Recommended read this morning, the op-ed piece by Kenneth Rogoff, “The Global Fallout of a Eurozone Collapse,” in the Financial Times. (http://www.ft.com/intl/cms/s/0/e66a3d7c-9073-11e0-9227-00144feab49a.html#axzz1OaJbLwdu)
“It is ironic that the euro…is suffering from having an overly strong exchange rate, particularly against the dollar, and at precisely the moment when a huge depreciation would be most helpful.”
“I think it would be more accurate to say that markets are more worried... about the US’s lack of a plan A than Europe’s lack of plan B.”
“Unfortunately…the euro is looking very much like a system that amplifies shocks rather than absorbs them. The UK, which of course did not adopt the euro, has benefited from a sharp sustained depreciation of the pound. The peripheral countries of Europe are meanwhile stuck with woefully weak competitive positions and no easy adjustment mechanism. European leaders’ plans to achieve effective devaluation through major wage adjustment seem far-fetched. The only clean rescue for Europe would be if growth far outstripped expectations. Unfortunately, post-financial crisis growth is likely to continue to be hampered by huge debt burdens.”
The worst of all worlds for this crisis…stagflation.
And, the United States continues to pound away creating more and more credit inflation for itself and the world…both in terms of monetary and fiscal policies. (See my post about the Fed’s feeding of world inflation: http://seekingalpha.com/article/273506-cash-assets-at-foreign-related-financial-institutions-in-the-u-s-approach-1t.)
“The markets are more worried about the US’s lack of a plan A…”
To me the world is seeing the current leadership in Washington, D. C. as little different than any group of leaders in Washington, D. C. over the past fifty years. For the past fifty years the government debt produced by the United States government has risen at a compound rate of growth of more than 8 percent per year. Economic growth has averaged a little more than 3 per cent every year for this same 50-year period.
This is “credit inflation.”
And, the value of the dollar?
In 1961, at the start of this binge, the value of the dollar was pegged to gold. In August 1971, President Nixon floated the dollar. With the open capital markets that arose in the 1960s, a country could not independently follow a policy of credit inflation and keep the value of its currency fixed.
Since the dollar was floated, the general trend in the value of the dollar has been downward with three exceptions. The first was in the Volcker years of the early 1980s; the second was when Rubin was Secretary of the Treasury in the late 1990s; and the third was in the world rush to quality during the financial crisis of 2008-2009.
The leaders of the United States have not had a plan to halt the decline in the value of the dollar for the past fifty years. And, the Obama Administration is no different from any of the other administrations that preceded it since 1961.
United States government officials have stated their support for a “strong” dollar throughout this time and yet have done little or nothing to stem the decline.
Again, “watch the hips and not the lips!”
And, the longer-term trend in the value of the United States dollar is still downward.
However, in an interdependent world, actions have repercussions elsewhere. And that is what Rogoff is calling our attention to. The policy actions of the United States government impact others. And, the blanket government policy of credit inflation followed by Republican and Democratic Presidents over the last 50 years has come to dominate the world.
Not only is it exacerbating the sovereign debt problems of Europe, it is spreading inflation throughout the world as the US dollars pumped into the US banking system by the Federal Reserve flow almost seamlessly into commodity markets throughout the world. (Again, see my post from yesterday.)
The irresponsible creation of debt and more debt does come to a limit. And, as one approaches the limit, the number of options available to the issuer of the debt shrink in number as the desirability of those options also lessen. (“Debt Ultimately Leaves You With No Good Options,” http://seekingalpha.com/article/271651-debt-ultimately-leaves-you-with-no-good-options.)
The United States is experiencing this difficulty as we speak. There are “things” the government would like to get into but can’t because there is no fiscal room for anything more, and there are “things” the government must get out of but don’t want to because they are in political favor.
In a world of excessive debt, there are no good choices…period!
Rogoff goes on to talk about whether or not the world will succeed in forming a co-reserve currency system. This would happen as the benefits of the co-reserve currency system were observed which would result in a trend towards the consolidation of currencies throughout the world.
The current period of stress, Rogoff argues, is a period of learning. “Having a smaller number of currencies is a phenomenon that makes a lot of sense economically, economizing on transactions’ costs and leveraging economies of scale. The real question is whether common currency is sustainable politically. My guess is that if the current slow patch in global growth does not quickly subside, we will not have to wait long for an answer.”
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