There is a silver lining in the clouds looming over the US economy: the fall in the dollar is starting to correct the current account deficit. Given the scale of the decline this is what you would expect to happen; but it is nice to know that it is.
The immediate news about the economy in terms of consumer confidence, the housing market (of course) and employment has all been solidly negative. But the bigger issue behind this is whether the long-standing imbalances both within the US (the dearth of savings) and externally (the current account deficit) can correct in an orderly manner. Can the economy, in the jargon, achieve a "soft landing"?
We are still in the very early stages of the correction but that possibility does looks rather more hopeful than it did even a couple of months ago. The dollar has fallen sharply but not yet to a level that is gravely undermining the competitiveness of the countries that have adopted the euro. Yes, the euro is at an all-time high against the dollar and yes, German industry is more negative than it has been for 18 months. But I think it would be fair to describe the situation for European exporters as difficult rather than desperate.
The present fall also seems to have been accepted by the principal holders of dollar assets in Japan, China and the Middle East – accepted in the sense that there has been no panic unloading of the currency. I picked up a fair degree of dismay about the state of the dollar when in China earlier this month and there is certainly evidence of diversification of investment.
One of the reasons why the euro has risen so much has been a switch of the flow of Asian and Middle Eastern savings from dollar to euro-denominated securities. This has, however, been an orderly retreat, not a rout, at least so far. While it is perfectly possible that the dollar could truly collapse, if the current level of the dollar is sufficiently great to set the correction in motion, well, maybe it does not need to fall much more.
To put this in perspective have a look at the top chart. This comes from the Ifo Institute in Germany and shows what it calculates to be the fair value of the four main currencies (the German mark being taken as a proxy for the euro before the latter's creation) since 1994. As you can see the dollar would seem to be somewhat undervalued, but not madly so.
It is certainly not as far adrift as it was in 2000, when it was ludicrously over-valued, particularly against the euro. Sterling, often accused of being overvalued, appears about right against the euro and only really too high against the dollar.
There is a further point, which the chart does not catch: that several Asian currencies peg themselves to the dollar, either explicitly or loosely, and that these are the ones against which the dollar really needs to fall. I accept that. But my point is notwithstanding that failure to adjust, and there are historical and institutional blockages there, the fact remains that the dollar's narrower decline seems to be effective.
You might say: not effective enough. The next chart shows the truly dreadful performance of the US current account deficit, which only briefly got back into the black in the early 1990s and subsequently reached nearly 7 per cent of GDP. But – and this matters because it is much harder to turn something round than to continue on an established course – there does seem to have been a clear turning point in the past few months. It is like turning round a super-tanker, or one of those huge container ships that bring the stream of imports from Asia to the US.
The deficit is now coming back towards 5 per cent of GDP, improving at a rate of roughly one percentage point of GDP per year. Indeed, were it not for trade in oil, the trade deficit would have been stable or narrowing as a percentage of GDP since early 2004.
You can see why in the final two graphs. Imports were running 15-20 per cent up year on year from 2003 through 2005, but now are only around 5 per cent up year on year. Exports, by contrast, which were negative back in 2002, are now running nearly 15 per cent up on the previous year. More encouraging still, the numbers seem set to improve further. Both graphs show an indicator of the future trends, new export orders and import projections. On the graph, from Capital Economics, these are advanced three months and hence signal a continuing favourable trend through the rest of this year.
How long might this improvement continue? Certainly for another year, by which time the deficit could be down to about 4 per cent of GDP. The reason for being confident about that is that global demand seems set to be strong through 2008, with consumers in the BRICs (Brazil, Russia, India, China) now supplying more additional demand to the world economy than the those in the US.
Meanwhile, demand for imports in the US is not going to surge through next year. I have just been looking at some forecast for consumer demand in 2008 from ING Bank, which thinks that growth in consumption, currently 2.6 per cent, could decline to 1.6 per cent. The ability of the US Federal Reserve to puff up demand by cutting rates is limited by the threat of inflation. In recent weeks it has started to cut short rates but there has been little parallel shift at the longer end.
Beyond 2008 anything is possible but were the improvement to continue, you could pencil in a move to balance around 2011. I personally doubt that that will happen, partly because it is hard to see such subdued demand in the US lasting anything like that long and partly because, once the correction is seen to be really under way, the dollar will recover. But nothing is forever and at some stage over the next generation the US will get itself back to current account balance.
I am not sure that the rest of the world quite appreciates the consequences of such a shift. Asian exporters will have to rethink their strategies, diverting output more to the fast-growing countries in their own time zone rather than focusing on the desires of American consumers.
European exporters will find that they are being out-priced by American ones, as is already happening in the case of Airbus and Boeing. We may find that the world does not like a super-competitive American economy at all.Reuse content