Nowhere to Hide
The dollar has been falling relative to other currencies for quite a few years now…but Nathan Lewis thinks that this process could be coming to an end.
The other side of the "falling dollar," for some years now, has been a "rising euro" or a "rising pound" or even a "rising Brazilian real." The dollar has been falling in value against other paper currencies. This affects all kinds of business arrangements, and thus gets lots of attention. European tourists flood into Manhattan, giving the locals an inferiority complex.
However, we may be nearing an end to this process. Other currencies have risen, against the dollar, to the point where European companies, for example, are feeling unfairly disadvantaged. Where are all the domestic tourists? This "competitive disadvantage" is unpleasant at any time, but it is particularly unwelcome when there is a slowdown due to other reasons, like the property and financial bust which has become a worldwide phenomenon.
So what do these foreign central banks do? They can kill two birds with one stone. They can handle the uncomfortably high currency, and the domestic softness, with what amounts to an "easy" monetary policy. Thus, we see the Bank of England and Bank of Canada cutting their policy rates recently. The Bank of Japan is still stuck at a puny 0.50%. The European Central Bank has been speechifying about inflation recently, but the pressure is on to do something about today’s problems. Yes, the official CPI might be rising faster than they’d like, but it’s not enough of a problem yet that anyone is willing to suffer higher interest rates or a further rise in the currency to do something about it. Besides, isn’t inflation caused by China?
In this way, we come to the point at which all currencies decline in value together, while their exchange rates remain relatively stable. Sort of like today’s dollar bill, ten-dollar bill, and the quarter. They all decline in value together, and their exchange rates remain stable.
This is what happened in the early 1970s. The world’s currencies were pegged at fixed exchange rates to the dollar in those days, while the dollar was pegged to gold. After the dollar left gold in 1971, and its value declined, other countries’ governments said: "Hey, wait a sec. I’m not sure of what you’re trying to do with this cheap-dollar stuff, but we don’t want any part of it." Sort of like the Middle Eastern dollar-pegged currencies today, or the Chinese yuan recently.
So, in the spring of 1973, they all depegged from the dollar. See ya later, greenback! That was the beginning of the floating currency system we have today.
Immediately after the depegging and floating, the dollar fell against all major currencies (and the minor ones too). The Fed’s dollar index, which remains popular today, shows this drop. This index, by the way, starts in 1973 because it was not necessary before then.
Then what happened? Governments of the time began to chew over the problems that emerged, and came to the same conclusion as governments today. Damn the inflation, we have to keep these forex rates under control!
The dollar index stopped falling. All in all, it only fell about 20%, as all the governments in the world inflated together. During the great dollar collapse of 1978-1979, foreign exchange rates were nearly unchanged.
The dollar actually fell in value by about 10:1 during that decade. It took only $35 to buy an ounce of gold in 1970. In the 1980s and 1990s, it took more like $350. However, this decline became invisible to a lot of people. The dollar/euro rate affects everybody, but the dollar/gold rate directly affects almost nobody.
It was no longer so obvious that inflation was being caused by a "falling dollar." When it took more dollars to buy things, most people did not figure out that the dollar — and the deutschemark, franc, pound, and yen — were simply losing value. On November 19, 1973, Newsweek magazine proclaimed on its cover that the world was "Running Out of Everything."
Either that, or those horrible Arabs! It’s true, there were some oil disruptions during the decade. Many people still blame these for the inflation of the time. None of these people has an explanation of why, years after the crises had passed, oil prices didn’t fall back to their 1960s levels around $2.50 a barrel.
A few people saw the way that currencies were losing value compared to gold, the timeless standard of value, and understood instinctively where the inflation was coming from. The government economists, however, didn’t see it that way. They couldn’t quite figure it out, but they were pretty sure that they didn’t want to add to the growing problems with a restrictive monetary policy. The Fed remained "accommodative," until finally the crisis reached a point that Paul Volcker gained a political mandate to do something about it.
If there is a difference between those times and today, it must certainly be the amazing deterioration of financial conditions around the world. This is matched by a consensus on what to do about it: central bank policy rates that are low, low, low. The big yield curve inversions of the 1970s aren’t coming back right away. Barring some unexpected twist — the Chinese pegging the yuan to gold for example — it looks likely that currencies will all go down together, as they did in the 1970s.
The only place to hide would be in physical things: cattle, corn, steel, and eventually property.
For the 1980 presidential elections, Ronald Reagan actually recorded a television advertisement that promised a return to the gold standard. The departure from gold in 1971 led to the first major episode of inflation in U.S. history. Wasn’t it obvious? The ad didn’t run. He was talked out of it.
Soon, politicians will have another chance. I think the next gold standard will appear in a place that nobody expects, like Moldova, Morocco or Vietnam. Home mortgages denominated in gold have been available in Vietnam for some time, and apparently some shopkeepers there are already adjusting retail prices according to gold exchange rates. They are, in effect, already on a sort of underground gold standard. Not everybody in this world is quite so benighted as our friends at the Federal Reserve.
for The Daily Reckoning
February 19, 2008
Nathan Lewis is the author of Gold: The Once and Future Money, published by Agora Books and J. Wiley. He runs an investment fund in New York.
America took a holiday yesterday to honor its dead presidents. The rest of the world remained at work. Of course, here at The Daily Reckoning headquarters in London, we rarely rest. But we honor dead presidents every day.
Jacksons, Franklins, Lincolns…we watch…we wait…we wonder what will happen to them.
The news is full of inflation. In China, the rate of consumer price inflation has risen to an 11-year high – at greater than 7%. The cost of living is rising fast in the Middle Kingdom. Wages are going up even faster. Suddenly, China’s low-cost exports are no longer holding the world’s prices down. Now, they are driving them up!
"Tea prices set to soar," says one headline in today’s Financial Times. "Cost of steel to rise as producers agree to pay 70% more for ore," says another one.
Oil is back over $95. Wheat is selling at prices three times as high as a year ago. The commodity index is near record highs.
A few years ago, nobody cared about the cost of tea in China. But now, prices are rising all over the world…and people are nervous.
Yesterday, we proposed a theory. If the future is really as bleak as economists seem to think, how come the stock market hasn’t gone down more? The stock market looks ahead; why couldn’t it see trouble on the way?
Our answer is that the stock market sees trouble coming from two directions. On the one side, deflation is dragging down capital values – houses, stocks, bad credits. (Corporate debt is the next debacle, warns The Wall Street Journal.)
But on the other side, inflation is battering the value of cash itself. Who wants to hold dead presidents when they are losing 4% per year and inflation is rising? Historically, in times of inflation, it’s better to hold shares in profit making businesses that can raise their prices than it is to hold cash.
With cannons to the left of them… and cannons to the right…all volleying and thundering…what direction should stocks go? Maybe they see it all…and sit tight?
In the Financial Times this morning is a brief description of Barclays Equity Gilt study, which the bank has been publishing for the last 53 years. The study takes a long view of the performance of British stocks and finds that for nearly 100 years – from 1899 to 1985 – U.K. stocks actually lost investors money. Compared to retail prices, the real return on equities over that entire period was negative. Part of the explanation is that Britain had peaked out. It had been the world’s leading imperial brand for at least the previous 100 years. Its people had grown rich. But by the turn of the century, both America and Germany were offering fierce competition. America’s GDP surpassed Britain’s around 1900. Germany’s GDP rose higher than Britain’s a few years later. Then, in the Great War of 1914, Britain passed the baton of imperial leadership to the United States.
Britain was having a hard time keeping up. As we’ve just seen, in real terms, its stocks went down for the next 85 years. So did its currency. The pound lost 99.3% of its value since 1899.
In America, the "dead presidents" didn’t do much better. We don’t have equivalent numbers, but the dollar lost at least 95% of its value during the same period. Lately, the dollar falls even faster than the pound. In 1985, we recall dimly, a pound and a dollar were worth about the same thing. Twenty-three years later, the pound is worth nearly twice as much as a dollar.
What lesson do we draw from this? First, if the United States really has peaked out, Warren Buffett is wrong. He says that selling the United States short is "not smart." But if America has hit its peak, as we think it has, 100 years after Britain’s peak, selling the U.S. short is exactly what you want to do. Sell its shares. And sell its money.
Write a little note…put it in a sealed envelope…address it to your heirs: "Open in the year 2100:"
"In the year of our Lord, 2008, I sold the United States short. Warren Buffett told me not to, but I did it anyway. Was I right? Here…I enclose a dollar bill as a memento. Today, if I had three or four more of those, I could buy a cup of coffee. If I had 920 of them, I could buy an ounce of gold. Good luck with it."
How much do you think that dollar will be worth in the year 2100? We don’t know. We just wish we could hang around long enough to find out! Instead, we will hang on to our Trade of the Decade and see what happens in the short-term. Our guess is that we’ll be pretty happy that we’ve hung on to the yellow metal and, as always, we think our dear readers should do the same.
*** The problem for the press is what to do with the recent news from Wall Street. Put it in the crime section? Or the health section? As we guessed, more and more often, the ‘financial’ news is becoming a matter for the cops. This from the Associated Press:
"A handful of state securities regulators and a couple foreclosure-blighted cities have fired the opening shots with lawsuits trying to prove that investment banks and big lenders are guilty of more than just bad business decisions and failing to foresee looming mortgage troubles. Some regulators say greed and fraud underlie much of the subprime mortgage mess that has spread across the broader housing market, triggering a spike in foreclosures.
"Aside from the civil cases, the FBI is looking at possible criminal action, focusing on what Wall Street firms knew about the risks of mortgage securities backed by subprime loans, and whether they hid risks from investors."
As we pointed out at the end of last week, all the latest products of Wall Street had a bit of Ponzi in them. Ponzi was a schemer from the early 20th century who figured out that he could pay people a high rate of return…entice more money into his hands…and pay the first investors’ yields with the capital investments from the last. It worked beautifully for people who got in early. But Ponzi schemes always blow up. The problem is essentially the same in all extraordinary financial episodes – from the South Sea Bubble to the Dotcom Bubble…to the Housing Bubble.
"Finance" itself adds very little to the world’s wealth. And the returns from "finance"…or, broadly speaking, from investing…can never actually exceed the real rate of wealth creation in the economy – at least, not for very long. Most financial activity is merely shuffling money from one person to another…giving the financial industry an opportunity to collect a toll along the way. But when a Bubble gets going, it begins to look as though there is a lot more wealth available to shuffle. The act of financing, itself, causes the value of the thing financed to rise. The first people in – who bought at low prices – make money. People coming in after them think they are buying into a booming market and bid up prices. What they are really doing is transferring money to the early investors – just like the late arrivals to a Ponzi scheme.
George Soros described the process as follows:
"Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available."
Prices are neither fixed, nor random, is how we put it, but subject to influence.
*** Bloomberg reports that, "Under Bernanke’s chairmanship, the Federal Reserve’s steepest interest-rate cuts since 1990 are limiting his Asian counterparts’ options to curb inflation." Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines.
"Such measures may backfire. Artificial price curbs and subsidies only feed more demand for oil and other commodities, and ultimately will make it harder to contain inflationary pressures worldwide, officials from the Group of Seven nations warned at their Feb. 9 meeting in Tokyo.
"Asia’s governments have experience with the destabilizing effects of runaway prices. China’s inflation contributed to the unrest that triggered the 1989 Tiananmen Square demonstrations. Indonesia’s attempt to increase fuel costs in 1998 was the spark for protests that led to the ouster of President Suharto after almost 32 years in power."
Colleague Dan Denning, at the helm of the DR-Australia, believes Bernanke’s cuts "might be undermining social and political stability in Asia…"
"Not that it was his intention to do so, but maybe Bernanke can succeed where than man standing in front of the tank in 1989 could not, putting massive political pressure on the communist regime. Such are the unintended consequences of playing around with the value of money. A surprising result, yes. But not impossible.
"Asian governments aren’t letting the rising cost of food be passed on to consumers in the form of high prices. Instead, they are setting price controls and subsidising consumption or providing rebates.
"You have total pricing dysfunction.
"On the one hand, years of cheap credit has led to over production of scarce resources based on demand that’s not sustainable when credit contracts.
"On the other hand, you have governments blocking higher prices from being passed through to consumers, where they would eventually curb demand.
"What do you get in the end? Well I reckon you’d get patterns of resource consumption that hit a brick wall sooner or later. And then you will have some really [angry] people who can’t find any cooking oil or any food to cook in that cooking oil.
"It’s one thing to replace cars with bicycles, or to cut energy consumption by shutting factories, or turning your air conditioner down a few degrees. But what do you substitute for the calories you get from, say, wheat?
"Let them eat dirt! I don’t know. But I’m storing up on canned goods."
*** Finally, a dear friend of ours has been battling cancer – and winning! He sends this update, relating his conversation, word for word, exactly as it happened:
"I’m doing much better, but I’m like a billiard ball, bouncing back and forth between doctors and nurses, hospitals and clinics, echographs and scanners.
"The other day I was at the clinic where I’m going to get radiotherapy. A young, pretty nurse was explaining, very nicely, the combat ahead: the area would be ‘targeted’…the doctor find the exact position on the scanner, then a ‘pet scan’ would verify it…and the doctor would validate it…then they’d hit it with radiotherapy every day for two months and then give it a dose of chemotherapy too…at the beginning and the end…then another scouting out by the scanner…followed two months later by the pet scan.
"I was very impressed by all this. So I asked:
"’All this intervention must be very expensive; do you have any idea of how much it costs?’
"But this is France, where health care is paid for by the government.
"’Uh…no…there isn’t any cost,’ she replied. ‘Do you want me to call a psychologist for you?’"
The Daily Reckoning