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Sunday
Dec102006

The Anatomy of Global Re-balancing ... continued

I did tell you to read Brad Setser in my post below and now I am going to tell you once again pointing you to Brad's recent excellent post which pretty much takes up the question I am scrutinizing in the post linked above. Is it really the end of the Bretton Woods 2 and time for the re-balancing here? I am glad to see that Brad has not been sucker-punched here by the recent dollar wobbles to begin hailing the major crack. As always he is watching the data and Asian CBs just keep on buying those T-bills. 

One thing which is important here is the perspective Brad and I take on this or more accurately the fact that we are attacking this issue from two sides (kind of, at least). In the post below I am investigating the viability in the prediction that the Dollar will continue to fall so much against the Euro on expectations on interest differentials that it will prompt the dollar peggers to move against the dollar and bet on the Euro instead; as such trading a Dollar-peg with a Euro-peg. As I am arguing this is pretty much nonsense and as such Bretton Woods 2 persists  ... unless of course as Brad is musing that the Asian dollar peggers actually began to float their currencies to a larger extent against the dollar? Admittedly, this might seem as a slipup from my side that I did not mention this possibility in my post below but I am cunning you see :) or at least I am trying to be ... 

Consequently, by suggesting that the Asian dollar peggers (and petro-dollar countries) at some point are going to get enough and will be forced to let their currencies appreciate Brad is taking up my invitation to discuss the fundamental question about what in fact the main structural drivers of global macroeconomic balances are? 

Let us first look at the two emerging possibilities for a crack-up of the Bretton Woods 2 as it looks now with the dollar as an anchor ...

1. The scenarion I describe below where the Dollar slides so much against the Euro that it will cause a deliberate run on the dollar as a function of a major Euro-biased reserve diversification, kind of like a Bretton Woods 2 Plaza Agreement I guess. In terms of the probability here ... well as I argue below it is next to none. 

2. That Asian CBs essentially have to abandon their peg due to the fundamentals of the real-exchange rate and also due to the major issues of holding an ever greater holding of dollar reserves to keep the peg.

Of the two scenarios above number 2 is clearly more probable than number 1 and also most importantly the two are not entirely inseperable. Yet as Brad argues (linked above) Bretton Woods 2 is effectively driven by rather complex politics. At this point there is seemingly no easy way out. However, let us imagine for a time that his actually happened ... would this really prompt a major re-balancing?

On a first note, it would clearly have a large efffect and although, in reality, I don't think anyone expect that for example China transists to a floating regime with the US from one day to another relative prices matter, as Brad Setser never tires of arguing. But would such a move be it more or less gradual really unwind the imbalances?

This seems to be the real question here and I do not have the answer but I have the possibility to give you a little food for thought I hope. In fact, I have already revealed my position below as I see that at least one of the major structural components of the global macroeconomic imbalances are vested in demographics. As such, the rebalancing thesis at this point still seems to hinge on for example Europe's ability to run a sustained and relatively significant trade deficit; I would argue that this is highly unlikely. Someone might also be tempted to mention Japan here but this is simply not feasible given the country's demoraphics. This of course leaves the rest of the world and clearly there is plenty of domestic momentum in some countries, more notably those currently moving through the demographic dividend. This would then include most notably India but also Turkey and Brazil. However, we are really circling the honey pot here are we not? So what about China then?

I honestly do not have the expertise to stick out my neck here but I am going to anyway. One of the most important features to remember here is China's growth path which essentially is investment driven (sorry; Roach/Setser 1 - The Economist 0) as a function of high corporate and domestic savings. This is working as a double whammy on global imbalances together with the dollar peg to create a huge strucutal deficit with the US. But in arguing this we also need I think to think of a world where the Yuan floated against the dollar. Given the strucutural relationship between the US and China as two of the world's biggest economies essentially producing in seperate ends of the value chain would we still not see the US running an overall deficit against China? This is of course all speculation but more importantly is the question of China's ability to import instead of export. I mean they are h'll of a lot of people and as for example The Economist has persistenly argued lately we are underestimating the consumption component in the Chinese economy which again would mean that if we were really to see some action here in terms of cracking Bretton Woods 2 we would expect the Chinese consumer to start doing some heavy lifting. Of course I am oversimplifying here since China already is importing; a lot actually. In fact, a great part of Japan's current growth comes from China and also Germany is exporting considerably to China.

However, given my belief that demographics matter here, I would argue that the window of opportunity is closing. I short, China is ageing and rather fast actually as a result of the one-child policy. In terms of estimates I really have no clue ... regarding the crucial measure of the dependency ratio I have seen estimates that the curve will crack as soon as 2015 but also some which estimate it to be 2030. What it all comes down to though in terms of a rudimentary thesis is that China's ability to contribute to a sustainable re-balancing process is not rising as we go along. This is of course still leaves India and other countries as well but given the overall demographic trend of for example the OCDE countries the nature of global imbalances can perhaps suddenly be seen in a different light?

Friday
Dec082006

The Anatomy of Global Re-balancing

Today the ECB chose to raise the Eurozone interest rate which effectively should not come as a big surprise for anyone following the European discourse and debate as of late. However, behind this move by the European Central Bank lies a more subtle narrative concerning the global macroeconomic imbalances and how some believe that while the US is slowing and the dollar falling the ECB will continue to raise rates on the back of a sustainable recovery in the Eurozone. As such, we are seing the beginning of the unwinding of the imbalances. This at least was how many argued a week ago, among those the influential British magazine The Economist (of which I am third year happy subscriber I should add) who in their cover story and following in-depth article hailed a new era in the global economy where the dollar and the US economy corrected to the fundamentals of a huge US current account deficit and the fact that Eurozone would take over pulling growth forward. In short, what we are seeing is a prolonged and sustained fall in the dollar. Also the notable economics commentator Martin Wolf from the FT noted that the current fall in the dollar would be sustained to correct the imbalances.

In the following I will argue that we are not on the brink of global re-balancing. My argument is initially based on the simple yet crucial notion that the extent to which the Dollar can fall hinges on whether other currencies can appreciate. I will present the theoretical components for re-balancing as two steps and show why this most likely will remain to be theory and not practice. My essay will end on an open note inviting to a discussion about the fundamental drivers of global macroeconomic imbalances.

Click to read more ...