Voor de dollar bulls:
Why We Will Dodge a Dollar Disaster
By Jim Jubak
MSN Money Markets Editor
3/23/2005 7:14 AM EST
First the bad news: The U.S. trade deficit hit a record $666 billion in 2004, and the euro is up 47% against the dollar since May 2002. The dollar's decline means slower economic growth, higher interest rates, a stagnant stock market and a slippage in the U.S. standard of living. All of which is enough to make me a pessimist.
Now the good news: The dollar isn't going to crash, and those market pundits urging you to short everything except gold and silver are wrong.
I don't buy the extreme scenarios because they underestimate the feedback mechanisms in capitalist economies that kick in when a trend swings too far in one direction or the other. In the current case, these mechanisms will help limit the damage to the dollar -- and to the U.S. and global economies.
Better Off Than Europe and Japan?
And what are these mysterious mechanisms? Nothing more complicated than this: You think we've got problems now -- just wait until the global financial markets latch onto the even bigger mess that the Europeans and the Japanese face. Sure, you may not want to own U.S. dollars because of trade and budget deficits, our aging population and the huge financial obligations they impose, not to mention our inability to agree on meaningful fixes for anything. But, hey, do you really want to own a lot more euros and yen when everything is so much worse in those economies?
Let's do a comparison of the dollar and its main global competitors, the euro and the yen, on the crucial points.
Government budget deficits. Ours is huge: $412 billion in fiscal 2004. That came to 4.4% of gross domestic product, one measure of the size of the U.S. economy. In France, the budget deficit in 2004 was 3.7% of GDP and in Germany, 3.9%, according to the Organization for Economic Cooperation and Development (OECD). Better but not hugely better.
If you prefer euros to dollars, though, what's important to you is the projected trend in future deficits. According to the OECD, the budget deficit will drop to 2.9% of GDP in France in 2006 and to 2.2% in Germany. But it will stay almost steady at 4.2% in the U.S. Score a point for the euro -- but definitely score one or more against the yen. Japan ran a government budget deficit of 6.5% of GDP in 2004, and the OECD is projecting the deficit will drop just a smidge to 6.3% in 2006.
Economic growth
We all feel that the budget deficit is out of control in the U.S., so why doesn't the comparison with Europe (let alone Japan) look worse? Growth. Economic growth in the U.S. is significantly higher than in the rest of the developed world -- and faster economic growth covers a multitude of financial sins.
Again using OECD projections, the U.S. economy will grow by 3.3% in 2005 and 3.6% in 2006 (in real terms, that is, after subtracting inflation). France's economy will grow by just 2% in 2005 and 2.3% in 2006. Germany will struggle with even slower growth of 1.4% in 2005 and 2.3% in 2006. For the euro-zone as a whole, growth will come in at 1.9% in 2005 and 2.5% in 2006. Japan, the home of the yen, is projected to show economic growth of just 2.1% in 2005 and 2.3% in 2006.
Demographic burdens. In the U.S., we've got a Social Security crisis, to use President Bush's word, because the ratio of workers paying into Social Security to the retirees receiving benefits has fallen to 3.4 workers to one retiree in 2000, from 16.5 workers to one retiree in 1950. And it's headed to a 2-to-1 ratio by 2030. Paying for the pensions and health care of those retirees when the number of workers is shrinking is enough to bust any budget.
Well, then, think how much worse the financial squeeze is in countries where the population is aging more quickly than it is here. In the euro-zone countries right now, there are 35 people of retirement age to every 100 of working age, according to the U.N. (In the U.S., the ratio is about 15 to 100, by my calculations.)
By 2050, the ratio in euro-land will be 75 people of pension age to every 100 workers, and in countries such as Italy and Spain, the ratio will be close to 1 to 1. German workers already pay almost 30% of their wages into the state pension plan. In Europe those demographics will, I think, make the OECD forecasts of falling budget deficits wildly optimistic, because they're founded on the assumption that European governments will be able to get the huge pension liabilities for their huge force of government workers under control.
In Japan, where the population is aging even faster, the budget problem is even worse. Fully one-third of Japan's population will be 60 years or older within a decade, according to Phillip Longman's book The Empty Cradle.
A Floor for the Dollar
OK, so let's sum up. The U.S. is faced with a huge budget deficit that makes foreign investors nervous about holding dollars. But as a percentage of GDP, that deficit isn't that much worse than those in Europe and better than the one in Japan, the homes of the two major competing global currencies. In addition, the U.S. economy is growing faster than those of Europe and Japan, and our budget-busting demographic burden isn't as serious as those faced by the Europeans and the Japanese.
To me, this situation puts a limit on how far the dollar will fall against the euro and the yen, the two other major international trading and investing currencies. The current decline of the dollar against those currencies comes as foreign central banks decide to diversify their holdings of foreign exchange. For a central bank like the Bank of Korea, for example, that means reducing the current 60% to 65% of the bank's $210 billion in foreign-exchange reserves now in dollars by adding investments in euros, yen and a few other currencies. Globally, the U.S. dollar made up 64% of central bank reserves at the end of 2003.
If foreign central banks stopped buying dollars entirely, according to Wall Street estimates the dollar would have to drop another 30% and U.S. bond yields would have to climb by 4.5 percentage points to attract enough private capital to fill the gap.
That's a worst-case scenario, and you'll note that it's still well short of the end of the world. And because you can't just sell a dollar without buying some other currency, the weaknesses in the yen and euro economies mean that the move away from dollars will stop well short of that. For example, even today, the yen makes up only 5% of central-bank reserves, because Japanese government bonds yield almost nothing and because the attractiveness of the yen is dampened, shall we say, for anyone who understands Japan's impending budget meltdown.
The same with the euro; euro-denominated bonds yield less than U.S. Treasuries, making diversification out of dollars and into euros prudent in the long run but painful in the short run. Closing that dollar/euro yield gap doesn't seem to be in the cards, either, because raising interest rates in Europe would slow those slow-growing economies even more.
Asian Banks to the Fed: Raise Rates
In fact, you can see all the talk about diversification from Asian central banks as just a signal to the U.S. Federal Reserve. The message? If you want us to keep holding dollars, keep raising U.S. interest rates so that holding dollars will produce more income for the world's creditor banks.
And as