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World Economy in Crossroads

September 6, 2009

CrossroadsNYC Let’s look at the hard facts again before going deeper. The amount of USD in circulation is the driving factor now. Like discussed earlier the USA must get the external value of USD down, which means devaluated against other currencies. The key here is the money supply. The history data shows that money supply and inflation are directly related with each other. This is of course debated amongs scholars, but we accept this relationship here as a basic fact.  Therefore, one of the major tasks of any central bank is to control inflation and therefore the money supply. This is valid also for the FED. The Central Bank controls physical currency and governmental money which is called M0. In 2008 the total amount of USD in circulation was around $ 833 billion, of which 70% outside of the USA.

Now it has been estimated that the money supply in the USA will grow during this and coming yerar from $ 262 billion to around 4 trillion – 15 fold. This is a lot! Therefore, we are going to see two major things happening: first the devaluation and secondly inflation.  The problems outside of the USA will start because of the devalution, but the inflation will hit on inland. In order to control inflation, the FED must start to break development at certain point through curbing interest rates up. When will that be – most likely during 2010 when employment starts to pick up again.  Whatsoever, the prices will go up and the average John Doe must look more carefully how to spend his dollars – the consumption might suffer from inflation. A part of consumtion will anyhow get cut off through a higher savings rate than in the past. This is certainly good, but slows down the economy a bit.

Now to the problem that will come up outside of the USA. The USA has a negative trade balance and deficit in the federal budget. These both must get compensated some how. That has been done by borrowing money by printing bonds and selling them to foreign institutions like other central banks, and attracting foreign investors to the USA. Investment capital has flown to the USA in expectation of higher return than outside of the USA. Now it is getting cheaper to buy assets in the USA, but low interest rates are not helping. So in this respect the interest rates should go up  at least for two reasons: to hinder inflation and to attract investments. This is self evident.

However, foreign central banks, governments, institutions, and companies are sitting on a hoard of greenbacks already. They don’t want to hear about devaluated USD. When the value of USD goes down, so will do their reserves on USD and receivables in dollars as well. The parties outside  the USA want to see a gradual and controlled drop in the external value of USD – a crash would be a horror story for them. At that moment when the USD gets truly devaluated, the assets must get depreciated to their true value, and that would mean huge losses in Japan, China, Europe, Brazil, South-Afrika, Arabic countries, and Russia. We can estimate that other nations are printing more of their currencies as well, but most like not in the same pace with the FED. I have projected an exchange rate of 1,6 USD to 1 €, but now I wouldn’t be surprised of a 1 to 2 ratio. A drop of 40-50% in dollar’s external value is like poison to lenders and foreign reserve banks holding USD assets. My estimation is that on the long-run the USD will have only 25% of the value it has today.  This would be around 2,4 dollars per 1 €!

The outcome would include national disasters in several countries by crashing banks and financial system, loss of jobs in tens or even hundreds of millions globallay etc. In order to linder effects something must happen up-front. BRIC-nations (Brazil, India, Russia, China) have demanded a new world currency, some OPEC (oil producing countries) consider to change from dollar to euro, more nations are joining EU and euro-zone, and China has demanded the USA to hold the value off USD stable. This is controversial then all these nations have lots of dollars in their reserves, have lended to US, or have USD receivables. On the other hand they want to keep up supplying and selling goods and services to the USA. At the same time they want to sell their assets in USD in order to reduce the risk of devaluation. By selling USD they increase the amount of USD in circulation – the money supply (M0). There are no easy ways out. The hard medicine is know to everybody and the time is near to start to take it. It is very difficult with USD assets – their value will drop anyhow,  so a write-offs must happen now or later.

All nations who have large surplusses in their trade with the USA must now find a way to balance the trade. The lower value of USD will automatically reduce imports by US companies and helps exports from the USA at the same time. The task is to increase trade between other nations and balance it out with the USA. Every nation must look at their home markets and their neighbor countries and focus on those relationships. Any dependence on exports to the USA is highly risky now and in the future as well. I’m saying both sides need the balance! The US economy will heal steadily, but it cannot be based on borrowing any longer.  The same is valid for others – the growth and wealth cannot be made only by selling to the USA and financing that by borrowing to them. In the meantime the USA will become again a very cost competitive and growing nation, and that is good for the whole world.

As a base-line the trade balance and growth of global economy can get handled somehow, but  avoiding the write-off of assets in USD is close to impossible. The headache is predicted and the medicine linders only, but doesn’t remove the cause. The change is irresistable.


The external value of USD must go down substantially

August 29, 2009

StrategystarThe Central Bank is printing dollars and US bonds. The Secretary of  State Mrs. Clinton is rallying around the globe to promote the sales of the bonds to secure the inflow of  dollars to finance the deficits. This seems to work for the moment. The path for lower external value of USD will get prepared. The USD must get devaluated against other currencies in order to let US economy to heal towards a trade balance on the long run.

It is obvious that an ever deeper trade deficit and foreign debt cannot be sustained forever. The biggest hurdle might be found in the USD/Yuan exchange rate. The Chinese government will control the value of Yuan (reminbin) against USD in order to guarantee the continuation of the status of China as the number one manufacturing location in the world.

China  hasn’t downgraded its receivables from the USA yet. That’s because the USD has been so heavily weighted in the currency basket of Yuan. When the external value of USD drops the PRC, banks and other Chinese lenders must correct the value of their assets down. That would mean huge losses in hundreds of millions or even billions of USD, and that they are trying to avoid now. China has demanded USA to hold the external value of the USD. However, this will become a task or mission impossible in the near future.  When USD looses its external value there is a risk of inflation because imported goods and service will cost more by then – like oil, gas, and other imported goods etc..

Like stated in prior blogs the USA needs jobs, stability, trade balance and therefore growth. The growth is guaranteed by growing population, but it must be able to consume. That is not possible without jobs and a strong middle class.  The Jobs are created by small and mid-size companies mainly. They must be able to produce, make, trade and especially sell their products in order to hire and make investing decisions.  Because the US economy is about 70% driven by inland consumption the FED cannot increase the interest rates too much – even if the inflation would pick up a bit. Now, I think the demand for goods and service is best generated in the USA by low external value of USD. And this devaluation untraditionally not because of  increasing the exports but to make returning of manufacturing possible!

What is that? US based corporations have outsourced and tranfered manufacturing to low-cost countries (LCC)  like China, India, Vietnam etc. Now, when the external value of USD goes down, the gap – cost difference – gets smaller between manufacturing costs in LCC (or other countries)  and the USA.  When taking into consideration the level of minimum wage of $ 6,- per hour in the USA (equals to 4,2 € per hour). At China’s west coast an average worker gets around $ 1,10 to $ 1,60 per hour in a Chinese owned company and up to $ 5,77 in a foreign owned company.  There is still a difference, but that is not the case when counting with total landed costs. Depending on the product the freight, handling, export and import related costs like duties and taxes come on top of that. We might estimate that around 25% must get added to the cost – material cost is seen here as a constant factor and therefore not considered. By doing like this $ 1,60 gets to $2,-  and $ 5,77 gets even to $ 7,21.When the exchange rate of USD drops against Yuan this gap gets narrower. When USD / Yuan ratio changes 30-40% then the remaining gap is only 6-2,80 = $ 3,20 per hour for manufacturing in real Chinese company and negative $ 1,21 in a western company. The final outcome would be that manufacturing in the USA would make sense again.

When US corporatoions start to bring manufacturing back home, a boom in investing, job creation, and growth will happen. The middle class begins to feel right, federal income would rise, and even foreign companies would begin to invest heavily in the USA. The nation would prosper again and easily pay back the foreign debt. The trade balance would get positive when imports drop and remain on a lower level. Inflation would go up and therefore also the interest rates, but that would be ok, when the whole world invests and believes in the USA again.

What that would mean for other nations and foreign corporations will get discussed next time.

A New Scenario starts to unfold

July 7, 2009

There is a good chance for a completely new scenario about world economic development. It’s not about BRIC-countries, but more about the USA and its impact onto others.

Let’s start with the good old greenback. The whole US economy will heal the most when the external value of USD is drastically lower than today – imports getting more expensive and exports lukrative. BRIC countires want to get rid off USD as a reserve and trade currency anyhow. So, on the long run others want to reduce their USD risk position (and sell their USD reserves) and the USA itself needs a lower USD value. I bet this will happen when now all parties want it – but steadily. USD will drop down to 1,7 or even to 2 against one Euro.

Now let’s think about countries having high reserves on USD: they hate to loose the value, but will accept it in small steady portions – China, Japan, India, Russia, Brazil, OPEC countries and the EU will all agree when the value of USD drops in small steps over a course of time. And they will write off assets or at least revaluate them down. That will burst some banks, financial institutions, even countries, and companies around the globe, but not the US ones – they will be dancing out of the trouble. This will be the phase one. Continues…

Backbone of the US economy

June 16, 2009

The upswing has started in the USA. Times are still somewhat rough though. The USA is still the single largest economy in the world – just not to forget it, and it is a flexible economy. So, it will adapt – resistance is futile!

The latest statistics from the U.S. Census Bureau show that 98 % of all U.S. firms have fewer than 100 employees. But here the real news: 90% of all firms in the U.S. have less than 20 employees and carry for over 97 percent of all new jobs created in the U.S. of America! When this engine starts to hum, what seems to happen step by step now, we will see growing investment values, higher hiring rates and growing economy again.

The US government will need to make sure that these SM enterprises will get all possible support like tax cuts and less bureaucracy.

One nation, small enterprises with employment and prosperity for all!

Business conditions in the USA are improving

April 20, 2009
According to the Tatum survey all but two indicators show an upward trend already! The lowest point of recession was reached in November 2008, and since then the condition has been improving. Only capital expenditure and employment are still weak or getting slightly weaker. This is similar to the message what Mr. Prof. Holmberg from MIT carried over in his NYC breakfast briefing. The brighter side is gaining momentum! Also certain industries are more lucrative in the future like nutrition, renewable energy, care of elderly etc.  It’s getting time to make investment plans again, and avoiding debt. Welcome spring and summer 2009!

Hello world!

April 18, 2009

Previous blogs can be found at http://strategystar.blog.com