Correction Turns "Great" Thanks to Government Intervention
The surprise at the beginning of the day yesterday was China’s announcement that it would end the dollar peg.
The surprise at the end of the day was that it didn’t make any difference. The news got investors all antsy…they spent the day preparing to drive prices higher. But at the end of the day the Dow finished lower – by 8 points.
It didn’t make any difference to the stock market. Even the currency market yawned. Bloomberg:
The currency advanced 0.36 percent to 6.802 per dollar as of 1:45 p.m. in Hong Kong, the biggest gain since Oct. 7, 2008, according to the China Foreign Exchange Trading System. The 12- month non-deliverable yuan forward rose 1.4 percent to 6.6209, implying traders are betting on a 2.7 percent appreciation.
What, not even a 1% move?
Our guess is that China has just stolen a march on its US critics. The currency move didn’t make any real difference. And by agreeing to end the peg, the fickle finger of blame now turns from the East to the West.
The complaint against China was that it was under-pricing its output, by keeping the yuan tied to the dollar. America was China’s number one customer. It made sense to keep the two currencies in line. But since China is a more efficient producer, it also caused US companies to lose market share to Chinese competitors or to shift their own production to Chinese subcontractors.
The best solution to that problem was just to ignore it. But US lawmakers needed a scapegoat and China was the best they could do.
But what are they going to do now? Who to blame? They could try “bourgeoisie parasites,” like Hugo Chavez. But Marxist mumbo jumbo never caught on in the US. Too many voters wanted to be bourgeois!
While China might have under-priced its output, the US certainly overpriced its ability to consume all that Made-In-China stuff.
“It’s just bad economics to pretend we can fix the lives of middle class American workers by getting the Chinese to revalue its currency vis-a-vis the dollar – it’s a horrible misconception,” Stephen Roach, chairman of Morgan Stanley Asia Ltd. said in a June 15 radio interview from Hong Kong with Tom Keene on Bloomberg Surveillance.
But don’t worry, dear reader. This is a problem that takes care of itself.
“Bill, you’ve been talking about a Great Correction for months. I don’t disbelieve you, but what the hell is a Great Correction?”
A Great Correction is what you get when a great many things need to be corrected at the same time. When the crisis of ’07-’09 came, economists immediately began talking about a ‘recovery.’ But there was no way the economy could go back to being what it had been. What it had been was excessive, over-the-top and unsustainable. It couldn’t go back. It had to go forward.
Specifically, it had to correct the many mistakes made by Americans who spent too much…and Chinese who made too much stuff for them to buy. On the Chinese side, that correction will take time. But it’s not a major change of direction. There is now more consuming going on in the emerging markets than there is in the US. GM sells more cars in China than it does in North America. And Coke says its profits went up in the first quarter, even though its North American sales went down.
China will have to adjust its product mix and its marketing/distribution system. But there is no theoretical reason it can’t continue doing what it does best – making things. China’s economy can recover (it just needs something to recover from!)
The bigger problem is on the US side, where no recovery is possible. Many people have houses they can’t afford – even after the price of housing was cut by around 20%. Many banks have more debt than credit, even after dozens of them have been knocked out of business. The big banks have still not been corrected. Their mistakes went into the Federal Reserve’s vault. So that is another thing that remains to be corrected.
At the household level, people have generally spent too much money. They had no savings…even as they were getting closer and closer to retirement. That situation has begun – but only begun – to correct itself. Savings rates are rising, while a good deal of debt has been cancelled, written off, or restructured.
Of course, there were many, many more mistakes – from private equity deals to commodity prices to over-employment in the retail sector. Most of them are being corrected.
If that were all there were to it, it would be an important correction, but not a Great Correction. As we keep saying, private industry and private initiative can make mistakes. But if you really want to make a mess of things you need taxpayers support.
Of course, the taxpayers were in on this from the get-go. The feds largely created the bubble in the housing market. And then, when the bubble blew up, they took over Fannie and Freddie…stuck the taxpayers with trillions more in liabilities…and generally made things worse.
But there are a couple of things, specifically, that make us think this correction will be worthy of the Great modifier.
First, it appears to mark the end of a 60-year credit expansion. That alone ought to make for an interesting correction.
Second, it also appears to signal the high water market for the USA. America may be on top of the world for a while longer; but other countries are growing much faster so that, relatively, the US will never be in such a superior position again.
The third thing to be corrected is the most interesting of all. The US-dollar based money system, created in ’71, is surely building up for some kind of correction.
While the private sector generally tries to correct its problems, the public sector adds to its own. It is living beyond its means. Sooner or later, it will need to be corrected too.
When will it happen? When the bond market is ready.
Already, in Europe, bond buyers forced the issue. Governments have begun to address the problem of excess public deficits. At least people are talking about it…and governments are promising cutbacks.
“We’re all austerians now,” says Martin Wolf, reprising the language that got us into the mess in the first place. (Richard Nixon once famously remarked that “we’re all Keynesians now,” referring to the widespread belief that government needs to meet downturns with counter-cyclical stimulus spending.)
Yes, dear reader, austerity is in style in Europe this summer. But not in the US. Which makes us think that investors are making a big mistake by buying dollar bonds. Dollar bonds are the investor’s choice because the US, and only the US, is ready, willing and able to print as many dollars as it needs.
Which is what worries us…