The End of Dollar Supremacy?

I'm reminded of people who get so hyped up to see a particular movie, that it's impossible for their expectations to be satisfied by the real thing. They leave the theater disappointed, even though others who had no particular prior expectations think the movie was pretty good.

I wonder if this is the essential mechanims behind trend reversals?

Dollar's drop becomes more ominous, investors say
http://biz.yahoo.com/rf/031221/markets_stocks_dollar_2.html
Sunday December 21, 12:35 pm ET
By Nick Olivari

NEW YORK, Dec 21 (Reuters) - After months of looking at nothing but the bright side of a weaker dollar, investors are starting to look at the dark side of its struggle against the euro.

Demand for the dollar has been dampened by concerns about the widening U.S. current account deficit and expectations that benchmark U.S. interest rates will remain low.

For most of the past six months, that was seen as positive for the most part, as U.S. goods and services become cheaper compared with those produced overseas. Now though, investors are looking at the pace of the dollar's decline, fearing that an orderly drop in demand may turn into a rout.

Indeed, this past week, several large companies said the weak dollar continues to be a boon to corporate results:

* On Monday, Illinois Tool Works Inc. (NYSE:ITW - News), whose products include fasteners, Wilsonart laminates and Hobart food equipment, boosted its fourth-quarter earnings outlook and said the weaker U.S. dollar added 5 percent to its revenue;

* General Mills Inc. (NYSE:GIS - News) said on Wednesday its quarterly sales rose 4 percent, to $3.06 billion, with most of the gain due to the weaker dollar, which boosts the value of sales in other currencies.

* Also, on Wednesday, Commercial Metals Co. (NYSE:CMC - News), which makes steel products, said its fiscal first-quarter profit more than quintupled, citing the weak dollar and continued strong demand from Asia, especially China.

* On Thursday, Nike Inc. (NYSE:NKE - News) said currency market swings, primarily a surge in the euro against the dollar added $30 million or 7 cents per share to Nike's bottom line for its fiscal second quarter.

ABANDON SHIP

Even with all these positives, some investors remain concerned.

"It's not the level that concerns me, but how the rapid change affects commerce and the willingness of foreigners to hold and purchase dollar-denominated securities," said Jim Luke, a money manager with Raleigh, North Carolina-based BB&T Asset Management Inc., which oversees $13 billion.

Any rapid change in currency makes it hard for companies to price cross border deals, Luke said, stifling sales.

Worse, if foreign U.S. investors start to abandon dollar-denominated securities on concerns that any profits will be lost as they convert back to their own currencies, U.S. investors may also take money from the stock market in a bid to beat the rush.

"If the dollar's slide is seen as transient, then the market will stabilize as investors realize the damage has been done," said Anthony Chan, senior managing director and chief economist at Banc One Investment Advisors, which oversees $180 billion. "But not even domestic investors are blind and they don't want to be in front of the train."

DOOMSDAY SCENARIO

Few are expecting such a doomsday scenario, but with the dollar at a seven-year low against the Swiss Franc, an 11-year low against the British Pound and the euro enjoying an 18 percent gain this year, investors are hoping that the dollar is closer to the bottom than not.

If that reluctance to hold U.S. securities spreads to U.S. Treasuries, interest rates will also rise, potentially jeopardizing the economic recovery.

Another fear is that the strengthening global economy will make it harder for the U.S. to fund its current account deficit as investors move into strengthening currencies and cyclical economic regions like Asia.

The U.S. also faces a unique problem in that commodities such as oil and base metals are priced in U.S. dollars.

Steven DeSanctis, small-cap strategist with Prudential Equity Group said his biggest concern is that oil prices can stay high in dollar terms, as people outside the U.S. are effectively paying less.

Economies using the euro will see lower energy costs and a lift in their economies, but in the U.S. -- the world's largest consumer of oil -- companies will see profits erode.

Inflation may also revive as a factor as with imports more expensive, local companies feel freer to boost the prices of their goods in the U.S. market without worrying about a decline in sales, DeSanctis said.

SILVER LINING

In the near term, it is still the silver lining that predominates as the dollar weakness is expected to add about 2 percent, to fourth-quarter earnings for Standard & Poor's 500 (CBOE:^SPX - News) companies, according to Ken Perkins, a market analyst at Thomson First Call (News - Websites) .

The fear, however, remains that as the effects of historically low interest rates and tax cuts wind down, the dollar's decline will prove more problematic than beneficial.

And that rubicon could be crossed as soon as the second half of 2004, according to Prudential's DeSanctis, "When the economy starts to decelerate."

The World Turned Upside Down

April 12, 2004

Chris Temple is editor of The National Investor newsletter and founder of The Foundation for American Renewal.

Much better news on the jobs front as well as another anticipated strong earnings season for Corporate America have helped Wall Street right itself somewhat following the nasty March swoon. This past week the market had to struggle with the escalation of violence in Iraq; thus, it did not manage to push ahead even further than it has recently. Nevertheless, most traders seem to view the Iraqi quagmire as more of a nuisance than anything substantive that will affect our economy over the longer term.

I won't argue that point here. Rather, I do want to remind readers that - quite apart from Iraq - there have been other developments recently which the overwhelming majority of investors have not paid nearly enough attention to. Twice in just the last few weeks, in fact, developments occurred which have much deeper implications for the U.S. economy and markets. In fact, the eventual effect of these for Americans particularly will translate into a drastically different standing in the world economically than what we've all been long accustomed to. It can truly be said that, for us, the world will be turned upside down over the next several years.

None of us alive today has ever dealt with an economic and market environment that did not have at its core somehow one important anchor. And that, my friends, was that - though there were transient occasions since World War 2 when there were some interruptions - the world, in the end, has revolved around the United States of America.

In a military sense, it has been American might and muscle that, for the most part, have kept most of the world a safer place. Sure, there have been small flare-ups, wars and their attendant "police actions." Yes, there are uncomfortably many of these kinds of things going on right now. Yet nobody can deny that America's formidable military strength and resolve won the Cold War, have kept historically volatile Europe free of conflict, and have otherwise created an environment of relative stability.

America's economy has for several decades been the world's largest. U.S. consumers, though they have dangerously built their seeming prosperity on mountains of debt, have nevertheless contributed to economic activity elsewhere by consuming so much. It can truly be said that, especially in recent years, Americans have virtually carried the entire world on their backs.

Part and parcel of the world being "tilted" toward the U.S. has been the establishment of U.S. capital markets as the largest and most liquid in the world. People and even governments the world over have shoveled endless amounts of money into U.S. financial assets, giving an even greater aura to the United States as the great engine of wealth creation in the world.

As one sage once put it, though, "Whatever can't last, won't." As the above scenario and America's being the consumptive center of the universe has endured, major imbalances have been built up. For years, pundits of all stripes have speculated as to when the "tipping point" would come, where America could no longer accumulate such massive internal and external debts; and, further, when others in the world would smell trouble - or greater opportunity elsewhere - and begin to change their behavior towards America.

Early answers to these questions - and warnings to the wise - are starting to come in. A few weeks ago, Japanese officials surprised currency traders by suggesting that their long and heavy intervention in the currency markets designed to keep the yen from appreciating too drastically was coming to an end. Make no mistake, said the Bank of Japan; it will still intervene if and when necessary to arrest any sudden or overly sharp yen rallies versus the greenback. However, the signal was clear; an orderly appreciation of the yen was something the BOJ was now resigned to, if not welcoming. As we all know, the Japanese have been buying boatloads of Treasury securities and otherwise keeping the yen in check in order to best protect their interests.

All things being equal, that nation has been best served until now by keeping its citizens employed in the many export-oriented businesses that have fed the American consumer economy. In the recent past, though, signs have been increasing that Japan's own consumer economy has been revived. Further, it has been doing increasing amounts of business with other nations in the Asian region; most notably, China. No longer as dependent on America's consumers, Japan has begun the process of a "readjustment" of sorts away from an economic model that has worked well in recent years. Now, Japan must see to its own domestic growth, a reinvigoration of its own lending industry, and as sustainable an increase in domestic consumption as it can engineer. An important element of this will be to, in effect, do what the United States did for much of the 1990's: have a stronger currency so as to make imports as inexpensive as possible.

As Japan's resurgent economy increases its appetite for imported raw materials, it will need a strong currency to keep those commodities - all of which are priced in the U.S. dollar - from getting overly expensive in their yen. I predict that China won't be far behind in following the same course as Japan. As that nation of well over a billion people has developed an even more incredible appetite now for imports, inflationary pressures have grown; so much so that some are suggesting China has become a "bubble," whose rapid growth is unsustainable, at least in the near term. That may well be. However, what better way to take some of the inflationary pressure away than by "giving in" to the U.S. and finally allowing its currency to strengthen versus the U.S. dollar? The irony here - even more so than with Japan having already moved in this direction - is absolutely incredible.

For some time now, politicians of both parties have sought to cover their systematic dismantling of America's domestic economy on behalf of corporations by blaming China (just as they used Japan as a scapegoat in the 1980's.) "If only China would get rid of its unfair currency peg to the dollar and allow the yuan to rise," they tell us, "we wouldn't have such a trade imbalance. Exports would soar. We'd have an even playing field." And so on. There's an old saying that one should be careful of what one wishes for - because one just might get it! Soon, China will join Japan in allowing its currency to rise against the U.S. dollar. Particularly if this occurs before November, President Bush will claim a major victory in having finally succeeded in cajoling the Chinese into being more "fair" and in opening the door to greater U.S. competitiveness. Almost nobody will understand the true meaning of such a move, however. First, it will demonstrate China's belief that the previously insatiable American consumer is finally about "full," and that the best days of exporting gobs of cheap goods to America are over. Second, it will ratify China's own growth story; one that is likely to play out over many years to come, but perhaps with some future geopolitical tension thrown into the mix as China flexes its bigger muscles. Finally, the Japan/China moves will translate into soaring costs for everything priced in U.S. dollars which will, of course, most acutely affect Americans.

That brings us to the second watershed event of recent days: OPEC's refusal to cancel planned production cuts, thereby keeping upward pressure on oil prices. Here again, this signals a major change from a regimen that has pretty much been the norm for many years; that being America's past ability to compel the oil cartel to follow our will. Following the 1970's embargo, an implicit deal was struck between the U.S. and OPEC, with Saudi Arabia being the main representative of the latter. With the U.S. by far being the world's largest importer and consumer of oil, OPEC has had to consider at times what its major customer could "bear" as far as prices were concerned. Simply put, the U.S. has on many occasions been able to browbeat the cartel into pushing prices down to make already (relatively) cheap oil in America even cheaper. The threat was that if Americans were asked to spend a rising percentage of their incomes for energy, the U.S. economy would stagnate or go into reverse; and future sales at any price would thus suffer. That was a point that President Bush argued forcefully in recent weeks; but a point which the OPEC cartel, led by Saudi Arabia, rejected. This has led to some of the most lame partisan wrangling of anything we've yet seen in the early days of this election season (yes, I know, it's still early - and that things will get even more insulting by November.) Bush and presumed Democrat nominee John Kerry are jousting over what Bush might still do, or what Kerry would have done, in a juvenile discourse that completely ignores reality.

That reality, dear friends, is that the world has begun to turn upside down for America. We no longer dictate every element of the global economy and prices as we once did in order to maintain our own advantage (in this case, much cheaper costs for oil than in the rest of the world.) The real issue here is that, due in great part to exponential growth in China and elsewhere, demand for oil is so great that prices have to rise. That's the free market, folks, that Bush and others - and even John Kerry - claims to support. With other buyers increasingly demanding their product and willing to pay its price, why in the world would OPEC continue to kowtow to America, when it's no longer necessary? What OPEC essentially said to America a couple weeks ago was that, "We're sorry you think our price is too high; but if you don't want our oil at US$36 per barrel, we have plenty of customers in Japan and China (and, increasingly, India) who will buy it."

The implications for America are clear: Continuing records for gasoline and other energy products, with their attendant drags on corporate profits and spending, not to mention their own inflationary pressures.

As evidenced by both the Japanese and OPEC developments in recent weeks, America will no longer be the author of its own destiny. The implications are enormous; yet the handwriting now on the wall is being ignored by almost everyone else. Only those who understand that, for America, the world we've known for more than half a century is irreversibly changing will be able to both protect themselves and profit in the years ahead. In addition, only those who apply these new facts of life in a positive, constructive way will be able to lead their friends, neighbors and nation in, hopefully, one day repairing the damage to America that has been done while our caretakers and leaders have fiddled (or, in some cases, willingly sold out their countrymen.)

Will you be one of them?

Opinions expressed are not necessarily those of David W. Tice & Associates, LLC. The opinions are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.

The euro's big chance

The dollar's reign as the world's undisputed reserve currency could be drawing to a close

"The convention whereby the dollar is given a transcendent value as an international currency no longer rests on its initial base... The fact that many states accept dollars in order to make up for the deficits of the American balance of payments has enabled the US to be indebted to foreign countries free of charge. Indeed, what they owe those countries, they pay in dollars that they themselves issue as they wish.

.. This unilateral facility attributed to America has helped spread the idea that the dollar is an impartial, international means of exchange, whereas it is a means of credit appropriated to one state."

Thus spoke Charles De Gaulle in 1965, from a press conference often cited by historians as the beginning of the end of postwar international monetary stability. De Gaulle's argument was that the US was deriving unfair advantages from being the principal international reserve currency. To be precise, it was financing its own balance of payments deficit by selling foreigners dollars that were likely to depreciate in value.

The striking thing about De Gaulle's analysis is how very aptly it describes the role of the dollar in 2004. That is itself ironic, since the general's intention was, if possible, to topple the dollar from its role as the world's number one currency. True, pressure on the dollar grew steadily in the wake of De Gaulle's remarks. By 1973, if not before, the system of more or less fixed exchange rates, devised at Bretton Woods in 1944, was dead, and the world entered an era of floating exchange rates and high inflation. Yet, even in the darkest days of the 1970s, the dollar did not come close to losing its status as a reserve currency. Indeed, so successfully has it continued to perform this role that in the past decade some economists have begun speaking of Bretton Woods II - with the dollar, once again, as the key currency. The question is: how long can this new dollar standard last?

The existence of a dollar standard may come as a surprise to any American who has been considering a summer holiday in Europe. With the euro at $1.18 (compared with 90 cents two years ago), talk of a new era of fixed exchange rates seems far-fetched. But "son of Bretton Woods" is not a global system (nor, in fact, was Bretton Woods senior). It is primarily an Asian system. Pegged to the dollar are the currencies of China, Hong Kong and Malaysia. Also linked, less rigidly, are the currencies of India, Indonesia, Japan, Singapore, South Korea, Taiwan and Thailand.

As in the 1960s, it is not difficult to make the case that this system is highly beneficial to the US. Over the past decade or so, the American current account deficit with the rest of the world for goods, services and loans has grown dramatically. Add together the deficits of the past 12 years and you arrive at a total external debt of $2.9 trillion. At the end of 2002, according to the department of commerce, the net international indebtedness of the US was equivalent to around a quarter of GDP. Yet as recently as 1988 the US was still a global net creditor.

This rapid role reversal - from world's banker to world's biggest debtor - has had two advantages for Americans. First, it has allowed US business to invest substantially (notably in information technology) without requiring Americans to reduce their consumption. Between 10 and 20 per cent of all investment in the US economy in the past decade has been financed out of the savings of foreigners, allowing Americans to spend and spend. The personal savings rate is less than half of what it was in the 1980s.

The second payoff, however, has taken the form of tax cuts rather than private sector investment. The dramatic shift in the finances of the federal government from surplus to deficit since 2000 - a deterioration unprecedented in peacetime, according to the IMF - has been substantially funded from abroad. Had that not been the case, the combination of tax cuts, increased spending and reduced revenue that has characterised President Bush's fiscal policy would have led to much more severe increases in long-term US interest rates. Veterans of the Nixon and Reagan years can only shake their heads enviously at the way the present Republican administration has escaped punishment for its profligacy. To run deficits on this scale while enjoying long-term bond yields of under 5 per cent looks like the biggest free lunch in modern economic history. The cost of servicing the federal debt has actually fallen under Bush, even as the total debt itself has risen.

The reason is simply that foreigners are willing to buy the new bonds issued by the US treasury at remarkably high prices. In the past ten years, the share of the privately held federal debt in foreign hands has risen from 20 to nearly 45 per cent. Just who is buying up all these dollar-denominated bonds, apparently oblivious to the possibility that, if past performance is anything to go by, their value could quite suddenly drop? The answer is that the purchases are being made not by private investors but by public institutions - the central banks of Asia.

Between January 2002 and December 2003, the Bank of Japan's foreign exchange reserves increased by $266bn. Those of China, Hong Kong and Malaysia rose by $224bn. Taiwan acquired more than $80bn. Nearly all of this increase took the form of purchases of US dollars and dollar-denominated bonds. In the first three months of this year alone, the Japanese bought another $142bn. The Asian central banks' motivation for doing so is simple: to prevent their own currencies from appreciating relative to the dollar - because a weak dollar would hurt their own exports to the mighty American market. Were it not for these interventions, the dollar would certainly have depreciated relative to the Asian currencies, as it has against the euro. But the Asian authorities are willing to spend whatever it takes of their own currency to keep the dollar exchange rate steady.

This, then, is Bretton Woods junior: an Asian system of pegged exchange rates which keeps the Asian economies' exports competitive in the US while at the same time giving Americans a seemingly limitless low interest credit facility to run up huge private and public sector debts.

In one respect, at least, the claim that the world has unwittingly reinvented Bretton Woods is convincing. Taking a long view, the real trade-weighted exchange rate of the dollar has proved remarkably stable. It experienced bouts of appreciation in the early 1980s and the late 1990s, but then reverted to something like a mean value. Right now it is less than 10 per cent below where it was in 1973. And where the new system differs from the old is to the advantage of the former. The original Bretton Woods was premised on a fixed link between the dollar and gold. Remember the plot of Goldfinger? The prosperity of the cold war era supposedly rested on the foundation of the Fort Knox gold reserve. But that made the system vulnerable to speculation by foreigners who, like De Gaulle, decided they would rather hold gold than dollars. This time around there is only the dollar. The world's monetary system is built on paper.

But here's the catch. The proponents of the new Bretton Woods seem to see it as a system with a boundless, rosy future. The Asians, so the argument goes, will keep on buying dollars and US treasuries because they so desperately need to avoid a dollar slide, and because there is no theoretical limit on how much of their own currency they can print purely in order to make their dollar purchases. In any case, why should foreigners not want to invest in the US? It is, as numerous Wall Street practitioners have told me over the past few months, the place to invest now that recovery is under way. "Where else are they going to go?" one Wall Street banker asked me last month, with a rather superior sneer. "Europe?"

But this optimistic conventional wisdom overlooks a number of big differences between the 1960s and the present. American deficits under the old Bretton Woods system were insignificant; the US was running current account surpluses throughout the decade. People then were worried about the fact that Americans were investing quite substantially abroad, though that was counterbalanced by inflows of foreign capital. But mainly they were worried that overseas dollar holdings were outstripping the Federal Reserve's stock of gold. Today the US is running up huge deficits, while international capital flows are much larger. So, consequently, are the potential strains on a system of fixed exchange rates.

Whatever its virtues, the Bretton Woods system did not last long. If you count only the period when the dollar and the major European currencies were truly convertible into gold at the agreed rates, it lasted ten years (1958-68). There are reasons to think that this Asian son of Bretton Woods could prove equally ephemeral. And the aftermath of its breakdown could be as painful as the crisis of the mid-1970s.

For all the mystical appeal of the dollar bill, it is not a piece of gold. Since the end of gold convertibility, a dollar has been little more than a flimsy piece of printed paper that costs around three cents to manufacture. The design with which we are familiar dates back to 1957, since then, as a result of inflation, it has lost 84 per cent of its purchasing power. Tell the Japanese that they are the lucky members of a "dollar standard" and they will laugh. In 1971 a dollar was worth more than 350 yen; today it hovers around 100.

Until very recently, the frailty of the dollar has not really mattered. We have forgiven it the periodic bouts of depreciation for the simple reason that there has been no alternative. The sheer scale of American trade (the prices of so many commodities from oil to gold are quoted in dollars) means the dollar has remained the world's favourite currency and the first choice for settling international balances.

Yet no monetary system lasts forever. A hundred years ago, sterling was the world's number one currency. Yet Britain's soaring indebtedness during and after the first world war created an opportunity for the dollar to stake a claim first to equality and then to superiority. This pattern could repeat itself, for there is a new kid on the international monetary block. And few Americans have grasped that this new kid, despite the flaws of his parents, is a plausible contender for the top job.

Whatever you may think about the EU as a political entity, there is no denying that the currency it has spawned has what it takes to rival the dollar as the international reserve currency. First, eurozone GDP is not so very much less than that of the US - 16 per cent of world output in 2002, compared with 21 per cent for the US. Second, unlike the US, the eurozone runs current account surpluses; there is plenty of slack in European demand. Third, and in my view most important, since the creation of the euro, more international bonds have been issued in euros than dollars. Before 1999, around 30 per cent of total international bonds were issued in the euro's predecessor currencies, compared with more than 50 per cent in dollars. In the past five years, the euro has accounted for 47 per cent to the dollar's 44 per cent.

Could this mark a turning point? Last month, at a dinner held in London by one of the biggest US banks for around 18 clients at other major City institutions, I posed the question: who thought the euro could plausibly replace the dollar as the principal international reserve currency? No fewer than six thought it could - and were prepared to admit it before their American hosts. When I asked a smaller group of Wall Street bankers the same question, they were more doubtful - though one observed that the euro is already the preferred currency of organised crime because, unlike the Fed, which no longer issues bills with a value above $100, the European Central Bank issues a high-denomination E500 note. That makes it possible to cram around E7m into a briefcase - which can come in useful in some parts of Colombia. Maybe on Wall Street too.

The future of the Asian Bretton Woods system - and indeed of this year's US recovery - depends on the willingness of Asian institutions to go on (and on and on) buying dollars and dollar-denominated bonds. But why should they, if the Japanese economy is - as now seems to be the case - finally coming out of its deflationary slump? In any case, Japan's intervention has not been wholly successful in stemming the dollar's slide: over the past two years, the yen has gone from 135 to 110 against the dollar. In yen terms, the returns on the Bank of Japan's dollar portfolio have been decidedly negative.

Moreover, reliance on exports to the US may not be a long-term option for Asia. In a recent lecture in Washington, Larry Summers, the former US treasury secretary, argued that the US has no alternative but to increase its savings rates if it is to extricate itself from "the most serious problem of low national saving, resulting in dependence on foreign capital, and fiscal unsustainability, that we have faced in the last 50 years." His conclusion is that the world can no longer count on the US to be the consumer of first resort, which means in turn that "the growth plans of others that rely on export-led growth will need to be adjusted in the years ahead."

The Asian dollar dilemma is the euro's opportunity, both economically and politically. First, if the US does cease to be the only functioning engine of global demand, it is imperative that the eurozone step up to the plate, and soon. For too long the European Central Bank has made price stability the "magnetic north" of its policy compass. It has not spent enough time thinking about growth in Europe and the world. For too long ECB interest rates have been about a percentage point above the Fed's, despite the fact that deflation is a bigger threat to the core German economy than it ever has been to the US.

The president of the ECB is now a Frenchman. Maybe Jean-Claude Trichet should remind himself of some history. Thirty-nine years ago, the dollar was coming under pressure as US entanglement in a messy postcolonial war began to grow. It was Charles De Gaulle who called time on the Bretton Woods system, which, he alleged, obliged European economies to import American inflation. This is the moment for someone to call time on Bretton Woods junior. Asians and Europeans alike need to sell their goods somewhere other than to profligate America. And they need to recognise that the emergence of the euro as an alternative reserve currency to the dollar creates a chance to fundamentally shift the centre of gravity of the international economy.

If the Europeans seize their chance, Americans could face the end of half a century of dollar domination. Does it matter? You bet it does. For if Asian institutions start rebalancing their portfolios by switching from dollars to euros, it will become harder than it has been for many years for the US to fund its private and public sector consumption at what are, in terms of the returns to foreign lenders, low or negative real interest rates. (Do the maths: the return on a US ten-year treasury a year ago was around 4 per cent, but the dollar has declined relative to the Japanese currency by 9 per cent in the same period.)

Losing that subsidy - in effect, the premium foreigners are willing to pay for the sake of holding the world's favourite currency - could be costly. For a rise in US long-term interest rates to the levels recently predicted by the economist Paul Krugman (a ten-year bond rate of 7 per cent, a mortgage rate of 8.5 per cent) would have two devastating economic consequences. Not for big US corporations - they are hedged (more than five eighths of all derivative contracts are based on interest rates). But a 3 percentage point jump in long-term rates would whack first the federal government and then US homeowners with considerable force. For neither the US treasury nor the average US household is even a little bit hedged. The term structure of the federal debt is amazingly short: 35 per cent of it has a maturity of less than one year, meaning that higher rates would feed through almost instantly into debt service costs (and into the deficit). Meanwhile, even as rates have been nudging upwards, the proportion of new American mortgages that are adjustable-rate rather than fixed has risen from around 12 per cent in late 2002 to 32 per cent.

The geopolitical implications of this are worth pondering. A rise in American interest rates has the potential not just to slow down the US recovery; it could also cause the federal fiscal deficit to leap even higher. Under the circumstances, the pressure will increase to reduce discretionary spending, and that usually turns out to mean defence spending. It will get steadily harder to sell an expensive occupation of Iraq to a population groaning under rising debt service payments and alarmed by spiralling fiscal deficits. Meanwhile the Europeans will have added another string to their internationalist bow: not only will they be bigger contributors to aid and peace-keeping than the US; they will also be the supplier of the world's favourite money.

Such historical turning points are hard to identify. It is not clear when exactly the dollar usurped the pound. But once it did, the turnaround was rapid. If the euro has already nudged in front, it may not be long before oil producers club together to price their black gold in the European currency (an idea that must surely appeal to anti-American producers like Venezuela and Malaysia). World money does not mean world power: the EU is still very far from being able to match the US when it comes to hard military power. But losing the position of number one currency would without question weaken the economic foundations of that hard power.

As the ghastly implications of the demise of the dollar sink in across the US, the spectre of General De Gaulle will savour his belated vindication.

Bank of Japan governor says world needs rival to US dollar as global currency
Friday, November 12, 2004 10:12:00 AM

TOKYO (AFX) - Bank of Japan (BoJ) Governor Toshihiko Fukui said it would have a stablizing effect on the global financial system if a clear rival to the US dollar as a key global currency were to emerge

Speaking at a symposium in Tokyo on the theme "The Euro: Five Years On -- Implication for Asia", the Japan central bank chief cited data showing the common currency of the 12-nation European currency bloc is emerging as a serious rival to the dollar as a key currency for conducting global trade and investment

"In the past five years (since its launch in 1999), the importance of the euro has increased considerably," Fukui told the seminar, which featured such other speakers as European Central Bank vice-president Lucas Papademos, and Toyoo Gyohten, the highly respected former Japanese vice-minister for international affairs. Fukui said more than 50 countries link their currencies to the euro, while the proportion of foreign exchange reserves held in euros has risen to 20 pct, and nearly a third of the cross-border-issued bonds are now denominated in euros. Fukui seemed to welcome the growing prominence of the euro by referring to the dangers associated with allowing any single currency to dominate global commerce

"In such a situation, the economy of the key currency is easily tempted to focus its economic policy on domestic considerations," an apparent thinly veiled rebuke to the economic policies followed by the US adminstration of President George W Bush

"In today's globalized economy, this could lead to undesirable ripple effects on the rest of the world, through the fluctuations of the external value of the key currency." Fukui said if there were two competing key global currencies, "competition between them could lead to more attention to the external value of key currencies. This could have a positive effect on the stability of the global financial system." The BoJ chief briefly indicated that the Japanese yen also had a role to play in that regard

"I believe that the yen can and should play a larger role in the global market," Fukui said, citing trends which could make that a certainty

"Considering the deepening economic relations between Japan and the rest of Asia, Asia should benefit if the use of the yen could be facilitated," Fukui told his high-powered audience

In 2003, nearly half of Japan's foreign trade was with Asia, up a third over the past decade

Fukui said the yen could play a larger role in both fund management and fund-raising, especially in light of Asia's strong demand for capital and Japan's vast pool of savings

But the Japanese central bank chief dismissed the notion that an Asian equivalent to the euro -- an Asian common currency -- would emerge within the lifetime of any of his grey-haired listeners

"Could we see a common currency area in Asia? For the near future, you would agree that this is quite unlikely," Fukui said

He subsequently indicated it could be 50 years before Asia has a common currency -- the time it took a handful of Europe's nations to embrace the concept

Great changes would need to occur, such as the development of vibrant regional financial markets, made possible by liberalized cross-border capital flows

Fukui said there is encouraging evidence that that is already happening, beyond merely the tremendous increase in inter-Asian trade

He cited in particular the example of the Asian Bond Fund II project, promoted by the 11 central banks of the EMEAP economies. EMEAP stands for the Executives' Meeting of East Asia-Pacific Central Banks, an organization founded in 1991 by the central banks of Australia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore and Thailand

robin.elsham@xfn.com rte/jm For more information and to contact AFX: www.afxnews.com and www.afxpress.com

India, China and other countries start dumping US dollar and buy Euro

November 27, 2004

The India, China and other countries have started dumping US Dollar quietly and buying Euro. That put a very serious pressure on US Dollar. Chinese and Indian central bank officials denied such reports. But Foreign exchange traders say they are quite convinced of Indian and Chinese moves. According some traders, there are many other countries specially oil rich Middle Eastern countries running away from dollar.

Reserve Bank of India (RBI) Governor Y.V. Reddy said the composition of the country's foreign exchange reserves could change when asked on Wednesday if the bank was considering boosting its holdings of the strengthening euro. The central bank does not give a breakdown of its reserves -- the world's fifth largest -- but analysts said it may already have reduced the proportion of dollar holdings and would likely continue to do so. India's reserves, which comprise dollars, euros, sterling and yen in undisclosed proportions, have risen by nearly $23 billion so far in 2004 to a record $123.5 billion. "The question of composition of reserves ... it's a very dynamic situation. You can't take a view on a daily basis," Governor Y.V. Reddy told reporters on the sidelines of a news conference. The dollar has long been held as a reserve currency, but the single European currency hit a record high against it on Tuesday, and again on Wednesday, after the Russian central bank said it could review the share of euros it holds among its $113 billion in reserves. Asian central banks have been among the largest buyers of dollars as the economic tide turned in their countries'' favour leading to massive investment and trade inflows. These banks were partly looking to build up their ammunition following a crisis in 1997 and to protect their trade competitiveness. But the U.S. unit has declined sharply because of doubts about the fundamentals of the U.S. economy, which is running wide fiscal and trade deficits. It has fallen nearly 4.5 percent against the euro so far in 2004.

"housing"

The price of "housing" is to be distinguished from the price of personal use real estate. To the extent you are talking about the ultility of a place to live, price is probably dropping. The BLS market basket number for housing is rental value which is going down is almost all markets.

The disparity between rental value and price is larger than it has been at any point in history--and the spread historically has been completely eliminated by price drops in the next cycle.

Russia ends de facto dollar peg and moves to align rouble with euro
By Steve Johnson in London
Published: February 5 2005 02:00 | Last updated: February 5 2005 02:00

Russia said yesterday it had abandoned efforts to tie the rouble's movement closely to the dollar and switched to shadowing both the euro and the US currency.

The move heightened expectations that other countries operating de facto dollar pegs, such as China, could follow suit.

With 81 per cent of Russia's oil exports currently sold to Europe, the move also provoked fresh speculation that Russia could decide to denominate its oil in euros. Russia is the world's second-largest oil exporter, behind Saudi Arabia.

"Russia has talked about the idea of pricing its oil in euros. If it is starting to put more weight on the euro in terms of its forex regime and reserves, then that speculation will be re-ignited," said Ian Stannard, currency strategist at BNP Paribas.

Russia had announced its intention to introduce a basket arrangement last April but did not set a firm date for the change. The Bank of Russia, the central bank, has been building its euro reserves in readiness, with some 30 per cent of its reserves now estimated to be in euros, against just 5 per cent in 2000. Traders said it appeared Russia had begun to loosen its peg to the dollar in October, when the rouble began to strengthen against the dollar while the US currency fell strongly against the euro.

The bank yesterday indicated that its efforts to keep the rouble closely pegged to the dollar had caused the Russian currency to suffer against the strengthening euro, rendering the old policy "inexpedient".

The rouble has fallen by 30 per cent against the euro since January 2002, fuelling inflation in a country that conducts about 65 per cent of its trade with the eurozone.

"The rouble's performance has been highly correlated with the dollar. Now it will be more aligned with the euro," said Paul Timmons, economist at Moscow Narodny Bank.

He added that the new policy would help Russia move towards a free float of its currency in 2006, a target set by President Vladimir Putin.

This euro weighting will be increased in future to "a level that corresponds to [the] tasks of the exchange rate policy", leading some to conclude that the euro could ultimately account for 65 per cent of the basket, prompting a further re-balancing of Moscow's $128bn (€99bn, £68bn) of gold and forex reserves.

Julia Tsepliaeva of ING Financial Markets said that with inflation currently running at 11.7 per cent, Russia had been forced to stem rouble weakness in order to meet its 2005 inflation target of 8.5 per cent.

Moscow's move illustrates the growing global importance of the euro at a time when a number of central banks have been shifting reserves out of the dollar into the shared European currency.

"It is symptomatic of a global trend and reflects the growing international role of the euro," said Ralph Sueppel, head of emerging Europe strategy at Merrill Lynch.

"It is beginning to take its place in portfolios."

The Bank of Russia said it has been using a basket consisting of 0.1 euro and 0.9 dollars to target exchange rate policy since February 1. With the euro trading near $1.30, this currently gives the euro a 13 per cent weighting in the basket.

Little slow this morning, it took me a while to figure out what you had done here. Maybe it will be apparent to others that your post #48 is a today update to a thread that was current back in October of 2003, a year and four months ago.

Reason why it looks meaningful in terms of today's debate is that the arguments reflect today's news much as they did the news of October 2003.

With respect to the article you post in #48, from a trading perspective, the Russian's timing is bad however the reason they have done it is substantive rather than relative value of the currency.

At the moment, it still appears that the dollar is rallying against the Euro--the charts against the Euro are particularly impressive; the dollar is clearly in an uptrend; as it appears to be against the Yen, C-Dollar, and pound. As for real money, it looks as though gold is going down against the dollar also.

Two meaningful questions of the day: Why; and How Long?

Although the fed continues on its path of increasing the fed fund target rate (now 2.5%), long rates are declining. However the short rates may be having a positive short term impact on dollar exchange values.

The How Long question I think is ultimately determined by the answer to the Why question. If the dollar is firming up because of interest rates, the period will be relatively short. Even if there is a coordinated intervention coupled with interest rates, the dollar is still in a long term downtrend.

On the other hand, as you suggested somewhat earlier on this thread, if we have a deflation in which debts are liquidated by bankruptcy, default, or repudiation, the underlying value of the dollar might go up on a sustained basis.

Little slow this morning, it took me a while to figure out what you had done here. Maybe it will be apparent to others that your post #48 is a today update to a thread that was current back in October of 2003, a year and four months ago.

Yeah, mostly just intermittantly documenting the USD demise from world reserve currency to wallpaper.

Two meaningful questions of the day [re current USD uptrend]: Why; and How Long?

As to why, I believe it is due to positive interest rate differentials (vs ECB) and an unwinding carry trade overriding the negative record trade imbalances, on top of continued mercantilism of our trading partners providing a base support.

As to how long, these are short term corrective trends (4-8 months) to the USD long term devaluation.

Long term, the trade balance will continue to deteriorate as the 'critical mass' of our productive capital has been off-shored and we have little to export any more at even falling USD prices. The critical mass is gone in that foreign universities are now attracting the best & brightest, innovation and startups are increasingly in India, China, Japan, S. Korea, and job growth is in those countries. Nor do we have anymore the capital to invest in modern plants & equipment (that having been spent in countries where labor is cheaper) nor will the wages of the US worker/resident grow to support more consumption. Global labor arbitrage will hold wages in check, global excess capacity will hold pricing-power in check, but inflation will grow as liquidity growth outstrips production.

US corps will continue to look good on paper as their consolidated balance sheets reflect the cost cutting of moving production offshore and their international sales benefit from increasingly favorable forex treatment even though the profits are not repatriated into USD.

The only tool the Fed has is its printing press, hence every problem will be cured with increased liquidity. At some point our 'trading partners' will opt for the pain of reduced exports to the US and suspending further loans to the US (recycling USD profits into Treasuries) over the pain of increasingly worthless USD-denominated reserves & profits which impairs their import purchasing power for domestic consumption and as well as production for export to other (non-USD denominated) partners.

It was sourcery who maintains (still I believe) a deflationary debt collapse, not I. I anticipate global hyperinflation. When debt is 'liquidated by bankruptcy, default, or repudiation' the creditors balance sheet is impacted, but the money supply is unchanged. And while bankrupt borrowers/lenders won't be borrowing/lending more mponey into existence under our Fractional Reserve Banking system, the government has been and will continue to be the borrower of last resort and the Fed will be the lender of last resort - they make a great team and Greenspan their inestimable coach calling the plays.

I am still with sourcery on the deflation side of the issue. I don't discount the possibility of an error or unforeseen event that would result in hyperinflation but absent that, I think the end result will be deflation.

Levels of debt in excess of amounts which can be serviced from current income result in deflation. You avoid deflation by either getting rid of the debt or by increasing income. The inflation answer cannot work unless it can be accomplished in a process which increases income. Not only is that not happening now, it is difficult to come up with a hypothetical state of affairs in which increased liquidity provided through the bank fractional reserve process can result in increased income (in the real estate market but there is some finite limit there which I believe has been reached; maybe some other limited sector asset based areas for limited periods of time; but none of that is sustainable to cause a real expansion of income).

The interest rate differential explanation for the bounce in the dollar seems to be the conventional view--and may be correct. Thing is the result has come from a pretty small difference in a very short period of time.

How does unwinding the carry trade cause the dollar to go up against the Euro?

As to the long term trade deficit issue, if the domestic economy continues to deteriorate, US customers will reduce offshore purchases and the offshore economies will also contract. Since US consumption is the primary market, the offshore economies will suffer more from contraction in the US than the domestic economy does.

I see the real underlying dollar weakness emanating from long term lack of current liquidity flow to pay market interest rates.

My current forecast:

Long rates down, bonds/notes up (The dreaded yield curve inversion cometh)
Dollar up, gold down
Stocks up--headed for a major top

How does unwinding the carry trade cause the dollar to go up against the Euro?

The carry trade was put on by borrowing dollars at historically (hysterically?) low rates and reinvested (USD sold) in higher yield/risk assets.

The carry trade is unwound by selling those higher yield/risk assets for dollars (USD bought) which are then used to repay debts.

The unwinding carry trade reverses a 2-3 year trend of borrowing/selling of USD to a trend of buying/repaying USD. Buying USD and taking them out of the money supply by repaying debts puts upward pressure on the USD.

Foreign Central Banks also continue to support the USD & Treasuries, and interest rate derivatives may be getting exercised which involve dollar buying to cover hedged positions, (point being, an unwinding carry trade is not the sole factor), and the short term USD rise is not against EUR only, but against many currencies, especially the commodity currencies.

I agree with sourcery it looks like the yield curve is about to invert.

Levels of debt in excess of amounts which can be serviced from current income result in deflation.

Perhaps you could elaborate on the mechanics of this process? How does an aggregate inability to service loans (in full or in part) cause the money supply to contract, or at least contract faster than goods/service contract? Whatever that answer is, how does it prevent the Fed from printing money and buying back Treasuries (monetization of Govt debt)?

The inflation answer cannot work unless it can be accomplished in a process which increases income. Not only is that not happening now, it is difficult to come up with a hypothetical state of affairs in which increased liquidity provided through the bank fractional reserve process can result in increased income....

I contend it is happening now on a global scale. The US Federal Reserve and GSEs are inflating the USD money supply, the Japanese and Chinese are inflating their money supplies to sterilize their USD profits. Incomes are increasing in India, China, South America - the bulk of the worlds work force. They are buying food, cars, air-conditioners, cell phones, etc. Their governments and employers are buying up commodites and companies to make & power all that stuff.

As to the long term trade deficit issue, if the domestic economy continues to deteriorate, US customers will reduce offshore purchases and the offshore economies will also contract. Since US consumption is the primary market, the offshore economies will suffer more from contraction in the US than the domestic economy does.

Yes, and the 'solution' will be to do what Central Banks and governments always do - stimulate their economies with debt-based expansion and increased liquidity, except the target beneficiaries will be their own populations instead of the US.

But the pumping of the money supplies will continue. Debt being monetized in the US, and competitive currency debasement amongst the Asians & Europeans.

"My current forecast:

* Long rates down, bonds/notes up (The dreaded yield curve inversion cometh) * Dollar up, gold down * Stocks up--headed for a major top"

Absolutely I agree. However the stock top looms near--current month or perhaps as late as first half of March. The Treasury needs something like $150Bil of new money over the next sixty days and it is difficult to see them furnishing enough liquidity to hold the stocks together while they are sucking that much out.

The other issue is real estate. Again, I see the top as being fairly near. This is the hot sales season in most markets so the condition and direction ought to be fairly clear by the end of March. And the real estate markets are perhaps most exposed to liquidity flow problems--even with long term rates down; the rate on the ten year has trended down which will keep ARM's in check for the moment. But people are having trouble paying their current taxes; insurance; and debt service at current levels.

I was interested in your take on how unwinding of the carry trade might support the dollar. Seems to me that is a push for the most part--sale of the long term's to get the liquidity to pay the short term carry debt should depress the long term bond market supporting long term interest rates; which might have the impact of supporting the dollar. There is in fact a large amount of carry out there and it might be an impact. I have discounted it--it's not a market factor at this point; we know that because long rates are flat or down.

Otherwise it seems to me like dollars in dollars out; net wash.

Now your #54 is the global issue--inflation or deflation.

The short answer is that when the fed creates a lot of money through the bank reserve addition and lending process (which is the only way additional money supply gets into the economy, subject only to a little additional slippage as a result of the derivative process which I believe is not material), it also creates debt service requirements.

Income then gets used to pay debt service rather than to pay for new commitments so demand starts to slide; priceing power disappears; and pretty soon additional debt beings to be used to pay debt service on existing obligations. Money supply flattens out and begins to contract because the dollars that come out of income (or tax revenue) to pay debt service disappear (the money supply underlies the obligations--so whenever debt disappears, the underlying money disappears also)--pretty soon, the fed can't force enough additional money into the system through the debt process to exceed debt service on existing debt. Then we have deflation which becomes imbedded.

The only four obvious sectors where the fed can force money (in large enough quantities to make a difference) into the economy are stock margin debt; personal use real estate; consumer debt including auto loans; and capital spending with borrowed money by state and local governments. We have not yet rolled over but all four areas are under pressure (I assume last week's stock market rally is about over).

From 1924 to 1928, the fed used stock market margin debt as the primary vehicle to inject additional money supply into the economy. And it was really the only sector available (although the wealth created in the stock bubble was used as a basis for significant additional borrowing throughout the economy). So the end was a sharp cut off when it became apparent that stock values were insufficient to provide liquidity to repay the margin debt.

The debt that resulted in the period took through 1949 to eliminate through the process of inflation, repayment, and creditor realization. And throughout the 20 year period, commitment of liquidity to the debt liquidation process (coupled with poor federal fiscal policy and bad management by the fed of the monetary system, enhanced by the government's intervention--the gold price increase) eliminated most new spending for new capital commitments. Hence the economy stopped.

The current state of affairs is much more dire. The amounts are larger; the debt permeates our society in every segment of the economy--government; private industry; consumers; and investors. I read over the weekend (but have not confirmed the data) that one of the main Treasury demands behind the large borrowing this month and next is for money to pay unusually large tax refunds.

Why do we have big tax refunds? Because taxable income is down. (As is sales taxable consumption.) The single most accurate measure of the problem is tax receipts--because that number is not yet massaged.

Your point about offshore incomes is interesting. As an abstract proposition, if the US simply disappears as an economic factor, why can't China and Japan simply conduct their domestic economies by manufacturing and selling to domestic consumers? Because the domestic consumption maket doesn't support their manufacturing economy for the reason that it is not large enough. When their manufacturing economy implodes, so does the rest of their domestic economy.

Beyond that, however, you get into some esoteric areas that I can't see through to the end. The CB's of China and Japan don't just print money to support the domestic economy because that would be just a pure hyperinflation that would destroy their monetary unit--their domestic demand economy is not large enough, and can't be pumped up enough, to support the manufacturing economy they created to supply the huge US consumer economy.

But in managed economies like China and Japan, I can't tell what the end result is where their reserve base is US Treasury Debt. Nor can I speculate what will happen when there is a problem with maintainence of the Bond markets. And I don't think we can see clearly what will happen when the derivative markets become unstable as a result of counter-party credit issues.

On balance, I think the offshore economies are in worse shape that the US--and that the deflationary collapse will have a greater adverse impact there than here. But that is a speculative conclusion which may not be correct.

creditors balance sheet is impacted, but the money supply is unchanged.

I don't think that's right. The multiplier effect of fractional reserve banking goes into reverse.

may I ask both of you to post your opinions as to the effects of illegal immigration on the US economy.

I, live in Northern Nevada and it is very common to see illegals driving new vehicles. Auto loan accessibility must be open to all.

I am very interested in your opinions.

	2000	2001	2002
	Current Account	-410	-393	-503
Net long-term capital hereof:	422	335	285
Direct Investment		129	3	-93
Equities	90	15	35
Bonds	203	317	343
Basic Balance (b)	12	-58	-218

	2000	2001	2002	Total end-2002
Dollar reserves	115.5	82.9	219.8	1,751.4
Other currencies	75.2	58.1	48.6	643.8
Total reserves	190.7	141.0	268.4	2,395.2

	2000	2001	2002	Total end-2002
Euro Area	-9.4	-10.8	8.0	215.8
Japan	69.5	40.5	63.7	451.5
Asia (b)	52.5	76.0	173.3	943.8