Pictet Become “Secular Dollar Bulls” and Gold Bashers: Our Response

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George Dorgan
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Precisely at the moment when the dollar undergoes a secular bashing with a 6% loss against the yen and 3% against the euro, Pictet publish their “secular dollar bull era” video and recommend investors to avoid gold.

“Secular movements” in currency markets are mostly driven by current account (CA) surpluses or deficits, while housing market booms or busts might takes some years or even a decade. It seems that Pictet did not really read the economic history books.

In favor of the Pictet analysis speak:

1. High rises in income in emerging markets. This inverts the situation between 2000 and 2007, when developed markets increasingly consumed cheap goods produced in emerging markets (with the effect of low inflation : “the great moderation”).
   Many emerging markets have current account deficits now and increasingly consume goods produced in developed markets. The increase in German exports is the best example.
2. Some reduction in the US deficit thanks to shale gas and oil.
3. The recent collapse in commodity prices.
4. The necessary adjustment, e.g. low or no wage increases, high unemployment and falling home prices in Southern Europe weakens Europe as a whole.
5. The US is dependent on cheap oil. With each year that US oil and gas prices do not rise, the purchasing power of average Americans increases. Gas prices remained stable this year.
6. The improvements in the services sector that effectively created more jobs, albeit often part-time jobs.

Against the Pictet analysis there are the following arguments:

1. During the period between 1991 and 2000, rising demand from former communist countries turned the US current account (CA) deficit into a surplus. This led to the Russian default and the Asia crisis. Consumption from Eastern Germany reduced the previously high German surplus to a deficit in 1999/2000.
2. Therefore, the main reason for the rising dollar until 2000 was less the “PC revolution”, but the smaller US CA deficit and a fiscal surplus.
3. As recent numbers show, the European CA surpluses, in particular German, Swedish and Swiss but also the Italian one, are rising, but the US deficit has remained relatively stable since 2010.
4. The “shale gas/oil revolution” has for us far smaller consequences than the “PC revolution”.
5. Similar to the “PC revolution”, the “shale gas/oil revolution” will not be limited to the United States. Also the “services revolution” can happen in many places, not only in the US.
6. Thanks to immense Chinese and Indian reservoirs of poor rural people, strong Chinese and Indian growth will continue, albeit a bit slower than previously. The increasing wealth in China and India of previously poor people is still enough to support commodity prices in the future.
7. We judge that the sudden 40% appreciation of the Chinese yuan against the yen, slowed Chinese competitiveness against Japan in Winter 2012/2013 , helped to insource certain supply chains from China and elsewhere to Japan. Since commodity demand and pricing strongly depend on China, prices edged down. But like all exchange rate moves, this should be only a temporary movement and not weaken China forever.
8. China, India and other emerging markets are just in a typical cyclical slowing after the strong growth from 2009 to 2011.
9. As opposed to the 1980s, emerging markets have their own financing via CA surpluses. In the 1980s, Latin America lived a lost decade because they needed to finance their investments via high US interest rates.
10. Since 2001, however, the growth of emerging markets, especially China, have become self-sustainable, thanks to huge current account surpluses and central bank reserves. The Chinese have always been able to replace rising labor costs with more capital/technology.
11. As the recent ISM PMI of 49 shows, American manufacturing is weaker than ever in the last 3 years. Without US manufacturing the US deficit will continue and there won’t be an era of the US dollar.
12. The improvements in the US housing market are not sustainable, because they are mostly bought with the Fed’s and investors’ money but not by the average American.
13. In April the US trade deficit with China edged up again to a close to record number of 24 bln. USD, higher than in April 2011 or 2010 and six times higher than in 2001.

In summary, if Pictet wanted to deliver a really valid argument for a “secular US dollar era”, then they should explain why the US current account deficit should decrease.

It is true that the rest of the world, especially Europeans, have used some of their current account surpluses to finance a stronger US expansion and investments since 2012, while at the same time European investments declined. German investments declined in Q1, despite a huge 0.8% increase in consumer spending. This shows that German entrepreneurs do not trust their own consumers, but they are dependent on foreign demand. We think this will not last, 3% per year rising German incomes and record-low unemployment will finally translate into consistent higher spending and more investments in Germany.

Thinking that a foreign financing of a US expansion could continue in a “secular way” is rather ingenious. Most importantly it requires a higher yield on investment, like realized in emerging markets between 2000 and 2011. Achieving this yield in an advanced economy with super-low yields, a weak participation rate and stagnating incomes like in the US is fairly impossible.

Does Pictet really believe that Chinese investors will finance a US recovery and that they will not invest in China where they know  people, mentality and opportunities? True in 2012, FDI flows exited from China, but since March 2013 this movement has inverted and money flows back to China.

Still, we would rather judge that the next era goes towards countries with strong CA surpluses like Germany, Switzerland, Norway and Sweden, and most strangely these are Europeans. Due to the missing yields on foreign investments – currently even in emerging markets – these countries will continue to expand strongly internally. Thanks to cheap central bank money, housing booms will continue.

True, due to higher wages and possibly rising oil prices, the Chinese surplus could substantially decrease in the coming years, the surplus to GDP ratio is already falling.

When the Chinese current account surplus goes really down to zero and when the Fed does not need to hold hand of the housing market anymore, then it is time to be long the dollar, but this is far-fetched.

About George Dorgan

George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on SeekingAlpha.com and on this blog. Several Swiss and international financial advisors support the site. These firms aim to deliver independent advice from the often misleading mainstream of banks and asset managers. George is FinTech entrepreneur, financial author and alternative economist. He speak seven languages fluently.

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