Between hammer and anvil

Between hammer and anvil
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First Published: Mon, Apr 13 2009. 08 54 PM IST
Updated: Mon, Apr 13 2009. 08 54 PM IST
A day after Bare Talk’s column calling upon the world to focus attention on the problem currency of the world, Gillian Tett—who is widely followed these days, even in policymaking circles—wrote a column in the Financial Times on why and how the debate on gold standard roared on and would continue, even if it remained unsettled for a long period.
The US has no interest in settling the debate in favour of gold, for it loses its seigniorage benefits once the dollar is no longer the sole global reserve currency. At the same time, the US faces conflicting objectives with regard to the external value of the dollar. They appear formidable enough to cause severe strains to the existing arrangements.
One of the clues as to why the meeting of the Group of Twenty, or G-20, in early April decided to augment loan resources at the International Monetary Fund (IMF) comes from the minutes of the meeting of the US Federal Open Market Committee (FOMC) held in March.
In that meeting, FOMC downgraded growth, employment and inflation assessment for the US for 2009 and 2010. More than once, FOMC members lamented the absence of growth in foreign countries, as it meant that US exports would not be able to compensate for weak domestic growth.
Growth in the developing world took a big hit, partly due to the follies of some countries but largely due to the withdrawal of liquidity post-Lehman Brothers’ collapse. So, G-20 in an act of sensible self-preservation decided to make more resources available to IMF. In addition, G-20 decided to create a fund to facilitate trade financing under the auspices of the World Bank. Trade financing was badly affected by the same liquidity crunch. Therefore, this too is a small, but important, step towards restoring growth in the developing world.
Now, the questions are whether this marks the resumption of growth in the developing world and whether the US would benefit from it. We will tackle the second question first. For the US to export its way out of trouble, the missing piece of the puzzle is the value of the dollar. Other countries must find it cheap enough to buy from the US. That calls for a weak dollar, and that requires additional monetary stimulus. That is why FOMC reassures the US public that monetary policy would stay loose for long.
At the same time, the US wants to ensure that its fiscal spending plans are financed. It is not sure if domestic savings would increase by enough to fund the government spending plans. It wants foreigners to keep buying US treasurys. Hence, the Federal Reserve reassures the world that the recent liquidity support measures were temporary and could be exited expeditiously.
This contradiction would eventually be resolved in favour of domestic constituents since foreigners do not vote. It is hard to put a time on it, however. China is the single largest foreign holder of dollar reserves and, hence, it is anxious to delay, if not deny, this inevitable outcome, earning it valuable time to take compensating measures.
At the same time, a weak dollar would mean a weak yuan, given the loose peg that China maintains to the dollar. That helps China’s exports, but not others’, including the US’. When would this issue flare up is the question, not if it would. In sum, unresolved issues have large conflict potential.
Now, as to the first question of whether any recovery in the developing world would be durable, the optimistic answer is that it is too soon to tell and the pessimistic answer is that it is not. Not much thought is being given to the sustainability of the policies being put in place to stimulate recovery. The standard excuse is that crisis periods are not the time to worry about sustainability. However, once recovery sets in, so does complacency.
China’s banks have matched the loan disbursements of 2008 in the first quarter itself. Fixed asset investments and fixed capital formation are rising. This is not about transitioning to a sustainable growth model. In India, no one asks questions about the big picture because there is no one to answer them now.
That is why it is hard to get overenthusiastic about recent gains in the stock market, much as investors perceive that these gains signal the de-coupling of prospects in the developing world from the woes in the developed world. Such perceptions are hard to reconcile with objective reality. That is the dilemma for investment strategists—a dilemma that they had to, and they have to, live with in a world where the value of money and assets is driven solely by perceptions (or, more precisely, by flights of fancy). Of course, we know now that they do not end happily. The challenge is to time it.
Wonder if The Economist starting a separate column for Asian affairs is the equivalent of the “magazine cover curse”.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at
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First Published: Mon, Apr 13 2009. 08 54 PM IST