-- Posted Tuesday, 28 December 2004 | Digg This Article
The Daily Reckoning
Poitou, France
Tuesday, December 28, 2004
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*** How low can we go?...disturbing lack of concern over the dollar's slide...
*** GUDD times, bad times - you know we've had our share...the kind strangers may be tightening their purse strings...
*** Hoping for action without reaction...don't sweat the small stuff...it takes a village...and more!
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Poor Mr. Asakawa. The poor man must have dark circles under his eyes. He must nod off in meetings. Maybe he has a hard time paying attention.
For the last two nights, the ringing of his infernal currency monitor must have disturbed his sleep. You remember; he keeps the device near his bedside, set to go off whenever the dollar leaves its trading channel. And both yesterday and the day before, while Japan was in shadow, currency traders in the West sold the dollar. The dollar hit a new low each night.
This brings the buck to a new all-time low against the euro of near $1.36.
You may think that this has little importance to you, dear reader. You pay your bills in dollars. So what if they are worth less in Paris or Tokyo?
But overseas, investors - including, notably, central banks - have nearly $10 trillion worth of U.S. dollar-denominated assets. (By contrast, Americans have only $7 trillion worth of the foreigners' assets. This puts the difference at $3 trillion...)
So far, no one has gotten very alarmed by the dollar's decline. Quite the contrary, most people think a lower dollar will help make American businesses more competitive. Stock market investors believe U.S. companies will become more profitable.
The dollar has drifted down...down 33% against the euro in the last 3 years...down 4.4% since George W. Bush's re-election...and no one has worried too much about it. Except us...and, perhaps, Warren Buffett. Buffett has quietly added to his holdings of foreign currencies over the last two years. Now, he has $20 billion worth. In the first half of 2004, it looked like Buffett had made a mistake. The dollar rose...and Buffett lost millions. But in the second half, he has recovered his loss and made millions more - some $400 million in profit. Again, the Old Sage of Omaha has been proven right.
Of course, you have had our advice for the last few years, too. It would be a GUDD time, we guessed. Gold would go Up...the Dollar would go Down. Those have been the major trends of the last couple of years. Stocks have gone mostly nowhere. Bonds too. But the dollar is much lower than it was two years ago...and gold is definitely much higher, $446 per ounce, as of yesterday.
Most people hardly noticed. No one cares about gold. And a lower dollar - isn't that good for the economy? But the alarm bells would really go off, we thought, when the bonds begin to fall. That would be when Mr. Asakawa's nerves cracked...and he finally had to admit his mistake and stop buying dollars. Worse, he might start lightening up on his U.S. dollar holdings. Then, we also guessed, all Hell would break loose. Yesterday, bond yields rose. Trading was thin, but it looked like the bond market might be beginning its long-awaited detachment; bits of Hell were starting to fly off.
The devil detail in this diabolical situation is nearly $2 billion per day that must be "absorbed" by foreigners in order to keep the dollar in the same place. Up until now, kind strangers have been good enough to take the dollars and re-invest them in U.S. bonds. This held the dollar in place - more or less - while boosting the price of bonds (and not coincidentally, lowering the price of credit).
U.S. policy makers, analysts, and the chattering classes seemed to think that the dollar could fall - thus helping to eliminate the need for the $2 billion daily fix, and making U.S. business more profitable - without any nasty repercussions. They thought they could disprove one of Newton's Laws - they expected an action with no reaction. But here at The Daily Reckoning, we have faith in the eternal and essential truths: There would be no silver lining without a dark and ominous cloud attached to it.
And so, just yesterday, a little wisp of gray formed in the heavens over Wall Street. The dollar took its customary stroll down the hill. Its step was light. Its spirits high. It seemed not to notice that bond investors were selling. If the selling continues today...tomorrow...and thereafter...there will be Hell to pay.
And we kind of think it might...
More news, from our team at The Rude Awakening:
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Eric Fry, reporting from Wall Street...
"'But you cannot convince me that the long-term trend for the dollar is positive. If you swapped out of gold in time to catch a dollar rally, you'd feel like a genius for a while. But I doubt you'd feel like a genius for long.'"
For the whole story, and more market insights, see today's issue of The Rude Awakening:
Dead President Bounce
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Bill Bonner, back in the French countryside:
*** The hardest thing in investing - or in life itself - is avoiding distraction. Unfortunately, the whole world seems to want to distract you. The newspaper headlines. TV. Idle chit-chat. Before you know it, you find yourself worrying about things you can do absolutely nothing about. You may even find yourself caring about things that mean nothing. What are the gossip pages - but idle distraction? The sports pages? The editorial pages? Even the news pages.
In the financial markets, it's easy to let yourself have an opinion about the future of broadband...Las Vegas...outsourcing...the federal deficits. You might just as well have an opinion about Britney's new boyfriend/husband.
Keep it simple. Stick with things you know....things you can control. Avoid distraction. Find a business, like Warren Buffett, that you really understand. Buy it at a good price. If the price is too high, don't buy it. If you have money to save...buy gold. Or lend to credit-worthy borrowers in a reliable currency. There. That's enough advice for one day.
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*** How high will the price of gold go?
The question was posed to our old friend, Doug Casey. He gave the following reply:
"There are many ways of determining what it "should" be worth, based on fundamentals. The US Government owns a reported 261.6 million ounces of gold. If they were to back all the dollars represented by M-1 with gold, based on an M-1 of $1.31 trillion, it would require $5,000 gold. If we use M-3, which is $9.04 trillion, it would be $34,570 gold. Just to cover this year's foreign trade deficit of $600 billion would require $2,294 gold. And that's not the accumulated deficit, or those that may be run in the future. If gold were simply to return to its 1980 high, it would be close to $2,000 in today's dollars - and the situation is much more serious now that it was in 1980."
*** "Where is Henry?"
The question disturbed the whole family last night. By 6 pm, it was dark as a tax collector's tomb outside. And Henry, 14, had still not come back from his ride. He had left at 4pm, saying he was off on his horse to ride "Circuit #9." By 7pm, his father and mother were driving around, stopping to check the soft ground for hoof prints.
"We saw him go through here about 5pm," said a friendly man in a neighboring village. "He was headed down towards the river."
"And, just so you know," he added, "everyone in the village is ready to help find him, if he doesn't turn up soon."
There is nothing particularly dangerous about riding a horse over the trails of this region. The trails are well marked. The area is sparsely inhabited, but not desolate.
Still, you never know. The horse could have been spooked by the darkness. Or it might have slipped on the riverbank. Or Henry might have gotten lost. And now it was pitch dark; how could he find his way home?
By 7:30, Henry's mother was in a state of alarm.
After tracing much of what we took to be "Circuit #9" we returned to the house...hoping Henry had turned up. But the stable was empty.
Then, at the house, the phone rang. It was Henry himself. The lad had indeed gotten lost...and when night fell...he made for the nearest light and asked to use the phone.
"Where are you going?" asked the farmer.
"Well, I'm just trying to go back to Ouzilly..."
"Oh, where the Americans live..."
"Yes..."
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The Daily Reckoning PRESENTS : Most Americans refuse to acknowledge the absurd amount of damage the trade deficit has inflicted on the U.S. economy...luckily, the Good Doctor is here to illustrate the risks the trade deficit puts on the entire U.S. financial system. Read on...
THE MISSING LINK
by Dr. Kurt Richebächer
The badly flawed consensus thinking about the implications of sustained large U.S. capital inflow starts with the error that U.S. assets are uniquely attractive to foreign investors. The reality is that U.S. investors are earning far higher returns on their assets in Europe and Asia than foreign investors do on their U.S. assets. European firms and investors who invested heavily in the United States during the "new paradigm" years in the late 1990s are still smarting from horrendous losses. The DaimlerChrysler disaster is by no means an isolated case.
As to U.S. bond yields, they are just marginally above euro yields, but considerably below the yields obtainable in emerging countries. What is more, after inflation, they are the lowest in the world. A falling dollar is, of course, a virtually prohibitive deterrent to foreign bond purchases. In fact, it might induce selling.
This leaves the central banks of Asian surplus countries as the potential buyers of last resort for the dollar, unwanted by private investors. They did heavy dollar buying in 2003 and in early 2004, but never forget, the dollar purchases by the central banks have a heavy price in turning healthy economies into sickly bubble economies.
The sustainability of the U.S. capital inflows is, actually, the totally wrong question to ask from the American point-of-view. Far more important is another question, concerning the effects of the trade deficit on the U.S. economy, in particular on employment and income creation. We find that the dogmatic belief in the mutual benefit of foreign trade has stifled any reasonable discussion in this respect.
The benefits for the surplus countries are obvious. Exports in excess of imports create higher employment, higher profits and higher incomes. But what are the benefits to the United States? Frankly speaking, we do not see any true benefit of a trade deficit. What the American "mutual-benefit" apostles fail to see is that a balance in benefits essentially presupposes a balance in the underlying trade.
Yet there is a widespread view that the flood of cheap imports, by keeping a lid on U.S. inflation and wage pressures, fosters lower interest rates, which tend to spur economic growth.
For us, both effects are not beneficial at all, because the imports implicitly distort both inflation rates and interest rates to the downside. In essence, the lower inflation rates allow a looser monetary policy than domestic conditions justify. For Greenspan and many others wanting the loosest possible monetary policy, this was certainly a highly esteemed effect of the trade deficit. For us, it is insane.
Nobody seems to realize the enormous damages that the egregious trade deficit has inflicted on the U.S. economy. Indisputably, it diverts U.S. demand from domestic producers to foreign producers, and this implies an equivalent diversion of employment and associated income creation from the United States to these countries. That is the manifest direct damage of the trade deficit to the U.S. economy, the obvious main victim being the manufacturing sector, with horrendous job and income losses.
Blinded by the dogma of compelling mutual benefits; policymakers, economists, investors and the American public flatly refuse to see this disastrous causal connection. The alternative explanation is that America's extremely poor job performance has its main cause in the highly desirable high rate of productivity growth.
It is a convenient, but foolish explanation, reminding us of the early days of industrialization, when people destroyed machinery for fear of unemployment. For us, productivity growth that destroys millions of jobs is definitely suspect as a mirage. Historically, strong productivity growth has always coincided with strong capital investment involving, in turn, strong employment growth in the capital goods industries.
That is presently, of course, precisely the missing link in the U.S. economic recovery. (As an aside, in a healthy economy with adequate savings, cutting labor costs generally takes place through investment, not through firing.)
The job losses from the soaring trade deficit have always been there. But they did not show up in the aggregate for many years because the booming economy - driven by extremely loose monetary policy - created sufficient alternative jobs. But this alternative job creation has drastically abated since 2000, and the soaring trade deficit's damage to manufacturing is now surfacing in full force.
Having said this, we hasten to add that the U.S. trade deficit must be seen as one imbalance among several others, whether zero or even negative national savings, a soaring budget deficit, record-low net capital investment or sky-high consumer debt. They all derive from the same underlying key cause: Unprecedented credit excesses that have boosted consumption for years at the expense of capital formation.
What governs the U.S. trade deficit is not the law of "comparative advantages," but the careless depletion of domestic saving and investment resources though policies that have recklessly bolstered consumption. Essentially, employment creation through capital investment is out. Putting it bluntly, the U.S. trade deficit, like all other imbalances, reflects a grossly skewed resource allocation toward consumption.
To American economists, this idea that over time, excessive consumer spending leads to recession and worse, by crowding out capital investment may seem preposterous. Widely unknown, it happens to be the central idea that F.A. von Hayek developed in his famous lectures at the London School of Economics in 1931.
In essence, he explained in great detail that an increase in consumer demand at the expense of saving will inevitably lead to a scarcity of capital, which forces a "shortening in the process of production," and so causes depression. Putting it in simpler parlance: Excessive consumption inevitably crowds out business investment. As a share of GDP, consumption in the United States is presently excessive as never before. And it keeps worsening.
Assessing the U.S. economy's prospects, it also has to be realized that the bubble-driven consumer-spending boom represents artificial, unsustainable demand. Apocalypse will follow when the housing bubble bursts - which is sure to happen in the near future.
As the Boston Herald recently reported: "[Stephen] Roach met select groups of fund managers downtown last week, including a group at Fidelity. His prediction: America has no better than a 10% chance of avoiding economic 'Armageddon'... Roach's argument is that America's record trade deficit means the dollar will keep falling. To keep foreigners buying T-bills and prevent a resulting rise in inflation, Federal Reserve Chairman Alan Greenspan will be forced to raise interest rates further and faster than he wants. The result: U.S. consumers, in debt up to their eyeballs, will get pounded."
We could not agree more. Our particular nightmare is that the huge carry trade bubble in bonds will inevitably burst in this process. A fire sale of bonds in unimaginable proportions would begin, with bond prices crashing and yields soaring. With the prices of housing, stocks and bonds crashing, the entire U.S. financial system would be at risk.
It is typically argued that the U.S. economy is importing too much in comparison to exports. Superficially, that is true. Yet on closer look, it is a mistaken perception. Compared to other industrialized countries, U.S. imports are very low as a ratio of GDP. The true key problem is abysmally low goods exports, accounting lately for barely 7% of nominal GDP. This compares, by the way, with a German goods export ratio of 35% of GDP.
The next implicit question is the cause or causes of this extremely low U.S. export ratio. The answer is strikingly obvious. It is precisely the same cause that chokes productive capital investment - the progressive shift in the allocation of available domestic resources away from capital formation through saving and investment in plants and equipment, and toward immediate consumption.
That is the supply-side problem. Yet there is a demand-side problem, too. Greenspan and others like to boast that America is creating growing demand for the rest of the world. The ugly truth, rather, is that U.S. monetary policy has been excessively loose in relation to potential domestic output, because Greenspan has wanted maximum economic growth for years. But lacking domestic output capacity to meet the soaring domestic demand, an increasing share of the demand creation from monetary excess exited to foreign producers, resulting in the huge U.S. trade deficit.
It is a flagrant policy failure that has created a monstrous, unsustainable imbalance, both domestically in the United States and globally. However, for years, American policymakers and economists have glorified this deficit as America's great contribution to world economic growth. But the day of reckoning is rapidly approaching.
Regards,
Kurt Richebächer
for The Daily Reckoning
Editor's Note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer's insightful analysis stems from the Austrian School of economics. France's Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
This essay was adapted from an article from the December edition of:
The Richebächer Letter
-- Posted Tuesday, 28 December 2004 | Digg This Article
