Thursday, March 27, 2008

why the dollar may be doomed

I'm writing this to address head-on the full range of challenges facing the USD. sometimes when analyzing a financial asset, all factors unite in a single direction -- making it almost impossible to doubt the expected result will happen. right now, the forces seem to be lining up to make further and increasing dollar weakness almost certain.

I'd like to start by looking at money itself.



Is the Dollar Still Money?

in financial history, people create money from valued things. in primitive times: food, tobacco and gold ... in allied prisoner camps during WWII, cigarettes were used as money... and during the boom years of the 1990s, corporate executives printed common stock as shares to pay starry-eyed youngsters and to finance multi-billion dollar takeovers ...

in all these cases, the commodity is durable, divisible and uniform -- these are necessary conditions for something to be money.

but the single question that trumps all of these is: does anyone actually want to own it? does the dollar have its own inherent value, like wheat or cows? can you smoke it as you dream of returning home from war?

the nice thing about gold is you know there's never going to be much of it. can you say the same thing about the dollar, with ben bernanke cramming liquidity into our sick financial system? the answer is increasingly "no." consider the million and one transactions that happen every minute in the world... on the margin, people are increasingly shunning the dollar.

for instance Korea's National Pension Service says it's already bursting with US Treasuries and won't buy more. already china has been diversifying its own reserves, and middle eastern countries are suffering rampant inflation from their dollar pegs. (one thing that might happen over time is that brazil, colombia and chile may start buying more US debt as we start suffering wide recessionary budget deficits. in fact, Brazil's holdings rose more than 150% to $141.7bln in january. russia is also gaining.)


Still the Leader?

these countries all benefit from strong commodity production and trade surpluses. in contrast, the US is a net importer. but like all fiat money, the dollar is only as good as the government and economy backing it.

ever since the late 19th century, one simple assumption has been true in international politics and finance: america was either ascendant or was the clearly dominant economic power. our global dominance reached its peak in the 1990s stock market run, which was followed by a bubble in the dollar.

but events around the world are generating questions about our global dominance ... we face the bleakest set of challenges since the 1930s, while every other major economy in the world is doing somewhere between "OK" (japan) and "incredibly well" (china, brazil, russia). yes, they will be affected by the US slowdown, but I don't think it will be nearly as hurt as we imagine. their economies are healthy and relatively new.... our is sick and probably getting sicker.

does our sneeze still have the ability to infect the global economy?

or does it lead to even greater dollar weakness, which will drive up commodities and continue to help brazil and australia? now that oil prices are near record highs despite falling gasoline comsumption in the US and there's no political risk of iran or nigeria priced into the market, we clearly have less of an effect on the global economy that just 10 years ago.

I believe most emerging markets will remain strong for years. after knowing years of poverty, these third-world people are enjoying the lives we've taken for granted for the past century. they are happy and excited about a richer future. they're not going to let it just slip away.

in these countries, a virtuous cycle is in place as people see others succeed and aspire to their own wealth. many have declining inflation and falling interest rates... the basis is laid for years of steady economic improvement regardless of what happens in the USA. this could allow our country to become a stagnant and inflated backwater in the global economy within five years. as that unfolds, as fear and asset destruction overtake the US economy, it will increasingly make sense to allocate the marginal pound, euro or dinar into another store of value.

Dumping Dollars

once you remove the assumption of US economic supremacy and hegemony, the USD starts running into problems. yes, europe has worse problems in terms of unfunded obligations and aging populations. but, the euro is not a widely held commodity like the dollar. about $2.4trillion of Treasuries are held outside the US and supply is expected to keep rising as the economic slowdown widens the budget deficit.

plus, the ECB seems completely opposed to rate cuts, regardless of what the currency strategists think. without that on the table, it's hard to think the euro will stop rising. let's see if europe starts to slow the way the economists predict...

next, many currencies are pegged to the dollar. to me, it seems axiomatic that if they are undervalued and pegged to the dollar, they are forced to surrender some of that strength into the US. they are essentially subsidizing our consumption.

in other worlds, can't we say the dollar is now partially backed by the dinar and dirham? but since the peg is causing them inflation, how long can they hold out? here some instances of how some of the global pegs to the dollar are weakening:

UAE: the dollar-dirham tie could be broken if inflation worsens and the USD keeps falling.
Qatar: will revalue by april, according to a Standard Bank report this month.
Korea: pension fund to stop buying Treasuries.
China: chinese exporters are avoiding the dollar and devising ways to deal with its declining value.

and, a former Wall St banker who now teaches in China thinks they will do a sudden revaluation of 15-20% to prevent people from buying too many yuan in the near term.

it seems that in each case except korea, the greenback would be weaker if they let their currencies appreciate.

the only thing that could strengthen the dollar now is an unexpected strengthening in the US economy, or slowing in europe or china. so far, the news flow runs strongly against either proposition -- for the first time in a century, america is not the global economic hegemon. it's a new century.

The Future

now that we've reviewed what we know to be true, it's time to consider what might become true next. societies and markets are dynamic as past successes and failures influence future action. growth tends to beget more growth, and problems tend to bring on more problems.

one potential concern in the near-term is social unrest. we have record high gasoline prices months before the prime driving season. if it's a hot summer and people in urban areas are angry about paying too much for everything from food to gasoline, it's like dry tinder in the forest. add in the bizarre situation happening in the democratic party. the convention is held in denver aug 25-28... what if hillary pulls off a coup against obama and urban populations riot? ... after all, this year is the 40th anniversary of the violent protests at the convention in chicago during the height of the 1960s...

we must not underestimate the degree to which the US is vulnerable to social unrest because of high fuel prices. fuel riots have happened in places like venezuela, china and nigeria. millions of americans are dependent on cheap fuel to live their basic lives. it's a dangerous environment. I'm not saying it will happen. I am just saying, it's more probable now than it was 2-3 years ago.

let us think from the perspective of a foreigner thriving on growth in a country like china or india. he probably sees the US, loaded with bad debt and a declining currency. what happens when he watches the news and sees images of unrest in LA and Phoenix? what happens when he simultaneously hears the US will have widening budget deficits? he will simply want to avoid it, and sell it.

furthermore, oil prices have risen on their own, almost devoid of a political-risk premium. its current strength seems to be driven by real demand. light sweet crude has consolidated above 100.

it first probed the high 90s in november. it then consolidated, retesting the 86 level 3 times, before breaking above 100 in mid-february. it next moved quickly to 110... but this time, it only fell to 99.20 or so before rebounding again to the upside. this kind of consolidation at a key triple-digit level seems to me the kind of support that may never get taken out. a permanent repricing may have occured.

to me, it appears oil is consolidating at some very key levels before another bull run higher. looking at oil purely as a chart, it seems entirely possible for it to end the year at $150. I know that sounds outlandish and crazy, but it seems to be in a very strong uptrend.

things could also go worse in iraq and a more general state of conflict might occur in the middle east. it doesn't seem to be a danger right now, but geopolitical risk is not really reflected in oil prices right now. over time, it's reasonable to expect it could return.

now, to be honest, I know very little about the energy market. I'm only looking at the chart, which technicians believe is the best reflection of long-term demand.

it seems to me that hedge funds and ETFs are changing the nature of commodities. many experts say there's never going to be a chance that financial investors will matter more in the market than supply and demand for the commodity itself. I simply cannot believe that. right now, I don't have time to research who owns what in the commodities market. but I know how to put the pieces together. oil and commodities will become the favored investment of americans in coming years, further driving their prices higher. yes, they will form a bubble, but I think it still lies far in the future.

once again, imagine wall street's reaction to fuel riots? money would surge into ETFs like the USO.

furthermore, looking at another chart, between feb 7 and march 17, the dollar index plunged from 77 to 70.7... it then rebounded to about 73.2 before continuing to fall. this marked a 38% retracement of the move, confirming to me a stronger downtrend remains in place. a projection puts the next level around 66.9. I see technical obstacles or obvious support to halt this downtrend.

it seems the only hope for the dollar has been an intervention by foreign central banks... Bank of America's Robert Sinche addresses the subject in the last issue of their daily research report Situation Room:

There are probably four main preconditions for coordinated intervention in foreign exchange markets-significant currency misalignment, excessive speculative positioning, destabilization of markets or economies and a reasonable chance of success. While there is likely to be ongoing talk of imminent intervention by G3 Central Banks, our assessment of these criteria suggests the probability of intervention in the near term is, in fact, quite low.

if B of A is correct, the dollar bulls have virtually nothing to hang their hats on.

again, this posting is meant to paint the bleakest picture. many of the bad things in it might not happen. more worrying is the complete lack of bullish things going for the dollar. I can only imagine 3 things that could really help the dollar now -- barring some freak geopolitical event, like the arrival of extraterrestrial life:

1-a sudden, unexpected rally in home prices
2-a decline in oil prices
3-bernanke changes his position and drives up interest rates, inflicting paralysis on the US economy.

all three of these events seem pretty unlikely.

before, the unimaginable thing was that the US economy would cease to matter and that inflation would run out of control. most people still consider this highly unlikely.

but, the one thing that now really is unthinkable is that one of these three things will happen. now, looking at the facts, dollar strength itself is starting to seem unimaginable.

Wednesday, March 26, 2008

this doesn't happen in the text books


I don't know whether this is in a textbook, but it sure seems like it every time you talk to a trained financial professional or economist. they all believe energy prices will fall if the US enters a recession.

this seems fair, because it's often been the case. for instance, the chart above compares US durable goods orders to oil prices. they tracked each other 80% of the time over the last decade. but over the past year, they have a -0.2 correlation, according to haver analytics. that means they move in the opposite directions.

so, right off the bat, we know that we're in a world not covered by standard understandings of economic cause and effects. india and china's new middle classes will demand things, and get first dibs owing to their stronger currencies... that will make imports more expensive, and make some of our own home-grown products like food more expensive to us. we're no longer the driving force behind commodity prices.

over time, it will only move further in this direction. the emerging markets might very well continue to grow just as the US did 120 years ago. if that happens while our own economy is slowing and getting dragged down by debt, the dollar will continue to fall, hurting our purchasing power. (this is why in my previous entry, I urge the creation of a new non-oil economy that creates jobs for americans rather than filling arab pockets.)

so what's going on with oil? it's probably overvalued according to the traditional norms in the commodity markets, where worries about bottlenecks and shortages have typically controlled the market.
but let's think about oil from an equity investor's point of view: we already know this breed of investor will pay extremely high earnings multiples for companies like ISRG or RIMM because they have a very high confidence they will deliver on their growth. right now, all the evidence seems to point towards strong demand and relatively limited supplies of oil over the next several decades. in fact, it's pretty close to certain it will be in high demand.
we're starting to see oil priced according to the imagination of individual investors who see a world where oil remains in strong demand because new supplies become fewer and farther between. until that vision leaves their minds, these commodities could remain strong.
unlike the traditional commodities market, of which I know almost nothing, the buyer of stocks is a long-term holder. money in his ETF will get recycled from one futures contract to another. I would think this would dampen price moves for the spot price.

the stock investor knows that long term, oil HAS TO be worth more. sharon epperson on CNBC and others have been saying that there is a new kind of valuation being placed on oil. hedge funds seem to have discovered it back in early 2006, before it sold off. things like this may explain why someone like boone pickens changed his mind about oil, and why other experts have underestimated its strength. this trend will continue.
now that stock investors can buy commodities via ETFs, it's an entirely different world.

this use of oil as a long-term store of value seems to be real. I imagine it will remain between 100 anf 110 for several months before breaking out to the upside.

this also produce results that then push oil prices even higher... consider this:

last night on charlie rose, the president of shell warned that urban areas with lots of cars could suffer violence and unrest as people lash out against high gasoline prices. this guy clearly has an agenda, because he was trying to use the needs of american consumers to justify drilling in ANWR. so, he did have a vested interest in making that claim. but, it's still a pretty strong statement from a corporate executive.

after all, if you're a low income american with a family and a car, you will have a problem with surging prices and a slowing economy. this angst and frustration will play out in millions of homes across the country as people learn to do with less. of course, if social disruption occurs, it could probably trigger another bull run -- although at that point you wonder if the government wouldn't release some from the reserve.

so far, there aren't any documented cases of actual violence resulting from high oil prices this yet, but I did find a few cases of how it's having a negative effect...

a food pantry in WV http://wowktv.com/story.cfm?func=viewstory&storyid=36460

and reaction in wisconsin: http://www.lacrossetribune.com/articles/2008/03/25/news/01lead.txt

and angry police in ohio:
http://www.wtov9.com/news/15580934/detail.html

it's worth watching.

building the new apollo

I just saw the president of shell oil, John Hofmeister, on charlie rose.. he was one of the most interesting guests I've seen on the show. I liked him at first, but I found his low expectations for real alternate energy disappointing. at one point, he started whining about how it takes years to get wind turbines because of the huge over-demand in the industry.

this is the kind of foot-dragging, time-card punching corporate excuse-making has got to stop.

first of all, I have encountered many web sites where random hippies have built wind turbines in their spare time. for example: http://www.scoraigwind.com/CAT04/index.htm

it's really time to put something in perspective. does he really expect us to believe that when auto workers are being laid off across our industrial heartland, somehow he's not able to build a turbine? it's essentially a refinement of 19th century technology... our industries can easily produce wind turbines in great number. we're the country that went from making 3600 airplanes in 1940 to over 96,000 in 1944. this kind of hand ringing by an executive at shell is simply unacceptable. america has overcome much bigger obstacles than this before. if we kept russia and britain fighting during WWII, we can surely build some windmills.

here are some simple mathematic truths:
in 2007, shell paid $9bln in dividends and bought back $4.4bln of stock... that's $13.4bln given to investors.

COP paid back $3bln, CVX: 11bln, and XOM with a massive $39.3bln -- together these companies transferred $57bln of capital to their shareholders. these companies have A-AAA ratings, with vast financial resources... it's a bit pathetic for one of them to whine about a lack of wind mills when his buybacks and dividends totaled three quarters of the entire revenue at Boeing!

it's time for america to stop giving a pass to oil companies. they have profited for years from our public lands, our diplomacy and our trade negotiations. yes, they have a right to profit and reward their shareholders. and, their lobbying power makes them a pretty formidable adversary. it would be very hard doing anything direct like taxing these shareholder payments.

first, let us consider what they actually are: capital transfers. investors are essentially being told to pack it it, cash out their holdings and sell the shares.... what happens to the value? most likely, XOM will simply be a source of funds for years at its current pace. recently, it seems possible some of the money from selling XOM was used to cover losses in the credit market. that's a recipe for neither greatness nor stock rallies.

some of that capital -- that economic value, capable of mobilizing thousands of human beings and their resources -- will almost certainly leave the stock market over the next few years and may not come back. XOM is the largest member of the DJIA at a market cap of $455bln, towering over MSFT at $271bln and WMT at $212bln.

if the fed is willing to prop up bear stearns, why can't the government give a boost to stocks by cozying up to XOM?

how about instead of letting the oil firms just pay back shareholders, we find a way for them to keep their capital and build entirely new industries? after all, they have terrific expertise and can deploy resources in the US.

why not let them create new subsidiaries that can be spun off to shareholders in new transactions. why aren't we trying to ask the oil companies: how can we help you make your shareholders richer? that's the only thing they care about. why not ensure the best outcome by establishing targets: the fledging company needs xx in revenue, xx in profit .. and other targets. if they're met, you allow the oil companies to transfer xx billion in cash to the new companies. those new companies can then pay it as a tax free, or reduced tax, dividend. this would allow a cheaper transfer of wealth to shareholders while at the same time giving birth to new businesses and jobs.

we already know people are cashing out of the oil majors. what kind of executive is happy to see his shareholders as net sellers? it's kind of embarassing the market wanted to dump almost $40bln of our country's largest corporation last year. I don't have time to dig through its financials, but I don't think you can say the same thing about petrobras!

it says a lot about what's happening in the world right now where brazil's oil company is move loved than our own. they have new, booming reserves... we have some fields we've been pumping the last 100 years that now we're just letting run down and not replacing reserves.

the market knows about these issues and will continue to sell these stocks. as long as oil remains strong, they will edge higher. they're clearly lame compared to many other oil companies -- not just petrobras, also the great american name XTO. their stock is about to go parabolic and climb the wall higher.

getting back to XOM and the cash-oozing oil majors. I think we need to create a way for oil companies to develop and deploy new energy resources on a massive scale. say they kept about $10bln of their $50bln+ in shareholder payments, and created new ventures to produce wind mills, solar panels, concentrated solar arrays and geothermal on a massive scale. right now, there is a small company called Ormat that's profitably doing small amounts of geothermal electricity generation. I don't know why someone hasn't coughed up $1.8bln for them and scaled their technology to the rest of the continent.

many opportunities such as this exist. for example, First Solar, the largest solar panel operator, brought in just $500mln last year. just a few billion of those huge oil windfalls could spur entirely new businesses. some of them might create integrated consumer companies that install and service people's renewable energy needs. others will find ways to make home energy from food waste, etc.

say they put $10bln in into the new areas. have the law provide that one day they can spin off the company in a particularly advantageous way. maybe allow the new entity to emerge with a stash of cash that would be paid to shareholders in a TAX FREE dividend payment. this would allow XOM etc to return large amounts of capital to their investors at perhaps even better rates. and, it could be structured in a way to maximize the probability of success: companies would need a certain level of revenue, jobs, profitability, taxable income etc. a year or two after going public, and once they met the description of a healthy growth company, the parent oil company would have the right to transfer the cash to the child for distributions. this would immediate establish owners of these new companies.

that's might get Rex Tillerson's attention.

so, we should create a new legal concept: the society-improving start up. we say that if a business 1-helps cut carbon emissions 2-installs, makes solar wind etc, 3- etc, etc, ... then they qualify for being spun off under this new energy umbrella. that umbrella would be negotiated with oil firms and their lobbyists. it would keep capital in the US equity market and restore job growth. on top of that, we could create some large cap multinational industrials out of thin air. and, fast-growing non-oil companies would trade at much higher multiples than XOM and its peers do now.

here's some interesting background on why the oil majors will slowly fade away:
http://www.cnbc.com/id/23794175

2 other things to mention... the guy from shell did mention a huge potential factor in the world oil market: Iraq. this is something I have mentioned for years... iraq has the biggest and cheapest to produce oil fields in the world. there might be a law coming soon that would start to open it up to investment, but you have to think we would't see any big increases in production for several years, so it shouldn't matter to the oil markets -- yet.

another thing to watch, of course on oil, are PBR and XTO.

also on charlie rose, he had guests about how all these bats are dying in new york state. added to my worries about us running out of bees, this alarms me. I have heard more than a few investment experts saying we might have real food shortages in the world. it's time to get worried about our ailing wildlife. so far, the main ones to get hurt have the species that are useful to us...

Tuesday, March 18, 2008

where's the causation?

I am getting tired of economists and other bigwigs saying everything is going to be just hunky dory in the economy. one of the main lessons I learned from studying the sociologist max weber is that things have to be caused.. they don't just magically happen.

right now, I see few things lining up that are going to cause much of a recovery in the economy. everyone is hanging their hat on the idea of government stimulus -- almost like the government officials near the end of Atlas Shrugged, insisting that john galt will come to their rescue.

I prefer to borrow another weberian concept: that of unintended consequences. most economists and observers have generally said bailouts don't work. yes, the government can create a bubble, but I'm not aware of any instance in which politicians have managed to restore asset prices once they begin to collapse. at worst, I expect these various interventions will produce a series of negative unintended consequences. at best, they simply accomplish very little, but leave people with even less confidence.

house prices have begun a deflationary cycle. I think we should accelerated that process with swift interest rate increases that would bring the conclusion more rapidly. after all, it would flood the country with capital and slow the global economy. money would flee countries and assets that are attracting investor dollars. the long end of the yield curve would decline, restoring demand for spread-based instruments. it would also allow existing holdings to be repriced more quickly. this current hand-wringing about "nobody knows what anything is worth" only threatens to get worse the longer the government tries to prop things up. (of course raising rates would make some banks implode, but, of well.... )

even more important, it would slow the global economy. commodity prices would plunge and our knawing inflation problem would start to abate. that would make it easier for the Fed to lower interest rates later, triggering a completely new boom. and, it would be much more like the 1980s, based on low oil prices and solid confidence in the US currency and credit.

lawrence summers was just on charlie rose ... echoing things I heard all day on CNBC, he said the most important thing was to restore confidence in the market. I say: confidence needs to be earned. we earned the world's confidence by being the most transparent and honest economy in the world. we're not going to regain it by printing money, debasing the dollar or trying to prop up failing firms or home prices.

returning to causation, what's going to make the economy rebound? borrowing from a credit suisse report from neal soss, I see few things to cause such a change. let me cite a few things from soss, although to be fair, I must that his conclusions are more bullish than my own:

-only about 1/3 of the rebate checks will translate into consumer spending
-household discretionary purchases will be hurt by tighter credit conditions and falling real incomes (thanks to gasoline, etc prices)
-houses will continue to lose value

for the last 6-7 years, all we heard was that "the economy is great because consumers are spending"... now that they are going to spend a lot less, what's going to support the economy?

furthermore, this isn't the 1970s... one thing that definitely shouldn't worry us a wage-inflation cycle. in fact, times couldn't be more different from the 1970s. that decade followed a long process of increasing inclusion in the economic system, where more americans were draw into the workforce. the current system, coming after years of outsourcing and shifting jobs abroad, is the polar opposite of the 1970s. american companies have learned to grow without hiring americans. that's not going to just change. it's the new corporate culture.

also, no one is factoring in what a sad summer it's going to be for the millions of americans who will try to sell their homes starting in a few months when the key real estate season begins. last spring, conditions were weakening ... but this spring, we're going to be in full-scale collapse during the busiest time of the househunting season. this may cement into people's minds the bleakness of the housing problems and reduce people's ideas about their own permanent income, which would also be deleterious to consumer spending.

I see lots of things out there that can have causative effects.. but none are very positive:

-falling employment
-rising prices for food, energy and imports (stuff from china is going up 2-4% every month now)
-lower household wealth levels
-a corporate sector that's learned to grow without expanding in the USA

I also heard some worrying things from paul mcculley at pimco, who thinks the G-3 countries need to collaborate to "manage" the dollar's decline. this should worry any american with savings -- or, in fact, income ... he wants to see a nice, sane destruction of american's purchasing power and earnings. who cares if we wind up with unaffordable energy or food, as long as no feathers get ruffled in the process!?

Monday, March 17, 2008

alexander's boys

it's time to record an idea I've had for a while: an organization that will teach economic independence and sustainability, crossed with education...

I'd like to name this alexander's boys after alexander hamilton, who lifted himself from relative poverty to success with financial mastery..

it's simple: lease a store front or house in an inner city. invite kids who normally would be at risk of gang or criminal activities and sit them in front of computers with mock stock and currency trading accounts. have them trade using virtual funds, and use the organization's money to PAY the kids who do the best.

even though they know nothing about economics or companies, some of them will become successful traders. at a certain point, give them real money and share their profits 50-50 with the organization.

this entity could potentially be a school, or be set up as a philanthropy. alternately, it could be run completely as a for-profit private enterprise. after all, the biggest cost in any financial firm like this is salary... since you're starting off with teenagers with low education and skills, they'd be happy earning just a tiny fraction of what normal wall street professionals would make.

the labor laws would be an issue in this. perhaps it could be done better outside the USA.... but it would be an interesting dhando idea... small risk, but relatively high potential reward. who knows how many great potential traders currently live in muck on the streets of calcutta?

Saturday, March 15, 2008

no santa for the USD

sorry, USD ... there is no santa...

by this I mean, it's unlikely trichet will suddenly feel the need to cut rates when inflation remained above his target for the 12th straight month.

trichet thinks the risk to inflation remains to the upside... plus, this week's numbers exceeded the forecast, making me think they will remain strong. while many people are calling for a top in the euro, I just don't see how that's going to happen. their wages are going up along with prices ... this despite their consumer prices softened by weak-yuan imports .. if anything, their economy seems to be overheating.

it makes me ask whether europe is experiencing what we felt in the 1970s... an economy growing, yet facing several bottlenecks and running up against its own inherent inefficiencies.
they may be experiencing real "stagflation": 1.8% core cpi with 1.8% growth. that's pretty pitiful compared with the kind of numbers the US economy was generating until recently.

(italicized above, I said "real" because I don't think what we have in the USA is stagflation... we have devaluation. for proof, I point to the fact that the falling dollar, not surging wages, is fueling our inflation.)

for years, people have said europe needs to liberalize labor laws and allow more consolidation... one asks whether they might go through their own version of the reagan 80s, when taxes and regulation are eased, releasing an entirely new surge of economic growth ...

this may be the sequence:
-euro stagflation
-trichet tries to reenact volcker's legacy with high interest rates
-euro rallies
-european populations elect more pro-market politicians
-euro remains strong for years, and the zone enjoys a 10-25 year run like the 1982-2002 period for the US, with strong stock and bond markets.
-fitting into this entire cycle would be continued integration with the middle east

this scenario raises a question: will the dollar remain the global currency? I think a general basket of commodities and currencies are now replacing the dollar.. they seem the stablest store of value, and have attracted interest as the USD has weakened.

this situation may continue for several more years, given the strong demand for stuff like zinc, copper and wheat... and, the dollar still needs to get unhooked from all the little niches of official value such as commodity pricing and international trade agreements.

but commodities are not reliable enough as stores of value ... droughts and other events can effect their supply, so people will always need a fiat currency. the euro seems like a strong candidate to keep gaining importance ... it would probably be better picks than the yuan, rupee or yen...

one key thing will be its proximity to the hard-asset centers of the middle east, and its new role as the custodian of petro-money. furthermore, the euro is based on the solid old german central bank and represents what will probably be one of the world's top 2-3 economies.

so, it seem possible the euro will displace the dollar internationally ... maybe the visionaries of european integration -- who were all american! -- will finally achieve their vision of "another US". maybe one day the euro will have its own bubble just like the USD had five years ago!

Thursday, March 13, 2008

kamikazee approaching?

yes, I know everybody is used to seeing the yen over 100... I know it's always been that way and it will never change. but this time, it's different....

for the first time in many years, the US economy is doing worse than the rest of the world.. capital is fleeing the US and dollar assets ... over the past several years, when this entire credit bubble was forming, many of these assets were purchased using cheap money in the so-called yen carry trade... it was pretty simple: you had to pay less than 1% to borrow in yen, and could get many times higher than that in things like CDOs, subprime or simple corporate debt.

this works great as long as the purchased assets hold their value... and, as long as the yen stays weak.. but when the yen rallies, it increases the debt of the hedge funds owning those US assets -- like stocks and bonds.. so, they must sell their holdings and buy back the yen they previously sold.

the unwinding of the yen carry trade has been associated with stock market declines in the US for the past decade or so... it's a very real and directly connected indicator.

so, what happens if the yen goes on a sustained rally for its own reasons... just because it can?

this might sound a bit outlandish, but is entirely possible. as I write this around 530am GMT, the yen has been pushing against 100 for the last 5 hours or so. this is the strongest level since sometime around sept. 1995.

go back 25 years and it was around 240 ... its huge trade surplus and dollar holdings are still in place from that time.... I'm inclined to think the longer term trend towards yen strength may remain in force... we could be ready for another significant move... possibly down to the 80 level reached in july-aug 1995.

yes, its interest rates are low and its economy is weak. but when you consider our insterest rates are on course to approach theirs, it actually starts to make sense. they have the fundamentals on their side -- plus fear and momentum.

if this happens -- a strong USDJPY breakout -- the impact for US stocks would be negative once again.

it's not 2001 when the US was still feeling the euphoric rush of the greatest bull run in stock market history.. it's no longer the world where the US drives growth and controls the agenda. bigger things are happening and history will leave us behind.

people might say: markets don't think about things like that -- all they care about are the numbers.. but the only number that really matters comes from the Fed next week. maybe if they go to 2.25 we'll see that huge run on the dollar take shape ... or if we go to 2.50, we might get a short-term bounce...

overall, it doesn't really matter. the truth is that if we go into the kind of recession I envision, with significant consumption declines, the fed will end up cutting interest rates to BOJ-style levels... this time we'll be in a recession and much of the rest of the world won't be. that hasn't happened in a very long time -- probably not for a century.

so far, the dollar's decline has been orderly and rational. that's how many bubbles start: housing prices, US stocks in the 1990s, etc. all of these things behin with the safe and logical trade. then they gain momentum and more liqudity supports it. over time, the trend continues and, as more people rush into it, it assumes the bubble-like fever pitch.

my fear is we're entering this phase of the anti-dollar trade now. a new anti-dollar movement seems highly likely. with hundreds of billions of wealth and purchasing power being wiped out in housing and our country in recession, people will continue to win the bet against the dollar. all moves like this run their course ... we're nowhere near there yet.

the USDJPY kamikazee is honing in on our economy and our portfolios. does anyone other than me see it coming?

Wednesday, March 12, 2008

third worldism in america

while countries across latin america are starting to look increasingly developed, the US looks more and more like a third world country everyday.

imagine what it's like to look in on the USA from the outside...

we have a fragmented and unclear party system that could cast the democratic party into an historical rift before the one election they've been anxiously awaiting for the last 8 years.

who knows whether this will wind up in the courts, dragging the country through every kind of uncertainty and confusion....

next, I fear eliot spitzer will try to hang on to the governorship of New York state. I worry he will try to drag the whole thing out, hoping to defeat it legally.. again, the state could be locked up for months in an unproductive political fight over a bunch of personal affairs.. rather than real policy ...

I know this might be small... but for the same man who weilded such power over wall st and still runs the state that's home to the world's largest equity market is a bit worrisome. it's a bit backward and troublesome that such an important job could be so compromised. this does little to restore confidence in american governance or credibility -- at a time, of course, when the rest of the world is starting to question american standards of value more than ever...

in fact, bloomberg today reported that german CDS traded through the US levels. I am a bit loath to mention bloomberg because they can shoot for the sensational... but this comes after moody's mentioned long-term problems with the USA's AAA ratings... I know it's very very early to talk about something like this, but once a company or issuer does something to raise credit worries, it doesn't go away.. when it's voluntary, it's always worse ... just ask any bondholder who bought the debt of home depot or clear channel.. unlike when something happens, like when the FDA pulled vioxx, when credit problems are avoidable, it means that the people running the show are thinking a certain way... they chose that behavior... and they'll choose it again.

we're not doing things like levering up to buyback shares -- or are we? we're using debt to drive up assets trading at a big discount .... the basic point is that american creditworthiness is going to start being drawn into question. not much yet, but it will start emerging as a theme in coming months and years.

one other similarity to the third has long bothered me about the US economy ... the large number of employees out who seem to be dropping out of the workforce ... that reflects another problem that has resulted from this pattern: government data is increasingly inaccurate and dismissed -- like the unemployment data. people have long known the numbers didn't tell the whole story...

interestingly, the same also goes for moody's and s&p and their formerly AAA ratings on many subprime issues ... all these things we once took for granted as givens are at risk of crumbling into a world of relativism and intransparency.. after all, the thing that always made the USA stronger than third world countries was the level of rights open to everyman. now, the official rules and meanings are increasingly irrelevant, giving a clear advantage to the powerful and connected ... whatever happened to the america that educated millions of GIs, launching them into the middle class and setting lose the greatest wave of wealth, social justice and change ever known? have we all grown so cynical we don't even care anymore?

Friday, March 7, 2008

the poor child of the double mandate

the more I think about the dollar, the more it worries me.

it's hard to think dispassionately about the one's country when doing financial analysis ... to question whether it's really worth what everyone thinks.

trying to avoid any kind of emotional feelings about the USA as my country, I can't help but see major problems.

first of all, the charts on most other currencies are extremely bullish, essentially mimicking the nasdaq before it broke out in 1996. look at this:
http://finance.yahoo.com/echarts?s=%5EIXIC#chart3:symbol=^ixic;range=19900301,19940303;charttype=line;crosshair=on;logscale=off;source=undefined


and then a currency like these:
http://finance.yahoo.com/echarts?s=%5EIXIC#chart3:symbol=^ixic;range=19900301,19940303;charttype=line;crosshair=on;logscale=off;source=undefined
http://finance.yahoo.com/echarts?s=fxy#chart1:symbol=fxy;range=1y;charttype=candlestick;crosshair=on;logscale=off;source=undefined
http://finance.yahoo.com/echarts?s=FXA#chart1:symbol=fxa;range=1y;charttype=candlestick;crosshair=on;logscale=off;source=undefined

I am saying all of these need to be bought. other currencies are breaking out -- the inverse of our ever ailing dollar index. the chart on the dollar index now looks about as bad as anything can... a fibonacci line from 6/2/02 to the 12/31/04 low form a perfect 37% retracement around 11/28/05...

fibonacci projects another 15% move down to the 62 area. a bad jobs report, plus by ol' eazer ben on march 18, could well send the dollar there in a hurry.

Monday, March 3, 2008

another man on the moon

one of the things that most established JFK as a visionary for the future was his ambtion to land a man on the moon. FDR electrified rural america and harnassed millions of gallons of water into massive power plants.

they had a concrete idea of the future and gave people a sense of striving for it...

america needs another message like that. instead of embracing everything that's wrong with the economy, why don't we think of ways to start building now what america needs to be in 20 years?

everyone knows we need to make real strides in protecting the environment... why doesn't someone just say: let's do it.. let's end our dependence on oil and coal for good. let's find a way to massively expand the amount of solar panels and windmills -- a new TVA plan...

I am daring america to think about committing to end all oil imports in 5-10 years. let us be the world leader in this key issue.

why not use government money to build concentrated solar installations to feed into the grid at select places across the sunbelt... why not then look to sell them in coming years? why not commission a study of how much land in the country's desert interior that could be used for solar power? there must be millions of square miles.... why not let the government have its own source of revenue making electricity? another TVA?

already, electric utilties, mainly coal-fired plants, account for 40% of c02 emissions. they will have to spend billions over the years. why not create a financial mechanism that allows them to profit from investing in solar, wind, wave and geothermal?

I am talking about a huge, ambitious plan... more details to come soon on the numbers...

then we need to start digesting this message: an end to ethanol... another terrible idea that must be eliminated.

Saturday, March 1, 2008

it could happen here

as we continue to march into the financial abyss, it's worth addressing one of the key questions that has been in the media lately: are we headed towards a stagflationary period like the 1970s...

my immediate answer is: no. in fact, a far better precedent stands for the situation we're now facing.. the Latin American debt crisis of the 1980s.

I've been aware of the parallel for many months now ... after articulating it in conversations and emails, it's time to make it official.

let's consider how it started ...

Latin American countries displayed years of steady growth after WWII as modern capitalist/corporate principles were adopted. the simple introduction of better transport, the spread of electricity and the concept of the modern integrated business all permitted 2-3 decades of relatively consistent economic progress ...

most international capital flows were confined to the likes of multilateral lenders like the IMF and World Bank. for years, Latin countries showed themselves to be safe credits.
that's parallel #1 with the present situation ... what credit is safer than the USA? and, in the USA, what was previously the safest thing other than treasuries? mortgages... "houses never decline in value." people had seen companies like Enron, WorldCom and RJR blow up, plus commercial real estate in the previous credit crunch. but residential was never considered very risky because it was tied to "good collateral."

now, what happens when something has the precedent of being safe, and then you add a wave of liquidity? money rushes into the ultra-safe investments, causing a massive credit bubble.

how does this unfold? "official lenders" like the IMF and governments established Latin America as credits in the 1950s and 1960s, commercial banks stepped up to the plate in the 1970s. swimming in petro-dollars, they started lending and accounted for the vast majority of latin america's external debt by the early 1980s.

essentially, it went from a government-sanctioned, quasi-socialist form of lending to an aggressively capitalist and profiteering model. banks are far more prone to compete with each other by easing terms and offering larger amounts of leverage. just as automakers try to win business with unnecessary bells and whistles, wall street inevitably cooks up every form of financial novelty to win business when the bubble is forming. as a result, they continued lending to latin america long after it made sense.. after all, when something works for a long time, no one wants to stop. how can a CEO look shareholders in the eye when he walks away from a business that's still going good?

instead of the IMF, the US has Fannie Mae and Freddie Mac. they trace their origins to the 1930s, when the New Deal promoted home ownership and car-based exurban sprawl as a way to stimulate demand for everything from carpentry to crude oil. much like the IMF, they were originally government owned ... and for their first 30 years, they more or less controlled the secondary mortgage market -- just like the IMF and world bank owned the market for developing-country finance for decades before the banks get involved.

in our current situation, what Fannie and Freddie created, Mssrs. Mozilo, CDO, ABS and SIV made into a bubble.

the stamp of official/government sponsorship on a cerain asset class over a period of decades preceded both the Latin American debt crisis and our current housing meltdown. parallel #2

so far, we have only the seem that both the US and Latin America shared the same ground work. but mere than just creditworthiness are needed to make a bubble.

the key determining factor: a liquidity boom. ... parallel #3 the first time, it was petrodollars. this time, it started with asian export earnings and was beefed up with a surge of arab oil money filtered through london banks in the last 3-4 years.

and ever since the reagan years: an ever-widening trade deficit... parallel #4 ... our country's trade imbalance lasted a lot longer than latin america's because of its relevance in the world -- the biggest economy and anchor of the global financial system. but it still must reverse (and is starting to do so... but is a very painful process measured by in per capita income and standard of living.)

if that weren't enough, we're also following the Latin precedent with parallel #5: capital flight

between 1981 and 1982, mexico's private sector moved more than $20bln of assets outside their country. at the same time, the peso lost 80% of its value. (source: p 8-9
http://www.columbia.edu/~ad245/theberge.pdf )

fast forward 25 years and go one country to the north: last year out americans bought a net $223bln of foreign stocks and bonds -- approximately a threefold increase from 2004.

the dollar has fallen through the floor and is headed for new lows ... with ben bernanke taking up residence on easy street there's no reason to buy dollar assets now. money globally will avoid it like the plauge -- exactly the same way the world scoffed at latin paper 25 years ago.

a closely related item, parallel 6: were institutional shifts allowing capital to move more freely from "official standard assets" to other stores of value. countries like chile and argentina loosened restrictions on actions like repratriating profits in the 1970s, making it easier for money to leave the countries. in countries like venezuela, people opened US banking accounts and shifted their savings offshore.

this sort of thing was only a garden hose compared to the river of money that could flow from the ETF movement. capital is pouring into things like coal (KOL), gold (GLD), silver (SLV), agricultural commodities (DBA), euros (FXE), yen (FXY). people will come to realize we're not just suffering a downturn, but a genuine economic dislocation. that will cause a rush for these assets and ruin the dollar. (after all, when people buy commodities, they are selling dollars)
just as latin americans shifted from their accepted standards of value (their own currencies) in into dollars in the 1980s, wisdom tree and iShares are now shifting retirement savings into the new standard of value: hard assets. ETFs may uncork a completely new and unknown genie ... it was credited with the rally in gold starting in 2004

the next question then becomes whether the government will do anything about it? I suspect that if they do get involved, it would only come after years of impoverishment and runaway inflation.

when they write the history books, they will say it was subprime that brought down the american giant and ushered in the new global era. subprime will have its own chapter, standing alongside the panic of 1907, both world wars, the abandonment of bretton woods and volcker's triumph over inflation.

that brings us to to the most unduring similarity of of all.. parallel #7: devaluation.. the dollar index is down 10-15% in the last 12 months and looks ready to make another move lower...

Latin America circa 1982 vs the USA right now:

1- a government-sponsored benefactor makes a certain kind of risk safe ...
2- allowing a market to form around it....
3- separately, an exogenous wave of liquidity forms and seeks a home in this new, safe asset ...
4- a trade deficit develops (the inverse of the old capital account surpluses)
5- as the bubble bursts, interest rate differentials and capital flight occur...
6- an industry facilitates the capital flight, accelerating the trend ...
7- devaluation...

so, can it happen here?

a $10 slice of pizza, a $12 gallon of gas? at first inflation seems like a small thing..

$50 slice of pizza, $60 gas ... then it becomes scary

$200 pizza ... and eventually comical.

... I started as a journalist in Venezuela in 1999, and learned economics from men whose country was ravaged by financial mismanagement... while we're unlikely to repeat the stupidity of policies like multiple exchange rates, gentle ben is now playing much the same role as central bankers in latin america 25 years ago... yes, the differences between bolivia then and the USA now are obviously great. yes, we have the institutions and the reputation. it's easy to say "it will never happen here."

that makes me think of a parable I heard from several people in latin america. it seems to have been a common perception of the period: if you throw a frog into a pot of boiling water, it will immediately jump out and survive. but if you put the frog in the water first and THEN turn on the heat, it never becomes aware of the danger and winds up cooked solid....

the similarities are ever more glaring ...


IT COULD HAPPEN HERE