Back in November, I laid out the case for a multi-year bull market in the U.S. dollar. At the time I shared several reasons, and most of them seem to be playing out. One of the key factors was my belief that interest rates in the U.S. would be hiked by the Fed before any hikes came about in Europe or Japan. This is important because interest rate support is a powerful driver for a currency.
Interestingly it is not the Federal Reserve that may be the driver of higher interest rates here, supporting the U.S. dollar. Instead it’s the breakdown in the Chinese growth model and their desperate need to refocus on their own consumer for future growth, which could trigger real global rebalancing.
Let me explain …
First, take a look at how the U.S. dollar index has done since my November column: The dollar staged a sharp rally into January 2012; then fell in a decent sized correction. But the interest rate and global macro backdrop seems to be clicking into place for another leg up.
As you can see in the chart below, U.S. long-bond yields are rising. And that got me to wondering: What if the fall in the Japanese and Chinese current account surpluses continues, i.e. is this trend for real?
U.S. Current Account Deficit (black)
vs. 30-yr U.S. Treasury Bond Yield (blue)
If so, it means Japan and China recycle less of their yen and yuan, respectively, back into the U.S. capital markets. And that means the global economy could finally see some rebalancing between the major deficit country, the U.S., and the major surplus country, China.
It also means the U.S. current account deficit, which seems to worry many people and economists alike, is likely to improve, as Japan and China morph increasingly into capital importers instead of capital exporters.
Has this rebalancing begun?
We don’t know yet. But interestingly, given the needs for Japan to rebuild and China to change its growth model, it could very much be the next major global macro trend for the global economy. If so, there are three major implications, and several investment themes spawned:
- U.S. long bond yields have likely bottomed (price topped).
- The next major growth phase for the global economy will be the rise of the Asian Consumer.
- Global capital and trade flow will become a two-way street.
Set to Normalize
Japan recorded its first year-on-year trade deficit since 1980 in 2011. And this year because of nuclear power going offline, Japanese imports of crude oil are up 350 percent compared to the same month last year.
The tsunami and its devastation may have been the catalyst that leads to a normalization of the Japanese economy, i.e. rising interest rates, local commercial bank lending, and local business investment. Normalization is part and parcel to a weaker yen as the game of risk aversion and “hiding” large pools of capital goes away.
China Will Empower
China’s GDP growth will likely continue to fall, reducing its giant reserve surplus. But this will not likely be a disaster if China’s growth model changes to support consumers. Enriched consumers don’t care about GDP numbers; they care about reality.
In addition, China is likely to move away from State Owned Enterprises, which includes massive capital investment projects and consistent export subsidies of companies operating in the red or on wafer thin margins.
That in turn will eliminate the need to recycle surpluses and keep buying U.S. Treasuries in order to keep the currency suppressed, because …
… a stronger yuan will increase consumer wealth, relatively, making the transition to a new model more efficient, i.e. benefiting import industries at the expense of exporters.
Asian-block nations have suppressed the value of their currencies over the last several years thanks to China’s currency suppression and growth model. So they’ll be relieved if China signals it is serious about making a transition that empowers its consumers.
These countries compete against China for the same Western demand. In the process of that competition, consumer market development across Asia as a whole has been stymied. Thus, China’s signaling of a change in its local growth model will likely be reinforced strongly across the region.
Stronger Asian consumer demand and stronger Asian currencies mean Western consumer goods flow more freely to the East, and the U.S. trade balance improves dramatically. It will be quite good for Europe too.
Consequently, the U.S. trade balance and need for external capital to close the current account gap will decline naturally as Asian consumer demand increases.
There Are Risks …
This rosy long-term scenario has risks; here are just a few examples:
- Contagion to emerging markets triggered by the European debt crisis could be severe.
- Potential financial crisis in China as debt grows to dangerous proportions and unrest is met with more internal crackdowns on its citizens.
- A major debt crisis in Japan, triggered by its need to import funds, but inability to see long-term interest rates rise (which attracts funds from international investors).
- U.S. remains mired in its seemingly “never-ending” war policy and does little to improve its unsustainable fiscal deficits.
Net-net if this major trend plays out, it means the U.S. may avoid its fiscal train-wreck destiny. And paradoxically if Chinese leaders trust their average citizens more, they will gain even more control of their own destiny.
So the dollar looks quite good relative to Europe and Japan on the back of rising market interest rates. And if you consider the dollar relative to the commodity currencies i.e. Australian, New Zealand, and Canadian dollars, they appear overvalued if China is slowing.
Thus, the dollar could be looking quite good compared to the entire pack on the back of real global rebalancing.
P.S. I’ve been helping my World Currency Trader members prepare for this global rebalancing. Click here to learn how you can join them. And with our money-back guarantee, you have nothing to lose!