Tuesday, August 25, 2009

The $US - Some Musings...

I made an error just under a year ago, in predicting an early collapse of the $US; I predicted a collapse by April of this year. When the collapse failed to materialise I was forced to look at my model of the world, and explain why I had been wrong. Up to that point, my model had been reliable, and had managed to explain what was taking place in the world economy. Having been wrong before, I will this time discuss the $US in terms of 'musings' on the future.

My conclusion on reflection of the erroneous prediction was not that I was wrong about the underlying weakness of the $US, but that I had been wrong about difficult it would be to shift perceptions about the $US in world markets. I had written an article titled "The Myth of the Eternal Status of the $US as 'the' Reserve Currency", and still stand by the discussion laid out in this article. Reserve status can only protect a currency for so long when the fundamental poor state of the economy is apparent.

As an explanation for the error of the prediction for the collapse, I adapted Dan Ariely's anchor price theory, and therefore accepted that it would be difficult to shake the 'faith' in the $US. Putting the argument in simplistic terms, the belief is that because the US economy has always been a success, it is difficult to shift market perceptions to see the US economy as it is now. Quite simply, markets are valuing the $US on past performance of the US economy, not on the performance now. People have blind faith that somehow the US must recover the economic crown that it has worn for so long.

The US government is now intent on testing that faith to the limits, and the cracks are starting to appear in the faith. The bond markets are now appearing to shift:

Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.

Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month’s data. In May, China increased its holdings by $38 billion, according to the Treasury figures.

Nonetheless, the decline highlighted a fact shown in the accompanying graphics: Asia’s appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits.

The article is right to point out that one month's figures are not enough to be meaningful, but the figures will no doubt spook the market to some degree. The worry about the Federal Reserve's purchase of treasuries with printed money is already raising concerns, and the possibility of a $US rout is being discussed in the mainstream media:

Mr. Buffett worries that U.S. policy makers will fail to move decisively to curtail the nation's ballooning net debt, expected by some to rise to more than 75% of annual economic output by 2013. Instead, policy makers might tolerate higher inflation, which makes existing debt more manageable but would hurt the U.S.'s creditors, including China and Japan. In this scenario, investors would demand much higher interest when lending to the U.S. government, raising its borrowing costs and making further budget deficits harder to finance, at a time when an aging population will sharply boost the costs of Social Security and government-sponsored health care.

Doubts about the dollar are building while investors are growing comfortable with the idea of emerging economies like China, Russia, and Brazil playing a bigger role in shaping international finance. Some analysts, including Pimco portfolio manager Curtis Mewbourne, say emerging economies have an opportunity to use the crisis to reduce their reliance on the U.S. dollar, which tends to account for most of their foreign-exchange reserves.

It now appears that, with a rising savings rate in the US, the individual US investors are starting to take up some of the slack. This might be seen as a positive but, whatever happens, there still needs to be an influx of money from outside the US economy, if the US economy is to continue on the current path. In particular, the US is still running a current account deficit, and the only way to fund such a deficit is through overseas borrowing or further printing of money. Furthermore, the question remains as to whether the US savers have the resource to step into the breach in the event of an overseas exit, and whether they will continue to fund the deficits if the $US starts a dramatic fall.

Then there is the matter of yields. In the event of a shortfall in overseas purchase of US debt, can savers step up to the plate to an extent that they might hold yields down, or will they demand risk premia based upon a declining $US?

Whichever way you look, the prospects for the $US do not look good. Most importantly, the printing of money by the Federal Reserve to purchase treasuries is setting up a feedback loop; the higher the volume of purchases, the less the confidence in treasuries, and the more that the Federal Reserve must buy. It is very difficult to see how it might be possible to climb off the quantitative easing treadmill once the process has been started, in particular in the case where the policy is used to monetize government debt. Then there is the question of political influence.....with governments on a spending spree, with promises of sunny days in the future, no plan for deficit reduction, the pressure on the Fed to continue purchases will be high.

I learned my lesson before about naming a date for the $US to collapse. I am also not so sure now that a sudden collapse will be the outcome, but this is still possible/likely. It seems possible that the process might be a more steady decline, including moments of recovery, but with a declining trend. In all cases, the $US must, one way or another, decline in value relative to other currencies.

However, having said this, which currencies might the $US decline against? For example, the fundamentals underpinning sterling are perhaps weaker than the $US. The Euro area has its troubles, as does Japan. I argued before in TFR magazine that there would be a period of volatility, as investors flee in and out of different risks. I will admit that I have no clear answer to this question, and it is head spinning material trying to work out how a $US decline might play out globally. As simple example, what of the petro economies? How might a $US decline impact upon these states, and how will that impact upon oil prices. The $US remains so central to the world economic system, it is impossible to untangle how it might decline relative to other currencies, with further complications being caused by the state of the economic situation in the other major currencies.

Quite simply, the question that arises is how the world economy might pull itself out from the domination of the $US? It is a question on which fortunes will be lost, and fortunes will be made. It is a question of timing and a question of process, but the underlying problems will eventually make themselves felt, in one way or another. The $US is on the slide, and it is unlikely that the slide might now be reversed....the doubts are now cracking the walls of belief and, without 'belief', the $US has little left to support it.


  1. One of the tragedies of dementia in the aged, is that those close to the person neither recognise nor understand that the person they have known for so long, has begun to change, and is in fact becoming very ill. All too often it is only after some kind of disaster or breakdown in relationships that the realisation dawns, and even then they cannot bring themselves to accept that the person they know has gone, although the body exists. It is part of the human condition. The dollar now is no longer the dollar that has been, and the longer markets fail to understand, the greater the problems are likely to be.

  2. On most of the blogs I peruse nowadays everyone is scratching their heads how things have kept up so long, and I think you were not the only one at that time coming to the same conclusions about the $US.

    So I wouldn't say it was a bad call, just you underestimated how the mass psychology and the lengths TPTB would go to to restore confidence could keep it running on fumes while all the fundamentals show it should be headed to the rocks.

    In my view, and others, the governments knew they had to shore up confidence in their economy in the hope they could repair the damage they had let happen. (or till the next election) I think it was enviable that they brought out the big guns to defend the dollar.

    So they brought in the cheer-leading squad of the MSM and "experts", lied about the depth and scale of the crisis, and manipulated the markets any way they could.

    The cheer-leading can be seen any time you watch the news or read a newspaper online or off. This is normal and to be expected, if you read the news from the Great Depression, they where proclaiming "good news everybody!" all the way down, but since march the every things ok crowd have been more strident, ignoring every bad news or turning it into good (a bit less terrible a decline is the new double plus good) and focusing on the bubble forming in the stock market built up on QE and computer algos and good old fashioned delusion (the P/E rating was recently calculated by one measure as 150 which is way way out of normality)

    The lies and distortions keep getting found out - how may times recently has a figure been "revised" to show that things were worse than we were told, and the new figure slipped out when everybody has forgotten the way they lauded the less bad than expected figure?

    Also how many economic measures have they adjusted that have made the harder to get a true picture, and how many times has an older standard been highlighted if it paints a certain picture?

    The manipulations and interventions in the economy have been either been open like QE but often under-reported or slanted to one viewpoint with scant regard to the possible consequences, or covert, more difficult to prove so really can only be speculated on, so I will not bring them up here, as they are best left to the blogs like zerohedge that have uncovered them and have a large group of technical minds that can dissect them. If you want to read about High frequency trading, flash trading, dark pools, Fed monetisation of the treasury auctions via proxies, bank hiding real state of solvency, and numerous other scams, its well worth a read. Not all those problems will apply to the UK of course, but as both the governments and banks seem to be in similar situations, and the solutions of both very close, then I would not be surprised if similar things were going on.

    With regards to what you said about treasuries, have you seen the graph in this link? (or elsewhere)


    Notice how Corporate bonds and Government Agencies have plummeted down while Treasuries have really only recovered to close to what they where before the crash. So the big red line showing how much foreign demand there is for all US government items has really taken a big hit and kept on falling in this "recovery"

    There are plenty of other examples (look into FDIC running out of money and having to start using its reserves, and the number of bank failures to date this year and possibilities of many more failures as a good example) that show just how fragile the US really is, and the UK may possibly have less corruption, but just as fragile to the real economy.
    If you look at the housing, unemployment, manufacturing and business sectors (ie anywhere else that isn't having shovelfuls of free cash thrown at it, you can see behind the statistics a grim picture that is only getting worse more slowly, and will defiantly get worse as the real economy gets dragged down.

    Was a bit of a rant, but nm. In short, I agree with you :)

  3. As an addendum to what I wrote above.

    I knew that it wouldn't take that much digging to find dirt on Englands green and unpleasant land, but don't have the time atm to search it out with all the attention on the USA the UK's dirt I knew might get buried amongst the sh1t there.

    But is nice to find a prime example of the corruption in these isles shortly after talking about it. Saves me the trouble of searching out the crap.


    I think this makes the case better than I can.

    Its all a confidence scam and the only winners are the ones in charge.

  4. With regards to your prediction, and with the greatest respect for your ability to focus and elucidate in micro, what you failed to do was to recognise how much kinetic energy resides in the dollar - that is to say, not the paper dollar, but everything that paper dollar represents. That dollar represents a cargo ship that takes 1000 nautical miles to reach top speed, and a further 500 nautical miles to reach a halt. The cargo on board includes all sorts of strategic aliances and interconnections, not to mention hard to quantify perceived and actual wealth.

    I watched 'The Wrestler' the other night - a great film, but also a fantastic allegorical portrait of the condition of America... At least thats the way I read it. What happens when Mickey Rourke jumps off the ropes at the end? Is it the end of the empire or the fading light of a champion who's domain was the 1980's?

    My guess is, as it always has been - the slow degeneration of the dollar. Unless something happens out of left-field which causes global instability, like swine flu mutation etc. Doesn't make for blog-drama, but there's plenty of room for entertaining and incisive commentary! ;)

  5. I agree with Red. The dollar isn't the Berlin Wall of our time. Perhaps, the US is on a downward trajectory similar to the Holy Roman Empire.

    It's not in the interest of those who have the whip hand to facilitate a swift and momentous collapse sufficient to make the Bloomberg channel compelling viewing again. More a long dwindling, dull as ditchwater, allowing more than enough time for supranational interests to align themselves with the new global realities.

  6. I guess the discussion has run a bit dry, with the recession being over and all that (I jest). Until the tectonic plates start to shift again, could I ask a couple of questions?

    Mark, what are your views on inherited wealth? Socialists don't like the idea for obvious reasons, and I would guess that a true free market disciple would also dislike it as something that encourages idleness and kills enterprise. If inheritance of wealth were to be banned it is obvious what would happen to a person's accumulated wealth under socialism, but who should get it under a free market system?

    A related question stems from some of your earlier Cynicus Politicus pieces about the welfare state, and the recent hoo-hah in the US concerning universal health care. Do you believe that the average individual should never be allowed to feel 'secure' in life i.e. there should always a level of fear and desperation in order to spur one on to produce more and more wealth? Can the free market exist only on a basis of 'carrot' or must there always be some 'stick' too? My own guess is that by removing the fear in life it gives people the space to come up with all the frivolous ideas that are later developed into true wealth, but that desperate people in other parts of the world are needed to make the stuff and mine the materials. If you have the misfortune to be born in the desperate half you're probably condemned to stay there forever...


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