keep hiking if it seriously affects housing or will he pause? There are signs the economy is weakening and given the dual mandate of the FED (support interest rates and jobs/economy) it is likely IMO he will pause if the US economy stalls. Christmas spending and jobs will be the keys IMO. The Fed's dual mandate helped get us into the problem and I doubt it will help get us out of the problem. OTOH Will Europe just be inclined to hike rates if they get the chance? That is what Trichet has been saying. Won't that cause the Euro to soar if they tightened? I think so. At any rate, Europe wants the US to fix its problem when it has spending problems of its own. Its stability pact is exceeded by numbers of countries. Europe simultaneously wants a strong currency and a stronger US$. Japan wants to stay ahead of Europe but also lower oil prices and higher inflation, while the US wants the fruits of a lower US$ to help exports but also wants falling oil prices to help manufacturers. Sorry folks it does not seem possible to me to do all that by tweaking interest rates. There are just too many conflicting goals of too many players.
2) Increased consumption in Europe. With unemployment in Germany at 10% and probably going to get worse if the Euro rallies further, just how do we expect Europe to be paying for this stuff they are supposed to be consuming? What is it they need to consume anyway? Considering Europe's demographic problem, I just do not see them running out to buy the latest video toys, HDTVs, or any other such nonsense. Spend? On what? Why? Besides, why should anyone be forced to spend when there is no need to spend? There is every indication that Europe is pushing on a string right now with excess liquidity that no one wants to use or needs to use. Europe actually wants to hike in the face of 10% unemployment in Germany and structural deficits beyond the "stability limits" in about 6 major countries. Would hikes cause more unemployment and increased budget deficits in the EU? I think so. It seems the EU has a pretty big spending problem of its own, just not as big as the US.
3) Reforms of structural problems and unions in Germany. I fail to see how union changes and labor rules will "fix" German unemployment. I can see that there might be a refusal to hire workers if it is hard to get rid of them, but if worker rules were relaxed, I would think the first thing that would happen would be a huge flight of jobs to India and China. Short term anyway I think it would cause a flight of jobs. Who thinks long term these days other than China? The other reform that is mentioned is the need to eliminate the shorter work week in Europe. OK if you make people work longer and give them less vacations but pay them the same, you have an increased output of goods and less time to spend it and certainly less vacation time in which to spend money. With a glut of worldwide goods, will producing more goods while paying workers less to produce them solve the problem or make it worse?
4) Increased consumption in Asia. Given the demographic problems in Japan, I ask the same questions as I asked about Europe. Just what is it we want Japan to consume and why? China is probably different and there probably is pent up demand for stuff in China but wages of the masses do not support much consumption yet. It is those wage differences that is one of the reasons China is booming. No doubt there will be increased demand in China but China itself seems unlikely to come close to picking up slack from US consumers, right now anyway.
5) Decreased consumption in the US. OK. This will help US balance of trade and help strengthen the US$, but who is going to buy those goods coming from Europe and Asia? This is a practical as well as MANDATORY component of fixing the problem.
6) China floats the RMB. Does China have in place the structures necessary to handle it: currency markets, banks sound enough to handle the stress, and a means to deal with hot money floating into China? Bear in mind China is trying to slow down its economy. It seems to be succeeding at its own pace (the normal slow pace of reform in China). Is there really any advantage for China to do it on a pace that the US wants instead of the pace that China wants even assuming China could handle a sudden jolt to floating rates? Would we really be happy with the result if it happened?
OK so where does that leave us?
That leaves us with #1 and #5 as things that are practical. Floating the RMB is all talk for now and there are legitimate reasons for China not to do it. If the US economy tanks, floating the RMB may remain talk for quite some time. In terms of spending: How can the world force Europe and Japan to spend more? Japan has been trying for 18 years without any real success. If and when the problem is solved by increased consumption in China alone, the rest of the world is not going to like it at all IMO. Rising US interest rates are indeed happening and there are signs that consumer spending is about to slow as well, perhaps in a big way. China floating could force US interest rates up so fast the world just might not want it. The US raising rates at a "measured pace" is practical only up to the point it kills US housing. It is debatable if and when that might happen but if housing dies that forces the whole mess on a slowdown in US consumer spending. Of course that leads us to only one thing: A huge recession in the US and in this unbalanced state of affairs, probably the entire world.
The solution suggested by Roach and company is impractical. It could in theory work (up to the point that US housing did not crash), but from a political standpoint does not seem even remotely possible. Japan and Europe show no signs of wanting to spend more. Japan in fact seems headed back into a recession. Europe does not want to spend more and is very close to a deflation trap, and housing and consumption are on the decline in the UK. It kind of reminds me of all the bitching about the US$:
Everyone wants someone else to do something about it. No one wants to do what they can to stop it. If anything the US is encouraging the US$ to fall and the entire rest of the world is bitching about it but does not want to deal with the repercussions of stopping it.
The solution suggested by Roach and company is as impractical as having mice tie bells on cat's tails to know when the cats are approaching. The US and Europe for starters have conflicting goals. The US wants a lower US$ and Europe and Japan want a higher US$ and China seems happy with the status quo. That is a tough nut to crack in and of itself. Japan can slit its own throat by massively selling treasuries which could force the US to hike much quicker, but there would likely be very serious world repercussions to that. With the US government's inclination to spend (especially given who is in the White House) nothing is likely to be resolved until this whole freaking mess blows sky high when someone panics, or until the problem is fixed by a mammoth US consumer led recession. There are serious implications of attempting to fix the trade imbalances by #5 alone, but I view the possibility of it as being increasingly likely (I am assuming the FED will pause at some point soon). Whether or not such a single sided effort will succeed in solving the problem is another story (hint it won't), but it's at least a start. Ultimately, it will take a recession to fix this mess. Bring it on now.
This is a very good synopsis, so I won't comment on the details.
Essentially the problem of world imbalances has been caused by years of unbridled credit expansion (see Laurie's piece), which has caused over consumption in the U.S., along with untenable debt and consequential over-capacity. This over-capacity is now being exacerbated by Asia which is bringing on line more production of various types and ever cheaper labor.
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