Posted by Ambrose Evans-Pritchard on 12 Jul 2007 at 16:48
Tags: Economics, dollar, World economy, Demographics, Currency
all hysteria. The ailing Greenback will not collapse this
year, not in ten years, not in twenty years, not in half a
century. There is no credible currency against which it can
collapse. (Unless you count gold). None of the world's rival
power blocs have the economic and demographic depth to challenge
have a dollar rout on our hands. The markets have suddenly
begun to discount a nasty crunch in the US as the subprime
debacle spreads through the credit markets. The prospect
of rate cuts by the Federal Reserve is drawing closer,
knocking away the dollar's yield prop. Investors have
switched reflexively to the euro as the default currency.
This cannot last. It assumes that Europe has "decoupled"
from America and now has the umph to go it alone. German
finance minister Peer Steinbrueck played to this illusion
on Monday when he professed to "love the strong
euro" - (directly contradicting testimony he gave
to the European Parliament earlier this year).
Whether or not Germany is really that immune
to an exchange rate of $1.38 to the dollar (Professor Peter
Bofinger - one of the country's five "Wise Men"
- insists adamantly that it is not), it is in any case a foolish
error to treat Germany as if it were a proxy for the whole
eurozone. In reality, it has become the nemesis of Euro-land.
While the Teutonic Tiger is indeed springing back to life
after a decade-long slump, it is doing so by conquering market
share from the Club Med bloc in what amounts to a beggar-thy-neighbour
shift within the euro-zone. This has a zero-sum flavour to
France, Spain, Italy, Portugal, Greece, and latterly Ireland
are all facing very serious trouble. They are at or near the
top of the cycle. Housing bubbles caused by ultra-low interest
rates (geared for Germany, when Germany was down -- the dirty
secret of EMU) are starting to burst. Club Med's share of
global exports is collapsing.
Bernard Connolly, global strategist at Banque AIG and former
head of economic research at the European Commission (the
best informed euro-critic in the City, and the one most feared
by Brussels), says Spain will face an outright "depression"
by 2008-2009 and Italy will face an "Argentine crucifiction"
until it is ejected, or chooses to escape, from the euro-zone.
How has this "divergence" happened? In a nutshell,
Germany has gained 20pc in unit labour cost competitiveness
against France, 30pc against Spain, and 40pc against Italy
since the currencies were locked together in 1995 (EU data).
It has done so by screwing down wages, while Club Med has
done what it always does -- let rip on wages.
Or put another way, Europe's ancient nations have reverted
to type, as they were always bound to do. The elapse of
a decade has allowed this to go beyond the point of no return.
How is Italy, for example, supposed to claw back lost competitiveness
on this scale against low-inflation Germany? Yes, Italy
did this in 1927 under the `lira forte' policy of Mussolini,
but he was able to use Fascist powers to ram through a 20pc
cut in wages. Try that in a democracy. It would take a severe
recession to force down Italian wages enough to make a difference.
The budget deficit would balloon. The national debt (108pc
of GDP) would spiral upwards, setting off panic sales of
Italian bonds. The policy would instantly defeat itself,
even if it did not set off civil conflict - which it would.
Italy cannot break out of this impasse unless Germany agrees
to tolerate much higher inflation for the whole euro-zone.
Berlin would sooner choke on Sauerkraut.
The longer the euro stays near $1.40, the more severe the
coming crisis a year or eighteen months hence -- as the
lagged effects of over-valuation turns boom to bust with
even greater violence across Club Med. Sooner or later,
the markets will twig in any case. The screams coming from
southern Europe will be too loud to ignore. Worth noting
that Goldman Sachs has begun to recommending "shorting"
Italian and French bonds, expecting them to diverge further
from German Bunds. This is exactly how the unravelling begins.
It will become obvious at some point that the euro-zone
is just a glorified fixed-exchange rate system, not a sacred
union. The euro is an orphan, stateless currency, lacking
the mechanisms (a debt union, pension union, a shared treasury
and fiscal transfers) that makes a currency union work over
Contrast that with the dollar, the currency of a nation
forged by wars and the ancestral chords of memory (Lincoln's
words) - all for one, and one for all. America is a country.
(Again a Lincoln sentiment, but now a truism). That massive
historical fact makes all the difference.
Ah, but there is the Japan, at last breathing again after
its near-death brush with deflation. Now, I don't doubt
that the yen will at some point snap back violently as interest
rates (now 0.5pc) return to a semblance of normality. As
soon as global risk appetite fades again, the yen carry
trade will doubtless unwind - perhaps brutally as in 1998
- and some of that $500bn shipped overseas will come home.
That said, anybody who follows the rhythms of Tokyo's stock
market must suspect that a sharp appreciation of the yen
will cause the Nikkei index to plummet - bringing Japan's
fragile expansion to a swift halt. The "Seven Samurai"
exporters -Honda, for example, which earns 70pc of its revenues
in America - will take a battering. As month after month
of disappointing retail data this year keep showing, Japan
lacks the demand growth to take the baton from America.
Wages have fallen for the last five months in a row.
Japan is already the oldest society in the world, shrinking
since 2005. The population peaked at 128m in 2005 and is
expected to fall below 100m by the middle of the century.
If - as expected - Japan's aging grannies and housewives
raise the share of foreign assets in their portfolios from
3pc to 12pc over time, the yen must weaken further. It is
the dying currency of a dying country -- albeit a most charming
Which brings me to China, a country that is growing old
before it ever becomes rich. The working-age population
peaks in 2015 - just eight years time. China then dives
into the steepest demographic decline ever known by any
nation in peace-time. As for China's current boom, you need
only know three things so see where this is going: credit
is being channelled for political purposes through Communist
state banks that are not subject to market discipline; almost
half of GDP is going on investment, leading to a glut of
factories; return on that investment, measured by the incremental
capital output ratio, is 4.4. Much of it is being wasted.
Compare that to Japan (3.2), South Korea (3.2), and Taiwan
(2.7) during their growth spurts. China is not going to
take over the world economy, now or ever. The window will
close shut before they get there.
No, the 21st Century will be the American century, just
like the 20th Century. Americans may have to tighten their
belts a bit after all the sins of Alan Greenspan and the
Clinton-Bush debt generation. But the dollar will still
be the world's reserve currency long after the euro has
disappeared and the yen has been forgotten... Now, the Indian
Rupee? Hhm. Another day.