Financial Daily from THE HINDU group of publications
Monday, Nov 08, 2004
Columns - Global Finance & Overview
Economic consequence of Bush re-election
V. Anantha Nageswaran
Prof Steven Hawking in one of his lectures on the origin of intelligent life in the universe suggests that much of the behaviour of the human race "through out history, has been pretty stupid, and not calculated to aid the survival of the species".'
Entrenched fiscal deficits
Then came the news on Wednesday that the collective wisdom of the American electorate has given a second term to Mr George W. Bush with more than 50 per cent of the popular vote going to him. It appears that those who voted for him had overwhelmingly favoured ban on abortions, gay marriages and stem-cell research. Eulogies are being written for his campaign strategist Karl Rove for bringing out the `faith' voters. Democrats succeeded partially in bringing out their voters too but, obviously, it was not enough.
Despite the entreaties from the defeated candidate Senator John Kerry to the President to heal the divide in the country, it is somewhat remote that divisions would be closed rather than widened. The re-election of Mr Bush was built on the foundations of turning out the faithful. Any reaching out cannot be at the cost of abandoning the priorities of the party base. The gulf on some of these issues is so wide that no middle ground is possible. Hence, it is safe to expect, until evidence emerges to the contrary, that the second term would aim at securing the Republican conservative base for future contestants. That means more polarisation and not convergence. That means America's formidable economic problems are more likely to be compounded than dissipated. For a somewhat one-sided view of America's economic prospects, readers should refer to the web log of Professor Nouriel Roubini of New York University and November 5 posting on the site: "The Upcoming Twin Financial Train Wrecks of the U.S." (http://www.roubiniglobal.com/)
US economic troubles mean for the world too
The rest of the world should not rub its hands in glee at this prospect much as such behaviour is to be expected, given human nature. The rest of the world has no alternative in sight, should the US falter and stumble. Those who wish to prop up China have succumbed to schadenfreude. China is as vulnerable, if not more, as any other country to economic slowdown or contraction in the US. Prof Nouriel Roubini's research colleague Brad Setser maintains his own web log. He suggests that facts prove that China was not an externally dependent economy. Here are the arguments, in his words:
"China's exports to the US are on track to rise by 30 per cent this year, or by a bit less than $50 billion the increase alone is about 3 per cent of China's GDP... China's exports to the US are on track to double since 2000, rising from $100 billion to around $200 billion by the end of 2004, while overall US imports have gone up by only 20 per cent...and China is among the countries that is most dependent on the U.S. market. That sure feels like export led growth.
"China's underlying current account surplus (in 2003) was around 5 per cent of GDP, not 3 per cent -- cyclical credit driven bubble was driving the surplus down. Compare that surplus with the deficit that China could run given its ability to attract FDI, and you get a gap of seven, even 8 per cent of GDP. That is not small. There is a reason why China's 2004 reserve accumulation is likely to exceed $100 billion"
Bizarre October employment report
Given this frightening prospect, financial markets must have welcomed the news from the American job market that America generated 337,000 new jobs on top of the upward revisions to jobs created in August and September. In the wake of the report, US Treasury bonds saw their prices drop and yields rise. The 10-year US Treasury Note yield jumped from 4.05 per cent to around 4.20 per cent immediately. In my view, the bond market need not have panicked. The report merely capped a week of bizarre developments it was one of the most unusual jobs reports that I had come across. Let me explain.
The employment-population ratio and the labour market participation rate remained unchanged during the month. One would expect them to increase in a month when so many jobs were created.
Manufacturing employment was actually down in a month when the economy created upwards of 337,000 jobs. The average hours worked per week remained unchanged.
The Index of Aggregate Weekly Hours increased 0.3 per cent during the month. However, its two components, weekly hours in goods producing and service producing sectors separately added up to a net contraction of 0.1 per cent. Something is strange about the math: The total is far greater than the sum of its parts.
While the widely tracked unemployment rate of 5.5 per cent was a slight increase from 5.4 per cent, an alternative and expanded measure of unemployment went up to 9.7 per cent from the previous month's 9.4 per cent (Table A-12 of the Bureau of Labour Statistics monthly employment report).
The mean and median duration of unemployment remained unchanged. Again, this is unusual given the large number of jobs that have been created. Further, the proportion of the unemployed without jobs for more than six months jumped to 22.2 per cent from the previous month's 21.8 per cent. That more unemployed struggle to find jobs again is associated with recessions and not with vigorous economic expansions.
The most unusual was the drop in the diffusion indices of employment. They measure the per cent of industries that increase employment, where 50 per cent indicates an equal balance between industries with increasing and decreasing employment.
The diffusion index for all private non-farm industries (there are 278 of them) over the one-month span dropped from 59.2 per cent to 56.8 per cent. In the case of manufacturing industries (there are 84 of them), the index remained unchanged at 42.3 per cent - indicating contracting employment in manufacturing.
Dollar is hurtling to unprecedented lows
Therefore, it appears that the headline job creation report was a freak one and unlikely to sustain. In fact, the Bureau of Labour Statistics has a bit of explaining to do, on some of the parameters that do not seem to add up.
The reaction of the US dollar was rather interesting. It appeared to recover against other currencies but finished the day significantly weaker. Normally, one would have expected a strong employment report to be dollar-positive.
It was not to be. Two explanations are possible: One is that the foreign exchange market came to the conclusion that the author has reached above and hence did not think that the report would lead to any increase in interest rates in the US. That is somewhat odd given that the bond market reacted nervously to the report and stayed nervous throughout the day. Both the bond and foreign exchange markets are more liquid than equity markets and are not usually given to flights of fancy as the other.
Then the second explanation comes into play. The foreign exchange market has concluded that strong job creation means rising consumption and hence higher trade and current deficits in the coming years. Further, the foreign exchange market might have also concluded that the re-election of Mr Bush meant entrenched fiscal deficits. That heralds a substantially weaker dollar. That sounds more plausible. Dollar weakness predictions are now commonplace. Yet, they might still be underestimating the extent of the eventual decline of the currency.
Bullish fixed income outlook under lens
This raises the prospect of a more volatile bond market and rising yields in the coming weeks or, perhaps, longer. Further ahead, the US bond market has a decision to make: whether to continue to price in global economic slowdown and disinflation or to price in the prospect of higher budget deficits and more borrowing by the US government.
If they opt for the latter and if yields rise, then global bonds too would find their prices drop and yields rise. This is going to be the important theme for 2005: what happens to the US Treasury yields? I admit that re-election of President Bush and the rapid descent of the US dollar has introduced additional uncertainty.
The long and short view
Equities in the very short-term appear overbought just as the US dollar looks too oversold. Equity markets have celebrated, rather strongly, the re-election of President Bush. If history is any guide, the market is on its way to becoming a good sell. Nonetheless, with oil in short-term re-treat, the prospect of a rally in global stocks for the holiday season is largely intact.
Looking further out to 2005, none of the developments this week political, economic or social fills me with hope and optimism for the financial market outlook. For investors, next year may feel longer than this one.
(The author is founder-director of Libran Asset Management Pte Ltd., Singapore. The views are personal. Address feedback to email@example.com).
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