Nine Global Macroeconomic Trends: Watching the Currency Speculation, Watching the Inflation Pot Boil

  1. This piece is a little dated, but I’m using it to illustrate the nature of consumer surveys in the US.  If rates have been rising, those polled extrapolate the current trend.  As it was, that particular poll was close to the short-term turning point on inflation expectations.  I feel more comfortable trying to tease out inflation expectations by looking at the relative spread of TIPS to nominal bonds.  Right now, that’s not moving much.
  2. I’m already on record that I don’t like the concept of core inflation, and that I think current methods of measuring inflation understate it, though now I would say only by 1%/year.  But regarding core inflation, there are many who say there are better ways to remove volatility from the estimation of central tendency.  Use of a median or trimmed mean are superior methods to excluding whole classes of goods, like food and energy, which conveniently have been rising faster than most other good in the CPI.
  3. Inflation is rising in many places.  New Zealand is one example.  This is one of those temporarily self-reinforcing situations where foreign investors are willing to invest because of high nominal rates, while discounting any possibility of the currency moving against them.  In the short run, the more people who believe this, the less likely that an adjustment occurs.  But the additional liquidity stimulates the economy, raises inflation, and makes the central bank want to tighten more, leading to higher rates in which foreign investors want to invest.  It will only break when the high rates slow the NZ economy to a crawl, or, for some unexpected reason, the currency starts depreciating, and it feeds on itself.  Personally, I would not be long the Kiwi.
  4. The Economist has noticed many of the same trends, adding in Latvia and Iceland to NZ.  In the short run, so long as foreign investors have confidence in the currencies of these three nations, their central banks are impotent.  But in some sort of crisis that would disrupt global capital flows, all of these currencies would be at risk.  No telling when that will happen, but once the adjustment happens, like those who borrowed at teaser rates, they will be sorry they invested in high interest rate currencies, and borrowed in low interest rate currencies.
  5. China.  Easy to underestimate.  Easy to overestimate.  Hard to get a fair picture.  Their Central bank keeps tightening, but doesn’t let the currency adjust upward.  As a result, inflation keeps rising there… too much credit is chasing too few goods produced for domestic consumption. (Diseases affecting pigs, and high grain prices don’t help.  Food is a larger portion of the budget of the average person in China.)  Exports dominate Chinese economic policy, and with an dirty-floating undervalued currency, trade surpluses build up almost everywhere, except the Middle East and Japan.  The Chinese economy keeps rolling ahead, growing at near-record rates if you can believe the statistics.  (Which I largely believe, the current account surpluses don’t lie.)  That has costs, though.  There are costs to the environment, food safety, working conditions, etc.  The communist party has in some ways transformed themselves in a bunch of crony capitalists.  Those at the top get the favors, and the rest trickles down, but not as well as in the US.  In the short run, that can produce amazing economic results, but can’t produce a society that is truly creative, and self-sustainingly productive.  What will happen to China when it no longer has incremental cheap labor to deploy?  Productivity will drop?  Already I am hearing of some manufacturers decamping to Vietnam, and other cheaper places.
  6. The reported US Government deficit is shrinking.  Good as far as that goes.  Corporate taxes are filling much of the gap.  We still have the Iraq/Afghanistan Wars off-budget, and Social Security on budget, both of which reduce the true size of the deficit.  On an accrual basis, counting everything in, we are running deficits at near record levels.  Promises are being made for the future the aren’t getting counted today.  Corporations would have to accrue them, but the government does not.
  7. And now a word from our sponsors, the optimists.  Let’s start with the ISI Group.  They have ten reasons why we won’t have a recession soon.  I have been arguing for a recession in 2008, but as GDP growth remains positive each quarter, it gets harder to maintain that a recession is around the corner.  Though inflation is rising, credit spreads are widening, and the US Dollar is falling, the US economy has been resilient, credit spreads and implied volatilities have not been out of control.  And housing finance is not good, but most of the lending risk is concentrated in the hands of a few speculators.  The US economy is seeing export-led growth for the first time in a while.  There are reasons for optimism here; just because it is easier as a writer to be a skeptic and a pessimist, doesn’t mean you should invest that way.
  8. Why do I like most but not all emerging markets here?  They are better managed on both fiscal and monetary bases than many developed economies, and capitalism is finally becoming a sustainable ideology.  That’s why amid the rise in credit spreads for junk grade corporations here in the US, many emerging market spreads have tightened.  Going back to points 3 and 4 above, those that don’t have strong fiscal and monetary policies, like Turkey, may very well get whacked, after a disruption in capital flows, war, or some event that changed the willingness of investors to take currency or sovereign risk.
  9. What if we try to get away from currencies, and focus on commodities instead?  Metal scrap prices are robust.  Aluminum beer kegs are getting sold for scrap, among other things.  In another place, Historian Niall Ferguson tells us that we should not worry about running out of oil, but out of arable land for farming.  Personally, I’m not worried about either.  Rising food prices will slow the development on arable land, and in some cases, redevelop land for farming.  Further, contrary to the over-estimated Malthus (whose great contribution in life was giving inspiration to Darwin), we have been able to grow agricultural productivity considerably faster than population, in areas where capitalism is allowed to thrive.  That said, I am bullish on the prices of food products; in the short run, there will be more excess demand.