Tuesday, February 24, 2004

Japan And The U.S. - Historical Revisionism Run Amok

This is an amazing piece of currency wisdom by Marshall. He paints a very clear picture of the globe's structural future and "it ain't pretty." Anyone for architectural reform, yet?

Marshall Auerback

Japan And The Us: Historical Revisionism Run Amok

Since December 2000, the dollar has depreciated by 56 percent against the euro. For all of the fuss of last week’s “strong dollar rally”, that’s probably the best gauge of the greenback’s true underlying weakness. European Central Bank authorities (most recently, ECB chief economist, Otmar Issing) have made it abundantly clear that, unlike their Asian counterparts, they do not buy into the monetary snake oil currently being peddled by the Greenspan Fed and have accordingly refused to play the currency intervention game. But for the support of the neo-mercantilist Asians, the magnitude of the dollar’s fall against the euro would likely have been replicated against a broader basket of currencies.

Still, over the past year the dollar has slipped some 13 per cent against the yen, notwithstanding the fact that the Bank of Japan spent 187 billion dollars in 2003 buying all the dollars it could. With Japan and China serving as the United States' largest financiers of its current account deficit, now running at an annual rate of over 5 percent of gross domestic product, the U.S. Treasury bills and bonds held by these foreign governments are sinking in value while at the same time American exporters are attempting to reap the benefits of a huge currency-driven advantage in world markets.

And yet the Japanese, at least, remain adamant that they are likely to perpetuate this state of affairs. Merrill Lynch economist Jesper Koll tells us that for this year Prime Minister Junichiro Koizumi's national budget has raised potential intervention firepower by 61 trillion yen or about $580 billion: “Put another way: After spending $15 billion on average every month in 2003, Japan now has the budget to spend $48 billion per month to protect its corporations from a falling dollar, and $48 billion is more than three times Japan's monthly current account surplus.”

Japan has in effect acted as America’s leading sub-underwriter. It seems to have bought into the Ameri-centric view of its past policy failings, to the extent that it did not “do enough” during its own post bubble decline. To wit, Japanese policymakers at that time acted too late and with too little in the way of monetary and fiscal policy to counter the underlying deflationary undertow present once the bubble had definitively burst...

...In contrast to Japan, the U.S. economy cannot finance its economic expansion with its own internal resources, as has been exemplified by the ballooning current account deficit. The cumulative surpluses in Japan help to explain why there is persistent upward bias in the yen/dollar exchange rate, only alleviated to a limited extent by Japan’s extraordinary currency interventions, which the markets continue to perversely applaud even as it becomes more and more destabilizing.

And now that Tokyo appears to be playing ball with Washington, both seem to be locked into some mutual economic suicide pact (whilst the ECB stands on the sidelines, watching the whole scenario unfold with growing unease). Tokyo’s finances are beginning to resemble that of a Latin American country, with Washington rapidly catching up.

In the interim, the trans-Pacific trade imbalance has tipped further, resulting in the buildup of massive countervailing forces which will likely be unleashed later in the form of a further precipitous fall in the dollar. Furthermore, counting on the seemingly insatiable appetite of the American customer, the allocation of economic resources in the Japanese and other Asian economies appears to have been distorted to a larger extent than before.

By playing along like an American colony, Japan and the other Asian nations appear to be behaving like innocent merchants willing to sell on credit as much as their customers want. But at some point, either the creditors insist on proper payment for their large and growing I.O.U.’s, or the debtor simply declares, “No mas”, as Argentina has done, and the creditors are left with the prospect of huge write-downs. In such circumstances, credit will be harder to come by in the future, which bodes ominously for dollar assets.

At that point, the real consequences of this unhealthy symbiotic relationship will come home to roost. After all, when market commentators discuss the problems of the American twin deficits, what they really mean is that the sheer size of these deficits prevents any future short run policy stimulus-induced strength in US domestic demand from being sustainable over the medium to longer term. But if that is the case, logically it follows that one cannot be optimistic about the prospects for economies, like Japan, which remain dependent on exports to sustain growth, notably to the US. Which means less credit for the world’s largest debtor. How, then, does one resolve these awkward questions about exit strategies? Persisting in self-serving historical revisionism is clearly not an answer. ...Link

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