Gold is through $700 an ounce for the first time in a quarter of a century.Platinum prices have gone through the roof. Copper is now so expensive that the metal in a two pence coin is now worth three pence. Oil is trading at between $70 and $75 a barrel. Stock markets in New York and London are at their highest levels in six years. The MSCI — an index of 49 stock markets in 49 developed and developing countries — has hit an all-time peak.
But beware, it is a time of extreme danger for the unwary, with all the sadly familiar tell-tale signs of trouble ahead. There is the sense of supreme optimism that this time the permanent bull market is for real. There is always a reason why it’s different this time, and this time that reason is China.
Then there is the tendency to put the best gloss on what, on the face of it, looks like poor news. As such, the United States is not really running a trade deficit of 7% of gross domestic product (GDP), because ”dark matter” is boosting investment income, but not being captured in the data.
Similarly, when US house sale figures were announced last month, all the attention was on the number of homes sold being ”better than expec-ted” at an annualised 1,213million. Only a few analysts raised an eyebrow at the fact that developers had to cut prices by $15 000 a house to drum up business. Though that was good news for the 100 000 families that snapped up a bargain, it was less welcome to the 100million owner-occupiers in the US who saw the value of their assets tumble. Particularly, when tens of millions of them have been re-mortgaging their properties, adding to their debt levels, to maintain consumption patterns.
But, as Nick Parsons of Commerzbank — one analyst who did argue that the US housing market may not be in quite such good shape as the consensus thinks it is — noted: ”When you see the post-data headlines, remember always that no major US bank/builder/-mortgage lender/-federal agency or Fed official has any interest whatsoever in putting anything other than the most favourable gloss on the numbers.”
Finally, even those who have been issuing dire warnings about the horrors to come capitulate to the idea that a ”soft landing” is the most likely outcome. In that respect, the change of view by Stephen Roach, Wall Street’s most influential bear for the past five years, was significant.
Roach has not had a change of heart: his analysis is more nuanced. He still believes that the imbalances in the -global economy are serious, but is now more confident that a new spirit of international cooperation — seen at last month’s meetings of the International Monetary Fund — can prevent a hard landing. We have yet to see what happens now the fund has powers to conduct multilateral surveillance of the global economy and make recommendations for key countries. Yet, even if demand is rebalanced so Americans save more and consume less while the Chinese and the Europeans spend more, it is not obvious this can be achieved without difficulty.
That’s not to say the US economy is about to face a prolonged, let alone terminal, crisis — evidence shows that the world’s biggest economy recovers from setbacks quickly — nor that China’s growth is over. It is far more likely that any crisis there will be akin to the short, savage downturns that affected the US when it was growing fast in the 19th century, and rapid growth will then resume.
But optimism about the long term should not disguise the fact that the short-term outlook appears challenging. It’s hard to convincingly argue that the imbalances will be resolved in an orderly manner, even with the unprecedented level of international cooperation.
Clearly, any reduction in the US trade deficit will require a fall in the dollar and a concomitant rise in the Chinese yuan. Yet, as Professor Wynne Godley of Cambridge University and others have shown, the scale of the dollar depreciation required to bring the US trade deficit to manageable proportions (say 2% to 3% of GDP) by boosting exports would have to be massive.
The US Federal Reserve’s hawkish comments when it raised interest rates to 5% last week suggest that it is already concerned about the impact a cheaper greenback is having on the cost of imports when inflation is already more than 3%. The Chinese are not keen on seeing the value of the yuan rise much, hence the increasingly hostile language on Capitol Hill.
In truth, the US trade deficit is merely a reflection of the real problem: debt-sodden American households. There are several ways this can be illustrated. One is to look at the personal savings rate, which last year was negative for an entire year for the first time since the Great Depression. Another is to look at the balance sheet of the household sector. The latest figures suggest it is in deficit to the tune of more than 6% of gross domestic product.
Predictably, there are those who say things are not as bad as they look, and that if you add in capital gains from rising house prices and the stock market, the savings of US households are in far better shape than the raw data suggests. This is dangerous nonsense. As Brian Reading said in a Lombard Street note last week, asset prices in themselves do nothing to increase a country’s national income; only production does that. Homeowners become better off but, if national output is unchanged, people who don’t own houses are worse off. The net effect is zero.
It is worth wondering what the new spurious excuse will be now that house prices have ceased to rise. Households have been remortgaging at higher rates, wages are not rising very fast and disposable incomes are being squeezed by higher inflation and the sharp rise in energy costs. With the Fed seeking to underpin the dollar, all the ingredients are in place for a -savage retrenchment among US households.
This precarious state of affairs has been disguised by the strength of the US corporate sector, which has been expanding strongly. But the optimism in boardrooms would be quickly dented if consumers stopped spending.
If the US consumes at a slower rate, China will produce at a slower rate. That means commodity prices are likely to come down, oil is more likely to be $50 a barrel in a year’s time than $100 a barrel and the dollar is a sell.
And for anybody thinking of melting down a tonne of copper coins: don’t. It’s illegal, and by the time you find enough small change, it will be too late. — Â