Entries Tagged 'us' ↓

Yesterday, the price of oil jumped $16 (settling at $120 on the New York Mercantile exchange). This is a remarkable increase in the price of the world’s most important commodity. If the increase is permanent it will affect both inflation and economic growth forecasts.

On the same day, the price of Gold increased $44.30 to settle at $909.

Whilst gold and oil increased in price, the dollar fell to its lowest value against the Euro for a month. The US currency has now lost 6% in value since Sept 11th.

The reason is that Gold and oil are seen as a substitute to investing in dollars. With so much uncertainty surrounding the US economy, investors are looking for alternatives to the dollar - which many feel could fall in the coming months. Investors are nervous about the dollar because of the government’s ambitious $700bn bail out plan for the beleaguered financial system. The plan would increase the nation’s debt ceiling by 6.6% to $11.315 trillion. With such a large deficit, the dollar becomes less attractive.

There is also growing criticism of the $700bn plan to bail out banks. US house sales are still weak putting pressure on another US interest rate cut.

The Cost of Government Bailouts

Readers Question: What would stop the falling dollar?

The dollar has been falling for many reasons. These are some of the factors which would stop the dollar falling and lead to a recovery in the value of the dollar.

Higher Interest rates. US interest rates have been cut to 2% in an effort to stave off a US recession. This causes an outflow of hot money. If interest rates were raised it would encourage people to save in the US and cause an appreciation.

Recovery in US economy. The US fear recession because of a declining housing market, this is leading to lower interest rates and lower confidence about the US economy. If the economy recovered, interest rates would increase and people would have more confidence in buying dollars.

Fears Over the Euro. The main beneficiary of the falling dollar has been the Euro. People are increasingly seeing the Euro as an alternative reserve currency to the dollar. Therefore, investors have been switching out of the Dollar. However, confidence in the Euro may be misplaced. The Euro economy is not much stronger than the US. Many European economies face the prospect of falling house prices; also the strength of the Euro is causing problems for exporters. Arguably, the Euro is overvalued on economic fundamentals - the dollar looks cheap on purchasing power parity. Maybe the sell off of dollars has been overdone.

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Readers Question: Why is US in Recession?

Firstly, it may come as a surprise to most people, but, the US is not officially in a recession.

According to the latest statistics provided by the Economist April 24th 2008

• US economic growth is 2.4% year on year.
• In the last quarter, growth is 0.6%. This is still a long way off the technical definition of a recession - negative economic growth for two consecutive quarters.

Nevertheless people have been predicting that the US will soon enter into recession. This is because

1. Credit Crunch. Banks have lost money in lending subprime mortgages, which involved high levels of defaults. It is not just mortgage companies who have been affected, but, banks who lent to the mortgage companies. The result is that there is a shortage of funds for borrowing and bank lending has become more difficult.

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Readers Question: Why do foreigners often hold U.S. dollars? How does the holding of dollars by foreigners affect the welfare of American?

The Dollar still is the world’s reserve currency. With about 67% of the world’s currency reserves held in dollars. 

The reason foreigners often hold US dollars

• Historically, it has been seen as a safe, secure and strong currency.
• Because most other people hold currency in dollars, people may think there is strength in numbers
• Most commodities priced in US dollars. Most commodities such as oil and gold are priced in US dollars, so this gives an additional reason to hold currency in US dollars, minimising transaction costs of getting dollars to buy commodities

See: Why the US Dollar may lose its place as the world’s reserve currency.

How does the holding of dollars by foreigners affect the welfare of American? - will answer soon.

The  prospect of an imminent recession in the US becomes more likely despite the Fed’s bold moves to cut interest rates by 2% since the start of the year. Continual weakness in the housing market and the fallout from the credit crunch is undermining confidence and slowing down consumer spending. This slowdown is reflected in the growth in unemployment, especially in the construction and real estate sector.

In this essay, I have explained why the US is facing a recession.

As I often teach Monetary and fiscal Policy, I am quite interested to see how effective the attempts to avoid recession will be.

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For more details see this post - Effects of US economic decline

China certainly exports alot to the US. Exports to US totalled $295bn in 2007 (they were 32% of exports

US trade with China TOTAL

•  US exports to China $58,340.1m
• Chinese exports to US $295,817.6 m
• Trade Deficit -$237,477.5m Continue reading →

Readers Question: What are the effects of the economic decline in America to the country Vietnam?

If the US economy entered into a recession the main effects on other countries would be:

1. Decline in exports. American consumers are a key component of world trade. If there was a decline in exports to America it would lead to lower growth in countries like Vietnam. In certain sectors it could cause a rise in unemployment. There could also be a negative multiplier effect ‘knock on effect’/ The initial fall in exports could cause a bigger fall in Aggregate Demand.

However, it depends on what % of exports are to America. For Vietnam, exports to the US are important, but not a huge %.This page shows that Vietnam exports to us totalled $7.6bn in 2005. link US - Vietnam trade

This is not a huge amount, it is about 20% of exports.

It depends on how the rest of the economy is affected. For example if domestic demand remains strong then this might offset any fall in exports

It depends on whether Vietnam is able to increase its exports to other Asian economies. For example, it may be that China’s economic growth takes the place of US exports. China is nearer. Continue reading →

Back in March I wrote this essay - Is the US heading towards recession?

According to some doom mongers the US is already in recession. They point to the ‘collapsing’ housing market and the rise in ‘repossessions’
The irony is that US economic growth has remained unexpectedly high at 4.9% in 3rd quarter of 2007. Growth has averaged over 2.1% since 2001 (US economic snapshots)

Unemployment remains at 4.5%, although this masks some disguised unemployment, - it is hardly the sign of a full blow recession.

Nevertheless there are several warning signs that could push the US into recession by the end of 2008

Why US Recession is Likely

House Price Fall.

US house prices fell by 4.5% in 2007. (In some cities they fell by more). Falling house prices reduces consumer wealth and consumer confidence; this will lead to lower spending. (Consumer spending has been the main driving force behind the US economy in recent years)
There are also concerns that the fall in house prices could accelerate due to the glut in house supply and the fact more people are coming to the end of cheap mortgage terms.

House Repossessions.

There has been a record rise in home repossessions. The foreclosure rate on homeowners has risen to a 17 year high of 5.59%.

Global Credit Crunch

Due to mortgage repossessions, especially on sub prime mortgages, banks have had to write off a lot of bad debts. This has caused an increase in the cost of lending. For example, 3 month dollar Libor spreads have jumped by 60 to 80 basis points in recent months.

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Readers Question: I have heard it said that “American businesses are considered, as a whole, borrowers”. What does this mean?

I think it refers to the fact that most American businesses finance investment out of borrowing, rather than saving. Therefore, most of the big American multinationals have a balance sheet with heavy levels of borrowing.

This is because they can easily borrow through selling shares on the stock market. Investors are willing to lend them money in the expectation of higher revenues in the future.

Some of the companies with the biggest levels of borrowing include General Motors. - Their debts are so large they have been at risk of declaring bankruptcy. However, not all companies are indebted; Google are one company who have a lot of spare cash flow. We say they are cash rich. Google is listed on the stock market, but, they could probably buy back all their shares if they wanted to.

Of course, the whole American economy has developed a propensity for borrowing. The US economy has a large current account deficit (Value of imports greater than exports)

Consumers also have a very low savings ratio.

The Government also has a growing fiscal deficit. (Government spending greater than Tax revenues)