More about Iceland's CA deficit's ability to tell the future
CV
4 Comments
I think the Economist's economics editors are reading Nouriel Roubini's blog. If not they have certainly been tuned in to the same muse lately as one of the Economist's recent leaders about current account deficits resembles very much the recent post by Roubini about Iceland's and other small countries' current account deficit; I have posted on Roubini's post here. This is obviously not an issue in itself but as I have been quite interested in this topic lately I find the comparison between the Economist and Roubini interesting to pass on if not just to say that blogging actually does have an impact.
Consequently, there is not much new under the sun in the Economist's article but for those who won't bother churning through Roubini's the Economist offers an excellent summary of the argument and also asks the crucial question; is this a prevision of things to come in the USA?
"Over the past month Iceland's currency and stockmarket have fallen sharply; its banks have struggled to roll over short-term debt. Iceland's massive current-account deficit of 16% of GDP makes this tiny economy an extreme case, but it is not alone: New Zealand, Australia, Turkey and Hungary have also seen their currencies fall. Are these the local difficulties of a few small economies or a foretaste of the fate awaiting America?
These besieged currencies have something in common. Their economies all have big current-account deficits, driven in large part by rapid growth in consumer spending on the back of asset and credit booms. Recent events are thus an alert to larger countries with similar symptoms, not least America."
USA in proper company?
(...)
Iceland and New Zealand could be warning that countries with big external deficits are vulnerable. America's reserve-currency status makes it likely to be the last to blow, so its deficit may continue to grow. But those studying geysers know that the longer pressure builds, the bigger the eruption."
I do not study geysers but the Economist's and Roubini's points are an important contribution to the ongoing tale of the global economy and its imbalances.
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Reader Comments (4)
1 - When will the US crisis hit?
2 - Will the dollar no longer be the reserve currency because of said crisis?
The first is tough to forecast, of course, but not impossible. Debt is always and everywhere a speculation on the part of the buyer of that debt, regardless of whether it's backed up by a tangible asset (a mortgage), a known stream of income from a definite source (sovereign debt: taxes), or an unknown stream of income from indefinite sources (corporate debt: gross profit).
To buy up dollars, a la the Asian central banks, is to buy up not currency, but debt: sovereign or agency, for the most part. Agency = mortgage debt, mostly from the two large backers of mortgage debt in the US, Fannie Mae and Freddie Mac.
For some reason known only to themselves, the Asian central banks have been, for a time now, buying more and more agency debt. Mortgages, however securitized and packaged, are very risky for the buyers of them, because they are callable at any time, for the most part, which means that if rates go down, it's entirely possible you will find yourself having your debt called at a time when it will be impossible to replace the income you were expecting from the interest. But if rates go up too much, you could easily find yourself holding a bunch of defaulted debt because of the severe recession said rate hike would cause. And even if rates only go up some but not enough to cause massive defaults, since most of it is fixed rate, you don't get the benefit of rising rates increasing your income.
In short, it's a bad deal for the buyer pretty much no matter what happens.
It's worse when you consider that a recession with large default rates is pretty much an inevitable part of the cycle. When it comes to the Asian banks, they will start dumping when the pain becomes too much to bear from defaults on agency debt in the next recession.
That's when we get to the second question, will the dollar survive as a reserve currency?
Let's look at the alternatives:
1 - The euro: so far, the only thing the euro has done for its participants is quash the business cycle. The boom countries like Spain keep booming, while the stagnant countries keep on stagnating. This is a direct result of its killing both the interest rate and exchange rate feedback that used to function so well in keeping Europe's economy functioning flexibly. I firmly believe it will fail before the dollar has any kind of crisis.
2 - The yen: represents a country with a massive public debt, an inflexible political system, and no openness to immigration to solve its demographic crisis. In short, not a viable alternative as a reserve currency.
3 - The Chinese remnimbi: their demographics are bad, their political system worse than Japan's. The current burst of development is just that: a burst. Not an alternative in any realistic scenario.
4 - Indian rupee: maybe in the next century. Not in this one.
So, the dollar keeps its reserve status, just like it did after the bursting of Bretton Woods. But the crisis will still be a bad one, and may involve a kind of "Washington Agreement" among the Asian central banks to not sell off their dollar-denominated debt too rapidly.
Thank you for the elaborate comment. Number one still has me thinking ;) but in terms of number two I agree with you; it is hard to see any other currency than the dollar be the reserve currency. In this light it is also difficult to see China and the petro-exporters diversify their reserves anytime soon. However, the longer and stronger the build up the more pain it will inflict when/if diversification becomes a real issue.
Brad;
Of course it is Roubini; I don't exactly know what caused the name meltdown in this post. Perhaps it is because it is inherently easier to type "Rubini" ?