"Dollar surge will not stop America feeling the effects of a global crunch"

Despite the resurgence of the dollar, Ambrose Evans-Pritchard remains unconvinced that things in the US are now as rosy as the new found (albeit guarded) optimism suggests. He comes by his view without disputing the view that the dollar rally has legs. I’m not very optimistic about that.

Why? A drinking buddy with amazing connections in the international banking community (he and his parters can get Trichet on the phone) has said since January that the dollar would rally because foreign banks, particularly UK and European banks, were in simply dreadful shape, which in turn meant their economies would wind up in recession. Once the markets figured that out, the dollar would have a nice run. But he has been equally adamant that the dollar is a long-term sell because we will be unable to dig our way out of our trade deficits.

And there are plenty of other shoes about to drop. Chris Whalen of Institutional Risk Analytics has warned for some time of a second leg down in the credit crunch as regional banks take writedowns. The Financial Times today warns that “US banks scramble to refinance maturing debt“:

Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher and curb their profitability, say bankers and analysts…

The rising funding costs are set to put pressure on earnings because, in many of their businesses, banks rely on the difference between borrowing and lending rates to make money.

“It is difficult to see how banks will continue to repeat the heady profit growth of the past few years if they borrow at these levels,” said a Wall Street banker.

Banks could also be forced to raise lending rates, exacerbating the credit crunch felt by many businesses and individuals and further depressing economic activity.

Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.”

And if they don’t borrow at the same level, they shrink their balance sheets, which is also contraction-making.

From the Telegraph:

Two alerts landed on my desk this weekend from the elite markets team at Goldman Sachs. One was entitled “The Dollar Has Bottomed!”….

The other note advised clients to “Take Profit on Globalization Basket”, especially on Eastern Europe currencies. Goldman Sachs has quietly dropped its talk of $200 oil. Even Russia’s petro-rouble is now deemed suspect.

The twin missives more or less sum up the dramatic change in mood sweeping financial markets since it became evident that the entire bloc of rich OECD countries has succumbed to the delayed effects of the credit crisis.

Japan contracted by 0.6pc in the second quarter, Germany by 0.5pc, France and Italy by 0.3pc. Spain recalled the cabinet last week for an emergency summit. New Zealand and Denmark are in recession. Iceland contracted at a catastrophic 3.7pc in the second quarter.

“The whole decoupling thesis has started to come apart at the seams,” said David Bloom, currency chief at HSBC….

Yves here. Note the Nouriel Roubini from the get-go deemed decoupling to be bunk.

The UK economy is not my brief, but I see that hedge funds are circulating a report from the US guru Jeremy Grantham predicting a very bad end to Gordon Brown’s debt experiment.

“The UK housing event is probably second only to the Japanese 1990 land bubble in the Real Estate Bubble Hall of Fame. UK house prices could easily decline 50pc from the peak, and at that lower level they would still be higher than they were in 1997 as a multiple of income,” he said.

“If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial.”

For months the exchange markets ignored this impending train crash, just as they ignored the property bust in Europe’s Latin Bloc, or the little detail that UBS alone had just lost the equivalent of 8pc of Switzerland’s GDP. All they cared about in the currency pits was the interest rate gap: US low, Europe high.

Now the paradigm has flipped. The Fed may have been right after all to slash rates to 2pc. The European Central Bank may have panicked by tightening in July. Note that the elder Swiss National Bank did not do anything so rash.

Bulls now believe America is turning the corner. Financial stocks are up 20pc since early July. Some “monoline” bond insurers have risen 1,200pc in a month as fears of Götterdämmerung give way to sheer intoxicating relief, and a “short-squeeze”. Such are bear-trap rallies.

Regrettably, I remain beset by gloom. The US fiscal stimulus package that kept spending afloat in the second quarter is running out fast. There is nothing yet to replace it. The export boom cannot keep adding juice as the global crunch hits. My fear is that the US will tip into a second, deeper leg of the downturn, setting off a wave of savage job cuts. This will start to feel more like a real depression.

The futures market is pricing a 33pc fall in US house prices from peak to trough, based on the Case-Shiller index. Banks have not come close to writing off implied losses on this scale.

Daniel Alpert from Westwood Capital predicts that a mere 28pc fall would alone lead to a $5.4 trillion haircut in US household wealth, and leave lenders nursing $1.25 trillion in losses. So far they have confessed to less than $500bn.

Meredith Whitney, the Oppenheimer’s bank Cassandra, predicts a gruesome 40pc fall in prices. If so, expect prime borrowers facing negative equity to start throwing in the towel en masse. “I do not think we are near the end of writedowns. I continue to see capital levels going lower, and stocks going lower,” she said.

So no, this painful ordeal is far from over. We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.

It would be better if I were proven wrong, but Whitney’s estimate give me some solace. At the Inman Real Estate conference in San Francisco last month, I said that the peak to trough fall in housing prices would be between 35% and 40%.

Print Friendly, PDF & Email


  1. jest

    a question for the peanut gallery:

    it seems that we are headed towards (or already in) a classic liquidity trap. money is available, however banks don't want to lend.

    but for the last year, almost every monetary aggregate has increased.

    how can we be 1 year into the biggest deleveraging cycle of our lifetimes, and still not see any real signs of monetary deflation? (the spike down in the CRB notwithstanding/falling prices <> deflation)

    it's like we have deflation, ex-deflation, to pillage a term from barry ritholtz.

    so what does a central banker do in this situation?


    raise rates?

    cut rates?

    quit your job, leave the mess to some other sucker, and write a memoir about "turbulence?"

  2. Yves Smith


    I’m not going to do your question justice (I need to turn in), but quick and dirty: on a macro level, at least as of March 31, the US has not even begun deleveraging. Per a chart in this post, debt to GDP was still on a parabolic trajectory. Tim Duy in a piece at Economist’s View similarly mentioned that our friendly foreign funding sources had kept us afloat by lending $1000 per person since the crisis hit.

    So we are seeing specific types of borrowers have trouble getting credit or have been largely repudiated, but deleveraging hasn’t even begun in a serious way. AIG can still get plenty of funding, it’s merely pricey. If you are Warren Buffett, it’s apparently easy to borrow.

  3. Eurobear

    Looks to me that depsite being first to recognise the issue the US economy ‘appears’ to be the last to suffer. Globally we’re seeing recession calls but in the US its being masked by other factors like falling oil and strengthening oil.

    what concerns me the most is the countless educated people and commentators who are swallowing these events and touting them as being turning points , rather than the symptoms of a continuing death spasms of an ailing economy.

  4. Anonymous


    I don’t suppose there’s a link to the Jeremy Grantham report somewhere? Us Brits would love to read something like that.


  5. Anonymous


    If one lives in Florida, California, Nevada or one of the many other states where housing prices have already declined significantly, one can say that any dollars that they hold have increased in purchasing power vs housing.

    An individual that had $1M in a bank at the peak of the housing boom could have purchased X home for $1M or that same individual could have waited for the housing bottom and perhaps purchased X home for $600,000.

    This is an example of an individuals $s increasing in value or, alternatively, X home decreasing in value. Strictly speaking this is not the textbook definition of deflation but the results are the same for the individual with $s in the bank in pursuit of a residence, imo.


  6. Dean


    I find myself in such complete agreement that I find it somewhat embarrassing of having nothing to add.

    My personal decoupling theory (meaning that I would have something brilliant to say in the face of market consensus) has been burst! (at least for today).

  7. sc

    What are you thoughts about the market reaction to the Fed bailout of the GSEs? I expect a brief rally, followed by realization that nothing has changed and a fall.

    Watch the Canadian banks which will be announcing their Q3 next week (ending July 31). TD, BMO and CIBC should be horrible and portend US bank results.

    Finally, what does every Florida realtor not want right now – that’s right, a hurricane. Doesn’t help sales and think of the costs of fixing up all that REO!!

  8. Anonymous

    SC, ‘doesn’t help sales and think of the costs of fixing up all that REO’…

    The remodelers, roofers, landscapers, etc, will love the hurricane, for they really need the work. If power stays off for a while mold will begin in the REO’s for there will be no one to open windows and let in fresh air. More work for the dry wall crews, carpenters, and wall paper hangers. Then there is lots of OT for the power crews to replace power lines after the tree services have removed downed timber. Lowes, Home Depot and other building supply businesses sales will spike up.

    ‘Tis an ill wind that blows good to no one.’ :)


  9. Anonymous

    A hurricane might actually be a big step towards the black-humored, but realistic, suggestion for how to end the housing crisis (at least in Florida): “blow up the excess inventory”.

    I don’t think the banks want to throw good money after bad… the dry-wallers and construction crews may not be the beneficiaries of additional capital (oxymoronic, that) spending by the banks. Maybe if casualty insurance is in place … but expect haircuts as lawyers argue for what the “replacement value” actually is…

Comments are closed.