In your presentation, you have titled one section "Asia: a force to be reckoned with in its own right." What do you mean by that?
Llewellyn: There's been a perception that Asia is an exporter and principally to the US, and that is Asia's role in life. That's not right anymore. Not only is export demand growing strongly, but domestic demand is growing strongly in Asia. That is absorbing imports at a high rate. So Asia is becoming a growth pole in its own right.
Take China. If you look at the absolute increase in China's imports year to year, it's bigger than the absolute increase for Japan. So China is doing more for other countries growth than Japan is. Furthermore if you take that and project forward China's growth of 7% a year, the absolute increase by 2016 is bigger than that of the Euro area. Putting it in other language, China become a more important pole than the Euro area. That is only arithmetic, but it is indicative arithmetic.
This is one of the themes we've been trying to get across to people - Asia's reached that take-off point where Asian demand is important at a global level.
How long do you feel it will be before Asia (including Japan) becomes a self-sustaining trading bloc, that is no longer so dependent on the US economy?
There's two questions in there. The process of becoming less dependent on the US economy has already started. On the other hand, you never get to the point where you are completely able to steer your own course. The Euro area economy is the largest in the world, and one of the things we learned in the 2001 slowdown is that whereas we thought it would be little affected, it was quite badly affected not so much because of the slowdown in US imports, but because the slowdown had a big psychological effect on business confidence and business expenditure in Europe. That psychological transmission of mood is an important phenomenon in our modern, linked world. That's the same in Asia too. So you won't get to a point where Asia is totally independent. But the lessening of dependence has already started.
Over the next few years as Asia gets less dependent on the US, what then happens to Asian central bank reserves? Will the central banks keep buying US dollar assets such as treasuries - or will Asia be more reluctant to accept these IOUs from America? And will this be negative for the dollar?
In and of itself this is negative for the dollar. We have already seen that the Europeans are saying they don't need the level of reserves they inherited from each of the individual countries. So the more Asia thinks of itself as a region, the less dollar reserves it may hold for the same reason.
But it's fair to say that the accumulation of reserves by central banks is a small portion of overall flows. So as long as they didn't reduce their holdings dramatically it wouldn't put huge downward pressure on the dollar. However, it would remove a source of support.
In fact, when you look at Asian reserves now, you do wonder whether they are not concluding "Haven't we got enough eggs in that basket?"
Would this be positive for gold, if they reallocated reserves out of dollars?
It might be. Or possibly for equities too. Some countries, such as Norway, hold reserves in assets other than gold and government paper. The Norwegians have been buying worldwide equities for their petroleum fund.
What's your view on the Bank of Japan's massive interventions in the forex market? Do you view it as somewhat futile?
No, it's not futile. But it's perhaps less widespread than it ought to be. Japan has a deflation problem. Deflation is a rise in the value of money versus all other assets. Among those assets is foreign exchange. What is curious about the Japanese approach is they are only buying one asset: foreign exchange. We've been advocating that they buy a whole slew of assets such as land, or land-backed assets, and bad loans. The problem is they have a narrow interpretation of what is needed.
Will it become a political issue for Mrs Watanabe that $65 billion is being spent a month to support the currency?
I doubt it will become political. The government can always retort that this isn't taxation money but printed money. In effect, the Americans have given them a license to print treasury bills.
All of this comes down to the imbalances that exist in the global economy today. What is your view on these imbalances and how can they potentially be corrected?
These imbalances are a lot more serious than people realize. They worry you particularly when they are imbalances involving the world's second biggest economy. These imbalances are pretty big. The US, for the past decade, has been consuming 5% more than it produces. It's now in debt to the rest of the world to the tune of 30-50% of one year's GDP.
One thing we know from studying economic cycles is that when you correct large imbalances, there are awkward fallouts. You don't have to predict exactly what will happen to know it could be quite awkward. So we are actually quite worried. And some policymakers are worried about it too - that's why they have been managing the decline of the dollar, in the hope the process will bottom out and reverse, if the US has less import growth.
Is it almost like a juggling act or confidence trick on a global scale?
Yes. The US interest is very much in keeping it alive until the election, and if central banks are prepared to go on funding the US current account deficit between now and November, the Americans will reply thank you very much.
Does the average American realize their economy is effectively being funded by the Japanese and Chinese?
No, because what they have seen is an economy that has grown strongly, and even when it slowed down it didn't go into a recession of any significance. They see inflation under control, which is due to an inflow of high quality, low priced goods from Asia. And they don't feel anything about the current account deficit. Even among professional commentators I am surprised that they don't know the history of their own current account deficit.
At the start of a recovery, the US current account is normally in balance. And yet I've heard many people say to me, "Don't worry about our current account, we're always in deficit." That's simply not so. We have produced a chart that shows that at the end of recessions in the US going back to 1949 the current account was at or near balance at the start of a recovery. This time round there was a deterioration in the current account at the start of the recovery. So it is completely unprecedented [versus the eight recoveries since 1949]. It's a bold man who tells you you can come out of this without any flurry.
Basic economics suggest you are right. But are there conditions - such as new technology - to say why this situation is different?
There are some things you can say to ameliorate this, and that is one reason why we're forecasting that the dollar won't weaken as much as in the 1980s. One is that thanks to all the investment in the late 90s, productivity growth is higher in the US and therefore GDP potential is faster and therefore the debt service potential is enhanced.
Going back to Asia, what's your view on Asian currencies?
We think the dollar will weaken against all currencies, including Asian ones. Asian currencies deserve to strengthen. We see a 17% appreciation for the Korean won, for example. Asian countries used to be export-driven but now they have more balanced growth thanks to domestic demand - so the need for a weak currency is lessened. So we feel the majority of Asian currencies are undervalued.
And your view on the Chinese renminbi is there will be an appreciation?
Yes. Their currency intervention augments the domestic money supply. It's inflationary and in China, inflation is up to 3%, while domestic money growth is brisk indeed. Commercial property prices rose 25% suggesting some asset inflation, and business fixed investment rose 27% year-on-year in nominal terms, and that is faster than is warranted by an 8% trend GDP growth. China is showing all the symptoms of excessive money growth.
If you accept that then you say they should slow down their intervention. But that might see the renminbi appreciate more than they would like, so our answer is to ease restrictions on capital outflow. So it's a bit like keeping the hands on both taps to control the temperature of the bath. On that basis they might manage a modest appreciation of the renminbi of 5-10%.
