Everyone's a Back-Seat Driver at the G-20

11/11/2010 3:00 pm EST

Focus: GLOBAL

Igor Greenwald

Chief Investment Strategist, MLP Profits

Two world wars should have rid Germans of the notion that the best defense is a good offense.

But look who’s leading the blitzkrieg against the Federal Reserve’s new round of “quantitative easing” (QE2). Last week, German finance minister Wolfgang Schaeuble called the policy “clueless.”As G20 leaders gather in Seoul for an unusually awkward summit even by such affairs’ stilted standards, the Germans aim to team up with emerging powers in framing the US as a currency manipulator in need of remedial economic tutoring.

That’s more than a bit rich coming from a country with a 6% current account surplus, way beyond what most experts would deem sustainable. (The US overconsumption orgy climaxed at a 6% current-account deficit in 2006.)

Relative to the size of its economy, Germany’s current-account surplus, which could just as accurately be called a consumption deficit, is 30% bigger than China’s. And while China’s has halved in two years thanks to a huge domestic stimulus ordered by Beijing, Germany has worked tirelessly to suppress consumption across Europe with its mistimed insistence on austerity.

That’s about as selfish as a policy can get, since the point is to protect German banks—and, by extension, taxpayers--while stringing along over-indebted allies who owe those German banks a lot of money.

Virtual German client states like Ireland and Greece will get bled for as many more months as they can stand it, paying interest through the nose to prolong an unsustainable situation.

The German formula, as dictated to the struggling economies on Europe’s fringes, is a simple one: an overvalued currency plus draconian budget cuts and tax increases equal decent growth down the road. Local recessions, disappointing tax revenue, and public disorder seem more likely.

And when they can’t pay anymore, they’ll get cut loose from the European Union, while Germany, having bought some time, will shift its financial support to its own banks.

The Chinese seem somewhat less inclined to bait Washington. Still, the hard liners in Beijing couldn’t pass up an opportunity to tweak their adversaries.

China has a legitimate worry that some of the dollars created by the Federal Reserve will wash up on its shores. It could hardly be otherwise, as investors bet on the demise of the dollar peg that has been beggaring China’s more market-oriented neighbors for so long.

As a country whose largest export market has an unemployment rate of nearly 10% partly as a result of its own mercantilist policies, China, as a country with a $27-billion monthly trade surplus, holds no moral or practical high ground in this squabble.

The Brazilians are unhappy, too, with QE2, warning of ripple effects around the world--11 years after Brazil devalued its currency by half, driving neighboring Argentina to ruin.

It’s interesting to note that Brazil’s economy avoided hyperinflation as a result of the cheaper real, and in fact used it to jump-start a decade of growth. Now, the unemployment rate in Brazil is a record low 6.2%, and the real is the hottest currency around. So, you can see how Brazil has real problems on its hands that the Federal Reserve should care about.

A cheaper dollar is what it will take to stop the rot that threatens to turn the world’s largest economy into a hollow husk. A cheaper dollar is what’s needed for the long-term unemployed to become employed and not turn into a permanent underclass. There are worse fates than 3% inflation. Ask Argentines how their insistence on an uncompetitive currency worked out a decade back. Or wait a year and ask the Irish.

By sheer coincidence, the bond purchases planned by the Fed over the next eight months just about equal China’s holdings of US Treasuries. So, if Beijing is worried about the dollar, it’s got an opportunity to sell to the Fed and plow its dollars into a better inflation hedge.

Tom Slee thinks something like this might prove to be the pin that pops the bond bubble. Or a European debt default could do the trick. Or maybe a central bank will come along and make alternatives to bonds as attractive as they’ve looked in a long time. That seems to already have happened, sending longer-term bond yields higher.

Our imaginations prove inadequate to the course of events time and again. While Citigroup (NYSE: C) fetches $4 a share, Bancolombia (NYSE: CIB), headquartered in Pablo Escobar’s old stomping ground of Medellin, sells in New York for $65. It’s priced at three times book value while Citi’s is stuck below book. But while Citi’s return on equity is 1%, Bancolombia’s is more like 19.5%. Paul Goodwin notes that this steady earner comes from the hottest emerging market on the planet, and likes how the stock’s chart is shaping up.

China Mobile (NYSE: CHL) is another emerging-markets plodder with a decent yield, one that should rise for holders of the ADR, along with the yuan. Its $42-billion piggy bank and dominant position in China’s wireless market also have Yiannis Mostrous paying attention. And he’s hardly the only one bullish on China. At the moment, the US has fewer hangers-on, and hardly any real friends in Seoul.

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