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U.S. won''t get away forever with force-feeding dollars to world, Buffett warns
An Economic Playground
By John Mauldin
Tuesday, January 18, 2005
We are all familiar with the seesaw. Who among us did not play upon
one as a kid? Seesaws work as long as both partners work together.
Indeed, with the proper cooperation, they are quite fun. However,
there are more than few of you who let your partner get to the top
of his ride and then jump off, allowing him to drop to the ground.
I, of course, never did that to my younger brother.
The world is in a kind of seesaw economy, precariously balanced
between a U.S. trade deficit and foreign central bank buying of U.S.
Treasuries. In general, I think the game continues though 2005. It
is in no one's best interest to stop the game. It should be another
good year for the economy, but we are getting closer to the endgame,
when one partner decides they are doing all the heavy lifting and
the other partner is just along for the ride. And as I explain at
the end, it may not be our foreign partners who bail out of the game
On the global economic front, first and foremost, the U.S. trade
deficit looms large upon my mind. There are those who say deficits
no longer matter. We do not care that Oklahoma has a trade deficit
with Texas, so why in a global economy should we care if the United
States has a trade deficit with Asia? Clearly, the U.S. has been
running an ever-increasing trade deficit for years and our growth is
just fine, thank you. Arthur Laffer maintains in last week's Wall
Street Journal that a trade deficit is a sign of strength, not
weakness, as it means that people are lining up to invest in the
Well, not exactly, Art. First, there is no currency risk between
Oklahoma and Texas, so doing business is merely an issue of solving
credit risks. Doing business in another currency (and with another
government) poses major additional risk to the lender and the
borrower. The United States has so far gotten away with a trade
deficit that is almost (and unprecedented) 6% of GDP, but that is
primarily because we are the world's reserve currency.
But that may be slowly changing. Roughly half of China's growth in
foreign exchange since 2001 was placed into dollars. However, last
year China saw its reserves grow by $112 billion, but the dollar
portion was only $25 billion. (Source: Bank Credit Analyst.)
China has made it clear they are spreading out their reserves and
putting less emphasis on the dollar. It is reasonable to suspect
that this move to diversify out of the dollar is also putting upward
pressure on the euro and other "floating currencies."
Secondly, the level of private investment in U.S. securities has
plunged dramatically in the past four years. The difference has been
made up by (mostly Asian) central bank's buying of U.S. Treasuries.
Roughly half of that buying has been by Japan in an effort to keep
the yen from rising too much against the dollar and the Renminbi,
with other Asian countries doing their part.
This buying spree by primarily Asian Central Banks, and not the lack
of Fed action, is what has kept longer-term U.S. rates low. It has
allowed U.S. consumers to accumulate even more debt at low costs and
spend it on Asian goods.
In the 1990s private foreign investors lined up around the corner to
buy our stocks and invest in America. Today, the private foreign
flow is inconsequential. There is little or no foreign investor
confidence in the United States. Indeed, look at the very astute
Bill Gross's latest column from Pimco. He is not exactly a raging
bull on U.S. securities, suggesting foreign bonds as among his
favorite investments. This is from a conservative U.S. bond guy!
Foreign central bank purchases of U.S. Treasuries in order to
maintain a competitive currency valuation to attract the U.S.
consumer is not a sign of strength. It is a sign of desperate
foreign central banks trying to maintain their economies, which are
dependent upon U.S. consumers. They KNOW they are going to get hosed
on their dollar holdings, but feel they have no choice.
This is a trend that cannot continue indefinitely, but it can (and
probably will) go on longer than we think. The world must re-balance
from U.S.-centric growth to a more balanced growth, with Japan and
Europe, as well as the rest of Asia, becoming their own consumer
engines. But this will not happen overnight, or even in a few years.
This is a longer, more drawn out process. When it starts, it will
not be fun.
This next part of the process will start in earnest when the Chinese
let the Renminbi float. "Ah," you ask, "but when is that?" It will
be when we least expect it, or at least when the market does not
The Chinese agreed to let their currency float by 2007 when they
joined the World Trade Organization, so we have an "end date" in the
process. They would be foolish to wait until then, as the pressure
would become too big, with no way to gauge the response. The longer
they put it off, the more the market knows they must move.
So, it is likely to be done before then. My guess is that it is done
gradually, starting sometime no earlier than the last half of this
year (and of course, since I do not expect it until the last half,
that means it will almost certainly be at some other time). There
are two likely ways for them to go. They could simply set a limit or
a "band," say 5%-10% of the current peg, and over time increase that
limit. That would allow for gradual change.
Let me point out that it is not altogether clear that the Renminbi
would immediately rise if the currency were allowed to float and the
Chinese people were allowed to hold non-Chinese currencies. There
might be a lot of Chinese companies and individuals who would like
to diversify their holdings. Over time, the Renminbi almost surely
rises, and perhaps significantly, but the initial moves could be a
surprise. Since the Chinese Central Bank and government do not like
surprises, they are likely to approach things on a gradual basis.
And they will also do it when it benefits them the most.
Or, they might announce that instead of having a dollar peg as they
do now, they are going to peg the Renminbi against a fixed basket of
currencies (perhaps trade-weighted, perhaps not). That would allow
the Renminbi to rise against the dollar but stay relative to their
neighbors. It would also allow Asian currencies to stop the
competitive devaluation contest they have been in for a decade. They
could all allow their currencies to rise, more or less in tandem,
against the dollar.
The Asian organization SEATO, composed of ten major Southeast Asian
countries, basically announced such a basket of currency reserves
policy when they declared last quarter that they would work toward a
free trade zone including China. It would be the largest such zone
in the world. Part of the deal would be to value their reserves in a
basket of currencies of their trading partners, lessening their
dependence on the dollar.
So, how does the United States respond to the growth of free trade
everywhere? Maybe asking to join? No, we slap a huge multi-billion
dollar tariff on foreign shrimp today. Now, there's a threat to the
U.S. economy. Coming to a restaurant near you: Jumbo shrimp at much
higher prices. Your government at work protecting you. Maddening.
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