‘New Normal’, but is USD still King?

While not frontier related, most if not all market movement is still largely a function of how the U.S. dollar is trading.  So it’s worth keeping track of what the dollar index is doing, and moreover what government bonds are doing. 

On that front, The Economist’s special report on debt last week included some interesting pontifications on current sovereign statuses:

The citizens of Europe may now be realising that debt transfers power from the borrower to the creditor. The first world war destroyed Britain’s credit position and ushered in the era of American financial dominance. Now the debt burden reflects the shift in the balance of economic power from rich countries to developing ones. It is striking that on average developed countries now have a higher debt burden than emerging nations. Investors have certainly noticed, and have poured money into emerging-market bonds funds over the past year. Developing countries also have more chance of outgrowing their debt burdens. According to Tony Crescenzi of PIMCO, investors are asking themselves, “Would I rather lend money to nations whose debt burden is worsening, or to nations where it is improving?”

That said, in the short-term especially bond investors seem determined to push down the cost of borrowing for the U.S., one of the worst offenders behind Japan.  The 10-year’s breach of 3% recently was psychologically important on a variety of levels and seems to underpin The Economist’s take that “for the moment, the dollar is the one-eyed currency in the land of the blind”:

“America has two huge advantages over other countries that have allowed it to face its debt with relative equanimity: possessing both the world’s reserve currency and its most liquid asset market, in Treasury bonds . . . There may come a time when America is hit by a funding crisis, but it does not look imminent.  America would be more at risk if the Asian central banks and sovereign-wealth funds had an obvious alternative.  But with Europe in the midst of its own debt crisis, the euro does not look like an appealing option.  And there is simply not enough gold in the world to absorb a substantial portion of central-bank reserves.”

Of course, the Chinese-lead “vendor-financing” relationship which not only fuels America’s rising debt-to-GDP ratio but also ironically has made it ‘too-big-to-fail’ from a creditor’s viewpoint cannot be counted on ad infinitum, especially as the youthful demographics of emerging markets continue to be caught by the consumerism bug and start realizing the income and purchasing power growth to really start climbing a la Maslow’s hierarchy.

But America’s own relatively young workforce (compared with the EU and Japan, that is) and lack of structural impediments impeding labor’s productivity rate “put it in the best position long-term,” the piece concludes, to grow its way out of debt through growth.  And if its politicians ever really get serious about avoiding an eventual spike in yields, while also tackling the country’s leviathan-like legacy costs they’re so loathe to even acknowledge, they’ll begin to frame the country’s need for immigration reform not in terms of partisanship but in terms of economic necessity.  One way to keep the workforce as young and vibrant as possible is to embrace an outside population keen on adding to it and, of course, tax them accordingly.

The “new normal”: a plumper IMF?

How much was the global economic crisis made possible by a savings glut in emerging countries? While popular sentiment is to lambast securitization, bankers and even capitalism per se, a more nuanced view of the matter (and one widely embraced by economists of varying ideologies) embraces the appreciable role of emerging economies in inflating the world’s asset prices (though to be fair, said economies were awash in private capital flows from more developed nations).  And while emerging countries were stung just as hard (if not harder, due to capital outflows) as developed ones from the crisis, their long-term fundamental health is not questioned.  Among other changes which will be evident in international finance’s new paradigm, notes Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, the bond investment manager, is that “multiple growth engines, largely from the developing world, will replace the single engine of growth of the US-centric twentieth century.”

One change G20 countries would like to see is a draw down on those very reserves that flowed so freely during the boom times, depressing yields even as interest rates continued to be slashed.  The Economist writes this week, for instance, that the IMF’s resources will be increased by $500 billion to $750 billion, and that it will be allowed to issue $250 billion-worth of its own quasi-currency, the Special Drawing Right (SDR), to ease liquidity in emerging and developing economies.  In essence, the “fund wants to provide crisis insurance to large emerging economies suffering a temporary loss of liquidity but with basically sound policies.”

The creation of a beefier but gentler IMF will give emerging economies a credible alternative to the practice of building up enormous foreign-exchange reserves. Many countries have done this in the past decade to protect themselves against fluctuations in capital flows or commodity prices. Given the opportunity to insure with the IMF, countries should have less need to insure themselves with vast reserves or to arrange large bilateral swap lines. When emerging economies have reserves worth several hundred billion dollars each, the IMF could not possibly have provided a credible alternative to self-insurance with a kitty of no more than $250 billion.

Yet skeptics worry that the social and political stigma that is (understandably) attached to the IMF may preclude leaders from knocking on its door, even when times are tough:

An almost visceral dread of having to approach the IMF, especially after the Asian crisis, was at least partly responsible for the enormous build-up of reserves to begin with.

Yet Mexico’s recent willingness to open a flexible credit line is perhaps a sign that said stigma has dampened.  Gabriel Casillas, an economist for UBS Pactual in Mexico City, said the IMF loan “will in fact increase the central bank’s foreign reserves, giving…more firepower to the Mexican monetary authority to stabilize the currency.  “In our view, this could make market participants concerns about Mexico’s foreign reserves level vanish completely,” Mr. Casillas said, adding that he expects the peso to surge against the dollar in the short term.