China Continuing to Buy US Bonds “Every Day”
March 13, 2010 by admin · Leave a Comment
China says it is continuing to buy US bonds “every day.” It doesn’t have much choice. It earns money by selling things abroad. In fact, exports in February were up more than 40% over February ‘09. This leaves it with a lot of foreign money – most of it in dollars. What can it do with so much money?
China has quietly bought stakes in America’s leading companies…and in various businesses all over the world. But the only way large amounts of US dollar cash can be readily and safely deployed is in US bonds.
That said, China could also cause one helluva problem for the US if it ever chose to do anything else.
No worries on that score, said the Chinese official in charge of its $2.4 trillion worth of foreign reserves. He says China’s holdings of US debt are normal and that there is no intention of reducing them or playing politics with them.
He surely means it. And when the dollar goes down…and when the market turns, and China feels compelled to get rid of its US bonds, he’ll be totally sincere when he explains that to the international financial press too.
Markets make opinions, as they say on Wall Street. The market in bonds and the dollar has been very good for a very long time – since 1983, to be exact. As a result nearly everyone – including the Chinese – are of the opinion that US bonds are a safe place to be. When the market changes, so will opinions.
So far, no problem. But there’s no telling how long the foreigners will continue to support the dollar. Then what? Well…it leaves quantitative easing…in which the US central bank lends the money itself. Where does it get the money? It just invents it.
Which is why you can’t trust paper money. You have a dollar. You have it. You hold it. And you expect to keep it ’til death do you part. But then, along comes another dollar that looks just like it…fresh…young…full of vim and vigor. So why not? Everybody does it.
Pretty soon, there are a lot more dollars running around. And they change hands fast. In economists’ lingo, the velocity of money goes up…and the value of the dollar – like a faithless lover – goes down.
Bill Bonner
for The Daily Reckoning Australia
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Guest Post: A Bull/Bear Weekly Recap
March 13, 2010 by admin · Leave a Comment
All that “dry powder” that everyone is talking about, is not making
its way back to equities folks. Households have endured to massive
bubbles in a span of roughly 10 yrs and cannot be messing around with
their retirement.
DXY has been strengthening (particularly against the Euro and the
Pound). Continued sovereign debt problems will only ensure that this
trend continues, no matter how much it doesn’t make sense considering
our high debt levels. But it is still considered the currency of
choice in times of risk aversion, that is for sure.
(Technicals/Financials/Transports) –> Stocks continue to rise lead
by the most unusual leader, the financials. the streaks are amazing
and makes it perhaps the most impressive part of this whole rally.
Jobless claims remain frustratingly elevated. By this metric, we are still seeing job losses.
Transports are making new highs, we are seeing cautious commentary on
the recovery by FedEx. I think that’s pretty important.
Angela Merkel’s political life is now on the line. The idea of savers
and financially prudent citizens of Germany bailing out a profligate
sovereign entity (NO the EU is not a political union) seems ludicrous
even to an outsider. The German electorate must be furious. Moral
hazard continues and investors feel almost assured that this will be
the solution for every other country that’s next inline (UK, Spain,
Portugal, Austria, Eastern Europe), until it isn’t.
Tying in
with the Bearish news above, the news coming out of China is very
concerning in my view. Inflation seems to be heating up and may force
officials to raise rates. If they choose not to, inflation will
accelarate, affecting food and energy prices which are important to the
rural population. However, raising them will bring about additional
headwinds for the export sector as well as increase the possibility of
popping a potential bubble (shades of US. Which will officials choose?
of the rally are mixed, but with a bullish tilt. The transports and
the financials (BKX only, not XLF) broke through their highs as did
numerous other indicies like the NASDAQ and the Russell 3000. We would
only need the dow to break through to confirm that the rally is alive
and well under the Dow Theory (is that a bearish pennant I see?).
However, the recent rally has been marked by low volume and high
complacency and signals red flags.
the global recovery front, AUD/USD, a measure of risk taking (and
strength in China) in my view, is at the top end of its trading range
which it hasn’t been able to break out of. EWA is looking toppish.
(Investment Grade LQD Daily)
(High Yield HYG Daily)
it’s not very clear from the chart. It does serve to signify that
performance in gold has been closely correlated with TIPS, expectations
of inflation. Is deflation starting to win out now that the stimulus
is being withdrawn?
Have a great weekend
Disclosure: Short Emerging Markets
US Credit Rating: Who Will be the First to Downgrade?
March 9, 2010 by admin · Leave a Comment
During World War II, there was a saying, that, “loose lips, sink ships”… I think Greek Prime Minister, George Papandreou, should have taken those words to heart yesterday… You see, the currencies, led by the beleaguered euro (EUR), were rallying, and the single unit was nearing 1.37, when Papandreou made a statement that sunk the rally’s ship… He said, “Greece’s debt problems could soon spread to the rest of Europe and mean a weaker euro”
Now, that’s just what the markets wanted to hear… NOT! The markets were very content believing that Greece’s problems would fade away with a combination of Greek spending cuts, and aid from France and Germany… And you could see the euro shorts beginning to unwind… But… NOOOOOOOOO! The Greek PM sunk the rally’s ship, with his loose lips…
The Greek PM also said, “the Greek crisis has implications for the US dollar” but didn’t elaborate on that point, so the markets took that to mean the implications were good!
So… There you have it… Yesterday’s price action all rolled into a couple of paragraphs…
Overnight… We saw additional dollar strength… And when you see dollar strength, you also see yen (JPY) strength… At least since July of 2008. Safe haven flows… Yeah, right… And my first wife was a young Elizabeth Taylor… Yeah, that’s the ticket! Those “safe haven” flows sure helped shelter investors from losses last year, didn’t they? NOT!
Last night, the ratings agency, FITCH, fired some shots across the bow of the Eurozone… Let’s go the tape! FITCH told Portugal, that it may be downgraded if measures are insufficient, and they told Spain, its macroeconomic risks remain high.
The ratings agency also told Greece that their short outlook is probably OK… Huh?
Then FITCH went a step further and said, “there’s no pressure on the US credit rating in the short/medium-term though the US is vulnerable to interest rate shocks.”
Hmmm… Just last month the rating agency, Moody’s, issued a report that said the US debt problem was going to lead to a credit rating downgrade…
So… What’s it gonna be, boy? FITCH or Moody’s? I would have to think that since FITCH is the latest to come out, that it supersedes the Moody’s report last month… Or… That’s how the markets look at it, anyway!
The “loose lips, sink ships” arrow that was shot at the currency markets yesterday, carried over to the Aussie dollar (AUD), which makes little sense to me, given the rate differential, and the strong economic data that keeps printing in Australia… Last night it was the latest jobs report, which showed that job ads increased 19.1% in Feb, and… A business survey showed improvement in both conditions and confidence. Australia did receive one piece of economic data that is so strange you have to think that a revision will come… I’m talking about Capacity Utilization, which dropped from 82.1% in January to 80.7% in February… The 80.7% is the lowest print of Capacity Utilization since last September… Remember, just like here in the US… Capacity Utilization is about the only “forward looking” piece of data that prints… So… Just taking this report for what it said, one would think that going forward, the Reserve Bank of Australia’s interest rate hikes have begun to settle into the economy, which… Is a good thing, folks… The last thing you want to see in a country where you have money invested is an overheating economy!
Gold got smacked right on the chin yesterday… Just when it appeared that gold’s downtrend had been reversed (as I said last Friday), we get a day like yesterday, when the sellers of the shiny metal came out of the woodwork! Forces are pulling on both sides of gold these days, as there are those that believe gold will fall to $800… And there are those that believe gold will soar to $2,000… Me? I’m not a betting man, except for a shiny quarter, or a dollar to a Krispy Kreme, but I would think that gold slipping in price isn’t out of the question, but to $800? That’s a little extreme, and on the other side of the coin, $2,000 on the upside seems to be a little extreme…
I’m reading a story on the Bloomie this morning that caught my good eye; it’s about yields on Fannie and Freddie mortgage securities. It seems that the Fed’s buying of mortgage bonds to keep yields low, has worked… Unfortunately, that plan will cease to exist at the end of this month… What will mortgage rates do then? The Bloomie story was attempting to paint a picture whereby yields remain low after the Fed plan ends… I’m not buying that! I’m of the opinion, that the Fed might let this plan end, take a look at widening yields, and put it right back in place… But… I guess we’ll have to wait-n-see, eh?
I see where “my idea” of creating a European Monetary Fund (EMF) is gaining traction in Europe… I talked about this yesterday, and the plans to create this EMF began this past weekend. I had talked about the need for something like that last week! Of course I’m patting myself on the back right now, but it doesn’t mean that I’m full of myself! I’m sure there are thousands of people out there writing letters that talked about the creation of an EMF before the European authorities began discussing it…
The creation of this EMF would be like manna from heaven for Greece, and the other PIIGS… And… It would keep the egg off the faces of the ECB and the Eurozone officials. For those of you new to class, the ECB is the European Central Bank, and in no way are they going to allow the IMF to step in to help… This is the ECB’s baby.
OK… Enough on that! I read a report from my good friend, David Galland, yesterday, and his economist, Bud Conrad, who is among the best folks… Anyway… Bud was talking about the CBO’s (Congressional Budget Office) projections for the next 10 years, which says the deficit will see an additional $9.8 trillion… Bud was looking at the tax base, and concluded that the tax base will not grow as fast as the deficit.
So… That brings us back to what I always, always tell you… To finance the deficit, the country can raise taxes, raise interest rates aggressively, or allow a debasement of the dollar… Let’s go through those…
1. Raise taxes… This would increase the revenue, and decrease the amount of foreign financing needed.
2. Raise interest rates aggressively… This would make our Treasuries more attractive, and keep foreigners buying them to finance the deficit.
3. Allow a debasement of the dollar… This would allow foreigners to buy our Treasuries at a “discount” price and thus make them more attractive…
1. Hurts the economy… But face it, folks, this is what we’re leaving to our grandkids, higher taxes and less freedoms than we had, because of this deficit spending that’s gone on for 9 years now.
2. Hurts the economy… Yes, aggressively higher rates would bring the economy to its knees once again…
3. Well… You have to admit that what’s behind door #3 is what every politician, Treasury Secretary and Fed Chairman would prefer happened… But… For you and me… It represents a loss of purchasing power… Unless that is, you have taken steps to protect yourself from this choice…
In the end… It will most likely be a combination of higher taxes and a cheaper dollar… Oh boy, where do I sign up for that? I shake my head in disgust…
Then there was this… A new reader – and there a tons of them after the Wall Street Journal article – asked me what a “Pfennig” was… And I thought… Here’s my chance to tell everyone the history… In 1991, I took over the trading of foreign bonds at Mark Twain Bank. Now to do this job correctly I needed to come in quite early and get caught up on markets that were 8 hours ahead of me. I then noticed that the sales guys would come in and spend a good part of their morning trying to get caught up on the markets overseas… I decided to start writing a quick morning note about the markets that they would have on their desks when they came in, and therefore would be ready to begin trading immediately… The sales guys started taking those morning notes and faxing them to their customers… These were hand written, folks! In 1994, Frank Trotter, created the website for Mark Twain Bank, and we began putting the, now typed notes on the website… Frank then coined the term, “A Pfennig For Your Thoughts” which was the play on the American phrase, “A Penny For Your Thoughts”… The Pfennig, at the time, was the lowest denomination of a Deutsche Mark, and since I was talking about foreign markets and currencies it all fit… In 2001, the marketing team at EverBank changed the name to the “Daily Pfennig”… But I still refer to it as “A Pfennig For Your Thoughts”…
To recap… The currency rally yesterday was stopped in its tracks by Greek PM Papandreou’s comments… Loose lips, sink ships, is what he should have thought before speaking! Gold also took a shot to the chin yesterday. The Aussie jobs report was good, but Capacity Utilization dropped, which wasn’t good. We start today with currencies a bit lower than yesterday’s starting point…
US Credit Rating: Who Will be the First to Downgrade? originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”
Our Economy is in Recovery Mode?
March 7, 2010 by admin · Leave a Comment
When you think about it, unemployment insurance gives people a way to purchase items and continue life and at the same time stimulate the economy. What they buy determines who will stay employed. So if you are buying a TV or a toaster, someone in China gets to keep their job.
Most of what we consume is made in a foreign country; clothing, appliances, cosmetics, footwear, car parts, tools. We still produce our own food, autos and housing. And “by God everyone deserves to own their own home” —and we know where that went. Now we have cash incentives to buy homes, cash for clunkers, and the old standby, food stamps for those with no cash at all.
Right now the United States is a service economy. We don’t make ANYTHING! It is not hard to figure out our economic future. Our manufacturing base moved off shore because of the cheaper labor. There is little or no incentive to move back to the US, either. The US consumer is addicted to cheap foreign products. How do we stimulate our economy by buying stuff made in Asia? How can we compete against countries that have no health insurance or retirement benefits or unemployment insurance? Imported goods have to rise in price, in order for domestically produced goods to be profitable. The real question is: what sort of industrial production is going to come into play to put people back to work?
“Buy American” might be the final solution. Congress is doing their part (printing money); it now takes eighty US dollars to buy a barrel of oil when it used to take thirty. Put another way, the thirty dollars you put in your IRA 20 years ago won’t even buy half a barrel of oil today.
The President and his men are claiming that we are in a recovery. Bernanke is claiming that we averted a great depression. It’s what people want to hear, but sadly it isn’t based in reality. Their solutions are most probably part of the problem. It’s a little like a hooker with VD; you keep quiet about medical problems, it’s bad for business.
Weekend Reading: New Poems, Essays and Recipes
March 6, 2010 by admin · Leave a Comment
By Charles Hugh Smith, OFTWOMINDS
A cornucopia of stimulating (and mouthwatering) reading awaits you.
We’ve got something for everyone’s tastes this weekend: a great two-part poem, three new recipes and four new essays in Readers Journal. (As a special bonus, I won’t even mention Survival+, heh.)
Let’s start with the first stanzas of a singularly insightful and evocative poem byMike Dakota, The Working World
In the world I grew up on,
everybody worked,
from the farmer to the baker,
to the pharmaceutical clerk.
Cars rolled out assembled,
stores filled high with goods,
corn spilled out of silos,
and people rested when they could.
America was prosperous,
the whole world hoped to know,
how we built our factories,
and how our cities glowed.
But now these workers have grown older
and till the soil no more,
they spend the cream of taxes
from money others work for.
To read the rest of the poem and Part Two, The World of High Finance, please go toReaders Journal. It amazing how Mike has captured the essence of America’s decline in rhyme.
Next up, two new reader essays and two topical feature stories from oilprice.com.
20 Resilient Responses for Troubled Times
(Bob Waldrop, March 5, 2010)
Black and gold: oil and the US dollar
(Matthew Wild, March 5, 2010)
Iraqi Elections Likely To Fuel Ethnic Tensions, Further Delay Access To Kirkuk’s Reserves
(Gareth Jenkins, March 4, 2010)
Yemen’s Push Into the Gas Sector Fails to Stimulate Great Excitement and Raises Disturbing Questions
(Fawzia Sheikh, March 3, 2010)
Readers submitted three terrific new recipes to What’s For Dinner At Your House?:
Crock Pot Recipe for Deer Meat Stew
Real Homemade Mac and Cheese
Dan’s Man-Made Cornbread
There are now 12 scrumptuous recipes in this issue, so check them all out.
Knowledgeable reader George V. submitted an important story which I recommend: THE TRUE COST OF CHEAP FOOD. This explains why heavily subsidized (yes, subsidized by taxpayers) corporate agribusiness “cheap” food destroys the economies of agricultural-based economies.
Amidst the (empty) talk of (bogus) top-down “reforms” it’s good to remember:
“A healthy homecooked family meal and a home garden are revolutionary acts.”
If you haven’t visited the forum, here’s a place to start. Click on the link below and then select “new posts.” You’ll get to see what other oftwominds.com readers and contributors are discussing/sharing.
DailyJava.net is now open for aggregating our collective intelligence.
Order Survival+: Structuring Prosperity for Yourself and the Nation and/or Survival+ The Primer from your local bookseller or from amazon.com or in ebook and Kindle formats.A 20% discount is available from the publisher.
Of Two Minds is now available via Kindle: Of Two Minds blog-Kindle
Thank you, Amaze Productions ($20), for your continuing generosity to this site. I am greatly honored by your support and readership.
Thank you, Brian K. ($100), for your second stupendously generous donation to the site. I am greatly honored by your support and readership.
for the full posts and archives.
Marc Faber: "I Would Recommend People Buy Every Month Some Gold For Ever"
March 4, 2010 by admin · Leave a Comment
Marc Faber’s latest thoughts on the euro (not good), on Greece (also not too good), and gold (good to quite good). “I don’t think it will work out, and I think other countries like Spain and probably Portugal (and Italy) will then also have to be bailed out eventually, and it will lead to more monetization in Europe, one of the reason the euro has been so week… The pain of the austerity will be very, very burdensome on Greece, and eventually the economy can not grow with the kind of budget they will have to enact, and under these conditions their currency is way overvalued (they are in the euro). And so without the ability to grow, their ability to pay the interest and repay the debt will actually diminish…. I think everybody should accumulate some gold over time. I would recommend people to buy every month some gold for ever.”
Faber’s response to whether gold is the “ultimate ponzi scheme”:
“Gold is not a liability of someone else, you really own it, you keep it in a safe deposit box, its quantity can not be increased at the same rate as you can print money which will eventually again weaken the US dollar. I am not saying that the dollar will go straight down, but eventually the purchasing power of money will lose.”
Lastly, for Faber’s view on why this time it is different, and the developed world will not be able to pull itself out by its bootstraps, his view:
If you compare the depression years, in the depression years we did not have credit cards and we did not have unfunded liabilities from Social Security, from Medicare, from Medicaid. These are all debts that will come due that will have to be paid by the government, and eventually this fiscal deficit will lead to a government debt that will then, because of its increasing size lead to sharply rising interest burden. In other words, in ten years time I would estimate that between 30 and 50% of tax revenue will be spent on the interest payments on the government debt. That will necessitate the monetization of the debt and that will then lead to a weak dollar.
Full clip.
A TALE OF TWO RECOVERIES – GERMANY AND MALAYSIA, PART II
March 4, 2010 by admin · Leave a Comment
This is a guest contribution by Marshall Auerback, Braintruster at the New Deal 2.0 at Newsneconomics
By Marshall Auerback
My colleague, Rebecca Wilder, recently concluded a “Tale of Two Recoveries: Malaysia vs Germany“ which brought back memories of my own time in the Far East and some of the advisory work I did for the government of Malaysia during the financial crisis of 1997/98.
Before the historical revisionists get hold of this period, it is important to note that Malaysia’s initial response to the crisis was a textbook illustration of how to exacerbate, not alleviate, a financial crisis. Of course, it was a consequence of taking stupid and economically ruinous advice from the International Monetary Fund, which is to economic development what John Meriwether is to asset management. If anybody had any doubts, those of us who observed the crisis first hand realized that the IMF and the so-called “Committee to Save the World” were more interested in saving the first-world banks who were exposed than caring about the local citizens who were scorched by harsh austerity programs. Same old, same old.
It was only when the Deputy PM/Finance Minister was ousted from the Cabinet and his pro-IMF policies completely repudiated, that Malaysia’s economy began its long road back to successful recovery.
There is little question that former PM Mahathir Mohammed was a political thug, but not an economic illiterate. But his sacking of Anwar from the Cabinet and decision to press ludicrous sodomy and abuse of power charges against his former heir apparent foolishly undermined his economic legacy. It is certainly wrong, however, to criticise his response to the Asian financial crisis of 1997/98. Vindicated now with the benefit of hindsight, at the time his embrace of exchange controls, and a 180-degree reversal away from the policies of austerity advocated by the Fund, were viewed as dangerously anti-free market, destined to render Malaysia an investment pariah.
Before the temporary triumph of the so-called “Washington consensus” school of economics in the late 1990s, the so-called “interventionist” East Asian alliance model of capitalism was highly lauded by institutions such as the World Bank and even the IMF itself. A common thread characterizing the economic development of countries such as Thailand, Korea, Singapore, and, yes, Malaysia, were policies which transferred resources away from “unproductive” toward “productive” uses—often in the form of transfers from unproductive groups to productive groups and sometimes in the form of policies to convert unproductive groups into productive ones. Creating “rents” (above normal market returns) by “distorting” markets through industrial policies was essential, first, to induce more-than-free-market investment in activities that the government deemed important for the economy’s transformation, and second, to sustain a political coalition in support of these policies. Disciplining rent-seeking so that it remained consistent with these two objectives was also essential.
It was precisely this model that came under such sustained attack during the late 1990s. Then Secretary of the Treasury Robert Rubin, his Deputy, Lawrence Summers, and their lieutenants saw the crisis as the perfect opportunity to destroy this model once and for all, and to do this, they wanted the International Monetary Fund to impose conditions on the economies of emerging Asia that went far beyond the Fund’s traditional boundaries. Thus the U.S. Treasury kept steady pressure on Fund officials to extract more and more concessions from South Korea, Thailand, Indonesia, and Malaysia including instant resolution of all trade related issues in favor of the United States. The exasperated Asians were soon accusing the IMF of always raising new issues at the behest of the United States—something that the Fund officials readily acknowledged later.
Foremost in the minds of Treasury officials was also the interest of Wall Street, especially American financial services firms. These biases were manifested in the types of IMF conditions imposed on the emerging Asian economies during the height of the crisis, which clearly served the brokerage firms on Wall Street far better than the needs of emerging Asia.
In the early 1990s the economies at the core of the world economy (the U.S., “Euroland,” Japan), began to generate hugely excessive liquidity. In the early 1990s, mutual funds, pension funds, other institutional investors, hedge funds and—last but not least—banks became awash with deposits. They scoured the world for high returns. Investment houses like Goldman Sachs and Morgan Stanley sought the business of arranging the privatizations, securities placements, mergers, and acquisitions that surged on the wave of liquidity—business that became their main growth area. As a consequence, financial capital poured in to “emerging markets” (middle-income countries of recent interest to institutional investors).
Capital flows to developing nations in Asia and Latin America jumped from about $50bn a year before the end of the Cold War to about $300bn a year by the mid-1990s. From 1992-96, Indonesia, Malaysia, Thailand, and the Philippines were all experiencing money and credit growth rates of between 25-30 per cent a year. Emerging market stock markets boomed, nearly doubling their share of world capitalization between 1990 and 1993.
Proponents of capital liberalization justified these inflows on the grounds of (a) maximizing the efficiency of capital worldwide, (b) allowing a specific country to invest more than could be financed from its own savings, (c) bringing modern financial institutions into the country, and (d) deepening the liquidity of the country’s financial system and lengthening investor horizons, thereby making markets more efficient and more stable. In the end the case for free capital flows came down to the classic theory of comparative advantage, as though trade in dollars was essentially similar to trade in widgets.
In reality, however, the funds went into increasingly marginal and speculative developments and simply exacerbated an underlying credit bubble. Although they did not speak out at the time, a number of prominent economists and financiers have since pointed out the dangers of such “gypsy capital”. Joseph Stiglitz, for example, argued that the origins of the Asian financial crisis rested, in the first place, with the excessively rapid financial and capital market liberalization that the U.S. Treasury had pushed on these economies, on behalf of Wall Street, and over the protests of the Council of Economic Advisors, of which he was the chairman. “At the Council of Economic Advisors we weren’t convinced that South Korean liberalization was a matter of U.S. national interest, though obviously it would help the special interests of Wall Street” (Globalization and Its Discontents, New York: W. W. Norton, 2002, p. 102).
Similarly, Jagdish Bhagwati, one of free trade’s most passionate supporters for developing nations, argued that the idea of free trade had been “hijacked by the proponents of capital mobility”.
The end result of this drive to liberalise capital accounts in immature emerging economies was a series of booms and busts, culminating in financial crisis. Capital flows into emerging markets turn out to be less a diversification of assets, more another instance of “investment herding”, especially within regions, where market allocation was propelled less by differences between countries in their “fundamentals” (including “good” or “bad” policy) than by “push factors”—macro push factors like the amount of excess liquidity in different parts of the core zone of the world economy; and micro push factors like the incentives on institutional money managers and the corresponding drive to match the “benchmark weightings” devised by pension fund consultants, many of knew nothing of the various underlying markets. Money managers tend to be evaluated relative to the median performance of money managers in the same asset class. This encourages them to move in and out of markets together, producing “herding” or “trend chasing” or “positive feedback trading” and the crisis of 1997/98 was a textbook illustration of that phenomenon.
Malaysia was heading down this road in 1997. The currency, the ringgit, was collapsing, as the contagion effects from Thailand, Korea and Indonesia gradually extended into the country. Although Anwar had not placed the country under a formal imf program, he had been following the imf recipe: to forestall capital flight, fiscal policy was tightened and interest rates were hiked in order to protect the external value of the currency.
Based largely on their experience in Latin America, the Fund had already imposed directly these measures on Thailand, Indonesia, and Korea. The problem, however, is that whereas fiscal deficits have tended to be large and inflation chronic in Latin America, in the economies of emerging Asia, budgets had long been roughly in balance. In addition, as the Funds’ economists were unschooled in the links between macro conditions and corporate balance sheets, they failed to perceive the danger of high real interest rates in economies with high debt/equity ratios and low inflationary expectations. High real interest rates have deflationary and crisis-signalling consequences that prompt capital outflows regardless of the attractions of the high rates themselves.
Which is precisely what began to occur in Malaysia. The Malaysian economy experienced a contraction of credit growth from 30 percent in 1997 to minus 5 percent in 1998, reflecting a massive pullback of bank loans. The ringgit plunged, as capital outflows accelerated. A real estate collapse loomed.
Ultimately, seeing the failure in these policies, Prime Minister Mahathir sacked Anwar, and re-imposed capital controls to insulate his economy from the deleterious consequences of rapid hot money outflows. (The trumped-up political charges, which led to the latter’s imprisonment, only came later.) Monetary and fiscal policy became expansionary, the ringgit was pegged to the US dollar, and crisis credit conditions began to diminish as domestic rates were reduced drastically. Although Western finance ministries and institutional investors protested apocalyptically and predicted that Malaysia would remain beyond the pale of the investment world for the foreseeable future, six months later even The Economist, one of the IMF’s great apologists, was forced to acknowledge that the embrace of capital controls had done “short-term wonders” in assisting recovery.
This is all old history. But it is worthwhile recalling the actions of the Fund in the context of what it is advising countries like Iceland and Latvia to do today. Or when considering the hair shirt economics which seems to be championed by Germany’s economic elites.
Chinese Yuan v The U.S. Dollar: In The Case of Global Reserve Currency
The practice of accumulating dollar reserves by the central banks has become more pronounced after the 1997 Asian financial crisis, when currency speculators hastened a balance of payments crisis in Thailand, Indonesia and South Korea by demanding dollars for local currency, depleting the central banks’ dollar reserves.
Fast forward 13 years later, the dollar’s status as the world’s preferred reserve currency has come into question amid a ballooning budget deficit that keeps the U.S. dependent on foreign financing. Both Russia and China last year suggested a type of “super-sovereign reserve currency” to challenge the dollar, while Brazil and India also discussed substituting other assets for their dollar holdings.
IMF – “That Day Has Not Yet Come”
Reigniting the argument, Dominique Strauss-Kahn, the head of the International Monetary Fund (IMF), said last Friday that it would be “intellectually healthy to explore” the creation of a new global reserve currency to reduce dependence on the dollar.
Mr. Strauss-Kahn did say there could be a globally issued reserve asset some day, but “that day has not yet come.” However, his remarks signaled broader concern over the dominance of the dollar, and “the extent to which the international monetary system as a whole depends on the policies and conditions of a single, albeit dominant, country.”
All these beg the question – Who could be the next global reserve currency succeeding the dollar?
Dollar Reserve – A Decade of Decline
The most recent foreign exchange report from the U.S. Treasury Dept. shows that the dollar reserve holding percentage has been on a steady decline – even before the financial crisis. As of 2009, the dollar still comprised about 60% of foreign reserves, compared with less than 30% for the euro, followed far behind by the pound and the yen. (see graph)
According to the Peterson Institute for International Economics, although the dollar remains the most important reserve currency over the last ten years through the first quarter of 2009, adjusting for the exchange rate effects, the dollar’s share in foreign exchange reserves has declined on balance 4.3%.
Reserve Currency Factors
The U.S. Treasury report points to several key factors identified by economists that determine the use of a currency for reserves:
- the size of the domestic economy
- the importance of the economy in international trade
- the size, depth, and openness of financial markets
- the convertibility of the currency
- the use of the currency as a currency peg
- domestic macroeconomic policies
PIIGS Decimate Euro
Based on these criteria, the euro zone, similar to the United States in size, share of global trade, and currency convertibility, makes the euro a viable contender for the dollar’s crown. And in contrast to the dollar, the euro has steadily taken market share regarding global foreign reserves during the past ten years, and has become the second most popular reserve currency. (see graph)
Unfortunately, the debt and budget woes of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) have seriously damaged the confidence and credibility of the European Union and the euro, essentially decimating the euro’s chances as an alternative to the dollar.
The euro has already hit a one-year low against the yen, and nine-month low against the dollar on speculation that Greece’s credit rating will be downgraded further. The viability of the European Union and the euro as a going concern has also come into question.
Dollar Reigns Liquidity Supreme
Even without the Greece debacle, the lack of liquidity within the euro zone also makes it difficult to compete against the dollar. One important reason the US dollar remains the reserve currency is that the U.S. treasury market is the most liquid market of its sort. A liquid debt market allows central banks to intervene in foreign exchange markets in order to smooth currency fluctuations.
As noted by the U.S. Treasury Dept. report:
“The euro has not become the dollar’s equal as a reserve currency because there is no common sovereign-debt market across the euro zone.”
From that perspective, sterling and yen, the next two preferred reserve currencies following the euro, pale in comparison to the dollar in terms of liquidity and facilitating global trade. Moreover, Moody’s (MCO) warned of possible downgrades on UK and Japan due to high debt, interest payments and slow GDP growth. (The pound was in virtual free-fall at one stage this Monday and sank to a ten-month low against the dollar on renewed worries about a hung parliament.)
Gold or Yuan?
While there are many advocating an international gold standard, or another international standard currency based on a basket of commodities and/or currencies, it is very difficult to see sufficient international consensus for this to be practical or feasible.
So, waiting in the wings is the Chinese renminbi (RMB) or yuan. The appointment of Zhu Min, the deputy governor of China’s central bank, as a special adviser to the IMF seems to signal China’s assertion in the global currency scheme. The fund, historically led by a European but dominated by the United States, has tried to engage emerging economies like Brazil, China, India and Russia.
But according to economist Geng Xiao, director of the Brookings-Tsinghua Center for Public Policy, it’s still in China’s—and the world’s—best interest not to dump the dollar just yet.
Yuan Revaluation Solves Nothing
In an interview with McKinsey Quarterly, Xiao noted that there’s no argument on either side about the trade imbalance between China and the US. However, there are some philosophical differences between the two as the US places more emphasis on the short-term adjustment through price and the RMB exchange rate, whereas the Chinese put more emphasis on medium and long-term structural and institutional change.
Xiao finds it quite difficult for the exchange rate to correct the trade balance:
“Even if you change the exchange rate, it will have very little impact on US trade deficit because the US is going to buy from some other countries.”
Time To Reform & Float
China needs time to push through difficult economic reforms at home before it can allow its currency to float freely against the dollar, as Xiao explains:
“China needs a benchmark so that the price can be compared to the global price, to the price structure, compatible with efficiency. That’s why price reform is more important
than exchange-rate change… Exchange-rate change would not really change the inefficiencies … [as] the internal subsidies are still there.”
Xiao estimates it’s going to take 5 to 10 years for China to correct its distortions – land reform, reform of the energy sector, state-owned-enterprise reform, and social welfare. Only when the productivity of China reaches that of the United States will the two countries’ price structures converge.
The Worst-Case Scenario
A worst-case scenario might come to fruition if China allows RMB appreciation expectation to continue, building up more foreign-exchange reserves, as Xiao cautions:
“I don’t see that there’s any way that China can significantly reduce its holding of the dollar assets….But if pushed hard, China can always do more. And even marginally, a little bit more is going to have a big impact in the market.”
Dollar Rules … For Now
Indeed, overtime, China should be able to transform into a modern market economy. And if the Chinese economy continues to grow at its current pace, the RMB will eventually become one of the important reserve currencies, just like the US dollar.
But for now, there are several factors strongly supporting the dollar. In addition to a liquid debt market, many commodities, including oil and gold, are quoted in the US currency. Roughly 88% of daily foreign exchange trades involve US dollars. One currency essentially facilitates global trade, and commodities can be priced homogenously wherever traded.
And China, the top U.S. debtor with a massive holding of $894.8 billion in Treasury securities at the end of last December, is shifting to longer-term US treasuries and at the same time accumulating US stocks, raising its overall holdings of long-term American securities.
China’s huge holdings of dollar reserves in the form of Treasury securities has become a concern for officials on both sides of the Pacific. However, the fact remains that the dollar is still the most liquid, the most stable currency, comparatively speaking. In that sense, it is unlikely for China to significantly reduce its holding of dollar assets in the foreseeable future.
Dethroned By 2050?
Most Western experts seem to agree that the prospect of a dollar replacement for a new world reserve currency is unlikely to materialize anytime soon because there is no serious alternative on the horizon.
Doubts also remain that the Chinese can challenge the greenback. Nevertheless, there seems to be more or less a consensus forming among many Western experts that the Chinese are on an unmistakable path toward challenging the dollar in a transition period of 10 to 15 years, roughly coinciding with the projections of Mr. Geng Xiao.
British economist Angus Maddison predicts that China will surpass the US by 2015. Drawing historic parallels of the last switch in reserve currency (from pound sterling to the US dollar) would imply the Chinese renminbi may be expected to replace the US dollar as a reserve currency around 2050, the mid-21st century.
Dollar Demise by A Greece-Like Crisis?
Meanwhile, even though the debt crisis of troubled southern European nations have taken hold of headlines lately, Moody’s and its peers have expressed concerns about the financial health in Japan, UK and the U.S., mostly centered around debt and debt service in these larger nations.
For instance, interest paid on U.S. Treasury debt has been soaring the last two years and is expected to reach over $700 billion a year by the end of the decade. The U.S.’s ratio of total debt to GDP is likely to exceed 90% this year, making it more indebted even than Spain and Portugal.
While the US has been enjoying the reserve currency status, this is by no means assured for the future. For now, investors are seeking refuge in the U.S. Treasury market. However, a broken-down political system, the debt and the deficit inevitably could sink America into a Greece-like crisis, nudging the dollar’s demise sooner, rather than later.
Economic Forecasts & Opinions
Euro extends gains vs US dollar, trades above $1.37
March 3, 2010 by admin · Leave a Comment
The euro extended gains versus the U.S. dollar to trade above $1.37 in midday trading on Wednesday. Traders said the move was related to flows ahead of the 11 a.m. London fix.
GDP and Dollar Growth: It’s All Happening in Australia
March 3, 2010 by admin · Leave a Comment
I have to say front and center this morning, that while it may have taken the currency traders half a day to realize that Australia had raised rates, they finally began pushing the Aussie dollar (AUD) higher versus the green/peachback. I was beginning to think that I would have egg all over my face again, when the Aussie dollar didn’t respond right away… But it was all right on the night.
I had someone send me a note yesterday that was a little confused about the statement I made about the euro (EUR) getting dragged through the same mud as pound sterling (GBP) on the crosses… So for anyone else who’s thinking that this didn’t make sense… Here’s the skinny… If traders are beating up sterling through the sterling/dollar pair… Then the dollar is getting bought… But for those who have euro/dollar pairs, they get caught in the crosshairs of the sterling/dollar pair. It doesn’t have anything to do with the fact that sterling isn’t a part of the euro, etc… It’s in the crosses… If there’s so much dollar buying versus sterling, the dollar buying will carry over to euro, and other currencies… It’s not a one for one thing… And it takes a lot for a currency like the euro to buck the trend when the dollar is so strong versus sterling.
So… Just when I talked about that yesterday, sterling began to rally versus the dollar! HA! I said to myself…
I read some research reports yesterday that suggest that the short positions with euro are beginning to fade… Hmmm… That brings me to something that I referred to yesterday on my writer rage… Recall when I told you that George Soros said he believed gold to be the ultimate bubble, but then it was revealed that his fund had been buying gold?
Yes, get you all to sell your gold, so he can buy it cheaper… Well, that’s exactly what was going through my mind when I read the story about him calling for the collapse of the euro… I wouldn’t trust that guy if he was swearing on a stack of bibles! Anyway… The research I read was a shot in the arm for yours truly who had been feeling a bit beaten and left for dead with all the bad stuff written about the euro… Yes, the euro deserved to take some losses due to the debt problems there… But again, put into the proper perspective, these losses should have been held to a minimum when compared to the debt problems here, and in Japan!
I see where the US government is telling hedge funds not to destroy trading records on euro bets… This all stems back to the thing I told you about with Goldman Sachs, where they helped Greece pull the wool over the eyes of the Eurozone with their derivatives on debt, and then created a company on the other side that shorts the euro, knowing that eventually the toxic stuff they sold to Greece would explode… Hey! I don’t make this stuff up, folks; it was reported all over the place!
Now, though… The US government is going to stick their hands in there, acting like they know what’s going on… This ought to be good…
So, to continue on with Greece… It looks like the “Chicken Littles” are returning to the roost regarding Greece’s debt, as not only is the 34 billion euros package helping, but Greece itself has announced some spending cuts that are of size, so at least they are taking this battle to heart, eh?
More good economic news in Australia last night, following up on the Reserve Bank of Australia’s (RBA) rate hike, we saw the color of the fourth quarter GDP, which climbed 0.9% from the third quarter, when it gained a revised 0.3%. I know that this isn’t near the red hot Canadian GDP which gained 5% in the fourth quarter… But… It’s now not a question of whether the economy will grow this year, but rather how strong it will be! And… Shows that the RBA’s four rate hikes so far in the past six months are warranted! There’s no longer a need to stimulate the economy, I would think, eh?
Let’s move north from the South Pacific to Japan, where there was some startling news on wages… Let’s go to the tape! Japan experienced the first gain in monthly wages in 20 months last quarter! Does this mean that Japan could really, truly, and undeniably leave deflation behind? NO… Not yet… We’ve seen these “signs” before, only to be disappointed the following month. But for now, at least, it sure looks like things are getting better for Japan’s deflationary economy.
Well… How about that Canadian dollar/loonie (CAD)? The markets took the hawkish sounding words by the Bank of Canada (BOC) yesterday and ran the loonie higher and higher versus the US dollar. Imagine there’s no US debt problem, it isn’t hard to do, imagine there’s no toxic waste on the Fed’s books through and through, imagine all the people, making things difficult for the loonie to rise… But it does anyway!
Somebody asked me the other day, why I include Illinois with California when I talk about the states in the US that have debt problems greater than the PIIGS (Portugal, Italy, Ireland, Greece, Spain)… Well, it just so happens that our bond guru, Don Ries, sent me a note yesterday from the UK Telegraph, where you’ll usually find the most excellent writer, Ambrose Evans-Pritchard… Let’s hear what mister Pritchard had to say about Illinois…
“‘Barack Obama’s home state of Illinois is near the point of fiscal disintegration. ‘The state is in utter crisis,’ said Representative Suzie Bassi. ‘We are next to bankruptcy. We have a $13 billion hole in a $28 billion budget.’
“The state has been paying bills with unfunded vouchers since October. A fifth of buses have stopped. Libraries, owed $400m (£263m), are closing one day a week. Schools are owed $725m. Unable to pay teachers, they are preparing mass lay-offs. ‘It’s a catastrophe’, said the Schools Superintendent.
“In Alexander County, the sheriff’s patrol cars have been repossessed; three-quarters of his officers are laid off; the local prison has refused to take county inmates until debts are paid.
“Bad news: we’re back to 1931. Good news: it’s not 1933 yet.
“Ben Bernanke warns more is needed to help stabilize the financial system… $800 billion boost for flagging US economies in Florida, Arizona, Michigan, New Jersey, Pennsylvania and New York are all facing crises. California has cut teachers salaries by 5%, and imposed a 5% levy on pension fees.
“The Economic Policy Institute says states face a shortfall of $156 billion in fiscal 2010. Most are banned by law from running deficits, so they must retrench.”
That’s all scary stuff, folks; and stuff we should be concerned with… Not whether or not Greece meets the Maastricht budget deficit target!
Gold sure had a great performance yesterday, adding $18 to its figure… As I said on Monday, gold was the number one pick of the presenters at the FX University Conference last week, with Norwegian krone (NOK) coming in second. Of course, I was a bit different than the rest of the presenters, as usual… I said that we could look for gains in Aussie, Canada, and Norway, along with gold and silver…
Then there was this… The US Postal Service projected $238 billion in losses over the next decade. Postmaster General John E. Potter plans to press lawmakers and the Postal Regulatory Commission in the coming weeks to eliminate Saturday mail deliveries and allow the mail agency to raise prices beyond the rate of inflation, if necessary.
Can you believe that? Another government owned business running in the red… I can see it costing us a buck to mail a letter at some point in the future! OUCH!
But… This is just another brick in the wall… We don’t need no austerity measures… We don’t need no cost controls… All in all it’s just… Another brick in the wall… The debt wall, that keeps going higher and higher.
To recap… It took a while for it to settle in, but the Aussie dollar finally began to get some wind in its sails after raising rates a fourth time in the past six months. Greece announced some austerity measures that will reduce spending, and the shorts on the euro have begun to fade. The US states that are in deficit trouble continue to grow.
GDP and Dollar Growth: It’s All Happening in Australia originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”
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