Watch the dollar! We watched yesterday, but nothing much happened to the dollar. Instead, stocks fell. “Stocks mark worst drop in months,” reported Reuters.
Still, it wasn’t much of a drop – just 150 points. We’ve seen much worse. In fact, we think we will see worse. Booms are followed by busts; that’s just the way it works.
But as the boom goes on, more and more people think the bust will never come – that’s just the way it works too. And they begin to develop ideas, theories, and illusions that support their perpetual boom longings.
Here, a commentator explains why, although things may look bad for the dollar now, they won’t get worse:
“There is still enormous demand for dollars for purposes of financial speculation, ” writes our old friend Rick Ackerman.
“This fact is indisputable when you consider that there are $370 trillion of derivatives in play in a world [that] produces only about $55 trillion in real goods and services…[and] we can discount fears that China and Japan, the dollar’s main supporters, are about to diversify out of dollars in any meaningful way, as they’ve long threatened to do. The simple fact is that, to keep their export-based economies running smoothly, they will do whatever it takes to keep their respective currencies from appreciating. In the case of China, the tactic is more than merely expedient, since any slowing of the country’s manufacturing economy risks idling millions of workers who have migrated from rural China to urban manufacturing centers and huge factory towns.
“Meanwhile, although the dollar may look sickly at the moment, I doubt that its collapse is imminent. If I am right, we should expect the stock market to rebound with the dollar in the days and weeks ahead.”
But then, he covers himself too: “However, I am not married to this scenario,” he adds.
To Rick’s analysis we add another:
“Fallacy of U.S. as a debtor nation” is the headline of a research paper from Deutsche Bank.
“We believe the prevailing view of the [United States] as a net debtor nation is no longer appropriate and instead regard the [United States] as the world’s most powerful financial hegemon,” says the report, with unblushing ardor.
Okay…the gauntlet has been thrown down. We must pick it up. We’re not afraid of opposing views here at the Markets and Money. Just so long as they’re expressed clearly and stupidly enough for us to laugh at them. But the Deutsche Bank team disappoints us. It makes a powerful claim:
“Not only is the dollar not in decline but it is actually getting stronger and the international currency system remains exceptionally stable. In fact, we believe a global economic empire – meaning a cycling of funds that guarantees global prosperity – is not in place and that the global economy is thus entering a period of long term prosperity.”
But then, reading on for proof, we can’t seem to find it.
“The dollar’s dispersion on the back of the U.S. trade deficit and direct U.S. investment abroad has functioned to supply the world with growth currency and sharply boost global economic growth. This is nothing less than global Keynesianism. In short, the supply of currency from the [United States] has turned dormant resources and labor overseas into effective economic resources, driving a sharp increase in the global economy’s growth potential.”
All right so far…we agree. This is just what has happened. The U.S. dollar has worked its magic on the whole world – misleading practically everyone. As the supply of dollars increased, people took it as an increase in real demand. They started digging holes in Chile so they could bring up copper out of the ground. They began setting up tables in China where young women from the country could sit down and put gadgets together. They hooked up telephone systems in India and taught the locals to speak with midwestern accents so they could take orders for new gizmos.
Inflation of the worldwide money supply – with dollars – has produced a boom. No doubt about it. Our disagreement is not about the past, but about the future. The Deutsche Bank team sees a boom…followed by another boom. When we see a boom, on the other hand, we get suspicious.
Both they and we wonder marvel at how stable the world economy…and the dollar…have been.
“This stability appears to make little sense given the [United States’] massive current-account deficit,” they comment.
At $800 billion, the world has never seen anything like it. Normally, it would mean an increase in U.S. net debt, with which would come an obligation to pay interest. This year’s deficit equals 7% of GDP. Ten years at this rate would put the accumulated debt at 70% of GDP. At 5% interest, this would mean that the United States was paying out 3.5% of its GDP in interest to foreigners – an amount equal to all its GDP growth, and then some…forever.
Not good. But don’t worry; the system will blow up long before that happens. Team Deutsche Bank figures there must be a reason it hasn’t blown up already; their analysts come to the conclusion that the system is not unstable at all. Maybe it will never blow up!
What the researchers think they see is a “new global imperial cycle.” It is based, they say, on low-cost Asian labor, superior management and skills of U.S. companies, different rates of return from United States vs. foreign investments, high profits in the financial sector, high leverage, and the profit that the United States makes from issuing its own currency to the rest of the world. All of these factors, they say, give the United States an advantage that doesn’t show up in the world’s flow of funds statistics.
It is a kind of ‘dark matter,’ they seem to be saying. But it is so dark we cannot see it at all. Every one of the factors listed above could be taken as a negative as much as a positive. Low cost Asian labor allows American companies to cut labor costs…and increases their profits. But what happens to the displaced American laborers? How will they afford to buy the imported products, unless by going into debt (and thereby creating more profits in the financial sector)?
When they finally realize what is happening to them, shouldn’t we expect them to cut back a little? Maybe that is why auto sales are falling. House sales are falling, too. According to the Financial Times, sellers in Las Vegas are so desperate they throw in a free swimming pool and a vacation in Florida when you buy a new house. Cancellation on new house contracts are said to be running as high as 42 percent. And here comes Wal-Mart with the news that its same store sales have just suffered their first decline ever.
And at some point won’t all that leverage turn out to be not so great after all? Leverage is great when prices are rising. But when prices fall, it magnifies your losses.
And then, mightn’t foreigners decide to cut back too? Mightn’t they get a little weary of so much liquidity provided by the U.S. dollar and decide to hold a little more of their wealth in other brands? Isn’t that why the dollar is falling – even while U.S. interest rates are above those of Europe and Japan?
Yes…the system is stable. But it is only stable as long as it is stable. All it takes is something to destabilize it – and then the whole thing begins to wobble, and could fall apart.
We can’t look into the future any better than Deutsche Bank. Looking at the past, we see what they see; the dollar system has been a great success. The easy money it has provided the world has set off a global boom unlike anything in history. But also looking at history, we’ve never read of a Keynesian boom that didn’t end…or a paper-money system that didn’t eventually collapse.
But heck…there’s always a first time.