Tuesday, January 10, 2006

Is it any wonder international markets are going gangbusters -still?

Today's WaPo recaps a story that's been around for the past week or so:

SHANGHAI, Jan. 9 -- China has resolved to shift some of its foreign exchange reserves -- now in excess of $800 billion -- away from the U.S. dollar and into other world currencies in a move likely to push down the value of the greenback, a high-level state economist who advises the nation's economic policymakers said in an interview Monday.

As China's manufacturing industries flood the world with cheap goods, the Chinese central bank has invested roughly three-fourths of its growing foreign currency reserves in U.S. Treasury bills and other dollar-denominated assets. The new policy reflects China's fears that too much of its savings is tied up in the dollar, a currency widely expected to drop in value as the U.S. trade and fiscal deficits climb.

China now boasts the world's second-largest cache of foreign exchange -- behind only Japan -- and is on pace to see its reserves climb past $1 trillion later this year. Even a slight diminishing of the dollar as a percentage of those holdings could exert significant pressure on the U.S. currency, many economists assert.

In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower.

The comments of the Chinese senior economist, made on the condition of anonymity because the government disciplines those who speak to the press without express authorization, confirmed an analysis in Monday's Shanghai Securities News stating that China is inclined to shift some its savings into other currencies such as the euro and the yen, or into major purchases of commodities such as oil for a long-discussed strategic energy reserve.

Stephen Roach adds:

Globalization and the powerful cross-border labor arbitrage it has spawned has turned the US labor market inside out. The manufacturing share of US employment hit another record low as 2005 came to an end -- down to 10.6% of total nonfarm payrolls, or about one-third the share prevailing as recently as 1970. At the same time, employment and compensation is being squeezed in services as well, where offshore outsourcing is moving rapidly up the value chain. The speed of this transformation is what’s so daunting. Just five years ago, white collar outsourcing was confined to data processing and call centers; today, courtesy of IT-enabled connectivity, it has moved to the upper echelons of the knowledge-worker hierarchy -- software programming, engineering, design, doctors, lawyers, accountants, actuaries, business consultants, and financial analysts. The Internet is living up to its reputation of being the most disruptive technology in the history of the world.

The implications of these developments are profound. Long lacking in income support, the spending-addicted American consumer has turned to equity extraction from asset holdings in order to support the habit. According to Federal Reserve estimates, the current pace of home equity extraction was around $600 billion in 2005 -- more than enough to compensate for the $335 billion shortfall of real labor income generation noted above. But if the housing market softens and financing costs rise -- both quite likely, in my view -- equity extraction will fade and over-extended American consumers will then have little choice other than to bring spending and saving back into more prudent alignment with income.

That underscores the potential for a long-deferred and important transition in the US -- away from the newfound joys of the Asset Economy back to the Income Economy of yesteryear. Such a transition undoubtedly spells slower consumption and real GDP growth over the foreseeable future -- a downshift that may already have triggered a slowing in the underlying pace of hiring over the past four months. In that context, further tightening would most likely be out for a deflation-phobic Bernanke Fed, bonds should rally, stocks could be hit by an earnings shortfall, and the dollar will likely fall further. Only a spontaneous and powerful regeneration of labor income would allow the US economy to avoid such an endgame -- an outcome that would imply nothing short of an unwinding of the global labor arbitrage. Barring a dangerous outbreak of protectionism, such a reversal is highly unlikely, in my view.

Globalization imposes a new paradigm of competitive survival on the high-cost developed countries of the world. America, with its open and flexible system, is on the leading edge of feeling the heat and responding to these competitive pressures. It’s not just jobs and real wages, but also the legacy costs of healthcare and pensions for retired and existing workers. Recently, IBM and Verizon joined the ranks of those in Corporate America who have frozen pension benefits. There can be no mistaking such telltale signs of the global labor arbitrage: Companies in high-wage economies see little choice other than to rewrite social contracts as the means for competitive survival. For the United States, it’s the end of labor as we once knew it.

Now I for one think the US needs a definite industrial policy; which, outside of banking, and the organizations like the FAA and FCC with inherent conflicts of interest, doesn't really exist.

But that's not going to happen until people a lot more left then the current bunch gets into power.

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