April 10, 2008
Shipping Container Shortage in the United States -- What Gives?
Just a few years ago, container ships returned to China with much of their capacity unfilled. This situation has apparently changed.
Does a shortage of containers used to export product from the US imply a notable change in the balance of trade, as this article posits? or, is it simply that, as the article states:
Many shipping lines, including Maersk, have shifted container capacity away from the U.S., just when U.S. producers need them most.
I'm not sure I understand exactly what's happening. Are we genuinely seeing a reduction in total imports, in the rate of growth in imports or some other phenomenon? Posted by Richard at 1:55 PM | Comments (0)
December 19, 2007
Treasury Secretary Paulson: China is Not a Currency Manipulator
Riddle me this, Caped Crusader:
What American official puts pressure on the yuan by not putting pressure on the yuan? This just in:
"What we've said before in the report ... is if we were to designate China as a manipulator, the remedy would be to negotiate with China directly and through multilateral bodies including the IMF, which is exactly what we've been doing for some time," Paulson said. "We've been making the case as strongly as we know how."
In other words, the U.S. Treasury Secretary will not officially label China as a currency manipulator, but will continue to act as if it had. One supposes that this is how the old China hands in the US administration believe it has to be done -- avoid public shaming, put forth rosy statements, fight the good fight in private. And yet, where are the results? Can any be expected, except marginally, when change would directly harm China's interest?
Posted by Richard at 9:09 PM | Comments (0)October 4, 2007
U.S. Republicans Reject Free Trade -- China Takes a Hit
Over the last few years, the American ardor for China has cooled. Even I need a sweater. In speaking with Americans, the topic often turns to China. My partner in conversation, whoever it may be -- home improvement contractor, local attorney, bank teller, teacher -- is now, as a rule, adamant that China is not a friend. Of course, that person may delight in friendships with individual Chinese, but to many Americans, China has become more than just an adversary. And I believe I am right in saying that Chinese are similarly disposed towards the U.S. A dreadful state of affairs.
China has become a focal lens for the distress, anger and helplessness that Americans can no longer tolerate directing inwardly. No longer do we read encomia touting the virtues of ancient Chinese philosophies practiced in modern life, the beneficially high rate of savings and lack of debt, the care and respect towards the elderly, the veneration of education, the tolerance for long hours and hard work.
Instead, we read only that Chinese are rapacious money-makers who intentionally employ toxic materials to improve profit, dirty spitting pedestrians who copiously litter with no sense of public morality, brutal authoritarians who control the freedom of speech, association and worship that Americans believe God gave Man, and the like.
Now, mind you, there is truth in both viewpoints. But, over the past few years, Americans have focused on the latter, seemingly in forbearance of all knowledge of the former. There should at least be balance.
Historically, Americans have always expected that the next generation would enjoy an improvement in the quality of life -- until my generation, who expect its decline. The American senses narrowing opportunity amid heightened competition. What can one truly eat from the communal pie that always seems to shrink?
The hackneyed phrase is "the American dream." It originally referred to the desire of lifelong tenants to own their own home. It now seems to be used to describe a paradigmatically American ideal of plenty, a cornucopia of whatever the individual would wish for himself. But for the American individual today, there is no boom, only the residual smoke of a bust. And someone must be held to blame. Why not China? They're enjoying -- so goes the thought -- an incredible run, and entirely at our expense.
Even long held American commercial tenets may go the way of the perpetual Republican vow to cut taxes. According to this WSJ poll, even the Republicans are beginning to sluff off the centuries old hallmark of "free trade."
By a nearly two-to-one margin, Republican voters believe free trade is bad for the U.S. economy, a shift in opinion that mirrors Democratic views and suggests trade deals could face high hurdles under a new president.
Incredibly, China obliquely takes its licks in this article devoted to American politics:
We're seeing a lot of jobs farmed out," said Mr. Pirtle, whose father works for General Motors Corp. Rankled by reports of safety problems with Chinese imports, he added, "The stuff we are getting, looking at all the recalls, to be quite honest, it's junk.
Mr. Pirtle's comment is sadly typical in American society today. If it's junk, why are we're buying it? If it's of poor quality, why have we eagerly exported the work to cultures where standards are different? If it's unsafe, why have we authorized a branch of the federal government, proven time and again to be incompetent or incapable in so many aspects of life, to perform tasks it can't even begin to complete?
The decisions Americans have made, as a people, over the past generation are more the cause of our predicament than anything manufacturers across the globe could have possibly done. We will have rid ourselves of what we value most before it is over. But, for the instant moment, we deny ourselves the serious critical look at our own ideas and actions, which require far greater correction than we demand of our neighbors.
Posted by Richard at 1:10 PM | Comments (0)June 9, 2007
China Rejects U.S. Food Imports!
More of the old back and forth.
Only a piddling amount of money is involved -- as yet -- if any. It appears to be a simple statement without any details of the offending shipments. Did it really occur, i.e., is it an agressive tactic or only a mouthful of threat?
But that's not the most important question. Instead: who'll cave when the stakes are truly high? Will the Americans even last that long?
UPDATE (June 28, 2007)
From the New York Times:
The Food and Drug Administration today issued an alert challenging imports of five major types of farm-raised seafood from China, including shrimp and catfish, because testing found recurrent contamination from carcinogens and antibiotics.
The alert means that the fish will be allowed for sale in the United States only if testing proves that it is free of certain antibiotics and carcinogens
UPDATE (June 29, 2007):
American consumer reaction to Chinese food imports has been overwhelmingly negative. See for example this page.
Posted by Richard at 4:29 PM | Comments (0)May 22, 2007
US Treasury Secretary Critical of the Home Crowd, the new Trade Winds and more...
WSJ's article on Treasury Secretary Hank Paulson notes his frustration, not in dealing with Chinese officials, but with Americans. With respect to Social Security:
Mr. Paulson says it's "frustrating to be in an environment where well-meaning people on both sides of the aisle see there's a problem" but don't have the political will to act. "I've been asking people to come to the table, saying all options are on the table, and I'm getting a little tired of playing solitaire."
As to China, he appears to think that patience will, over time, result in the gains he is looking to achieve.
Under pressure to take a tougher stance, the administration has unilaterally imposed sanctions on China for alleged improper pricing of exports, and in a World Trade Organization complaint, has accused China of lax enforcement of copyright violations. Mr. Paulson didn't oppose the moves, although he knew it would be an obstacle to discussions, Treasury officials say. The Chinese reacted angrily, and Mr. Paulson spent about four hours on the phone with Ms. Wu to smooth over tensions, people familiar with the conversation say.
A quote verbatim would have been more revealing than this paraphrase. Did Mr. Paulson really say that the WTO IP complaint was an obstacle to his discussions with China? Isn't it, instead, a valuable tool of negotiation with China? The article thus leaves the reader wondering about his priorities and methods.
UPDATE (May 24, 2007): Chinese authorities have proven as incapable of restraining its prolific counterfeiting as American federal departments were of providing humanitarian assistance during hurricane Katrina.
On Tuesday, Ms. Wu said that efforts by some to “politicize” the Chinese-American relationship were “absolutely unacceptable.” This was taken as a reference to the American challenges to Chinese subsidies of exports and piracy of DVDs.
IP is precisely the kind of issue that the U.S. can not let go of. US representatives in China have been banging away on IP -- with words alone -- for at least 4 years, but it is chopping a redwood with an invisible axe.
The hot air -- the new Trade Winds? -- that has blown forth and back between these two Great Nations has accomplished scant little over these many years.
Action -- even if it is only symbolic -- will speak far louder. [Symbolic acts are typical of Chinese political tradition, e.g. to disarm an enemy by executing the leaders of the group and not the entire group itself.]
Susan C. Schwab, the United States trade representative, speaking at the conclusion of the talks Wednesday, made it clear that her own session with Chinese leaders had done little to narrow differences on these issues. “Suffice it to say we had a healthy exchange of views,” she said.
Meaning that the banquet was terrific.
But this quote gives us serious gastric distress:
Mr. Paulson said he was impatient for more concrete results himself and hoped there would be further progress before the third session of the dialogue, in Beijing in December.
“I have no doubt that we’re getting more results than we would have without this dialogue,” he said.Everyone expects results. And therein lies the problem. Posted by Richard at 2:03 PM | Comments (0)
May 18, 2007
US Treasury Dept. Efforts Move Exchange Rate by 67%! Melamine in the Pet Food, Trade Talks and More
All the news that fits, we print:
"The People’s Bank of China said in a statement posted on its Web site that it would allow the currency, known as the yuan or renminbi, to rise or fall up to 0.5 percent in each day’s trading. The current daily limit is 0.3 percent."
WOW!
***
UPDATE (May 19, 2007): Here we go again!
"There was hope that broader cooperation was on the way, but a lot has changed in a few months. On the American side, with Democrats in control of Congress and a presidential campaign gearing up, there's a growing impatience with the pace of economic reform in China and a slew of anti-Chinese trade bills pending."
Does Miss Cha mean that under the Republicans progress could have been made?
"In recent months, official rhetoric on U.S.-China trade has grown increasingly hostile."
Rhetoric is an empty tide that ebbs and flows between China and the U.S. For all the hot air, the Americans have been entirely unwilling or incapable of acting. As I have written for years, empty American threats prove worthless in the face of Chinese political administrators who are just as canny and talented (or stupid incompetent, as the case may be). The money continues to roll in. How can the Chinese be expected to step in and stop it?
Now, however, ammunition has passed up to the front lines. The melamine-in-the-pet-food scandal (see my post and podcast) has already galvanized the American consumer to avoid Chinese food products, and the FDA's response appears to be earnest. Will an American negotiator in a position of substantial authority make the link between the food impurities case and the trade war at large?
UPDATE (May 20, 2007): This morning's Washington Post picks up on this thread. The strong language of this front-page piece made me stutter for a second - I thought it was an editorial!
For years, U.S. inspection records show, China has flooded the United States with foods unfit for human consumption. And for years, FDA inspectors have simply returned to Chinese importers the small portion of those products they caught -- many of which turned up at U.S. borders again, making a second or third attempt at entry.
Now the confluence of two events -- the highly publicized contamination of U.S. chicken, pork and fish with tainted Chinese pet food ingredients and this week's resumption of high-level economic and trade talks with China -- has activists and members of Congress demanding that the United States tell China it is fed up.
Chinese food imports are a serious public health concern. Some have begun to see the extraordinary value of the pet food scandal in the context of trade negotiations. Let us hope the American negotiators are hammering away at it with the clobberingest mallet they can find.
UPDATE (May 21, 2007): Bloomberg:
``Paulson, as somebody who understood China, was trying to reach a conciliatory approach,'' says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. ``The question is, has the political pressure taken away his freedom to move?''
With respect to Mr. Stiglitz, that is not the question. Rather, it is the validity of conciliation in negotiation. Conciliation is ineffective with Chinese, unless paired with its subtle black sheep twin brother, Threat.
And neither can be made of straw -- they will both go up in flame. As we've written in the past, one hand must caress while the other is held ready to strike.
Posted by Richard at 8:13 PM | Comments (3)February 2, 2007
U.S. Treasury China Personnel Change: Adams Leaves Office
Tim Adams has left Treasury. Is Mr. Paulson about to announce a shift in Treasury's China policy?
Posted by Richard at 1:46 PM | Comments (0)December 20, 2006
Audio: Renminbi Redux - Have They Begun to Circle the Wagons
More renminbi revaluation silliness from Washington... Click the little triangle to listen to today's post.
Renminbi Redux: Have They Begun to Circle the Wagons?
UPDATE to this post: More silliness from Washington. [One is sorely tempted to employ the perjorative "stupidity," given the continued emphasis upon ineffective strategies.] The Chinese government will give scant attention to strident but empty-fisted pronouncements.
Token offers of appeasement, like the single digit percent movement of the value of the RMB, effected over years -- we have heard similar promises about revaluation since the early 1990s -- should be taken as mere off-putting tactics which many in the American business community have come to understand for what they really are.
Why should China move when there is little genuine pressure upon their position? American investment money flows into China like the proverbial honey. Americans purchase ever increasing quantities of China-made products, even as their own manufacturing base has suffered terribly.
Change in yuan policy will come only when export revenue diminishes and inbound investment falls. Chinese understand that American pols are, frankly, impotent -- none will attempt to curtail U.S. domestic consumption of Chinese product or the massive capital outflows from the U.S. into China that do more to strengthen the Chinese position than anything the Chinese could do themselves.
Posted by Richard at 1:19 PM | Comments (0)November 23, 2006
US Officials To Embark on Magical Mystery Tour
American cabinet officials will travel to China to "press for changes in Chinese economic policies long criticized by the administration and Congress, officials said Wednesday."
At long last, another Magical Mystery Tour. The mystery is that they should believe in the power of their magic at all. Chinese can be awfully stubborn when asked to take actions they see running contrary to their interests. (Was that too subtle?)
You may remember that the film was panned with gusto. We await the film of this trip with bated breath.
Posted by Richard at 12:04 PM | Comments (0)July 10, 2005
Audio: Chinese Oil Rigs and Crews in Colorado
Click the little triangle to hear today's post.
Chinese Oil Rigs and Crews in Colorado
Shades of the Golden Horde? The hysteria continues into the 21st century:
"'Over the next couple of years, 10 Chinese [oil] rigs - and crews to operate at least half of those rigs - will be imported from China to the Rocky Mountain region of the U.S.,' said Bill Croyle, a partner in Western Energy Advisors."
In response, "Rep. John Salazar, D-Colo., whose district includes some of...[Colorado's]...largest gas fields, is not happy about the trend.
'I am totally against the Chinese government running the jobs in our country,' Salazar said. 'With the Chinese government getting involved, it's not even a competitive business model. Outsourcing has already claimed millions of jobs. We cannot allow that to happen within our own borders.'"
The Pipefitters Union naturally offered to protect its turf and its membership. But is reported to have stated, incredibly, that "importing Chinese crews could raise issues much like the controversy raised in the 1800s when Chinese laborers were used to build most of the West's railroads."
After all, in the 19th century, violence against Chinese the western U.S. was commonplace. "Attacks began in the 1850s against Chinese gold miners and continued throughout the century. In 1871, for example, a white mob descended on Los Angeles's Chinatown. Fighting erupted and when it was over, 15 Chinese were found hanged. Six years later, arsonists attempted to burn down the entire Chinatown in Chico, California."
I have a good deal of trouble deciding whether this union utterance, if accurate, is simply a bald-faced assertion of labor unrest or a veiled threat at something even less enlightened.
UPDATE, July 11, 2005: The Washington Times carries the story.
Posted by Richard at 6:28 PM | Comments (0)June 16, 2005
Guest Column: Sam Park on the Fed
[Editor's Note: For today's guest column, we welcome back Sam Park with the New York investment and business development advisory service of R. W. Wentworth & Co. Sam's post of March 9, 2005, "Dealing with Greenspan's Conundrum," may be found here. Many thanks as well to Mr. Alan Rude, President of R. W. Wentworth, as well as his staff, for permission to post.]
Can't Blame the Fed for Everything
The Fed's Duties
Contrary to the belief of many bullish investors, the Fed has not increased rates simply to put an end to the party. Greenspan has been marked as the villain because he¹s an easy target to blame for the flattening yield curve. It is true that the Federal Open Market Committee's decision to push short-term rates higher contributed to the flattening curve. However, it is highly doubtful that the Fed ever intentionally tries to put an end to a good thing. If anything, one key word is probably in the forefront of the FOMC's thinking minds, and that word is stability.
According to Jack Guynn, President of Federal Reserve Bank of Atlanta, the Fed must strategically "act before the appearance of widespread price increases to keep inflation and inflation expectations firmly in check." The objective, which eludes laymen, is to make preemptive moves before excessive inflation is present. If high inflation appears in core inflation benchmarks, then the Fed has not moved aggressively enough. By then it would be too late, and the Committee would be forced to take a tighter stance and make steeper hikes.
However, the Fed does not always make all the right moves. The Committee has in the past pushed rates too high, which have triggered a slowdown or even a recession. Monetary policy is not an exact science; indeed it is more like chess match with the outcome in doubt. While the Fed carefully and diligently observes relevant data, and develops a strategy that they feel is best, the outcome is not always what is desired. The following topics are some matters that the Fed and Wall Street are taking into consideration before they make their moves.
Situation with Oil
How much oil is needed to make the world turn? Apparently the world needs 84.3 million barrels per day (mb/d) to run its activities. Of that amount, the United States consumes 20.7 mb/d, or approximately 25% of total world supply. U.S. imports almost 60% of its crude oil mostly from Canada (1.6 mb/d), Mexico (1.6mb/d), Saudi Arabia (1.5 mb/d), Venezuela (1.4 mb/d), and Nigeria (1.1 mb/d).
Since U.S. imports a majority of its oil consumption, it depends on stable foreign relations with suppliers. However, OPEC does not seem to have much direct impact on U.S. consumption, since our top two oil providers in 2004 were Canada and Mexico. Then again, OPEC supplies about 40% of world's total consumption. Therefore, OPEC directly impacts the U.S. through its ability to affect world oil prices.
Moving prices by adjusting production levels only explain part of the story. Demand also drives market prices of oil as with any other commodity. Much of the demand for oil has lately been attributed to China and India; both of which have been experiencing strong growth over the recent years. In the short-run, OPEC's production levels and growth in China and India will contribute to oil price increases.
Some reports show concerns that there may be a decline in worldwide oil reserves. London-based Oil Depletion Analysis Centre (ODAC) foresees oil production to peak at 85 mb/d by 2008, when oil extraction is expected to reach its highest point and then start to decline. International Energy Agency (IEA), on the other hand, does not expect "peak oil" until sometime between 2013 and 2037. These outlooks may have helped push recent oil prices to reach record levels. Nevertheless, economics 101 tells us that shifts towards substitutes will occur before a certain resource (i.e. oil) runs out. Greenspan believes that "in the decades ahead, natural gas and oil will compete in the United States with coal, nuclear power, and renewable sources of energy."
A Reluctant China
Some U.S. policymakers have expressed their disapproval of China's currently erroneous policies involving trade and exchange rate manipulation. Bush's administration continues to push China to revalue the Yuan. Bush continues campaigning that he will save U.S. jobs by trying to keep Chinese import prices at reasonable levels, so that U.S. domestic producers can stay competitive. The artificially weak Yuan also makes prices of U.S. exports expensive relative to competing Chinese products. U.S. exports to China have suffered from this currency imbalance.
The Bush Administration's principled intentions are respectable and reasonable, but its "persecuting" methods may be doing more harm than good. One thing we would want to avoid is a trade war with China. U.S. has recently imposed quotas, limiting Chinese imports to 7.5 percent a year. This quota particularly affects Chinese textile product prices in the U.S. While this quota may protect domestic textile producers, it hurts U.S. clothing producers and does not help consumers that buy clothes or the overall inflation situation.
Because of the trade and payments imbalance with China (and also Japan), these countries have accumulated enormous dollar assets, which they have invested for the most part in the U.S. Treasury bond market. At some point, these foreign holders, due either to geo-political situations or a realization they have excess dollar holdings, may start selling their long-term Treasuries causing a sharp increase yields.
Solid US Economy
Overall, the U.S. economy appears solid as the labor market has been improving and as investment spending is expected to climb. The Bureau of Economic Analysis revised recent GDP figures, saying that the inflation-adjusted GDP grew at a relatively stable and healthy rate of 3.5 percent during the first quarter of 2005. This growth, however, comes at a gradually decelerating rate since the second half of 2004. On the other hand, corporate profit continued to rise and reached 13.8 percent during the first quarter.
The unemployment rate has been steadily declining since its recent peak in mid-2003. At the same time, the employment cost index shows that wages and salaries have been falling since 2000. The rising employment signals that the economy is improving; however, falling wages has been supplementing these added jobs to the economy. While the employment picture indicates that more wealth is steadily being added to the economy, the declining salaries counters the aggregate wealth effect from the additional jobs.
Housing Situation
The falling income trend is apparent throughout the various income measures. Some may argue that falling wage inflation should ease inflationary worries. However, employers may be the only ones to benefit from falling wages.
Despite the falling wages, residential investments remain very strong, growing 6.7 percent on a year-over-year basis during the first quarter in 2005. The sizzling housing market has been fueled by the low mortgage rates. Homeownership rate is estimated to have reached nearly 70 percent nationwide.
Housing is seen as a local business, and Greenspan has noted some "hot" markets. In FOMC's May minutes, there have been remarks of "speculative excesses" in certain areas. The areas cited are California, Florida and parts of the Northeast, hardly isolated instances in that these contain at least one-third of the U.S. population. Speculation poses a threat because speculators create artificially inflated prices. These property flippers generate synthetic demand for the property and pass this gain to the next purchaser.
Certainly high housing prices are not a big problem if homebuyers are buying for permanent living arrangements. It is a big problem when speculators cannot sell their assets and are left with falling housing prices and excess housing inventory. Credit lenders must carefully consider to whom they lend, and real estate agents should not relax purchasing requirements despite the increased competition among brokers.
The increasing number of real estate brokers is of concern because they will vigorously compete for sales, pushing up prices. If speculators are allowed to continue their practices, these artificial prices will continue to balloon. The problem will arise when rising mortgage interest rates slow demand, and the excess supply will initiate the downward cycle of home prices.
Are Hedge funds in Trouble?
We would hate to see another LTCM and its aftermath brewing in the current markets. There have been reports and rumors that a number of prominent hedge funds are currently experiencing troubles. Their unregulated practices make it difficult to diagnose the funds¹ potential problems. LTCM¹s past predicament should have taught us to realize that a good game will be mimicked and arbitrage opportunities will diminish quickly. Maybe we have yet to fully grasp and measure all risks.
More Hikes Up Ahead
As shown, several factors continue to contribute to the potential imbalance in the U.S. economy. Oil prices remain relatively high, and the Fed acknowledges that the high energy is negatively affecting household and business confidence. The negative trade situation with China is another issue and poses a threat to both price stability and interest rate stability. Also potential problems with hedge funds and housing situations could cause shocks to the economy. Despite the potentially dangerous conditions, Greenspan expressed that the U.S. has exhibited the ability to handle negative shocks.
Nonetheless, the Fed will continue to feed us what it sees as our necessary medicine by gradually raising rates by 25 basis points at a time. Fed fund futures shows that the FOMC will almost definitely increase rates to 3.25 percent in the upcoming meeting at the end of June. Market participants are also pricing that the Fed will continue to raise rates into next year.
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Posted by Richard at 12:31 PM | Comments (0) | TrackBackMarch 9, 2005
Dealing with Greenspan¹s Conundrum
[Editor's Note: For today's guest column, we are pleased to present analysis by Sam Park with the New York investment and business development advisory service of R. W. Wentworth & Co. While his article doesn't focus on Asia, Mr. Park writes fluently from an economist's perspective on subjects in which the readers of this weblog, especially those residing in Asia, have expressed keen interest. Indeed, American markets, the trade deficit, the movement of the dollar and Mr. Greenspan's comments are perhaps of even greater moment to the businessman residing on the left coast of the Pacific as on the right. Many thanks as well to Mr. Alan Rude, President of R. W. Wentworth, as well as his staff, for permission to post.]
February Minutes of the Federal Open Market Committee
The Federal Open Market Committee (FOMC) continued with its effort to increase transparency by revealing the minutes of its February meeting. The minutes disclose the discussion among the members as they had decided to raise fed funds rate 25 basis points to 2.5 percent. This transparency allows the public to scrutinize and analyze reasons behind the Committee¹s decision on their recent monetary policy.
During the meeting, the consensus was that the economy steadily expanded in recent months. Real consumer spending continued to expand as real disposable personal income rose moderately and consumer confidence remained favorable. New and existing home sales maintained their robustness, however at a decelerating rate. Business fixed investment grew in the fourth quarter and was bolstered by favorable fundamentals. Since the recent data indicates a solid economy, the FOMC has some freedom to raise rates closer to their neutral level that ranges between 3.5 and 4 percent.
A Large Trade Deficit and a Weak Dollar
The U.S. international trade deficit continues growing to record levels, both in nominal terms and percent of GDP. Recent data suggests that the U.S. trade deficit had swelled in the fourth quarter, which had resulted from a decline in exports of goods and increases in imports of oil and consumer goods. Despite the optimistic view of the U.S. economy suggested in the February minutes, the current trade deficit may pose a threat to the ability of sustaining high Federal deficit levels and to the continuing of the economic expansion.
Large deficits typically cause worry that they could hurt the U.S. industry, eliminate jobs, and cause "hard landing" scenarios. Growing deficits could burden future generations with overwhelming foreign debt, leaving the U.S. susceptible to foreign pressures. This could discourage foreign investor confidence in the U.S. and may trigger capital flight, causing a downward spiral of the dollar.
However, according to America's Record Trade Deficit, large trade deficits are typically accompanied by improving economic conditions because of the link between trade deficits and rising investments. The primary cause of the U.S. trade deficit is due to insufficient domestic savings to fund all available domestic investment opportunities. This insufficient savings is filled by inflow of foreign capital, which allows the U.S. to buy more than it sells resulting in a trade deficit. Trade deficits are sustainable as long as the U.S. remains a safe and profitable designation for the world¹s savings.
Several factors challenge the sustainability of the trade deficit. Historically, the U.S. dollar and Treasuries have been viewed as safe and profitable. While the dollar is still safe, several major dollar-holding foreign central banks had recently issued statements of the dollar¹s unsatisfactory returns. These central banks have also indicated their plans of decreasing their exposure to the dollar, and these banks may diverse themselves away from the dollar. The weakened dollar must turnaround to avoid a possible capital flight and recession.
Inflationary Pressures
Another major focus on the Committee's minds is inflation. The weak dollar has caused import prices to rise. This combined with record high crude oil prices are creating inflationary pressures. High productivity growth rates have previously eased such pressures; but as the productivity rates decelerate, core inflation to the consumer will begin to increase.
The latest core Producer Price Index rose .8% (its highest monthly jump in nearly a decade). This implies that costs to firms have risen. The rise in the latest core Consumer Price Index was more moderate. However, unit labor costs had accelerated over the last year; and if this trend persists, core CPI is likely to increase.
The FOMC puts more focus on CPI figures than that of the PPI, and the Committee does not currently seem to be in a panic situation. Then again, some firms/producers have indicated their ability to pass cost increases to product prices, which directly causes higher core CPI figures. FOMC members probably understand this possibility and may take a more aggressive monetary stance in the months ahead.
Contradictory Interest Rate Situation
As shown in previous newsletters, consumer inflation levels affect FOMC's policy stance and decisions on fed funds rates. Given so, the upward inflationary pressures will force the Committee to take a tighter stance, which will effectively increase short-term interest rates. Nonetheless, consequences result from actions.
Greenspan has mentioned how he faces a conundrum seeing the recently declining long-term Treasury rates after having raised rates six consecutive times. Rising short-term rates not only causes a flattening yield curve, but the low long-term rates also accelerates the process. This implies that economic outlook appears uncertain. If the curve becomes inverted (when short-term rates exceed that of loner-term Treasuries), then we are likely to face a dismal economic situation.
Where Fed Funds Rates Are Headed
As mentioned, the FOMC tends to focus majority of their attention on consumer's inflation. Granted so, they will continue raising target rates. Currently, the fed fund futures is pricing approximately 65% probability of a 50 basis point increase in fed fund rates during the upcoming FOMC meeting and implies that at least 25 bps rise is virtually definite in their meeting on March 22nd.
Summing It Up
The Federal Reserve forecasts real GDP to expand between 3.5 and 4 percent for 2005, and the Committee expects the pace to slightly decelerate and range between 3.25 and 3.75 percent in 2006. Firms surveyed by the Fed have indicated more confidence about the economic outlook, and a significant reduction in capital spending is not anticipated in the early part of 2005. Both firms and consumers have taken advantage of low longer-term nominal interest rates, which is partly attributable to well-contained inflation expectations.
The low rates have discouraged savings and helped sustain spending trends. The current low savings rate appear to have resulted by expected income gains, low interest rates, and higher household wealth. The rise in equity and housing prices were major factors in creating that wealth. A reversal of home price appreciation trends would adversely affect household wealth.
A downward spiraling home price or bursting of a housing bubble is possible only if a negative catalyst occurs (i.e., unemployment rates taking a sudden and sharp hike). Since this scenario appears doubtful in the foreseeable future, downside economic risk seems contained. A bleak economy can be avoided as long as imbalances do not force the FOMC to considerably deviate fed fund rates away from neutral levels.
The Federal Reserve Board will most likely raise rates 25 bps on March 22nd. However, if Greenspan fears that increasing inflationary pressures to the consumer is eminent, the FOMC may opt to raise more aggressively by 50 bps during the March meeting.
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