Faith in the Dollar

Nouriel Roubini and Brad Setser have recently published a Paper on the risks of the Fiscal and Current Accounts deficits--Past, Present, and predicted Future; accessible from either of their Blogs, where they each highlight their findings. They basically assert:

Roubini
We argue that the likely collapse of this regime in the next couple of years would result in a Hard Landing scenario: the dollar would sharply fall, US long term interest rates would sharply increase, the price of most risky assets - equities, housing, high yield debt, emerging market sovereign debt - would significantly fall, and a sharp US and global economic slowdown - if not outright recession - may ensue. The probability of such hard landing is increasing.

- Chances of an orderly global rebalancing rest on three elements: 1. a significant fiscal adjustment in the US that requires - at the very least - a reversal of unsustainable tax cuts (as spending controls will not be sufficient) and giving up a budget-busting social security privatization; 2. a revaluation of the Chinese and other Asian currencies; 3. policies leading to higher growth in Europe and Japan.

Setser
The 2005 current account deficit is likely to be around $800 billion, maybe a bit more. If nothing changes, the 2006 deficit, is likely to be around $900 billion: Remember, just paying interest on the $800 billion borrowed in 2005 might add $40 billion to the overall 2006 deficit. That implies a total two year financing need of $1.7 trillion dollars IF net equity outflows stop, and a need to place around $2 trillion in debt abroad over the next two years if net equity outflows continue at around $150 b a year.

The US still needs to raise at least $700 billion by selling debt to foreign private investors, and perhaps more if net equity outflows continue. That amount of private financing may not be available from private investors around the world at current dollar interest rates.

Greenspan Not Really Optimistic on Account Gap: John M. Berry
Feb. 9 (Bloomberg) -- Federal

In the first 11 months of last year, imports totaled $1.6 trillion, 65 percent more than exports of $1.04 trillion. Exports rose 12 percent, compared with the same period in 2003, and the trade deficit would have stabilized if the increase in imports could have been held to only 8 percent. In reality, imports jumped by 16 percent. (excerpted from Greenspan's London speech)

even if the real value of imports were to fall, their nominal values might not. If the nominal trade deficit did not fall, the need for foreign financing would not either.

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This Author agrees with most of the Roubini-Setser argument, and believes We are in for a Hard Landing. He thinks, though, Greenspan may have the right idea. The Cure in not in the elimination of Central Bank interventions; it stands in the refusal of foreign trading partners to accept further reduced Profit margins. The Dollar remains basically sound, based on real asset equity--Domestic and Foreign. A further devaluation of the Dollar(within a range of another 10% drop possible) seems highly unlikely. Central Bank interventions have probably ceased in greatest measure.

Third Generation analysis (the Bush Tax Cuts estimated to be First Generation) would indicate Import prices will increase in a range of 22-27% within the current Year(2005). The Fed will be compelled to raise the Overnight rate to 4% to hold down Domestic Inflation, and the quantity of Imports will decline sharply (down 37-40%) by Y2007 due to curtailment of easy Consumer Credit. Impact will be offset by OPEC being unable to sustain an Oil price over $40/barrel because of decline in economic expansion coming from American constriction of Imports.

The impact on Federal Spending will be drastic: Social Security Privatization will not occur, even if passed into law; the Drug benefit Law will not be implemented fully, and likely discarded; Bush will get his additional Funding for Iraq and Afghanistan in Y2005, but not in Y2006--except to extract all U.S. military personnel; the Bush Tax Cuts will be allowed to die; and Capital Gains taxation will be raised to Clinton-era levels. lgl