One of the funny things about slow motion train wrecks in the financial arena is that even when they are painfully obvious, they can be so long in coming that the Cassandras come to look like idiots, or worse, throw in the towel.
Remember the dot com era. Anyone with an iota of common sense knew that companies with no earnings, and no even remotely feasible prospect of positive cash flow could not survive in the long run. Yet so many formerly sensible people were seduced by the New Economy model, and in particular, by the spectacle of instant wealth via multi-billion-dollar IPO valuations, that the nay-sayers looked like dinosaurs, until they were proven right.
One train wreck in motion that no one wants to discuss is the coming end of the dollar hegemony. Mind you, this wouldn’t be a given if America was prepared to address its chronic current account deficit, which means increasing its savings rate, which means lowering consumption….which for some reason is anathema.
We have commented before on this blog that our trading partners, even the ones like China that benefit from our profligate consumption, are getting tired of buying dollars. From their perspective, they aren’t simply funding our current purchases. They are also funding all of our past purchases, and the cumulative cost is starting to look too high. China and Saudi Arabia have both announced they intend to diversify their reserve currency holdings away from dollars. That means they will sell dollars to buy other currencies, further depressing the value of the dollar.
Why is this bad? It isn’t just that our imports become more expensive and we get an uptick in our inflation rate. If the dollar falls far enough, our trading partners will no longer allow us to fund in our currency. Running large current account deficits won’t be pretty if we can no longer simply issue bad checks, um, more dollars, to pay for them. It’s another sign of America falling into banana republic practices. Banana republics debase their currencies. And having the reserve is a powerful economic advantage, not to be thrown away. But nevertheless, that appears to be what we are doing.
The market seers point to the near term consequences of the trashing of the dollar, namely, inflation. As Barry Ritholtz informs us, QB Partners, a hedge fund, has looked at the situation facing Bernanke, whether to lower or raise interest rates, and tells us he has no choice. First, despite what the Fed and popular press says, the US already has a high rate of inflation (it hasn’t yet turned into wage push inflation at anything below the CEO level because workers have no bargaining power) and the Fed will decide to prop up asset prices rather than the dollar.
From Barry Ritholtz via Seeking Alpha:
This week’s Up and Down Wall Street looks at a recent analysis out of QB Partners. It is a hedge fund run by Lee Quaintance and Paul Brodsky.
QB put together an analysis of the U.S. dollar, and why its ongoing weakness is both significant and ongoing. In their analysis they see the buck ultimately ending its run as the world’s reserve currency.
The heart of the analysis is the quandary left for the current Fed chairman Ben Bernake by new PIMCO flack and former Fed Chair Alan Greenspan.
Poor Ben is confronted with a long term Hobson’s choice: tighten the monetary and credit screws to bolster the dollar, go the other way — loosen credit and lower rates even further to prop up asset prices. Why is this no choice at all? Because history has taught us the Central Bank will continue to “inflate the money supply and promote more credit, thereby sustaining asset prices at the expense of the purchasing power of the dollar.”
Here’s an excerpt:
That may seem the downward path to financial and eventually economic rack and ruin. But such a trivial consideration has never deterred Washington. You don’t have to swallow whole QB Partners’ gloomy diagnosis and prognosis for the beleaguered buck to find it valuable as well as provocative. Even though we agree there’s plenty of sliding room left for the greenback, we’re not convinced the outlook is as apocalyptic as the duo contends…
The pair point out that the vigorous monetary inflation manifest in the 30% decline in the value of the dollar in the foreign-exchange markets since 2002 is seeping inexorably into the economy: “Prices paid in the U.S. for goods, services, financial assets, real-estate assets and natural resources have risen in recent years significantly more than population growth and organic demand.”
They then cite the findings of Shadow Government Statistics, an independent research outfit, that “U.S. prices have been increasing at annual rates ranging from 8% to 11% since 1996. This contrasts with the Bureau of Labor Statistics’ core CPI, which has risen in the 1.5% to 4.5% area.”
And they comment dryly that most Americans likely “intuit their rate of inflation more in line with the higher ‘unofficial’ rate than” the conveniently low numbers calculated by the BLS.
Timely, too, is their take on our increasingly leveraged markets, the inevitable result of all that cash and credit the government is so sedulously pumping into the economy. “Levered funding,” they warn, “gives the public markets an embedded tendency to fall faster and harder than they otherwise would.”
Leverage, they point out, enters markets leisurely but can exit quickly and violently. Might keep that in mind when some shill next tells you there’s just too much liquidity around for stocks to ever go down.
Nevertheless, Rithotlz sees a near-term dollar bounce for technical reasons, but is still a long term dollar bear.
What is the source for the argument that the Saudis intend to diversify — I would be most interested.
The use of the term “announce” may have made the Saudi moves seem more public than they have been. Here are some links:
“UAE denies political motive in foreign exchange shift to euros”
“Wave of petrodollars hits UK“
This article, “Greenback tumbles against euro,” in discussing daily currency trading, made a more general comment about the Saudi posture:
“However, much attention was focused on the Saudi Arabian Monetary Authority, which was said to have bought somewhere between €1.5bn and €5bn worth of euros yesterday, selling dollars in the process.
“If true, this could simply be the ongoing diversification of dollar-denominated oil proceeds into other currencies. However, with King Fahd having died only days earlier, this inevitably led to rumours the dollar selling was, in part, politically motivated, possibly linked to a long-term plan to shift the riyal away from a dollar peg to a basket arrangement.”
Although per the SAMA trading, some of the dollar selling has been explicit, a lot of it appears to have been acheived via the rebalancing of their various equity/private equity/DFI investments, which can be presented to the US as having to do with the merits of the particular investment, rather than being largely or entirely motivated by a desire to move away from the dollar