The Dollar... Again...
Each year for the last two, we have forecast a decline in the value of the dollar relative to the euro…and to gold. Predicting a decline in the dollar’s value has become an annual ritual here at the Daily Reckoning.
This year we keep the tradition alive. In 2002, as the year before and the year before, we expect the dollar to go down. And even if it fails to go down… well, it doesn’t really matter. For here at the Daily Reckoning, our forecasts tell only what should happen…not what will happen.
In that sense, we’ve been right two years in a row. The dollar should have gone down in 2000 and it should have gone down again in 20001. Will it now, finally, actually go down? That is not exactly the subject of today’s letter… but we expect to pay it a visit once or twice on our meander through the thicket of monetary past, present and future.
Statistically, this year’s forecast is more reliable than those of previous years undefined if only because we are less likely to be wrong three years in a row than two. But readers who took our counsel for more than it was worth have nothing to complain about. Stocks over the last two years have lost approximately 25% of their value undefined measured by the Wilshire 5000. A reader who shifted from stocks to either euro bonds or gold is at least no worse off than he was in January 2000.
But there are at least a few reasons to believe that this may be the year in which the dollar begins its long-awaited fall. Saudi businessmen, for example, are said to be dumping dollar-based assets out of disgust with the U.S. government’s heavy handed tactics in its war against terrorist financing. Drug dealers and other cash-economy entrepreneurs are said to favor the new 500 Euro notes over the smaller $100 bills. Still other investors are said to be taking a second look at the euro, since the European economy is growing faster than the U.S., European equities are only half the price (in P/E terms) of U.S. equivalents (and thus, in theory, better investments), productivity levels are higher in Europe, and debt levels are much lower.
But in addition to the little waves of monetary fashion, there are also the epochal tides.
“Not since Jimmy Carter was president, I quote myself from above, has the nation seen anything like it.” The ‘it’ to which I refer is the increase in the money supply, recently clocked at 18% per annum… which is infinitely more than the increase in the supply of goods and services that it is supposed to purchase. The nation’s output of ostensible purchasing power is phenomenal. But the nation’s output of purchasable things is in decline. You don’t have to be a monetary economist to guess what should happen. More dollars in circulation chasing fewer goods and services should lower the value of each dollar doing the chasing. Like millions of spermatozoa in search of an ovum – the more there are, the less likely each one is to reach the prize.
The Carter Administration also marked the last time when America, relative to the rest of the world, was neither a net borrower nor a lender. Since then, America has become the world’s leading debtor nation undefined with $2.59 trillion owed the rest of the world. This amount is not trivial. It equals a quarter of the nation’s GDP…about $40,000 per household.
In the ’70s and ’80s, the U.S. was concerned undefined as Japan is today undefined that its currency was too high in relation to others. An expensive currency gives a nation a competitive disadvantage, makings its products difficult to export. But by the time of the Clinton Administration, this worry disappeared. Japan, Taiwan, China and other far eastern nations had already taken away much of America’s manufacturing base. So, the country turned to software, services and high tech industries where cheap labor posed less of a threat.
These new industries were so promising that the rest of the world wanted to own a piece of them. A new and very curious financial model developed in the U.S. undefined helped by Robert Rubin’s strong dollar policy. Instead of producing and exporting things the world wanted to buy, America’s consumers went on a buying spree, and made up the difference by selling off capital assets and exporting dollars!
The strong dollar made U.S. investments more attractive to foreigners. And it made it easier for U.S. consumers to continue to buy more than they could afford. Every day, the difference between what consumers bought from foreigners and what they sold to them equaled about a billion dollars undefined financed by foreign investors.
No country could have gotten away with this except the U.S. Because it is America that produces the key variable undefined the currency in which all these transactions take place. America bought foreign-made goods and paid for them with dollars. Then, it borrowed back the dollars undefined trillions of them. Aided and abetted by foreign investors, the dollar was kept high throughout the ’90s and early 2000s.
But there was no guarantee: the nation that borrowed expensive dollars may pay back cheap ones. We don’t know, dear reader, but the thought crossed our mind as we were watching a video at the hardware store: there are some temptations so great they are irresistible.
Almost 4 decades ago, Charles DeGaulle noticed the temptation offered to a nation whose currency has attained the status of the dollar – it can make the currency worth whatever they want it to be worth, noted the old general. Prodded by DeGaulle, France demanded payment in gold…which later forced America off the quasi-gold standard.
Once completely free from the restraints of gold, the dollar became almost as good as gold; it became the currency of nearly last resort… the currency in which the world’s financial business was conducted.
America is in a unique position in monetary history. Its consumers (and voters) labor under a greater burden of debt than any people ever have. Their mortgages are higher than ever. Credit card debt is higher than ever. Collectively, Americans owe $2.59 trillion to foreigners. How could the load be lightened? Simply by lowering the value of the currency in which it is calibrated. How can this be done? In theory, it is simple undefined by producing more of it.
No cobwebs adorn the money-creation wing of the Federal Reserve bank. The machinery that increases the money supply must whir and buzz around the clock. While the rest of the economy experiences flat or negative growth, the money supply has been growing all year long at double-digit rates.
According to the formula, the quantity of ‘money,’ ceteris paribus, is inversely proportionate to its quality. If the available goods and services remained constant, and the supply of money doubled, each unit of money should be worth half as much. It is, of course, never quite that simple. But neither is it ever completely contrary to the formula. Money, like water, has to go somewhere. And sooner or later, somehow or other, it will get there. Maybe this will be the year the dollar leaks to lower levels.
More to come on this subject…
Your correspondent, wishing you a Happy New Year.
December 31, 2001
The Dow rose 1% last week. The increase in stock prices, combined with falling earnings, has driven the S&P 500 P/E ratio over 40.
“Economy Shows Signs of Rebound,” says the Washington Post.
“December confidence index soars,” says Bloomberg.
“Homes sales climb,” adds an Associated Press headline.
Only one of Barron’s top 10 Wall Street strategists undefined Doug Cliggott undefined sees any trouble on the horizon. (Cliggott thinks the Dow will end next year at only 8,500.)
Meanwhile, the week before last, the money supply (M3) increased by a spectacular $47.8 billion to a grand total of $8.1 trillion. The money supply rose at a 14% annual rate in November…and closer to 18% more recently. Not since Jimmy Carter was president has the nation seen anything like it. And yet, except for real estate, prices seem stable. Surely, there must be more to this story. And there is…below.
But let’s get to Eric’s report from Manhattan first:
Now, Cisco! Now, Intel! Now, Micron and Goldman!
On, ebay! On Yahoo! On, Berkshire and Lehman!
O fabulous stocks! So fabulous all!
If we buy ’em and buy ’em, they can’t ever fall!
The Santa Claus rally continues, whisking the market merrily higher, and making way for undefined what else undefined the January-effect rally (to be followed in short order by the Presidents’ holiday rally, and then the sometime-around-Valentine’s-Day-rally).
“A flurry of unexpectedly positive reports hinted [Friday] that the economy might make a swift exit from recession,” gushed New York Times writer Daniel Altman. “The latest figures on home sales, consumer confidence, orders for durable goods and claims for unemployment benefits all came in better than anticipated.”
Emboldened by these reports, investors strode into the market brimming with Custer-like confidence, and scooped up expensive stocks with falling earnings. Confidence is a valuable trait, unless it is misplaced.
“The market is still caught in a strange twilight,” says DR Blue editor, Dan Denning. “It’s not quite ready to give up the ‘Santa’ rally. But it’s not sure that 2002 will be that much better than 2001…Absent a 500-point rally Monday (Santa putting in some overtime), the Dow will finish down for the second straight year. It hasn’t done that since 1973-1974.Even the spate of apparently good economic news about housing and consumer confidence only pushed the Dow 5 points higher on Friday.”
Nevertheless, the Dow finished the week at 10,137 — its highest close since the terrorist attacks. The NASDAQ also gained on Friday — up 11 points to 1,987.
Bond investors exude just as much confidence these days as their stock-buying counterparts. Junk-bond prices are strengthening relative to U.S. Treasury bonds. In other words, investors are betting that a recovering economy will enable financially weak companies to pay their debts more easily, thereby making their bonds less risky.
But interestingly, at the same time that junk-bond investors are becoming more optimistic, Moody’s itself is predicting that about 25% more companies will default on their debts next year than this year.
Moody’s might be wrong. Or bond investors might be too hopeful. You decide.
Shifting back to the stock market, legendary hedge fund investor Michael Steinhardt suspects that the bear market has not yet finished its work, although he acknowledges that there are significant bullish factors at play.
“We’ve got a guy at the Fed who has the confidence of the world,” Steinhardt tells financial writer Kathryn Welling during a recent interview, “We’ve got a good, solid Republican capitalist-supported Administration. And we’ve had a recession. So what better time to be a bull?…To be a bear, at this point — in the face of all the things I’ve just mentioned — you at least have to recognize what you’re going against.”
Despite that, Steinhardt is bearish because “the weakness that has occurred in the economy has occurred more from oversupply [and] from over-spending,…which leads me to question, first, how much can lower interest rates really stimulate?” Net-net, Steinhardt suspects we’re going through a fairly typical bear market rally.
Remember that the stock market rallied more than 20% on five separate occasions between 1929 and 1933. And the first such rally was a doozy. Beginning less than one month after the Crash, stocks soared 48% between November 1929, and April 1930.
The Treasury Secretary of the day, Andrew Mellon, offered the same kind of mindless, comforting forecasts that we now hear ad nauseam on CNBC, “I have every confidence that there will be a revival of activity in the spring…” (Sounds a little like Chauncey Gardener from “Being There,” doesn’t it?)
Despite record high stock market valuations and dubious prospects for economic growth, the optimists are out in force. They are counseling everyone who will listen to repeat the age-old lunacy of paying rich prices for risky assets — a.k.a. common stocks at 50 times earnings.
Perhaps the Wall Street bulls are right this time. On the other hand, Enron was the second most highly rated stock in the S&P 500 by Wall Street analysts, less than two months before it filed for bankruptcy protection.
Happy New Year to one and all! 2002 should be a fascinating year.
Back in Ouzilly…
The movie showed a naked woman soaping herself in her bath. And… oh… what a woman! Blonde, with full, firm breasts… she seemed to be enjoying the shower.
This was not an X-rated movie your correspondent rented for the holidays. Instead, it was a video playing on a monitor at the hardware store undefined demonstrating a shower head! What a country…you’d have to pay good money to see something like that in America.
A short, plump man stood in front of the TV watching, while your correspondent fumbled through the plumbing section… union joints, female ends, nipples…it was all too much..
I was trying to connect a radiator. Each time I came close to getting the pieces together, I found that I lacked something. So…I returned to the hardware store.
“You’re back again,” noticed the woman at the checkout counter on my third visit, with the sex video running in the background.
“Yes,” I replied, “I wanted to see how the movie turned out.”