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Monday December 8, 2008 - 16:28:01 GMT
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Detroit's Failure and the Dollar

On first analysis it would seem that the survival or not of the American automobile manufacturers will have little direct effect on the dollar.  The United States economy is no longer a manufacturing economy, less than 15 % of GDP is directly tied to producing goods.  Though the US is still the world’s top manufacturing nation by total value, autos are not a US export.  In 2005 the value of US produced goods was $1.5 trillion, 1.5 times the value of the production of the next country Japan.  The US leads the world in productivity per worker, in productivity gains, and in the flexibility and responsiveness of its economy.

The US has a successful, growing and very productive auto manufacturing sector, it is simply not in Detroit, not in union plants and it is not owned by Ford, GM or Chrysler.  Almost every major German, Japanese and Korean car company has factories in the United States.  In many cases the imports that Americans buy are manufactured in the United Sates. Cars with industry leading quality ratings from Toyota and Mercedes Benz are the product of American hourly workers.

The potential demise of the Detroit car industry is not due to lack of automotive ability. Ford and GM are not unable to make cars. They both have thriving and profitable overseas operations, manufacturing and marketing cars based on local designs and facilities.  Their problems are tied to the North American market, to the cost structure that has evolved with its unions and to the impositions of regulators.  The American manufacturers are not competitive in their home market but they are extremely so in Europe and China.

The greatest threat to the US economy of an auto industry bankruptcy lies in its unpredictability. That is the primary reason the big three will get their loans. If the Detroit factories close there will be unforeseen consequences.  The bankruptcy of Lehman Brothers was a warning. When Lehman was permitted to close shop it was thought to answer the moral hazard problem.  If failed firms are not subject to the culling of the marketplace there is no market discipline. The government cannot rescue every badly managed financial institution. But the failure of Lehman brought on the acute phase of the credit freeze in September and October. And that credit freeze pushed a weakened economy and consumer into serious recession.  The incoming administration will not dare take such a chance with Detroit.

Automobile manufacturing employs 200,000 or so workers directly with perhaps two million more throughout the supply chain. Even if half of these jobs were lost through the consolidation of chapter 11, the difference is one of timing and not amount. Whether employment in the auto industry shrinks through the enforced decisions of a judge or voluntary accession as part of a government loans, shrink it will.  Congressional legislation cannot restore the profitability of Detroit’s North American operations.  Congress will set some type of viability standard when it provides the automakers with loans but without a wholesale restructuring of their production costs the US car companies simply cannot compete with their newer, more efficient, less unionized rivals.

The risk that the collapse of Detroit poses to the American economy and by default to the dollar is not one of fact but of perception. 

Until now the dollar has not suffered any penalty for the US recession. Though the US economy is in no better shape than the Eurozone the dollar has gained a huge advantage. Because its policy makers recognized the severity of the financial crisis last August and began corrective measures while the ECB slept, the European central bank has a much longer repair to undertake. Once it became clear that the economic downturn would be worldwide and deep, and the Europeans could no longer pretend otherwise, the euro and the yen crosses sold off rapidly.

The currency markets have reached a rough equilibrium between the dollar and the euro.  The ECB and the Fed now have the same rate policy; the economies of the Eurozone and the United States are in recession.  The dollar has benefited from the early comprehension of the Federal Reserve and the Treasury and their willingness to use their powers to ameliorate the crisis. These early actions combined with the resilience and adaptability of the US economy are behind the assumption that the US will surmount the recession first.  A prolonged and well publicized bankruptcy in Detroit, with its potential for unforeseen and unpleasant consequences could undermine the US recovery first scenario.  Undermine that idea and the dollar could suddenly become very weak.  

Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst

[email protected]

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