Tags: IMF | growth | eurozone | dollar

The US Dollar Can't Save the World

By    |   Wednesday, 08 October 2014 09:32 AM

After the International Monetary Fund (IMF) released its latest World Economic Outlook (WEO), the global markets apparently had widespread concerns about the continuing slow pace of global growth, concerns that in my opinion don't make much sense because it is well-known the IMF, most of the time at least, lags consensus on forecasting GDPs.

That said, the IMF has a lot of enlightening and serious information packed together in that one single report.

Among the boatload of information that stands out from rest and that could be of interest to long-term investors is that the IMF revised its growth outlook for the United States by 0.5 percent to 2.2 percent for 2014 since the July WEO. In addition, the IMF expects further growth to 3 percent in 2015, unchanged from the previous estimate. Besides the United States, only Canada and Spain were among the advanced economies that had upward revisions for 2014, both revised by 0.1 percent to 2.3 percent and 1.3 percent, respectively, and by 0.1 percent to 2.4 percent and 1.7 percent, respectively, for 2015.

Among the emerging and developing economies, India had the highest upward revision for 2014, with a 0.2 percent upward revision to 5.6 percent, and growing to 6.4 percent in 2015, unchanged from the previous estimate.

All other countries remain unchanged or were revised downward for 2014.

The eurozone was revised downward by 0.3 percent to 0.8 percent growth in 2014 and by 0.2 percent to 1.3 percent in 2015. The IMF also warned that there is now a 40 percent chance, up from 20 percent six months ago, that the eurozone could slide into recession once more, and if that would be the case, growth of the global economy will be hurt once again.

Growth for China remains for now unchanged at 7.4 percent in 2014, but is expected to slow down to 7.1 percent in 2015, unchanged from the previous estimate.

Interestingly, growth for "Latin America and the Caribbean" was also revised downward by 0.7 percent to 1.3 percent growth in 2014 and by 0.4 percent to 2.2 percent growth in 2015. Brazil was revised down 1 percentage point to 0.3 percent growth for 2014 while it should grow at 1.4 percent in 2015, down 0.6 percent from the previous estimate.

This doesn't bode well, if you ask me.

Again, after the Bank for International Settlements, the 16th Geneva Report on the World Economy and the G20 and others have warned during the last few weeks for the downside risks that should imply broad-based "market corrections," the IMF now also warns about too high financial market optimism, as reflected in many indicative components of these markets, That optimism is now back to what we call "pre-crisis" levels, when at the same time the world economies are slowing down to way-too-low levels and are once again at risk for serious bumps in the roads that could postpone healthy growth for some time to come. The U.S. and to a somewhat lesser extent the United Kingdom remain the big exceptions.

When the IMF states that "low potential output growth and "secular stagnation" are still important risks in advanced economies. . . . Robust demand growth has not yet emerged. . . . A pickup in investment has not yet materialized. . . . For emerging markets, despite downward revisions to forecasts, the risk remains that the projected increase in growth next year will fail to materialize. . . . Potential growth is lower than currently projected," it's certainly not an overstatement to say the IMF is not optimistic.

In my opinion, these are remarks long-term investors should take into account when making investment decisions in the foreseeable future. Yes, the goldilocks times belong definitively to the past for a very long time to come.

Besides all that, long-term investors would also do well not negating the risks of a hard landing in China, because excess capacity in China hasn't found a workable solution yet and because of the lethal credit overhang that faces the country, private as well as official, as a whole.

In the meantime, Moody's stated that China's easing of mortgage lending terms will benefit property developers, but the negative outlook for the housing sector will remain.

In my opinion, China still is bound for a "bust," but, of course, I don't have a crystal ball.

Please take care that if a hard landing in China were to happen it would hurt every economy on the planet. No doubt about that.

Turning to the dollar's strong performance we're witnessing these days, and which in my opinion will continue for some time to come, it has been interesting to take notice of the comments by Charles Evans, Chicago Federal Reserve Bank president and a voting member of the Federal Open Market Committee (FOMC) next year, when he said at a conference held at the Peterson Institute on Sept. 24 that a much stronger dollar might lead the Fed to pursue an easier monetary policy than it would otherwise. By the way, he didn't go into detail about what a much stronger dollar meant. Tellingly, at that same occasion he also said that monetary policy in Europe warranted attention.

One day before, Federal Reserve Bank of New York President and permanent voting member of the FOMC William Dudley said at the Bloomberg Markets Most Influential Summit in New York: "If the dollar were to strengthen a lot, it would have consequences for growth. We would have poorer trade performance, less exports, more imports. And if the dollar were to appreciate a lot, it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account when setting policy."

Dudley also failed to be more specific about at what level the dollar becomes too strong against, for example, the euro.

So, we all know the European Central Bank (ECB) will try to do "whatever it takes" to come to some, maybe one or two, form of ECB quantitative easing (QE) program even with the opposition of Germany that could bring, if a full-blown ECB QE were to happen, the case before the German Constitutional court. The outcome of that would be anybody's guess.

That the eurozone needs urgently all the help it can get to stimulate growth is clear and as the eurozone is an export-driven economic bloc, a weaker euro shouldn't hurt, at least not in the short term.

I think that the euro, in order to really stimulate exports and to try to "import" inflation at the same time, should drop about 10 percent to 15 percent on a trade-weighted basis, which is approximately 20 percent in the foreign exchange market against the dollar from where it quotes these days and what would bring it in the zone of parity with the dollar.

Now, I don't think the people at the Fed and the U.S. Treasury would be completely happy with that, certainly if it would occur too quickly, like within about one year. Better and more acceptable timing would be a couple of years. I myself have no doubt the euro is definitively on its downward path, as I have written here before.

What I'd like to say is I think once the euro breaches the $1.20 mark and overshoots to the downside, authorities in the U.S., but also other important eurozone trading partners, could start getting nervous and some kind of a stealthy "Currency Wars Second Edition" could come out of the blue.

We are not there yet, but as a long-term investor I would keep an eye on that level of $1.20 per euro. Once we are there I'll give you my view.

For now I have no doubt the dollar is on a bull run and not only against the euro, but against practically all currencies.

Does that mean the dollar will save the world? I must say, I don't know, but I have my doubts.

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After the International Monetary Fund (IMF) released its latest World Economic Outlook (WEO), the global markets apparently had widespread concerns about the continuing slow pace of global growth.
IMF, growth, eurozone, dollar
Wednesday, 08 October 2014 09:32 AM
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