The Suzerain

Manipulations always end in disaster. The Great Asian dollar-repurchase scheme represents the largest exchange rate manipulation the world has ever seen. A tragedy is unfolding…

The monetary world is one of competing devaluations, currency blocs, exchange controls, political posturing and jawboning – in short, a sort of serial economic conflict. Where once all money found a common denominator in some metal, today’s currency is fragmented money with an added layer of political instability on top of the natural uncertainty of free market prices.

This added uncertainty is not without consequence. Capital as a financial concept is defined by the price of money. Monetary calculus takes place in dollars, or yen, or euros, amongst a myriad of other monetary symbols. When that money price no longer reflects the realities of supply and demand, becoming distorted – as is often the case when the political mixes with the economic – you have the ingredients for a crisis.

Currency manipulation is effectively a cloaking device, where political ambition seeks to change the natural pattern of the market. Today, it is frequently in the news, as America continues to suffer job losses to nations that can produce the same for less. Chief among the new habitats for these migrating jobs is China.

Suzerain: Exchange-Rate Manipulation

The Chinese yuan is linked to the dollar, as are other Asian currencies – the Hong Kong dollar, and the Malaysian ringgit. Japan, while not officially pegging the yen to the dollar, has joined its Asian neighbors as a large purchaser of U.S. dollars. As James Grant noted in the April 9 issue of Grant’s, "The pell-mell purchase of dollars for yen, renminbi and other Asian currencies constitutes the largest exchange-rate manipulation in the history of the world."

By absorbing America’s prodigious production of dollars, the finance ministries of Japan and China, in particular, have helped to bolster the dollar’s value. The Asian countries follow this path to keep their own currencies from appreciating against the dollar, thereby protecting what they perceive to be the key to their own prosperity – namely, exports.

In times when the paper monetary emissions of a nation’s government were redeemable in specie, such a charade had a definite life span that was circumscribed by its gold stock. Eventually, the offending treasury’s gold reserves would start to dwindle, and the inflation would either have to be brought to heel or the gold standard suspended (which happened frequently enough). Either way, the jig was up. Not so in today’s accommodating monetary marketplace, which allows for evermore widespread and extended inflations.

Nonetheless this, too, will end, as all manipulations end, in disaster. It will end in devaluation, as tremendous purchases of dollars cannot be sustained. That is the way of all unsustainable trends. They go on for longer than most people think likely, eliciting elegant theories to rationalize them…and then the trends stop, usually to the surprise of many and to the detriment of their portfolios.

Suzerain: Ceding Monetary Policy to the US

The relationship between these Asian countries and the U.S. is such that the Asian countries seem to have ceded their discretion over monetary policy to the U.S. Ludwig von Mises observed that the monetary policy of one nation voluntarily becomes a satellite of a foreign power when it pegs its own country’s currency rigidly to the currency of a monetary "suzerain-country." Under such an arrangement, the pegged-currency country is bound to follow all the changes the "suzerain" brings about in its own currency, against other currencies and against gold.

Today, it is not hard to discern that the U.S. is the suzerain. China, for as long as she cares to link her currency at a fixed rate with the dollar, is forever at the mercy of U.S. dollar policy.

The media highlights China’s advantage, however…derived, they say, chiefly from the fact that her currency is deliberately fixed at a cheaper value than the market might independently appraise. But China’s policy in this regard is hardly wholly beneficial to China. China sells its exports for dollars. These dollars have gotten cheaper and will likely get cheaper still. China sells, and in return receives notes that, in a sense, will never be repaid at par value.

But the cycle doesn’t stop there. Devaluations are often followed by more devaluations, as each nation is deluded into thinking that the way to prosperity is to destroy the native currency to stimulate exports and to preserve jobs. "At the end of this race," Mises warned, "is the complete destruction of all nations’ monetary systems."

Whatever the advantages put forth by advocates of devaluation, Mises pointed out that they were at best temporary, resting entirely on the fact that adjustments to currency changes take time. Temporarily, exports are stimulated by devaluation, as that nation’s goods and services suddenly appear cheaper to customers overseas and abroad. But ultimately, devaluation simply means that those bound by the currency must work that much harder to purchase the same quantity of foreign goods that they were able to purchase before for less work. Devaluations make one poorer, not richer.

Any manipulation of exchange rates, devaluation or otherwise, creates imbalances and tensions that foment crisis and economic ruin. China, by continuing to allow for the cheap accumulation of yuan with overpriced dollars, is doing U.S. consumers a favor that cannot last.

When China stops, and when the rest of Asia follows suit, the end result ought to be higher interest rates and a cheaper dollar…not to mention painful economic adjustments.


Christopher Mayer
for The Daily Reckoning
May 4, 2004

P.S. The end of Asia’s vendor-financing scheme will herald unhappy times for the holders of many U.S. financial assets, but it will likely reward those that have hedged or sold their dollars for assets likely to rise against the dollar. The biggest casualty will likely be the U.S. housing market. [Ed note: The demise of the dollar-repurchase scheme will come about abruptly…and perhaps much sooner than you think. Are you prepared?

Christopher W. Mayer is a veteran of the banking industry, specifically in the area of corporate lending. His essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is also the author of "Capital and Crisis," a recently launched investment advisory for contrarian-minded financial observers. For details, see:

Capital & Crisis


Many investors believe Warren Buffet walks on water. Many think he has the gift of prophesy. Even the cynical financial press regards him as a minor divinity, able to transform base metals into pure gold.

The Sage of the Plains…the Oracle of Omaha…is there any accolade so dear that the world’s second-richest man cannot afford it?

Of course, Warren Buffett is a fool like all of us, and a bigger fool than many. We know that not by tallying his money…but by checking his politics. We find that he is backing John Kerry in the presidential race. Why? What is he thinking? The only worse choice would be George W. Bush! But Buffett likes Kerry because the democratic candidate has promised to raise his taxes. Buffett would like to pay more.

Of course, Buffett could perfectly well send as much of his money to Washington to fritter away as he would like. What he means to say is not that he would like to pay more in taxes, but that he would like you to pay more. In this we see some unfairness. Even if the marginal tax rate were 90%, it would not affect Buffett’s lifestyle in the slightest way. You and I, dear reader, might actually feel a pinch.

But our beat here at the Daily Reckoning is money, not politics. We choose money because it is more entertaining and less costly. Besides, there are no fundraisers to attend.

So, what would Warren do? WWWD?

We found out over the weekend as Warren conducted his annual ‘Woodstock of Capitalism’ meeting.

We already knew what the lumpeninvestors were doing. They’ve been mortgaging their homes…and putting money into stocks at a near-record rate. Inflows into equity funds reached $43.8 billion in January…and a total of $75 billion in the first quarter, not much less than the amounts invested during the bubble peak in early 2000.

We know also that investors and investment advisors have rarely been so positive in their views. An overwhelming majority expect stocks to go up at least until after the election; nearly as many think they will go up forever.

We can’t help but wonder. Anyone reading the paper must now know that the best investor who ever lived thinks otherwise. Almost all financial assets are "more than fully priced," says Buffett. He sees no stocks worth buying. He has no interest in getting shares in Google. He believes inflation is "heating up." And he is now betting against the currency in which almost all Americans’ wealth is calibrated – the U.S. dollar. Buffett has more than a third of his enormous cash pile invested in foreign currencies.

WWDWWD. We would do what Warren does. More or less. We would sell expensive shares and hold cash – either in euros, or in gold.

But the lumpen are betting that Buffett is wrong. What must they think? That they are smarter than Buffett? That they understand the financial markets better than he? That they – by some gift of the gods – will be luckier than the man who has been luckiest of all?

Of course, they may turn out to be right on all points. But it is a remarkable wager.

Over to the East Coast for more news:


Addison Wiggin from the ‘Old Line’ state…

– Any trader, analyst or investor worth their weight in salt knows that today is the day when the teddy bears at the Fed have their picnic. Despite widespread predictions of ‘no change,’ the troup of market spectators and commentators will be braced to rip Greenspan’s commentary to shreds in their search for clues: are Teddy bears still Teddy bears, or are they morphing into Teddy Bulls?

– Like circus goers packing the big top, all eyes are on Greenspan, who has just stepped out onto the tight rope. There is no safety net in this circus…this is the real deal. The crowd is hushed, and even the clowns (Jim Cramer is one of them) have shut up for a second, dropping their unicycles and custard pies to watch the Maestro. One false step, a random gust of wind, or even an untimely sneeze could prompt disaster…deflation to one side, inflation on the other…frying pan or fire?

– "No one expects the U.S. central bank to raise interest rates at Tuesday’s policy session," assumes Reuters, "but Fed watchers said a post-meeting statement needs to bow to recent strong economic data and free the Fed’s hand for eventual action…economists are increasingly convinced the recovery is durable – the past three quarters have seen the strongest economic growth in 20 years – and some think the Fed risks doing too little too late to head off inflation."

– But what if we just step back for a moment, dear reader, and speculate what might happen if they did raise rates today? We called our favorite analyst, Dan Denning, to get his take…

– "Raising rates now? Before the jobs report? It would be an unmitigated disaster. Nobody could predict what might happen. The Fed needs to go nice and slow, get everyone warmed up, then make a move. Raising today would smack of desperation. Besides, the debt-sponsored consumer-spending glut would stop dead in its tracks. The ramifications for the housing bull would not be pretty…"

– Talk about a housing bull…it’s hard not to talk about a housing bull. It’s impossible to avoid. Everybody feels rich and clever and shrewd for having bought a house. Now they want more, and there’s no shortage of banks and pseudo-banks to lend the equity. But a rise in interest rates, albeit a small rise, will have profound consequences – mortgage defaults, collapsing lenders, collapsing stocks, collapsing bonds…maybe even collapsing banks.

– "Consumer spending, which has been a major prop for the stock market’s gains, may fade in coming months, raising questions about where the economy and stocks will draw future strength," reports Kenneth Barry at Reuters. "Consumer spending, which accounts for 70% of U.S. economic activity, has benefited from fiscal stimulus like tax cuts and from easy credit engineered by the Federal Reserve, but these stimulants have pretty much run their course."

– Stocks were sold hard last week, and yesterday they bounced…the S&P added 10 points to 1,118, up nearly one percent. The Dow Jones added 88 to 10,314 and the Nasdaq gained 19, 0.97%, to close at 1,939. Otherwise, the markets echoed the Fed’s nonchalance…the dollar rose slightly against the euro and the yen, and also against silver, which fell 4¢. Gold bucked the trend and rose, adding 60¢ to $387.65.

– Adding some more fog to an already cloudy outlook, the ISM manufacturing index for April eased to 62.4 from 62.5 in March. Although the figures are virtually unchanged, a reading over 50 implies growth in the manufacturing sector. The reading has now exceeded 60 for 6 months straight, and now at just a whisker shy of the January reading – which at 63.6 was the highest in two decades – the latest report may add further fuel to the Fed’s fire. Hmmmn…


Bill Bonner, back in London…

*** Watch out! Richard Russell tells us that a combination of indicators has touched off what is known as the "Hindenburg Omen." You will recall that the Hindenburg was a German airship that burst into flames over New Jersey and collapsed. There were no survivors. Russell warns that the stock market is in "potential crash mode."

*** Poor Frank Quattrone. When the SEC began sniffing around, the dumbbell told his staff to "clean up those files." This single act of tidiness is likely to get the man 1 to 2 years in Federal prison. After earning $120 million a year helping to puff up the tech stock bubble, the poor man will bring in only $4 per day in the hoosegow.

At least he won’t have to worry about his job being outsourced to India.

*** What is wrong with the Lords? Today’s Times of London brings news that the Lords have come up with a plan that will make the House of Lords an "indirectly elected" group.

The saving grace of Lords was that they were not elected; they were chosen by the luck of birth rather than the fraud of elections. Now, the Lords will soon reflect the same grasping, low-life, clod politics as Commons…or the U.S. Congress.

*** And now we come to religion.

For over on page 22, the Times reports:

"Vatican cuts out kissing and pew-jumping at Communion."

This comes as good news. We recall the dignified church services before the ’70s; we never quite took to the hugging and kissing and wandering around during the passing of the peace that came later. It seemed out of keeping with the solemn atmosphere; it broke the spell. We’re glad the pope put a stop to it.

Our family became Catholic without intending to do so. Out in rural France, we found no Episcopal churches within commuting distance.

Many of our friends cannot understand it. Like our own son, Jules, 16, they wonder why we should go to church at all.

"You don’t know whether any of this stuff is true," they say. "Why waste your time believing in mysteries…and going to church?"

Here, we have no ready answer.

Yesterday, we dined with an old friend…and asked for news of a mutual friend who has been fighting cancer.

"Bad…" came the reply. "He went down to a clinic in Mexico, but it was too late. They flew him home. He has only a few days left."

"May God be with him…"

"But he’s an atheist…"

"Well, I doubt if God cares what he thinks. He may have gotten no comfort in this world…but God will decide for Himself what he gets in the next."

Unlike the tawdry frauds and conceits of secular life, the promise of Christianity is so magnificent and so elegant…we would admire it, even if we were not True Believers.

Our expectations are modest – more poetic than logical. Maybe we will get into heaven and maybe we won’t; but at least, while we are alive, we can offer our family what W.B. Yeats described as a little "custom and ceremony" where "innocence and beauty" might flourish.

Besides, we like to pray to God before making an important decision. We get the answer we wanted anyway…and have someone to blame if it doesn’t work out.

The Daily Reckoning