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BY MURRAY LEITH
Globe Investor Magazine Online, March 31, 2009
Many believe that the United States' debt problems are insurmountable and that the U.S. dollar is destined to collapse.
But the conventional wisdom regarding the United States is shortsighted. Mainstream thinking misses the big picture and fails to consider that the attractiveness of a country depends on its "relative" position in the world and not its "absolute" predicament. The unconventional truth is that the rest of the world has major problems as well, some of which are more worrisome than the challenges south of the border.
It is easy to believe that the United States has the biggest banking problems, given the high-profile failures of companies such as Lehman Brothers and AIG.
But the U.K. and European banking systems are in worse shape. According to work by David Beim at Columbia Business School, the weighted average drop in value of big U.K. banks was 76 per cent in 2008. In Europe, the decline was 69 per cent, whereas the North American banking system lost a significantly lesser 54 per cent of its value in 2008.
The fact is, U.K. and European banks are considerably more leveraged than their counterparts in North America. While the five major U.S. investment banks got into trouble because they operated with asset-to-equity leverage of 25 to 35 times, the overall U.S. banking system is much less leveraged at about 12 times, according to Mr. Beim.
By the same measure, German and U.K. banks are leveraged at 42 and 27 times, respectively. Not only do the Western European banks have homegrown problems, but they also have huge exposure to Eastern Europe, which is under considerable pressure as a result of the plunge in global trade.
Although Republicans and Democrats have struggled to agree on the correct measures to resurrect the American banking system, significant progress has been made. Not only does Europe have bigger problems brewing, but it is not hard to envisage political gridlock and a lack of effective action, given the number of countries in the European Union.
With economic conditions worsening, the U.S. Federal Reserve has resorted to quantitative easing, which is a fancy term for printing money. The alarmists declare that this latest initiative will be inflationary and destroy the value of the U.S. dollar.
There are two reasons to disagree. First, there does not seem to be a viable alternative to the U.S. dollar. Second, there is too much unused labour and productive capacity in the world to create widespread inflation.
The U.S. dollar depreciated by almost 40 per cent relative to the currencies of its major trading partners between early 2001 and early 2008, making the country significantly more competitive. It is doubtful that other countries will want to experience further currency appreciation that will undermine their competitiveness.
Despite widespread pessimism, the American dollar staged an impressive rally, rising almost 25 per cent from its low before renewed weakness in recent weeks. The dollar strengthened when the rest of the world's central banks aggressively lowered interest rates upon the realization that the credit crisis was global.
Likewise, the American dollar will regain its appeal when investors realize that other central banks will also resort to money printing to keep local currency appreciation in check and stimulate their own battered economies.
The problem in the world today is that there is too little demand and too much supply. It will take a tremendous amount of money printing, credit creation and time before inflation is a threat. There are simply too many unemployed workers, unwanted houses, vacant office space and underutilized factories to believe that demand will overwhelm supply and create inflation any time soon.
Global trade has collapsed because the world's banking system is going through a massive deleveraging process. Indeed, the World Trade Organization predicts that global trade will plunge 9 per cent this year, the most since the Second World War.
The U.S. economy has held up relatively well under the circumstances, in large part because it is less reliant on exports compared with Europe and Asia. For example, exports account for about 12 per cent of U.S. GDP versus more than 45 per cent of economic output in Germany and China.
The bottom line? America is starting to look pretty good relative to the rest of the world.
Special to the Globe and Mail
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