USD Clamor; The USD won't go quietly
09 Sep, 2009 @ 08:54 am ET | By Christopher Laird
As gold tries to break and hold $1000 it brings up the larger question of how long the USD has to last. At the very least, after the markets digest the debate over deflation which is USD bullish, the question becomes: how long can the USD hold together before it falls in value drastically.
Big drumbeat out there
I am sure that you know about China vigorously complaining about the abuse of the USD, most loudly complaining about the Fed's quantitative easing (buying any and all bad assets from banks and putting them on their balance sheet - called monetization, which is printing the money to replace the losses). The Fed had to back off this Summer from that plan and significantly reduce those policies, said in large part due to China's vigorous complaints.
No, we cannot
Or, in other words, the Fed is finding it cannot just print its way out of its problems, it cannot just 'drop money from helicopters', Bernanke does not have the latitude he thought he would have when he made that infamous statement, the bond markets won't tolerate that without crashing the USD and skyrocketing interest rates. Skyrocketing interest rates would totally stop any remaining credit growth, which will strangle the remaining life out of the economy.
If you agree with that, then the prognosis for the US and Western economies will be a second round of credit deflation, and must result in much lower stock markets. Without going into a whole paper on how that will work, basically, if credit growth falls further, the Western economy will contract faster than its -3% rate at this point. That will cause stocks to have a second big down leg crash, akin to the second down leg of the stock crashes following the first 1929 stock crashes. The second stock down leg took stocks down eventually to 10% of their 1929 highs by the early 1930's.
But a recent development just out, that the UN stated that a new world currency not dependent on the USD must be created:
"In a radical report, the UN Conference on Trade and Development (UNCTAD) has said the system of currencies and capital rules which binds the world economy is not working properly, and was largely responsible for the financial and economic crises.
It added that the present system, under which the dollar acts as the world's reserve currency , should be subject to a wholesale reconsideration. Although a number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency, the UNCTAD report is the first time a major multinational institution has posited such a suggestion..." Telegraph.co.uk
And of course we heard that the IMF is using SDRs (special drawing right - a quasi reserve currency that central banks share, a sort of basket currency made up mostly of USD consisting of the Euro, Yen, USD, British Pound). China for instance just bought $50 billion worth of SDR denominated bonds from the IMF. Not a whole lot of money in the scheme of things, but this shows what is beginning to happen. The IMF has now about $500 billion of SDR out (rough guess). It is growing. As a true quasi currency, the SDR is an alternative to the USD if the world wanted to push it. Still it's a drop in the bucket now though.
But, without going into an SDR subchapter, the point is, the USD will not go down quietly. Now, I don't just mean that the Fed or the US treasury will balk and stop it. What will work against any new USD alternative is the fact that everyone is dependent on the USD and also the Fed's massive bailouts of the credit system worldwide. It has been said that it's wrong for the world to rely on the US Fed, the BOE, ECB etc, the Western deficit countries, to bail out the financial system. The Fed alone has carried more than 2/3 the total cost of the many costly bailouts not only in the US but also the related troubled financial problems in the EU and UK.
As a side note the UK fiscal and Pound bear close watching as a next possible flash point in the evolving global financial mess.
So while China and others complain the US Fed is monetizing the bad debts, if not for that the entire world financial system would have collapsed on two occasions. Remember the near bank runs in the UK and the US in latter 07 and 08 especially?
But the USD won't go down quietly either because someone like China will force the Fed to stop the bailouts, or else trying to wean the world off the troubled USD will prove so painful that the world will scream when it happens. Not only would there be tremendous economic damage and contraction if the USD were to crash, but also there will be a wave of currency crises as the world tries to readjust all the major currencies to that event. It's not an easy situation for anyone. The demise of the USD will have vast unpredictable results. And in our present fragile financial world, unpredictable is bad.
Nevertheless, the USD must revalue down. But how is this to be done?
Gradual devaluation scenario
One problem is that China, Germany and Japan and the other major trade partners with the US will try to co devalue with the USD unless they make a major change to their export driven currency policies. They co devalue to keep their currencies cheap for exports. So, a gradual USD decline, which is what most people hope for, is likely to lead to competitive devaluations, not only with the USD but among each other trade partner. Everyone wants to export their way out of this economic contraction. But exports have crashed 30%. It's the shrinking pie problem.
Bond revolt scenario
If competitive devaluation proves to be a big impediment to a USD revaluation down, then the only other alternative appears to be a bond revolt, which causes interest rates to spike and thus a turn of sentiment negative on the USD, and a rapid USD revaluation down, before the competitive currency devaluations can happen.
It is not in China's nor Japan's nor Germany's interest for any big once off USD devaluation to take place. The US still exports a great deal and will capture a lot of business from the rest of the exporting world. Just consider what Japan's cheap yen policy has done for Japan for the last 20 years. They were able to export their way out of the worst part of their deflation since 1990 exporting to the US. OF course that gravy train is now running off the track, seeing Japanese exports down as much as 30% to the US by some measures in 2009 year over year.
This is the dilemma for all concerned. Getting off the USD is not exactly easy after the USD spent 50 years after WW2 ended sopping up most of the world's trade, and wealth. The USD won't go quietly.
But, putting aside the deflation arguments which will help to keep the USD stronger for longer than it might be, revalue down the USD must.
Now this devaluation transpires, either with a bond revolt and hard revaluation down, or gradual slow death by a thousand cuts. The outcome will be some post USD world.
Is this big USD revaluation near? Or far (10 years or more away)? At the moment, we leave that 'when' question for another day. But the USD days are numbered. The question is where will your retirement savings be then, your pensions, your savings CDs, bonds, insurance policies?
In short all of them will likely be cut in half in purchasing power, and that is for starters. And that is IF the USD does not collapse outright, which is a distinct possibility. That is because the US fiscal situation is so bad that only a real economic recovery will give it some breathing space, if not fix everything. Just some more time at that. Not a real fix.
Therefore, we feel that it is imperative, regardless of the USD having rallies during deflation, to have about 25 to 50% of your savings in real things, such as gold, gold stocks, or some paid off farmland, or a small farm, or a nice piece of choice property that you buy when the real estate market bottoms.
09 Sep, 2009 @ 08:54 am ET | By Christopher Laird
As gold tries to break and hold $1000 it brings up the larger question of how long the USD has to last. At the very least, after the markets digest the debate over deflation which is USD bullish, the question becomes: how long can the USD hold together before it falls in value drastically.
Big drumbeat out there
I am sure that you know about China vigorously complaining about the abuse of the USD, most loudly complaining about the Fed's quantitative easing (buying any and all bad assets from banks and putting them on their balance sheet - called monetization, which is printing the money to replace the losses). The Fed had to back off this Summer from that plan and significantly reduce those policies, said in large part due to China's vigorous complaints.
No, we cannot
Or, in other words, the Fed is finding it cannot just print its way out of its problems, it cannot just 'drop money from helicopters', Bernanke does not have the latitude he thought he would have when he made that infamous statement, the bond markets won't tolerate that without crashing the USD and skyrocketing interest rates. Skyrocketing interest rates would totally stop any remaining credit growth, which will strangle the remaining life out of the economy.
If you agree with that, then the prognosis for the US and Western economies will be a second round of credit deflation, and must result in much lower stock markets. Without going into a whole paper on how that will work, basically, if credit growth falls further, the Western economy will contract faster than its -3% rate at this point. That will cause stocks to have a second big down leg crash, akin to the second down leg of the stock crashes following the first 1929 stock crashes. The second stock down leg took stocks down eventually to 10% of their 1929 highs by the early 1930's.
But a recent development just out, that the UN stated that a new world currency not dependent on the USD must be created:
"In a radical report, the UN Conference on Trade and Development (UNCTAD) has said the system of currencies and capital rules which binds the world economy is not working properly, and was largely responsible for the financial and economic crises.
It added that the present system, under which the dollar acts as the world's reserve currency , should be subject to a wholesale reconsideration. Although a number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency, the UNCTAD report is the first time a major multinational institution has posited such a suggestion..." Telegraph.co.uk
And of course we heard that the IMF is using SDRs (special drawing right - a quasi reserve currency that central banks share, a sort of basket currency made up mostly of USD consisting of the Euro, Yen, USD, British Pound). China for instance just bought $50 billion worth of SDR denominated bonds from the IMF. Not a whole lot of money in the scheme of things, but this shows what is beginning to happen. The IMF has now about $500 billion of SDR out (rough guess). It is growing. As a true quasi currency, the SDR is an alternative to the USD if the world wanted to push it. Still it's a drop in the bucket now though.
But, without going into an SDR subchapter, the point is, the USD will not go down quietly. Now, I don't just mean that the Fed or the US treasury will balk and stop it. What will work against any new USD alternative is the fact that everyone is dependent on the USD and also the Fed's massive bailouts of the credit system worldwide. It has been said that it's wrong for the world to rely on the US Fed, the BOE, ECB etc, the Western deficit countries, to bail out the financial system. The Fed alone has carried more than 2/3 the total cost of the many costly bailouts not only in the US but also the related troubled financial problems in the EU and UK.
As a side note the UK fiscal and Pound bear close watching as a next possible flash point in the evolving global financial mess.
So while China and others complain the US Fed is monetizing the bad debts, if not for that the entire world financial system would have collapsed on two occasions. Remember the near bank runs in the UK and the US in latter 07 and 08 especially?
But the USD won't go down quietly either because someone like China will force the Fed to stop the bailouts, or else trying to wean the world off the troubled USD will prove so painful that the world will scream when it happens. Not only would there be tremendous economic damage and contraction if the USD were to crash, but also there will be a wave of currency crises as the world tries to readjust all the major currencies to that event. It's not an easy situation for anyone. The demise of the USD will have vast unpredictable results. And in our present fragile financial world, unpredictable is bad.
Nevertheless, the USD must revalue down. But how is this to be done?
Gradual devaluation scenario
One problem is that China, Germany and Japan and the other major trade partners with the US will try to co devalue with the USD unless they make a major change to their export driven currency policies. They co devalue to keep their currencies cheap for exports. So, a gradual USD decline, which is what most people hope for, is likely to lead to competitive devaluations, not only with the USD but among each other trade partner. Everyone wants to export their way out of this economic contraction. But exports have crashed 30%. It's the shrinking pie problem.
Bond revolt scenario
If competitive devaluation proves to be a big impediment to a USD revaluation down, then the only other alternative appears to be a bond revolt, which causes interest rates to spike and thus a turn of sentiment negative on the USD, and a rapid USD revaluation down, before the competitive currency devaluations can happen.
It is not in China's nor Japan's nor Germany's interest for any big once off USD devaluation to take place. The US still exports a great deal and will capture a lot of business from the rest of the exporting world. Just consider what Japan's cheap yen policy has done for Japan for the last 20 years. They were able to export their way out of the worst part of their deflation since 1990 exporting to the US. OF course that gravy train is now running off the track, seeing Japanese exports down as much as 30% to the US by some measures in 2009 year over year.
This is the dilemma for all concerned. Getting off the USD is not exactly easy after the USD spent 50 years after WW2 ended sopping up most of the world's trade, and wealth. The USD won't go quietly.
But, putting aside the deflation arguments which will help to keep the USD stronger for longer than it might be, revalue down the USD must.
Now this devaluation transpires, either with a bond revolt and hard revaluation down, or gradual slow death by a thousand cuts. The outcome will be some post USD world.
Is this big USD revaluation near? Or far (10 years or more away)? At the moment, we leave that 'when' question for another day. But the USD days are numbered. The question is where will your retirement savings be then, your pensions, your savings CDs, bonds, insurance policies?
In short all of them will likely be cut in half in purchasing power, and that is for starters. And that is IF the USD does not collapse outright, which is a distinct possibility. That is because the US fiscal situation is so bad that only a real economic recovery will give it some breathing space, if not fix everything. Just some more time at that. Not a real fix.
Therefore, we feel that it is imperative, regardless of the USD having rallies during deflation, to have about 25 to 50% of your savings in real things, such as gold, gold stocks, or some paid off farmland, or a small farm, or a nice piece of choice property that you buy when the real estate market bottoms.