Response to a Synical Swiss About the Dollar

Over dinner a few weeks ago, I was discussing the falling dollar with some friends, among whom was a Swiss economics journalist. He said something like, "But is the fall of the dollar really very important?"


[Thanks to TradingCharts.com for the chart. Click on it for a larger version.]

I piped up that surely it was, if only because the value of the dollar was a kind of contract, a promise to pay and, given its reputation, a promise to remain a good store of value.

He replied, "But I don't think the dollar is a contract anymore. Everyone knows that currencies are floating, and that they are taking a calculated risk when they hold or invest in them."

I was shocked, even though I realized that technically he is correct. The dollar--in fact all currencies--are based on nothing other than our faith in them. They fluctuate today; everyone knows it. Yet I continue to hold that a strong dollar is in everyone's interest, not only those who travel abroad.

I tried to illustrate the kind of damages that were being done, giving the example of Saudi Arabia, where America has the privilege of buying oil in dollars that are getting weaker and weaker, and because of old agreements the Arabs have nothing to say about it. The conversation moved onto other subjects.

Today, I read this article in The Economist. The following sentence jumped out at me:

"The dollar's decline already amounts to the biggest default in history, having wiped far more off the value of foreigners' assets than any emerging market has ever done."

This speaks for itself, and somehow it carries more weight, coming off the black and white pages of a well-known economic magazine. I hope my Swiss journalist is reading it, too.

How a High-School Dropout Made Millions in Sub-Prime Real Estate Lending

If ever the banking police needed an excuse to regulate the mortgage industry to death, Quick Loan Funding is it.

This Oange County Register article describes the amazing run of Daniel Sadek.

Read his story. It's an eye-opener. He went from Lebanese wartime high school dropout to real estate mogul multimillionaire to debtor in just a few years.

I respect his gumption. He grasped the American brass ring on the first try. The only problems were twofold: the ring was an exceptionally low-hanging fruit at the time, and he's incompetent, or immoral, or both.


[Thanks to dupagechildrensmuseum.org for the image.]

But that's what happens when an inflationary bubble works its way through the market system. Incompetence and immorality are rewarded. Money seems to be growing on trees -- indeed, money is growing on trees. Every Tom, Sadek, and Harriette can find easy dough to roll in with little or no effort or expertise.

After the Dot-com fiasco the mountains of cash still in the system turned to mortgage securities, encouraged by three things: (1) the Federal Reserve's lowering of rates in 2001, not for its direct effect on interest rates but for its signaling of more loose-cash times ahead; (2) the government-sanctioned mortgage-qualifying looseness of the GSEs (government sponsored entities like Freddie Mac and Fannie Mae et al.); and (3) the normal evolution of the securitization business. ("Securitization" is the packaging and marketing of various debt instruments like mortgage MBOs [mortgage backed obligations] that is now being done outside -- or at least at arm's length from -- the banking industry per se, thereby avoiding regulatory supervision to date. This is likely to change within the next five years, in my opinion, because without limitation of these products' use as credit collateral, the global economy is going to be in deep doo-doo very soon.)

This shift of excess monetary wherewithal was no surprise to anyone. Securitized bonds look like a good secure deal. Foreign central banks, global dollar investors and pensions alike moved billions into that market. In fact, there was so much cash available that credit became cheap for lack of takers, and vultures like Sadek (bless his innocent little heart) were allowed to go on a feeding frenzy.

Who is to blame? Not the vultures. Vultures are just acting like they are supposed to, i.e. like birds of prey. The real culprits are:

(1) Former and present US Congresses for enacting legislation to create and preserve market-maiming monsters like Freddie and Fannie.

(2) The governments of the US and of the other industrialized nations who participated in the decoupling of the dollar, the British pound, the European currencies, the Japanese yen, etc. from the price of gold back in the 1970s.

(3) The Federal Reserve and the central bankers of a number of foreign nations on several fronts:

- For devaluing our 1900 dollar from $1 to $.06 or less through ineffective efforts to "push the economy string" by inflating the currency, the latest episode being between 2001 and 2004; for devaluing the Japanese yen, most recently since the 1990s; for quasi-illegally supressing the revaluation of their currency by pegging the Chinese yuan and other nations' currencies to the dollar;

- For being fully aware, as the well-trained economists that they are, of the easing monetary effects securitization would have on money and credit, and for failing to do anything to set reserve standards for this wildcat bank-industry-clone that is presently threatening global economic equilibrium (the central bankers have now seen the dangers and are desperately trying to correct their mistake behind closed doors with the participation of the BIS [the Bank for International Settlements] before the messy situation hits the fan);

- For knowingly playing a chauvinistic international inflating game, pitting national policy against that of their respective trading partners in an attempt to favor their own industries and profit from currency imbalances come hell or high water (all countries are guilty of this, but most egregiously the Japanese, the Chinese, and even the buck-stops-here US. We should be making an effort to be the standard bearer of monetary policy instead of the tallest-dwarf bully on the block who gets his kicks watching the weaker sidekicks flounder around.)

I wonder if Sadek will end up like that Thai real estate "tycoon" we all saw on 60 Minutes -- you remember, the guy who took us on a tour of his semi--finished but abandoned gazillionaire's golf paradise. These days he's hawking hamburgers from his bicycle in the streets of Bangkok -- probably where both he and Sadek should have been all along.

Is the Dollar a Dwarf or a Midget?

A couple of charts not seen very often in the news are the ones you can create with some Fed dollar statistics. Two of these are the "Nominal Major Currencies Dollar Index" and the "Price-Adjusted Major Currencies Dollar Index." The Fed uses a complicated set of formulas to come up with these numbers and has been doing so since the early 1970's.

The "Major Currencies" indices are "a weighted average of the foreign exchange values of the U.S. dollar against a subset of currencies in the broad index that circulate widely outside the country of issue." [Source]

What is in that subset of foreign currencies? The euro (remember, that includes all the major European countries), the Canadian dollar, the Japanese yen, the British pound, the Swiss franc, the Australian dollar, and the Swedish krona.

I have made two charts showing the difference between the nominal chart and the inflation-adjusted one. The first shows us the actual exchange situation of the dollar today. (Click on the image to get a much larger version.)



As you can see, this month of April 2007, our dear dollar has hit rock bottom, at 78.9902 on the scale. [Source for the nominal chart.]

Here below, we have the inflation-adjusted version of this chart. This time, the different currencies have been weighted by the statisticians so that the degree of inflation in each country is reflected on the chart. In other words, here we have what the world sees as the US Tallest-Dwarf Status. The results are not quite so drastic.



But as you can see, and no matter how you look at it, the US dollar is getting smaller and smaller. We have been in a position to claim "Tallest Dwarf" status only twice in our more recent history (i.e. since 1973.) As of today, we are flirting with the loss of the title -- again. [Source for the price-adjusted chart.]

What I believe is unconscionable on the part of the central banks of this world, is that they are beginning to talk as though inflation is a necessary evil, something every nation must just "live with" and "make the best of." And now they're even talking as though our status as tallest dwarf were actually a handicap.

Meanwhile, the speculators are having a field day and the little guy is getting raked over the coals -- in other words, Big Financial Business as usual. (This reminds me of 1929....)

Wha' Happened?

Okay, so China's stock market, being the first to wake up in the morning, started off a flame of panic across the world that ended in the West. Two things are weird about this one: (1) The cause -- or rather the match strike -- of this surprise is not readily evident, and (2) gold didn't react by moving in the opposite direction.

I guess people are so scared they think they'd better have cash for a few "seconds" until they figure out what to do next.

All of us gold bugs have been warning the world of the imbalances we perceive in the world markets but none of us can say how and when they will all unravel. Is this the beginning of the denouement? And why China?

What I see so far is this:


[Thanks to fiscalstudy.com for this photo of an ironically relaxed Doomsday Greenspan.]

Greenspan was giving a speech in Hong Kong. When Greenspan speaks, the East listens. Greenspan predicted an American recession by the end of the year.

No matter that his predictions have usually been wrong in the past; as usual, panics don't listen to statistics. And anyway, the underlying causes of the imbalances are what we goldies have been howling about for months and years now. (Start with my March 2005 archives and read forward.)

To run that by you again, there are two fundamental principles at work here:

1. The lack of an international hard monetary yardstick such as the gold standard; combined with
2. Human nature.

The two are a highly flammable mixture, even if they can waft together for years without a hitch as long as they don't come into contact with a match.

Out of this lethal combination come:

1. Inflating of and speculation in currencies that float (and those that don't, i.e. those that are pegged and/or otherwise manipulated);
2. Protectionism through currency manipulation;
3. Use of the money supply to ease market tensions (the Federal Reserve and other central banks do this all the time -- big mistake);
4. Lack of the discipline and will power to return strength to the monetary system once they have used it for No. 3 (the Fed governors are only human after all and hate to be the bearers of bad news);
5. Naivete of the voting public as to what is going on, which allows the power players to gamble all day long at our (the public's) expense.

Who is it that said: "The only thing we learn from history is that we don't learn from history." How many times do economies (and governments) have to tank for lack of monetary discipline?

Here is Bill Cara's article over at Seeking Alpha along these lines. I agree with him that:

"[T]he Gnomes are bulldogs, and they have put their terriers into the U.S. Fed and Treasury. I believe there will be one final attempt to print the way out of a market crash. Ergo; I see one final push in precious metal prices. But the end of the long-term global stock cycle is near. It has been driven by a credit balloon that cannot be pumped higher. The peak of the cycle would have occurred in May 2006 except for the programs of the U.S. Administration (including the Fed) to ramp up the money printing. [Katy's Caveat: I would have added the other central bankers who are playing the same game, i.e. Japan, China, et al. The Fed is not alone in this.] The sad thing is that at the end of the day, when inflated stock prices blow up, those holding debt will still be holding the same level of debt. The banks will be demanding payment. That's what bankers do -- real bankers, not trader-bankers."