Any real change is resisted because bureaucrats have a vested interest in the chaos in which they exist. – Richard M. Nixon
We truly live in a convoluted and strangely chaotic world. This last week alone has been a mix of all kinds of 'Updates' – worthy matters to discuss, one interlinked with the other. Where should I start??? Goldman Sachs? Eyjafjallajökull (the ominous volcano in Iceland)? US-Chinese trade battles? International currency wars?
Well, I'm not in the mood for narrow choices today. Therefore, I've picked a few to deal with in this commentary and will continue with a few others next week – a bit of a potpourri of topics so to speak.
Goldman and volcano "hiccups"
At the end of last week, global stock markets retreated considerably. Commodity prices retreated as well. The correction was primarily described as a result of the 'Goldman Sachs effect' – the concerns over the bank´s legal problems. It didn't take long before hearing wide-spread concerns that this could lead into a bigger correction, possibly similar to the one in the fall of 2008. Interestingly, this action in and of itself against Goldman Sachs deserves a closer look because Goldman Sachs was considered to be well-networked into the political area and therefore immune against such allegations.
Meanwhile in Europe, air traffic disruptions caused by the volcanic eruptions in Iceland led to huge costs for the European and international airline industries. Estimates put the costs at $300 million-a-day lost in revenue alone; higher than the costs to airlines resulting from 9/11. Nevertheless, while a few stocks – for instance, that of Lufthansa or Air Berlin – corrected starkly, financial markets overall were not phased too badly by Iceland's latest greetings.
Unsurprisingly, European carriers are now seeking state aid as a result of the closure of the region's airspace. This is becoming standard procedure these days…
"European airlines have asked the EU and national governments for financial compensation," British Airways Chief Executive Officer, Willie Walsh, said in a statement. "There is a precedent for this as compensation was paid after the closure of U.S. airspace following the terrorist events of 9/11, and clearly the impact of the current situation is more considerable."
The effects of Eyjafjallajökull, however, went beyond the airline and travel business. International transportation of goods temporarily all but stalled. Retailers across Europe are still reporting shortages of goods. In the U.K., Waitrose has encountered difficulty stocking shelves, for example, with fresh fruit from Africa. We even felt it in Zurich as we celebrated a local and centuries-old tradition called 'Sechseläuten' on Monday. For the first time in its history, the event lacked the number of flowers used as it had in past celebrations.
Perhaps the potential ramifications and effects of both the Goldman Sachs concerns and the volcano in Iceland are underestimated. Both matters certainly need to be monitored further.
What is interesting for investors to observe is the fact that, despite all, stock markets globally have pushed through these 'hiccups' with fervor. They do indeed look more stable than I would have expected. Certainly, the lack of flowers in Zurich did not faze anyone in the markets!?!?
In conclusion, the "Up-Down" scenario we predicted for 2010 still seems fully intact.
Are the Chinese guilty of unfair currency manipulation?
The US media is riding a wave of comments concerning the Chinese and their maintaining an artificially 'undervalued' yuan. US Senator Charles Schumer (D-NY) has been at the forefront of those who would like to retaliate against China for what they claim is a policy of manipulating the Chinese currency to gain an "unfair" trade advantage against the US.
He argues that the Chinese central bank had been buying US dollars and selling its yuan to prevent the yuan from strengthening against the US dollar. On March 29, Mr. Schumer announced that he and 15 of his Senate colleagues were sponsoring what he calls the "Currency Exchange Rate Oversight Reform Act of 2010." The act would let the US Treasury identify a nation as a "currency manipulator" without having to show that the manipulation was "intentional." Having done that, the Treasury could then initiate sanctions becoming progressively severe over time. Finally, the US Commerce Department could use "anti-dumping" laws and impose tariffs of their choosing to counter the currency "manipulation."
Senator Schumer assures us that "nothing is more important than jobs in America!" "You might get the Chinese mad. You know what I say to that…too bad", added Mr Schumer. I´m sure this goes down real well with his electorate.
However, it is worth reviewing Mr. Schumer's political perspective and constituency-driven fervor a little closer. Personally, I think Mr Schumer could afford to calm down, assuming of course that he is indeed interested in America's fortunes and jobs. His assumptions and allegations need to be put in a bigger perspective.
First of all, we live in a world of fiat paper currencies. In such a world, EVERY nation 'manipulates' its currency to some degree or another. Economic interests our fought out continuously in the arena of international currency battles.
Secondly, the question of how many jobs (especially government jobs) would be left in America if China had not mopped up the TRILLIONS of US debt paper should be considered. There are really two very distinct sides to 'this coin'.
Thirdly, let's assume that the yuan would indeed appreciate 10%, 20% or 30% against the US dollar and other international currencies. What would the effect really be? Would this create jobs in America or Europe? I doubt it. The current cost advantage of Chinese production is of such magnitude that even a strong appreciation of the Chinese yuan over the US dollar wouldn´t make US (or European) products significantly more competitive over Chinese produced goods. Therefore, the effect this would have on US employment is highly questionable.
However, what is much more certain is the effect it could have on inflation. If imports from China would increase by 30% in price, it would INSTANTLY translate into higher inflation – and higher interest rates (we´re at the border-line already, as discussed last week).
Furthermore, while the impact of a higher yuan would hardly help America's exports, it would strengthen the position of other Asian contenders, such as Vietnam or Bangladesh. The appreciation of the yuan against the dollar would certainly weaken the Chinese position in relation to their strong competition from other Asian nations and currencies (some of which are pegged to the dollar as well).
Let's look back in history a little. The Chinese central bank tightened the 'peg' between the yuan and the dollar in July 2008 – less than two years ago. In the three years before, the yuan had appreciated by 22 percent against the US dollar. So, the Chinese reacted and installed the peg. They complained too, but not too vociferously.
Then, at the end of 2008, the US dollar (surprisingly for most) appreciated rapidly in the context of the global financial crisis and the huge deleveraging that came with it. The Dollar Index rallied from 72.00 in July 2008 to 89.20 by early March 2009, roughly a 24 percent appreciation versus the index basket of other world currencies. The Chinese, kindly enough, kept the yuan/US dollar exchange rate flat during this phase, thereby locking in the 23 percent 'gain' made against the dollar over the previous three years. During the same period and contrary to the yuan, other currencies plummeted strongly versus the dollar.
Since then, i.e. after 'part one of the GFC' (Global Financial Crisis), the dollar has pretty much gone back into its long-term depreciation mode. And, the American administration has been crying wolf, demanding sanctions. If it weren´t so pathetic, it might be considered amusing.
What appears to be the problem is that China has been given the global task of recycling their trade surpluses back into US dollars by buying Treasury debt paper. This was the role of Europe in the 1960's and 70's, and that of Japan in the 1980's to mid 00's. Since then, the Chinese have come to the forefront in this practice and thus have apparently become the scapegoats for the unwillingness of the US Treasury and US government to return to a responsible monetary, fiscal and economic policy.
America has been exporting its 'inflation' (the creation of ever more US dollars) for over half a century. But never have they been as dependent on one nation for their consumer goods as they have been on China for most of the past decade. The result has been a huge pile of US dollar 'reserves' in the Chinese central bank with the consequence of a huge – and possibly artificial – 'boom' in the Chinese economy.
History is repeating itself. As was the case for the German mark and after it the Japanese yen, the Chinese yuan appears to be the latest scapegoat. Japan has been suffering from its role as the major US 'trading partner' ever since its markets toppled two decades ago. One major contributor to this problem was the simple fact that the Japanese yen soared from 360 to 80 against the Greenback in the decade between 1985 and1995.
The Japanese did what the Chinese are refusing to do: let their currency appreciate massively against the dollar. Apparently, the Chinese are not interested in paying the same price themselves.
The Euro is still relatively strong
In the wake of the Greek debt crisis, numerous experts and commentators decreed the euro a "dead duck." In the not too distant future, the euro was widely considered the main contender for the spot next to – or even above – the US dollar as the number one world reserve currency. Now, the big question is whether the Euro land will be able to retain its own currency for much longer.
Personally, I am not a fan of the EU construct. As a Swiss, I treasure our independence and am solidly against EU membership for Switzerland. The European Union has considerable structural weaknesses and is, by nature, an increasingly centralistic and socialistic system. However, the euro doom of late is exaggerated. In the big scheme of things, the euro has remained relatively stable.
Since its beginnings as a cash currency in January of 2002, the euro has risen continuously versus the Greenback with the very normal gyrations of any currency. The recent retreat in the context of Greece, and in the big scheme of things, does not qualify as a death sentence quite yet.
I expect the euro to continue playing a leading role in currencies and I expect it to at least match the dollar´s position. Whether that, in the very end, means much in the context of fiat currencies in general, is another topic – which will bring us to a few brief comments on gold that we´ll discuss next week.
Until then, I hope you watch and decipher the chaos out there with as much interest (and confusion) as I do.