G-7 Economies in Crisis

July 8, 2011

The euro area’s sovereign debt crisis began in mid-November 2009 when Eurostat, the EU statistical agency, revised Greece’s fiscal deficit sharply higher.  The crisis has been a tale of contagion to other peripheral members of the common currency area, repeated aid packages to cauterize the problem, sky-high peripheral bond yields, and the mounting belief that defaults will be unavoidable and that all solutions will fail if they do not include the exit of Greece and perhaps other members.

The United States has a busted labor market.  The country had 1.03 million fewer jobs last month than ten years earlier in June 2001.  The previous sequential ten-year intervals saw non-farm payroll jobs increase by 17.3 million in the decade to June 1971, 20.2 million in the decade to June 1981, 16.8 million in the decade to June 1991, and 23.8 million in the decade to June 2001.  The narrowly and broadly defined rates of unemployment three and a half years after the onset of the recession are at 9.2% and 16.2%, respectively.  The number of hours worked per week is falling, and earnings are anemic.  Conditions became much worse in May-June.  Overall jobs rose 21.5K per month in that period, down from 215.3K in February-April, and private-sector jobs went up 65K per month, a quarter of the pace in the prior three months.  The magnitude of this wholly unexpected deterioration is similar to what surrounded the onset of the Great Recession that saw the change in jobs swing from +101K per month in the final quarter of 2007 to a drop of 47K per month in the first quarter of 2008.

Japan never recovered from its earlier financial debacle  that began twenty years ago.  Real GDP in the world’s third-largest nation-state economy contracted 1.0% over the past year and expanded at a 0.8% per annum pace over the twenty years between 1Q91 and 1Q11 versus growth of 4.6% per annum in the prior decade between 1Q81 and 1Q91. One still cannot wave the all-clear flag on Japanese deflation.

Britain’s economy failed to grow on balance between 3Q10 and 1Q11 and advanced just 1.6% over the past four reported quarters when personal consumption and business investment dropped by 0.3% and 0.2%.  The U.K. has seen higher inflation than the other areas, reaching 4.5% in the year to May and projected to touch 5.0% later this year.

This is no longer the early stage of cyclical recovery, which began about two years ago.  Balance sheet adjustments are the great counter-weight that continues to slow rates of recovery.  Bloated public sector deficits in the above economies are in large part derived from excessive private debt that built up earlier.  When the latter crashed and burned, tax revenues plunged, and governments stepped into the breach to prevent a meltdown of unthinkable dimensions in the world financial system.  Fiscal policies are now in crisis everywhere, and much deeper government cutbacks than seen thus far are coming and will augment private sector balance sheet adjustments to keep growth rates too slow and unemployment too high.  Optimistic spinsters point out that all this is a normal occurrence for recoveries that follow financially caused recessions.

Democracy is on trial, as the disarray has been complicated by the inability of political leaders to separate near-term growth needs from unsustainable long-term trends that must be addressed with structural changes.   It’s hard to lead when the masses are protesting in the streets, and it’s naive to expect actions in the best collective interests of nations when policymakers are bankrolled by wealthy special interests and in politics because they believe foremost in untested ideologies.  The uncertainty factor that many blame for the sluggish recovery is over-rated.  Today’s myriad of problems in the advanced economies can play out in countless ways, but the breadth of dysfunctioning systems, severity of the needed adjustments, and polarization of politics point compellingly to an unhappy ending.  Investors are unnerved not because the future is uncertain but because it is bleak

Into this mess, bets have to be cast on which currencies will perform best and which are liable to do poorly.  The euro crisis has taken Europe’s currency down a few notches. Since mid-November 2009, the euro has lost 20.7% against the Swiss franc, falling at an annualized rate of 13.2%.  Sterling has performed just as badly as the euro against which the pound remains at its starting level.  In fairness to the euro, it was trading at a very elevated $1.4973 when the Greek deficit revelations were made public some 20 months ago.  The DEM 1.3062 translation value of the euro then was 3.0% stronger than any level actually reached by the German currency prior to 1999.  Against the dollar, the euro has on net lost just 4.6% or 2.8% per annum through these twenty months of ever-deteriorating fiscal prospects and tensions in the euro area.  

The euro has shown less resilience against currencies associated with fairly balanced public finances.  The aforementioned Swiss franc is one example.  Another is the Swedish krona, which is worth 11.4% more against the euro now than at the start of Euroland’s crisis; that’s an annualized advance of 6.8%.  By far, Japan has a larger debt-to-GDP ratio than other G-7 economies and the whole euro area, but with a gain against the common currency of 15.9% or 9.4% per annum, the yen also has out-shined the dollar and sterling over the past twenty months.  A disproportionately large share of Japanese public debt is held domestically, and that economy runs a chronic current account surplus that contrasts with the U.S. and British deficits.

The dollar’s difficulties reflect reserve asset diversification by big holders of wealth and the fate of any currency hegeman on the downhill slope.  The U.S. currency is presently 16% weaker against the euro than its average value over the 12-1/2 year life span of the common currency.  On my first day as a currency market watcher in late-March 1975, the mark, yen, and pound were trading at 2.3463 per dollar, 293.8 per dollar, and $2.4090.  Those levels represented a change over the prior ten years of -41.1%, -18.4%, and +16.1%.  I’ve subsequently seen the dollar slide against the synthetic mark and yen by an additional 41.5% and 72.6% and climb another 50.0% against sterling.  Britain had been the world’s military and economic superpower before America, and sterling was the planet’s most important paper currency, a role that naturally generated abundant offshore holdings of British pounds.

Currencies embody the present value of a nation’s future power in all senses of that term.  After spending unchallenged time at the top of the currency market pyramid, it’s difficult to avoid long-term depreciation when the relative image shows scratches.  Sterling is ahead of the dollar in this progression, and the dollar needn’t lose as much stature as the pound.  People are worried about whether America’s best days lie behind it, but the pertinent comparison is how the United States stacks up against other nations.  To stay on top, the U.S. will need to out-innovate other economies, and its slower growth of jobs and GDP this past decade suggest that America isn’t matching earlier periods in the quantity and quality of its innovations. 

With the euro’s very integrity in doubt, the dollar really ought to be doing better.  The most useful and telling currency information is often contained in the market’s response to news rather than in the details of the news or one’s interpretation of the numbers.  When discrepancies exist, it’s time to think outside the box.  One omen is that the United States can no longer spare the economic resources to support its foreign policy interests.  Another surprise is that QE2 has ended without triggering a jump in U.S. bond yields.  The biggest U.S. economic problem, too little activity to employ its working population, is not getting addressed by the main policy priority, which is to slash the short-term trajectory of the federal deficit as soon as possible.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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