Three Unorthodox Views

In separate pieces we have sketched three views that are outside the consensus. We thought it would be helpful to pull them together into one note.

1. Resilience of the US economy: Many fear that the end of the payroll savings tax holiday and the sequester will undermine the US economy and, possibly, push it back into a recession, after a pitiful 0.1% expansion in Q4 12, before the spending cuts and tax increases were implemented.

We demur. The recent ISM suggests an under-appreciated resilience of the world's largest economy. Auto sales have remained strong and steel output is at its highest level since last September. The wealth effect of rising stocks and home prices is not being lost on US consumer confidence. 

What we are suggesting is not unprecedented. Just like the tax hikes in Reagan's second term and tax hikes in Clinton's first term were "supposed" to derail the economy, it did not then either. The underlying strength of the US economy is illustrated by two numbers. First, in 2012 US exports exceeded China's, according to the respective government's data. Second, the US oil production exceeded Saudi Arabia last November, the most recent comparative data.

2. Skepticism about the prospects of Abenomics: We argue that the yen's weakness was not only a function of the change in regimes in Japan, but actions of the ECB last summer to ensure the survival of the EMU project reduced the need for safe havens in general and this was clearly a force much larger than the yen, but impacted other safe havens and risk asset more broadly. Of course, signals of aggressive fiscal and monetary stimulus further encouraged the yen's weakness.

However, barring a remaining window to shock and awe at the April BOJ meeting, we think the major parts of Abenomics are in place and that the government will not turn its attention to its political agenda ahead of the summer upper house elections. 

Our concern is two-fold. First, that as the LDP seemed to have demonstrated previously, monetary and fiscal stimulus in the absence of structural reforms are not effective under present conditions in Japan. Second, while foreign interest in Japanese equities remains keen, and many international fund managers remain underweight Japanese shares, Japanese investors are keeping more of the investment at home. It seems as if the realization that their yen can buy few foreign assets has caused a bit of a sticker shock and have been spurring the selling of foreign assets. The inability to recycle the current account and portfolio capital inflows may exert upward pressure on the yen.

3. Currency Wars: Although the media continues to press this line and many commentators refer to it, the recent G7 and G20 meetings agree with our assessment that current behavior--the pursuit of monetary and fiscal policies for domestic objectives is not tantamount to a war. Japanese officials have moved back within compliance by not citing specific bilateral exchange targets. 

In addition, over the past couple of weeks, Japanese officials have played down the need to buy foreign bonds (which is too close to fx intervention), and showed less urgency to change the BOJ's charter, Abe appears to have picked the official to head up the BOJ that has the highest international gravitas, and Japan seemed to be more likely to join the trans-Pacific free-trade agreement. The existence of circuit breakers and conflict resolution mechanisms, like the World Trade Organization reduce the chances of currency tension spilling into trade.

One of the dangers of exaggerating currency wars is that it distracts our attention from the real systemic fissures. Unlike the 1920s and 1930s, the critical fissure is not between countries (as was the case in the aftermath of the end of WWI--see The Economic Consequences of Peace by Keynes), but within countries. Rather than confront the political and economic elites in other countries to soften the blow at the end of the credit cycle, the domestic elites have turned on their own people. 

Capital accumulation and profits are largely being preserved at the cost of further erosion of the social contract and the increased concentration of income and wealth domestically. This assessment suggests the international order may be more robust than many have argued. This in turn underscores our belief that the role of the dollar in the international economy as a reserve asset, a store of value and a means of exchange has not and will not be significantly altered by the financial crisis.