The Daily Reckoning: Weekend Edition
April 15-16, 2006
by Dr. Kurt Richebächer
MARKET REVIEW: WHAT NEXT?
According to the consensus forecasts, the U.S. economy is in robust shape and will continue to forge ahead at recent growth rates of around 3.5% for as far as the eye can see. Looking at the various big imbalances, we see an economy in very bad structural shape. There are really two key questions: first, soft or hard landing of the housing bubble? And second, is business fixed investment taking over from consumer spending as the economy’s driver?
Trying to make our own judgment, we scrutinize the recent data flow. Putting particular weight on the housing bubble, we observe distinctly more weakness than strength, and we think that this weakness is sure to accelerate. Mr. Bernanke seized the occasion of his first address to stress again his familiar view that under present conditions the flat yield curve is quite harmless because interest rates are still at historic lows.
As it happens, we disagree with both sides. What matters more than interest rates is monetary tightness. We are sure that the emergence of an inverted yield curve in the past reflected truly tight money. This time, the Fed has maintained full monetary looseness, as measured by the growth of high-powered money and credit. The changes in the U.S. yield curve are the mere product of rate hikes at the short end.
Yet it had an important effect, not on the U.S. economy, but on the U.S. currency. The rate hikes at the short end curbed dollar-funded carry trade. But instead of closing their positions, many carry traders shifted their funding to the currencies with low interest rates – yen, euro and Swiss franc. The new result: a strong dollar on top of very low U.S. long-term interest rates.
The great question now is what may most probably upset the U.S. bubble system, now heavily exposed to carry trade in foreign currencies. We think the main threat is obvious, and actually in the making. That is a weakening U.S. economy forcing the Fed to stop its rate hikes, and later to cut them. Relatively strong U.S. economic growth and the rising interest rate differential at the short end have been a main pillar of the dollar’s strength.
A weakening U.S. economy is bound to crack this pillar. Due to the gigantic leverage implicit to carry trade, a modest rise of the yen, euro and Swiss franc against the dollar by just 2-3 percentage points is enough to abruptly torpedo the whole carry trade in these currencies, triggering a fire sale of unimaginable proportions of both dollars and U.S. bonds. In our view, this is plainly written on the wall, and a true miracle is needed to avoid this debacle.
This has just happened to the Icelandic krona, the New Zealand dollar and several other minor currencies crashing by double-digit rates. The point is that owing to the heavy leverage involved, conditions for a violent chaotic unwinding are prone to abruptly evolve. Any selling may quickly turn into an unstoppable avalanche when participants suddenly recognize a risk. Since early last year, shorting the yen, the euro and the Swiss franc has been deemed to be a safe, one-way bet. This can suddenly change.
There is no way to know the depth and pervasiveness of the U.S. carry trade funded in foreign currencies. In our view, it must be immense, simply because there exist no domestic savings to fund the rampant credit expansion. The whole U.S. financial system is built on carry trade, borrowing short and lending long.
As to the general hopes that a weakening economy will lower long-term rates and boost bond prices, we have to warn that the rapid unwinding of the carry trade in response to dollar weakness will probably overwhelm this effect and send U.S. bond prices sharply downward.
Dr. Kurt Richebächer
for The Daily Reckoning
P.S. You’re probably thinking that this doesn’t leave anywhere to invest – but that couldn’t be farther from the truth. In fact, I’ve found the only five investments you’ll need this year. I’ll give you a couple of examples. One of these investments is a very simple, but powerful hedge, against a collapsing stock market.
Another is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under new Fed Chief Ben “Printing Press” Bernanke.
— Daily Reckoning Book Of The Week —
Demise of the Dollar…and why it’s great for your investments
by Addison Wiggin
This acclaimed book spent over a week in the #1 slot on Amazon’s bestseller list – knocking Harry Potter to number two. It then showed up on Barnes and Noble’s bestseller list and debuted on The Wall Street Journal’s Business bestseller list last week at #8!
The only logical next step was for the book to get on the New York Times bestseller list…which it and sat strongly at #5!
The Demise of the Dollar examines the reasons for the dollar’s slide – including the nation’s historic trade deficit, the euro, government spending habits, globalization, and other international factors – and offers an up-close look at the Federal Reserve’s attempts to “manage” the dollar’s value.
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THIS WEEK in THE DAILY RECKONING: Since taxes are on everyone’s mind, (have you sent yours in yet?), Steve Forbes gave us a bit of a background as to how we ended up with the tax code we have today. See “The Birth of the Tax Beast,” below…
Pilate Error 04/14/06
by Bill Bonner
“Jesus may have been no menace to Rome, but he was a troublemaker in the Levant. The elders wanted to get rid of him. The mob wanted his blood.”
The Birth of the Tax Beast, Part I 04/13/06
by Steve Forbes
“Imagine what Hamilton and Jefferson would think of today’s mammoth tax code, with its multiple rates and convoluted system of deductions! In our earliest days, America had no income tax.”
Shadow Statistics 04/12/06
by Chris Mayer
“The economy is far weaker than generally portrayed. Most investors ignore the rat’s nest of risks and invest indiscriminately in stocks – without proper due diligence.”
The Secret Oil Sands 04/11/06
by Doug Casey
“Political problems are looming in almost every major oil-producing nation around the globe. Iraq is a mess, with production still below the levels prior to the U.S. invasion. Iran looks like it may be next on Bush’s hit list.”
The “Two Trill In Cash” Plan 04/10/06
by The Mogambo Guru
“This whole ‘two trillion in cash’ scenario has some, umm, merit, especially if you are thinking that foreigners dumping American securities would instantly be reflected in instantaneous losses in bonds.”
FLOTSAM AND JETSAM: Americans can only be mystified by the protests that rocked France and led to a cave in by the government. A small economic reform that would have meant the start of much-needed liberalization has been repealed. Lew Rockwell explains…
The French Employment Fiasco
by Llewellyn H. Rockwell, Jr.
The change in labor law would have permitted employers to fire workers, age 25 years or younger, in the first two years of employment. On the surface, it seems that workers in this category – backed by nearly the whole of French public opinion – regard this common-sense change as treason to all that is good and just. In fact, they are demanding what no dynamic and productive economy can or should ever promise: lifetime job security.
Under the present system, there is no fraternity or equality much less liberty. Workers are free to withdraw from their jobs. To leave employment is rightly considered a human right; to deny it is tantamount to slavery or feudal serfdom. At the same time, then, it is pure hypocrisy to expect that the employer not be able to sever contracts with employees. To deny that – as the French protestors demand – is tantamount to enslaving employers and turning them into indentured servants of workers and their unions.
Many Americans and most reporters look at this situation and dismiss everything the workers are demanding as socialist rubbish. There is truth in that. And yet there are other reasons for their reaction beyond ideological corruption. The unemployment rate in France exceeds 10 percent, and it is on the rise. Among the group hit by the proposed reform, the rate is 22 percent. Every young person knows that it is incredibly difficult to find employment. Once they get it, they want to hold onto it for dear life.
Permanent employment is completely incompatible with productivity in a dynamic market setting. French business has responded in two ways: refusing to hire new people or hiring them only on a short-term basis. The problem with the second solution is another regulation that forbids the temporary employment contract to be used as a means of hiring those who are really permanent employees. So unless the business is prepared to take on the huge costs of permanent employment, the employer must let these “temporary” workers go, no matter how much investment the firm has in them.
These kinds of practices – brought about by regulation – have acculturated French workers into misunderstanding the nature of the labor contract. In a free market it is a mutually beneficial exchange like any other that takes place between a buyer and a seller. Both come to the bargaining table with equal power and they only make the exchange if both sides expect to benefit.
This system does not exist in France because a vast and incomprehensible code of regulations interferes. As a result, there is no evidence of a dynamic market for labor anywhere in sight. Rather than create new opportunities by deregulating the business environment, the government has chosen to make jobs even less secure and more vulnerable. It doesn’t matter that the effect of the change might be to intensify demand for workers; with millions currently looking for work and finding none, it is easy to see why the young are in a panic.
Imagine if jobs were available for everyone who wanted to work. What if “help wanted” signs were everywhere? What if skilled laborers could pick where they wanted to work, and unskilled laborers could gain skills in a large range of environments? Or imagine if French workers were in the position of deciding – as many young Americans are – whether to work for someone else’s company or take the risk of starting their own.
If that were the case, I would venture a guess that there would be no energy behind any protests of a law that grants business more liberality in firing. And yet a huge range of laws prevent that from happening. It is not easy to start a business in France or hire people. The taxes, mandates, and wage controls are wickedly restrictive. In the name of human rights, France has managed to deny people their most basic right of contributing to society in a manner of their own choosing.
But how can we know that a free market would guarantee high employment opportunities? In any society, in any time in human history, there is always and everywhere work to be done because there are people with unmet needs. That is because we live in a world of scarcity. Think of this in terms of your own domestic environment. Is there work to be done on your plumbing, paint, carpets, yard, and cabinetry? Is there not work you would gladly have done if the price were right? Of course there is. And this is true in every sector of society.
When we speak of unemployment, we cannot be talking about a shortage of jobs to be done. There is always work to do at some price. For that reason, there can be no such thing as involuntary unemployment in a free market. Everyone who wants to work is working and everyone who does not want to work is in that position by choice. This is a truth that follows from the universal reality of scarcity.
There are only two reasons for unemployment: legal restrictions that forbid contracts from forming (France has plenty, and the United States does too) and price restrictions that prevent the market for labor from clearing properly (France has that too, as does the US). In other words, involuntary unemployment is always and everywhere brought about by the same cause: government restriction of the market.
Editor’s Note: Lew Rockwell is president of the Mises Institute and editor of LewRockwell.com. You can receive the Mises Daily Article in your inbox. Go here to subscribe or unsubscribe: