The Burden of Rebalancing

(click on graphs for better viewing; sorry for lack of x-axis formatting)

Nothing good lasts forever, or so at least many would have us believe. I shall neatly leave it aside of whether this is true in a general sense but merely note that it appears that we are moving closer to some form of another of crunch here. And my rationale you ask? Well, let me simply note that it appears, despite the fact one would believe that investors' and punters' should know better, that we are headed right back into the same dead end as we did the last time the Dollar was canooled with the Euro taking center stage. Of course, this is not only a Euro story even if it may appear so and in this sense the current environment once again shows us the very real obstacles which exist in terms of correcting global rebalancing since while everybody seems to agree that this is what we need, nobody wants to hold the old maid represented by a role of importer with a strong currency.

Over at Macro Man, the Dollar's recent plight to reflect lingering risk appetite and low volatility (mmm, the USD as the new carry funder) was given an acronym a long time in the form of DGDF (dollar-goes-down-forever) and I am very symphatetic to MM's ending point in today's installment;

It's entirely possible for this liquidity/positioning/DGDF rally in risky assets to continue through year end; in many ways, it's in everyone's best interest for this to happen. But Macro Man can't shake the feeling that we're all repeating the mistakes of the last cycle (in fast forward, no less!) and that when the reckoning comes, it won't be much fun.

In fact, Macro Man does one better I think since he also points to the very telling issue about Brazil and Turkey fighting tooth and nail to avert an appreciation by, among other things introducing taxes on capital inflows (so far, only Brazil has introduced this measure). I cannot tell you how strongly I feel the sense of deja-vu here since this is exactly what happened the last time the USD began a decline everyone hailed as natural and long overdue but whose counterpart in the form of the inevitable appreciation of other currencies was unduly and harsh. This narrative of course does not make sense and it will be interesting to see this time around where the discourse takes us.

In Europe, policy makers are fast becoming very nervous and although Trichet delivered his well known ECB-speak at the most recent board meeting; the mentioning of a worry of excess currency volatility is indeed, as Macro Man also notes, the closest we will come to the ECB expressing concerns over the flight of the Euro.

It is indeed funny to hear the staunch messages of Eurozone officials only to have them end with the almost laughable notion that the Eurozone is very committed to the US' comittment towards a strong Dollar. I find it hard not to agree with first Macro Man that this latter committment may in fact be a myth and then secondly, and as a result, with Willem Buiter that the ECB will need at some point to get serious about the Euro, even if it will be interesting to see whether the ECB is really ready to act here either operationally or merely through a stronger discourse.

Meanwhile and despite the growing woes in Brazil and Turkey (and India) about shouldering the burden of global rebalancing, one economy that appears to be tackling it rather nicely is Australia where an AUD closely approaching parity with the USD does not seem to deter the RBA (hat tip: Stefan Karlsson).

A local analyst on the ground in the form of Commonwealth Bank’s chief currency strategist Richard Grace even ventured the forcast that the AUD/USD would move beyond parity and on to 1.10. I won't dare confirming or denying this point forecast but merely note that as long as the volatility stays low and that risky assets, by consequence, lingers with an upward drift, it is steady as she goes.

So the real question to answer in this context of global rebalancing is not whether it will be sustainable, but rather which chain will break first. Will it be liquidity driven bounce in risky assets that suddenly runs out of steam or will it be a sudden surge in volatility brought about by an "unforseen" event. In the case of the latter I could mention a couple of sources of such an event, but so far the march goes on and the noose is tightening especially in the context of Europe the statements of policy makers are likely to become increasingly desperate.

In the end, it is not up to the Euro (or the JPY) to bear the burden of rebalancing which must fall on the shoulders of economies such as India, Brazil, Turkey, etc. The key here is that the US does need a weak Dollar to reduce the overall borrowing of the economy, but that this is not possible with one or two economies bearing the brunt of the adjustment process. This has long been a widely circulated fallacy in the sense that many have believed that we could simply twist the tables and move from one importer of last resort to another. This is not possible in the current context and is complicated by the fact that as our OECD economies age, they become increasingly reliant on external demand to spur economic growth.

It may take another round of old maid for global market participants and policy makers to get this and if this is the case, let us hope that Spain, Latvia, Germany, Italy, Japan and the rest of the de-facto export dependent economies won't fold in on themselves.