Deficits Do Matter!
"Why is this deficit important? Many popular think tanks have been saying that 'deficits don't matter' and that we are in a 'new economy,' where globalization and new investment parameters have made deficits less important."
By Chris Gaffney
In this issue… Deficits do matter! More US data! Yen to rally! Goldman stands up!
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--------------------- And Now… Today's Pfennig! Deficits do matter! Good day. The dollar gained slightly on Friday ending what turned out to be one of the best weeks of the year for the currencies. Many, including Chuck, pointed out that the yen's move in particular was too much, too fast. So, a slight pull-back wasn't a surprise. With the holidays just around the corner, expect light trading this week, which usually means little or no major moves. On Friday, we found that the U.S. current-account deficit unexpectedly narrowed from July through September as insurance payments and donations from abroad poured in following Hurricanes Katrina and Rita. The current account, the broadest measure of trade, had a deficit of 195.8 billion last quarter compared with 197.8 billion the previous three months. It was the second straight quarter that the gap narrowed after reaching a record 198.7 billion in the first three months of this year. But no matter how the popular press may want to spin this 'narrowing,' a 195+ billion deficit can't be viewed as a positive! And this deficit is likely to increase since the insurance payments and donations are a one-time event. The deficit will probably reach a record $225 billion this quarter, as the gap in goods and services trade unexpectedly widened to a record $68.9 billion in October, as Chuck told everyone last week. Why is this deficit important? Many popular think tanks have been saying that "deficits don't matter" and that we are in a "new economy," where globalization and new investment parameters have made deficits less important. Here is a quote from Fed Chairman Alan Greenspan, "The rise of our deficit and our ability to finance it appears to coincide with a pronounced new phase of globalization that has emerged in the past decade. A jump in U.S. productivity, which raises returns on U.S. assets, is supporting this trend, as is a decline in what economists call home bias, the parochial tendency to invest domestic savings in one's home country." As Chuck pointed out recently, this sounds a lot like the stories we were reading near the top of the technology bubble. The deficits do matter, and here is why: The U.S. needs to attract about $2.1 billion a day to fund the gap and keep the value of the dollar steady. That's right, 2.1 billion dollars a day!! That, my friends, is a lot of foreign capital! And with interest rates here in the United States beginning to top out and rates just starting to rise in Asia and Europe, don't you think these foreign investors are going to start demanding more of a return to keep buying into America? Even Big Al says there is a limit on the funding of our current account and that rising deficits, "cannot persist indefinitely." So, it looks as though the recent debate of "do deficits matter" may be finally settled sometime in 2006. Unfortunately, I don't believe it will prove to be good year for the United States nor for the U.S. dollar. Economic reports to be released this week include the PPI data for November, housing starts, and ABC consumer confidence tomorrow. Third quarter GDP and personal consumption come out on Wednesday, while personal spending and income and the weekly jobs data arrive on Thursday. Finally, we'll see durable goods orders and new home sales at the end the week, on Friday. The Fed will be watching this data to see if borrowing costs need to be increased further, or if they can pause the rate increases. I tend to believe we are nearing the top of the rate cycle here in the United States and that the FOMC will only increase rates two more times during the first quarter of 2006. The Japanese yen was buoyed by a government report which predicted the Japanese economy will grow for a fifth straight year and that the deflation which has plagued the world's second largest economy for the last seven years will be coming to an end. The gross domestic product deflator, a broader price index that reflects consumer prices, capital investment and exports, will rise 0.10% next fiscal year, the first gain in nine years, the government said. Once the Japanese interest rates begin to climb back into positive territory, we may start to see investors repurchasing yen to invest back into this economy. While 2005 was not a good year for the Yen, I believe 2006 will be much better as there are several factors which could move this currency up in a big way. Another factor, which could weigh on the dollar next year, is the end of the tax break that allows U.S. companies to increase the amount of profits they send back to the U.S. business have repatriated around $300 billion in profits ahead of the year-end deadline, of which, a third were in currencies other than the dollar. These flows are partially responsible for the temporary halt of the decline in the U.S. dollar, which started in 2001. Next year, we expect to get back to this trend and see significant declines in the dollar. While we were one of the first to point this out, we are no longer alone in this call. Goldman Sachs, the third largest securities firm by market value, predicts the dollar will drop to $1.30 per euro and 95 yen by the end of 2006. When you combine the end of this tax break with the end of interest rate increases in the United States, attention should shift to the U.S. current account deficits, which would mean a dollar drop similar to what we had seen in 2002 and 2003. Currencies today: A$ .7447, kiwi .6925, C$ .8615, euro 1.2014, sterling 1.7661, Swiss .7750, ISK 62.89, rand 6.38, krone 6.67, forint 210.31, zloty 3.21, koruna 24.10, yen 116.16, baht 40.94, sing 1.6638, China 8.073, pesos 10.75, dollar index 89.79, and gold $506.19 That's it for today. We had our annual Holiday Party on Friday night. Thanks to Sue for organizing it. Everyone had a terrific time! Look for slow trading days this week, as most of the big boys (no pun intended, Chuck) will be leaving the desks early for the holidays. Hope everyone has a great start to your week! |
