China will be the new global standard

The loonie will continue to advance against the U.S. dollar over the near term, but it’s sustainability on the longer term is doubtful.

The commentary is part of a larger discussion on currencies and global interest rates, delivered by Francis Scotland, director of global macro research, Brandywine Global Investment Management.

“It seems to me we’re probably entering some sort of trading range in the currency,” says Scotland. “We are probably at the mid-point of that trading range.”

Other currencies such as the Chinese yuan and the euro are also subjected to close scrutiny.

“There’s a sense that China will ultimately be the new global standard,” Scotland says. China is already moving in that direction, but a lot remains to be done. For China to become a global standard the country will need to “develop a capital market (in which) we can actually buy and sell our securities and the currency is completely flexible and exchangeable.”

That is all highly unlikely in the foreseeable future, says Scotland, but he says it will inevitably come to pass over the next 10 or 20 years.

He remains optimistic about the future of emerging economies in general, pointing out that economies can no longer expect to grow on the back of the developed world and have been creating their own consumption culture. Scotland singled out China as the country with tremendous growth tailwind behind it.

“They can’t rely on the U.S. to absorb their excess production over the next several years so they are going to have to stimulate consumption (within China).

The outlook for the euro, however, was far from positive.

“I’ve been a euro skeptic my entire career and I don’t think it made any sense,” says Scotland, while asserting the euro won’t disappear any time soon. “Euro was developed out of a political realization that European countries must stop fighting with each other.”

Scotland expressed strong views, backed by detailed research work, on the state of European economy. A large part of that was hogged by the anatomy of a sovereign debt crisis and how it’s playing out in PIGS (Portugal, Italy, Greece and Spain).

“The economy generates savings and those savings are used to fund growth,” he says. “If along the way it gets funneled into supporting national debt, then there is less money available to fund growth.”

When all the savings of a country are used to support the interest payments of the national debt, “there’s nothing left over to fund growth, let alone replacement capital money.”

Long before a country gets to that point, it has an economic crisis on its hands, with debt restructuring and devaluation of the currency inevitably following.

It is important to know the tipping point, says Scotland. Greece did not know this point and is paying the price for it. Iceland and Portugal appear equally clueless.

“At what point do you know that you are at that spot where you have to turn back? Greece hit that tipping point earlier this year. Iceland hit it in 2008 during the crisis.”

He says the savings are initially allocated to primary balance — government borrowing requirement — and then to servicing the national debt, and what’s left over may fund growth.

(07/16/10)