Inflection Point?

Earlier this month, when Edward wrote

The alarm shot was given by Dalls Federal Reserve President Robert McTeer when he declared in a speech in New York last week that whilst overseas investors now ?finance? the US current account gap, ?theoretically some day that process will come to an end, the flows will turn against us and there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar.? This prospect, which currently seems remote, should not be taken lightly. It is real, and it is there.

I noted that this prospect had been around for a long time (close to ten years at least) and asked what would constitute a sign that this time might be different.

This could be it:

On Sept. 9, as it must frequently do, the U.S. government turned to Wall Street to raise a little cash, and Paul Calvetti bet that demand for $9 billion worth of long-term Treasury bonds would be “huge.”

But at 1 p.m., as the auction opened and the numbers began streaming across his flat-panel screens, the head of Treasury trading at Barclays Capital Inc. slumped in his chair. Foreign investors, who had been voraciously buying Treasury bonds, failed to show up. Bond prices cascaded downward, interest rates rose, and in five minutes, Calvetti, 38, who makes money by bidding on bonds at one price and hoping market demand lets him quickly resell them at a profit, had lost $1.5 million.

“It’s amazing,” he gasped, after the Treasury Department announced that Wall Street traders, not foreigners, had been left to buy virtually the entire auction. “I don’t think I’ve ever seen this before.”

Losing the favor of the bond market can be laid squarely at the foot of the present US administration. The move from surplus to record deficits in just three years, abandonment of fiscal discipline, a view that economics don’t matter in the face of politics, policy choices that mean deficits as far as the eye can see, refusal to be honest about the cost of those policies; all purely voluntary choices, and the price may have just arrived.

One thing that has protected the US against an earlier reversal is the perception that future US growth will be stronger than future European growth. In the face of massive fiscal irresponsibility, differing growth prospects may not matter as much to international investors. Rapid flight from Treasuries is not in anyone’s interest. That doesn’t mean it won’t happen.

5 thoughts on “Inflection Point?

  1. >One thing that has protected the US against an >earlier reversal is the perception that future >US growth will be stronger than future European >growth.

    Anne has pointed to the latest Stephen Roach in a comment below. It’s worth reposting it here:
    The entire thing:

    “Productivity growth is where the rubber meets the road for economic and financial market performance. One of the key assumptions embodied in the collective mindset of investors, businesspeople, and policy makers is that the United States has established permanent leadership in the global productivity sweepstakes. A corollary to that belief is that Europe will never get to the Promised Land of productivity revival. In the realm of economics, it?s change at the margin that always matters most. For a congenital euro-skeptic like me, it is very hard to admit it — the coming productivity convergence could force us to rethink the long-standing contrast between America and Europe.”

  2. Roach’s comments about India in the article cited by Tobias chime with two snippets of news today: One’s from the FT – “Manmohan Singh, India’s prime minister, on Tuesday urged foreign investors to contribute to $150bn worth of planned infrastructure spending”.

    The other’s from the Hindu (
    It reports that India plans to wire up the whole of the country with broadband by 2007. That’s not just the cities, but eight hundred thousand villages too.

    It did make me curious as to where the money was going to come from; this would provide part of the answer.


    Asia’s Own Agenda
    Stephen Roach (New York)

    I spend a lot of my time these days in Asia. I am currently between trips to the Far East ? having just returned from Hong Kong and India a couple of weeks ago and getting ready to go back out to Singapore, Japan, and China in early November. My fixation on Asia reflects my view that this region is now where the action is. Most things we buy these days are made in Asia. Most of the incremental funding of the West?s excess spending is also provided by Asia. Yet signs are increasingly evident that this symbiotic relationship could be changing. Asia is now paying greater attention to its own agenda ? a refocusing that could have profound implications for the global economy.

    A story in the weekend Financial Times (October 16/17, 2004) contained a fascinating glimpse of this shift in Asian thinking. The headline said it all: ?India to dip into forex reserves for domestic infrastructure upgrades.? As I noted recently, India?s infrastructure gap is staggering ? it represents a very serious constraint on any manufacturing-led development strategy (see my October 4 essay, ?From Mumbai to Pune?). The new Indian government is under intense pressure to follow the lead of China in modernizing its antiquated infrastructure of roads, port facilities, and power distribution. But unlike China, which is awash in domestic saving to fund such efforts, India faces the serious twin constraints of a private saving deficiency and a budget deficit problem. So it has turned to some creative financing in order to meet this urgent need: According to the FT story, India has elected to put some $10-15 billion of its nearly $120 billion in foreign exchange reserves to work in funding this effort.

    India is not alone in following this approach. At the start of this year, China led the way in deploying some of its foreign exchange reserves for domestic purposes ? in this instance, injecting $45 billion of capital into two of its largest policy banks, the Bank of China and the China Construction Bank. Here, as well, the Chinese were earmarking a portion of what at the time was $415 billion in official currency reserves to deal with a major national issue ? the deadweight of nonperforming loans.

  4. Stephen Roach is suggesting that China and India may be inclined to take a broader approach to using foreign currency reserves than just storing dollars to maintain American consumption of Asian exports. If that is so, the doolar could soon be under considerable pressure.

  5. The trade on the dollar collapsing seems to me to have become too obvious. The latest slide in the dollar was aided by the recent report that private flows into the dollar weakened considerably.
    But my personal opinion is that we’re in a new bull market for stocks here in the US. Yesterday, Ebay gave a good earnings report, and tonight it was Google’s turn. Yahoo reported earlier in the month, and it was good. Morale in the market has suddenly become much better.
    Given that, private flows into the US will begin to pick up again, and the dollar will at the least stabilize – indeed, it already has to some extent, as a new low on the dollar index hasn’t happened in something like the last six months at least. If you believe the BOJ, that same period saw no intervention on their part either. In any event, as private flows pick up, the importance of what China and India do with their reserves recedes.
    The edge, in my opinion, now goes to the dollar bulls, who are few and far between right now. That mere fact makes it more likely that the cycle will turn in their favor again. Too many dollar bears out there. Believe it or not, it’s possible that sometime soon the currency that will be the default depreciator, as it were, will be the euro. Fundamentally, it has precisely nothing going for it, given the persistent stagnation of the Eurozone. The ECB’s inflation target is too low to shake that stagnation off, at least for France and Germany. A 2% target, as Barron’s recently pointed out, means you have to seriously hold back Germany in order to meet it, and I would add France as well to that. If the smaller countries grow faster and have too much inflation as defined by this target, the bigger countries have to compensate by growing more slowly, if at all. Thus stagnation is designed into the euro. The only real way to get rid of this problem is to get rid of the euro, in my opinion.

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