Yesterday's U.S. data showed American consumers have really started shunning the shopping mall and are saving money instead, including the 0.4 percent boost to income that they received from the fiscal stimulus. This is in line with what Treasury Secretary Tim Geithner just said in China and is a necessary part of the deleveraging process.
That said, today there are clearly a lot of people out there in China and all over the world who are really interested in Geithner’s professed desire for a stronger dollar. Nevertheless, in my opinion, Mr. Geithner’s objective could lie beyond a number of hurdles that might turn out to be insurmountable, at least in the short-to-medium term.
Therefore, it’s completely understandable to see the market’s implicit skepticism over the credibility of any U.S. Treasury commitment in this regard.
These past two days, Geithner has tried to assure about the reliability and resilience of the dollar and has centered on the Treasury’s goal to shrink its budget gap as soon as an economic recovery takes hold to a deficit of roughly 3 percent of GDP from a projected 12.9 percent this year.
As of March, China held about $768 billion of Treasuries. According to the Congressional Budget Office, for the fiscal year that ends Sept. 30, the U.S. deficit is projected to reach a record $1.75 trillion from last year’s $455 billion shortfall.
Nobody can deny that a retrenchment in fiscal stimuli would be a risk-laden and premature proposition in the face of a financial and economic crisis whose ultimate scale and legacy has yet to be appreciated. Therefore, Geithner’s assurances could probably center more on the longer-term; but even then, there are inherent risks in airing plans for belt-tightening in the current still fragile environment.
Personally, I have my doubts whether or not this announced belt-tightening is realistically doable. When unemployment is still projected to rise further the risks of derailing a still unsure recovery are not to be taken lightly.
Remember Japan, when the Hashimoto government decided to hike the Japanese sales tax in 1996. That resulted in catastrophic consequences for the country’s early recovery.
Also, as a means for shoring up the dollar, monetary policy appears to be a better prospect than fiscal policy. With a policy of quantitative easing currently underway, it would be illogical to expect the FOMC to move to tighter monetary policy any time soon.
In this context, last Friday, Dallas Fed President Richard Fisher commented that the U.S. economy will not recover in a meaningful way before the end of this year and that deflation remains a risk in this climate.
I can’t call this a solid basis for moving to any tightening in policy soon. Yet, even in the event that the levers of U.S. economic power were freed-up in the short term, it is by no means certain that this would necessarily revive the interests of international investors.
After all, focusing only on the negative forces being brought to bear upon the dollar would be to ignore positive developments in a number of markets around the world that are underpinning the dollar’s counterparts.
Indeed, data show that the downtrend of the dollar since mid-to-late April coincided with the onset of a modest outflow from U.S. fixed income assets, and that is still continuing.
We also have seen the beginning of a steady rise in foreign interest in a number of emerging equity markets. One of them happens to be South Korea, which today shows an unprecedented rise to record foreign exchange reserves.
Since mid-April, too, we have seen a rising preference for assets that are expected to offer greater yield-enhancement potential than dollar denominated assets.
Coupled with the obvious constraints on the domestic monetary policy front in the United States, this sheds further light on the degree of difficulty Geithner is facing to secure a stronger U.S. dollar if the U.S. Treasury is not to resort to other, more direct means of proffering support, which, of course, shouldn’t being ruled out by any way.
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