Stars and strife (archive)


Dollar thrill

  • Evan Davis
  • 29 Nov 07, 12:35 PM

For virtually my last excursion on this trip, I get into the dollar printing facility in downtown Washington DC.

evandollar.jpgAlthough we only get up close to one of the printing machines inside, it's still quite a thrill. Here I am with a pile of unfinished $100 banknotes.

There are only two of these facilities in the US, though they are capable of producing millions of notes a day. And it seems very different to the equivalent operation in the UK. We Brits print banknotes out in Debden in Essex, and have contracted it out to the private sector.

Here in the US it is a government operation right in the heart of Washington next door to the Holocaust Museum.

Now, the staff at the Treasury Department's Bureau of Engraving and Printing were very efficient and cooperative in allowing us in. They get nothing out of it (after all, they don't need TV publicity to sell their product).

But I detect a small amount of disappointment that we are using the facility as a backdrop to talk about the falling value of the dollar in the international currency markets.

I can understand why they might think the story is negative – people generally prefer strong currencies to weak ones. And the weak dollar reflects some of the current problems in the US economy (international investors have less enthusiasm for investing in the US).

And it is clear the BEP staff are like other Americans in becoming more aware their currency has fallen. In a country as big as this, people would be entitled to forget the value of their currency to foreigners, and yet people keep mentioning it.

They even make reference to the strong euro - a marked shift from previous trips, which sometimes left me with the impression the euro had barely dented the public consciousness.

But people here should not feel so negative about it. A weak dollar is not just a symptom of the problem; it is also possibly a solution. It provides a positive story in that it is helping the US adjust to a new phase in the economic cycle that places emphasis on exporting rather than importing, saving rather than borrowing.

In fact, the people who might need to worry most about how things are going are the Europeans.

Their currency is rising sharply against the dollar, and as a large proportion of the world ties its currency to the dollar, the euro is rising against other currencies too.

This is a bit of a pain.

There are a number of trade imbalances in the world, none more important than the trade deficit of the US. When that deficit is reduced, there has to be a reduction in some other countries' surpluses.

One option, which seems much the most desirable, is that the unsustainable US deficit is resolved by a reduction in the unsustainable surpluses of China and other Asian countries.

But the rising euro might mean that the US deficit is just transferred to Europe. The problem passed on, not solved.

It won't matter much to the Americans whether it is solved or transferred – either would be nice. But to create long-term stability, the rest of us should probably hope that the Chinese currency is allowed to rise further against the dollar, to ease pressure on the euro, stemming from the dollar's fall.

Of course, we are not going to get a complete end to the US deficit; and we are not going to get a US-sized deficit in the euro-zone, any more than we'll get US-sized portions of food.

But that is still quite worrying for Europe's economies, which for all their strengths, lack labour market flexibility. If there's weaker growth, it can quickly escalate into real economic woes.

I've spent a week here now, have spent the budget and am apparently expected to return home tomorrow. Maybe it is a good time: if we want to examine America's economic problems, Europe might be a good place to get a view of them.


Prompts v causes

  • Evan Davis
  • 28 Nov 07, 10:22 AM

I spoke to a second-hand car dealer today. A nice chap called Mike Navidi out in Arlington, just close to Washington DC.

evan_caroutlet.jpgApart from enjoying the chance to be simply amazed at how cheap his cars are ($12,000 for a neat-looking Mustang on the forecourt) I wanted to know how easily sub-prime customers were finding it to get car loans.

I was a bit surprised to hear that he still writes loans all the time, even for sub-prime customers, and that they rarely get turned down.

That could be seen as reassuring.

The great worry at the moment is that the credit crunch in the financial sector will lead to real economic problems as banks stop lending anymore. (That's what I was talking about in the blog yesterday in fact).

But my car dealer implied that's not been affecting him. It's not the credit crunch constraining credit.

So surprised was I, that I spoke to a second second-hand car dealer to get another opinion. He told me the same thing. He said you wouldn't get a sub-prime mortgage now, but you can still get a sub-prime car loan.

However, Mike Navidi was adamant about something... that even though credit was available, he's not selling so many cars. Not because people can't get loans, but because they don't want them.

This might turn out to be important. It might be that the credit crunch is not pulling the economy down by reigning in the supply of credit; it could be that it is simply the trigger to remind consumers that they need to reign in the demand for credit. After all, their balance sheets have suffered in the wake of housing market falls.

In this sense, one might view the credit crunch not so much as causing the problems, but as prompting them. A subtle distinction, I know, but an important one all the same.

A "prompt" launches something that you might have expected to occur anyway at some point.

A "cause" brings something about that would not have otherwise happened.

I'm not sure whether the credit crunch will turn out to cause problems or prompt them. It's worth us being wary of both, and it is possible it can cause and prompt at the same time.

But I'm perhaps increasingly thinking that the credit crunch has activated a big economic shift that was already waiting to happen, as unsustainable economic trends unravelled.

That has an interesting implication: we shouldn't just focus on the credit crunch, we should also look at the economic fundamentals.

And it also implies that although the credit crunch itself was not really predictable, all the big things apart from the credit crunch that are going on right now, could have been foreseen.

• Falling house prices in the US

• A falling dollar, leading to an improving trade balance

• Potentially slower consumer spending in the US

• Higher than expected sub-prime mortgage defaults

Just because we didn't know what form the crisis would take when the economy moved out of its unsustainable phase of low consumer saving and trade imbalances, does not mean we couldn't have known there would be big adjustments.

Being interested in why the world has apparently been taken by surprise at a turn of events that were to some extent inevitable, I asked the chief economist of the International Monetary Fund today, Simon Johnson, what he thought.

Of course he rightly made the point that no-one predicted the intensity of the credit crunch.

But he also made the point that there are lots of pieces of the crisis that you could have predicted individually, like the falling dollar, or falling house prices, or high oil prices, but not the confluence of different things that are going on simultaneously. (You should be able to hear part of that interview on Radio 4's PM programme, on Wednesday evening at 5pm).

For example, Mr Johnson argues that you might have predicted high oil prices, but not at the same time as a housing market correction. It's unusual to have a US recession threat preceding an oil price hike.

He might be right on these points. But the truth remains that when big economic shifts occur they sometimes tend to be a bit messy. And when things get messy, everything tends to get messy at the same time. Things that look unrelated, like the value of the dollar and the direction of house prices, suddenly seem related after all.

We probably ought to have known that.

We can be forgiven for not forecasting the time and the precise trigger for economic adjustment. We can't be forgiven for not realising that adjustment had to come.


Dow vs ABX

  • Evan Davis
  • 27 Nov 07, 01:20 PM

I'd say that the success of business television (CNBC and the like) in the US, is built on one fundamental insight by those producing it: if you can make it sound like sports coverage, then it feels engaging.

And we all know that Americans love their statistics - in sport, obviously. And in finance too.

Yet one of the problems in covering the sub-prime debacle is that the usual scoreboard measuring US financial health is the Dow Jones Industrial index. And although it has had its ups and downs this year, it really doesn't tell a very interesting story of near financial meltdown.

We need another way of scoring the financial sector, to better reflect the way the game is going.

With that in mind, I today went to get a lesson on the ABX indices. These have had some recent prominence in the financial pages and get mentioned on CNBC, but I'm surprised they haven't made it much beyond. Because if you think a financial crisis of the magnitude we have endured deserves graphs diving in a downwards direction, then the ABX is what you want.

There are lots of ABX indices actually, so take your pick. You can find them here.

I had them explained to me today by Robert Pickel, chief executive of the International Swaps and Derivatives Association. And I made sure we had a photo of a couple of the graphs so you can get the general idea.

Essentially, there is one index for each vintage of sub-prime mortgage backed assets; and there is one for each level of risk. So for example, there is one index for AAA ultra-safe sub-prime assets, from each half of both 2006 and 2007.


In the picture with my fingers in, you are looking at the performance of AAA securities, from the second half of 2006. In the picture without my finger, you looking at BBB- of the most recent vintage.

I won't go into much detail, suffice to say that the index is always constructed to perform like a bond price, so that par value is 100. Expected defaults in the assets underlying the index lead to prices below 100 (but you can't read the value of the index as a percentage default rate; it's more complicated than that).

But there are two fascinating things about ABX.

First is the rating of those AAA ones. They were worth about 100 until May and you can only describe the performance since then as a crash.

Yes, a crash.

And secondly, it is noteworthy that the 2006 mortgages seem to perform better than the 2007 ones. The longer the sub-prime boom went on, the more reckless was the lending and the higher the expected defaults.

So the first AAA index from early 2006 is worth about 90 now; a pretty awful performance for a AAA rated product. But the most recent sub-prime AAA securities are trading at 67.

Now I'm not index mad. But I do like an index to reflect the story, and the stock market is not doing that.

Obviously long term, the fate of the entire corporate sector of the US - encapsulated in share prices - matters more than the fate of one kind of sub-prime asset-backed security market.

But in the short term, it is the exotic paper that is driving things. Why?

Because of the degree of bank exposure to sub-prime mortgage assets. When stocks fall, wiping hundreds of billions of dollars off share prices, the people who own shares are poorer. So, that happens from time to time.

But when hundreds of billions of dollars of losses are being made by banks (or their off-balance sheet profit-centres), well that affects their capital, and their ability to lend. And as banks lend a big multiple of their capital, when the capital falls only a even a small amount, their lending can fall a lot.

And when lending falls a lot, the economy can stumble. Just as it did in the great depression for example.

Of course, when the stock market wakes up to that possibility, it might fall a lot more than it has, and then it to will tell the tale of what's going on.

But at the moment, it is our relatively new friend the ABX to watch.


What next for US economy?

  • Evan Davis
  • 26 Nov 07, 10:22 AM

Where will the American economy go next year?

Perhaps it'll help you answer this if I tell you that last year it grew 2.9%; this year it is set to grow 2.1%.

Rather than get caught up in the decimal points of forecasts for next year, think about three scenarios.

a) next year's growth number is significantly below this year's;
b) next year's number is about the same as this year's; and
c) next year's number is larger.

The argument about the economy's prospects at the moment is between those three options: there are those who think there's downward momentum; those that think the slowdown currently occurring will be contained and those who think it will be a small temporary phase before the economy reverts to the norm.

evan_us_2.jpgNow, talking to folks out on the streets – from market traders to students – I find a variety of views about the economy. But it is conspicuous how many people are upbeat about things, and assume there is little reason to get very worked up.

And even more interestingly, the same is true of the professional economic forecasters.

The optimists may be right. I can't stress that enough. I am still surprised however, there are so many of them.

According to the ever-useful Consensus Forecasts the average forecast for next year is that US growth improves marginally to 2.3%.

But that underplays the optimism. Half the forecasts out there are plainly built on the assumption that by the second half of next year, the US is back on its old upward trajectory.

The most optimistic of the professional forecasters is The Conference Board, a large and respected non-profit business think-tank. It expects US growth to re-bound to 3.0%. Bear Stearns thinks the US will grow 2.7%, as does Fannie Mae (the government-backed private mortgage guarantor organisation) . The National Association of Home Builders expect the economy to grow by 2.5%.

If any of them are right, you would say that is quite a result, given everything that is happening at the moment.

Only two forecasters think the economy will slow-down very significantly. The Economist Intelligence Unit and Merrill Lynch. And no-one appears to be predicting a recession.

Now, I am not one to criticise forecasters. But I can't help but feel there is a bit of anchoring going on.

You know what anchoring is? It is a tendency to produce numbers that are close to ones that are already in your head.

Famously, it has been shown for example, that if you ask people the percentage of African countries that are members of the United Nations, you will get higher estimates if you first ask people whether it is more than 65%, than if you first ask them whether it is more than 45%.

Experimenters that get people to look at totally arbitrary numbers – like social security numbers – and then to guess something quite unrelated, tend to find a bias. People with higher social security numbers come up with higher results.

Bizarre I know, but well documented. (Indeed, the discovery of this tendency was part of the reason Daniel Kahneman won a Nobel prize.)

Now I think the fact that growth has tended to be around 3% in the US in recent years, might be anchoring expectations. It's not quite the same as using social security numbers to make predictions. But forecasters are undoubtedly subject to the same kinds of cognitive mistakes that the rest of us are, and they might simply lack imagination in thinking about the many different paths the US economy could conceivably follow.

Why else would forecasters be so happy about the prospects?

Joseph Stiglitz (who I mentioned yesterday) puts it down to the fact that Wall Street forecasters have to be professionally upbeat to sell stocks. They are not liars, they just live in a world where you learn to believe what suits you. (Similar considerations might be alleged of
those forecasters tied to the housing industry).

But actually the Wall Street forecasters are not always the most optimistic at all; they are scattered throughout the distribution.

So no I don't think in general that explains it. I think anchoring is the answer. Anchoring to the idea that normal service will soon be resumed.

And it might be. But in general, economies almost always revert to their long term trends in the long term, but exhibit far more volatility in the short term. And the long term is longer than six months.

It's quite rare for a downturn as serious as the one now underway to be over by next Christmas, given there are with so many unresolved problems in the banking and housing sectors.


Made in America

  • Evan Davis
  • 25 Nov 07, 09:30 AM

Having arrived here a couple of days ago full of thoughts about the falling dollar and the improving state of American trade, it is fascinating to observe at first hand that perceptions of low quality in Chinese products are the issue that seems to be driving consumers away from imports.

Recent recalls of badly designed toys and toxic toothpaste seem to have driven a surge of interest in the "Made in America" label. Websites such as offer lists of US products that don't
bite or poison you. This site offers an eco-friendly four tips on buying lead-free toys made in the US. Or look at the poll on Chinese goods on the website of Duncan Hunter, a presidential candidate.

The mass media is talking the issue up. I was surprised to hear advice offered this morning that one advantage of buying goods online is that if they are recalled, you will automatically get an e-mail telling you, without you having had to register your purchase.

Does that really happen so often?

It's fascinating that fear of foreign goods is taking hold just as the trade position of the US has turned a long-awaited corner. In September, for example, the trade deficit in goods and services was $57 billion, (or "a lot" as we say in English).

But it was still 12% smaller than the September before.

Something is changing. Imports were up by 5%. But exports were up by 14%.

This is of course exactly what the US economy needs. If the country is going to avoid recession while hard-pressed consumers save more now their houses are not increasing in value any more, exports have to be part of the answer. And reduced imports will help as well.

What is good for the US may not feel good to the rest of the world of course. In many respects we have become more used to the US as a customer not a competitor. Suddenly the US bites back, lets its
currency fall and starts improving its trade balance, by worsening everyone else's. But it is only fair - the US needs to improve its position more than anyone else. Its deficit last year was over 5% of its whole GDP.

So how far can improving the net trade position, help the US sort out its difficulties?

I've been speaking to several economists on this. One thing they all agree on is that the US does not do enough trade for it to be the piece of GDP that underpins the rest of the economy. Big countries do not need to trade as much as small countries, because residents have more choice from within their own jurisdiction to choose to trade with.

But that being said, trade is a small but volatile portion of GDP. It can grow or contract more than the personal consumption typically does, for example. (Those exports growing at 14% for example). So let's not diminish the role for trade too quickly.

I think there are two other challenges for the US in trying to improve its trading position.

First is the idea the problem of oil. As that gets more expensive, the US deficit has to export more just to stand still, and pay for its oil.

Secondly, does the country have the capacity to export? Once you have stopped making things, and have learned how to source them elsewhere, it takes quite a bit of time to re-build that capacity. Growing exports at 15% per year, year after year, will be no mean feat.

evan_2.jpgI spoke to Professor Joseph Stiglitz yesterday (pictured). He's well known as the former (and controversial) chief economist of the World Bank, a Nobel prize winner and author of Making Globalisation Work. He is sceptical of the idea that the falling dollar will improve the trade position and bail out the economy, and he uses the interesting argument that America's "new economy" exports, in sectors like software are ones where the falling dollar will do nothing to improve things.

The argument goes like this – Microsoft have already priced their software as profitably as they can in each overseas market. And selling intellectual property is not like selling automobiles: the cost structure of software is far less sensitive to the level of the currency. Microsoft won't be stealing market share from the Europeans because the dollar has made it more competitive.

It's an interesting argument. The new economy is not about toys made in America; and the new economy may not respond in the old ways to the traditional price signal of the exchange rate.

If Professor Stiglitz is right, growing exports won't be helping out much. It'll have to be shrinking imports if anything, that will sort out the trade deficit.

Which I suppose is where the Made in America fad comes in. When the exchange rate fails to solve a problem, you can always rely on fear of badly made foreign products to help.


Black Friday

  • Evan Davis
  • 23 Nov 07, 04:47 PM

evanheathrow.jpgI've arrived in the US for a 10-day look at some of the economic jitters here. And guess what: I find I have arrived in New York on Black Friday.

That term is apt to mis-interpretation. Black Friday is not another bad hair day in Wall Street. It's the term used by American retailers to describe the day after the Thanksgiving Holiday, seen as the semi-official start of Christmas shopping season. (It isn't really the start, by the way: the decorations do go up earlier.)

The name Black Friday is reported to derive from the 1970s, and comes from either the bad traffic conditions prevalent, or from the fact that retailers expect this day to mark the season of the year, in which they expect to go into the black.

It is a bit of a tradition. To my amazement, the shops open at about 5am; some in fact are beginning to open on Thanksgiving itself. Queues build up round the block, the shops offer so-called "doorbuster" deals. It's all great fun.

Now, the shops will look busy today, and there is already a lot of hype around the great deals on offer. But the big question is whether this year's Black Friday will really be black for retailers. Can they possibly enjoy strong trading in the frazzled economic conditions of the time?

It's a question of importance to the whole world.

For years, we've grown dependant on American consumers as the world's spenders of last resort. They've kept Europe out of recession, allowed China to industrialise, and prevented global deflation.

But at the same time, they've not been looking after their own futures. The savings ratio in the US (the proportion of households' disposable income that is not consumed) has been in a long-term decline since the early 1980s. In the most recent data, it has dipped negative – yes negative. It means they are "running on empty" as they say. It can't go on.

This year surely has to be the one where the long-awaited turn occurs.

Why now? It's simple. For the past decade, Americans have seen their wealth increase without them having to save: first, their shares went up, and when they stopped rising in 2000, their houses went up.

That gave people a sense of wealth that appeared to justify saving less.

But with the housing market in serious decline, people will have to save if they want a pension. Not just sit and watch the pension materialise out of nowhere.

So the question for the shops over here, and for the world's manufacturers, is how big and how fast will the adjustment in US savings be? Here are three options.

• Will Americans just raise their savings to back inside positive territory for example? That would still be an adjustment for us all, because world spending growth has been boosted in the recent past by that small decline in US savings.

• Or will Americans slowly raise their savings back to a normal historical level – 5 to 10% of income, say? That would represent quite a big adjustment for the world economy. Remember the US is 25% of global spending, and US consumer spending is probably about 20% of the world's total demand. Saving 5% of that, is like a 1% reduction in global demand.

• But the third and least attractive option for the world is that Americans over-compensate. They might see their house price fall, and think "not only am I not getting richer anymore, I am actually getting poorer". In which case instead of simply reverting to normal and saving 5 to 10% of income, they might choose to make up for lost ground and save 10 to 15% instead, at least for a few years.

We won't know which of these three courses the economy will follow by the end of Black Friday, but this season's shopping might provide the first clues.

I'll hope to get some early comments on the retail scene on BBC TV news programmes early next week.

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