Sometimes the future catches up with the present faster than we originally had anticipated. A couple of years ago we had suggested that a time would come when the US Federal Reserve would be in bit of a bind, as domestic pressures were for interest rates to move downwards, but external pressures would be for interest rates to move upwards. In our original thinking, we foresaw this happening in the time frame of about 2009 to 2011, and we viewed it as part of a much larger and much longer term realignment of the world economy.
An interesting article in the Wall Street Journal caught my attention this week (see article) as it suggested that the conundrum to be faced by the Fed had, actually, happened a couple of years earlier than we had anticipated. This position was supported by The Economist, which has a nice little graphic that captures the situation (see article).
We are starting to live in interesting times! It was more than coincidental that the sell-off last week was caused by a minor official in the Chinese Government thinking aloud about the diversification of the currency reserves away from a depreciating currency (i.e. the US Dollar). In this area, we have two key milestones. The first is the composition of the East Asian currency reserves. The second is the destination of the Petrocurrency surpluses. In recent months, both have been away from the US Dollar, which has created the bind that the US Fed faces.
It could be that other OECD members might act in concert to support the US Dollar, by why should they? Open market operations to support the US Dollar would effectively export inflation into the Euro and Sterling zones. It would help the US if the Sterling and Euro nominal interest rates were to fall faster than the fall in the Dollar interest rates, but monetary conditions in Europe do not warrant such a move.
From a longer perspective, we can now visibly see the wealth and influence of the US flowing out of the country and into China, Japan, South Korea, Russia, and the EU. Every time a US citizen fills their car with petrol, money and influence flows out of the US. And yet, such is the disconnect that the US voters have not seen this linkage. Mere rhetoric will not restore influence to the US. It will take actions such as the conservation of energy and the restoration of production over consumption to restore the US to its position of primacy.
As we look at the candidates to be the next US President, we cannot but help thinking that the mediocrity of the Clinton years and the disaster of the Bush years are not likely to be turned around by the next incumbent. For this reason we are still bearish about the US, and we wonder if the US Dollar might have a long way further to fall.