Currencies – Page 19 – The Aleph Blog

Book Review: The Trouble With Prosperity

Posted on 29 November 2007 by David Merkel

In principle, I make a pittance off of any book sales from clicking on the links in any review that I write.? But I will write about books that are “out of print” as well (no money there); whether in print or out of print, my goal is to serve readers by bringing important investment ideas to their attention.

Presently, I am reading Money of the Mind, by James Grant, but I have also read The Trouble With Prosperity, which is important to understanding our present circumstances.? Both analyze monetary and other economic policies in the past, with an eye toward what it implies for us today.

In The Trouble With Prosperity,? Grant’s main theme is what happens when monetary policy is perverted from trying to preserve purchasing power, to trying to assure a perpetual prosperity.? He wrote this in 1996, when the US was recovering from the severe Fed tightening in 1994, which resulted from lax monetary policy 1991-1993, where the Fed funds rate was stuck at 3%.

As with most things, James Grant is right in direction, but early.? Back in 1996, he could not envision a 1% Fed funds rate, much less the mysterious hypothetical helicopters of Chairman Bernanke.? Capitalist economies are quite resilient, and can survive considerable mismanagement.? Today we are far closer to what he worried about eleven years ago.

A central bank trying to assure continued prosperity will always be biased toward inflation.? How the inflation manifests is a function of demographics.? With a younger population, goods inflation will be stronger (buy more, save less), and asset inflation for an older generation (buy less, save more).? At the same time, such a central bank will be biased against major losses in financial institutions.

The trouble is, the likelihood of the Federal Reserve rescuing troubled financial institutions raises the odds that the institutions will get into trouble.? It skews the payoff to financial executives, and makes them more willing to take risk, because the institution will not be under threat if they fail.

In The Trouble With Prosperity, Grant walks us through:

The puzzle of the markets in 1958, given the rise in interest rates and inflation
A tall building that characterized the troubles of the Depression.
The Japanese real estate and stock bubbles, and their deflation (still early in 1996)
The S&L crisis in the early 90s
Willingness to sponsor speculative ventures in the early 1990s, with a focus on gambling.

My opinion: low Fed funds rates foster speculation in healthy assets.? Lever them up more, because we can.? Ignore risk, and focus on the income one can generate today.? Of course, the eventual risk is that the US ends up in a liquidity trap similar to the which the Japanese have been in for the last 17 years.? Of course, the US economy is more flexible than that, but the risks are still significant.

Don’t view soft FOMC policy as a panacea.? Eventually we will have goods inflation as a result.? For now, the market is rejoicing in an accommodative Fed.? Enjoy it while it lasts, buy inflation is coming.

Notes on Fed Policy and Short-term Credit

Posted on 28 November 2007 by David Merkel

I just did my usual review of my FOMC indicators.? The FOMC should cut 25 basis points at the December 11th meeting.? Whatever the formal “bias” is, the verbiage will be a little of this and the a little of that, something like:? “Yes, we are worried about the solvency of some financial institutions.? That’s why we cut.? But this cut very likely should be enough, so don’t expect anymore.? Now leave us alone.”
So Goldman sees a 3% Fed funds rate in mid-2008?? So do I.? Small moves in FOMC policy don’t achieve the desired ends, either when policy is rising or falling.? Large cumulative moves are needed to affect the behavior of market participants.
The TED [Treasury – Eurodollar] spread is at its largest one-year moving average since 1990.? That’s significant short-term credit stress to the large banks, and it is worth watching.? It’s not just a US phenomenon either; in the UK the banks are under stress as well.
Residential housing is driving the decisions of the FOMC.? As prices fall, more houses become non-refinancable, and non-salable (except at a loss).? All it takes then is for a problem to happen… death, disability, divorce, unemployment, or casualty, and another house goes on the market because of insolvency.
So, I agree with Accrued Interest (great blog, doesn’t everyone want to read about bonds?).? Many Fed governors talk between meetings, and they trot out their baseline scenario, but often it is the worry of avoiding a somewhat likely negative scenario that can drive policy.
At some level though, if the dollar falls far enough, the FOMC will have to reverse course, as Caroline Baum has pointed out.? Remember, that’s what drove the FOMC to tighten in 1986-87.
Of course, the credit stress in the short end of the market has led some money market fund sponsors to bail out their funds (Legg Mason, Wachovia and B of A, while GE lets a pseudo-money market fund take a hit.? Remember, with money market funds, it’s not wise to stretch for yield, particularly not in bear markets for credit.
One more weak Commercial Paper [CP] funding structure: using it as part of a “super senior” tranche in CDOs.? Now in this case, the collateral is weak — subprime mortgage loans, but this could be true of any CDO where the collateral comes under stress in the future, including high yield corporate bonds.? I wrote about this three months ago, but this one is still unraveling.
I haven’t talked about it, because I wasn’t sure I had anything to add to the discussion, but the M-LEC, or super-SIV, proposed by the major banks seems like hooey to me.? After all, if this shifting of assets from one pocket to another created value, why wasn’t it done before?? It doesn’t change the underlying asset prices, and for the banks as a whole, it is just a zero sum game, unless new parties enter, at which point, they will have to offer a discount to move the paper, which eliminates one of the reasons for doing the deal.
Putting another nail in the coffin, HSBC takes their SIVs onto their own balance sheet, cleaning up their own financing, and making it more difficult for the other banks who want to do the Super-SIV.

What an interesting time in the short-term debt markets.? For now, prudence dictates staying high quality in what financial institutions you lend to short term.

Ten Chosen Items from the Current Market Troubles

Posted on 27 November 2007 by David Merkel

Superstition is alive and well.? Google at $666?? Personally, I think it is all hooey.? There has always been a morbid fascination about the Antichrist in Western Culture.? Would that they had more concern about Christ.
Longtime readers know I am no fan of FAS 157 or FAS 159.? From the Accounting Onion, here is a good demonstration of what could go wrong as FAS 157 is implemented.? In my opinion, the concept of fair market value allows managements too much flexibility.? For assets that have a liquid market bigger than the holdings of the company in question, fair market value is not a problem.? It is a misleading concept otherwise, because the ability to realize that asset value in a sale is questionable.
This is an “uh-oh” moment on two levels.? Level one is defined benefit pension plans exiting US equities.? They are big holders, and a reallocation could hurt US stock prices.? Level two is that foreign markets have outperformed the US by a great deal over the last few years.? Perhaps the DB pension plans are late to the party?
There are no “almosts” in investing.? I have owned Genlyte twice in my life.? Great company.? I had it on my candidate list in my last reshaping.? I didn’t buy it then.? Now it is being bought out by Philips Electronics.? Good move for Philips; the only way they could make it better would be to take the management team of Genlyte, and have it run Philips.? That won’t happen; it is more likely that Philips will ruin Genlyte.
Activist hedge funds don’t always know best.? Smart managements and boards don’t get scared.? They calculate.? What’s the best thing for shareholders in the long run?? Do the hedge funds really have the willingness to fight?? Personally, I think it is usually best for managements to “call their bluff” and make the hedge funds work for control, rather than wave the white flag early.
Higher US dollar oil prices are only partly a dollar phenomenon.? Oil prices are rising in almost every currency; there is a relative shortage of crude oil globally.
Want an antidote to pessimism?? Read this post from VOX.? Personally, I think the lending issues are bigger than they think, but it is true that corporate balance sheets are in good shape.? Would that we could say the same for the consumer or the government.
Appreciation of the Chinese Yuan versus the Dollar may be accelerating.? Alongside that, many of the Gulf States are re-evaluating their peg to the US Dollar.? Given the inflation, who can blame them?
$300 Billion in losses from US residential mortgages?? That’s a believable figure to me.? Underwriting got progressively worse from 2003 to the first quarter of 2007.? Needless to say, that would kill a lot of non-bank mortgage lenders, and a few banks as well.
Could Japan be the great countercyclical asset in this market phase?? There is more speculative fervor in Japan at present, and many Japanese investors are buying stocks and selling bonds, partly due to relative yield measures.

That’s all for now.? More to come.

The Rising Disconnect between FOMC Policy and LIBOR

Posted on 26 November 2007 by David Merkel

The FOMC can loosen interest rate policy, but how much will unsecured interbank lending rates like LIBOR respond?? As it stands right now, the Treasury-Eurodollar spread [TED spread], is at 180 basis points, up from 96 basis points (or so — don’t have access to a Bloomberg Terminal).? 17 basis points of that rise is a rise in LIBOR.? Not the usual response that you expect to loosening monetary policy, but these are unusual times, when credit spreads dominate over monetary policy, even on high quality lending and short term.

It feels like the major global banks don’t trust each other enough to lend to each other short term.? This has impacts on mortgage markets as well, such as the ability to refinance mortgages, and resetting mortgage payment rates even on prime mortgages.

Typically the TED spread does not stay this high for long.? If the FOMC cut the Fed funds rate to 3%, that might normalize things, but for now they will be content with half measures like temporary injections of liquidity.? Now, a 3% Fed funds rate will produce other problems (inflation, lower dollar), and it won’t really solve the overall mortgage credit problems in the short-run, but it is what the market expects by mid-2008.? It might help out in problems with the banks that are on the cusp of creditworthiness, and that is what may drive the FOMC to act.

More later.

Musings on the Fed and Yesterday’s Article

Posted on 21 November 2007 by David Merkel

From Tuesday’s Columnist Conversation over at RealMoney.com:

		David Merkel
		Thinking About the Fed
		11/20/2007 1:51 PM EST

One of my maxims of the Fed is that it is better to watch what they do, and pay less attention to what they say. The markets are saying that they expect Fed funds at 3% sometime in 2008. The Fed governors see that also, and are being dragged there, kicking and screaming. They don’t want to do it; there is real risk to the US Dollar, and there are inflation risks as well. As they measure it, the economy is growing adequately, and labor employment is fairly full. But as Cramer and others point out, the financial system is under stress, manifesting most sharply in mortgage lenders and insurers. Secondary stress is in the investment banks and financial guarantors.

But what exactly has the Fed done so far? Most of the monetary easing has not come through growth in the monetary base, but from continued relaxation of reserve requirements. Given that the Fed is loosening, I would have expected a permanent injection of liquidity by now. As it is, the last one was May 3rd, when there was no hint of the loosenings coming.

So what then for future FOMC policy? The banks are increasingly incapable of levering up more. The monetary base will have to grow. With the Treasury-Eurodollar spread at over 170 basis points, the big banks don’t trust each other. Again, this measure points to 3.00-3.25% Fed funds sometime in 2008.

I see them getting dragged to cuts, kicking and screaming, until a combination of inflation and the dollar force them to change. Then the real fun begins.

Fed minutes out soon. Watch them make a fool out of me.

Okay, the FOMC minutes did not make a fool out of me.? Neither did the market action.? I’m in the weird spot of thinking that nominal economic activity is higher than expected, on both an inflation and real GDP basis.? I don’t like the mortgage and depositary financial sectors at present, two areas that are dear to the FOMC.? That’s where I stand.

One reader asked, what do you mean by, “Then the real fun begins.”?? Maybe I have to do a book review on James Grant’s, “The Trouble with Prosperity.”? James Grant is very often correct, but usually way too early, which is why it is hard to make money off of his insights.? The “real fun” is watching FOMC policymakers squirm as they balance off costs of inflation and economic growth on the negative side, as it was in the late 70s and early 80s.? It is also the fun of watching policymakers at the Treasury Department squirm as they realize that the the fiscal wind is in their face and not at their backs anymore, as the demographic winds spin 180 degrees.

Other readers e-mailed, asking the practical question of how to invest in such an environment.? First, don’t overdo it.? Invest for a normal market scenario, and then tweak it to add more short bonds, TIPS, Commodities, Foreign bonds, and stocks with good inflation pass-through.

I got a few questions asking me to justify my bearish view on the US Dollar.? On, a purchasing power parity basis, the US Dollar is fairly valued now.? (What goods can the Dollar buy versus other currencies?) Unfortunately, currencies react more to forward covered interest parity in the short run. (What will I be able to earn by investing my money in dollar denominated debt, instead of another currency?)? Low intermediate term interest rates in the US portend bad returns from investing in US Dollar denominated debt, so the US Dollar declines.? The rest of the world seems to be bracing for more inflation and more growth.? Because US policy is headed the other way, the US Dollar is weakening.

As for my longer-run negative view on US Bonds, US government policies are designed to undermine bonds.? They have made more future promises than they can keep.? Who will they renege on their promises?? Bond investors are the easiest target; they don’t vote in large numbers.? It will be harder to turn their backs to those receiving social insurance payments, at least in nominal terms.? They have a lot of votes.

That’s all for now.? More tomorrow.

The US Dollar and the Five Stages of Grieving

Posted on 20 November 2007 by David Merkel

Recently I had dinner with a college friend of my oldest son.? It surprised me, but he was interested in how the US dollar was doing.? I likened the current situation to the five stages of grieving.

The first stage is denial.? As it respects the US Dollar, in the initial phases in the decline of the US Dollar, most foreign? finance ministers and central bankers are pretty happy.? After all, foreign exchange reserves are at an all time high.? Export industries are booming.? The government loves the exchange rate policy that keep the US Dollar artificially rich against the foreign currency.? The banks are flush, credit is booming… what could be better?? After all, you can’t have too much in the way of US Dollar reserves, can you?? (They never have to worry about a currency crisis again!)? The government is happy with them, especially since they are supported by the exporters.

Anger is the second stage.? The dollar reserves are worth less and less on a relative basis, and they keep coming in.? The wisdom of having a fixed rate, crawling peg, or dirty float against the dollar is questioned.? Goods inflation is rising in the foreign market, and credit creation is getting out of control.? The finance minister or central banker face the hard choice of revaluing the currency up versus the US Dollar, which slows the economy, particularly exports, or let the situation continue, and build up more US Dollar reserves.? (“What will we ever use all these Dollar reserves for?” they might ask in a moment of lucidity. “What if the US Dollar fell a lot further?? That would reduce the value backing our currency…? Why is the Fed loosening so much?? Don’t they care about the Dollar?”)

So, some of them revalue their currency upward versus the US Dollar, some reduce the basket weight of the Dollar, some let the peg crawl faster, and some do nothing… and the US Dollar predominantly falls in value.? Some finance ministers complain about the Dollar, and net exports to the US begin to decline.? This is where we are now, and I don’t know how long it will take to get to the next stage.

The third stage is bargaining.? The foreign finance ministers and central bankers are stuck.? They are getting pressure to lower the value of the currency against the dollar from exporters, and the politicians that they support.? They wonder if an intervention on the foreign exchange market might do it.? They call their opposite numbers around the globe, proposing an intervention to raise the value of the dollar.? Enough agree to do it, and the coalition of the willing does what they don’t want to do.? They sell their own foreign currencies, and buy more dollars.? The surprise works!? They caught the FX traders leaning the wrong way, on a day when economic news was going their way, they cooperated, and they did it BIG!? The US Dollar rises a full five percent. (“See you at the party tonight!”)

Only one problem, which is clear the next day to Finance ministers, Central bankers and FX traders alike.? (“What are we going to do with all the new US Dollar reserves that we bought?? We already have too much of that…”)? The FX traders pounce, and take the opposite side of the trade, and push the US Dollar lower.

Stage four is depression.? (“There’s no way out, and we got snookered by the neo-mercantilist exporters who got us to keep the currency too low versus the US Dollar.”)? The US Dollar is below the earlier intervention level, and there have been a few additional failed interventions, where the FX traders ate the central banks for lunch.? The US Dollar continues to fall.

Finally, stage five, acceptance.? The foreign currencies rise to sustainable levels versus the US dollar.? Inflation and real economic activity decline in the foreign countries.? They begin buying more goods and services from the US, and dollar claims are redeemed.? Inflation and interest rates rise in the US, as we have to produce more to pay off the dollar reserves now being redeemed by foreigners.? (Send us goods and it will pay off your debts!? Amazing how the US got good terms on both sides of the transaction.”)

Well, maybe.? It will take a while before all major trading parties in the world float/adjust their currencies to fair levels.? At? the time that happens, though, it will be obvious that the US is less important to the global economy.? The relative value of all US assets will be a smaller proportion of global assets, though it will still likely be the largest share in the world.? My view is this process to get to stage five will take no more than 10 years.? By that point, the hopelessness of Federal social insurance programs like Social Security and Medicare, plus underfunded Federal and state retirement plans, will force benefit reductions and tax increases on the US, and crimp borrowing capacity, unless they borrow in a currency other than dollars.? There are five stages of grieving for US social welfare programs as well, but I am afraid we are only in the first stage now, denial.

That is a topic for another day, and not one that I am excited to talk about.

Seven Observations From Barron’s

Posted on 17 November 200718 November 2007 by David Merkel

Kinda weird, and it makes you wonder, but on the WSJ main page, I could not find a link to Barron’s. I know I’ve seen a link to Barron’s in the past there; I have used it, which is why I noticed its absence today.
I found it amusing that the mutual fund that Barron’s would mention on their Blackrock interview, underperformed the Lehman Aggregate over 1, 3 and 5 years. Don’t get me wrong, Blackrock is a great shop, and I would work there if they offered me employment that didn’t change my location. Why did Barron’s pick that fund?
I’m not worried about the effect of a financial guarantor downgrade on the creditworthiness of the muni market. Munis rarely fail. Most of those that do fail lacked a real economic purpose. What would be lost in a guarantor downgrade is liquidity. Muni bond insurance is a substitute for analysis. “AAA insured, I’ll buy that.” Truth, an index fund of uninsured munis would beat an index of insured munis, because default rates are so low. But the presence of insurance makes the bonds a lot more liquid, which makes portfolio management easier.
I’ve been a US dollar bear for the last five years, and most of the last fifteen years. Though we have had a little bounce recently, the dollar has of late been at record lows against currencies that trade freely against the dollar. I expect the current bounce to persist in the short term and fail in the intermediate term. The path of the dollar is lower, unless the Fed decides to not loosen more. Balance needs to be restored in the global economy, such that the rest of the world purchases more goods and services, and fewer assets from the US.
I don’t talk about it often, but when it comes up, I have to mention that municipal pensions in the US are generally in horrid shape. The Barron’s article focuses on teachers, but other municipal worker groups are equally bad off. The article comments on perverse incentives in teacher retirement, which leads older teachers to retire when it is feasible to do so. For older teachers, I would not begrudge them; they weren’t paid that well at the start, and the pension is their reward. Younger teachers have been paid pretty well. I would not expect them to get the same pension promises.
I like Japan. I own shares in the Japan Smaller Capitalization Fund [JOF]; it’s my second-largest position.

Japan is cheap, and small cap Japan is even cheaper. I would expect a modest bounce on Monday.
We still need a 15-20% decline in housing prices to bring the system back to normal. There might be an undershoot in price from the sales that forced sellers must do. Hopefully it doesn’t turn into a self-reinforcing decline, but who can be sure about that? At that level of housing prices, man recent conforming loans will be in trouble, much less non-conforming loans.

Full disclosure: long JOF

Reviewing the Fed Data

Posted on 26 October 2007 by David Merkel

Last night’s post got eaten by a loss of power. It’s time to return to “FOMC mode” in anticipation of the meeting ending on the 31st. Let’s review the data as I see it:

Even with the recent loosening in FOMC policy, the Fed still hasn’t done a permanent injection of liquidity since May 3rd.? Growth in the monetary base since then has been anemic.
The narrow monetary aggregates have not been growing rapidly, even since the FOMC began its temporary liquidity injections back in August.? Even M2 has been flat.
My M3 proxy has not been flat, though it overstates matters somewhat.? Total bank liabilities have grown 4% since mid-August, which is close to a 20% annualized rate.? This has to be taken back a bit, because with the Treasury-Eurodollar [TED] spread around 110 basis points, liquidity from the unsecured Euro-dollar markets has diminished.? How much for US banks?? I’m not sure; I can’t find a data series for that yet.
The TED spread has retreated 65 basis points since the last meeting.? Things are better, but external dollar liquidity is still tight, which in my book means a TED spread above 60 basis points.
Off of Fed funds options, the odds of no change are 10%, odds of a 25 basis point cut are 70%, and the odds of a 50 basis point cut are 20%.
Since the last meeting, fed funds have averaged 3 basis points over the target.
The discount window moves aided PR efforts, but never amounted to much.
As measured by TIPS, five year forward five year inflation has fallen since the last meeting, but has been slowly rising over the past five years.

There’s my data, now for the analysis.? Credit conditions have loosened, but monetary conditions aren’t loose.? Banks have been willing to expand their balance sheets, I believe partly due to the Fed loosening capital requirements, e.g.,? lending to securities affiliates.? Also, with the bigger banks, the Federal Reserve is talking tough, but not playing tough in bank examinations, because they can’t allow credit to contract that much, or their loosening policy will have little impact.? The smaller banks, and banks where mortgage lending could have a big impact are undergoing sharper examinations.? Part of that looseness is canceled out by the tightness in the Euro-dollar markets; the big banks are less than fully willing to trust each other’s balance sheets.

My opinion: The FOMC will loosen 25 basis points on 10/31, and will continue to express worries over economic growth.? Though inflation is a growing threat, the FOMC will downplay that.? There will be a lot of trading noise around the news, but after the dust clears, stocks and bonds won’t have done much, and the yield curve will be a little wider.? TIPS should outperform inflation un-protected bonds.? The dollar will weaken to the degree that the FOMC hints that they aren’t done.

Crash Remembrances

Posted on 20 October 200721 October 2007 by David Merkel

On Friday over at RealMoney, I posted the following:

		David Merkel
		1987 Memories
		10/19/2007 5:20 PM EDT

I was a young actuary when the crash hit in 1987, one year and change into my career. I did not have any investments at that time, but I had just bought a house with my (then) new wife. Few today remember that the crash of 1987 was the culmination of three separate crashes. In late 1986, the US Dollar hit new lows, amid massive intervention by central banks. In February 2007, I came down with a bad cold that sidelined me for four days. Cuddled up with the WSJ while my wife was at work, I concluded that the bond market was about to fall apart, so we accelerated buying a small home. Two months after we completed the financing, mortgage yields rose by 2% during the bond market meltdown.

The stock market roared on, though. Through August, the market rose, and the earnings yield shrank. Bond yields remained stubbornly high; it was a great time to invest in high quality long bonds, particularly long zero coupon bonds.

The eventual crash in October is no surprise to me today. Equities could not stand the competition from bonds, so the market slumped from August to October, until the pressure of dynamic hedging took over starting on Friday the 16th, selling into a declining market in order to maintain the hedges, and spilling over in a self-reinforcing way on the 19th. For what it is worth, there was a humongous rally in long bonds as people sought safety.

Now, my Mom was buying the day after the crash. This is why she is more professional than most professionals I know. She bought solid companies that would survive bad times. I knew far more people who sold into the panic. As for me, I got a trial subscription to Value Line, and picked six stocks, which I sold too soon for a 20% gain, and didn’t return to direct investment in single equities until 1992. (I used mutual funds.)

Since then, I have been consistent in plying my advantage in picking cheap stocks where the fundamentals are under-discounted. It’s been a good niche for me, maybe it can be of value to you as well.

PS — no bounce today, kinda like October 16th, 1987.

Position: none

Now, should the crash have been bought? Yes, at least in the short run, even without knowing the verdict of history. The difference between stock and bond yields narrowed dramatically, and option implied volatility was making a bold effort to escape earth orbit. Beyond that, fast moves tend to mean revert; slow moves tend to persist.
Now, my knowledge of the markets was rather crude back in 1987, so I never would have caught those then; nor did most commentators at the time. People were too scared to be rational. Even the FOMC blinked, with a neophyte Greenspan, with no serious crisis imminent, thus beginning his career of throwing liquidity at small problems, and leaving the consequences for later.

Well, at least I bought the lows in 2002. That event was similar, but not nearly as short-run severe as 1987, though it had the “strength” of longer duration as a bear market.

Before I close for the evening, I would like to mention that I will have the portfolio reshaping complete on Monday, and watch for it here first. As an aside, there are a lot of cheap small cap shoe retailers, and a lot of cheap general and apparel retailers also. I don’t normally buy retailers, but this time things are too cheap. Expect to see me buy one.

Ten Points on the Global Economy: The Diminishing US Dollar

Posted on 19 October 2007 by David Merkel

Back after a hiatus of sorts.? I should have a piece on my portfolio reshaping coming on Monday or so.? Tentatively, what I find fascinating, is that I have so many shoe and retail names near the top of my list.? Oh, and a few mortgage REITs, if they make sense… 🙁

But on with this morning’s topic, which deals with global macroeconomic pressures.? A few of the articles are a month dated, most are current, but this is meant to illustrate the pressures that the economy is under.

Let’s start with the good news, ECRI still doesn’t see a recession on the horizon.? They’re pretty accurate, so I give them room, and mute my own views.
That doesn’t mean there aren’t significant pockets of weakness.? Mortgage equity withdrawal is a spent factor, so to speak, and it ripples through current consumption and housing price weakness.? The less equity available, the less to pad consumption, and the less buying power for homes.? Credit card default rates are worsening, which can’t be good for buying power either.? On the low end of the income spectrum, many Hispanic workers are finding it hard, and that affects Wal-Mart, among other retailers on the low end.? That said, I have read that the Hispanic immigrants are much less likely to default on their mortgage loans than non-immigrants with similar credit characteristics.
CLSA predicts a record gold run, and so far, gold is cooperating.? That said, it will take a lot more to get gold to $3400/ounce.? We would need a real dollar collapse, and not this slow grinding selloff.? That said, the grinding selloffs tend to persist; more on that later in this post.
Of course, we could look at the price of wheat, or even just the price of stuff.? If it deals with food or energy, two items that are core to almost everyone’s budget, prices are rising.? John Wasik repeats a number of my arguments for why core CPI does not represent the diminution of the average person’s buying power.? I’m honestly surprised that no one has made a campaign issue out of honesty in inflation statistics so far.? It helped Reagan versus Carter in 1980.
That said, maybe we should be grateful that fuel grade ethanol is in surplus, at least temporarily, because we can’t distribute it to the end consumers efficiently.? Maybe not.? It’s no good for price to go down, if it only indicates lack of effective end-demand.
Oil at $90/barrel?? It’s partly a US dollar phenomenon (new trade-weighted low today), but not just a US dollar phenomenon.? In Euros, as I measure it, it’s a new high there as well, just not by much.?? Now, when a critical commodity becomes scarce, it tends to attract wars, kidnapping, sabotage, etc., because bargaining power goes up as the price of the commodity goes up.? (Think of “blood diamonds” for another example…)? So we see pipeline sabotage, graspy politicians wanting a bigger cut of the royalties (no, not Chavez this time), and tensions between the Turks and the Kurds.? This leaves aside issues in Nigeria, and other aspects of supply disruption.
Now if that’s not enough, Western oil companies, which are often shut out of places where goverment monopoly oil companies tread, are finding less oil, and find that they have to buy back stock because of a limited number of places to invest in new fields.? Now, perhaps OPEC has the same problem, but it manifests differently.? They’re making a lot of money also, and don’t want to plow it into too many new projects, for fear of killing the price.? So what do they do with the free cash flow?? Their governments buy US Treasuries and other US debt claims, closing the money loop and financing the US current account deficit.
Well, maybe not entirely, though.? We had a glitch in capital flows in August, and foreigners sold more US securities than they bought by a significant margin.? Can’t help but think that it led to more pressure on the US dollar.? That said, the books have to balance: foreign capital inflows must balance the current account deficit over the intermediate term.? That doesn’t mean that they have to balance at the same price, though, just that the nominal values must balance at some implied exchange rate.? On the other hand, some nations are adjusting their currency baskets, like Vietnam and Qatar to reflect the lower value of the US dollar.? Quite a statement about their relative faith in their own currencies versus the US dollar.
The US has not had a strong dollar policy for some time, despite protests to the contrary.? We are happier to see export industries prosper, US tourism prosper, and consumer buying power from abroad suffer.? My question is when we will see foreign governments notably uncomfortable.? We’re not there yet, which makes me think that the path for the US dollar is lower still.
One final factor that doesn’t help: the size of the US budget deficit on an accrual basis.? Much larger than the stated deficit because of extra inflows to social security, and debt that doesn’t get counted because other government programs buy it to fund future liabilities.? Add onto that the wars which largely off-budget, and you have a significant present and future cash flow hole to cover.? Here’s to our children and grandchildren, who will have to pay it one way or another.