‘US dollar will go down against yuan, but less so against rupee'

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We will see a shift from domestic demand to exports: US economist.

Mr Dean Baker, Economist and Co-Director, Centre for Economic Policy Research
Mr Dean Baker, Economist and Co-Director, Centre for Economic Policy Research

The big banks are being taken care of by the government. The smaller ones are going out of business. — Mr Dean Baker, Economist and Co-Director, Centre for Economic Policy Research

C. Shivkumar

(Recently in the US)

The US economy is faced with a major downturn that is forecast to worsen this year. Green shoots still appear some distance away. In reality, it is actually in the midst of a major overhaul and transition that is likely to have global ramifications, particularly on countries whose major export destination it is. India is unlikely to escape the ripples of this shift, since the bulk of its exports are US dollar invoiced. Economist and Co-Director of the Washington-based think-tank, Centre for Economic Policy Research, Mr Dean Baker, in an interview explained to Business Line, the trajectory of the transition. Excerpts from the interaction.

There are talks of a recovery, but how do you reconcile the situation with high job losses and loan foreclosures?

We did take a big hit in the GDP. Is the unemployment rate little higher than expected? May be. It is not regular pattern if you look at downturns. It is very irregular. So I am not really that surprised that unemployment rose. But the story that we are looking at now is one where the economy is growing, but very slowly. If you look back at the last time when we had really steep recessions in the 70s and in 81-82, the economy grew fairly rapidly, 7-8 per cent in the four quarters immediately following the recession. We are looking now at 2 per cent growth, certainly not the sort of 6-7 per cent growth we should expect to see. But by March or April, it is certainly possible we will be creating jobs at a very slow rate. To keep unemployment rate from rising, we have to create somewhere around 100,000 to 125,000 jobs a month.

So does it mean an exit from the fiscal stimulus becomes difficult?

Absolutely. I think we need more stimulus efforts. People don't appreciate how little we actually had, because the number in the Bill was $787 billion. But write off $80 billion because it was a technical adjustment to taxes. So the actual stimulus is about $700 billion. Some of that is money to be spent in 2011 and 2012. So if you pull out the money spent in later years, you will be looking at $600 billion or $300 billion a year. That is about 2 per cent of the GDP. If you take the government sector as a whole, states and local governments, in almost every case, with few exceptions, they are all looking at big deficits, primarily because the economy is shrinking and they are getting less tax revenue. With the housing bubble collapsed, they are collecting less money from property tax. So states and local governments are looking at shortfalls of $150 billion a year. They have to either raise taxes or cut spending to make up for their shortfalls. That means the stimulus is only one per cent of the GDP. It is nowhere near large enough given the size of the downturn.

But didn't the GDP contraction result in asset price correction?

I don't think they are directly related. You could have envisioned, with good policy an asset price correction without a collapse of GDP. I mean the housing prices collapsed basically under their own weight. You had a glut of real estate. That is what's driving house prices down. First and foremost you have so many unemployed. But the simple fact that we had record levels of vacant units before the economy went into a downturn. So in 2007 the vacancy rate on ownership units was 50 per cent higher than it had ever been before, that's before it went into a recession. So the problem was simple supply and demand. We had built more that there was demand for. So you would have seen big plunge in house prices even if we didn't have a recession. Now its hard to envision not having recession in a context where you are talking about a loss of $6-8 trillion in housing loans. So on the one hand that has destroyed the construction markets. The rate of building homes is about 40 per cent lower than what we were building in 2005-2006 at the peak of the bubble. So it seems just a plunge in output in residential real estate. The other thing was that housing wealth was driving consumption. People were spending based on the wealth of their homes. Now that it is gone, people are saving at a much higher rate.

Does it mean a transition from a leveraged economy to a savings driven one?

Well, assuming that the bubble doesn't re-inflate, we will absolutely move into a savings oriented economy. I am not sure how far it will go. If you look back at the 50s, 60s, 70s and even the 80s the savings rate of the household disposable income averaged over 8 per cent and it didn't really vary that much all through those decades. It's quite striking. There were little ups and downs, but it didn't change systematically from the 8 per cent a year. Beginning in the mid-80s and the late 80s it started to fall. By the mid-90s it was down to 4 per cent and by 2000 it was down close to zero. It was close to zero in 2006. We are now looking at a savings rate of 5 per cent. Will it get higher? My guess is it will go higher, though I don't know whether it will get to 8 per cent. I should also point out that one of the factors in that is the demographics are very heavily tilted towards savings rates right now. The baby boomers born in the 1960s are all in their peak savings years. So if the normal savings rate is 8 per cent looking through the 40s to the 80s, the demographics could push the savings to 10 per cent. I think we still probably have someway to go, but I won't say it is written in stone.

This shift will have an impact on the big banks here?

Yeah! We have lot of issues to be resolved as far as our banking system is concerned. Some of the big banks Citigroup and probably Bank of America are still on shaky financial footing. We changed their accounting standards, moved away from marked to market accounting to fair value. By reasonable standards they would have written down their mortgage, but we have allowed them to keep it on their books at full value. That makes their books look better obviously because they don't have to take the losses. So it looks they are fully capitalised though they surely are not. The large banks have to work through this. The Federal government is going to give them enough support. The big banks are being taken care of by the government. The smaller banks are going out of business every day. But the larger issue — what is the financial sector going to look like moving forward? It (the financial crisis) was an incredible blow on the financial sector. This is on account of a huge proliferation of complex financial instruments and huge amount of trading. To my mind this is totally wasteful, if it is not making the economy work better. So the question is whether there will be policy changes to rein in the financial sector. Even if there is modest tax on financial transactions, there will be a big impact and a sharp reduction in trading.

This transition will also impact the manufacturing sector?

It is obviously re-shaping demand. For instance, our auto output was 17 million a year before the downturn. So 05-06 we still sold about million vehicles. We just have the data for 2009. It was under 12 million about 11.8 million cars. That was a collapse in demand. We might probably recover some from that, but I don't think we will get to 17 million. That is going to be changed picture.

Now over a slightly longer period, we will see a shifting from domestic demand to exports because part of the story here is the big imbalance. We had a current account deficit that peaked at 6 per cent GDP in 2006. It is down a little bit this year since the dollar has fallen a little bit. We've done a lot this year because of output. We envision getting back to full employment. We will probably be below 6 per cent GDP. That is still high. We will get to a situation where the dollar is going to fall more primarily against the East Asian currency, particularly against the Chinese yuan. We are getting to a situation of producing more for exports rather than for domestic consumption.

The dollar depreciation would be resisted through additional purchase of US Treasuries. Won't that negate the effects of depreciation?

I am thinking of China, which is the lead actor. China had remarkably successful stimulus programme. The implication of that China doesn't need foreign demand because the conventional wisdom the view was that there was a co-dependency. We needed them to buy our debt and they needed us as their market. Well, I don't think we need them to buy our debt, but apart from they don't need us for their market. If they had a policy raising 10 per cent of stimulus, surely they can find a mechanism to make up the loss of export demand to the US. China can pay its people to buy their stuff. They don't need to pay us. My expectation is that they will be moving away from the policy of keeping the yuan down against the dollar and gradually letting it rise.

The dollar depreciation would also impact outsourcing to countries like India?

I don't think so. There are number of countries that closely follow the yuan. I don't think India has. The dollar will probably go down further against the Euro, but not hugely so. The currency that it has to adjust against is the yuan and several other currencies tied to the yuan. The dollar will go down against the yuan, but less so against the rupee. You still have some rate of growth in industry that will have some impact. There will be some impact, but not a huge one. The cost differences are so large between US and India in these sectors.

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(This article was published in the Business Line print edition dated February 8, 2010)
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