gordeeva_o_g_praktikum_po_perevodu_ekonomicheskih_tekstov_s

Instead of going into productive investments, cheap money may be overheating spending and sending asset prices soaring too high, setting the stage for a future bust.

For many investors, the question is not whether there is a global savings glut, but how long it will last. And on that score, there are plenty of reasons to expect it to continue for a while. First, the rise in oil prices worldwide is causing a massive transfer of wealth to oil-producing countries. Russia’s trade surplus, for example, is running at $100 billion annually, up from $65 billion a year ago.

Demographic shifts are driving up savings as well, as aging societies in Japan and Europe accumulate funds for retirement. That’s holding back both consumption and business investment, as many European and Japanese companies are cautious about committing much capital to expand their domestic operations. In Japan, the combination of weak wage growth and strong exports have boosted corporate profits, with a much smaller increase in business investment. The same story also holds in Europe.

If global savings are channeled in the right ways, it can be a great boon for the world economy, enabling the sort of investment and risktaking that fuel growth. But there’s far too much evidence right now that low rates are encouraging behavior that could cause trouble.

Business Week July 2005

It is dangerous for the markets to expect too much from the Fed

Last month’s jobs figures were depressing but useful: they clarified what the Federal Reserves needs to do when it meets on September 18th. Not only did the American economy shed 4,000 jobs in August (rather than gaining some 100,000 as most forecasters had predicted), but revisions to earlier figures showed that the pace of employment growth has been slowing sharply for several months. The numbers suggest that America’s economy was sputtering well before the credit crisis.

America needs to create at least 100,000 jobs a month merely to absorb the growing working population. Now that the growth in

152

employment seems to have stalled, the economy looks vulnerable. Add a credit crunch on top and the risks of a sharp slowdown, even a recession, are uncomfortably high. With inflation under control, the country’s central bankers clearly ought to counter that risk by lowering their benchmark interest rate.

In the short term, lower interest rates will not achieve all that much. Given that the central bankers do not know exactly how weak the economy is (the jobs figures, although important, are only one piece of evidence), let alone what damage the credit crunch will wreak, it would be irresponsible of them to slash the Fed funds rate. Any responsible rate cut will solve the problems of neither the markets nor the economy.

Start with the financial markets. Lowering the benchmark price of money will make other assets more attractive. It will counter investors’ risk-aversion by reducing the odds of a truly nasty economic meltdown. But cheaper money will not, by itself remove the source of the recent turmoil: worries about who holds the losses from the sub-prime mess and the uncertainties over banks’ balance sheets. Assuaging those concerns will take time – time to work out what illiquid securities are worth, who bears the ultimate losses and how much capital banks will need to clear up the mess. A Fed funds rate at 4.75% or 5%, rather than today’s 5.25% will make that process easier, but it will not make it painless.

Nor will a moderately lower Fed funds rate do much to stop the economy from slowing. It normally takes months for interest-rate changes to affect spending. And it may take even longer now because one of the direct routes from lower interest rates to more spending may be clogged: a disproportionate share of the effect of lower interest rates on overall spending comes through housing, and with house prices falling amid a glut of unsold homes, that channel looks as if it will be weak. The effect of a gloomy housing market will be offset by strong corporate balance sheets and the falling dollar but the mechanism that cushions a slowdown may work less efficiently than it has in the past.

153

Some economists say dollar may resume its decline as foreign oil producers turn elsewhere to invest

The value of the U.S. dollar has big implications for the global economy. It’s also profoundly hard to predict. Still, some intrepid economists believe they have an insight: Follow the oil money.

Over the past few years, the rising price for oil has shifted a big chunk of the world’s wealth into the hands of exporters from the Middle East, Latin America and Russia, making their investment decisions an important driver of global markets. Their penchant for dollardenominated investments has helped buoy the U.S. currency, confounding economists’ predictions that the U.S.’s growing debts must eventually scare investors away and cause the dollar to fall. Now, though, some economists expect oil producers to shift their investments away from dollars, allowing the U.S. currency to resume a slide that started back in 2001. They cite a litany of reasons; renascent economies in Europe and Japan, political reactions in the U.S. against foreign investment and those nagging U.S. debts, among other reasons

The U.S. spends about $800 billion more abroad than it takes in annually, so it needs to attract about that much in net investment to support the dollar’s exchange rate. If it doesn’t and the dollar sinks, the repercussions will likely be felt around the world. As less money flows into U.S. stocks and bonds, for example, their prices could fall.

On the brighter side, a lower dollar would make U.S. exports more competitive abroad, helping to close a gaping trade deficit that many economists see as a sign that the world economy is dangerously out of balance. But if the dollar drops too far, the stimulating effect on the U.S. could force the U.S. Federal Reserve to hit the brakes by taking shortterm interest rates higher – a move that could be disruptive to global growth.

So far, however, the available data suggest that oil-exporting nations, rather than moving away from dollar-based investments, have played a role in propping up the dollar.

As the price for oil has more than doubled over the past few years, the revenues of major oil-exporting nations have more than doubled as well. As a result, oil exporters’ bank accounts have swelled to the equivalent $700 billion as of September 2005, compared with less than

154

$400 billion at the end of 2002, according to the Bank of International Settlements. Most of that money is held in dollars, so the growing accounts have boosted the U.S. currency.

If history is any guide, though, all that money won’t stay in the bank for long. Past oil booms have seen similar patterns, in which exporters first built up reserves of cash, then spent it or moved it into longer-term investments, says Thomas Stolper, global markets economist at Goldman Sachs in London. ”They are still very much in the process of figuring out how to allocate these reserves,” he says. “Everything points towards gradually more diversification out of dollars.”

In coming months, the arguments against dollar investment are likely to get stronger. For one, economies in Europe and Japan are doing better than expected. That will likely prompt European and Japanese central bankers to raise interest rates in an attempt to damp the inflationary pressure that often accompanies growth. That, in turn, will increase the potential return on euro and yen investments at a time when the Fed is likely to end a long series of interest-rate increases, reducing the relative attractiveness of dollar investments.

Data from the Bank for International Settlements show that when interest rate differentials have changed in the past, oil exporters have been quick to switch currencies. In the year after the Fed started raising rates in mid-2004, for example, the dollar share of their bank deposits rose by more than eight percentage points.

Beyond that, domestic political opposition to big foreign investments could make the U.S. a less attractive place for cross-border mergers and acquisitions – a form of investment that has become increasingly popular among oil exporters. In the year ended last month, they had put about $45 billion into foreign acquisitions, more than twice the level a year earlier, according to Citigroup. But the U.S. isn’t looking like the most welcome recipient.

“The European and Asian markets will benefit more from oil money,” says Dr. Fatih Birol, chief economist at the International Energy Agency in Paris. “There are two major reasons: one is the interest-rate movements, and the second is the general political context. As a consequence, there will be a shift out of dollars into euros and other currencies.”

intrepid penchant (for) confound

155

Dollar demand recovers in oil-producing nations

The appetite for dollars from oil-exporting countries has recovered from a two-year low, according to the latest available data from the Bank for International Settlements, which provides banking services to central banks.

Cash-rich oil producers are an important source of demand for U.S. dollars. The figures released yesterday are one indication that the dollar remains an attractive currency in which to hold deposits. Market watchers pay close attention to such data since one fear weighing on the dollar is that foreigners will shift away from the currency and cause it to lose value.

In December, for example, currency traders were abuzz when a previous report from the BIS showed a slight decrease in dollar deposits from members of the Organization of Petroleum Exporting Countries. The latest BIS quarterly report said that U.S. dollar deposits from OPEC members rose by $44 billion, propelled by increases from Libya, Saudi Arabia, and the United Arab Emirates. The dollar holdings of Russian residents increased by $6 billion and their euro deposits grew by $10 billion. The figures are for the third quarter of last year. In the same report, the BIS provided further evidence of the popularity of the carry trade, a maneuver where investors borrow in countries with low interest rates to reap higher returns elsewhere. Places like Australia, New Zealand, and Hungary are often the destinations of such funds, since they have relatively high interest rates.

The carry trade was also evident in lending patterns in Asia, the report suggested. Loans to Korean borrowers, for example, expanded by $27 billion in the third quarter of last year, with much of that amount in foreign currency as borrowers sought lower interest rates abroad than those available at home.

156

Less bashing, please

It is time to defend the ECB – and to tell it to grow up

The European Central Bank is everybody’s favourite scapegoat for the euro area’s feeble growth. The 12 countries’ GDP grew by only 1.3% in the year to the first quarter, one-third the pace in America, and yet still the ECB left interest rates unchanged last week, at 2%, for the 25th month. No wonder many people think the bank is run by inflation fanatics, unwilling to cut interest rates regardless of the lack of growth.

Yet the bank has actually done a better job than is generally thought. Many critics have argued that the ECB has been too slow to cut interest rates. In fact, by most measures its policy has been fairly loose. Currently, real short-term interest rates are close to their lowest for more than 25 years, and long-term rates, have fallen by more than a percentage point over the past year. Even the euro, which surged in 2004, is now (in trade-weighted terms) just below its level when the single currency was launched. So it is ludicrous to suggest that monetary policy is strangling Europe’s economies. The blame ought to be laid on tight fiscal policies and a host of structural rigidities.

The ECB also deserves credit for the way that it managed the largest merger in history, involving no few than 12 central banks, and introduced a currency across those same countries, simultaneously providing a firm anchor for inflation expectations. Before the euro succeeded, there was wide-spread concern that it would be hobbled by high inflation.

But this is not to say that the ECB is perfect: far from it. The bank’s problems lie less in its actual interest-rate decisions than in its poor public communication, its apparent lack of flexibility and its excessive independence, all of which make it an easy target to attack.

The constantly hawkish tone of its monetary policy statements give the impression that the ECB focuses only on inflation and does not care about growth. Yet several studies suggest that there is little significant difference in the way the ECB and America’s Federal Reserve respond to changes in output and inflation. There is, however, a big difference in their respective language, and this matters. If you hold interest rates low, but keep warning, as the ECB has done, about the need to remain

157

“vigilant” against the threat of inflation, then neither households nor companies are likely to rush out and spend.

The ECB boasts that low government bond yields are evidence of its success in establishing its anti-inflation credentials. But this definition of success is too narrow. The pursuit of price stability is a means to an end (to achieve maximum sustainable growth), not an end in itself. While the ECB’s prime task is price stability, it is also legally charged with supporting growth. Last year it could have cut interest rates to offset the impact of the rising euro; today it should stand ready to ease monetary policy to cushion the impact of structural reform and fiscal discipline. The ECB is no longer an infant central bank. Having gained its credibility, it now needs to make better use of it. In short, it is time for the ECB to grow up.

The Economist July 2005

When does a gentle slide become a dangerous skid? That is the big question as the dollar’s decline gathers pace. The greenback fell almost 2% against a basket of major currencies in the week after the Federal Reserve cut America’s short-term interest rates on September 18th, hitting a new low for the post-1973 floating era. The fall was particularly pronounced against the euro, where the dollar fell to a record $1.41 per euro on September 25th.

Those nervously inclined see plenty of reason to fret. Some worry that central banks and other official investors may be about to dump dollars. Saudi Arabia decision not to follow the Fed’s lead and cut interest rates fuelled speculation this week that the oil kingdom was about to break its 21-year peg with the greenback. Others fear that a plunging dollar will fuel inflationary pressure in America and thus limit the Fed’s ability to cut interest rates further. In Europe there are worries that a stratospheric euro will imperil the region’s growth. Nicolas Sarkozy, France’s president, recently declared that the currency’s rise above $1.40 was a “problem” for eurozone competitiveness.

Some of this nervousness is exaggerated. With inflation rising fast in Saudi Arabia, the link to a falling dollar is causing a growing

158

headache. A revaluation against the dollar or, better, a link to a basket of currencies – similar to the one Kuwait now has – would make more sense. But the Saudi government has denied that it plans anything of the sort. Its central-bank governor repeated a commitment to the dollar peg on September 26th. More important, a change in Saudi Arabia’s currency regime – or that of other oil exporters – need not cause a dollar crash. Shifting to a currency peg does not mean a central bank would suddenly dump its dollar assets.

The inflationary risks from a weaker dollar are also easily overdone. Most economists reckon that the pass-through from a weaker dollar to higher import prices has weakened in recent years, and is particularly low in America. A new study by Robert Vigfusson, Nathan Sheets and Joseph Gagnon, three economists at the Federal Reserve, suggests that countries are more willing to absorb a rising exchange rate in their profit margins when exporting to America than when they export elsewhere, perhaps they are keen to protect their share of America’s huge market. Such a profit squeeze cannot continue indefinitely, of course, but as yet there is little sign that the dollar’s weakness is aggravating price pressure.

For the moment, the dollar’s decline is reflecting investors’ expectations of Fed policy rather than tying the central bankers’ hands. Financial markets increase the odds of more short-term interest-rate cuts this weak after a barrage of grim economic news. The pace of home sales fell again in August; the backlog of unsold existing homes rose to ten-months’ worth of supply; and consumer confidence plunged. As the gloomy economic news piled up, yields on ten-year treasury bonds, which had risen on inflation jitters after the Fed’s rate-cut, fell back.

Today’s pessimism is centred on America – hence the tumbling dollar. Bur there may soon be reasons to worry about Europe. Germany’s Ifo index of business confidence fell again this week for the fourth consecutive month, to a 19-month low. The aftershocks of the credit crisis coupled with a surging euro could make life difficult for Europe’s firms.

So far, the European Central Bank has played down these risks and is signaling the likelihood of higher interest rates ahead. That hawkishness is part of the reason for the euro’s rise. But if America’s economy is truly in trouble, the outlook for the euro zone will darken too. America’s currency will become others’ problem.

159

Birth pains

A new global system is coming into existence

All monetary and economic systems are a struggle between borrowers, who favour inflation, and creditors, who are determined to maintain the purchasing power of the currency. In a democracy, this is a very fluid battle. The creditors have the money and therefore the ear of the political elite; the borrowers tend to have the votes.

Creditors have periodically imposed monetary anchors in an attempt to defeat the borrowers’ lobby. These anchors are devised in prosperous times but run into difficulty during recessions. The gold standard failed to outlast the Depression. For nations with a shortage of gold, the “right” thing to do was to raise interest rates in an attempt to lure gold back; the austerity this imposed on the rest of the economy was politically unacceptable.

The Bretton Woods era replaced a gold standard with a dollar standard (albeit with the American currency theoretically linked to bullion). The system worked well for more than two decades, helped by the post-war economic boom, particularly in Germany and Japan which began the period with undervalued exchange rates. It broke down because America refused to pay the domestic price for bearing the system’s weight.

When Bretton Woods failed, it was not immediately obvious what would replace it. European nations, in particular, maintained a hankering for fixed exchange rates. But floating rates eventually prevailed, particularly for the major currencies of the dollar, yen and D-mark.

The problem for creditors was that the floating-rate system was based on fiat (paper) money. What would keep the inflationary instincts of governments in check? The answer took a couple of decades (and recessions) to hammer out.

Once it was accepted that the markets could set exchange rates, there was no real need for capital controls. And once capital could flow freely, ill-disciplined governments could be punished by higher bond yields. Politicians accordingly tried to reassure the markets by giving greater power to central banks, some of which set explicit inflation targets.

160

The post-Bretton Woods system worked well, engendering the long period of low inflation and steady growth known as the Great Moderation. But one of the reasons for its apparent success—the growth of India and China—may have sparked its demise. The addition of these two great nations to the international financial system was a supply shock that put downward pressure on inflation rates.

As Stephen King, an economist at HSBC, has pointed out, the result might have been a benign deflation that boosted Western living standards. But central banks struggled to avoid a deflationary outcome; the result was a loose monetary policy that encouraged asset bubbles. Those bubbles lasted longer than expected because the flood of savings from developing markets held down the risk-free rate.

Now it seems to be recognised that inflation targeting is not enough. Given the explicit government guarantee behind the banking system, central banks need to monitor both financial stability and asset prices. At the same time, some central banks have adopted (via quantitative easing) a policy of creating money to boost markets that also has the convenient side-effect of funding budget deficits. That is just what opponents of fiat money feared would happen in the long run.

The same old dilemma will eventually occur. Having spent a fortune bailing out their banks, Western governments will have to pay a price in terms of higher taxes to meet the interest on that debt. In the case of countries (like Britain and America) that have trade as well as budget deficits, those higher taxes will be needed to meet the claims of foreign creditors. Given the political implications of such austerity, the temptation will be to default by stealth, by letting their currencies depreciate. Investors are increasingly alive to this danger; ten-year Treasury bond yields are around a percentage point higher than they were at the start of the year.

Creditor nations tend to set the rules and the new global monetary system will be unable to operate without the approval of China, a creditor country that has capital controls and a managed currency. It has been assumed that China will have to move towards the Western model. But why not the other way round? Western countries adopted free capital markets, as the British adopted free trade in the 19th century, because it suited them. Will China now be able to call the shots? Uncomfortable as it might be for the West, the next monetary order is more likely to be made in Beijing than in New Hampshire.

The Economist May 2009

161