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Key News

  • There’s no impulse to buy back euros when the Irish/German, Portuguese/German and Spanish/German 10-year govt bond yield spreads have all widened. (Reuters)
  • Euro zone economic sentiment improved marginally in June after falling sharply in the previous month, as fears eased over the currency area’s sovereign debt crisis. (Reuters)
  • Japan’s industrial output fell 0.1 percent in May and shipments fell by the most in more than a year, suggesting that the benefits of a rebound in exports to fast-growing Asian economies may be moderating. (Reuters)


“In every particular state of the world, those nations which are strongest tend to prevail over the others; and in certain marked peculiarities the strongest tend to be the best.”

                          Walter Bagehot

FX Trading – Goldilocks sees her shadow.

Typically when Goldilocks emerges from her bunker, sees her shadow, and returns to the bunker, we can expect six more weeks of recession. But I’d suggest she re-stock her canned foods supply – she could be in there a while.

Catching a glimpse of Goldilocks yesterday gave me a bit of hope. US consumer spending increased again, though slightly slower than the previous month. Personal income rose; disposable income rose; and savings as a percentage of disposable income rose.

Not a bad day.

I keep saying Goldilocks because a report like this pretty much represents the best of both worlds: the government has been focused on getting the US consumer to spend while the US consumer has been focused on deleveraging and saving money. Having the two occur simultaneously is sweet music for the US recovery.

And if the trend continues then we’re in pretty good shape. Unless, of course, the recovery is headed off at the pass by public stimulus efforts and pesky deficits. But let’s leave that alone for now.

We’ve talked about global imbalances. And we’ve talked about how they might imbalance with European growth tanking, the euro tanking and the appeal of then running current account surplus growing. Here is some additional insight from Richard Alford:

In addition, US-based macroeconomists and policymakers are now focusing on and criticizing proposed fiscal austerity in Europe. Their concern is not solely with European economic performance per se. Among their concerns is the perceived impact that European austerity would have on US economic performance. They view demand and income growth in Europe as the means by which the US will reduce its current account deficit. There is little or no mention of any need for the Euro, the Dollar, or any currency other than the Yuan to adjust to promote or support the rebalancing.

These positions reflect interesting wrinkles in US economists’ and policymakers’ mind sets. They are a variant on the old US policy position first espoused by the then Secretary of the Treasury John Connolly: It’s our currency, but it’s your problem. The current version is: It’s our current account deficit, but it’s your problem. Alternative wording of the revised up dated Connolly doctrine: If the rest of the world will just pursue expansionary fiscal monetary policies, then the US can avoid having to choose between austerity and unemployment on the one hand or further increasing unsustainable deficits on the other.

What I’m getting at here is: it may take more than demand from Europe and current current account surplus nations for the US to experience sustainable growth. (The US-tone at the G-20 this past weekend was characteristic of this idea: get other countries to support their economies with stimulus spending because that would help support the US.) In other words, the US needs to spur domestic demand to complement its efforts to grow exports.

Back to Alford (my emphasis):

Calling on our trading partners to increase demand and their imports from the US will not narrow the trade deficit unless there is a narrowing of “the difference between net domestic savings and net domestic investment…”, but US domestic economic policy is not supportive of the required domestic adjustment. Continued deficit financing of stimulus packages widens the difference between net savings and investment. Monetary policy is also geared towards increasing consumption and reducing private savings.

Alford again:

The relative downplaying of the importance of exchange rate adjustment in addressing the US trade imbalance is also troubling. If the US is to correct its external imbalance, resources (capital and labor) are going to have to be reallocated to the production of tradable goods and services. In the absence of Dollar exchange rate adjustments, it is difficult to see reasons why the US economic agents would move into the tradable sector.

Sure, the exchange rate can play a role. But the current value of the US dollar is such that it won’t alone prohibit a move into tradable goods. (Note: the make-up of these tradable goods is important, as the US will not be looking to compete with the low-value stuff we’ve see overflow from China et al.) In fact, the accompanying capital inflows of a strengthening dollar, combined with increased savings, will support the move into production of tradable goods and services.

Basically, we need Goldilocks to stick around for a while. That way we can see the gap between net savings and net investment narrow … with an increase in savings. And we can see domestic demand support our goal of reducing our current account deficit … with an increase in spending.

But we also can’t have the deficit spending and super-lax monetary policy steering the economy back to “business as usual” — bubble-inducing booms and bubble-deflating busts. Capital simply will not reach the desired, sustainable destination if it’s steered by that uncomfortably familiar scenario that created global imbalances in the first place.