It was a week full of reports. The US treasury department released its semi-annual assessment of global exchange rates and regimes, and called the Chinese currency’s value troublesome. The Rockefeller Institute of Government published its report on the finances of the states in the US and called them perilous. Six German research institutes revealed their dour outlook on German and the eurozone economies for this year and the next. The European Bank for Reconstruction and Development pared back growth estimates for central and eastern European economies for 2009 and raised them slightly for 2010.
In addition to these, there were two important pieces of statistics. One was the admission by the Chinese government that its foreign exchange reserves had risen to $2.27 trillion by the end of September. It was hard to make out if the increase in foreign exchange reserves was due to valuation changes or actual accretion to reserves. The other was the report on foreign purchases of US assets for the month of August. Foreign appetite for US assets remains low and is declining too. Of course, the mother of all news was that key Wall Street firms would pay bonuses to their employees that would exceed the 2007 bonus payouts!
The two key challenges, as 2009 winds down, are global exchange rates and the divisions that are coming out in the open in US society and the impact this would have on US social stability and global standing. First, we turn to currencies.
In the course of 2009, ironically, the world’s worst performing currencies against the US dollar are from Asia. Given all the hype about the region’s potential, one would expect its currencies to be leading the charge. It is the other way around. The Chinese currency has remained anchored at a nominal exchange rate of 6.82 against the dollar this year.
In fact, Latin American currencies have performed the best against the dollar this year. If general dollar weakness persists and if it leads to a resumption of boom in commodities, then perhaps one should be looking at the Latin American region for real decoupling rather than Asia, with its obsession with undervalued exchange rates.
The US treasury, while refraining from naming China as a currency manipulator, spoke plainly, however, on the issue of renminbi undervaluation. It also added that the real effective depreciation of the Chinese currency this year undermines the global demand rebalancing that has begun to take place. The president of the European Central Bank and the head of the council of European Union finance ministers are to travel to China before the end of the year to discuss the renminbi exchange rate.
Clearly, if China refuses to show leadership on exchange rates, not only does it risk international tensions, but also domestic inflation. As Bare Talk mentioned last week, if the credit crisis and recession ended the US’ excess spending, a nasty bout of inflation would be required to rid China of its reserve accumulation obsession.
On state finances, the Rockefeller Institute said that “for the second quarter in a row, tax revenues collected by states across the US plummeted sharply in April-June 2009. When compared with the same period one year earlier, second quarter 2009 tax revenues in the 50 states dropped a record 16.6%—the second consecutive quarter in which revenues fell more sharply than during any previous time on record. Preliminary figures for July and August for 36 early-reporting states show continued deterioration, with overall tax collections dropping 8%”.
M. Vidyasagar, former senior executive at Tata Consultancy Services in Hyderabad and now Cecil and Ida Green Chair professor at the Erik Jonsson School of Engineering and Computer Science at the University of Texas at Dallas, adds his powerful anecdotal information to this story: “My colleagues at the University of Illinois are facing the problem that the state of Illinois is not paying physicians, as a result of which the physicians are not seeing state employees! Consequently, the medical insurance for state employees (including professors) is now essentially worthless! Professors in the California system have been given a ‘furlough’ whereby they have a ‘temporary’ salary cut of 8%.”
Given these two key issues that could snowball in the coming years, one is left scratching one’s head on the predictions of a surge in operating margins in the US (operating profits/sales) to record and unsustainable levels. From 60 years of data, it is clear that the levels of operating margins that analysts project were seen only twice—in 2000 and 2007. On both occasions, they could not levitate at those levels and crashed. Despite the backdrop painted above, analysts are implicitly predicting a return to such levels (see www.hussmanfunds.com/rsi/forwardearningsmargins.htm)
Kenneth Rogoff reminds us pointedly in his latest syndicated column (www.project-syndicate.org/commentary/rogoff61) that if financial crises hold one important lesson, it is that their after effects have a very long tail. Enough said.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org