Sage Analysis From a 93 year-old Economist

Anna Schwartz is 93, an economist, a nobel laureate and she has studied the economy as closely as anyone for about 70 years. Her analysis is devoid of politics and refreshingly full of common sense.

Global Economy Requires Chinese Leadership

It is now essential for China to take the leadership role in the global economy, otherwise the world may truly face a horrific depression. Calls for a new global reserve currency are wrong-headed. Though that may eventually be the consequence, it won't happen just because it has been ordained by a group of Finance Ministers or Central Bankers. The real issue is how China manages the unwinding process of its IOU's (US Dollars), which should be for real goods, not some other paper currency issued by a different Government.

Since at least the 1940's and perhaps earlier, the US has always been both the engine of global growth and the foundation of the financial system. Most recently, the US consumer has been the magnet attracting exports from China and the other developing nations, who have been happily accepting dollars in return. By their continued actions, it is clear that the US and China put their faith in the notion that those IOU's would continue to hold their value till the time would come when China would eventually cash them in.

As long as US consumers continued to import from abroad, Chinese exporters sent their wares to US shores and the Fed financed all these transactions by providing a steady supply of US Dollars, everyone was happy. This resulted in massive current account and trade deficits in the US, but did not harm the real economy until the financial system collapsed last Fall.

The perscription for the financial crisis was an absolute massive increase in the supply of the IOU's, and now China is predictably worried about whether they will receive full value for the more than $1 Trillion they are holding. Therefore, China will not choose to sell those dollars in favor of other currencies as doing so would catastrophically kill the nation's wealth.

Instead, the world requires China to turn its economy inward and fire up a domestic engine of growth much as the US did through the second half of the 20th century, so that all the accumulated dollars can be used to purchase US-priced goods, services and assets.

The other side of this coin, is that the US must quickly get on the path of repairing credibility in the US Dollar or China's actions won't matter. Though China may hold enormous power due to its US Dollar holdings, international investors and currency traders can quicly launch an assault on the Dollar if they smell blood, ushering in destructive inflation that will take at least a generation to deal with. To prevent this, the US must face reality and curtail spending right away.

Obama's Policies are Socialist - Accept It and Let the Debate Begin

Many people have been afraid to term Obama's economic policies as Socialist. But the reality is that they are as close to Socialism the US has seen in at least 70 years and there is nothing wrong in stating that fact.

Obama and his like-minded advisors are smart enough not to roll out the entire philosophical vision all at once. Instead, they adroitly tap into anti-establishment populism, exploit the fears of the masses and then propose a socialist policy as the answer.

We have seen this in banking, the auto industry, executive pay and it is being attempted in healthcare and the entire manufacturing base via cap and trade. I believe the pattern has been set. Every time there is an economic challenge, Obama will exploit the fears in the grass roots as a means to propose a socialist policy. That way he can be viewed as a pragmatic problem-solver, rather than an unyielding ideologue.

The term Socialist needn't be as loaded as both sides would have us believe. Obama should stand up and be proud to state that he fundamentally believes that Socialism is his preferred philosophy upon which to draw economic solutions and his opponents should argue against that position based on the merits rather than demonizing the term.

Analysis of China's Strategy

It is essential for China and the US to cooperate on monetary policy. During the enormous consumer-led boom in the US and consequent export boom in China, the US issued massive amounts of IOU's in the form of US dollars, but what most people fail to see is that the other side of the equation requires China to extinguish the IOU's by buying goods/services/assets in exchange for its dollars.

While the US continued to grow and its economy could continue to absorb huge amounts of Chinese exports, the brewing problem could be ignored. But not anymore. The financial meltdown in the US caused the recession which in turn has focused a huge, bright light on the international trade imbalance. Now the IOU's have to be reversed. China must buy goods/services/assets from the US and the dollars must come back.

If China and the US do not cooperate through this massive monetary realignment, the US Dollar could fall precipitously causing inflation in the US and a huge degradation of wealth in China. this is not a good scenario for the global economy. To prevent this, China must focus its economy domestically and import from the rest of the world, especially the US and trade must be liberalized.

Example of China's Strategy

China's Talk of New Global Reserve Currency is just that - Talk

China is very slowly transitioning into a domestic demand led economy from an export led economy. That means that over time, their accumulated US Dollars will be used to finance an import boom to feed the appetite of a growing Chinese middle class and for Chinese investment in its productive capacity. But, China is understandably concerned that its huge stock-pile of dollars will be worth less in the coming years due to the unprecedented oversupply being created by the Fed. China's answer is to use the dollars to purchase large stores of physical assets, such as oil and base metals and to purchase foreign suppliers of commodities. China's public admonition to the US to assure it of its commitment to reducing debt and to raise the issue of an alternative global reserve currency is just talk. China needs the value of the dollar to remain in tact over the next several years to maximize its purchases of hard commodities. So China won't diversify from Dollars to Euros or IMF special drawing rights or any other currency. They instead will hold their wealth in goods.

Franken becoming 60th Democratic Senator won't tranlate to 60 reliable Democratic votes

The New York Times does a great job explaining why Al Franken's election to the US Senate won't deliver 60 votes; Kennedy is ailing, Byrd is ageing, Spector is questionable and many others won't follow Reid's orders.

Will the Canadian Dollar reach parity with the US Dollar in 2009?

It's Canada Day and for currency traders that just means a slow day in the Canadian Dollar FX world. So, I thought it would be a good time to kick off some reflection and contemplation on the longer term direction for the USD/CAD exchange rate.

Please be sure to vote in the poll and provide your comments below.

There are many good arguments suggesting that the Canadian Dollar will appreciate from current levels and equally good arguments suggesting the opposite.

Some factors in favor of the Canadian Dollar:

• Much better fiscal management than the US
• Much more stable banking system than the US
• Recovery in commodity prices, especially oil

Some factors working against the Canadian Dollar

• Aussie Dollar (considered an alternative currency investment to the Canadian Dollar) is likely to attract much more demand than the Canadian Dollar due to better than expected economic performance and higher interest rates
• US economy may be weaker for longer than expected, reducing demand for Canadian Dollars as global investors react to tight integration to the 2 economies
• Canadian Government is in a minority position and could fall at any time, increasing the chances that a new Government who is less fiscally responsible could be elected

These are only a small sample of the factors out there. Please place your vote in the poll and add your comments.

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