Jack’s economic outlook
Posted by Jack Haddad on January 11, 2008 at 2:35 pm
I thought you might be interested in my perspective on the current economic outlook–for what it’s worth.
As you may recall, I have not been as pessimistic as others on the economy. (I still think we are unlikely to “recess.”) But for the purpose of forecasting the markets, this is not so important. Growth has certainly slowed and, especially given the fact that we are in the most sensitive phase of the four-year national political cycle, this is enough to get policy makers going in the direction of re-stimulating the economy. So stimulus is coming.
The question is “In what form?” As an article in today’s NYT suggests (see http://www.nytimes.com/2008/01/06/opinion/06sun1.html?ex=1200286800&en=fff3109ad939e2a8&ei=5070&emc=eta1), it is unlikely to be fiscal stimulus. We’re already over-stimulated in this area, and weaker economic growth mainly will keep a check on how much democrats and conservative republicans try to curb fiscal stimulus in an effort to balance the budget. So this leaves only interest rate reductions by the Fed. And the Bernancke Fed has already shown it will act promptly and rise to the task of heading off weaker economic growth without worrying so much about inflation.
As I expected, rising inflation has now begun to show its ugly head again. I previously expected that political pressures would keep the Fed from raising rates as inflation rises this year. I did not think the Fed would be lowing rates further in the face of rising inflation, but, unfortunately, that looks likely now. So more rate cuts are coming.
As the Fed sells out to political and market pressure, the rest of the world will conclude (correctly) that we have lost our monetary discipline and the dollar will tank (much, much) further. Here we go into a déjà vu replay of the late 1970s. (And, the more likely it becomes that Obama, who is Carteresque in experience and wedded to amorphous feel-good policies, will be our next president, the more deja vu it will feel.) Buy euros, yen, and any other foreign assets that are solid. If you must go domestic, look for companies with a heavy amount of foreign earnings or foreign assets, or have good export prospects, or have assets that foreigners will want to buy.
The most important thing to recognize in all this is that we are still in the early phase of a massive secular decline of the world’s premier, reserve currency. This will not be just another repeat of the 1970s. Since then, the euro has emerged as a major factor and success story and there is China, with its huge trade surplus and holdings of dollars. By the end of the process we are fully into now, we will have seen the most radical change in our international financial structure since WWII, with the dollar completely unseated as the world’s dominant reserve asset.
No one can foresee what will replace what we have now. However, it’s not hard to speculate that the new system will include a super-powered IMF (SPIMF), acting effectively as a global central bank with a truly international reserve currency (call it the earth dollar) indexed to a basket of currencies. The US may decline to participate, but that won’t matter. Other countries’ central banks will be able to exchange the reserve balances of US dollars they have now for SPIMF earth-dollar balances; and they will be able to acquire additional earth-dollar reserves by creating and exchanging non-interest-bearing balances of their own currencies for them—at exchange rates established by the SPIMF. The SPIMF will pay no interest on the earth-dollar deposits or earth-dollar paper currency it issues. In addition to acquiring deposits of non-interest-bearing reserves of US dollars (held with the Fed) and other currencies (held with other respective central banks), the SPIMF will be able to purchase interest-bearing government bonds denominated in different currencies with additional issues of earth-dollar balances. The interest earnings on such holdings will fund the expenses of the SPIMF.
With its value linked to all the major currencies, the earth dollar will become a convenient pricing unit for oil and other internationally traded commodities. One can also imagine the development in time of earth-dollar private banks, licensed by the SPIMF to issue deposits and make loans denominated in earth dollars. The reserves of these banks will be deposits held at the SPIMF and an overnight market in such reserves will develop with an interest rate comparable to the fed funds rate. The SPIMF then will be able to influence the global cost of money through manipulations of the SPIMF funds rate.
Getting back to the world of today and given the prior discussion about the economy and likely Fed policy, where are the currency, commodity, and equities markets headed near-term? Through we may have broken through the bottom of the range since last summer, I still think we are in a trader’s market for equities where you buy the dips and sell rallies. The equities market will view likely easing moves by the Fed favorably, even if it means a weaker dollar. So buy equities during the current dip and then look to sell after the Fed provides comfort via statements and rate cuts. The market will sell off again after future economic data confirm a stronger inflation threat than the market and the Fed are hoping.
As for currencies, buy any dips and hold for long-term gains of huge proportions. The same strategy applies to internationally traded commodities, such as oil, gold, and grains.
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I agree that economic growth is slowing - the bull market we have enjoyed since ‘03 is getting pretty long in the tooth. As a result, we may see the dreaded “R” word rear its head soon.
I think consumer credit will emerge as a problem in the US in the wake of the subprime lending fiasco. ARMs continue to reset and families will realize they can’t borrow against home equity. With personal consumption accounting for around 70% of GDP, this increases our chances of recession.
I’m curious - what opportunities do you see overseas? What about Japan? Also, are opportunities in the yen carry trade a thing of the past?
Very insightful Jack, great read! Question: with China having such a large foothold in US currency, how are they going to bail themselves out so to speak with it continuously declining? Even with the SPIMF, which is by no means something that is going to happen in the immediate future, wouldn’t it be bad news central for them? I’m not an expert economist, so pardon me if I’m asking the obvious.
[…] Read Jack’s Economic Outlook […]
Jack,
You’re kind of creeping me out with the concept of the “earth dollar”. Sounds like one world government could be a reality in a hundred years or so.
Should be interesting to see the dollar tank. I personally don’t see a way to right the ship.
I agree with the economic outlook (dollar falling flat on its head) completely and have been writing about it for a long time.
I believe they want the USD to severely fall at which time they will try and get a North American currency. I also agree about the basket of currencies replacing the USD for world currency status.
I think it is a shame too. Fiat currencies always fail. Creating a new fiat currency will also eventually fail. We should be practicing the Austrian school of economics and not be interferring!
As long as fiat currencies are around, we will experience so much manipulation that things only get worse. Lowering the interest rates to entice consumers to take on MORE debt so they can avoid a recession is stupid as it delays and intensifies the situation so its worse in the future. Everyone already bought homes in the last several years ’cause the Fed lowered interest rates. None of those MILLIONS of people are going to buy another home, so obviously there will be less spending and the economy will struggle. Lowering interest rates won’t do much except waeking the dollar. To top it off, the lower interest rates will cause the dollar to fall further and all commodities and imported goods will cost Americans more money. The Fed is either stupid or doing this on purpose…
Evaluating stocks.com,
As to overseas opportunities, I see expansion secondary to middle-class growth only! India, for example, is now selling a 4-door car for 2,500 US dollars. Sources told me that a waiting list of 3-months is now in place.
Brandon,
China has from time to time threaten to cash on our 1.3 trillion bonds, however, nothing came of it.
Yea that would be game over…
Since we are talking about currencies, Jack, do you do any FOREX trading? I’ve always read that it’s the only “pure marketplace” however how can you try and quantify unforeseen future events…
[…] Read Jack’s Economic Outlook […]