When Bad News is Good News
A colleague of mine, Jon, posed an interesting question on why it is that bad news today for the US economy (worst existing home sales number since ‘99) could be good for the US dollar.
Recall now the long-awaited death of the American consumer. Consumer spending has accounted for two-thirds or more of our economic growth and also for our huge trade deficit (as Americans have kept on partying like it’s 1999 and importing more than we export). Much of that spending has come in the form of Mortgage Equity Withdrawal (MEW) as Americans have treated their homes like an ATM. That works only as long as prices keep going up. But now we all know that has reversed.
The only surefire way throughout economic history to cure a trade deficit is a good recession. So if the housing numbers keep proving worse than expected and markets hear the death knell of the American consumer, is that necessarily bad for the US dollar?
Consider that if we cut our consumption drastically, imports will go way down and possibly dip below exports, correcting our trade balance. If the same amount of investment keeps coming in to the US because investors seek the safe haven of the US during a global slowdown, then the dollar would gain value.
Throughout the economic boom of the past 5 years the US dollar has been dropping, and perhaps throughout a recession we’ll see it rise. Take a moment to think beyond the talking heads on the news and consider that one can’t have it both ways: One can’t just say about the dollar that good news is bad news and bad news is bad news.
1 comment
Has the American consumer cracked? The recent credit crunch would lead a rational individual to think that the US consumer must crack. Consumer spending makes up a little more than 66% of GDP and the correlation between easy access to credit and consumer spending is very strong. So a recession is pending if we are not already in one. This being said, will the balance of payments deficit reverse and lead to an appreciation of the dollar?
No, because the expansion of our current account deficit has come from an increased trade deficit with China. The goods that the U.S. imports from China are relatively price inelastic. The price inelasticity is evident because individuals do not decide not buy a Barbie doll after a 25% appreciation of the yuan. This is a direct contrast with the price elasticity or sensitivity of the US consumer for big ticket items. Mainly produced in OECD countries namely Japan, and as an investor you understand why the Japanese government intervenes and holds nearly 700 billion of our debt (which is dwarfed by China’s 1.1 trillion in U.S. government debt.) While the Chinese economy is roaring the Japanese economy has stagnated despite the central banks intervention. Both countries have intervened to promote exports but only China is seeing the growth associated with an undervalued exchange rate.
The increase in the current account of April to -60.9 billion which beat the forecast of -59.6, shows that the current account is not slowing anytime soon. To reference the current account statistics please visit the below site, and realize that the deficit will not fix itself. Perhaps the recession will slow the widening current account but it there will definitely not be a surplus in my lifetime.
http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm
Leave a Comment