SPEAKING
FREELY The US asset
catch-22 By Max Fraad Wolff
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The past four weeks
have demonstrated the continued existence of
gravity in global financial markets long
unfettered by shifting realities in the
risk-reward environment. The international market
downdraft that began on May 22 signaled the
presence of linked fears and risks.
Sadly,
however, the context is changing but the responses
are not. US dollars and markets remain the gold
standard. Scared of the precarious nature of
global imbalances centered on US consumption and
rising interest rates, why would rational
investors retreat to the United States? Downdrafts
of this variety
are
not productive. These re-pricing episodes don't
signal new thinking or positioning - a crucial
point, because the arrival of new thinking and
understanding would be required for a long,
tempered and transparent unwinding of the current
imbalances.
Asian central-bank cash, UK
area funds and petrodollars still find their way
into US assets far more than prudence would
suggest. Commodities take a hit and send people
running for the safety of their default buys.
Emerging markets come in for a round of selling on
declining loose money from the US Federal Reserve,
the European Central Bank and the Bank of Japan
and decade-overdue fears about US weakness.
If these factors are the reason money is
being scared out of these markets, then what is
sending money running to US assets? The United
States borrows about 80% of the world's excess
savings, so who is most vulnerable to rising
rates? This is the catch-22 of asset markets
today. Decision makers seem to have taken in the
dependence of present asset prices on loose money
from leading central banks. When pressed, they
found nothing new to buy, so they simply ran to
the usual risk exits.
This standard
reaction is occurring despite changes - still
being ignored - in global asset markets. China
sits vulnerable to a US consumer slowdown and
inflated raw-material prices, but its growth
remains robust. India is struggling toward growth
despite energy and infrastructural risks worthy of
concern. South America is pursuing alternative
development paths 20 years into the sorrows of
ill-shared and inadequate gains from orthodox
economic policy. Asia sits ready as the world's
emerging workshop with inadequate domestic demand
and a still-heavy export dependence on legions of
broke American consumers. Materials and energy
exporters have coffers bloated from robust demand
and high prices.
What exactly, about any
of this, justifies running for Treasuries? The
truth is, driving this illusory "flight to safety"
is little but pure force of habit, and continued
neglect of structural shifts in the global
economy. Global investors will not move forward
until they question past practice in the light of
new information.
New realities suggest
that Treasuries are not the flight to safety they
once were. Aging demographics in the developed
world push serious money into "safer"
long-maturity sovereign debt. US interest rates
are higher than EU area and Japanese debt. None of
this explains rapid shifts or flight money, only a
slow, steady market based on fixed-income
reallocation. US debt prices are high and rates
fairly low, particularly if one factors in the
possibility of serious attempts to defend the
dollar. Yet we see retreat to these assets during
stress periods, despite known risks and clear
overweighting in them. For the legions of offshore
buyers this is compounded by the prospects of
further losses for the dollar.
The US
scene is defined by overdue cooling in profit
growth, a need to raise rates into a fragile
housing market, and a mutually exclusive impulse
to defend overvalued and overheld greenbacks.
S&P 500 profit growth has been stellar -
roundly double-digit - for three years. Even if
this remains true through 2006, it is unlikely to
last for much longer. These earnings are based on
international as well as domestic earnings, and
are a dismal proxy for US macroeconomic health.
The comparisons are getting harder and the
consumer binge is audibly wheezing as housing
cools. The slashed 2006 forecast of top
luxury-home builder Toll Brothers speaks volumes
to this emerging reality, independent of April's
strong housing numbers. Consumer spending simply
cannot grow much more. Personal consumption
spending again outpaced income in March and April,
with savings rates of minus-1.4% in March and
minus-1.6% in April. Even if rates are done
rising, the process of adjustment and the
filtering through of past rate hikes will weigh on
borrowers with no budget slack.
This is
the catch-22 in US economic policy. How can the US
defend an overvalued dollar while holding down
spiraling trade shortfalls and prevent housing
from a long-overdue reversion to trend - negative
growth? What conceivable policy will allow the
dollar to stay strong, imports to be reduced,
exports to grow and interest rates to stay low?
The quick and dirty answer is that at least one of
the above goals will prove beyond reach.
Many years of consumption that exceed
earnings and an upward redistribution of wealth
form the foundation of America's position in a
world of imbalance. Congressional Budget Office
data suggest that real after-tax income growth
from 1979-2003 averaged just over 10% for the
bottom three quintiles, or 60%, of the American
public. For the top quintile, growth stood at 54%;
for the top 1%, it averaged 129%.
From
1980-2005, real personal consumption outgrew gross
domestic product growth and wage growth in the
United States. Rising asset incomes and values,
falling savings and ballooning debt generate those
GDP and profit numbers that generate endless
positive buzz. Consumption's share of US GDP has
marched upward as consumption-related employment
growth moved up to account for more than 60% of
employment growth. Federal Reserve statistics
reveal a 723% growth in household debt 1980-2005.
Growth around the world has much to do
with US consumption. All this is funded with
massive capital importation, which supports
dollars and asset prices. The US and the broader
world economy have become dependent on this
unsustainable dynamic, and the bubbles that arise
from increasingly desperate loose-money efforts to
extend it. When spooked by recognition of such
risks, why should investors run to the safety of
dollar debt?
The US has become a leveraged
eating machine consuming imported goods and
capital with reckless abandon. The world has put
its stock in the US to cash in and support the
splurge that debt and redistribution built. Hence
a reallocation to US assets is only a temporary
shelter offered by flight into the eye of the
hurricane. Until there is a sea change in
perspective, retrenchments will prove short-lived.
The catch-22 facing the world involves
exposure to the United States' debt-driven
consumption and dollar-denominated assets. This
so-called flight to safety is dangerous,
exacerbating the very structural problems that
generate it. The present arrangement is rendered
more precarious by the increasingly bellicose,
unilateralist and protectionist bent of US
politics.
No one sane and independent
wants the present conditions to persist. However,
no one can conceive of an adequate replacement
structure. That is the central catch-22, and what
leaves us weary of short and shallow downdrafts
seen as restructurings. Knee-jerk responses that
deny massive flaws in the current system offer
false comfort.
Max Fraad Wolff
is a doctoral candidate in economics at the
University of Massachusetts, Amherst and managing
director of GlobalMacroScope. This work was
written for www.GlobalMacroScope.com.
(Copyright 2006 Max Fraad Wolff. Used by
permission.)
Speaking Freely is an
Asia Times Online feature that allows guest
writers to have their say. Please click hereif you are interested in
contributing.
