Samuel Brittan: Were the dollar really to collapse...
Samuel Brittan: Were the dollar really to collapse...
By Samuel Brittan. Copyright by The Financial Times
Published: June 15 2006 20:39 | Last updated: June 15 2006 20:39
According to the Bank for International Settlements, share prices have been falling and commodity prices have been volatile, not because of a deteriorating outlook for companies or worries over inflation, interest rates or growth, but because of greater nervousness about holding risky assets, particularly in emerging market equities and bonds. On the other hand, the European Central Bank, in its June Financial Stability Review, still puts the main sources of risk and vulnerability as “global financial imbalances”, which is code for the risk of a plunge in the dollar.
So when a friend suggested I look at the global implications of a serious dollar collapse I jumped at the idea. Asking about the implications of a dollar collapse is a different ball game from predicting its likelihood or timing. Instead of hopeless crystal ball gazing we can ask what this event would mean and what kind of policies should be adopted in response.
Let us define a dollar collapse as a dollar depreciation of at least 20 per cent within a period of weeks. Initially the drop would be mostly against the euro, but such a drastic fall in the dollar’s external value could well be the signal for Asian authorities to cease stockpiling assets and even start dumping them.
Most important, however, are the circumstances in which the crash occurred. As one who has been sceptical of the talk of international imbalances and even more sceptical of some of the supposed remedies, maybe I will be forgiven for beginning with a relatively benign scenario.
The most likely trigger for a dollar collapse would be a US housing market setback, which would deliver a blow to US consumer spending. The Federal Reserve would then pause in, or even reverse, its present policy of gradually raising short-term interest rates. So both the immediate economic prospects and the behaviour of international interest rate differentials would be bearish for the dollar. The bond market would decline and both real and nominal long-term interest rates rise, thus contributing a further recessionary impact.
Nevertheless, the results for the US economy need not be entirely adverse. The whole scenario starts with the weakening of the domestic economy. In these circumstances the depreciation of the dollar would provide an offsetting external stimulus. But it does mean that the US economy could not continue growing each quarter at an annualised 3 to 4 per cent rate.
How bad that would be would depend partly on developments in the rest of the world. Optimists hope that instead of retaliation, an offsetting boost would be given to demand in the eurozone and in Asia. Pessimists fear that political leaders such as President Jacques Chirac of France – if still in office – would retaliate by raising protectionist barriers, attempting competitive devaluation or by ill-conceived taxes on international capital movements.
More likely than either of these extremes is that dollar depreciation might come at a time when the rest of the world is still enjoying an economic upsurge along the lines predicted by the International Monetary Fund, the Organisation for Economic Co-operation and Development and similar organisations. In that case it would not be such a tragedy if Europe or Asia failed to take offsetting demand- boosting measures. Indeed, if the world is experiencing excess demand, as the pressure on oil and commodity markets and the abundance of credit suggest, a modest recessionary movement in the US might be just what the doctor ordered.
It follows from this that if there is to be a dollar crash the sooner the better. For retaliation and perverse reaction would be less likely while Europe and Asia are enjoying an upsurge than they would be later on when these other parts of the world may be slowing down or in recession.
But I must say a bit more to satisfy the demand for pessimism. Suppose that the price of oil rose to $100 a barrel or more. Central banks might have to rein in demand even while there was a physical surplus of industrial capacity and little sign of overfull employment. The US could be more severely affected because US energy imports are greater per dollar of gross domestic product than in other parts of the developed world.
The worst scenario goes well beyond conventional economics and could occur if, for example, the Straits of Hormuz at the mouth of the Persian Gulf were to be closed. The action would then move to the political and military front. But the world financial community could be forgiven if it reacted with a horse laugh to any Pentagon talk of a quick, clean strike to reopen the Straits.
In these circumstances the dollar would be the least of our worries. As in similar crises in the past, one might expect a shift from currencies into gold, land, jewellery, cowrie shells and other such assets. But the dollar would be likely to suffer relative to the euro and sterling. Is there a chance that Congress will take fiscal measures against gas-guzzling before it is forced to by such events?
www.samuelbrittan.co.uk
By Samuel Brittan. Copyright by The Financial Times
Published: June 15 2006 20:39 | Last updated: June 15 2006 20:39
According to the Bank for International Settlements, share prices have been falling and commodity prices have been volatile, not because of a deteriorating outlook for companies or worries over inflation, interest rates or growth, but because of greater nervousness about holding risky assets, particularly in emerging market equities and bonds. On the other hand, the European Central Bank, in its June Financial Stability Review, still puts the main sources of risk and vulnerability as “global financial imbalances”, which is code for the risk of a plunge in the dollar.
So when a friend suggested I look at the global implications of a serious dollar collapse I jumped at the idea. Asking about the implications of a dollar collapse is a different ball game from predicting its likelihood or timing. Instead of hopeless crystal ball gazing we can ask what this event would mean and what kind of policies should be adopted in response.
Let us define a dollar collapse as a dollar depreciation of at least 20 per cent within a period of weeks. Initially the drop would be mostly against the euro, but such a drastic fall in the dollar’s external value could well be the signal for Asian authorities to cease stockpiling assets and even start dumping them.
Most important, however, are the circumstances in which the crash occurred. As one who has been sceptical of the talk of international imbalances and even more sceptical of some of the supposed remedies, maybe I will be forgiven for beginning with a relatively benign scenario.
The most likely trigger for a dollar collapse would be a US housing market setback, which would deliver a blow to US consumer spending. The Federal Reserve would then pause in, or even reverse, its present policy of gradually raising short-term interest rates. So both the immediate economic prospects and the behaviour of international interest rate differentials would be bearish for the dollar. The bond market would decline and both real and nominal long-term interest rates rise, thus contributing a further recessionary impact.
Nevertheless, the results for the US economy need not be entirely adverse. The whole scenario starts with the weakening of the domestic economy. In these circumstances the depreciation of the dollar would provide an offsetting external stimulus. But it does mean that the US economy could not continue growing each quarter at an annualised 3 to 4 per cent rate.
How bad that would be would depend partly on developments in the rest of the world. Optimists hope that instead of retaliation, an offsetting boost would be given to demand in the eurozone and in Asia. Pessimists fear that political leaders such as President Jacques Chirac of France – if still in office – would retaliate by raising protectionist barriers, attempting competitive devaluation or by ill-conceived taxes on international capital movements.
More likely than either of these extremes is that dollar depreciation might come at a time when the rest of the world is still enjoying an economic upsurge along the lines predicted by the International Monetary Fund, the Organisation for Economic Co-operation and Development and similar organisations. In that case it would not be such a tragedy if Europe or Asia failed to take offsetting demand- boosting measures. Indeed, if the world is experiencing excess demand, as the pressure on oil and commodity markets and the abundance of credit suggest, a modest recessionary movement in the US might be just what the doctor ordered.
It follows from this that if there is to be a dollar crash the sooner the better. For retaliation and perverse reaction would be less likely while Europe and Asia are enjoying an upsurge than they would be later on when these other parts of the world may be slowing down or in recession.
But I must say a bit more to satisfy the demand for pessimism. Suppose that the price of oil rose to $100 a barrel or more. Central banks might have to rein in demand even while there was a physical surplus of industrial capacity and little sign of overfull employment. The US could be more severely affected because US energy imports are greater per dollar of gross domestic product than in other parts of the developed world.
The worst scenario goes well beyond conventional economics and could occur if, for example, the Straits of Hormuz at the mouth of the Persian Gulf were to be closed. The action would then move to the political and military front. But the world financial community could be forgiven if it reacted with a horse laugh to any Pentagon talk of a quick, clean strike to reopen the Straits.
In these circumstances the dollar would be the least of our worries. As in similar crises in the past, one might expect a shift from currencies into gold, land, jewellery, cowrie shells and other such assets. But the dollar would be likely to suffer relative to the euro and sterling. Is there a chance that Congress will take fiscal measures against gas-guzzling before it is forced to by such events?
www.samuelbrittan.co.uk
posted by Carlos T Mock at 4:12 PM
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