Why the Dollar is Falling

[FaGal]

Il «New York Times»: dopo i rincari dell’energia arriva la recessione. Benzina sempre record in Italia: sopra 1,3 euro in autostrada

L’America teme lo choc e il petrolio frena

Si fermano i consumi Usa motore della ripresa. E il barile va sotto i 64 dollari

Il petrolio frena, ma crescono i timori degli americani. E adesso c’è anche chi comincia a parlare di recessione. Il giorno in cui la corsa del greggio sembra prendere una pausa, dopo le impennate che hanno visto salire le quotazioni per 7 giorni consecutivi (ieri è sceso a 63,45 dollari al barile, malgrado la riduzione delle scorte di benzina di 5 milioni di barili), si acuiscono Oltreoceano le preoccupazioni, legate all’inflazione (?0,5% l’ultimo dato mensile), visto anche il balzo dei prezzi alla produzione annunciati ieri (?1% a luglio, il doppio rispetto alle previsioni degli analisti), alimentate pure dalle sempre più diffuse incertezze sul futuro dell’economia americana. Un recente sondaggio Usa ha infatti rivelato che due terzi degli intervistati temono un impatto negativo del rally del petrolio sul proprio portafoglio: in pratica, hanno detto, i prezzi del petrolio, e in particolare della benzina, avranno un’incidenza negativa sul proprio reddito nei prossimi sei mesi.
Lo scenario disegnato ieri dal New York Times , ipotizza a causa del caro-petrolio un pericoloso effetto domino sull’economia Usa. Del resto, come i dati confermano, negli ultimi 25 anni, il balzo dei prezzi del greggio ha sempre accompagnato l’inizio di una fase di recessione economica. Come avvenne, in tempi recenti, nel periodo compreso tra il 1990 e il 1991, e più tardi, nel 2001: in entrambi i casi, le spinte recessive non si manifestarono subito, ma a più di un anno di distanza dall’inizio della corsa dei prezzi energetici.
Le prime vittime sono i consumi, che finora si sono confermati l’asse portante della ripresa economica made in Usa. Una prova dell’impatto esercitato dai prezzi del petrolio sulla propensione a spendere dei cittadini americani è arrivata dai dati di bilancio del secondo trimestre di Wal Mart: a fronte di un rialzo degli utili pari al 6%, il colosso mondiale della distribuzione ha riportato un giro d’affari inferiore alle previsioni.
Il problema, spiega ancora il New York Times , è che il tasso di risparmio degli americani è sceso in media a un livello vicino allo zero. Questo significa che le famiglie non hanno più neanche un fondo di emergenza a cui attingere per pagare le proprie spese. La maggior parte dei lavoratori Usa, inoltre, ha ricevuto dal 2001 un aumento delle paghe orarie quasi irrilevante, soprattutto se si tiene conto del rapporto tra stipendi e tasso di inflazione.
Finora i consumi hanno sostenuto l’economia, e un loro rallentamento si tradurrebbe inevitabilmente in un calo della produzione, e in un’inversione di tendenza nella crescita del Pil. Ancora più preoccupante il fatto che gli analisti sembrano concordi nel prevedere che le quotazioni del greggio continueranno a salire. Tra l’altro i prezzi della benzina sono già arrivati a 2,55 dollari al gallone (3,78 litri). E l’incubo, per gli americani, che possa arrivare a tre dollari al gallone, sembra avvicinarsi a grandi passi. In sostanza, fatte le debite conversioni, si tratta di 0,64 euro al litro. Una cifra che fa sorridere l’automobilista italiano, proprio nel giorno in cui scopre che, in autostrada, la benzina ha sfondato il massimo di 1,30 euro al litro.


Gabriele Dossena
corriere

[FaGal]

Euro dollaro, la scommessa continua
A dare una mano al biglietto verde il rimpatrio dei dividendi e la politica restrittiva della Fed
FINANZA & INVESTIMENTI Dopo l' ultima correzione della moneta unica, gli esperti ipotizzano un altro indebolimento

Il rafforzamento è iniziato a marzo ed è proseguito fino a inizio luglio, quando il dollaro ha toccato 1,19 sull' euro. Poi la risalita della moneta europea, che ha però ceduto nelle ultime settimane, dopo l' incertezza determinata dall' esito del voto in Germania. E il biglietto verde è tornato ad avvicinarsi a quota 1,20. Mentre la Fed decideva l' undicesimo rialzo consecutivo dei tassi Usa, a 3,75%. A cui potrebbe seguire alla prossima riunione una nuova spinta all' insù. Ci si avvia dunque verso una fine d' anno con la valuta statunitense in ulteriore ripresa sull' euro ? Forse. Ma non tutti sono d' accordo. "È una sorta di tiro alla fune", spiega Nicholas Pifer, responsabile dell' obbligazionario internazionale di Riversource investments (gestore dei fondi American Express), "da una parte il deficit cronico, dall' altra l' economia Usa che va meglio rispetto a quella europea. In tre anni il dollaro è però sceso molto ed è ora nella parte bassa delle quotazioni storiche. E gli argomenti a suo favore stanno cominciando a formare una base di sostegno per la valuta Usa". E per i prossimi 12 mesi, Pifer prevede "una volatilità nel breve, ma minore rispetto al passato, e comunque un impatto inferiore sui mercati rispetto agli ultimi sei sette anni. Anche se", conclude, "gli investitori sottovalutano la portata di un probabile aumento dei tassi da parte della Fed". Lo stesso argomento che per Roberto Mialich, strategist valutario di Ubm, potrebbe spiegare almeno un balzo del dollaro da qui a fine anno: "Anche dopo il rialzo dei tassi del 20 settembre, il mercato sconta meno di quanto la Fed possa essere aggressiva. Noi invece pensiamo a nuovi rialzi a 4,25% a fine anno e a 4,75% nel primo semestre 2006. Inoltre, nella parte finale dell' anno ci potrebbe essere il rimpatrio dei dividendi, con forti incentivi fiscali se reinvestiti in azienda, al momento frenato da molti punti oscuri nei benefici: dalle analisi risulterebbero addirittura da 200 a 300 miliardi, e finora ne sarebbero rientrati solo 20". A dare sostegno alle ipotesi di Mialich ci sarebbe anche l' analisi tecnica: "Il mercato ha già dato un buon segnale ribassista", sottolinea l' analista, "e l' area 1,20 1,25, che è stata il motivo di tutta l' estate, potrebbe ora spostarsi a 1,15 1,20". Ma Antonio Cesarano, responsabile per reddito fisso e valutario di Mps finance, è di diverso avviso: "Per ora ipotizziamo una tenuta su 1,20. Ma a 6 12 mesi rimane la view di deprezzamento del dollaro con possibilità di arrivare su livelli intorno a 1,30". E spiega perché: "I deficit gemelli continuano per noi a essere il driver principale, anche se il disavanzo delle partite correnti nel secondo semestre è passato al 6,3% rispetto al 6,5% dei primi sei mesi, mentre il deficit pubblico è migliorato per le entrate fiscali della normativa sul rientro degli utili. Ma la normativa termina a fine anno e bisognerà capire quanto peseranno le spese di ricostruzione post uragani sull' economia americana". c' è chi punta su ulteriori rialzi: tassi Usa al 4,25% alla fine di quest' anno
il mondo 7 ottobre us

[FaGal]

The Federal Reserve - A hard act to follow
www.economist.com - October 13, 2005

Who could fill Alan Greenspan's shoes?

On the ground floor of the Federal Reserve building in Washington, DC, there is an electronic game which tests a visitor's skill at setting interest rates. You have to decide how to respond to events such as rising inflation or a stockmarket crash. If you get all the answers right, the machine declares you the next Fed chairman. In real life, because of huge uncertainties about data and how the economy works, there is no obviously right answer to the question of when to change interest rates. Nor is there any easy test of who will make the best Fed chairman. So who would The Economist select for the job?

Alan Greenspan will retire as Fed chairman on January 31st, after a mere 18 ½ years in the job. So George Bush needs to nominate a successor soon. Mr Bush has a penchant for picking his pals to fill top jobs: last week he nominated his personal lawyer Harriet Miers to the Supreme Court (see article). But his personal bank manager really would not cut the mustard as Fed chairman. This is the most important economic-policy job in America—indeed in the whole world. The Fed chairman sets interest rates with the aim of controlling inflation, which in turn helps determine the value of the dollar, the world's main reserve currency. It is hardly surprising that financial markets worldwide can rise or fall on his every word.

Financial markets are typically more volatile during the first year after the handover to a new chairman than during the rest of his tenure. In October 1987, barely two months after Mr Greenspan took office, the stockmarket crashed. Current conditions for a handover are hardly ideal. America's economy has never looked so unbalanced, with a negative household savings rate, a housing bubble, a hefty budget deficit, a record current-account deficit and rising inflation. Figures due on October 14th are expected to show that the 12-month rate of inflation has risen above 4%—its highest since 1991.

Monetary magic

Because Mr Greenspan is widely rated by investors as the greatest central banker ever, their confidence in his mystical powers has helped to hold down bond yields and prop up the dollar. But combine America's domestic and external financial deficits with a looming “Greenspan deficit” next year and markets could well push down the dollar and push up bond yields, thereby bursting the housing bubble. With inflationary pressures rising, the new Fed chairman will need to push short-term interest rates higher; there will be much less room to cut rates later, as Mr Greenspan did after the stockmarket bubble burst in 2001. Would any sane person want this job?

It is worth recalling that in 1987 many doubted whether Mr Greenspan could fill Paul Volcker's shoes. The skills required of a Fed chairman are indeed demanding. He or she needs to be an expert in monetary policy, have a good instinct for economic data and an insight into the big policy debates. A chairman must be respected by financial markets, able to keep a cool head in crises, and be politically independent, while well attuned to political opinion. Mere mortals need not apply.

All the main candidates commonly touted are highly respected economists who could be trusted to pursue a sound monetary policy, and yet each also has serious drawbacks (see article). President Bush said last week that he is looking for a successor to Mr Greenspan who would be seen as politically independent and who would thus inspire global confidence. Yet the leading candidates have all advised or worked for Mr Bush. Mr Greenspan, of course, also has close Republican ties, but financial markets will be less forgiving of his replacement. Any suspicion that Mr Bush has selected someone simply because he is a loyal Republican would undermine confidence in the next chairman, even before he takes office.

Expert and independent

If Mr Bush means what he says about the next chairman being politically independent, then we believe the best choice would be Don Kohn, a governor on the Federal Reserve Board, who is not affiliated to any party. Mr Kohn has another big advantage. As a staff member before being promoted to governor in 2002 on Mr Greenspan's recommendation, Mr Kohn has been attending the Fed's policy-making meetings for almost 24 years, even longer than Mr Greenspan. His vast experience of monetary-policy decisions and financial crises would be invaluable in troubled times. He is highly regarded by economists in the Fed and on Wall Street, and having worked with Mr Greenspan for so long, his thinking on interest-rate policy and financial markets is also close to the chairman's. He would offer continuity and a safe pair of hands.

Yet how can The Economist endorse Mr Greenspan's right-hand man, when we have long criticised the chairman for failing to curb the stockmarket bubble in the late 1990s, and later for propping up the economy by inflating a housing bubble? The answer is that the maestro seems to be changing his tune. In several recent speeches Mr Greenspan has expressed concern about the housing market and, in an apparent effort to talk it down, gave warning that prices could fall. There is a stronger case for restraining housing bubbles than stockmarket bubbles, because they tend to cause greater economic harm when they burst. His public view on the link between monetary policy and asset prices has also shifted. He now concedes that the Fed's success in delivering low inflation and interest rates may have made bubbles more likely, ironically, because investors are demanding less compensation for risk.

Whether central banks should respond to asset-price bubbles is one of the hottest debates in monetary policy. The Fed's failure to curb bubbles, while aggressively easing policy when they burst, is partly to blame for America's imbalances, which could give the next Fed chairman a lot of grief. Mr Kohn's experience within the Fed makes him the best man to cope with this. Mr Greenspan could help him immeasurably and enhance his own legacy by going much further, and explicitly supporting the view of many other central banks that sometimes policymakers should act to restrain asset-price booms. When you are the world's greatest central banker, after all, you should be able to admit the odd mistake.

[FaGal]

George Maynard Bush
Sep 1st 2005
From The Economist print edition


Most American liberals are now fiscal conservatives. But not all

LIKE all the fiercest debates in American politics, the fight over the budget deficit has its hawks and its doves. But on fiscal matters, it is now the American left that brandishes talons and the right that carries an olive branch in its beak.

One exception is James K. Galbraith, of the University of Texas, Austin. “A card-carrying member of the Texas left”, he is also the whitest of fiscal doves. That makes him a rare bird indeed these days. He shares not only his famous father's initials, but also his sharp pen and his passion for the economics of John Maynard Keynes. In a recent pamphlet* on the budget deficit, Mr Galbraith argues that members of the present Republican administration are unwitting disciples of the Cambridge master.

That administration ran a deficit of $412 billion, or 3.6% of GDP, in the most recent fiscal year. The deficit this year will narrow to $331 billion, according to the Congressional Budget Office. But under some plausible assumptions about congressional budget-making, America's deficits will average about 3.5% of GDP over the next decade, estimate William Gale and Peter Orszag of the Brookings Institution.† By 2014, they project, America's public debt will amount to 55% of its GDP. By 2030, on present trends, debt could reach 139% of GDP.

How much will this matter? Messrs Gale and Orszag think that chronic deficits will eat away at the pillars of American prosperity like “termites in the woodwork”, as Charles Schultze, former chairman of the Council of Economic Advisers, once put it. The coming decade of big deficits will reduce national saving by 2-3% of GDP. As a result, American households will accumulate fewer assets, yielding $1,500-3,000 less income a year.

The deficits serve only to divert resources from investment to consumption, they argue. When taxes are cut, households spend up to 80% of the proceeds, they find. But this extra consumer demand must compete with other claims on a fully employed economy. In their view, extra household spending crowds out investment, dollar for dollar.

Ah, a Keynesian might ask, but what if the economy is not fully employed? Then, says Mr Galbraith, a budget deficit adds to demand in the economy, bringing into play labour and capital that might otherwise have lain idle. These resources might not be put to their best use, to be sure; but what matters is that they are put to some use. The economy is bigger as a result, so even if the deficit reduces investment's share of GDP, it might (at least in principle) raise the actual amount of investment that takes place.

Few could disagree with this logic: it is the basic case for a counter-cyclical fiscal expansion. Even the administration's critics concede that its 2001 tax cuts were impeccably timed (if fortuitously so), boosting consumer demand at a time when many workers were at risk of forced idleness. But as the economy nears full employment, those same critics believe, budget deficits become more damaging.

Doom or Verdoorn?

Mr Galbraith thinks otherwise. America's sustained deficits will help it outgrow the liabilities they leave in their wake, he believes. And if that fails, they will help inflate those liabilities away. As an economy approaches full employment, any fiscal stimulus is dissipated by higher prices. In this case, the stimulus may add nothing to real GDP. But, Mr Galbraith points out, it still adds something to nominal GDP. This will ease the government's debt burden, since it is out of nominal GDP that the government must repay the nominal claims held by its creditors.

Inflation, like devaluation, is a tried and tested way for an indebted government to escape its obligations. It is because it is so tempting that macroeconomic stability is so hard-won and so easily lost. It may be true, as Mr Galbraith suggests, that America would rather let its inflation rate multiply than its debt-to-GDP ratio explode. But why would anyone want either?

In fact, Mr Galbraith is confident that a sustained fiscal stimulus will yield more than just inflation. When demand is strong, innovation quickens, he argues. He cites Verdoorn's law, named after the Dutch economist Petrus Verdoorn, which holds that the pace of productivity growth picks up as the economy nears full capacity. If a government deficit adds to the demands on an economy at full stretch, the economy may find ways to stretch a little further.

There may be a grain of truth to this observation. But Mr Galbraith presumably does not believe in a world without any supply-side constraints, in which the only check on the ingenuity of the American economy is the timidity of its fiscal authorities.

In so far as there is any truth in Verdoorn's law, its practical implications are more modest. It suggests that America's policymakers must test the economy's limits before they can know precisely where they lie. The American economy might, for example, learn to cope surprisingly well with a tight labour market, as it did in the late 1990s. At that time, the Federal Reserve seemed to take the view that faster productivity growth had allowed the unemployment rate consistent with stable inflation to be temporarily reduced. More generally, the Fed knows that it cannot be quite sure exactly where America's natural rate of unemployment and its neutral rate of interest lie.

But if the Fed can be trusted to explore the economy's limits and respect them, Congress cannot. Fiscal policy is made in a spirit of political point-scoring, not macroeconomic inquiry. Given too much licence to roam, Congress would soon reach the economy's outer frontiers—and carry right on over the edge.

“Breaking Out of the Deficit Trap: The Case against the Fiscal Hawks”. The Levy Economics Institute. June 2005
http://www.levy.org/default.asp?view...ID=104bea1f434


“Budget Deficits, National Saving, and Interest Rates”
http://www.brook.edu/views/papers/20...orszaggale.htm

[FaGal]

Hard-landing heresy
Sep 8th 2005
From The Economist print edition


If the dollar dives, what will happen to America's interest rates?

WHEN policymakers and pundits debate America's current-account deficit, the phrase “hard landing” is never far from their minds. It sums up what might happen if foreigners tired of financing the gap, now over 6% of GDP: a sinking dollar, soaring interest rates, tumbling asset prices—all dragging America's economy into recession.

Optimists, including Alan Greenspan, chairman of the Federal Reserve, think that all this is pretty unlikely. It is far more probable, they say, that America's imbalances will come right gradually, via a (gently) weakening dollar and slower demand growth at home. More pessimistic observers fear that the risk of a hard landing is rising. Some of these point to the financial crises that hit several emerging markets in the 1990s, in which currencies collapsed and interest rates climbed as foreign investors fled. The same could happen in America, they worry, once foreigners sour on Uncle Sam.

So far, the optimists have had the better of it. Foreigners have carried on lending to America, and at low rates of interest. Although the dollar has weakened, it has not crashed. But what if it did sink suddenly? Then, surely, the hard-landing logic would come into play: bond yields would rise sharply as investors demanded compensation for the risk of higher American inflation and further falls in the dollar.

Or maybe not. In a new paper*, Joseph Gagnon, an economist at the Federal Reserve, takes issue with this argument. It is true, he says, that currency crashes in emerging economies have sent interest rates soaring. And it used to be true of rich countries, too; but in the past 20 years their experience has been rather different. Since 1985, every industrial country whose currency has crashed—defined by Mr Gagnon as a depreciation of at least 8% in the first year and over 20% in two years—saw its bond yields fall, by 1.5 percentage points on average, the following year. Nor did bond yields rise much in anticipation of a currency's troubles: Mr Gagnon finds an average rise of only one-fifth of a percentage point in the year before a currency crash.

Mr Gagnon ascribes this change in rich countries' experience to the taming of inflation. A weaker currency might boost bond yields if investors fear higher inflation, or if they think monetary policy might be tightened to combat it. Yields might also be pushed up because investors fear further depreciation, or suspect that borrowers—in particular, the government—might default on their bonds. In rich countries, however, the default risk is remote, since rich countries issue debt mainly in their own currencies, so that the real burden of repaying debt does not rise after a depreciation. What really matters is the inflation risk, and this has become much less of a worry in the past 20 years. If inflationary expectations are falling, the link between tumbling currencies and rising bond yields may be weakened.

And another thing

Mr Gagnon's paper is one of several recent studies by Fed economists that dispute much conventional, pessimistic analysis of America's current-account deficit. Another†, by Hilary Croke, Steven Kamin and Sylvain Leduc, finds “little evidence” that shrinking current-account deficits in rich countries were accompanied by both sharply weaker currencies and recessions. Sometimes, the shrinking of a deficit went with a downturn—but with neither a plunging exchange rate nor rising interest rates. Sometimes, the currency dropped as the deficit narrowed—but then economic growth was strong. History suggests that not everything goes wrong at once.

Such studies might suggest that it is time for the pessimists to quell their fears. Or they might be a sign that the Fed's researchers are as sanguine as its officials, perhaps unwisely. Which?

Both studies may overstate the relevance to America of the other rich countries' experience. The sheer scale of America's economy and its borrowing may make it a case apart. In addition, American interest rates are already unusually low and although expectations of inflation are low and stable, they are not falling. A sharp fall in the dollar could therefore push inflationary expectations up. Perhaps most important is the role of foreign central banks, especially in Asia, in financing America's current-account deficit. Their willingness to devour American bonds has helped hold down American interest rates—maybe, reckon some, by two percentage points. If the central banks lost their appetite, the dollar could tumble while interest rates rose.

But Mr Gagnon has a counter-example. In 1997-98, Australia's dollar tumbled. Net foreign purchases of the country's bonds, worth 5% of GDP in 1996, turned into an outflow of 1% in 1998. Yet bond yields fell by more than two percentage points, partly because of the inflation-fighting reputation of Australia's central bank, but also because investors were worried about the country's growth in the wake of the Asian financial crisis.

The point is that there is no mechanical connection between currency crashes, long-term interest rates and the hardness of a landing. A fall in the dollar when America's economy was at full tilt ought to boost exports and might cause the economy to overheat; interest rates might rise, but no recession would ensue. Or a fall in the dollar might be the product of a slowdown—if, say, America's consumers stopped spending. Then lower, not higher, interest rates could ensue. Mr Gagnon has not refuted the idea that America could have a hard landing; but he has exposed some loose thinking on the subject.

* “Currency Crashes and Bond Yields in Industrial Countries”. August 2005. Available at
http://www.federalreserve.gov/pubs/i...37/ifdp837.pdf

† “Financial Market Developments and Economic Activity During Current Account Adjustments in Industrial Economies”. February 2005. Available at http://www.federalreserve.gov/pubs/i...27/ifdp827.pdf

[FaGal]

Economics focus

Currency competition
Sep 29th 2005
From The Economist print edition


How the dollar might lose its status as the world's main reserve currency

ONCE a decade or so, economists ask whether the dollar's reign as the world's number one reserve currency might be at the start of a slow decline. These musings usually coincide with a fall in the dollar's value. In the past 30 years, the dollar has had four bouts of marked depreciation. During the most recent, which began in 2002, it has fallen by 28% against the euro and by 14% against a broad basket of currencies. Even so, 66% of the world's official foreign-exchange holdings are still in dollars, compared with 25% in euros, 4% in yen and 3% in pounds, according to figures published last week by the IMF.

And yet dollar sceptics note that this time the dollar's crown is, if not wobbly, at least skewed. America's current-account deficit, at 6% of GDP, is its highest on record; its net foreign liabilities, at 22% of GDP, are also close to an all-time high. Foreign central banks seem to have reduced their purchases of American Treasuries: official holdings of these rose by only $2 billion in the first seven months of 2005, against $295 billion in (the whole of) 2004 and $175 billion in 2003. If this trend continues, other currencies could one day challenge the dollar's dominance.

History offers perhaps only one true example of a reserve-currency shift, from the British pound to the dollar. The pound was king during the era of the gold standard. But in the years after 1914, Britain switched from net creditor to net debtor, and by the 1920s the dollar was the only currency convertible to gold (although the pound returned to gold in 1925). Two costly wars and two episodes of currency devaluation in Britain later, the dollar was unchallenged as the world's chief reserve currency.

The likeliest pretender to the dollar's crown is the euro. Reserve currencies need to have a home economy with a large share of global output, trade and finance. America's economy still dominates, but the euro area is not much smaller. The euro area's total trade with the rest of the world is about as big as America's; about half of this trade is invoiced in euros. The financial market of the reserve currency country must also be deep, open and well developed. America leads the euro area by most measures, but the creation of the single currency has helped to integrate Europe's financial markets.

Confidence in the value of the currency is also an important requirement, and this is where critics of the dollar have mostly taken aim. Barry Eichengreen, of the University of California at Berkeley, argues in a recent paper* that whether the dollar retains its reserve-currency role depends mostly on America's own policies. If America allows its large current-account deficit to persist and its net foreign liabilities to rise, foreigners will become less willing to hold more dollars. The dollar would depreciate, creating inflationary pressure in America and making dollar reserves less attractive still—perhaps even if the Federal Reserve raised interest rates.

In another recent study†, Menzie Chinn, of the University of Wisconsin, and Jeffrey Frankel, of Harvard, estimate the importance of these factors in determining the shares of different currencies in the world's total reserves. They also take “network externalities” into account: the tendency of each monetary authority to favour the dominant currency because all others do. They use these estimates to predict whether the euro could overtake the dollar as the world's main reserve currency.

It could, but not soon. Suppose, say the authors, that the dollar loses 3.6% a year against a basket of other currencies, while the euro gains 4.6% a year—the same rates as in 2001-04. Then, they reckon, the euro could become the top currency by 2024. If in addition Britain, Sweden, Denmark and all the central and eastern European countries that joined the European Union last year adopted the euro, it would supersede the dollar by 2019.

Of course, it is impossible to forecast such a change with any precision. The dollar, after all, took decades to displace the British pound. And the euro zone has obvious economic weaknesses. Moreover, with the stability and growth pact in a shambles and the EU constitution rejected by France and the Netherlands, some even wonder whether the single currency will be around in 20 years, let alone compete with the dollar.

Sharing the crown

Another view, offered by Mr Eichengreen, is that the world might eventually have more than one main reserve currency. The dollar could share its status if other currencies become more attractive. The preference to stick with the dominant currency might secure the greenback's position for a long time. However, as financial markets in other countries become more liquid, this effect is weakened and other currencies become more trusted as a store of value. Reserve-currency competition will then cease to be a game in which the winner takes all.

This process, thinks Mr Eichengreen, favours the euro. He is doubtful about other candidates, notably the yuan. He argues that both Europe and America “have strong institutions, respect for property rights, and sound macroeconomic policies relative to the rest of the world.” In China, by contrast, capital controls, financial markets that are neither very liquid nor transparent, and uncertainty about property rights make the yuan an unlikely contender for decades to come.

Whether the dollar ever loses or is forced to share its pre-eminence among reserve currencies depends mostly on whether America continues to run the economic policies that will eventually undermine its position. But even if America changes course, the crown may slip a bit.

* “Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition”. NBER Working Paper No. 11336: www.nber.org/papers/w11336

† “Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?” NBER Working Paper No. 11510: www.nber.org/papers/w11510

[FaGal]

Economics focus

A foreign affair
Oct 20th 2005
From The Economist print edition


Inflation is increasingly determined by global rather than local economic forces

THE average inflation rate in the G7 economies rose to an estimated 3.2% in September, its highest for 13 years. The main reason for the return of inflation is that oil has become a lot more expensive; “core” inflation rates, which exclude oil and food, remain much lower in all countries. But fears are mounting that higher oil prices will feed into other prices throughout the economy, pushing inflation higher still.

This is particularly worrying for America. On top of soaring oil prices, companies' unit labour costs rose by 4.2% in the year to the second quarter, mainly thanks to slower productivity growth. The rate of growth of these costs increased by more over the year than at any time for two decades. With energy and labour becoming conspicuously dearer, any inflation model based on a mark-up of prices over costs should be flashing red. Yet in the past year core inflation has not budged. How come?

Stephen Roach, chief economist of Morgan Stanley, suggests that thanks to globalisation, the inflation process has changed over the past three decades in a way that has significantly weakened the link between domestic cost pressures and inflation. He draws on an analysis in the latest annual report of the Bank for International Settlements (BIS), which suggests that global forces have become more important relative to domestic factors in determining inflation in individual countries.


According to the BIS, the correlation between core inflation and the growth in unit labour costs in America fell to only 0.3 in 1991-2004, from nearly 0.8 in 1965-79. The link between inflation and labour costs also faded in other developed economies (see chart). This probably reflects two things. First, the integration into the world economy of China and other emerging economies with vast supplies of cheap labour has curbed the bargaining power of workers in developed economies. These workers therefore find it harder to secure higher wages when inflation picks up. And second, fiercer global competition has made it more difficult for firms to pass increases in wages through to prices. Instead they must absorb them in their profit margins.

As further evidence that firms are less able than they were to hand cost increases on to their customers, the BIS found that fluctuations in import prices also have much less impact on core inflation than they once did. Similarly, the link between movements in exchange rates and import prices has sharply diminished. Standard economic theory has it that a fall in the dollar against the euro should push up the dollar prices of European exports to America, raising America's inflation rate. But the proportion of exchange-rate changes passed through to import prices has fallen everywhere; in America, it has been 60% lower since 1990 than it was in the previous 20 years. Today, exporters set their prices for a local market and then either hedge their currency risk or absorb currency changes in their margins.

Increased global competition has thus limited the room for firms to pass on higher costs. This makes a nonsense of traditional economic models of inflation, which virtually ignore globalisation and assume that companies set prices by adding a mark-up over unit costs, with the size of the margin depending largely on the amount of slack in the economy. In reality, when setting prices firms are increasingly likely to be constrained by global competition. Given the price the market will bear, they design and make their products as profitably as they can. As a result, domestic cost pressures, whether in labour or energy, no longer lead automatically to higher inflation, but are more likely to show up as swings in profit margins.

This suggests that in forecasting inflation central banks now need to pay less attention to domestic shifts in unemployment and capacity utilisation and much more to the global balance between supply and demand. The BIS's research shows that since 1990 the core rate of inflation has become less responsive than it used to be to changes in the output gap (a measure of economic slack) in all the main developed economies except Britain. The ups and downs of inflation increasingly reflect the global balance between supply and demand.

A premature obituary

The nature of inflation has thus changed. But it has not died, although the forces of globalisation have helped to combat it. Policy blunders by central bankers could still allow it to break out again. Indeed Don Kohn, a governor of the Federal Reserve (and one of several potential successors to Alan Greenspan as chairman), reckons that the impact of China and other newly industrialising economies on inflation is often exaggerated. In a speech last week, he drew on a Fed study which concluded that the direct impact of cheaper Chinese imports on American inflation was modest. However, this study ignored the indirect effects of China on wages and the fact that cheaper Chinese goods do not just reduce the price of imports from China but, through competition, the price of all goods sold worldwide.

Mr Kohn may well have underestimated the extent to which globalisation has borne down on inflation in past years. However, more important for policymakers today is its future effect. As Mr Kohn argued, the emergence of new industrial giants has increased not only global supply but also demand, particularly for oil and other raw materials. By running large current-account surpluses these economies are currently adding more to supply than to demand, so their net effect is disinflationary. But this could change. If their exchange rates rose and their domestic demand increased, said Mr Kohn, downward pressure on prices would ease, and might one day be reversed.

Even though globalisation has helped to hold down inflation so far, capacity constraints will eventually appear in the global economy, just as they always have at the national level. Globalisation does not relieve central bankers of their responsibility for maintaining price stability. But it may require them to steer policy by a different compass: one that takes much more account of developments abroad.

[FaGal]

Closing the growth gap
Oct 27th 2005
From The Economist print edition


A theory to explain why Europe has fallen behind America, and how it might catch up

IN THE past ten years, the economies of what is now the euro area have grown by around 2% a year. America has managed a full percentage point more. Lots of reasonable explanations of the gap are on offer: America has freer markets than Europe; it is better at finding and using new technology; its fiscal and monetary policies have been more supportive of growth; and so forth.

You might expect such explanations, and a bundle of policy recommendations, to tumble out of theories of growth—the branch of economics concerned with the medium- and long-term fortunes of economies. You'd be disappointed. Growth theory is good at explaining why rich countries are rich and poor ones poor, but much less so at divining why some rich countries (eg, America) grow faster than others (eg, much of Europe) and telling the laggards how to catch up.

A recent paper* by Philippe Aghion, of Harvard University, and Peter Howitt, of Brown University, attempts to fill the spaces between fact, theory and policy. One branch of theory emphasises the role of capital accumulation in generating growth: save more, is the implication. This might help to explain why, say, East Asia sped past Latin America in the last part of the 20th century, but not why Europe has been trailing America: Europe, after all, has a higher saving rate. Another line of thought holds that good “institutions”—the rule of law and all that—are essential. This can account for much of the chasm between rich and poor, but not the fine variations among rich countries with sound legal and political systems. A third angle identifies innovation as the fuel for economic advance. Messrs Aghion and Howitt argue that models of this type have hitherto had little to say about how economic laggards catch up and then keep up (or not) with the latest technology—and thus about why Europe, having grown faster than America for 30 years after the second world war, stopped closing the gap and fell farther behind.

Technological advance, though, is at the core of their own approach. In essence, a given industry in a given country can use either the best technology available or an older, less efficient version. In countries already at the cutting edge, innovation is the source of growth. Those not at the frontier advance by implementing existing, but still better, methods of production.

From this, two observations follow. The first is that the institutions and policies best suited to countries at the leading edge need not be the right ones in less advanced places. Education, say Messrs Aghion and Howitt, is a case in point. The closer a country is to the technological frontier, the more growth depends on having a highly educated workforce. Further back from the frontier, education still matters; but university degrees matter relatively less and good primary and secondary education count for relatively more. Evidence from different countries and from American states appears to bear this out. And what does this imply for the transatlantic growth gap? America spends around 3% of its GDP on tertiary education; the European Union only 1.4%. More than a third of Americans have degrees; fewer than a quarter of Europeans do. Against that, many EU countries are considered to have stronger secondary education than America does. Europe may therefore have been well equipped for its post-war decades of chasing the United States, but did not adopt the policies needed to push back the technological limits.

The second observation is that, whereas most theories of growth laud the accumulation of capital, it is sometimes good to see it destroyed. Growth is likely to be higher if markets are open to new entrants, which either drive less efficient incumbents out of business or scare others into investing, updating their technology and seeing off the raiders. Again, this is likely to matter more the closer countries are to the limits of technology. And again, the destructive process appears to have a freer rein in America than in Europe. For example, say the authors, half of all America's new pharmaceutical products are introduced by firms less than ten years old; the proportion in the EU is only 10%.

Budgeting for growth

More controversially, Messrs Aghion and Howitt also turn their attention to macroeconomic policy. Most economists think that budgets and interest rates ought to be geared mainly to the short-run course of the economy. Not necessarily so, say the authors: countercyclical budgetary policy can be aimed at long-term growth, and the case is stronger in Europe than in America.

If capital markets are well developed, they argue, sound companies can borrow to tide them over in recessions; if those markets are thin, good businesses will sink. And where capital markets are less well-developed, policies that dampen the business cycle can help more good firms to survive. Econometric tests suggest that well-targeted fiscal policy—investment, rather than government consumption—might work. Because Europe's capital markets are less deep than America's (its ratio of private credit to GDP, for example, is much lower), budgetary policy ought to lean against the cycle more in Europe than in America. In recent years, however, the opposite has been true.

When Mr Aghion proposed this idea last month, at the annual conference of the Centre for Economic Policy Research and the European Summer Institute in Frankfurt, he met a fair bit of scepticism. It is easy to see why. Countercyclical policy is much harder to get right on purpose than by accident. And, as one economist there remarked, America's growth rate has actually been more volatile than Europe's—implying that Europe has less need to smooth out cycles to encourage growth. Still, Mr Aghion and Mr Howitt have produced some provocative research. More—and more arguments—will surely follow.

* “Appropriate Growth Policy: A Unifying Framework.” Available at post.economics.harvard.edu/faculty/aghion/papers/Appropriate_Growth.pdf

[FaGal]

Investment banking

Looking for directions
Jun 23rd 2005 | NEW YORK
From The Economist print edition

Wall Street's titans complain that the stockmarket doesn't understand their business. Given the latest results, that's no wonder

YOU might expect that the stockmarket would, if it understood no other industry, be able to fathom investment banking. Yet the heads of Wall Street's biggest firms are no different from the bosses of companies the world over, in complaining that the market consistently undervalues their shares. The Wall Streeters may have a point. Investment banks trade at below 11 times past earnings, a third less than the average listed company. And that is despite pre-tax profit margins that even in 2002, at the depth of the bear market, never dipped below 18% and have subsequently hovered around 30% (see chart). Numbers like that are the mark of a resilient and prosperous industry.


A sense of why the stockmarket views the Street so sceptically can be gleaned from the second-quarter earnings figures now coming out of investment banks. The numbers have been full of surprises, both good and bad. Overall, conditions for the industry have been decent, but not great. Markets have been a bit more volatile than they were, which can be unsettling but should still be handy for trading profits—the recent difficulties of some hedge funds notwithstanding. Short-term interest rates have continued to rise, meaning that borrowing money, an important cost, has become dearer; but long-term rates have declined, meaning better conditions for underwriting and buy-outs, both important sources of revenue.

With these conditions, it would not have been a shock if most firms had done pretty well. Instead, results have diverged widely, taking analysts by surprise on both sides. The stockmarket likes firms that earn money in predictable ways. Recently, even Wall Street seems to be at a loss to understand itself.

Prominent among the success stories was Bear Stearns. However, in areas in which it is perceived to be particularly strong, notably the trading and issuance of fixed-income securities such as bonds and mortgage-backed notes, profits dropped. It was in other areas where expectations were more modest, in particular equity trading and merger advice, that revenues were sharply up.

Lehman Brothers has been the other star, continuing a long run of good performances stretching back to the 1990s. Yet even Lehman managed a surprise, in revealing that a record 40% of its revenues came from outside America. Lehman's consistently good record has earned it, alone among the leading firms, the likelihood of an upgrade in its credit rating from Standard & Poor's, a rating agency.

In many industries, form like Lehman's would be rewarded by the stockmarket too, but not, it seems, in investment banking: Lehman's shares are priced much like its competitors'. An indicator of the market's difficulty in reading investment banks is, perhaps, that Lehman is one of the few companies whose biggest shareholders include one large mutual fund that invests only in growth stocks and another that invests only in shares that look cheap.

Oddly, the big investment bank whose price, relative to its earnings, is highest is Morgan Stanley, on the face of it the most troubled firm on the Street and arguably its most disappointing performer. On June 13th it said that its earnings would be poor. On June 22nd it reported a drop in profits of 24%, compared with the second quarter of 2004, even worse than it had led the market to expect. Revenues from trading and underwriting were down, and its retail operations are listing. Support for Morgan Stanley's shares must come from either the hope of better management or the daily rumours of a takeover.

Goldman Sachs, often thought of as the securities industry's leading light, also had a disappointing second quarter. Its earnings release raised at least as many questions as it answered. Investment-banking revenue was down a bit, although the firm said that business conditions were now improving. Worse, though, was a steep decline in revenue from trading and investment. Goldman Sachs explained the decline, a little elliptically, by saying that during the quarter it had fewer clients doing fewer things. David Hendler, a senior analyst with CreditSights, speculates that its proprietary trading desk may have been so weighed down with various commitments that the firm could not react to improving market conditions in May, but this is just a guess. It is hard to work out where Goldman makes its money, and thus to place a value on it.

It is not just the variation and unpredictability of performance that makes investment banks hard to read. The industry is under continual legal attack. Several banks have recently shelled out billions to settle investors' suits related to the Enron affair, and more are expected to do so. The latest assault consists of class-action suits filed against Goldman and Lazard, another investment bank, concerning Lazard's initial public offering in May.

The shares were priced at $25 each, producing a total stockmarket valuation just shy of $1 billion. Investors had reason to be cautious. The financial structure of the deal was unusually complex. Pay for Lazard's bankers was significantly higher than at other investment banks. Internally, the firm was enmeshed in outright warfare between its long-time controlling shareholder, Michel David-Weill, and its current chief executive, Bruce Wasserstein. Whereas many share offerings raise money to pay for reinvestment, much of the cash from this one was needed to pay Mr David-Weill to go away. And it is a fact of equity underwriting that every dollar taken off the offering price is a dollar taken away from the seller. It is the art, and responsibility, of the underwriter to set a price that attracts buyers, yet gives the seller the fullest possible haul.

Within days of the flotation on May 5th, the price of Lazard shares had fallen to $21. Despite a bounce, it has yet to achieve the level at which the shares were sold. In response, no fewer than five law firms have filed shareholder suits against Goldman and Lazard since June 16th.

A chief contention of the plaintiffs is that both firms knew Lazard should have been valued below $22 and engaged in a complex manipulation to push it briefly upwards. Goldman unequivocally denies the charge of manipulation. Perhaps its strongest defence would be to dismiss the notion that anyone could possibly know what an investment bank was worth.

[FaGal]

Faithfully following Fidelity
Nov 10th 2005 | NEW YORK
From The Economist print edition


A giant American fund manager finds that these days it's hard to be big

A DECADE ago, having survived the hardest apprenticeship in the investment business, Bob Stansky and Steve Kaye were rewarded with the management of Fidelity's Magellan and Growth & Income funds, two of the largest pots of money at America's biggest fund-management company. On October 31st, both were replaced, after failing to produce satisfactory returns in recent years.

Whether this will boost the performance of their former funds will interest not only Fidelity but all companies that try to manage a lot of money actively—not to mention their investors. There are many possible reasons why Messrs Stansky and Kaye lost their sparkle, but it is difficult—nearly impossible, perhaps—to tell whether fund managers' performances should be ascribed to talent or chance. It seems clear that neither picked stocks brilliantly. And at least some of the blame ought to be placed on the strategy, used by both, to bet on stocks with large market capitalisations. Given the size of their funds, this was a perfectly reasonable plan. Sadly for them, such stocks have been in a long slump.

A more worrying thought for big asset-management firms is that Fidelity could be suffering from “information leakage”—the inability to capture all the profits from investment ideas because others track or even anticipate its trades. For years Fidelity's size has meant that its positions are carefully followed by others. The giant asset-management company's routine filings disclosing holdings are scrutinised; so are caps it might put on its total holdings. Much to Fidelity's irritation, the Wall Street Journal noted that after Mr Stansky's resignation, the prices of stocks in the $7 billion Fidelity Capital Appreciation fund run by his successor, Harry Lange, spiked. Investors seemed to be betting that he might buy more of his favourite shares for the $53 billion Magellan fund.

The activities of human Fidelity-watchers may now matter less than the ability of some hedge funds to develop software that can pick up whether shares changed hands at bid or asked prices, and to draw inferences for future demand. The role of Wall Street firms is also worth thinking about. Their commissions on trades have fallen to almost nothing, and complaints about Fidelity's tight-fistedness on commissions are common. Yet it is hard to find a firm that rejects Fidelity's trades. One reason is that they all want to see its orders, to help position their own dealings. Might this even help Fidelity get a cheap price for its transactions?

Fidelity points out that it has large funds that have performed well, besides those that have done poorly, and that the returns on its smaller funds have been similarly mixed. It could be, therefore, that its overall performance has simply been lacklustre, and that size has had nothing to do with it. Fidelity has made some changes to trading operations in order to bolster returns. Communication between traders and fund managers is supposed to go beyond the placing and taking of orders. Efforts are under way to invigorate research by hiring some experienced analysts.

Maybe this will be enough. Size, at first blush, has not hindered Capital Research and Management's hugely successful American Funds, which are currently top sellers. That said, the funds are not quite as big as they look, because in practice they are split into pieces, each with its own manager and analysts. And there are signs that even American Funds may be hitting a wall. The global fund has a wonderful track record, but results have dipped recently. Some outsiders blame its size. In New York, at least one top investment bank has changed how it runs a proprietary fund to avoid sending out obvious signals about what it buys and sells. The era of big, truly transparent, managed public funds may be ending.