The demise of the US dollar.
Posted 08 May 2003 - 10:08 AM
When a non-linear market event that is inherently unpredictable like the Russian Debt Crisis occurs, its effects on carefully crafted derivatives portfolios can be catastrophic. Long Term Capital Management folded during the 1998 crisis. It was an elite hedge fund run by some of the most brilliant market geniuses of the entire last century. The all-star brain trust at LTCM could probably have helped put men on Mars, as the stellar IQs and acclaim of the founders were without equal in the financial world. The gentlemen helping to build the sophisticated computer derivatives trading models for LTCM were Nobel-prize winning economists who understood more about markets and volatility than pretty much everyone else on the planet. Here are a few paragraphs on LTCM from an earlier essay we penned on gold derivatives volatility titled, "Gold Delta Hedge Trap (Part 2)".
"LTCM employed Scholes' and Merton's work to hedge and protect its bets. Through Black and Scholes based hedging strategies, LTCM became one of the most highly leveraged hedge funds in history. It had a capital base of $3b, yet it controlled over $100b in assets worldwide, and some reports claim the total notional value of its derivatives exceeded an incredible $1.25 TRILLION. LTCM used extraordinarily sophisticated mathematical computer models to predict and mitigate its risks."
"In August 1998, an unexpected non-linearity occurred that made a mockery of the models. Russia defaulted on its sovereign debt, and liquidity around the globe began to rapidly dry up as derivatives positions were hastily unwound. The LTCM financial models told the principals they should not expect to lose more than $50m of capital in a given day, but they were soon losing $100m every day. Four days after the Russian default, their initial $3b capital base lost another $500m in a single trading day alone!"
"As LTCM geared up to declare bankruptcy, the US Federal Reserve believed LTCM's highly leveraged derivatives positions were so enormous that their default could wreak havoc throughout the entire global financial system. The US Fed engineered a $3.6b bailout of the fund, creating a major moral hazard for other high-flying hedge funds. (Expecting the government or counterparties will bail them out of bad bets once they get too large, why not push the limits of safety and prudence as a hedge fund manager?)"
Long Term Capital Management had $3b in capital allegedly supporting $1,250b of derivatives notional value, an implied leverage ratio of 417 to 1. JPMorganChase, per its own reports filed with the US government, has $42b supporting $26,276b of derivatives notional value. Incredibly, JPM's implied capital leverage on its derivatives is far, far higher than LTCM's at 626 to 1. Isn't it disconcerting to realize JPM management has further leveraged its shareholder equity than even the infamous Long Term Capital Management?
LTCM had the best economic minds in the world running the fund, unlimited brain and computer power, but still an unpredictable volatility event spurred by the Russian Debt Crisis caused their painstakingly developed computer derivatives models to blow up. By many reports, including from the Federal Reserve, the LTCM failure was so dangerous it threatened to take the whole financial system down if LTCM's obligations to its counterparties were defaulted upon.
We are NOT suggesting that JPM is another LTCM. We know that the men and women running JPM are very intelligent and have a deep understanding of the global markets in which their company operates. We know they have cross-hedged and carefully modeled their enormous derivatives portfolio to try and make it net market neutral and therefore resilient to shocks. But, just as a tiny imperfection can cause a massive hardened-steel shaft connected to a nuclear aircraft carrier's propeller to vibrate uncontrollably until it shatters, even a "balanced" net derivatives portfolio of massive size is highly vulnerable to market shocks that can push it out of proper equilibrium and spin the computer hedging models out of control far faster than derivatives can be unwound.
There comes a point when leverage becomes so extreme that even a tiny unforeseen event can break down the complex contractual glue that holds the various components and players of the convoluted derivatives world together and cause the whole structure to shake or crumble.
We believe that JPM's management is taking a mammoth gamble with the wealth of its shareholders by supporting derivatives with a notional value of over $26 TRILLION dollars with a relatively trifling $42 billion of shareholder equity. Any discontinuous market volatility event that is unforeseen and beyond JPM management's control could conceivably cause this immense pyramid to rapidly unwind, utterly annihilating the company's capital in a matter of days or weeks.
Also, JPM, just by virtue of having extreme leverage, is placing itself at risk for a Barings Bank type scenario, where a rogue trader hid derivatives trading activities from management until it was too late and the damage was irreparable. What if some twenty- or thirty-something derivatives trader working for JPM accidentally makes a big mistake in his or her trading and destroys that fragile balance supporting the whole massive JPM derivatives pyramid and the whole structure comes crashing down?
Posted 08 May 2003 - 02:39 PM
[B]The Street knows that there are a lot of good reasons for the dollar to decline right now. Slow economic growth in the United States, low domestic interest rates. A climbing U.S. budget and trade deficit. A new Treasury secretary who has made it clear that he won't intervene to prop up the dollar.
My friend what most of us here neglect to mention is, that most currencies these days are based on trust. Early last century most major currencies were covered with gold or silver. Nothing of this sort exists anymore. It takes only one major ripple and the whole consortium can collapse.
Posted 10 May 2003 - 10:28 PM
Thirty-three Year Decline by Michael W. Hodges, Author
Grandfather Economic Report
May 9, 2003
....... In the past several years many average citizens experienced large decreases in the dollar value of their stock market assets due to huge market declines of a bubble economy that was pumped-up by soaring debt. Many more conservative citizens, who stayed away from the market pounding to protect their savings, at least came out with their assets in tack but were later horrified to witness interest earnings on their assets chopped 60%+ the last 2 years as the Fed forced rates to record low levels. On top of this, during the past year comes the huge depreciation of all dollar assets in terms of its international-value, as the dollar falls. All of this leaves the too few US savers (including a lot of seniors) vulnerable and devastated, wondering who represents them and why are powers-to-be making war on savers instead of on debtors?......
MORE AND CHARTS.
Deflation isn't the pressing worry for the U.S. economy. It's the possibility of a "liquidity trap."
May 9, 2003: 11:58 AM EDT
By Justin Lahart, CNN/Money Senior Writer
...... Here's how it works: For some reason (like a busted bubble) everyone gets tremendously worried about the future. The central bank cuts rates, the government passes fiscal stimulus measures, but consumers and businesses are so jittery that they just stuff all that money into the proverbial mattress.
Or at least in Japan, a nation of savers, they stuff it into their mattress. In the United States, a nation of debtors, the money would go (and it seems to be going) to "balance sheet repair." Now both saving and getting oneself out of hock are noble things, but when everyone does it at once, it does the economy no good at all. It's what the economist John Maynard Keynes called "the paradox of thrift."...........
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Have a great weekend!
Posted 11 May 2003 - 09:10 PM
Although the derivatives market still is complicate for me to entirely figure out, everything I have read about *it* gives me the impression the threat is beyond everything I may try to imagine. If the highly knowledgable Jim Sinclair is getting frightened by his own findings, it tells a lot, isnt it?
Never Say Die
Author: Jim Sinclair
How are derivatives different from old soldiers? Simple, they do not fade away when markets change. They only get larger and larger and larger! You want a reason for gold at orders of magnitude higher than $400? Well, try this one!.........
Remember a short while ago when we were shocked that the world wide over the counter derivative number was USD$ 72 trillion. In the last nine months, it has grown to US$142 trillion.
God help us when the long and medium US treasury market finally tops. We will probably in the next three months after a confirmed top in the bond market go over USD$200 trillion on world wide derivative nominal value. These derivative daisy chains will be made larger to supposedly offset the shift in risk that a change in the interest rate structure would transmit across every derivative that exists.
The derivative dealers may win in gold one more time, but they will not win in gold when the interest rate structure changes because the size and short time over which derivatives will vault the US$ 300 trillion level will panic regulators, credit rating services that oversee the derivative dealer parents, and maybe even god himself, herself or its self...........
...... If you thought Enron was a horror, the Sum of All Fears is another word for DERIVATIVE. Buffet's definition of derivatives as a mountain of sewage is in truth, kind.
Ok, OK I will give you one more. Derivatives have laundered more money than all the organized crime that existed on this planet since the first cave man and his kin stole a wife or three from their neighbors. Seems the regulators do not want to find that characteristic of Enron is its true dimension. IMO, Enron was created and existed for no other reason..........
SEE MONEYFILES' SPECIAL PAGE: THE KISS OF DEATH
Posted 12 May 2003 - 12:41 PM
AN ADVICE: PROTECT YOURSELF, DONT LET TOO MANY $$$ ON YOUR BANK ACCOUNT AND CONSIDER TO BUY LIBERTY DOLLAR NOW... AND GET RID OF YOUR DEBT LOAD ASAP.
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King Dollar Meets the Guillotine
9 May 2003 | John Mauldin
Posted on 05/10/2003 2:14 PM PDT by sourcery
King Dollar and the Guillotine
"Whoever you are, I have always depended on the kindness of strangers." (Blanche Dubois from Tennessee Williams' A Streetcar Named Desire.)
The world is in the midst of a major transformation of the global economy. This realignment will mean that a number of trends that have been in place for many years are going to be reversed. These changes have the potential to be quite painful for persons and businesses involved, not only in the US but those abroad as well.
We will look at several individual pieces of the global economic puzzle and then see if we can put them together to give us a true picture of what we face as the decade evolves.
The Kindness of Strangers
The US is "borrowing" roughly $500 billion per year from foreign nations. Our economic growth has been predicated on this borrowing. Of course, the growth of the world economy has been based upon the US expansion. It has been a virtuous circle which is about to reverse into a vicious cycle. The following quote from the ever-insightful Stephen Roach gives us a starting point:
"A saving-short US economy has had to import surplus saving from abroad, mainly from Asia but also from Europe, in order to support economic growth. And the US has had to run a massive balance-of-payments deficit in order to attract that capital. As America's federal budget now goes deeper into deficit, the country's net national saving rate -- for consumers, businesses, and the government sector combined -- could easily plunge from a record low of 1.3% in late 2002 toward "zero." In that case, the US current-account deficit could approach 7% of GDP, requiring about $3 billion of foreign financing every business day. The world has never before faced an external financing burden of that magnitude." (Stephen Roach of Morgan Stanley) ........
Fantasy, the Fed and the falling dollar: Oh my!
I'm increasingly inclined to park more of my hard-earned money in precious metals, where meddling regulators and currency panic can't touch it.
By Bill Fleckenstein
Fantasy's power to reinvent fact can be awesome. So it is on Wall Street, where lots of folks want to believe that every rally will usher in a new bull market. Our post-bubble problems have not gone away, but when fantasy holds sway, the market can "act" as if our troubles were behind us. The slide in the dollar (down 27% against the euro since July 2001 and 14% since the end of October), I would note, has been no act, though most people don't seem to care yet. With an irresponsible Fed chairman calling the shots, that complacency may change. See the numbers
that lenders see.
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Readers know that I have complete contempt for the Federal Reserve, but last week, thinking about what they were up to began to scare the daylights out of me. In Tuesday's FOMC statement, the Fed cited as a concern "an unwelcome substantial fall in inflation," which to me is the clearest declaration yet that they will not tolerate "not enough inflation." At some point, I fear foreigners are going to freak out.
I believe it's only a matter of time before a complete panic is on in the dollar. I fear for the value of the paper dollars that I have accumulated over time, and I'm not going to let the Fed cheat me out of my hard-earned money without putting up a fight. (I may be overreacting, and I may be way too early. Nonetheless, the Fed has no business saying that it won't tolerate "not enough inflation," or that it won't tolerate deflation, even though I think deflation is unlikely.).........
Posted 12 May 2003 - 10:30 PM
Chart looks like the US$ fell off a cliff.
Loonie closes just under 72 cents US
Last Updated Mon, 12 May 2003 17:32:29
TORONTO - The Canadian dollar continued to hit five-year highs as it moved above 72 cents US early on Monday, but lost ground later.
In morning trading, the loonie got up to 72.21 cents US, before pulling back. It settled at 71.92 cents US, up 0.12.
The loonie last finished above 72 cents US on October 20, 1997, when it closed at 72.19 cents US.
The Canadian dollar's gain comes as the U.S. greenback continued its decline amid concerns over the health of the American economy.
Posted 13 May 2003 - 09:29 AM
US backs off from 'strong dollar'
A weak dollar will help exports, Snow says
US Treasury Secretary John Snow has broken with the long tradition of backing a strong dollar, hinting that the boost to exports from a weaker greenback is a welcome change.
Posted 13 May 2003 - 09:29 AM
US backs off from 'strong dollar'
A weak dollar will help exports, Snow says
US Treasury Secretary John Snow has broken with the long tradition of backing a strong dollar, hinting that the boost to exports from a weaker greenback is a welcome change.
Posted 13 May 2003 - 09:25 PM
It seems that the Fed is signalling to the market that it is shifting from its traditionally advertised role of fighting inflation to fighting deflation. Most experts, including Fed officials, are of the view that deflation is a much greater menace than inflation and therefore deserves special attention.
It is held that a fall in prices, which is termed deflation, causes consumers to postpone their buying of goods and services. In short, if people hold on to their money during deflation its purchasing power will increase and this will enable them to buy more goods some time in the future. It is for this reason, so it is held, that people choose to spend less once prices are falling.
It is further believed that since consumer spending is almost 70% of GDP this means a cut in consumer spending would slow down the economy. A slower economy in turn, would cause businesses to retrench labor, increasing unemployment and slowing consumer spending further. All this intensifies the economic slump and depresses prices further. According to this way of thinking, falling prices set in motion a vicious downward spiral that spreads economic havoc.
The usual examples cited are the U.S. 1930's Great Depression and the current Japanese economic slump. In the U.S. between January 1930 and May 1933 the consumer price index (CPI) fell by 26.3%. This fall in the CPI was accompanied by a sharp decline of 47% in industrial production between January 1930 and July 1932.
According to Murray Rothbard,
Improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards.
Prices will also develop a declining tendency on account of the bursting of the monetary bubble. In other words, once the bubble is burst this undermines various nonwealth-generating activities that sprang up on the back of prior monetary pumping. Note however, that this fall in prices is welcome news because the fall indicates that the diversion of real wealth from productive activities was arrested. In short, a fall in prices is indicative that the healing of the economy has begun.
On this Mises wrote,
As soon as the depression appears, there is a general lament over deflation and people clamor for a continuation of the expansionist policy. . . . Every firm is intent upon increasing its cash holdings, and these endeavors affect the ratio between the supply of money (in the broader sense) and the demand for money (in the broader sense) for cash holding. This may be properly called deflation. But it is a serious blunder to believe that the fall in commodity prices is caused by this striving after cash holding. The causation is the other way around. Prices of the factors of production-both material and human-have reached an excessive height in the boom period. They must come down before business can become profitable again. The entrepreneurs enlarge their cash holding because they abstain from buying goods and hiring workers as long as the structure of prices and wages is not adjusted to the real state of the market data. Thus any attempt of the government of the labor unions to prevent or to delay this adjustment merely prolongs the stagnation.
It follows then that a fall in prices, which is labelled as price deflation, is always good news.
The Fed may have painted itself into a corner
Despite all the attempts that the Fed is likely to make in order to inflate the economy there is a possibility that it may fail. Why is that so? The main reason is that the current aggressive loose monetary policy, in addition to previous loose monetary policies, may have severely weakened the pool of real funding-the heart of economic growth. Various indications raise the likelihood that this pool is in trouble. For instance the income-to-consumption ratio is in free fall. In fact the fall in this ratio is currently much steeper than during the Great Depression.
Posted 13 May 2003 - 10:00 PM
Although I am very hesitant to disagree with a quote from Mises,I'm going to have to.
Under "normal" circumstances moderate deflation caused by increased productivity is a healthy thing and benefits everybody as it raises living standards,so far so good.
The current problem is that lack of pricing power threatens to bankrupt too many companies,and put too many americans out of work.The level of debt in the economy results in people not spending OR saving,merely servicing debt which in a deflation would be secured by depreciating assets.
And here is the really big problem,our tax structure is such that rising asset prices result in revenue,government became addicted to that revenue during the bull market,and any real deflation in asset prices would put the debt markets underwater,as the assets securing the debts depreciate. So any real and lasting deflation will result in massive bankruptcy in the personal, corporate and government arenas,which would lead to more severe deflation,which would lead to more bankruptcy. This is what I mean when I say "bankruptcy cascade"
If you believe,as I do, that the debt and malinvestment built up during the boom must be eliminated from the system before we can move forward,then the only possibilities are a bankruptcy cascade or sufficient monetary stimulus to result in inflation severe enough to bring the debt burden down to healthy levels. The worlds largest debtor nation is unlikely to opt for deflation,which is why I believe they have chosen to prop up the housing,bond and EQUITY markets through interest rates and the use of options,derivatives and outright purchases of treasuries and perhaps stocks as well. They will monetize any and all assets they need to to avoid insolvency,at the expense of the value of the currency,even if they drive it to worthlessness in the process.
Deflation in terms of the dollar is not a risk we the people have to worry about.
Posted 13 May 2003 - 10:20 PM
(From the Economist) -- In uncertain times, gold still retains a special lustre for some investors: although its price has fallen back from recent, war-spurred highs, it is fetching about $340 an ounce, up from $280 at the beginning of 2002. Yet gold's golden age, so to speak, is long gone. Since the 1970s it has become almost like any other precious metal, and increasingly one that central banks no longer care to hold in reserve.
That is why the gold industry is looking to China in hope. For decades the country severely restricted the buying and selling of gold, which put a heavy damper on demand. Now, however, China is liberalising. When India did likewise in 1996, it promptly overtook America as the world's largest consumer. China, now in third place, might also begin to climb the league.
Until last year, its central bank fixed the domestic price of gold. It bought all the gold produced by China's 1,000 or so mines and allocated it to jewellers. This ended in October when a gold exchange opened in Shanghai where producers and wholesalers trade directly with one another. In March, the central bank went further and gave up its power to license producers and retailers. Now anybody can enter the gold business in China.
A far bigger change is planned for June, when individuals will be allowed to invest in gold, either by buying ingots or by opening gold accounts at their banks. China has one of the highest savings rates in the world, officially about 40%. But its mutual-fund industry and stockmarkets are fledglings, so the Chinese keep most of their money in humdrum bank deposits, which pay a miserly 2% in interest before tax. If India's experience is a guide, many will now shift their money into gold.
This will drive up prices inside China. Since Chinese demand (200 tonnes) already outstrips domestic production (190 tonnes), it will also lead to more imports. International trade, however, is one aspect that the central bank is not eager to liberalise. Its biggest task during this decade is to prepare the yuan for convertibility. But until that happens it will be wary of free international flows of gold, which could serve as a proxy for hard currency.
Still, even this is only a matter of time. "Gold has no boundaries," says Albert Cheng, a director of the World Gold Council, an industry body that has been lobbying the Chinese government for a decade. "If China's demand goes up, it will help everybody."
(I would add to the above: According to the 2002 bestseller "The Coming Collapse of China", most of the PRC's banks are actually insolvent, casualties of a failed command economy that can't admit failure. Gold would offer the average Chinese a far more attractive and sound investment and savings vehicle than a bank floating on a sea of "non-performing" loans. JMO, as always).
Posted 13 May 2003 - 10:24 PM
So you are not expecting the dollar/euro to stop sliding around 1.20
bush scares me, not because he dont care about amerikans and turning them into beggars, but he wants to turn us all into beggars and I am not sure he knows what he is doing.
I agree with you but I am not sure they are doing it on purpose, greenie already said they are ready to monitise the debt, that would mean the dollar would be worth even less. So why is there not a flood? All those people holding trillions arent stupid enough to not realise that they are basically holding worthless paper and when everyone runs for the exists they will have to pay others to keep holding it rather than getting something for it.
Posted 14 May 2003 - 02:25 PM
Gold may have retreated from its pre-war highs, but the bull market will persist for at least the remainder of 2003, according to research house AME Mineral Economics.
AME said a combination of political tensions, the threat of recession, the outbreak of SARS and fundamental factors would underpin the gold price.
It said tangible supply and demand factors supported a long-term price rise out to 2007.
"This includes a levelling off of mined supply, an increase in end-use fabrication, reduction in hedging activity, controlled official sector sales, deregulation of key markets and a concerted industry marketing effort to promote gold both in jewellery and as an investment."
AME's new report, GoldMine Costs 1998-2007, said a sustained period of falling exploration expenditure due to low industry profit margins would result in a fall in gold supply.
It said the estimated 2515 tonnes of gold mined last year was the lowest since 1997 and marked the first time since 1995 that annual gold production had fallen.
AME also said that although AngloGold lost its crown as the world's biggest gold producer following Newmont's takeover of Normandy and Franco-Nevada, it has emerged as the world's lowest-cost producer among the global players.
AME's analysis showed the United States was no longer the lowest-cost producer among the four major gold producing countries.
The average production costs for western world mines in 2002 was estimated at $US217 per ounce.
This story was found at: http://www.theage.co...1987604610.html
Posted 14 May 2003 - 03:54 PM
The June Euro was lower overnight due to light profit taking as it consolidates some of this spring's rally but remains above the 75% retracement level of the 1998-2000 decline crossing at 113.61. If June extends this spring's rally, weekly resistance crossing at 119.19 is a potential target later this spring. The daily ADX (a trend-following indicator) is bullish signaling that sideways to higher prices are possible near-term. Closes below last Thursday's low crossing at 112.93 would greatly increase the odds that a short-term top has been posted. Overnight action sets the stage for a steady to weaker tone in early-day session trading.
The June British Pound was higher overnight and is poised to test the 75% retracement level of this year's decline crossing at 1.6146 possibly later today. Stochastics and the RSI are overbought but are turning neutral to bullish hinting that additional gains are possible near-term. Closes below last Wednesday's low at 1.5864 would increase the odds that this spring's rally has come to an end. Overnight action sets the stage for a steady to firmer tone in early-day session trading.
The June Swiss Franc was lower overnight due to profit taking as it consolidates some of this spring's rally but remains above broken resistance marked by March's high crossing at .7577. If the rally off April's low continues, long-term resistance crossing at .7920 is a potential target later this spring. The daily ADX remains bullish hinting that sideways to higher prices are possible near-term. Closes below the 10-day moving average crossing at .7558 would signal that a short-term top has likely been posted. Overnight action sets the stage for a steady to weaker tone in early-day session trading.
The June Canadian Dollar was slightly lower overnight as it continues to consolidate below the 38% retracement level of the 1991-2002 decline crossing at .7215. Closes above this resistance level would open the door for a possible test of the October 1997 high on the monthly chart crossing at .7335 later this spring. Closes below the 10-day moving average crossing at .7129 would signal that a short-term top has likely been posted. Momentum indicators are overbought while the daily ADX (a trend-following indicator) is bullish signaling that sideways to higher prices are possible near-term. Overnight action sets the stage for a steady to weaker tone in early-day session trading.
The June Japanese Yen was lower overnight and hints that the two-day rebound off last Friday's low might be coming to an end. Closes below the 10-day moving average crossing at .8526 would confirm that last Thursday's high marked a double top with March's high crossing at .8645. Stochastics and the RSI are overbought but remain bullish hinting that additional strength is still possible near-term. Overnight action sets the stage for a steady to weaker tone in early-day session trading.
Posted 14 May 2003 - 09:30 PM
Dollar Is In Big Trouble
5/13/03 12:57:59 PM
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US Fed acknowledges deflation threat
By Nick Beams
12 May 2003
The statement from the Federal Reserve Board last Tuesday announcing its decision to keep its interest rate on hold at 1.25 percent Tuesday was just four paragraphs long but it attracted attention around the world. It wasn't the decision itself-that had been expected-but the accompanying statement on the economic outlook that sent a tremor through international financial markets.
According to the Fed, over the next few quarters the upside and downside risks to the attainment of economic growth were 'roughly equal'. But then an additional assessment was offered: 'In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level.' Consequently, the 'balance of risks' was weighted to the 'downside' for the foreseeable future.
What this rather convoluted phrasing added up to was that, after decades of trying to contain price increases, the Fed had offered an official assessment that too-low inflation represented a danger to the US economy. The signs that such a re-orientation in policy was about to be undertaken were clearly visible in the days leading up to the May 6 meeting of the Federal Open Market Committee (FOMC).
On April 30 Fed chairman Alan Greenspan, in testimony to the House of Representatives Financial Services Committee, warned that with price inflation already low, 'substantial disinflation would be an unwelcome development, especially to the extent that it put pressure on profit margins and impeded the revival of business spending.'
In March, senior Fed staff member Vincent Reinhart told the National Association of Business Economists that times had changed. 'For the first time in 40 years,' he said, 'the Federal Open Market Committee is not in a position where it should obviously desire inflation to be lower than its current rate.'
Minutes of the FOMC meeting of March 18, released last week, highlight the growing concern among Fed members over lower price levels. 'Members saw further disinflation in core prices as a distinct possibility over the next several quarters,' the minutes noted.
They were also pessimistic about the possibility of increased business investment, which is regarded as crucial for any sustained upturn in the US economy. There were a 'variety of factors' likely to induce business firms to continue to hold back on investment decisions in the near term and there was 'as yet not persuasive evidence that business fixed investment would provide the needed support for the strengthening in overall economic activity.'
The immediate problem created by lower than normal price increases (disinflation) or outright price declines (deflation) is the setting up of a vicious economic circle. Stagnant or falling prices, reflecting lower profits, increase real interest rates and the debt burden on businesses, prompting them to cut back investment decisions. This leads in turn to a fall in economic growth, reduced profits, further price cutting and higher real interest rates and lower prices as firms try to maintain their share of the market.
Under these conditions, the ability of the Fed to stimulate the economy becomes increasingly restricted because interest rate cuts, aimed at trying to boost business investment, are overshadowed by the fall in prices. According to former Fed governor Laurence Myer, much of the benefit of the Fed's interest rate cut of half a percentage point last November has already been wiped out by the fall in the inflation rate since then. Real interest rates, he has concluded, after adjustment for inflation, are as high as they were six months ago.
The Fed's statement that it expected growth to recover, but was nevertheless worried by low inflation, has been interpreted as a commitment that it will not raise interest rates until the threat of deflation has passed. However, it remains to be seen whether the Fed can uphold such a commitment. This is because the sharp fall in the US dollar over the past few weeks is tending to increase American interest rates.
Following the Fed statement last week, the dollar fell to a four-year low of $1.15 against the euro. The euro has been steadily rising against the dollar for the past 10 months, after falling for the first three years of its existence, and on present trends may soon reach, or even exceed, its January 1999 issue level of $1.18.
The main factor in the fall of the dollar is the shift out of American financial markets by private foreign investors fearful that, with a record balance of payments gap of around $500 billion coupled with rising budget deficits, the value of the dollar is going to drop further, causing them significant losses.
While the general consensus among economists is that the US dollar should start to fall over the longer term, thereby boosting exports and easing deflationary pressures, there are concerns that serious financial consequences could follow if the decline is too rapid.
As the Washington Post's economic commentator Paul Blustein noted, '[A] tumble in the dollar risks getting out of hand by prompting foreign investors to dump their holdings of US stocks and bonds, which could drive interest rates up and choke off US economic growth.'
According to International Monetary Fund chief economist, Kenneth Rogoff, while a moderate fall in the dollar would be a 'welcome correction', a sudden decline 'might lay bare weaknesses in the financial system' by causing huge losses for financial operators who had banked on the US dollar remaining stable or declining at a gradual rate.
The situation is further complicated by the contradictions besetting the world economy as a whole, some of which were elaborated by Morgan Stanley chief economist Stephen Roach in an article published in the Japanese newspaper Nihon Keizai Shimbun on May 1.
Roach began by pointing out that the threat of deflation reflects 'the inherent tensions of an increasingly dysfunctional global economy.' Since 1995, demand in the US has increased on average by 4 percent a year, double the 2 percent annual increase in the rest of the world. This has meant that the US accounted for 64 percent of the cumulative increase in world gross domestic product in the period 1994-2001-double its share of the world economy.
This imbalance has expressed itself in the growing US balance of payments gap which, if it continues, could reach the equivalent of 7 percent of gross domestic product (GDP), requiring a foreign capital inflow of $3 billion every business day. 'The world,' as Roach noted, 'has never before faced an external financing burden of that magnitude.'
The other major problem to which he pointed is the growth of excess capacity in key industries, a legacy of the collapse of the financial bubble of the late 1990s. In this respect 'the American disease bears an eerie resemblance to the Japanese strain.'
A so-called 'rebalancing' of the world economy would require a fall in the value of the US dollar and a consequent appreciation of the yen and the euro. But this would lead in turn to cuts in demand for both eurozone and Japanese exports, under conditions where both these economic regions have relied on external demand to promote growth.
If rising currency values led to falling growth rates via a reduction in export demand, this could bring financial complications as well. The consequences of low growth and deflation are already visible in Japan, where the bad loan problems of the banks and major financial institutions have steadily worsened over the past decade. Now there is a danger that the same process could afflict the German financial system as well.
Examining each component of the world economy in this way reveals a series of interconnected contradictions.
The US economy needs a fall in the value of the dollar to increase exports and cut its balance of payments deficit but without too rapid a decline which would precipitate a capital outflow, interest rate hikes and recession. Europe and Japan, however, do not want to see appreciation of their currencies and a consequent reduction in markets. On the other hand, however, the process which has seen them finance the US deficit, thereby maintaining a 'strong' dollar, cannot continue indefinitely.
While it is not possible to predict exactly how these contradictions will unfold, the fact that they have emerged with such sharpness points to the development of a major financial crisis of which deflation is a harbinger.
Posted 15 May 2003 - 10:13 PM
A word of caution! For those of you that have done quite well in the Euro and Canadian dollar please take note. Every market ebbs and flows as it reaches for a final bottom or top.
We have witnessed a significant fall in the US dollar to present levels. Right now I want you to stay tuned to the .945 support and .955 resistances. A close above .955 could rally the dollar back to the general .98 area. I am not saying this will occur but in the end it's the market that is always right.
As you can see, we have not put together three rising days in the dollar in a long time. If it occurs here and closes above the .955 level, I would close my trading positions temporarily in the Euro and the Canadian dollar.
As for gold, we are still working a resistance higher than I suspected. I anticipated the top of the resistance to hold us back for a while was $348.50 but it looks like $352 was the resistance top. We closed at $350.50 today and are somewhat on the defensive this evening.
I do not expect any reaction here to endanger the basic uptrend #1 noted on the chart although it could be contained at up trend #2. I believe it all depends on the dollar so a close under .945 gives you the low $360s. A dollar at .92 gives you $380. A close above .955 will give us a short term reaction in gold depending on how long it holds an uptrend to UT #3, #2 or #1.
Just consider this a Heads Up, not a call to action.
May 13, 2003
Jim responds to a reader's questions
Q: Jim. You have mentioned on occasion that for gold to re-enter the monetary system to backstop the dollar it must do so before the price reaches $529 an ounce. Further, you state that this event will come about before June 2004. Why June 2004?
A: As everyone knows, 2004 is an election year in the USA. Gold will not be used if it is not required. If the dollar is still weak and the economy has not recovered to sustain a bull market in general equities, then gold will come into play in the unique and new way I have outlined.
Please understand that gold will not serve as a convertible asset for the dollar nor will there be any official re-valuation of the gold price. There will be a recognition of the market price by the US treasury as the value of the gold held at the NY Fed on their behalf.
Gold will serve as it did for the Federal Reserve Gold Certificate Ratio but this time will be different. It will be tied to the annual rate of growth of M3 above a 3% level. If M3 contracts, nothing happens in the value of treasury gold.
The optimum time for a bottom in general equities that can be supported by an improving economy measured from the breakdown of general equities world wide in the first quarter of 2000 is June of 2004.
If this bottom does not develop in economic terms, then gold will be utilized to help it happen. Please note that the year after gold was revalued by the Roosevelt Administration was the best year in the 1930's for general equities as well as gold shares.
Q: If gold does not return to help the dollar by that date what happens?
A: The question is not relevant since, IMO, gold will return if all else fails and not return if other measures now being taken to resuscitate the stock market actually work. What gold does then depends on the variables we will have to access at that time.
Q: Does gold start a chain reaction that can't be stopped and so blows through 529 wrecking bush's effort to gain another term?
A: Gold never starts or does anything. Gold reacts to other things. Gold never changes in value. Currencies change in value relative to gold. This is the 'Golden Perspective you must understand to be a player in this market.. This perspective is what any gold producer hedger lacks.
Q: Are you implying an exploding gold price summer/autumn 2004 if it is not brought back officially by June?
A: No. What I am saying is that when things go wrong for the dollar, for the worldwide OTC derivatives, and in general equities, gold could before 06/01/2004 move out of a normal bull phase as it did in 1979 and move into a run away market. I see that as bad for gold because such a run away market would only occur as a short squeeze and cover.
No short squeeze and cover in history has ever held its final price or its uptrend. Gold would if it broke through $529 and then moved above $1200. The result is gold would disqualify itself as a currency due to volatility.
When gold finally brakes, as gold did at the $887.50 high in 1980, I believe gold will have a hard time holding the $248 when it returns there two years later. I say this because of the implications economically of what would cause gold to make that plus $529 run to the four figure level in the first place.
All you want to think of when gold breaks $529 is when you get out of gold and all gold related investments. It will be later and higher but few will then take that mind set.
May 13, 2003
Need more reasons for gold over $400?
Last Monday 52 people were killed in Chechnya in a terrorist bombing incident. Since yesterday, more than 29 deaths (including nine terrorists) have been reported from an apparent al Qaeda suicide attack on residential compounds in Saudi Arabia. Seven of the victims were American nationals and almost 200 other people were wounded, some critically.
News reports quote a US survivor as saying ''The fact that they have attacked three compounds in a coordinated way sends a message to the Western community that we are not safe here. It's like they're saying, 'We can get you any time, anywhere.'"
The attack was well planned, precise and disciplined and achieved its objectives despite accurate and coordinated fire from opposing forces as the terrorists pressed their attack on the compound.
Both attacks were hardly the work of amateurs, proving once again that we are up against formidable forces who conduct war on their terms only. Do not be fooled by the quick and decisive victories produced by Western-style wars in Iraq and Yugoslavia.
Only Special Forces can wage war against al Qaeda on its terms and be successful. Terrorists can only be beaten with terror as there is no other effective means to defeat them given the fact they are willing to die for their cause.
Therefore, these twin al Qaeda events lend credence to the immediate need for answers to the following important questions.
1/ Are we involved in World War 3?"
2/ What is the cost of this emerging global conflict?
3/ Did the US/Brits win in Iraq or will we end up fighting the traditional Arab war of attrition from within which could extend our present commitment in Iraq into decades and cause untold casualties.
Then there is an even more important question to ask. In discovering the perpetrators of these heinous attacks, finding their sources of finance will be critical. That being the case, what major world nation in competition for economic and political leadership has had no attacks by al Qaeda?
This question might well identify the "Fifth Column" that history teaches us is often behind major conflicts conducted under the guise of a new political ideology. But this story is for another day.
Russia Check Mates the US
On control of Oil Prices
Need another reason for gold over $400? Russia has made public its attention to work with OPEC (by invitation) for the purpose of controlling the price of oil.
US control of the Iraqi oil fields, although quite pivotal to the price of oil, will not set OPEC on its rear end as so many expected. All the US has accomplished is to guarantee supplies of Iraqi oil production and not much else.
Posted 16 May 2003 - 12:18 PM
The slow recovery in the United States and the record current account deficit of $547-billion will cause continuing selling of the U.S. dollar, which will boost the Canadian currency further, according to BNP Paribas.
BNP Paribas raised its Canadian dollar forecast to 78 cents, or $1.28 (Canadian) by the end of this year.
The U.S. 10-year Treasury bond yield tumbled yesterday to a 45-year low of 3.51 per cent, causing investors to look elsewhere for higher returns. The yield on the comparable Government of Canada bond is at 4.74 per cent.
Tim Wood wrote...likely to see a return to the bad old days of sub-$300 gold if interest rates.....
If the economics turn around and cause short-term interest rates to jump out of the free money regimen we are in, we are likely to see a return to the bad old days of sub-$300 gold.Smith's long range view is clouded by the continued decline in Indian, Chinese and European demand with rumbling noises in the once stalwart American jewellery market. There is also a boatload of fear to sniff out of central banks.More.......
Posted 22 May 2003 - 11:07 AM
An economic 'menu of pain'
By Laurence J. Kotlikoff and Jeffrey Sachs, 5/19/2003
UR GOVERNMENT is going broke. The feds face bills that are far beyond our capacity to pay -- by $44 trillion to be precise. The longer we ignore them, the bigger they get. Yet President Bush is working overtime to deepen our fiscal trap. This $44 trillion figure is not ours. Nor is it some other academics' calculation. It was produced last fall by economists and budget analysts at the US Treasury, the Federal Reserve, the Office of Management and Budget, and the Congressional Budget Office. The study was ordered by then Treasury Secretary Paul O'Neil and was slated to appear in the president's budget, released in February.
The answer is no, and the fiscal gap is the $44 trillion. Now, that is big bucks by anyone's definition. It's four times current GNP and 12 times official debt. Imagine everyone in the country working for four years and handing over every penny earned to pay this bill, and you'll grasp its size.
Unfortunately, we can't ascribe the $44 trillion calculation to overly pessimistic assumptions. On the contrary, the assumptions are optimistic with respect to future longevity as well as growth in federal health expenditures, discretionary spending, and labor productivity.
Posted 22 May 2003 - 12:00 PM
>"The huge imports of foreign goods, which amounted to 452 US dollars in 2000 and to 427 billion US dollars in 2001, have kept down the domestic price level thereby contributing further to lower interest rates and higher real growth."<<
I see in this all the good things that economists tell you why unfettered free trade is a good thing: Low interest rates, growth, and "aquired efficiency" from imports.
I read a few economists arguments, and kept thinking to myself: "Yeah, but who's going to pay for it?"
Silly me because according to the articles I read, its not just that someone is owed money. Its also that someone else now has an asset. See, its better than zero sum. Now the producer has capital coming to him and the importer has a product. Can't lose.
But I kept thinking: "Yep, but someone better check the books from time to time."
Goods depreciate in value quicker than currency devalues from inflation. And a lot of goods like food and other perishables disappear off the shelves. And the debt remains. And of course there's the interest on the debt.
Anyone here who can see where I'm wrong? I'm not that knowledgable about economics.
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