Monday, May 15, 2006

The Dollar, Cheap Imports, and No US Savings...

A friend of mine, who has businesses in the USA and China, emailed me some wonderful feedback about my recent blog entry about “Currency Markets and the Falling Dollar”. His perspective and insight add further dimension to my discussion.

Here are some quotes and excerpts he provided, plus some commentary I offer in return:

“In regards to the Chinese currency revaluation, we need to first realize that there are two camps interested in the rate, the first are US investors who do not want to see the exchange rate change as that increases there costs of doing business [in China]. The second are those who want to try and make up gaps in the trade deficit and make Chinese goods more expensive so they can compete. In my opinion cheap Chinese goods are an asset to more people then poorly competing US firms that have higher production costs. Chinese have along history of not importing and it is not because the foreign goods are too expensive – it is that they do not cater to the Chinese culture. The US has been an expert in exporting its culture around the world, however when there are countries who are not willing buyers, they [US firms] resort to other means to try and force the issue. Imagine a 40% revaluation of the currency and how that will affect prices of everyday goods for Americans, versus how much revenue it will bring in for US companies that export a few more goods to China. The Chinese government is taking steps to change the exchange rate, and personally it has already cost me quite a bit of money as a US investor in China.”

“Since I have been here [in China] I have already seen a few percentage points drop [in Yuans / USD]. It’s a strange feeling because I understand the market fundamentals and how a revaluation will make things fairer for other competing nations, however I feel the side that wants to keep my costs low, and that influences my thinking. I can now see how big business/governments get so corrupt.”

True, the currency (the Chinese Yuan) is allowed to “float” now against the USD, though within certain parameters that limit the amount of float per day. Here is an article on the recent value of the Yuan, and how it is making gains against the dollar.

Regarding the comment about how big business and governments can get so corrupt, my friend is dealing with the influence of the exchange rate on a relatively small business and investment in China (< $5MM USD / year). And, even at his current investment level, he sees how keeping the value of the Chinese currency depressed works to his advantage and keeps his labor and direct costs in China low. Can you imagine how badly the largest corporations with huge investments in China must want the Yuan to remain week vs. other currencies? It is in their best interest for the Yuan to stay low, so long as countries like the USA continue their Chinese-imports-feeding-frenzy.

And, speaking of this import feeding frenzy, my friend has this to say:

“The fundamental problem with the US financial state is that it is a culture of [people who are] spenders and not savers. The savings rate in many Asian countries is near 40% and the US, I believe, is close to single digits [Mike comment: actually, it is ZERO – read this recent article about the savings rate in the USA hitting ZERO]. This creates a large need for capital in the US which cannot be supplied by the little saving Americans have. This by its very nature forces the US to export its money and other counties are willing buyers at a low price. The sucking sound you hear is the need for US capital because there is none here [in the USA], we have spent it all. This is why a large trade deficit isn’t a bad thing for the US. This is an indication of foreign countries willing to invest in US Dollars. The question is: are we doing the right things with the foreign capital? If we are buying expensive houses and sports cars, then the answer is no. If we are improving education, funding cutting-edge research, and so on, then yes. As we export our culture and turn these [other] societies into spenders and not savers, this competition for capital will increase, and with more competition, the Dollar will slide further against other currencies.”

"Another interesting problem that I think underpins many future issues will be that of investment in research. Currently the US has shifted from traditional production to high tech production, and this I believe will cause a fundamental problem in the future. The issues stems from the combination of government’s inability to fund long term science projects that will help keep the lead, so to speak, for the US in the technology sector, and market driven economies inherent weakness in encouraging long term investment. As “third world” countries invest more in higher education and at a higher rate than the US, the low hanging fruit the US currently eats will be going away very soon. I feel and this includes software development, technical management, and high tech production and research. The higher hanging fruit requires massive long term investment that just doesn’t seem to be a priority in a heavily market driven economy where the pressure is to meet quarterly expectation, and where no one cares about the company’s growth ten years from now. The government has been in a freefall of cutbacks on research since the 70’s and there doesn’t seem to be any comeback on the horizon. This, coupled with the inability to cut back spending in general, leaves us [the USA] in a bad situation; the government is spending far more on things that will not take us into the future […] it seems whenever countries historically get on top, they then look for ways to maximize their lifestyle and loose the “eye of the tiger” [that got them to the top to begin with]. The danger of this is that the US will find itself on equal ground with many new nations, and couple this will a falling dollar, it may cause countries currently holding dollars to start to sell, and we all know what that will do."

Wow! Those are all great points and wonderful insight! Keep it coming people!

The final comments from this friend also covers the topic of my other blog entry about stock market investing. His overall take on investing is an interesting one we should all keep in mind, since it focuses on the macro psuedo-psychological factors behind buying and selling stocks, currencies, and the likes (and, how their expectations drive price determination in the market):

"One observation you made [in your blog] which I think is critical for people investing to understand, is that relationship between good and bad news and the price of the stock, currency, or whatever instrument being trading. The point that I think is often misunderstood or forgotten is that the market price already reflects the expectations of that market on the instrument. Simply put: the dollar doesn’t go up much on good news because people are expecting good news! You expect good news from Microsoft, and not bad news, which is why it is a blue chip stock. Bad news on a stock that is expected to do well is really bad news for the pricing expectations, and therefore has a greater impact on the percentage change. People need to remember that when they invest in a stock that they think is going to really go up, that you are betting against the market, which sets the price based on what everyone thinks will happen. This [logic] is the same on the downside. [...and] why you find stable companies that have modest returns, and are expected to pay dividends. This [logic] is especially true in the case of the dollar, which has been such a large tool for countries to help stabilizer themselves with (by holding lots of US dollar reserves). As I said before, as more countries start down the road of spending as the US (such as the EU, China, etc.), there will be more competition for the money from countries that save, and this will push down prices paid for currencies currently held by [savings countries that move towards] spending countries."

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