The importance of the US consumer and related matters
With the dollar falling and the Fed raising rates to fight off looming inflation we are bound to ask what this will do for US growth which in this case also means global growth. The case in a nutshell is that the large US current account deficit has been able to grow on the back of others' savings; here we are talking most notably China where the deficit is structural but also oil exporters accumulated dollar savings are important here. See also these two posts here and here for more on the global imbalances ...
Returting to the US consumer we can easily see what happens if the US consumer stops consuming because rates go up and exacerbates the housing bubble for example.
(quote from one of my previous post)
"Now, what happens when US consumers no longer will be able to us their houses as ATM machines? Their consumption drops sharply and if the saving glut argument has any bearing at all, we should worry when American consumer confidence drops because the following recession will be global not just American."
Just to give an example ...
So if the recent drop in the dollar is a sign that the it is finally time for correction because investors are turning the their back against the dollar, should we expect a hard landing? Let us first of all look at the alternatives ... in this case alternative currencies.
The Euro ... The real question here is whether the Euro can actually stand it. If the Euro actually is allowed to appreciate extensively against the dollar the pressure on Italy and Portugal certainly will not diminish, in fact they could be forced to throw in the towels and devaluate.
The Yen ... This is more tricky in my opinion. The Yen is certainly going to climb as the excess liquidity from many years with zero and below interest rates is mopped up. Carry trading is surely one to watch here but I don't believe the Yen will be able to climb substantially mainly due to growing trade with China and the demographic demise of Japan.
The Remninbi ... Well the Remninbi is certainly showing some aspirations at the moment, and amongst the brightest and most influential economists there is still substantial talk and debate over just how much the structural currency relationship between US and China matters in a global imbalance/CA deficit context?
"With the US deficit now so large, economists believe that to bring imbalances under control will require a combination of much higher growth outside the US, a big slowdown in the US and a large fall in the dollar. “Any one alone will not be sufficient,” says one economist."
Let us scrutinize that equation a bit further ...
"Much higher growth outside USA" - Here we encounter the first problem ... where ? Yes I know that China is racing ahead but remember once again the structural nature of the US-China relationship which heavily driven by politics and the fact that the US and China are producing in seperate ends of the value chain, although China might be converging. This basically leaves Japan and Europe and in both cases this is unlikely. In Europe The Euro with its strict demands of convergence and the ECB's "vigilance" against inflation stands in the way and so incidentally do the demograhics. In Japan; well it does seem as if we are moving away from deflation but on the back of the world's oldest society, we should not get our hopes up.
Which brings me to ...
"(...) a large fall in the dollar" - This seems unlikely does it not? At least, when we look at the alternatives. However, one thing that could drive the dollar would be a new politically driven scheme like the plaza agreement; see here and here for more.
"(...) a big slowdown in the US" - Ending off with the US consumer we could very well see a slowdown in the US mainly because of rising rates brought about by Bernanke's need to establish his credibility as an inflation-fighter. Obviously, the asset bubble in the housing sector is very vulnerable to this which would further exacerbate the situation.
Luckily for the global economy I might be wrong in many of my assumptions and casual links but still I believe that at the current juncture, the grand correction is not here quite yet; but we might be seing the forplay.