The Dollar is Now the World's Most Hated Currency
America's Newest Export Is Inflation
By blackhedd Posted in Dollar | Economy | gold | oil — Comments (25) / Email this page » / Leave a comment »
The US dollar is in a full-fledged rout. It's trading at historic lows against every major currency except the Japanese yen, and against a raft of minor currencies as well. Dollar-prices for commodities like oil and gold are at record highs.
Dollar weakness is an expected consequence of the Federal Reserve's two recent cuts in its benchmark short-term interest rate. But dollar sentiment around the world has become extraordinarily negative over the past week or so, and people are starting to pile on.
Is this behavior normal? Or is something new and different going on?
More...
First some numbers. This morning, the dollar reached lows of nearly $1.47 against the euro, $2.09 against sterling, $1.10 against the Canadian loonie. The yen strengthened to below 114, and the Chinese yuan touched 7.44, from 7.47 at the beginning of the week. The Aussie dollar and the Norwegian krone also strengthened against the greenback, about which more later.
The basic story here is really rather simple. As an asset, the dollar has become less attractive because of lower interest rates and perceived poor economic fundamentals in the US. (The latter is code for "everyone thinks the reduction in housing values is going to cause a recession.")
In addition, huge writedowns in securities backed by US home-mortgages are causing pain in portfolios all over the world. Many of these securities are denominated in US dollars. There's no place for these assets to go since there's no liquid secondary market for them (and there never has been, so that's not a distress signal in itself). But holders of mortgage-backs face pressure to increase reserves against their losses and they do so by selling other dollar-denominated assets.
One of the most basic features of financial markets is momentum. The old cliche' is that it makes as much sense to buck a trending market as it does to stand in front of a runaway freight train.
And so you get stories like the one from China (quoted in the article I linked above). Cheng Siwei, a senior legislative official, came out and said that China would be diversifying its foreign exchange holdings away from dollars and into stronger currencies.
Now Cheng has a reputation as a loose cannon, and the People's National Congress is not involved in China's monetary policymaking. His statement probably has more shock value than anything else.
That's because China has already been doing what he says, since about the beginning of the year. They have already reduced their holdings of long-dated US Treasury debt to about $400 billion. That's not a big change from where it was, but the direction is what matters. China no longer participates in auctions of new Treasury debt as much as they used to.
They also have a $200 billion "sovereign wealth fund," which is increasingly seeking new investments not in dollars. This is an interesting kind of a vehicle. It's basically a sterilization fund, where countries that make too much money park it, so it won't cause too much domestic inflation. (Norway, with its huge revenues from oil exports, also has one. Hugo Chavez needs one, but he's not smart enough to know that.)
Speaking of oil, that's another big part of the dollar momentum story. We've had a few discussions about this on RedState lately, and I've made the point that speculative buying of crude oil futures is distorting the market for that commodity. Such buying is largely a response to dollar weakness (and the anticipation of further weakness). As we get further into the week, I'm hearing a lot of people confirm this view and I'm basically convinced of it now. Oil will probably hit $100 in the near-term, and may go considerably higher.
Another thing that has changed recently: I see a consensus forming among business people that Hillary Clinton will be the next President of the United States. That's not news. However, the sentiment is also growing that her regime will seriously damage the US economy in absolute terms, and in terms of our global competitiveness. Practical result: some people are scaling back their growth projections (and their investment plans) for 2009 and beyond.
Inflation
The oddest and most striking thing about the current dollar trend is inflation. You can't help seeing that inflation is anywhere from a serious concern (continental Europe) to a blazing inferno (China). Except in the United States.
The US, Japan, and perhaps the UK are the only major economies in the world with no significant inflation in evidence. (I'm discounting US food-price inflation, which is partly driven by government ethanol policy. Japan is simply on the floor economically, with almost no dynamism except in their export sector.) Australia, Norway, India, Russia, and many others have serious inflation issues that are causing them to raise interest rates, which adds still more downward pressure to the dollar.
And oil-states that don't actually have economies, like Saudi Arabia, are feeling the pain in a different way. Since most of them peg their domestic currencies to the dollar, they now have way too much money as well. They're seriously considering diversifying reserves out of dollars too.
Because the global economy is tightly integrated with the American one, the effects of dollar weakness are being transmitted like plague to every other economy. We're exporting inflationary pressure instead of experiencing it at home, and it's possible that this is the cause, not the result, of higher interest rates abroad.
It's a perfect storm. The broad question we have to ask is: will the dollar find a floor, or are we in the middle of a long trend that will fundamentally re-align trade flows around the world?
At this point, all I can do is pose the question. I have to admit I don't know the answer. If you've been around markets at all, you know that they will always surprise you. If we get an unexpected improvement in the US economic outlook, the resulting firmer interest rates will probably halt the dollar's decline, in the near term at least.
But the center of gravity in the global economy is marching south and east. As the largest economy in the world, we're still the most important player in the global game, and will be for a long time to come. However, we're no longer the most dynamic. The American business world, which is extremely good at adapting to changing conditions, will have a lot of adapting to do.
We're now in the early stages of a secular transformation that, in its scale and impact, will match the Industrial Revolution and the late-19th Century exodus from farms to cities.
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Or we have the possibility of a Japanese-style deflation, or the world will do what it always does in times of severe economic pressures--war! The net result of all this--whichever way it goes--will be further erosion of US soveriegnty and further loss of individual freedoms. This has a way to go.
says we're already having inflation. It's not in the form of increasing the currency supply, but it's the same effect. Some things that used to cost $100 now cost significantly more.
My take is that the Fed is trying to avoid a recession by devaluating the dollar (through low interest rates). This doesn't seem like a workable strategy in the long term due to capital flight, which is what's being illustrated in the OP. Too much of this, and I fear we'll get Carter's wondrous combination of recession AND inflation.
He has long held that bull markets "climb a wall of worry" and agrees with the Rothschild view that the time to buy is "when blood is running in the streets."
If everyone thinks the dollar is going to collapse, that suggests that it will soon turn around. Similarly, if everyone thinks that the price of oil has nowhere to go but up, that suggests that the oil bubble is about to burst.
Neither suggestion is more than a suggestion, but sometimes the mere fact that everyone is betting the same way suggests that they're all wrong.
In fact, I've been scanning the markets this morning looking for something to buy. Haven't done anything yet, though. It looks really ugly out there.
The market can stay irrational longer than you can stay solvent. John Maynard Keynes
If you have really deep pockets you can afford to step in front of the freight train.
I like looking in a contrarian view too but if you are contrarian too early (i fight that all the time) that hurts as much as being too late.
It's a puzzle of human psychology. When will the critical mass of humans start seeing the risk/reward of being long start to worry them. When the market goes up, the talking heads highlight the positive causes, when the market goes down they highlight the negative news when in fact both exist in some proportion all the time.
If I could unlock the thought process and psychology of the herd I'd own the world ;) Don't worry it won't happen but if I did, the world would be a better place w/ me as dictator ;)
Ask not what I can do for my country, ask what my country can do for me. Washington Elected Elite
What is hard is similar to poker. Some play their cards, others play their opponents.
Similarly, in the markets the underlying data/news/info(cards) is one factor but much more important is the investors(opponents which can be much more fickle and unpredictable)interpretation of that information.
Ask not what I can do for my country, ask what my country can do for me. Washington Elected Elite
As an equity trader, I am well aware of the factor momentum can play. However, the most glaring attribute of momentum in my experience is that those who place trades based upon it almost always seem to get burned in the end, especially after the momentum has become readily apparent. Witness the Internet bubble, real estate bubble, etc. While I have never played in the currency markets(aside from making some crude calculations on equities that trade in multiple international markets to determine where certain equities should open based upon their closing prices in foriegn markets), it would seem to me that the current dollar weakness has already made the majority of its move, being that the Euro has nearly doubled in value against the dollar in the last few years. Anytime you see non-financial types talking about making a financial move based upon what they've heard in the news, as in the recent Gisele Bündchen story, it's virtually guaranteed that the end of the run is near - if I remember correctly, Joe Kennedy dumped all his stocks shortly before the crash in 1929 because his shoe-shine guy asked him about stocks and Joe's reasoning was, "if this guy is thinking about buying stocks, who is left to drive the price higher". Thus, my bet would be that the dollar finds a floor relatively soon.
So what are the effects if everyone panics and dumps the dollar? If that happens - the US just sold high and bought low(in terms of bond pricing), yields become more attractive to both foreign and domestic investors, attracting dollar investments, strengthening the dollar.
In addition, aren't US companies throwing off record earnings in relation to sales? What are they doing with it - it seems that most of them are sitting on it currently, realizing that it doesn't make sense to invest elsewhere in the world with the exchange rate so unfavorable.
Also, something to think about is Andy Kessler's(I think it was him anyway) point from a while back - our trade deficit doesn't matter, because that's merely a revenue measure, what really matters is profits. For instance, take the Chinese firm that puts together DVD players - a US company may sell them the chips to decode the DVDs at $5/chip which has a marginal cost for the US firm of a couple of cents per chip, so the US company earns(or adds that amount of value to) $4.95/DVD player. The Chinese firm has to buy all the components to put it together(not necessarily from US companies), and lets say it costs them $38 in parts, wages, and shipping to the US and no other US company sold them any other parts. What does the deficit look like in that case - the US sold $5 worth of parts to get a DVD player that comes back to the US at $40 wholesale - so the trade deficit looks awful from our standpoint, but China is facing the bigger "profit deficit". Who got the better end of the deal? In my opinion the US did - we added the most value to that transaction. Plus, by essentially pegging the Chinese currency to the dollar so as to make the sale to us(by keeping their goods cheap), there is an inflation cost incurred by China which doesn't matter in the US.
Concerning your China-trade example, how you tend to look at this depends on whether you earn wages or profits. On the profit side, the reason the US companies had commanded most of the profits was because we provided the intellectual property - the chips and software that give the product value. That situation has changed for many if not most such products. The DVD example is almost universally no longer true. The chips come from Japanese, Korean, or, more often now, Taiwanese suppliers and the products are designed in China. (I just happen to have one such DVD player open on my desk and there is virtually ZERO US content - something I have the experience to know). Without the profit side, the trade flow does start to matter. It would be interesting to see data on the profit flow today. I think it would confirm that the flow of real money is changing.
...is largely restricted to final assembly. What they have had to sell is largely restricted to cheap labor.
They're very well aware, however, that this is an Achilles heel, because their labor is no longer the cheapest in East Asia, not by a long way. And that's the reason they persist in keeping the yuan undervalued.
They're going all out to change this dynamic, and I've heard they're making surprisingly fast progress. What they want is to start doing component assembly themselves instead of importing components from Korea, Taiwan, Singapore, the US, etc.
I believe the yuan/dollar exchange rate is the tea leaf to read. If the yuan starts appreciating faster, you'll know the Chinese are getting more confident about their position in the value chain.
True enough that my original example(DVD players) probably doesn't apply to the current state of affairs of assembling DVD players. However, it still seems that the profits taken out of Chinese manufacturing generally accrue to those outside of China - whether it be raw materials sold to China or profits made on selling the Chinese goods bought at wholesale elsewhere. Wages, of course, are a different matter, but with the current unemployment rates in the US, it would be hard to definitively argue that China is taking more jobs here than it is creating(anecdotal evidence doesn't carry much weight, although that's what everyone cites).
I, too, would like to see data on the profit flow. Specifically, how much is China cutting back on investments in T-bonds & T-bills. Assuming it has slowed down to a large degree, would this be due to China's economy slowing down, because they wanted to diversify, or what?
Assuming the following about the recent past:
* China kept the dollar pegged closely to the yuan in order to provide stability for their exports and to keep them cost competitive with other Pacific Rim countries.
* China has experience higher than normal inflation.
* Publicly-traded(and perhaps all) US companies have experienced record profits in the recent past
* China has invested heavily in dollar-denominated assets.
* US companies currently have large cash hordes due to the record profits.
I am a little rusty on my international econ, and there are surely more factors at work here, but wouldn't it follow that the dollar peg helped create the inflation in China and their investments in dollar-denominated assets, specifically bonds, had an effect upon the earnings of US companies due to cheap money and relatively good investment opportunities with relation to their borrowing costs? Apparently, the investment opportunities for US companies aren't quite what they were in the recent past(whether in the US or abroad), as they have largely decided to sit on the cash.
What happens if a recession starts in the US, which seems to be conventional wisdom amongst the media? Do the Chinese dump all their dollar-denominated assets? If so, wouldn't that shoot themselves in the foot? Where do they put the dollars they just sold? It would seem foolish to try and throw them at their own economy, exacerbating inflation and making their products more expensive to US consumers. Do they put them in the European nations or Japan or wherever else? This would cause the dollar to decline further, but the money would likely find itself quickly back into dollars as the investment opportunities in the US would likely be greater than those found in Europe/Japan/elsewhere due to the dollar being so cheap relatively.
Also, as oil sales are denominated in dollars, the weak dollar causes oil to be much cheaper to those abroad, causing our oil prices to increase more than otherwise, and makes energy-intensive industries more sensible to operate abroad. Just imagine what oil would cost in Europe if the Euro was still .85/$...
For some reason, given the conventional wisdom, and my penchant for contrary thinking, I get the feeling that this is somehow going to end up causing a mild recession here and a bigger recession in Europe - just a feeling, I'm not going to elaborate.
...the one they run against us. They're not about to dump $1.43 trillion in dollar reserves for the reason you give, which is that there would be no place for the dollars to go.
That's more a question of size than of quality, however. Like any commodity, risk-free debt is subject to substitution when it gets too expensive, as US Treasuries have become. There are very similar assets out there that you can buy if you don't want to buy Treasuries.
Central bankers are by nature extremely conservative and risk-averse people. They hate to do anything fast. China's bankers are all of that, plus they have the added financial conservatism of Chinese people generally.
They are definitely diversifying their exposure to the dollar, but you won't see fire sales of dollar assets held by China. Instead, they will no longer buying as much of our new debt as they have in the past. Over time, they hope this will give them a much better rate of return on their reserve portfolio.
There is already a lot of evidence that the slowdown in the US is affecting China. One recent signal (among many) is the break in the price of copper, of which China is the world's largest consumer.
The Eurozone is facing a very difficult policy dilemma. They really would like to raise interest rates, and were planning to, until the credit crisis struck in August. They have a lot of inflation, especially in Germany. But they can't raise rates now that credit impairment around the world is threatening a slowdown. So they're stuck in a box. Us lowering our interest rates raises the euro sharply, which makes Europe's position all the more difficult.
As I said in the OP, we're exporting inflationary pressure all over the world without experiencing any ourselves. It's really an odd situation.
I actually didn't mean to put forth any reasons why, just put a few questions out there.
I missed the Bloomberg link in the original post, that helped shed some light on your OP.
Good post, by the way, makes one think...
In general, I agree with you about breaking from the herd. However, contrarian thinking might have had you buying Quest Software at $40.00 or Yahoo near 100.
Trying to call a bottom is the hardest thing in finance. Sometimes, you think, "This has to be it!!! It can't go any lower!" only to see it an asset do exactly that.
I've been in foreign stocks and foreign currencies for three years. I have zero savings in dollars. None. Zippo. My family in Europe holds only Euro assets at this point.
The temptation is to call this decline overdone, but I don't think we can say that at this point.
I'm not talking about trying to "catch a falling knife", just saying that when the common wisdom says one thing, look out for the opposite to be happen - ie, start watching for a bottom when everyone knows XYZ is going to happen...
I, like you, have had a good portion of my retirement savings in foreign stocks currently, and I allocated it that way when it was common knowledge that the Euro was going to zero. I am contemplating switching it back into domestic investments shortly, based upon the current conventional wisdom. I may be wrong in the short-term, but long-term, I think it'll be hard to be completely wrong.
If you really want to make a bet that no one else is making, go short volatility.
Premium has gotten so ungodly expensive in the last few months or so that there's at least a theoretical possibility that it's overpriced.
(By the way, I'm not recommending you do this, nor do I ever give any kind of investment advice when I write here at RedState.)
Now that would be a trade that goes well beyond trying to catch a falling knife. It's more like dancing where angels fear to tread.
There's a reason why contrarianism, while appealing and logical in theory, is so hard in practice: because it takes balls.
A few years back, when I was working for a large brokerage firm, I probably would've thought about going short the VIX, although I probably wouldn't have done it at these levels, probably more like high 30s or higher. I used to have the balls to make my superiors very nervous, however, now that I'm the boss, no thanks!
Contrarianism is just a useful way to build up a "watchlist" in my mind. My biggest trades have always been buying stocks when everyone hates them(and there isn't much downside left) and selling them when everyone loves them.
Also, regarding the Heritage piece - do you have any stats on what it costs to collect business taxes versus what the collections are? I recall hearing a while back that the difference between the two was something less than $100 billion(federally, anyway). Thus, you would think that with the proper education of the electorate, a politician should be able to make the case that the proper tax rate for business is 0%. Of course, everyone thinks that they're screwing the executives of the business by taxing them, when really they're just screwing themselves - perhaps the way to go about it would be to play the 'class warfare' game to a certain degree and say, "let's give the corporate tax lawyers and corporate accountants something productive to do".
VIX isn't nearly as high right now as it was back in August.
I've had a hunch for some time that volatility is systemically underpriced in periods of low volatility, and vice versa. The intuition is confirmed by the fact that if you plot real asset prices against a stochastic random walk, the "tails" in the real data are always fatter than in the theoretical data.
And if I'm right, the inefficiencies are likely to be larger (and more exploitable) in specific assets rather than in a broad measure like VIX.
Just a thought. If I'm wrong, I'll let you know. But if I'm right, I'll take the secret to my extremely well-appointed grave. :-)
Business profits: you're making a different point from taxes on exports, but there's no question to me that taxes on business profits should be zero. A corporation can't consume its own profits. They will always be distributed before they can be consumed. Those distributions are already taxed now, so it's stupid to tax twice.
Stupid, that is, if your goal is to maximize material wellbeing across the whole population.
If (as with the Democrats) your goal is to make sure that everyone ends up with about the same amount of material wellbeing as everyone else, then taxing business profits heavily is pretty smart.
The American people have to decide between equality and prosperity. Since in this election cycle, the Democrats are selling equality and the Republicans aren't selling anything, it's an easy bet which will win.
What are the futures markets saying? Is the dollar still seriously overvalued?
...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...
---Thomas Paine---
...rate cut in December, and no rate cut in Europe. Bottom line, they're expecting more dollar weakness. If that expectation changes, the dollar will reverse.
The dollar has backed off its low against the euro. Oil down sharply, gold up a bit. Bonds are continuing their wild rally. Yen is very strong today, but it follows a somewhat different dynamic. The dollar-euro rate is the one to watch.
The Heritage piece you linked is a brief editorial, light on analysis, but the authors do touch on one extremely interesting point: in addition to overtaxing capital and savings, the Federal government goes out of its way to make exports more costly by taxing them in ways that our trading partners do not.
It turns out that the economics of export/import taxation is an extremely complicated subject, and I'm not mathematical enough to describe it. (Ironically, one of the key experts in the field is Paul Krugman, who's a pretty smart and accomplished guy when he's not being a tendentious, left-wing gasbag.)
But the bottom line is that tax and regulatory policy combine to make it more logical for American companies to invest overseas rather than here. And of course the inevitable result is that other countries will "borrow" (Alan Greenspan's euphemism for steal) our technology.
And as I pointed out in the OP, it now looks like the American people will have the bad taste to elect more Democrats next year. We're going very much in the wrong direction. Instead of more self-defeating economic populism, we need some pro-business leadership.
Hopefully it will only take four years of President Hillary Clinton, not eight, to make Americans understand where their own self-interest lies.
Hear! Hear! to pro-business leadership. It's really bad when the GOP, the party of American Business, loses that title to the Democrats by default.
Prosperity for the masses comes not from the government, but from the economic engine that is America. Or at least that's how I remember life long ago.
When I first started traveling to China and manufacturing products there, soon to be 20 years ago, I found state of the art automated electronic assembly equipment even in small companies. Things you found only in the largest and most specialized companies stateside. The reason? The didn't buy them. The government did. (Actually, the PLA in some cases). They didn't pay for them up front. They didn't depreciate them. They were either provided no charge, or, pay-as-you-go. There was no way American companies could compete with that, even before you took labor into account. I don't know how it's done today. I don't travel there anymore. But it's an example of how the playing field wasn't level. The reference to taxation of exports is another example. So, GOP candidate of choice (as if there was one), we need a level playing field for American business, large and small.
While we are on this subject, does anyone realize that much of the modern weaponry that we now depend on is based on technology that we import from other countries? There was a day, before I started traveling to Asia where I designed military electronics. There was a simple rule. If it wasn't made in the US and approved for military use, you couldn't design it in. Today that rule is impossible because many of the components just are not made here any more. This is a national security issue.
Another burden on American business. Healthcare. I know I'm opening a can of worms here but it's a BIG problem. I don't have an answer. Neither does Hillary. But, somehow, somewhere, we have to address it. Otherwise, remember the book (and movie) Logan's Run. We'll either all die trying to solve this...or only those over 30.
Next on my soapbox...BALANCE THE BUDGET. I know.."Deficits don't matter". I know "it's being paid for by foreigners". I know.."it's a debt to ourselves". What I really know is it's irresponsible. I know that it's necessary at times to run a deficit (war, crisis, big Lousianna purchases, etc.) But mark my words, some day it will come to call. I don't want to leave that to my children to fix.
Somewhere else here I think I wrote about oil, one of the big topics from the blackhedd's OP. Another national security issue, but, since we consume 30% of the worlds oil exports, not one that's going away anytime soon. We are, by far, the world's largest importer of oil and the most at risk because of it, from a security sense, and a financial one.
Our ability to marshal amazing economic strength helped us win WWII. We won the cold war with economics. We turned Communist China from our Indochinese adversary to #1 trading partner with economics. It has been the most powerful weapon in our arsenal. We need leadership that knows how to use it.
OK...too much soapbox. I yield the floor.
I wrote this piece about five hours before the stock market opened today, and I guess I should have paid attention to that old gut feeling.
At least the bond market had a good day today.
;-)
Are you sure our currency is more hated than those of Mexico, Venezuela, and Zimbabwe?
We have a bunch of Wall Street banks and brokerages caught in an incredible credit ponzi scheme, and it's costing them billions of dollars in writeoffs, and none of them know anythinng about the instruments they had on their books. Take that, with the Federal Reserve, anxious to try and bail them out, refusing to acknowledge there's any inflation in the economy (I have no clue where they live) and hence relying on questionable goverment statistics (try and rationalize the CPI calculation). Just comprehending that, what confidence would you have in the US dollar? Based on what I'm seeing with the currency traders, not very much, and they know a moment of "irrational exhumberance" when they see it, and they're taking advantage of it. Sit tight, it's not over.