February 11, 2004

Short Term Logic

"The world's exchange system should be regarded as completely out of control." So says Lord Rees Mogg in the weekly missive below. I think he's spot on, as the English say. I'll have more to say about it in a different post, looking specifically at Chinese and Japanese currency reserves. And by the way, thank you for all the suggestions on what to call Lord Rees Mogg's weekly contributions. I especially liked Rees-Blogs. Short Term Logic by William Rees Mogg 12 February, 2004 The G7 meeting at Boca Raton has been a failure. This is bad news for everyone. It is bad news for the United States and has been followed by a further fall in the dollar. It is bad news for Japan, which has been buying vast numbers of dollars in order to stabilise the yen. It is bad news for China, under ever greater pressure to revalue or float the renminbi. It is bad news for Europe, with an overvalued euro and a depressed domestic market. It is bad news for Britain, with the pound at its highest rate against the dollar for eleven years. As the G7 communiqué piously observed that “excess volatility and disorderly movements in exchange rates are undesirable for economic growth”, the markets have already given the G7 a massive snub. Some dealers had hoped that the G7 would at least take the pressure off the dollar for a few days. What has actually happened has made the world’s central banks look completely impotent. As their authority is essential to their effectiveness, they have lost their most powerful weapon. The world’s exchange system should be regarded as completely out of control. One view is that the dollar is a problem for everyone else except the United States. So long as the Asian countries lend billions of dollars to the United States, it is possible for the U.S. Government to run the double Budget and trade deficits. And finance them by their borrowing. It is possible for American consumers to continue to buy on borrowed money. This is short term logic. At some point the American economy will have to be brought back into balance. That point is probably closer than most of us think. Whoever wins the Presidential election will have to try to restore the balance of the Budget in the difficult post-election year. The continued decline of the dollar does, in any case, threaten the re-election of President Bush. The Democrats seem to have found their most “Presidential” Presidential candidate in years. Senator Kerry is a war hero with the best senior statesman’s profile in the political casting lot. He seems already to have a united party behind him. He will carry New York and California in November. He could win, and he will win if the American voters believe that the Bush administration have lost control of the economy. As the G7 plainly has lost control of the world’s currency system, American voters could well decide that the U.S. economy was in trouble, even if employment remains high and growth is maintained. Both economics and politics are ruled by expectation, as the Austrian school of economists pointed out. Prosperity is how the economy is doing today; expectation is how the economy is expected to do next year. When the dollar is at $1.27 to the euro, $1.87 to the pound, and only buys 105 yen, one does not need to ask what the expectation is. The markets are telling us that there is trouble on the way, and the trouble is not good news for the re-election campaign. ###


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