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James Turk: Gold or the S&P? Cash or stocks?
By Mike Dolan
Reuters
Friday, November 4, 2005
http://today.reuters.com/news/newsArticleSearch.aspx?
storyID=307973+04-Nov-2005+RTRS&srch=dollar+surge
WASHINGTON (Reuters) - As the U.S. dollar rockets to its strongest
in 18 months, many experts are tempted to conclude currency markets
could not care less about the global imbalances much feared by
policy-makers around the world.
Economists acknowledge there is a tendency in markets to assume that
if a major hiatus from these imbalances hasn't happened by now, it
may not happen at all.
"The longer the world endures mounting imbalances without suffering
any serious consequences, the more the financial market consensus
believes this disequilibrium is sustainable," Stephen Roach, Chief
Global Economist at Morgan Stanley, said in an opinion piece in the
Financial Times on Tuesday.
But has a crisis been averted or just postponed?
The long-running debate over the risks posed to world financial
stability from burgeoning world imbalances, clearly evident in the
ballooning U.S. current account deficit with the rest of the world,
splits into two camps.
The doomsayers insist rising U.S. indebtedness is unsustainable and,
any time soon, the willingness of foreigners -- mainly Asian central
banks -- to keep plowing larger chunks of their savings into U.S.
assets will wane.
When it does, they say the dollar will slide, long-term borrowing
rates will soar and debt-dependent U.S. households will be forced to
cut back, triggering a world recession.
But as the dollar surged to its highest in 18 months against a
basket of major world currencies on Friday, notching up 13 percent
gains so far in 2005, proponents of this argument could be forgiven
for scratching their heads.
The optimists, on the other hand, will say 'we told you so'. No such
crisis is anywhere on the immediate horizon.
They argue the sustainability of deficits is greater now because the
increasingly interdependent global economy has seen a much higher
level of cross-border capital movement over the past decade and U.S.
investments remain an unusually "safe" and attractive destination.
Once again, Federal Reserve Chairman Alan Greenspan led the "don't
worry" brigade on Thursday, insisting a rise in the U.S. payments
deficit to more than 6 percent of gross domestic product was driven
mainly by long-term forces of globalization that would not disappear
overnight.
Greenspan, describing the ability of the U.S. to sustain these
deficits to date as a "market phenomenon which is reflecting
globalization," said this could not continue indefinitely but
neither did he see some sudden crisis.
"At some point globalization will slow down, but we're in a period
where it's been undergoing an extraordinary expansion and has had
effects we have yet to fully understand," he said.
One problem is this relatively rosy view of the world is not shared
by many policymakers elsewhere the world, belying a view that there
is consensus on what to do about it at top global forums like that
of the Group of Seven rich nations.
European Central Bank chief economist Otmar Issing, speaking in
Paris on Friday, said the U.S. current account deficit had got
to "worrying proportions."
Bank of Japan Governor Toshihiko Fukui, speaking at the same Paris
event, seemed to take the middle ground, acknowledging Greenspan's
long view may buy time for corrective policy action but being
equally wary the current benign financial environment could change
quickly.
"Capital markets are extremely forgiving when things go well.
Nevertheless, markets are extremely unforgiving when things take a
turn for the worse," Fukui said.
"The sudden reversal of large capital flows might be a low
probability event, but damaging when it occurs," he added.
Some analysts said the comments suggested higher interest rates in
the U.S., Europe and Asia may well be seen as part of the policy
process to correct the imbalances, just as much as tighter U.S.
fiscal policy or flexible Asian exchange rates.
That is because much of the unbridled flow of money across the world
in recent years has been driven by ultra-cheap credit everywhere.
And this abundance of global liquidity has seen money and capital
become highly leveraged in risky, bubble-like markets and
dangerously speculative trading.
Yet, for all the seeming certainty of dollar bulls of late,
financial analysts too remain just as split as policymakers.
Roach at Morgan Stanley said he sees a 40 percent chance of the
imbalances coming unstuck in 2006. "The history of economic crises
is clear on one important thing: the longer any economy holds off in
facing its imbalances, the greater the possibility of a hard
landing."
But Deutsche Bank economists Michael Dooley, Peter Garber and David
Folkerts-Landau, who insist Asia's dollar pegs and subsequent build-
up of dollar reserves is the key driver of the imbalances, reckon
the situation is far more stable.
They reckon the policies of these emerging Asian countries are akin
to another semi-fixed global exchange rate regime or "Bretton Woods
2."
The use of plentiful, cheap labor and dollar pegs to boost exports
and growth is the deliberate flipside of banking the resulting
reserves pile back in U.S. debt to keep U.S. consumer borrowing
costs low and demand for Asian exports high.
"Whatever the judgment that hindsight will deliver on these academic
disputes, it is clear that the global monetary system that we have
described has some legs to it," the Deutsche Bank economists said in
a research note on Friday.
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