scenario is not
likely, therefore the US will have to endure a
painful recession all alone.
Readers
looking at this week's mild recovery in asset
prices should be cognizant of this risk. I expect
further downturns for US equity markets in coming
weeks and months; it is likely that the widely
watched Dow Jones average will close this year
below the level of 10,000 from about 12,200
currently as investors adjust downward their
earnings expectations as well as the multiple of
earnings they are willing to
pay for owning shares. In turn, this would prompt
declines in other stock markets around the world,
particularly in South America, whose economy, if
not its politicians, depends almost entirely on US
economic growth.
Why the US will stand
alone In past crises, such as the 1987
stock-market crash or the recession in the early
1990s that sank the administration of president
George H W Bush, the US could depend on the
munificence of strangers. In particular, the
world's sole superpower attracted enough money
from risk-averse investors to refloat its economy.
That time has, however, come and gone as
developing countries no longer "need" to buy US
government bonds. Indeed, as I argued in a
previous article, [3] they are better served by
investing in physical assets such as commodities
directly rather than diverting their savings to
the low-return US markets.
In addition to
the economic rationale of protecting their own
growth, the world's investors are also not
interested in US assets for political reasons. A
quick look at the world's largest repositories of
savings shows the extent of the problem: Middle
Eastern investors will buy anything as long as it
is not American, while Asian investors are likely
to be scared off by recent losses on mortgage
holdings. Other countries such as oil-rich
Venezuela and Russia explicitly use their reserves
as diplomatic tools.
With friends like
these ... Perhaps a diversion to consider
the fragile reputation of America's politics is
necessary here. The lost war in Iraq has failed to
make the US government honest - indeed, the
opposite appears to have happened. Like an
alcoholic on the run from his treatment clinic,
wrecking drink cabinets, Vice President Richard
Cheney stomped into the capitals of US allies as
the unapologetic face of the most unpopular US
administration in recent history.
In so
doing, he caused more damage to America's friends
than its enemies could possibly inflict in a
one-week window. To name just two, Cheney's visit
has virtually guaranteed Prime Minister John
Howard's re-election defeat in Australia, [4] and
rendered precarious the position of Pakistan's
unelected President General Pervez Musharraf, who
had the indignity of being admonished by the
petulant "veep".
At home, the conviction
of Lewis "Scooter" Libby has added another layer
of concern for the besieged White House, while the
poor treatment of its war veterans in hospital
will likely depress even diehard Republicans. That
leaves the field wide open for a Hillary assault
on the presidency next year. I expect that on her
way, Senator Clinton will put into play everything
that the Republicans stood for, including free
trade and a measured approach to China.
This is where the Asian response becomes
critical. Expecting no help from the American
consumer is one thing, but also to confront
political assaults is an entirely different
matter. The upshot is that Asian countries will be
forcefully cajoled into allowing their currencies
to appreciate against the US dollar in coming
months, with people like US Treasury Secretary
Henry Paulson urging action (as he did this week)
sooner so that these countries do not have to
confront something worse later on, viz a Hillary
presidency.
China has the most to lose
from a currency appreciation. In addition to the
accounting losses on its foreign-exchange
reserves, the country will also have to set aside
money to rescue its banks, whose bad debts will
mount precariously when the economy suddenly
lurches from export orientation to domestic
consumption. The only reason to rush this through
now is that waiting a few more months would make
the eventual impact worse for both the US and
China.
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