Commentaries

from Rolfe Winkler:

Rickards: You can’t print your way out of debt

Reader note: This is Jim's second piece in an ongoing debate with Warren Mosler about the economy. Here are links to previous posts in the series: Writer biographies / Mosler #1 / Rickards #1 / Mosler #2.  There will be one more post from each writer.

by James Rickards

Before I lay siege to Warren Mosler's remedies, let me say he's a brilliant guy I've admired for 25 years going back to his days at AVM.  I got reacquainted in 2004 when I lived in St. Croix and Warren ran for Congress from the Virgin Islands.  His campaign ads were 5-minute infomercials; tutorials on economics and gems of sound fiscal advice.  But this is a debate, so let's begin.

Warren makes eleven points and I agree with two - the elimination of payroll taxes and converting banks into utilities.  Payroll tax elimination spurs consumption and stimulates job creation. As for banks, we need them, we just don't need casinos that call themselves banks.  Bring back Glass-Steagall, separate deposit and loan functions from proprietary trading and banish the latter to hedge funds.  Speculation should survive on its own dime.

I don't need to take the rest point-by-point because they're the same thing - an unlimited belief in the Fed's power to print money.  Warren calls for a $500 per capita state rebate, a federal job for all takers, direct Treasury funding of housing, unlimited deposit insurance, no debt ceiling, Treasury overdrafts at the Fed and federal purchase of foreclosed homes. He doesn't propose free ice cream for children but I don't see why not; just print some money and go for it!

Warren's program would work if the world had as much faith in the dollar as he does.  But it doesn't, and neither do the American people. If we were all captives of a government dollar monopoly with no alternative, then maybe his plan would work for awhile.  But we do have alternatives in land, art, commodities and the oldest form of money - gold.  It's no coincidence that when FDR debased the dollar in 1934 he simultaneously banned private ownership of gold.  He knew citizens would hoard gold when he trashed the dollar so he made that illegal.  One of Reagan's lasting gifts to the American people was a law in 1985 which made U.S. mint gold coins available to average citizens.  Now when the Fed cranks up the printing presses, citizens have a choice.  Foreign central banks have the same choice in terms of gold bullion and commodities such as oil and copper which serve as stores of value and industrial inputs.

Here's where complexity theory comes in.   Each citizen, company and central bank is an interdependent agent with a threshold for dollar rejection based on the thresholds of others.  Some will not flee the dollar unless many others go first.  But some have already bought gold and others are on a hair trigger.  What does the complete system look like? Are we in the critical state where a small shift brings the entire edifice crashing down - the tipping point? It's impossible to say, but we're certainly closer than ever.  Warren's cavalier approach to printing money as the cure for all ills guarantees the greatest disease of all - destruction of the dollar.

from Rolfe Winkler:

Evening Links 12-6

(Reader note: One bug we're still trying to work out is that links in the top line of a post aren't "hot" in the front-page view of the blog. If you click "continue reading" the link is available)

The FBI agent inside the Galleon case (Goldstein, Reuters) More great work from Matt.

MIT team wins DARPA red balloon challenge (darpa.mil) But how did they do it?

Requiem for the dollar (James Grant, WSJ) A fun (and frustrating) piece to read. Grant is a good writer, but he throws provocative comments around without explaining them. He says we need to collateralize the dollar, presumably with gold, but acknowledges early in the article that the gold standard was far from perfect: "The lifespan of no monetary system since 1880 has been more than 30 or 40 years, including that of my beloved classical gold standard..." No doubt he has ideas to improve his "beloved" standard, and that would be useful to read. Too bad he doesn't go into it.

Bair weighs loan principal cuts to fight foreclosure (Vekshin, Bloomberg) Writing off principal is the opposite of extend and pretend. But if Bair wants to pay for it using the Deposit Insurance Fund, she'll have to stay aggressive with assessing insurance premiums on banks.

Amazon in secret plan to open high street shops (Davey, Times UK) Some brick and mortar for Amazon? Update: Amazon says "no plans" for physical stores. A non-denial denial...

The gambler who blew $127 million (Berzon, WSJ) "During a year-long gambling binge at the Caesars Palace and Rio casinos in 2007, Terrance Watanabe managed to lose nearly $127 million. The run is believed to be one of the biggest losing streaks by an individual in Las Vegas history."

Euro at $1.50 — a disaster or an alibi?

The French can never resist blaming a strong currency for their misfortunes. So it should come as no surprise that Henri Guaino, President Nicolas Sarkozy’s influential political adviser, has said that having the euro at $1.50 is “a disaster for European industry and the economy”. Since the euro stood at just above $1.49 as he spoke on Tuesday, Guaino presumably sees the single currency area as on the edge of the abyss. 

This is manifest nonsense. European exports to the rest of the world, including the dollar zone, were booming in mid-2008 when the euro stood at just short of $1.60. The euro area had a trade surplus with the United States at the time. The steep slide in exports over the last 15 months has been due to a collapse in demand, even though the euro fell as low as $1.25.

A strong currency is not necessarily an economic handicap. West Germany’s export-fuelled post-war economic miracle was built on the foundation of a strong deutschemark.

A strong euro has kept the prices of imported commodities and energy under control and thus helped moderate inflation. That in turn enables the European Central Bank to keep interest rates low, benefiting industry.

Guaino forecast that the European currency’s against strength would become unbearable and Europe would have to react, most likely by printing euros, which would lead to inflation. That too seems improbable. If it were really worried by a strong euro, the European Central Bank could start by cutting interest rates, which are stuck at 1 percent — higher than U.S. or British levels. It could also intervene on currency markets, alone or in concert with other central banks, to buy dollars.

The ECB and other central banks intervened jointly in 2000 to stop the fall of the euro. The action was successful, putting a floor under the European unit. There has been no equivalent joint action in history to try to halt the dollar’s slide. But barring a disorderly dollar rout, which would not be in U.S. interests either, that may not be necessary.

Guaino should ask his countryman Yves-Thibault de Silguy, who was the European Economic and Monetary Affairs Commissioner at the time of the euro’s launch and is now CEO of French construction multinational Vinci. The company does 90 percent of its business in the euro area. So like most other big European corporations, it is relatively little exposed to dollar risk. Vinci has been using the strong euro as an opportunity to buy assets outside Euroland, notably in Britain — not because business is good (it’s lousy) but because assets are cheap and he can buy market share and prepare for future growth.

Dow hits 10K

OK, it’s finally happened so hopefully talking heads can stop obssessing about this magic number. Traders in the more esoteric spaces, like non-agency mortgage bonds, are even feeling the love. We get another round of bank earnings tomorrow, including Goldman Sachs, which if they’re anything like JP Morgan, could ignite even more euphoria in markets.

Still, the Dow needs to close above 10K for everyone to truly feel like the good times are finally here to stay. While it pierced 10K, it’s since bounced lower.

I’m still not sure I buy that any of this really matters in the grand scheme of things since it’s all coming due to the artificial support of government money. Free markets indeed.  That said, it’s sure to bolster confidence and if the U.S. economy is lucky, that will be enough to keep things on stable footing. Then again, there’s that thing called the dollar that also hit another 14-month low again today.

For those who love historical stats, here’s some from S&P’s Howard Silverblatt.

March 29, 1999  first time the DJIA closed above 10,000 (10,006.78), then crossed the 11,000 on April 5, 1999 (11,014.19; 24 trading days)

October 3, 2008 last time the DJIA closed above 10,000 (10,325.38), dropped 18.15% over the next 5 days (all down)

The DJIA set a high on October 9, 2007 at 14,164.53, the same day the S&P did at 1565.15; the NASD high close was on March 27, 2000 at 4704.73

Kohn on V-shapes, housing, inflation and a whole lot more

Donald Kohn, the Fed’s number 2, has a lot to say about the economic outlook but not a whole lot new in terms of when the central bank will reverse course on its extraordinary easy monetary policy. Full speech at the National Association for Business Economics in St. Louis can be found here.

Some choice bits:

I don’t think a V-shaped recovery is the most likely outcome this time around.

I’m not sure the stock market and credit markets agree, but they might come around to his way of thinking eventually.

The demand for U.S. exports has been increasing lately after falling sharply in the first half of the year. However, with the firming of domestic demand, imports have also begun to increase, and, on net, the external sector appears to be a roughly neutral influence on overall economic activity at present.

There’s been lots of talk about a weak dollar feeding an export-led recovery, but it doesn’t look like it’s weak enough just yet.

And here’s my favorite on the recovery in the housing market. Emphasis mine.

Don’t worry about the weak dollar

By John M. Berry

There’s no way to shut off the incessant warnings about a weak dollar from foreign officials and some economists, but it’s perfectly safe to ignore them.

You can also yawn the next time Treasury Secretary Timothy Geithner repeats the mantra, “It is very important to the United States that we continue to have a strong dollar.”

Everybody is blowing smoke. (more…)

Carrying the dollar lower

There’s been lots of hand wringing over the fate of the dollar, with its recent slide giving rise to, in the words of blogger Macroman, the “dollar going down forever” crowd. Data released from the U.S. Treasury on foreign capital flows didn’t help matters. Seems in July foreign investors wanted to put their funds elsewhere.

Lots of ink has already been spilled on the well worn arguments that blame reckless borrowing by the US government and the growing movement toward establishing an alternative world currency as the drivers behind the dollar’s decline.

The latest theory gaining traction is the dollar is becoming the funding currency of choice. It’s a compelling case that the FT lays out nicely. It also fits snuggly into the “US. is becoming Japan” school of thought.

Analysts say negligible US interest rates, its quantitative easing measures and little sign that the country is set to withdraw from its ultra-loose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.

“This puts the dollar in exactly the same position as the yen back in 2001 and makes it naturally attractive as a carry trade funding currency,” says Simon Derrick at Bank of New York Mellon. “The dollar is the new yen.”

The carry trade strategy, in which low-yielding currencies are sold to finance the purchase of riskier, higher-yielding assets, was widely used in the years prior to the eruption of the financial crisis.

But then again, it’s nearly impossible to prove how much this is driving the currency.

“It’s notoriously hard to find real data to determine the size of carry trades funded out of any currency, let alone the dollar. Hence, it has to remain the subject of conjecture,” he says. “Nonetheless, we feel that it is advisable to assume that this funding switch is happening.”

Macroman throws in his 2 cents here, and notes that the recent declines most likely have to do with foreign central banks cutting back on their dollar stocks that they built up over the last year. (China and Japan, however, added big to their US asset stock pile in July).

Love affair with FX reserves

The post-crisis world order is starting to look distressingly similar to the old one.

Swollen foreign-exchange holdings helped set the stage for the meltdown by suppressing interest rates and boosting mortgage lending in the United States.

Now those reserves are back on the rise. Stockpiles of hard currency recently topped their pre-crisis peak to reach $7 trillion. And China, the undisputed champion of currency hoarders, has passed the $2 trillion mark, up almost 20 percent in the last 12 months.

Reserve accumulation can be added to the list of bad habits that countries failed to wean themselves off during the crisis. Unless this trend is controlled, it will increase the risk of aftershocks.

Of course, the surge in reserves comes as a relief to rich nations — especially the United States — as they attempt to sell record volumes of government bonds to investors. For much of the past eight years, foreign central banks were the most loyal clients of the U.S. Treasury. After a brief hiatus, they are once again likely to scoop up a big share of new government bonds. Since the post-crisis low for reserves in March, central banks have bought nearly $500 billion of hard currency. Traditionally, about two thirds flows into dollars.

Developing nations, too, should be more in love with reserves than ever. Flows of capital back into emerging countries threaten to push up their currencies and undermine their exporters at the worst possible moment. Siphoning that capital to the central bank is a good way of avoiding the problem. In addition, the financial crisis offered a powerful demonstration of the value of reserves. For example, Russia’s foreign exchange arsenal allowed it to avert financial catastrophe, stabilizing financial markets and rescuing the banking system. Russia burned through a quarter of its stockpile in a matter of weeks, causing many to recognize just how big reserves need to be in a crisis.

Ultimately, however, such massive reserve building is costly and risky, both for the holder and for the financial system. At the most basic level the trend separates financial markets from economic reality.

Stiglitz not to be outdone by Pimco, Buffett

The future of the dollar has been all the rage this week as Warren Buffett and Pimco portfolio manager Curtis Mewbourne chimed in about its demise as a store of value. It somehow seems appropriate then that Joseph Stiglitz, the Nobel Prize-winning economist who is no stranger to the debate, would weigh in on the need for a new reserve currency at a conference in Bangkok.

From the Reuters article:

A new global reserve system is needed after the global financial crisis exposed the U.S. dollar-based system as flawed and risky, Nobel Prize-winning economist Joseph Stiglitz said on Friday.The “dollar now is yielding almost zero return,” Stiglitz said in a speech at the United Nations regional headquarters in Bangkok. “The current global reserve system is fraying. It’s falling apart. The issue isn’t whether we go to a new system. The question is do we do so in an orderly or disorderly way.”

The build up of the U.S. deficit, debt and “the boiling up of the balance sheet” is cause for anxiety, he said.

But then again, Stiglitz has been calling for such a system at least since 2006. Here he is in an op-ed from the New York Times:

Underlying the current imbalances are fundamental structural problems with the global reserve system. John Maynard Keynes called attention to these problems three-quarters of a century ago. His ideas on how to reform the global monetary system, including creating a new reserve system based on a new international currency, can, with a little work, be adapted to today’s economy. Until we attack the structural problems, the world is likely to continue to be plagued by imbalances that threaten the financial stability and economic well-being of us all.

Stiglitz also headed a UN panel that earlier this year that championed the idea.

As long the dollar continues to slide, looks like this is going to be a theme that keeps on giving even though most in the foreign exchange market think an alternate to the buck as the reserve currency of choice is decades away if it happens at all.

Getting ready for the dollar’s fall

It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to world.

Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.

But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.

Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.

“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.