from Follow the Money

Tim Adams frets …

December 19, 2005

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Treasury Under Secretary Adams worries about "which developing country is ready to go bust, what hedge fund is heading toward a meltdown, which currency is teetering on the edge of collapse, what protectionist legislation Congress is yearning to pass."

My leading candidate for the currency teetering on the edge of collapse: the dollar.  Obviously, the markets disagree. 

But a rally in the currency of a country with a 7% of GDP current account deficit (and in all probability a growing income deficit) looks like a recipe for future trouble.   I am what Stephen Jen would call a structural dollar pessimist.   7% of GDP trade and transfer deficits and a 10% of GDP export base is not a good long-term combination for the dollar, particularly if net interest payments on the US external debt are set to rise significantly.   Deficits did not matter to the market in 2005, but they may start to matter in 2006.   Even Stephen Jen is tempering his dollar bullishness a bit.

That is why I applaud Treasury Undersecretary Adam's attempt to "urge everyone to prepare for a set of conditions that are less benevolent than the current ones."

My list of things of trouble spots would not be quite the same as Adams.   He left the now-set-to-expand US fiscal deficit, and the structural gap between government spending and tax revenues off his list.  The 2006 fiscal deficit may return to the $400 billion range.  The problem is not that the US fiscal deficit is so large absolutely relative to US GDP, but rather that if the US fiscal deficit stays large or even grows, the only way the current account deficit can adjust is through a large fall in private investment, or a sharp increase in private savings.  

Adams beats up on continental Europe a bit more than I would; the current account surpluses that finance the US deficit are not found in Europe, and, relative to the consensus, I put far less emphasis on a growth rebound in Europe.  I don't expect a European current account deficit financed by emerging economies to replace a US current account deficit financed by emerging economies.  I would be happy if Europe can just keep on growing should the euro once again start to appreciate.   I don't think US protectionism is the only thing China needs to worry about either; it also shoudl worry about a sharp fall in investment.  That would lead to a rising Chinese current account surplus, a China that is even more dependent on exports and thus less willing to change its dollar peg, and a likely confrontation with the US in a (Congressional) election year -- or, if the investment slowdown doesn't materialize, in the Presidential election cycle. 

I would fret about excessive savings, large budget surpluses and dollar pegs in oil exporters - not just froth in their local equity markets.   Oil exporters have to play a role in the resolution of global imbalances one way or another.  Either oil prices fall, or consumption in oil states needs to rise ... 

All in all though, I liked the absence of (economic) cheerleading from Adams.   His somber tone strikes me as the right tone.   He must not have gotten the Administration's "sell the expansion" memo ...

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