The Dollar...Er, Again...
As we prepare ourselves to forecast the economic events of 2003, we thought a look back at year-end 2001 would be in order. Thankfully, the market didn’t embarrass us too much…this year.
This essay was originally broadcast on New Year’s Eve of 2001.
Each year for the last two [now three] years, 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 2001. 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 – 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 – 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.
[Editor’s note: Such an astute reader would have, in fact, fared quite well in 2002. Gold is 24% higher for the year…the XAU and HUI gold indexes are likewise up 38% and 115% respectively. And while at the beginning of the year it would have cost you US$.88 cents to buy a Euro…today the price has risen US$.15 cents. Figures in the rest of this essay were current on the eve of 2002, but as we’ve noted above, the economic picture has changed little… except to have been stretched farther out of whack. Cheers, Addison.]
Not since Jimmy Carter was president has the nation seen anything like 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 – 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 – as Japan is today – 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. – 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 – financed by foreign investors.
No country could have got away with this except the U.S. Because it is America that produces the key variable – 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 – 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 – 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. [Maybe, indeed.]
December 26, 2002
Only four more trading days left…the Dow is down 15.5% for the year…and 37% below its ’99 high.
Investors have given up on ’02; they’re already wondering about next year. Once again, they turn to the financial press for the usual plague of predictions. The seers have been blind, deaf and dumb to the biggest financial trend to come along in the past 20 years – a major bear market.
But maybe they’ll get lucky next year.
Falling stock prices are unthinkable; the experts seem not only unable to imagine them falling but unable to see them falling right in front of their own eyes. Almost all those quoted in the press at the beginning of 2000 thought stocks would continue to rise. Then, again in January 2001, Abby Cohen, Rukeyser’s ‘elves’ and the other loudmouths on Wall Street foresaw rising prices. And a year later…same thing.
And, now three years later – three years of declining prices on Wall Street later – and what do they see: rising prices! Business Week interviews 65 of the ‘smartest players’ on the street and, guess what…62 of them say that stocks will go up in ’03.
Why will stocks go up? The analysts give a variety of reasons. Among them is the continued willingness of the American consumer to ruin himself in order to keep the entire world economy spinning around.
The Fed reports that consumers added a record $1.7 trillion in personal debt through October – almost 4 times Russia’s entire GDP. Eric Gillen, of TheStreet.com calculates that consumer will pay $3 trillion in interest on credit card debt over the next 50 years, even if they never charge another thing.
This record debt leads, of course, to record bankruptcies and a record level of foreclosures. There were 1.5 million bankruptcy filings in the last 12 months.
But just as Wall Street could see no break in rising stock prices coming 3 years ago…few economists can see a change in the borrow/spend/go bust pattern of the American consumer. Consumer borrowing and spending "will continue to be a boon to the economy," says Gillen.
Then again, perhaps Christmas sales figures are giving us a hint that the poor fellow has had enough? Maybe he’s reached his credit limit. Maybe he’s just tired of being the world’s patsy? Or maybe he’s noticed that most of what he’s buying is getting cheaper…autos, TVs, even food…and maybe he’ll just wait a little longer before spending his money…?
Of course, if he does that, it may be the end of America’s consumer economy… the End-Of-The-World-As-We-Have-Known- It (EOTWAWHKI)…and welcome to Tokyo! (Or is it Buenos Aires?)
Here’s Bob Prechter’s prediction: "We’ve entered a bear market that’s so big, we haven’t had anything like it since the 1700s, and that was a 64-year corrective process… This is a great opportunity to get out. By the time this whole thing is over, you’ll be able to buy your favorite neighborhood mansion from the bank at 10 cents on the dollar."
Stay tuned for our own Daily Reckoning predictions for 2003…next week! (And a look back at what we were saying this time last year… below.)
Over to you, Eric…
Eric Fry in New York…
– The New York Stock Exchange was locked up tight for the Christmas holiday yesterday…but we won’t let a little thing like that stand in our way. As we like to say down on the factory floor, "the reckoning never sleeps…"
– When we last visited our hero, he was handing out a lot more lumps of coal than sugarplums. On the day before Christmas the Dow lost 45 points to 8,448, while the Nasdaq fell 9 to 1,372. Not only is the so-called "Santa Claus rally" failing to materialize, but the Santa Claus sell-off has shown up instead…
– Weighing on share prices Tuesday was a durable goods report that was far more naughty than nice. Orders fell 1.4% in December instead of rising slightly as most economists had forecast. Orders for non-durable goods – like Christmas presents that break on Christmas – haven’t been too great either. Holiday sales have been downright terrible.
– "Sales for the seven days ended Saturday were down 5.8% from the week," says USAToday citing a report from Instinet Research. "Sales at major chain stores grew 0.2% in the three weeks ended Dec. 21 compared with the same period last month. Sales were consistently "below plan" across Instinet’s entire sample in the third week.
– "Wal-Mart is barely making the sales it projected," USA Today continues. "Federated, operator of Bloomingdale’s and Macy’s, continued to see sales weaken…Most retailers estimate low single-digit sales growth and blame sluggish economic conditions for consumers shrugging off of ever- steeper discounts through the season."
– "The pre-Christmas retail figures weren’t just bad," says Dan Denning of the Strategic group, "they were the worst in the 32 years the figures have been kept. Part of the problem was the old `expectations game’. Following upbeat forecasts after Thanksgiving, retail stocks surged. But since December 2nd, the S&P’s retailing index has fallen 13%, over twice the 6% decline in the S&P itself.
– "Maybe this is good news for consumers," Denning continues. "You can expect to see a blizzard of falling prices and sales in the next two weeks. But even if the price-cutting strategy works, it’s bad news for corporate profits. The Fed, the financial media, Wall Street analysts…every one keeps telling us there’s no deflation…but we keep seeing companies like Federated Department stores forced to cut prices just to maintain sales figures from last year. Is it deflation? Is it a tapped-out consumer? Is it really bad weather? There may be lots of reasons…but the bottom line is that it’s an excellent time to be short retail stocks."
– Up here in the Northeast, a huge winter blizzard is blanketing the landscape with snow. It’s absolutely beautiful. And for a California guy like myself, having an honest-to-goodness white Christmas still seems a bit bizarre. Amidst the winter freeze here in the Northeast, I am reminded once again of the balmy breezes of Central America.
– "Remember, it’s a third-world country," one recent visitor to Nicaragua told me before I headed down there. And that’s a true statement. North American visitors should be prepared to observe poverty in all its various forms, especially in Managua. But having visited both Mexico and India, I was prepared for a much more horrific form of poverty than what I observed in Nicaragua.
– It’s true that one passes miles and miles of very humble houses and shacks, surrounded by pigs, chickens, cows and dogs, not to mention beautiful flowering bougainvilleas. But the locals seem to eat pretty well and most of the houses out in the countryside were very well tended. Pick- up baseball games among boys of the various villages are as much a staple of Nicaraguan life as rice and beans. And nearly every boy I saw carried his own glove.
– "Better to travel hopefully than to arrive" is an expression that often pertains to international travel. But it did not pertain to my visit to Nicaragua…Something strange and wonderful happened to me when I visited Rancho Santana. My anxieties vanished. I didn’t give a single thought to any of the various concerns that I had left behind in the States. Instead, I gazed out at the majestic, blue Pacific and "zoned out."
– Is Rancho Santana a great investment? I don’t know. I do know that it is a great place…and that I can’t wait to return. I also know that I’d prefer to buy an $85,000 lot in Rancho Santana than $85,000 worth of an S&P 500 Index fund…But that’s just me.
Back in Ouzilly…
*** Here at the Daily Reckoning, we believe in full disclosure. We open our raincoats readily, like the aging prostitutes on the Rue des Lombards…and hope we won’t be arrested. Your editor already has a house on a cliff at Rancho Santana and is an investor in the development. But he has mixed emotions about the whole thing. On the one hand, he recognizes that the when others come down and buy lots and build houses, his investment increases in value. But on the other hand, he likes the isolation and loneliness of the place and would like to keep it that way.
Again, if you’re interested, you can take a look at the property by clicking here:
*** Christmas came to Ouzilly yesterday, just as to the rest of Christendom. Each of the children has come to expect one special present from Santa. Jules, who was born on Christmas day 15 years ago, sometimes gets 2.
We were especially proud of Henry this year. The 12-year- old sang a solo in church on Christmas eve…and again on Christmas day. His voice is changing and almost cracked…but the pure, clear tones echoed through the small stone church as if from an angel.
It reminded us all of the time, at least 7 years ago, when Jules sang a solo at Christ Church, in Maryland, and brought tears to almost every eye.
(Since then, he has brought tears to his mother’s eye on more than one occasion – even without singing.)
This year his father decided it was time to get him an electric guitar. The present was a big hit. Jules opened the box, reached in to pull out a shiny red instrument, plugged in the amplifier…and scarcely another word was heard from him the rest of the day.
But your editor is no fool. He included a pair of earphones so that the boy could do his Grateful Dead tunes in silence…while the rest of the family listened to Connie Francis singing Ave Maria.