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Widening Global Imbalances
Rodrigo de Rato, Managing Director of the International Monetary Fund at a recent speech at the University of California at Berkeley, stated that "while global current account imbalances have been widening, the fact that they have been financed easily thus far seems to be inducing a sense of complacency among policy makers. I think they should be more concerned. This is not to say that the risk of a disorderly adjustment is imminent, but the problem is growing, and if a disorderly adjustment does take place, it will be very costly and disruptive to the world economy.
The most visible aspect of the global imbalances problem is a very large deficit in the current account of the balance of payments of the United States - amounting to about 6.25% of GDP. The main problem is that in the United States savings are too low. These global imbalances could unwind quickly, and in a very disruptive way, with either an abrupt fall in the rate of consumption growth (i.e. increased savings) in the United States which is holding up the world economy or by investors abroad becoming unwilling to hold increasing amounts of U.S. financial asset, and demand higher interest rates and a depreciation of the U.S. dollar, which in turn forces U.S. domestic demand to contract."
Economic Pain
Timothy Adams, Undersecretary of Treasury for International Affairs, stated recently that "the world economy is dangerously imbalanced and the U.S. current account deficit is now at levels that many experts fear could trigger a run on the dollar, soaring interest rates, and global economic pain."
Severe Consequences
Robert E. Rubin, director of Citigroup Inc. and former Secretary of the Treasury; Peter Orszag, Senior Fellow at Brookings Institution; and Allen Sinai, Chief Global Economist at Decision Economics Inc., made a presentation to a joint session of the American Economic Foundation and the North American Economics and Finance Association recently. They stated that "the scale of the nation's projected budgetary imbalances is now so large that the risk of severe consequences must be taken very seriously. Continued substantial deficits could cause a fundamental shift in market expectations and a related loss of confidence both at home and abroad. This, in turn, could cause investors and creditors to reallocate funds away from dollar-based investments, causing a depreciation of the exchange rate, and to demand sharply higher interest rates on U.S. government debt. The increase of interest rates, depreciation of the exchange rate, and the decline in confidence could reduce stock prices and household wealth, raise the cost of financing to business, and reduce private-sector domestic spending."
Wild Ride
Paul Kasriel, Director of Economic Research at Northern Trust and co-author of the book 'Seven Indicators That Move markets', has stated that "If foreign creditors should question our ability and willingness to repay them without resorting to the currency printing press, there could be a run on the dollar, which would lead to sharply higher U.S. interest rates, which would do great harm to household finances and the housing market, which would put a crimp in consumer spending, which would increase unemployment, which would result in a spike in mortgage defaults, which would likely cripple the banking system given that a record 61% of total bank credit is mortgage related, which would, in turn, render future Fed interest rate cuts -expected on or about September 20th, 2006 - less potent in reviving the economy.
We have the most highly leveraged economy in the postwar period and the Fed is still raising rates and in the past 30 years or so, whenever the Fed has raised interest rates, we have usually had financial accidents. Our federal government is spending like a drunken sailor so my advice is to put on your safety harness as it is going to be a wild ride. My bet is that we are going to end up on the rocks."
Category 6 Fiscal Storm
Isabel V. Sawhill, Vice President and Director and Alice M. Rivlin, Senior Fellow of Economic Studies at the Brookings Institution have said that "the federal budget deficits pose grave risks - a category 6 fiscal storm - to the U.S. economy. The current course is simply not sustainable. Promises to the elderly, especially about medical care, cannot be kept unless taxes are raised to levels that are unprecedented or other activities of the government are slashed. Postponing such action would be reckless and short-sighted. Massive amounts of capital have flowed in from around the world, financing much of America's federal deficit, as well as its international (or current account) deficit. While this inflow of foreign capital has kept investment in the American economy strong it means that Americans are accumulating obligations to service these debts and repay foreigners out of their future income. As a result, the future income available to Americans will be lower than it would have been without the government deficits. Foreign borrowing also makes the United States vulnerable to the changing whims of foreign investors. There is a risk that Asian central banks, or other large purchasers of dollar securities, will lose confidence in the ability of the United States to manage its fiscal affairs prudently and shift their purchases to euros or other currencies. Such a shift could precipitate a sharp fall in the value of the dollar, which could cause a spike in interest rates, a plunge in the stock and bond markets, and possibly a severe recession. The risk of such a meltdown is unknown, but it seems foolish to run the risk in order to perpetuate large fiscal deficits, which will ultimately reduce Americans' standard of living."
Drastic Fall
Sebastian Edwards, the Henry Ford ll Professor of International Business Economics at UCLA's Anderson School of Management and a research associate of the National Bureau of Economic Research and has been a consultant to the Inter-American Development Bank, the World Bank, the OECD and a number of national and international corporations, has stated that "The future of the U.S. current account - and thus of the dollar - depend on whether foreign investors will continue to add U.S. assets to their investment dollars. Any major reduction in the USA's ability to obtain sufficient foreign financing would cause the dollar to fall by 21% to 28% during the first three years of any adjustment period, cause a deep GDP growth reduction, and push the USA into recession."
Substantial Macroeconomic Consequences
Ian Morris, Chief US Economist at HSBC, has said that "about half the US housing market may be overvalued by as much as 35-40%. When these housing bubbles begin to deflate, it is likely to have a substantial macroeconomic consequence."
Serious Collapse
Ian Shepherdson, Chief US Economist for High Frequency Economics, has warned that "house price increases are going to slow much further dragging down expectations for future price gains and therefore raising real mortgage rates. This, in turn, will be the trigger for a serious collapse in home sales. The housing market is a bubble, and it will burst."
Economic Earthquake
Robert R. Prechter, President of Elliott Wave International and author of 'At the Crest of the Tidal Wave' and 'Conquer the Crash,' calls for "a slow motion economic earthquake that will register 11 on the financial Richter scale.
The Great Asset Mania of recent years is in its final euphoric months and the next event will be a sharp decline of historic proportion in stock prices - the Dow should fall to below the starting point of its mania which was 777 in August 1982 and probably below 400 by no later than 2008 - resulting in a deep economic depression lasting until about 2011. If an across-the-board deflation occurs, which has a substantial probability, then real estate, commodities and all bonds issued by other than those rated AAA will fall in value as well. That we are in the midst, and apparently near the end, of the greatest debt build-up in world history suggests that the resulting deflation and depression will be the biggest deflation in history by a huge margin. A corollary of deflation will be a soaring value for the U.S. dollar, contrary to virtually all current expectations. Credit expansion is a major reason why stocks have kept rising and the dollar has kept falling but when the bubble begins to deflate, the investment markets will go down and the dollar will start up. The period after the market crash will be the most vulnerable in terms of the potential for hyperinflation. The ultimate result will be the destruction of any value remaining in bonds and the wipe-out of all dollar-denominated paper assets."
Giant Speculative Bubble
Ravi Batra, Professor of Economics at Southern Methodist University, in his book 'The Crash of the Millennium' foresees not a deflationary depression but an inflationary one. He sees "the giant speculative bubble that we are currently in bursting, the stock market crashing and then the U.S. dollar collapsing almost immediately followed by a rise in interest rates and plunging bond prices culminating in a depression made doubly damaging by rising inflation through the early part of this decade. In spite of the inflationary nature of the coming depression, property values will tumble in most parts of the United States. In the long run, home prices will probably continue to climb but in the short run, however, they could sink and sink hard."
Systemic Banking Crisis
Richard Duncan, a former consultant for the International Monetary Fund, current Financial Sector Specialist (Asia) at the World Bank and author of the book, 'The Dollar Crisis', writes that "the United States' net indebtedness to the rest of the world, already at record highs, will continue to increase every year into the future until a sharp fall in the value of the dollar against the currencies of all its major trading partners puts an end to the gapping US current account deficit or until the United States is so heavily indebted to the rest of the world that it become incapable of servicing the interest on its multi-trillion dollar debt. In the meantime, as long as the US current account deficit continues to flood the world with US dollar liquidity, new asset price bubbles are likely to inflate and implode; more systemic banking crises can be expected to occur; and intensifying deflationary pressure can be anticipated as low interest rates and easy credit result in excess industrial capacity and falling prices (i.e. deflation)."
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