February 12, 2014

Hard to win if you do and hard to win if you don’t

Has that become the best way to describe the U.S. and world economies?

Ongoing improvement in the U.S. economy — surely a desired state of affairs — is leading the world in some unwelcome directions.

This isn’t your old-style global recovery/expansion and there are some specific reasons for the wobbly gait.

Ever since the U.S. Federal Reserve announced in May of last year that it was close to “tapering” its $85 billion per month bond-buying program, the “game” has changed.

The official U.S. interest rate (i.e., the federal funds rate) will continue to stay flat and nearly zero for a long time to come, but the bias for a multitude of other public and private yields has moved upwards.

More recently, with the Fed actually cutting its “quantitative easing” by $10 billion monthly, there are significant consequences.

Earlier, when credit was especially tight, cranking up the printing presses in the U.S., Europe and other industrialized nations encouraged a strong spillover of funds into emerging nations.

Now, with U.S. interest rates tending to move higher, some of that money is being repatriated.

The stronger inflow of greenbacks into America is helping to lift the value of the U.S. dollar versus many other currencies.

On the flip side, it’s lowering the exchange rate of the currencies of many nations in the developing world.

Living here in Canada, where a lower-valued loonie is often viewed as a panacea for all-manner of economic woes, you might well ask the question, “What’s so wrong with that?”

For many an emerging nation, the drop in value of their home currency will raise the price of imports, including raw materials that are priced in greenbacks.

But that may be the least of the problem. The debt that’s being carried by the governments of those same nations is often designated in U.S. dollars.

Each incremental drop in the value of the home currency features an automatic and opposite uptick in nominal interest owed (designated in U.S. dollars) on that nation’s foreign debt.

If this trend continues unabated, questions about solvency arise, such as has been most recently witnessed in Europe.

Turkey, as just one example, is taking extraordinary action to raise its home interest rates in order to slow the fall in value of its lira.

Street rioting in the capitals of the Ukraine and Thailand are adding to the unease about lesser-developed markets. While appreciating that nascent democratic sentiments are bursting forth, the resultant uncertainty is worrying for investors.

Canada has been similarly caught in the lower-valued-currency trap.

A less-valuable loonie will boost manufacturers’ export sales, and may eventually provide a spark for the TSX (e.g., the profits of firms in the energy sector will increase since oil and gas are priced in greenbacks); but there is also collateral damage to take into account.

Air Canada successfully negotiated pension reform and surmounted a number of other hurdles to become the darling of the TSX in 2013. Now, with a currency-induced increase in the cost of jet fuel, the company will have to overcome a new challenge to its profits.

The same fight will be waged across Canada’s transportation sector, including trucks, buses and railroads.

Added delivery costs will place a burden on consumers, who are already facing extra charges on other day-to-day living expenses, such as electric power usage.

The cost base for many Canadian families has passed beyond simply burdensome.

Consider the auto sector. An interesting debate has emerged about why there has been a drop-off in car purchases among the young. One argument is that they would rather spend their money on smart electronic devices.

The more likely explanation is that the cost of driving a motor vehicle for teenagers and twenty-somethings — after taking into account items beyond the sticker price, such as insurance, repairs and fuel — has become prohibitive for many, especially when they face an uncertain job market.

Previously, America’s business sector and entrepreneurs would have provided the supreme confidence and optimism to pull the economy out of the underbrush.

Washington, through adoption of expansionary fiscal policy as well as accommodative monetary tools, would have been a partner in this economic rebuilding.

The following are two headline examples of how Washington is currently hindering the process rather than helping it.

Despite their usual tendency to support workers and unions, the Democrats have yet to approve the job-creating Keystone XL pipeline.

The Republicans, who well know the advantages of federal expenditures in excess of revenues, are at this time adamantly opposed to raising the debt ceiling.

It’s a 50-50 proposition that each party has taken a position off-balance with its basic principles.

Some analysts are suggesting this opens the door to a compromise solution — agree to let the debt ceiling rise and approve Keystone. And abandon the inflammatory wording that would say acceptance of the one is “conditional” on the other.

After the stock market crash in 1929, years of economic hardship followed well into the 1930s.

It affected the attitudes and approach to life of a whole generation, causing it to treasure frugality and expect further alarming tidal shifts.

Those individuals were correct. WWII was the next monster to leap out from under the bed.

Here’s a shocker for you. It’s been six years and counting since the beginning of the Great Recession in 2008.

Are today’s youth going to be permanently affected by what they’ve been experiencing?

This is certainly likely in a country such as Spain where the overall unemployment rate is 25% and half of younger workers can’t find jobs.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog.

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