This is not the normal kossack diary but bear with it, it's a powerful indictment of Bush. I'm sure you've noticed the odd conservative finance person here and there saying something about US monetary policy and the out of place news bit on Warren Buffet types betting against the dollar. Maybe you heard something about the Korean central bank recently selling dollars? What's up? Well not the dollar.
A little history is in order. During WW2 a global monetary policy was created at a meeting in Bretton Woods, NH (I kid you not). Under the Bretton Woods system, central banks of countries other than the US were given the task of maintaining fixed exchange rates between their currencies and the dollar. They did this by intervening in foreign exchange markets. If a country's currency was too high relative to the dollar, its central bank would sell its currency in exchange for dollars, driving down the value of its currency. Conversely, if the value of a country's money was too low, the country would buy its own currency, thereby driving up the price. The idea was that the dollar would stay relatively STABLE....more
What we are coming to is almost an informal Bretton Woods 2 or as an analyst recently said, a global game of Old Maid only in this case it's the Dollar you don't want to get caught holding.
Remember, the USA Borrows when it has large deficits. It Borrows from other countries. Asian countries are now taking US dollars that are going to be worth less at some future point than they are today. This is not some paper transaction, costless central bank game. These will be real losses of buying power and in some countries can mean significant (I mean quite large in terms of GDP) loss of cash reserves, especially for some of the smaller Asian economies. So at some point they have to invest in currencies that are more Stable and worth more. Let's say the US government needs money to finance oh a war or two or maybe the $1-2 trillion to 'privatize Social Security. In today's climate, it won't happen without a good deal of pain.
I've read different analysts opinions and their verdict on a major re-adjustment of currencies is between 2-6 years. That means some currencies increase in value and some decrease. Guess where the dollar is?
Here's a a quote from Stephen Roach (Chief Economist, Morgan Stanley):
"Global rebalancing does not occur spontaneously. It takes adjustments in economic policies and asset prices to spark a meaningful realignment in the mix of global growth. Shifts in currencies and real interest rates are the two major instruments of rebalancing. The ideal prescription for today's lopsided US-centric world would be a combination of dollar weakness and a rise in US real interest rates. However, there is serious risk that the Fed will not execute the full-blown normalization of real interest rates that the US economy requires. If that's the case, then there will be even greater pressure on currency adjustments to correct today's imbalances - a development that could take world financial markets by great surprise."
Asia is a big part of the picture so Let's take a side trip and look at a few paragraphs from a recent Korea Times:
"The local currency market is turning into one of the most popular playgrounds for hedge funds, with the won (Korean currency) becoming the main target by the international speculative funds aimed at short-term gains, analysts said.
"Hedge funds are viewed as the main force behind the won's steep gains recently, they said. It is concerned that they will continue to bet on a stronger won, a major negative for the country's economic recovery.
"Hedge funds were one of the main forces behind the 1997-1998 financial crisis. They usually grow on volatile currency markets."
Notice how hedge funds were one of the main forces behind the 97-98 crisis? Back then, hedge funds shorted the local currencies. Now, they are shorting the dollar and buying the Korean won. They are saying that the won is a stronger currency than the dollar. This of course has Korean authorities upset as they want to keep their currency weak while they sell their dollar holdings.
So, if you're an Asian central bank and have a lot of dollars based on your loans to the US, you're in trouble. Why? 'Cause the mighty dollar isn't worth as much as it used to be. As you may recall those old European currencies have made a rather remarkable transition to the Euro. Two short years ago 88 cents got you one euro. Today it takes $1.36 to get one euro. Is that eye opening enough?
Not to pick on the Koreans, but this dilemma is facing all of Asia. When do you start the diversification process? How much of a loss do you take? Another analyst, Dennis Gartman says:
"Finally, while discussing the US dollar, we thought it interesting to note comments from Mr. Pierre Lassonde, the President of Newmont Mining. Mr. Lassonde has been steadfastly bearish of the US dollar for quite some long while and has been correct, so we give his views some larger credence than we might otherwise give that past performance. He believes strongly that the dollar has much further to fall. With private capital flows insufficient to fund the US' current account deficit, and now with the additional loss of foreign central banks as suggested by the statements much earlier this week by the S. Korean central bank, Mr. Lassonde speaks now of a literal run on the dollar.
"Following S. Korea's 'lead,' he expects countries like Malaysia, Thailand and Singapore 'to be the next defectors... [for] the appetite of foreign central banks for US dollars is starting to wane.' Interestingly, Mr. Lassonde said that Japan and China shall be the last countries to continue to support the dollar, for they have such enormous positions already established that they've no choice but to hold to their present course of action and try to defend their positions. If we had to bet, we'd bet that Malaysia will be next on the list to join S. Korea."
In other words, no one wants to be caught with the Old Maid which is now the dollar. So what happens at home during all this?
Roubini and Setser (more analysts) have a sense of the problem when they write:
"If the US does not take policy steps to reduce its need for external financing before it exhausts the world's central banks willingness to keep adding to their dollar reserves - and if the rest of the world does not take steps to reduce its dependence on an unsustainable expansion in US domestic demand to support its own growth -- the risk of a hard landing for the US and global economy will grow. The basic outlines of a hard landing are easy to envision: a sharp fall in the value of the US dollar, a rapid increase in US long-term interest rates and a sharp fall in the price of a range of risk assets including equities and housing. The asset price adjustment would lead to a severe slowdown in the US, and the fall in US imports associated with the US slowdown and the dollar's fall would lead to a global severe economic slowdown, if not an outright recession."
Chickens come home to roost. This is being fueled by ever increasing deficits from the biggest borrow and spend government ever. Bottom line, Clinton was on the right track and Bush is not. What I've found is the dire warnings from folks like From The Wilderness are now matching much more 'conservative' sources like the ones I've quoted here. It will take extra ordinary cooperation both from other countries, Congress, the financial community, led by the least competent President ever to turn this mess around. I'd like to be more hopeful and helpful but we're likely to be entering a painful period. I usually try to find the positive and the way up and out but just like our collective stupidity in not addressing environmental issues we may be too late to fix this one too. Onward thru wever it is.
Note: Most of the info was obtained from John Mauldin's comment at http://www.investorsinsight.com/