The dollar reserve currency risk premium ongoing story

We have written about the dollar reserve currency risk premium over the last few months. More talk has occurred about the role of the dollar as a reserve currency in the last six months than in years. This talk continued with a Bloomberg story that the yuan is deposing the dollar on China's border. More transactions will be allowed to be settled in yuan. This is a policy objective of the PBOC. The PBOC has also provided over $95 billion in swap lines to countries like Argentina, Belarus, Hon Kong, Indonesia, Malaysia and South Korea in 2009.

This growing importance of the yuan makes perfect sense. There is little reason to have settlement in a third currency for close cross-border trade. Given the size of the Chinese economy and its growing role in global finance, it should also be expected that these events will continue to occur and the PBOC will ask for more policy input with the IMF. The dollar will have to suffer. This may have nothing to do with the value of the dollar as much as it has to do with ascent of China; nevertheless, current policies by the US do not help to strengthen the dollar.

Follow the business cycle performance curve grid

A very good graphic was in the NYT "Turning the Corner?" story. The live graphic looks at the business cycle through a two dimensional grid. On the vertical is growth compared with trend and on the horizontal, change in growth over the last six months. When growth is above trend and the change is positive, the economy is in expansion. When the change is negative but still above, trend the economy is in slowdown. When growth is below trend and negative, the economy is in downturn. Finally, if growth is below trend but there has been positive change in the last six month, the economy is in recovery.

We are clearly in a downturn that has not abated. The recovery will take time because of the distance that has to be covered to get some positive growth.

Why has trade fallen so hard during this recession?

Trade has fallen off a cliff for many economies around the global. In fact, trade declines have been multiples larger than the decline in GDP. This has been surprising but a recent study by Caroline Freund in voxeu.org starts to explore this issue. See "Demystifying the collapse in trade". Freund first shows that the sensitivity of trade to changes in GDP has increased dramatically in the last few decades. The impact of every 1% decline in GDP is now almost 3.5 times greater. The issue is why is there an increased sensitivity to trade. 

Freund offers some possibilities which make sense but have to be explored in detail. These include greater drawdown in inventories which hurt production, greater protectionist policies in recessions, sourcing more form home countries in a downturn, and the use of foreign sources for marginal increases in trade.

The result is greater vulnerability for countries that have large export business; however, it also means that a turn around may also have the biggest impact for these exporting countries. At issue will be how importing countries behave. Protectionist policies will be harder to reverse so there needs to be care with restrictions on trade. The global impact of protectionist policies will change the elasticities of trade to changes in growth. 

Where is the stimulus? unemployment up

This is an unfair question with government passing the legislation less than six months ago, but then the hype about creating jobs immediately for a back-loaded program was also hype. 

The non-farm payroll numbers came out worse than expected and any tonic that we are on a better path has been eliminated. We have had 18 months of job losses and a doubling of the unemployment rate in the same amount of time. The only positive is a stabilization of initial jobless claims and continuing claims albeit the levels are extremely high. The slight increase in factory orders was positive but there was an equal decline in the revisions from last month. There are no green shoots here. 

The long history in the short shows a deep decline in employment and the consistent behavior over the last few recessions of slow recovery. The natural forces have been for declines and muted recovery. The stimulus may help quicken the recovery but the size is deeper. Unfortunately, the current unemployment rate is higher than what was predicted by the administration both with and without stimulus. It is the economy, stupid, yet the focus seems to be in many other areas.

We are seeing scared consumers that understand the economy is weak. They have been taking whatever benefit from tax cuts and saving most of it to pay-down debt. The multiplier is much weaker than expected. The wealth effect can work in both directions. Increased housing wealth that was liquefied for consumption is now being reversed. There may be little that can be done with changing consumer behavior in the short-run.