A Flash in the Pan?

Will the plan to make over the pan-Asian currency set the stage for a U.S economic meltdown? It depends on what side of the table you’re sitting on.

The pan-Asian currency markets are in dire need of a makeover. These economies are critically important and inexorably interrelated to the still-tentative Western recovery. They are characterized by a hodgepodge of exchange rate regimens: fully free-trading currencies in Australia and New Zealand and purely price-fixed exchange rates in China. From everywhere in between, there is the gray scale where, with a wink and a nudge, lip service is paid to the marketplace, while intervention rules the roost.

These exchange mechanisms create barriers in trade, transactions and investing. When the product manager of a company in Japan or the United States sends a price list to Malaysia, what price do they use? In what currency should it be quoted? Can it change throughout the year? Can an investment in a joint venture produce triple-digit profits, only to see a seemingly random governmental change in exchange rates wipe out the earnings? These questions, and so many more, demand answers.

It is time for this community to recognize who they are collectively, and then to begin the long march to the ultimate great leap forward – a single currency to shepherd the economic zone into a dominant role in the 21st century. It is time to create the "Pan."

Pan-Asian Currency: Required Characteristics

The required characteristics of the Pan must include full convertibility in all participating countries, coupled with complete transparency; timely and accurate data dissemination; formation of a single central bank; a plan for conversion to use currency daily; a pooling of exchange reserves; and a coordination of fiscal and monetary policy. It’s time to form the group and fix the date for the launch – say 2015.

There are certainly enormous political and cultural barriers to overcome. Growth rates, exchange reserves, fiscal policy, monetary policy and the fundamental approach to economic theory stretch from the pseudo-free market Communist government in China to authoritarian capitalism in Singapore. There are countries that don’t know they belong in the club and others that might be blackballed as members of this new world coprosperity sphere. And what to do with places like Myanmar? Asia looks as bad as Europe did as the plans for the euro were being set in stone!

There are a number of great reasons for Asian countries to join together to create the Pan. First, here are a few of the obvious:

With a single unit of trade, there is a reduction in transaction costs for exchanging currencies, as goods and services move between the pan-Asian countries. With this benefit comes a broader hedging capability for companies and governments, as one currency can now cover the entire zone. In addition, no one country can upset the apple cart and fix their currency in a vacuum, producing mayhem for investors.

The accumulation of exchange reserves can be concentrated for smoothing, protecting and stabilizing movements. All the regional governments should contribute the current U.S. trillions (that’s right) of exchange reserves to an independent privately chartered central bank. From the Asian side of the table, this may be the most powerful argument for the single currency – with central control of exchange reserves, the Pan Central Bank would hold sway over U.S. policy makers, who are debt-burdened to the rest of the world.

When taken together, China and Japan as members of the Pan form a tremendous economic bloc. Japan is already the No. 2 economy in the world, and China is poised to become the largest, even as the growth rate is reduced over the next 10 years. Add in India, and you have the lion’s share of the global population. By joining together to form the Pan, along with a diverse group of countries from India to Pakistan, Australia and New Zealand, and to the far flung islands of Indonesia, China and Japan can become the leaders of what will likely be the 21st century’s greatest economic story.

Pan-Asian Currency: Let the Market Set the Pace

In a fiat currency world, it is difficult to determine the intrinsic value of any currency. Letting the market set the pace under the direction of a pan-Asian central bank with rational and coordinated fiscal policy may be beneficial for the world. But even deeper, the prolonged international cooperation that is required may provide the forum for these countries to discuss and engineer solutions to the thornier issues of their underclass, along with religious and caste prejudice. As a distant hope, or perhaps a fantasy, the widespread poverty that is likely the fuse for the exploding distribution of the anti-West message of terrorism can be extinguished by an economic expansion and the replacement of despair with hope.

On the other hand, with political disharmony reigning in East Asia, even talks of currency unification could lead to regional meltdown. Disparate governing bodies – from communism, to military rule, to fledgling democracy – distrust one another. China-Taiwan tensions could erupt into invasive action within the next 12 months. Do they invite North Korea, a belligerent nearby nation with nuclear capability, to join? Will tensions break out if they don’t?

Then there’s the potential fight over which currency the new one will be based on. Will the potential members agree to a new currency springing from the Japanese yen? Those who bitterly remember World War II will not be on board for that. Next option: basing the new buck on the Chinese yuan? Not with the region already distrustful of the authoritarian administration. Merely floating these options for discussion could fuel deadly skirmishes – or at least brutal trade wars.

Political differences aside, the wide economic gap among the region’s nations hampers the single currency idea. To force struggling economies to meet near-unattainable membership standards (think euro criteria) could intensify the divisions, rather than narrow them.

Finally, there’s the idea that dealing with a single Asian currency and a single Asian central bank would ease trade relations for the rest of the world. More likely, though, such an alliance would hamper member nation negotiations with trading partners, such as the United States. Rather than dealing with an individual country, where (at least ostensibly) the United States would maintain the upper hand, we’d now be forced to negotiate with an alliance – one with considerably more power than the sum of its parts. It is in this aspect that the interests of the world may diverge most starkly from the interest of Asia.

It’s no secret – a single Asian currency means a single Asian central bank – and that would greatly increase the potential for currency crises, precipitating bigger economic bubbles. Central banks by their nature influence currency; this convergence would intensify the punch their manipulations pack.

pan-Asian Currency: Global Politics

When the value of a currency has more to do with global politics than with its intrinsic worth, the stage is set for economic meltdown. Rather than let the world markets work for natural balance, central bank politicians (in the guise of economic policymakers) print money and monkey around with exchange – attempting to alter the relative strength of their currencies and dictate a change in the prevailing economy.

These shortsighted measures (theoretically) designed to prop up flagging economies, merely postpone problems – and intensify the eventual crisis. A unified Asian central bank, intent on strengthening its member nations’ individual economies, will resort to wide-scale currency manipulations just like any other central bank – only now with an added power punch…directed right in the face of the U.S. economy.

As of June 30, 2004, seven East Asian countries held a combined 14.6% of the U.S. outstanding public debt; and when you discount U.S. intragovernmental holdings, that number climbs to 25.2%. Just two countries hold the lion’s share of that total $1.06 trillion: Japan and China. So it’s already pretty concentrated.

Already, dollar bears warn of the implications of a dollar dump by China or Japan – such action would send the U.S. currency into a hopelessly downward spiral, literally flooding the market with unwanted greenbacks and deeply depressing the dollar. Why would countries that have been shoring up their forex reserves with dollars want to get rid of them? The economic answer: to hedge against a falling dollar by selling forward, and, at the same time, taking some profits due to extremely low short-term U.S. interest rates. The political answer: to deliberately trash the U.S. economy, challenging America’s position as a world superpower.

The effect of either China or Japan unloading their dollar reserves could put a significant dent in the U.S. economy. Now, picture that $1.06 trillion held by a single unified entity. A combined effort, created by a fused currency system, could impact the entire American financial system: think interest rate spikes and currency devaluation. Those are huge threats to hold over the United States, and they could color virtually every facet of our dealings with the multinational Asian union.

The bottom line? Even attempting to force such disparate economies into a single mold could incite violent political skirmishes in the region. And the creation of yet another mega central bank paves the way for expanded political/financial manipulations…and global negotiations in which the United States no longer takes the chair.


Chuck Butler
for The Daily Reckoning
October 6, 2004

Editor’s Note: Chuck Butler is president of Everbank World Markets and the author of the popular Daily Pfennig newsletter.

Mr. Butler is also a respected and frequently quoted analyst of the currency market; his name has appeared in The Wall Street Journal, U.S.News & World Report, Time magazine, CBS MarketWatch, USA TODAY, CNNfn, the Chicago Tribune and many other publications.

Mr. Butler also writes A Pfennig for Your Thoughts, which is delivered via email to tens of thousands of market watchers globally to help traders stay on top of the economic, currency, and market happenings. The "Daily Pfennig" (as it is more commonly called today) has become a popular resource for currency investors and traders alike over the past 11 years.

We continue our lonely vigil, dear reader.

We are waiting for stocks to fall out of bed. We sit by the bedside like a woman waiting to be a widow. We know we’ll be expected to shed a few tears, but we’re not at all sure we won’t like our new situation.

But nothing happens. Instead, stocks, bonds, gold and the dollar – all snooze peacefully.

Other than the normal heave and ho, the breathing in and out of a market – there is nothing much to watch. We doze.

But what’s this?

The homebuilders – Lennar and Pulte come to mind – are collapsing. Pulte fell more than $5 yesterday. In terms of price to earnings, they were already cheap…Lennar, for example, sold for only 9 times earnings. Now it sells for only 8.

What could it mean? What could Mr. Market be trying to tell us?

If America really were recovering…and if the housing boom really were going to continue…wouldn’t the house builders be going up?

So far as we know, the Chinese have not yet entered the U.S. housing market. When they do, the story may change, but for the moment, house prices are still rising sharply. You can see the results in Lennar’s results. The company earned only $1.24 per share five years ago. Today, EPS are over $5.

Of course, while earnings rose, so did share prices. You could have bought Lennar for $8 in September 1999. On Sept. 20, 2004, the price was over $45.

The trend in Lennar’s earnings and share price tracks yet another trend: From 1965- 1995, the percentage of American households with a house to hold of their own was fairly constant – about 64%. Then began a bull market in homeownership – by the second quarter of this year, it had almost reached 70%.

"A chicken in every pot," has gone out of style as a campaign slogan. George W. Bush tried out a new one at the GOP convention last month: "Tonight, we set a new goal," said the nation’s chief executive, "7 million more affordable homes in the next 10 years, so more American families will be able to open the door and say, ‘Welcome to my home.’"

No mention was made of how the new houses would be financed. But we think we know.

America’s households are running "the largest net deficits in 76 years," notices Paul Kasriel of Northern Trust. They have bought houses – and refinanced them. They have traded in the old Buick for a new SUV…and then bought another one. Never has the going seemed so good.

But there is always some catch. The catch, as Kasriel remarks, is that never before have their monthly payments relative to after-tax income been so high at the beginning of a tightening cycle. "Households may finally be borrowed up," he concludes. "That is, they may not be able to borrow that extra dollar to spend in the face of higher interest rates on that extra dollar of borrowing…"

Whether they are borrowed up today, we don’t know. But as to whether they will be borrowed up someday, we have no doubt.

We’ll keep an eye on it.

More news, from Eric Fry in New York:


Eric Fry, reporting from Manhattan…

– Crude oil jumped to another all-time record yesterday, in the process increasing the already considerable wealth of T. Boone Pickens…

– "Better late than never" would seem to be a fitting description of Mr. Pickens’ financial fortunes. The one-time corporate raider didn’t do too badly for himself during the 1980s, when, as president of Mesa Oil, he reaped hundreds of millions of dollars for his shareholders and himself by attempting hostile takeovers of companies like Phillips Petroleum and Cities Services.

– But raiding, says Pickens, was never as profitable as simply riding the energy bull market of the last few years. The oil maverick’s Dallas-based hedge fund, the BP Capital Energy commodity fund, has soared 283% so far this year and has racked up profits of more than $1.3 billion since the start of 2000.

– "I really needed to win," the 76-year-old Pickens explains to Bloomberg News. And win he did! This senior citizen of the oil patch has increased his wealth by more than 3,000% since 1997, finally nosing into the 389th slot on the Forbes’ list of America’s 400 wealthiest people. Pickens says he has paid 75% of his lifetime’s income taxes since he turned 70.

– "He just got lucky," gripes one oil industry consultant. Maybe so, but luck of this magnitude has a mysterious way of repeating itself…which is why we are intrigued by Mr. Pickens’ particular brand of luck. He owes most of his good fortune to some extremely prescient – or lucky – calls on the price of natural gas and crude oil. To cut to the conclusion of this tale, T. Boone Pickens believes oil and gas prices are headed higher still…But first a little history…

– In the late 1990s, Pickens launched a tiny hedge fund dedicated to making leveraged bets on oil and gas prices. His fledgling BP Capital Energy commodity fund had barely flown the nest before it encountered life-threatening difficulties. The fund suffered large losses in its first two years, 1997 and 1998, trimming Pickens’ personal wealth from $35 million to $24 million. But the fund turned the corner in 1999, when it squeaked out a $900,000 profit. BP Capital has been profitable every year since…immensely so. Pickens has seen his personal fortune rise to about $760 million.

– "He understands the industry and business like no one else," says billionaire Harold Simmons, one of the BP Capital Energy commodity fund’s original investors. In 1997, Simmons kicked $5 million into Pickens’ hedge fund, only to see the investment shrivel to $400,000 in 1998. "I thought we were going to lose the whole thing," says Simmons.

– Instead, as luck would have it, Pickens’ fund handed Simmons about $150 million in profits over the ensuing four years. Let’s take a closer peek at the DNA of Pickens’ good luck…

– In late April of 2003, T. Boone Pickens kicked off the Grant’s Spring Investment Conference here in Manhattan by declaring, "I don’t believe I’ll ever see natural gas below $4.50 again."

– Inventories are extremely low, he explained, and supply is falling and demand is holding steady – a potentially explosive situation for gas prices. "If we get another cold winter next year," Pickens predicted, "the gas price could go to $10/mcf or more…the gas price could do anything, and I mean anything!"

– Sure as shucks, the gas price soared above $7 later that year, and has only "kissed" $4.50 a couple of times since then. More to the point, the gas price has averaged about $5.60 since Pickens’ declaration and topped $7 again yesterday.

– Fresh from his dead-on prediction for natural gas prices, Pickens issued a second Delphic forecast last May – this time about crude oil prices. "I think you’ll see $50 before you see $30 again," said Pickens. At the time, crude oil was changing hands for $41.50 and had averaged only about $36 for the year to date. But as we all know now, the price profile of the crude oil market has changed dramatically since then. Crude decisively scaled the $50-mark yesterday and planted its flag at TK.

– Pickens continues to up his forecasts. On Sept. 27, he said in a radio interview with Bloomberg News that he expects the price of crude to surge to $60 before it returns to $40. Should we trust his judgment?

– Many of the attendees of the May 2003 Grant’s conference wondered the same thing, when Pickens predicted a new era of permanently higher natural gas prices. One skeptical attendee asked the oilman, "If high, and rising, natural gas prices seem so probable, why aren’t the exploration and production companies working feverishly to increase their drilling activity?"

– The answer, according to Pickens, was that "there’s nuthin’ to drill." The oil and gas industry keeps poking holes, of course, but they aren’t finding very much oil or gas to suck out of those holes. About 1,243 drilling rigs are currently operating on U.S. soil and in contiguous waters, according to Baker Hughes – that’s about 12% more than this time last year, and about 40% more than two years ago. Even so, domestic production of crude oil and natural gas has tumbled 5% since 2001.

– Proven reserves of U.S. crude oil are close to a 29-year low after falling 3.5% last year. Meanwhile, demand charges ahead. Worldwide oil demand will average 82.2 million barrels a day this year and jump by another 1.8 million barrels next year.

-T. Boone Pickens is fallible, of course. But he seems to have a knack for putting himself in luck’s path. All else being equal, we’d rather align ourselves with a consistently lucky soul than a consistently unlucky one.


Bill Bonner, back in London:

*** The English seem obsessed. Each and every news item in popular press comes with a price tag.

A recent murder/suicide story, for example, told us what seemed like superfluous information: how much the killer’s house was worth…and what kind of car he drove. But the more we study the popular press, the more we see that nearly every news story has a touch of envy about it. Hardly a person is mentioned without some reference to the market price of his house…or his car…or his yacht…or his last vacation.

*** Ooh la la…here, an English reader has missed the point:

"Thank you very much for renewing your daily mantra of ‘Buy gold’ and, more specifically, precious metal mining shares. I’ve heeded your advice on this various times in the past five years – and now I’m sick to death of reading it…as well as being so gullible about heeding it. Bill Bonner and associates, including (today) Alan Leishman, have a way of seeming so authoritative and convincing that I’ve acted on their recommendations a few times…and am still waiting to come out ahead in the long run.

"The first time I put my money where your mouth is was when I switched from ailing media and leisure funds into gold. My fund manager at Credit Suisse was aghast when I instructed him to get into gold at $63 a share, with dire warnings of the volatility of such stocks and how they showed no gain over a protracted period. When they rose to $108, he congratulated me for buying ‘at exactly the right time.’ I bought more and watched them rise to $126. Three years ago, they began to fall – every day – then tumble and then topple into free fall. I checked The Daily Reckoning every issue for updates, explanations or any kind of advice…but there were none."

*** The reader goes on to describe his efforts – trying to trade in and out of gold stocks – and blaming us!

Yes, we like gold, dear reader. But, no, we never suggested trying to make money from the stuff. And never would we recommend trying to trade it!

We like gold the way we like stacks of firewood, jars of canned green beans and cheerful women. They make the going so much more fun when the going gets rough. As we mention above, the going has never been easier. So easy have things become that people no longer see the need for reserves…savings…manners…or inventories. Unless there’s a hurricane, everything seems to come along just in time. The food on the table. The electricity to run the air conditioners. The money to make the monthly payments.

But someday, the going may not be so good. We hold it in inventory for the day when "just in time" fails and "just in case" comes back into style.

*** A couple of Daily Reckoning readers took up the question of voting:

"I discussed this around the dinner table at a big family gathering last Sunday and was met with looks of horror and disbelief.

"’You mean, you’re not going to vote?’ my poor mother asked.

"’It only encourages them…’ I say.

"’What are you anyway if you are not a Republican or a Democrat?’ my brother asked.

"’I belong to no party. I like to say that I am part of the intellectual tradition started by the patriots of the American Revolution…You know, Thomas Jefferson – "the government that governs least governs best," or something like that. Live and let live, I say.’

Eyes roll."

*** "I’ve been sitting here trying to think of some way in which the choice of presidents touches me personally. But I can’t. That’s true of local elections, to governor, mayor, judges and sheriffs…I’m not going to pay less taxes. Nothing in my life will improve dramatically as a result of who gets elected.

"I’ve never in my life once thought, ‘Damn! If only I’d voted for the other guy. I wouldn’t be in this horrible bind right now,’ or, ‘Whew! That was close. I almost voted for the wrong guy,’ or ‘Thank goodness. Now I won’t have to throw half my salary down the drain for taxes.’

"So this is my question: Can you ever remember a time in your life when you thought to yourself, ‘Damn! If only I’d voted for the other guy, I might not be in such bad shape right now,’ or either of the other two quotes above? If so, please forward the details to me."

The Daily Reckoning