Sunday, January 18, 2009

Thoughts on the state of the World Economy

I have said that my appetite for purchasing equities has increased in recent months, and I continue to look for opportunities to do so. That said, I have had some interesting thoughts about the world markets that I'd like to share.

The United States vs. China

I am deeply worried about how the overall world economy can grow in the future without some decoupling of the Chinese currency from the U.S. currency. Only a year ago, the U.S. government was begging the Chinese to remove their peg of the U.S. dollar (by selling the dollars/Treasuries they currently own - in the trillions of dollars) - and allow the RMB (yuan) to inflate from its artificially low USD peg. Twelve months later, I'm sure the Chinese are wondering why they didn't move to further de-peg their RMB. The USD has been rapidly strengthening against virtually all major currencies, save for the yen, and it has caused quite a Catch-22 for the US and China. Should the Chinese sell those treasuries and dollars to the open market, surely the appetite for US dollars will appreciably fall, and the dollar could collapse under the weight of the US's very own printing press. This could have one of two effects, one desirable and one undesirable.

If this were to occur, we may worldwide be lucky enough to see a decline in the USD - and the return of inflation, the growth engine of the world. A stronger RMB is in the cards in the next 5-10 years anyways. The Chinese will become a consuming nation of finished goods rather than a supplier of them, and will need to offload its peg to be able to consume more using a higher valued currency. Why not now?

Well, the flip side of the question is the answer to that question. The Chinese economy could potentially trade places with the U.S. by selling its treasuries. By strengthening the RMB at this time, it loses its global position of cheapest mass producer, which is the engine it has now. If it doesn't sell the USD and treasuries, it is already losing that position with other global players like the EU.

The European Union - is the model sustainable

The EU continues to lower its interest rate, to stave off huge problems for behemoths like Spain (the housing bubble) and Germany (which has seen its share of problems with the likes of VW). This brings me back to my old question - will the Euro survive? By creating the Euro, Germany and other large European countries placed their confidence in the hands of emerging economies like Slovakia and Slovenia. The dynamics in each country can conflict with each other, and result in movements by the European Central Bank that may run contrary to the needs of individual member states that have adopted the Euro. In late-2008 Germany was already handing hundreds of billions of Euros to its banks in an effort to shore up its banks, while the ECB was still being implored by the world to lower its rates. The ECB seems to be very much behind the curve now, and is desperately trying to catch up with lower rates that the US has already applied. I feel that the EU is showing tremendous cracks under the pressure of its model. While free trade is always an ideal, countries giving so much control of their economic viability to a central bank certainly is not. How this affects trade with China and the U.S. is still emerging.

This is the primary reason I love macro-economics - there are millions of issues at play (with a few Black Swans that will emerge along the way), and it takes market makers months to digest a slice of that information to make decisions. We are participants of the most exciting film (I just hope most of us can leave the theater with our shirts) the world has seen in some time. This is the essence of globalization: we will see more volatility, more Black Swans and more currency blowups.