The Washington Post recently carried a news story on the Chinese having brought down their holding of US treasurys in the last five months. It is true that China has brought down its treasury holdings. But that is only part of the story. China has been buying far less US long-term securities after the crisis compared with before. Whatever it has been buying, it has confined itself mostly to US treasury securities. The same applies to foreigners. Take away treasurys and there is not much confidence in US assets among foreigners. Foreigners still own around 44% of all marketable US treasurys and China owns around 25% of that portion.
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These data do not show much confidence in US assets. With this information, the US stock market rally since March 2009 looks even more orchestrated than before. Further, with the US dollar depreciating, there has not been much in it for foreigners.
What does this mean for the outlook for the US dollar and US assets? The message is mixed. For the US treasurys, the message is positive. Foreigners will continue to buy US treasurys. China’s reduction in recent months of its treasury holdings has been modest. It is sitting on a huge pile of them. As long as the threat of US dollar depreciation hangs in the air, many developing countries will continue to resist or slow the pace of appreciation of their currencies.
That threat is not disappearing any time soon. With recent US economic data once again bringing back memories of last year’s double-dip recession fears coinciding with the conclusion of the Federal Reserve purchase of US treasury securities, the chance of the US central bank reaffirming its commitment to looser (not loose) monetary policy has risen.
Also, the “Earlywarn” blog has recently carried a table from the US Bureau of Labour Statistics. US manufacturing labour costs per hour were about 25 times more than that of China’s in 2008. More recent figures are not available. It would take a long time for the Americans to restore any manufacturing competitiveness with Asian nations, let alone China. That is why they are hammering away at the theme of Asian currency appreciation. They will do so for a long time to come. Further, that also makes the case for the US holding down wages for the labour force for a long time, if they can manage that, without triggering social unrest. You cannot blame the US corporate sector for not trying though.
This means that, as in the case of Japan, the US has some captive buyers of its debt securities except that in the US case they are foreigners and its own central bank. The treasury market would thus continue to reflect the interest rate subsidy offered by them. That is, the exorbitant privilege foreigners give to the US would stay. Whether this makes the debate in the US over deficit reduction any less urgent is unclear. But senator Tom Coburn thinks that there is still quite a bit of implicit complacency in the manner in which the US Congress, on either side of the aisle, is pursuing long-term deficit reduction.
All this makes for a very unclear global macroeconomic situation in the world. Assets everywhere will not reflect their true values. Asian currencies would be cheaper and the US treasurys dearer than they should be.
This situation should come to an end some time in the next few years. These set of policies have elevated the risk of inflation and economic stagnation, in that order. Inflation is the outcome of global resource constraints and loose monetary policies ushering in elevated inflation expectations, worldwide. The resulting caution on consumer and investment spending would trigger economic slowdown. Eventually, that would create a collapse in demand and deflationary conditions, but not before policymakers take a stab at engineering an inflationary bust, first.
With Europeans bending over backwards to unravel the single currency— an event that many would have assigned a very low probability even two months ago—and with the Federal Reserve pursuing unilateral monetary policy, dollar depreciation and with emerging economies still worried more about slowdown and less worried about inflation, the world is set for an un-coordinated and eventually unsustainable macro policies.
Maintaining consumer and business confidence so that saving, investment and spending decisions are taken appropriately without excessive caution requires the political leadership creating a feel-good effect. In India, such an effect can be achieved through unleashing the second wave of economic liberalization. In effect, India needs to bring back the sense of excitement that prevailed in the wake of the 1991 liberalization, if it wishes to avoid the prospect of the likely tidal wave of global economic instability running its economy aground.
Regardless of whether the political leadership is up to it or not, the challenge for the rest of us is to figure out how to persuade them to think globally and act locally.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views.
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