Ray Hendon’s Economics Blog

Like the great American humorist, Samuel Clements ( Mark Twain), reports of the death of the dollar have been highly exaggerated.  I follow commentary and developments in the currency markets, and there has been a downbeat attitude about the dollar for years, especially from those who fail to understand the strength of greenback as the ultimate reserve currency.

If we line up the current levels of American unemployment, GDP, budget deficits and the current account deficit, the dollar can be made to look like a pig.   The problem, though, is that a currency’s value is never a matter of absolute value.  It’s always about relative value.

Certainly the absolute picture of the American economy is gloomy.  But, then, so is almost everybody else on the world stage.  In Europe, both the developed and developing nations are worse.  Their banking crisis is similar to ours, and their exports are falling fast, as the recession strikes all parts of

Euro/Dollar–Feb 08 to Present 

the continent.  A look at the euro/dollar chart above doesn’t inspire confidence in that currency as a replacement for the dollar.  The euro has fallen about 20% since July of 2008.  For economies that are dependent on exports, their currencies are vulnerable to world demand.

Asia is also in a world of hurt.  Only China and India are reporting continuing growth, and even in these engines of growth, the growth rates have slowed dramatically.  China has had tens of thousands of export-oriented plants close down recently, and is pushing an army of millions of unemployed workers back to their rural villages, seeking to scrape a bare living from tiny farming plots of less than a tenth of an acre in size.

The Japanese Yen is the only major currency that has appreciated with respect to the dollar, as the chart below shows.

Dollar/Yen–04/07 to present

The yen, however, is not rising against almost all currencies because of the strength of the Japanese economy.  Quite the contrary.  Japan is rapidly descending into a major recession.  The reason the yen is strong now is because a decade of being the borrowed side of the carry trade means that those who are exiting the carry trade must now purchase yen to square with their brokers.  The “strong” yen is not helping Japan, it is, in fact, increasing the devastation.  A strong yen means that prices of Toyotas, Sony TVs, and everything else Japan sells to the rest of the world are increasing in price just when they need to be falling.

Since the world wide recession began, the dollar has actually risen in value.  The flight to quality phenomenon is well known, and with economies crashing all over the globe, the greenback has regained its allure as a safe place to be, relative anywhere else.

The flight to quality effect is also seen in the price curve of U.S. Treasuries .  In the chart below, the iShares ETF, IEI, shows how the price of 3-7year Treasuries has risen since the global slowdown began.

Since its low in late June of 2008, this ETF, which holds only Treasury obligations, has risen about 7.5%.  Much of this rise was because of the repatriation of dollars that had flowed to emerging market equities and debt obligations during the boom period.  But, now that the currencies of almost all the emerging markets have tanked (30-50% declines in the last year), those monies have flowed back into U.S. dollars to be used to purchase Treasuries. 

The reserve role of the dollar continues to define its resiliency as a safe haven in a turbulent market.  The dollar is not imperiled.  It is prospering, and will probably continue doing so for a long time to come.

For many years the tradition for a new American President has been to make Canada his first international visit. This underscores the close relationship between the neighboring countries.

President Obama and Ottawa from the American side of the St. Lawrence River

We share a long, un-guarded border with Canada, and we also share a common British heritage that covers a wide swath of commonality in language, legal system, political tradition and general culture. We also trade together. We export more to Canada than any other country, and Canada sells 33% of its GDP to Americans. There is good reason Canada gets the first Presidential visit, and I am glad Mr. Obama has continued the tradition today when Air Force One touches down on Canadian soil. 

Ottawa’s Parliament Buildings

There will be much of the plate for Mr. Obama and Mr. Stephan Harper, Canada’s Prime Minister, to discuss. The traveling companions of Mr. Obama speak volumes about the agenda: Larry Summers, Mr. Obama’s economic coordinator, Ms Carol Browner, the energy and climate coordinator. U.S. National Security Adviser Jim Jones and Deputy Secretary of State James Steinberg.

With the economies of both nations in a terrible state, it is not a surprise that the economy and employment will probably be the highest order on their agenda. Part of this agenda also sloshes over into oil, which Canada has plenty of and more to develop if environmental problems with the mining and refining process of Canadian tar sands can be overcome.

Also, something Mr. Obama will have to overcome is the ”Buy America” provisions that Democrats inserted in the recently passed stimulus bill. This feature also has Europe, China and Japan worried. Taken with some of Mr. Obama’s strong anti-NAFTA campaign rhetoric, Mr. Harper will need some reassurance of America’s commitment to maintaining free trade between the two countries.

These issues have already been at least partially addressed by Mr. Obama in recent public statements and in his insistence with Democrats that the “Buy America” provisions in the stimulus bill be tempered to preclude violating existing treaties. This gets him off the hook in many ways, since trade with Canada and Mexico is subject to NAFTA provisions and World Trade Organization rules. Mr. Obama has also stated recently that it was not in the interest of either Canada or America to reduce trade between the two countries.

There will be some security issues to discuss. Canada has about 2,800 troops in Afghanistan, and it would be important to Mr. Obama that Canada commit to keeping a presence there during the American troop buildup.

Mr. Obama is popular in Canada, as Mr. Bush was not. I hope this will help him and Prime Minister Harper have a productive meeting and a warm relationship

A general view of the Group of Seven (G7) Finance Ministers and Central Bank Governors meeting in Rome, Saturday, Feb. 14, 2009.

The group shot above show the attendees of the meeting.  The photo below is a close up of U.S. Federal Reserve Chairman Ben Bernanke, left, U.S. Treasury Secretary Timothy Geithner, second from left, and U.S. Deputy Assistant Secretary of Treasury Mark Sobel who accompanied Mr. Geithner to the meeting.

In a joint statement, issued after the final meeting on Saturday, the members said: “The stabilization of the global economy and financial markets remains our highest priority.”

The group also endorsed Mr. Geithner’’s plan to recapitalize banks, leaving questions about nationalizing banks unanswered. Virtually all G7 members are facing a similar problem, as many of the largest banks in the world bought the toxic derivatives whose origins were in America’s largest banks.  As these assets’ true value is exposed, many banks all over the world will find themselves technically bankrupt.  No country can afford to have their largest and most influential banks go under, so they are searching for ways to put public capital in them in order to keep them solvent.  The question as to what the governments get for their money is still up in the air.  Many of the European and Asian countries have no qualms about nationalizing banks.  But this is no considered a desirable solution in America.

All of the G-7 members took a conciliatory view of China, praising the Asian giant for its strong stimulus plan.  They also muted their criticism of China for keeping the yuan relatively weak.  They are now happy if the Chinese monetary authorities keep the yuan appreciating slowly in “relative” terms.  This mean that with European currencies already depreciating relative to the dollar, China can allow the yuan to appreciate to falling currencies. This makes it much easier for China to comply and to keep their growth going.

This deference to China underscores how irrelevant the G-7 has become.   The economies that are expected to grow over this year (China, India, Brazil and South Korea) are all members of the G-20 rather than G-7:   The “old” powers of the G-7 desperately need the growth of China, Brazil and others to at least partially counter the fall in domestic demand they are currently experiencing.  America, of course, need China to continue buying its debt.  

The final verdict of the meeting is that it is a prelude to the G-20 meeting in London on April 2.  The G-20 not only includes among its members the best growing economies, it also includes heads of states as attendees rather than finance ministers.  This give it much more clout in its recommendations. 

The heaver lifting will be at the G-20 meeting.  Greater regulation of the world’s banks, expanding IMF funding and lending, and enhanced membership in the IMF for China and India will be on the table.  Also, all the committee leaders will have many additional issues to resolve.

For example, Australia’s Prime Minister, Kevin Rudd, co-chairing the G-20 working group on IMF reform, believes IMF member states will need to act quickly to reform the Fund’s governance.  This means, among other things, giving China greater membership clout and give Special Drawing Rights (SDR)to new members.  SDRs are an official international reserve asset issued by the IMF to its members, which can exchange them for freely useable currency.  Countries that joined the IMF after 1981 have never received an SDR allocation. SDRs can be used to support their own currency if it comes under attack from speculators.

There are many other issues that will be taken up at the G-20 meeting, and I will have a more detailed description of the agenda in the weeks ahead.  For an update on the agenda of the London G-20 meeting, follow http://seekingalpha.com/article/123178-prelude-to-april-s-g-20-meeting-showdown-at-the-london-corral 

the link above. (2/28/09)

All eyes should be on Rome today (Friday, Feb. 13) and tomorrow. The G7 meeting is taking place there, and the American representative, our Secretary of the Treasury, Timothy Geithner, will have his first chance to meet the finance ministers of Canada, France Germany, Italy, Japan, and the United Kingdom.(click here for an earlier review of Mr. Geithner)

The meeting is important because Mr. Geithner will be forced, to some degree, to put some meat on his proposal to salvage the American banking system. His proposal of a few days ago, as to how to spend the balance of the TARP funds, has not been greeted with any enthusiasm in America.

American banks are in horrid shape, especially our largest ones. Today, the market capitalization of our top banks is below $500 billion. Yet the International Monetary Fund estimates that the write-downs of their loan portfolios will rise to $2.2 trillion once a full accounting is required. When this happens, Mr. Geithner will be forced to step up to the task of rescuing them. But it is hard to imagine a scenario where the American taxpayer will pony up $2 trillion and not want a piece of the action. Yet “nationalization” of our banking system is not something he, or many others, want.

This state of affairs is understandable. America condones nationalization of the postal service, some parks, some forests and national monuments, but banks are a different matter. Our public sector has no experience running giant banks, and there is much resistance to trying it. Yet, we are going to be the capitalists of last resort to the giants that got us into this mess, so there will be a huge outcry to bite the bullet and take them over.

My own preference would be to nationalize them, and then set up an immediate procedure to denationalize them by breaking them up and selling them off in pieces. If they are too big to fail, as they are, then that are simply too big. We can get along without these behemoths. Local banks have served our economy well, and there is still room for large, internationally connected banks in our large trading cities. But we do not have to have banks as large and Bank of America and Citibank have become. At their current size, their mischief becomes a potential catastrophe for the entire world.

At any rate, Mr. Geithner will have his work cut out for himself as he faces his European and Pacific counterparts today and tomorrow. As Morris Goldstein, a policy analyst at the Peterson Institute for International Economics in Washington said: “There is a vacuum to be filled. The United States, as the largest global player, needs to lead the show.”

Most of the other ministers there will not have Mr. Geithner’s resistance to taking over their failed banks. The U.K. is well on its way there, now, and other will probably follow soon, as the shoes continue to fall in the banking crisis of the century.

The American economy lost almost 600,000 jobs last month and the unemployment rate rose to 7.6 percent, its highest level in more than 16 years, the Labor Department said Friday. Overall, the Labor Department reported that since the U.S. economy went into recession in December, 2007,

3.6 million jobs have been lost.  (For an update through February, see the charts below.)

Businesses in all sectors except health care are cutting back on their payrolls. It is a major retrenchment and is still getting worse. The chart above shows the change in employment levels by month. Considering that the U.S. needs, on average, about 1.5 million new jobs each month in order to keep up with labor force growth, the effects on the economy are worse than the bar chart shows. As jobs become harder to get, as they are now, this discourages many workers from even looking for work. These “discouraged workers,” as they are called, are then no longer counted in the labor force—thus understating the unemployment levels.

If the labor force participation rate was today what it was when George W. Bush took the oath of office, today’s unemployment rate would be over 9.5%.

The chart below, which tracks the unemployment rate, has been moving almost vertically since September of 2008. This is cause of great concern. This type of rapid retrenchment can lead to a spiral of self-fulfilling behavior that is exceptionally hard to stop. This is one of the reasons President Obama has spoken so forcibly on the need for speed in getting the economy righted and job creations begun.

The next chart shows the effects on unemployment among workers with various levels of education. High school dropouts are most severely affected, seeing their unemployment rising to 12%. As a worker’s educational level improves, the percentage unemployed drops. Note that those with at least a Bachelor’s degree suffered only a 4% rate of unemployment.

There isn’t much in expectations about a recovery until July, at the earliest, and even then, the recovery is expected to be slow.

This could make our current recession the longest since the 1930s, outlasting the two record-holders, the mid-1970s and early 1980s downturns. Each of these recessions lasted 16 months. The current recession, which started in December 2007, would reach that milestone in April.

Update on Unemployment: 3/6/09

The U.S. economy continued the trend of high job losses in February. The last six months have seen 3.3 million jobs disappear, sending unemployment to 8.1%, the highest level in 25 years. The surge in unemployment in February was caused by the loss of 651,000 jobs for that month, according to the U.S. Department of Labor. Last month represented a 59-year high for job losses in one month.

Jobs Lost Date:

The only good news in this set of data is that February lost no more (actually slightly less) than January, and less than December. However, this does not constitute a trend. It is too early to make that kind of call. March could go up, down or stay the same. We just don’t know where the bottom is.

Unemployment is a lagging indicator, so once the unemployment rate turns down, the economy will have already have begun improving.

Graph of Quarterly Change in GDP

See update to this chart for late February, below.

The graphic above shows the dramatic drop in annualized GDP quarterly growth for the fourth quarter of last year. Two other points  are well demonstrated in this data:

· The effects of the stimulus rebate last year is clearly seen in the spike in the second quarter of last year. The jump from less than 1% in the first quarter to about 3% in the second is probably attributed to the checks that were sent to taxpayers in the late first quarter. It was effective, but it was simply too small to overcome the momentum that had accumulated to the downside by that time.

· The drop in the 4^th Quarter is actually more dramatic than shown. The drop in consumer spending, which is behind the GDP drop, was so steep that producers could not adapt their production fast enough to counter the fall in sales. As a result, many of the products made during the quarter simply piled up as unsold inventories. But, the production was counted in GDP, so the slowdown in GDP was lessened by this artifact. The unsold inventories, now gathering dust all around the country, is the main reason we see huge layoffs  being announced in January—pointing to an even worse drop if quarterly GDP figures for the first quarter of this year.

There is no mystery about the dramatic slowing of consumer spending. For years prior to 2008, consumer spending had been artificially propped up by home loans. Home prices were going up so fast that home owners could refinance their new-found wealth one or twice a year and spend the proceeds on home improvements, new cars and large television sets. When the housing bubble burst, the prop was pulled from consumer spending, and it fell like a stone.

I expect unemployment to continue going up as millions of workers are being given pink slips every day so far in 2009. Manufacturers have to trim their production not only to make up for the over-production of late 2008, but they must also slow production lines for the lower sales levels anticipated in the future. This spiraling effect is well understood in business and economics. It’s hard to stop, once it gets going, and it is going now with full steam.

The scary part of this scenario is that this exact same process is being repeated in Europe, Asia, Latin America and Africa. No region is immune; no country can escape its effects. The good news is that virtually all the world’s economies are generating counter-cyclical spending plans to help pull out of the nosedive we are in. Simultaneous stimulus spending will help the world’s economies recover faster than otherwise, since there can be no beggar-thy-neighbor polices when everyone is going through the same thing.

Also, keep in mind that unemployment is a lagging indicator of future production. By the time unemployment stops falling, the recovery is likely to already be underway.

UPDATE on 4thQ, 2008 GDP (2/28/09)

The Commerce Department has just revised the 4thQ GDP estimates, and the news is not good.  The top chart shows a 3.8% annualized decline.  The revised figures, show in the chart below, are much worse:

It turns out that a better estimate of the fall was 6.2%, not 3.8%.  Every major component of the economy shrank, except government spending. Economists said all signs point to a similar drop in output in the current quarter.

The revision could be traced primarily to a contraction in inventories of unsold goods, which the government had previously said had grown.  Businesses were able to trim their inventories faster than first estimated.  The good news is that the pile of unsold goods is not as large as first estimated.

But, traditionally inventories in a recessions fall much faster than they have so far.  This suggests that the worst is yet to come as far a cutbacks in production.

The final adjustment will be made next month by the Bureau of Economic Analysis.

The Bureau of Labor Statistics provided the data for the chart below.

In a sea of bad news, the water just got a little deeper, as every state in the United States reported a month over month and year over year rise in their rate of unemployment.

It is not surprising that the agricultural states in the center of the country have the lowest levels of unemployment, since so much of farm labor is supplied by the families that own the farm.  The industrial states are suffering the most, as they are most dependent on factory employment.  But, even the service industries are hurting, as California, Florida and Nevada, three states that have large service industry composition, all show unemployment of 10% or higher.

A report from the Associated Press today discloses that nine out of ten banks that got bailout funds have kept their senior management in place.  In other words: “The same executives who were at the controls as the banking system nearly collapsed are the ones the government is counting on to help save it.”

The regular employees of these banks have not been so lucky.  The same report details how there have been about 100,000 job cuts in the banking industry since the failures began.  Unfortunately, the job cuts are coming from the ranks, not from the top. 

The taxpayers, too, are not getting a fair deal for the billions they are handing over to the failed banks.  We will have no say or right to questions decisions by the same executives who misguided their corporations to bankruptcy.

In another report, the high-flying execs at Citibank caved under pressure from President Obama and decided today to abandon plans for a luxurious new $50 million corporate jet from France.  The decision came 24 hours after the banking giant, which was rescued by a $45 billion taxpayer bailout, defended buying the state-of-the-art Dassault Falcon 7-X U.S. skies — as a smart business deal.

These kinds of stories are making it impossible to generate any public support for the bailout plans.  With staggering sums being offered and no public control over their behavior, how can anyone support them.

I hope the Obama Administration will see what is wrong with this picture and make some major changes in the way the handle the second half of the funding that is working it way through Congress now.  It is much more likely, now, that there would be some support for nationalizing the failed banks, at least for a few years, and have them operated by the Federal Government until they could be broken up and sold in smaller pieces.

From the looks of the chart below, don’t talk of decoupling in Taiwan. In a country where almost 50% of GDP comes from exports, the world wide recession is having a devastating effect. With exports down 40% from last year, Taiwan is suffering a 20% drop in GDP if last month’s losses are annualized.

Compare this with an expected GDP drop in Germany or America of from 1-2% and you see how the losses in their major markets translate in a multiplier effect of around 10 times in Taiwan. They are not decoupled with America and Western Europe. They depend on demand from these regions to fuel their internal employment and growth.

On Thursday, January 22, Japan said exports fell 35 percent in December from a year earlier as the crisis hurt its main markets. Japan is being hit by a triple whammy: its economy is slowing for internal reasons, its exports are slowing because of the recessions in its major export markets of America and Europe, and the yen is rising, making the first two problems even worse.  Sony Corporation lost almost $2 Billion last year–its first loss in 14 years, much of which is attributable to the rising yen and the global recession that adversely affects its high value products.

The rise in the yen is a payback of a decade of being the borrowed currency in the carry trade.  Now that interest rates all over the world are dropping, all those who borrowed yen to invest in higher interest rate currencies are being forced to buy back the yens they borrowed.

UPDATE on Japan

On February 15th Japan announced that its real GDP  shrank at an annual rate of 12.7 percent from October to December after contracting for two previous quarters. When compared with the third quarter of 2008, Japan’s economy receded 3.3 percent.  This was the worst drop since the first three months of 1974.

“There’s no question that this is the worst recession in the postwar period,” Japan’s economic minister, Kaoru Yosano, said after the results were released.

The dismal figures also place Japan firmly among the worst-hit in the global crisis, dwarfing economic declines in the United States and Europe.  The United States GDP declined at a 3.8 percent annual rate in the fourth quarter and 1 percent when compared with the previous quarter.

This will probably thaw out the fiscal freeze that has gripped the Japanese legislative process for the past months. Prime Minister Taro Aso has promised spending worth almost 50 trillion yen ($545 billion) in two packages. But political bickering in Parliament has slowed progress.

In South Korea, industrial production is dropping at the fastest pace since record keeping began in 1975.  Only Vietnam and Bangladesh are holding up, mostly because they produce low value-added goods that are increasing in demand, such as cheap clothing.

In China, economic growth slowed sharply during the last quarter of 2008, to 6.8 percent, and to 9 percent for all of 2008, down from 13 percent growth in 2007, the Chinese National Bureau of Statistics reported. And the South Korean economy shrank 3.4 percent during October to December compared with a year earlier.

Keep in mind that the data from China is of an unknown quality. The Chinese government is the sole keeper of production, employment and monetary data, so I am always a little skeptical of the accuracy of what they publish. Compared with America and Europe, China is more closed to the inner operations of the bureaucracy that husbands their national data.

Indonesia is the least susceptible of those shown to a slowdown in the west. It has the world’s fourth largest population and can depend more on internal aggregate demand than almost any other economy in Asia. Taiwan and South Korea are the most dependent on exports to sustain their local economies.

The graphic below, supplied by the New York Times, provides a strong image of how the global recession is affecting countries around the world. For December of ’08, the three largest exporters in the world , China ($105.7 billion), the U.S. ($98.1 billion), and Germany ($96.1 billion) all showed losses from December of ’07. China slowed 3% in December and 2% in November. The U.S. slowed 4% from a year year, and Germany dropped 21%.

Taiwan, which exports high-value-added merchandise (computers and expensive electronics) suffered the most with a 42% loss. This is particularly devastating to Taiwan since exports as a percentage of their GDP are close to 50%. The math of this relationship shows a 20% annualized decline in GDP for the month of December.

South Korea lost 17%, again, like Taiwan, a nation heavily dependent on exports. Political unrest in both these countries may surface if it doesn’t get better, soon. One can also see from these pictures why the stock markets in these countries have crashed, along with their currencies.

The most troubling news, though, is that mot economists look for things to get worse before they get better.