What's Ailing the Dollar? Part I: Current Account Deficit

[GRG55]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

so here's my 3rd post in a row on this thread:


the prior 2 posts really highlight ej's notion of poom in the form of dollar repatriation. all those dollar assets being held by foreign central banks are in essence sterilized or frozen. they are not a part of the "money" supply. turn them into actively traded liquid assets and suddenly the money supply jumps enormously, and u.s. dollar denominated assets get a huge inflationary bid. this causes me to begin to think about buying equities -- which are, after all, dollar denominated assets.

finster has long maintained that equities are a good inflation hedge. i've been reluctant to accept that, remembering back to the 70's when i first came across that notion. when inflation got serious, it turned out that equities weren't a good hedge at all. but that was inflation in things like wages, causing a wage-price spiral and gravely impairing corporate profits.

Inflation has already appeared in commodities – notably energy and food, and in non-importable services like education and healthcare. House prices are dropping but are still way above trend. Stock prices are rising. I think they are destined to rise [nominally] much higher. Zimbabwe’s rocketing stock markets are the reductio ad absurdum for this process.

But there is still enormous risk embedded in the credit markets; risk which might manifest as craters in financial institutions’ balance sheets, and as impairments in consumers’ income/expense balances. Somehow pm’s seem like more of a sure thing.

I've been working through much the same thought process jk.

FWIW here's my line of reasoning. Seems to me the biggest difference between the 1970's and now is that capital has soundly trounced labour. In the 1970's, without the global labour arbitrage dynamic, North American and European labour was able to negotiate wage increases to offset monetary and consumer price inflation (remember COLA clauses?). This kept up demand for consumer goods and this demand pressure = price inflation = higher wage demands, and so forth. Two oil supply shocks (1973 embargo, 1979 Iran revolution) added...ahem...fuel to the fire. Various attempts at wage and price controls proved ineffective at breaking the cycle; Volker finally killed demand with brutal interest rates & two recessions, and the rest is history.

The most durable consumer "good" was housing, which generally proved an excellent inflation hedge in the 1970's as I recall. On the other hand, equities did not (unless you were in raw materials and energy), probably because, as you say, real margins kept shrinking due to rising raw material and labour inputs, and the inability to completely pass these costs to final customers.

My guess is the most recent bubble catagories of housing and tech are unlikely to repeat any time soon, and may not even keep up with inflation this time. With capital trumping labour, it seems to me that a falling US dollar means relative labour costs in the USA are declining rapidly, as are operating costs for US based companies. To see this dynamic in action, compare the 1-year stock price behaviour of US drilling company Noble Corp (NY:NE) against Canada's premier drilling company, Precision (NY:PDS). Precision's customers are seeing their opex in Cdn $ rising quickly while the product they sell (mostly natural gas) is priced in US$ and has been declining (in real and nominal terms!). I also think this dynamic, coupled with increasingly creative international competition, is finally going to bring down the real cost of education and health-care.

When I see Buffett selling PetroChina and buying US railroads I have to think that many US companies are going to be raising their global market share of whatever they make; and many will start making more of it in the USA. We've seen a lot of crazy things, but I would venture that repatriated capital won't buy US housing, financial paper, or the discredited banks that created it (not until the fire sale because nobody wants to repeat Prince Al Waleed's mistake the last time Citi was in trouble). I think Finster is correct that equities may be a good inflation hedge this time, but it will be selective (driven by the rising cost of capital vs falling cost of labour dynamic) and just buying the index may not work - except, perhaps, in the very late stages of this multi-year cycle.

Having said all that, I come back to the same point as you (and Charles MacKay, and EJ, and...) - hands down, in today's situation, PM's still seem like the best risk/reward.

But that leads to another dilemma...does one now buy more bullion, or more gold miners.? :confused:
Back in mid-March and again in mid-August, when the Au/XAU ratio was above 5, it was a no brainer. Now with the potential for an "all assets down" move in the markets I am not so sure...

[jk]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

i am tracking you closely, grg55. re equities: the dow has been leading the u.s. market largely because it's composed of big multinationals which benefit from overseas sales as well as increasingly beneficial currency conversions as the dollar drops. your point about noble v precision is well taken.

i watch the equity markets with fascination and envy, especially because i have been following the winners - the bhp's, sgf's, etc - literally for years, but haven't bought them because i've been waiting for the big sell-off. i've known what to buy, but not when.

in recent times, when i've felt a strong urge to buy something but still worry about the all assets down scenario, i've bought a few out of the money leap calls on gdx. when i bought some more gld about a month ago, i took profits on some of my gdx calls. basically i think of gdx calls as a cheap way to scratch an itchy trigger finger.

but i also think gld will suffer in an all assets down scenario, just not as much as gdx or other equities. this has kept my pm exposure at 25% instead of the 30% i think of as my maximum for the asset class.

[GRG55]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

i am tracking you closely, grg55. re equities: the dow has been leading the u.s. market largely because it's composed of big multinationals which benefit from overseas sales as well as increasingly beneficial currency conversions as the dollar drops. your point about noble v precision is well taken.

i watch the equity markets with fascination and envy, especially because i have been following the winners - the bhp's, sgf's, etc - literally for years, but haven't bought them because i've been waiting for the big sell-off. i've known what to buy, but not when.

in recent times, when i've felt a strong urge to buy something but still worry about the all assets down scenario, i've bought a few out of the money leap calls on gdx. when i bought some more gld about a month ago, i took profits on some of my gdx calls. basically i think of gdx calls as a cheap way to scratch an itchy trigger finger.

but i also think gld will suffer in an all assets down scenario, just not as much as gdx or other equities. this has kept my pm exposure at 25% instead of the 30% i think of as my maximum for the asset class.

I can't think of any way to deal with the all assets down scenario other than holding a package of cash spread between Yen, Swissie, US$ (incl. our local currency here which is a $ proxy). I agree Au will probably track down in such an event.

[GRG55]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

Well here's someone else in Asia "fleeing" (Finster's apt description) the US$. Interestingly enough it means some Canadian shareholders are accepting US$. Wonder what they will buy with them? Maybe this is the new Chinese and Arab strategy. Can't buy anything in the USA because of the politics. Well, buy something in Canada and then let those nice Canadians go shopping in the malls of America. By the way, the exchange rate note at the end of the article is part of the original Reuter's release.

Cheung Kong to pay C$629 mln for TransAlta Power

Mon Oct 15, 9:37 AM


TORONTO (Reuters) - TransAlta Power said on Monday it will be acquired by Hong Kong's Cheung Kong Infrastructure Holdings Ltd in an all-cash deal worth about C$629 million.

Under the deal, Cheung Kong Infrastructure will pay C$8.38 per unit for all outstanding units of TransAlta Power.

That's a 15.7-percent premium over Friday's closing price of C$7.24 a unit for TransAlta Power on the Toronto Stock Exchange.

TransAlta has also agreed to a break-up fee of C$17 million if the deal is not completed. The transaction is also contingent on the usual regulatory approvals and the acquisition of 66.66 percent of the outstanding units.

The deal comes months after TransAlta's board said it was beginning a review of strategic alternatives.

"Through the process we reviewed a myriad of alternative proposals. The board has concluded that the sale to CKI provides the best opportunity to maximize unitholder value," Stephen Mulherin, chairman of the board of directors of the General Partner of TransAlta Power, said in a release.

($1=$0.97 Canadian)

[c1ue]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

JK, GRG,

It is good to see your thoughts on how to protect and grow your existing nest eggs.

A couple of notes:

1) Even with a cheaper dollar, US labor is not going to be lower than Chinese labor. Not unless the dollar drops 90% AND China fails to follow. As I have repeatedly said, Japan has hitched their wagon to the US; the price for Japanese support of all US policies is US acceptance of a cheap yen peg vs. the dollar plus military counterbalance vs. China. And if you think this doesn't have real effects - have you priced a high-end Mercedes or Audi recently? The Euro rise has made these already expensive cars absolutely unreal. 5 years ago a top line Merc was $110K, now it is $170K - right in line with the euro appreciation.

While some of this is avoided through US factories, ultimately something has to be made in Europe, also profits have to be converted to euros.

2) I do agree that in inflationary scenarios, gold will profit. However this is assuming we don't have government intervention. I've looked at numerous historical examples, and NONE of these practices can be ruled out this time around:

a) fiat currency peg to PM, but without exchangeability
b) currency/commodity controls
c) additional 'wealth' taxes on PM holdings
d) confiscation (see above)
e) nationalization of holding companies

There are many more...just check out the early (1770-1820) history of the US as one example, also the later Roman eras.

Ultimately while I don't know exactly what will happen, I still hew to my belief that the only way to get out of this alive and prospering will be to own a business which has pricing power. Low cost food, fuel, low price entertainment. Increasingly I see agriculture (i.e. farms) as being an excellent option due to secular changes in food demand worldwide. Unfortunately commercial agriculture in the US may a terrible investment from a stock perspective - between management manipulation and extreme reliance on fertilizers/fossil fuels, it is not clear to me that companies like ADM will be able to make bank - especially with GM restrictions.

Ultimately I think it will be the boutique brands as well as perhaps a few middle sized, high quality outfits that will disproportionately grow - not an easily investable option.

[GRG55]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

Well here's more bad news for the bonar...
Foreigners Sold Record $69.3 Billion in U.S. Assets

By John Brinsley and Kevin Carmichael
Last Updated: October 16, 2007 09:57 EDT
Oct. 16 (Bloomberg) -- International investors sold a record amount of U.S. financial assets in August as tightening access to credit threatened economic growth and spurred an exodus from American stocks.

Total holdings of equities, notes and bonds fell a net $69.3 billion after an increase of $19.2 billion in July, the Treasury Department said today in Washington. Including short- term securities such as Treasury bills, foreigners sold a net $163 billion, compared with a gain in the previous month.

Demand for U.S. stocks overseas declined as the deepening housing recession and credit-market rout threatened investment, hiring and consumer spending. The drop in purchases was the first since August 1998, when Russia defaulted on its debt.

``The turmoil in August had a huge impact,'' said Mike Englund, chief economist at Action Economics LLC in Boulder, Colorado. ``These figures will refocus attention on that and may aggravate the tensions in the market.''

After the report, the dollar pared gains against the euro, trading at $1.4169 at 9:35 a.m. in New York, from as high as $1.4144 earlier today.
Economists predicted international investors would buy a net $60 billion of long-term securities in August, based on the median estimate in a Bloomberg News survey.

The Treasury's reporting on long-term securities captures international purchases of U.S. government notes and bonds, stocks, corporate debt and securities issued by U.S. agencies such as Fannie Mae and Freddie Mac, which buy mortgages.

Agency Debt

International holdings of U.S. stocks fell a net $40.6 billion, compared with net purchases of $21.2 billion in July. The Standard & Poor's 500 Index rose 1.3 percent in August, while the Dow Jones Industrial Average gained 1.1 percent.

International demand for Treasuries decreased by $2.6 billion, compared with a loss of $9.4 billion the previous month. The yield on the benchmark 10-year note in August averaged 4.73 percent, compared with 5.04 percent in July.

Holdings of agency debt increased a net $9.6 billion after a $8.7 billion net gain the month before.

U.S. investors bought a net $34.5 billion of overseas assets in August, after buying $5.5 billion in July.

Private investors sold a net $10.6 billion, compared with a net $20.6 billion in purchases a month earlier. Official purchases, including those by central banks, fell by $24.2 billion after an increase of $4.4 billion in July.

Foreigners sold a net $1.2 billion of corporate bonds, compared with a $4.5 billion increase in July.

Dollar's Decline

Some economists say the difference between the U.S. trade gap and securities purchased by foreigners is an indicator of how easily the nation can finance its external obligations. The trade deficit in August shrank 2.4 percent to $57.6 billion, the smallest since January, as exports climbed to a record, the Commerce Department said on Oct. 11.

The U.S. current-account deficit, a broader measure of trade that includes investment income and transfers, narrowed to $190.8 billion in the second quarter, the Commerce Department said on Sept. 14.

The U.S. dollar dropped 0.2 percent in August against the currencies of 17 major U.S. trading partners, the seventh straight monthly decline.
Chinese investors decreased their holdings of U.S. government debt $8.8 billion in August, while Japanese investments declined $24.8 billion, the

Treasury said. Holdings the U.K. jumped $33.4 billion.
Caribbean banking centers, which analysts link to hedge funds, bought a net $33.1 billion.

Holdings of Major oil exporters -- a group that includes the members of the Organization of Petroleum Exporting Countries, Ecuador, Bahrain, Oman and Gabon -- were unchanged at $123.3 billion.

[hayfield]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

finster has long maintained that equities are a good inflation hedge. i've been reluctant to accept that, remembering back to the 70's when i first came across that notion. when inflation got serious, it turned out that equities weren't a good hedge at all. but that was inflation in things like wages, causing a wage-price spiral and gravely impairing corporate profits.

Strategic Asset Allocation and Commodities, Ibbotson, pp18

Practitioners frequently use equity asset classes to hedge against inflation, but our analysis shows that both U.S. Stocks and International Stocks are negatively correlated with inflation.

Is there evidence to the contrary?

[Spartacus]

Re: I don't know if Mish is specificially responding to this

but here's his take

He has a chart showing the deficit bobbing up and down as the dollar is mostly going nowhere.

his reliance on the charts is "interesting" to say the least - has anyone actually claimed there is a statistical correlation between the dollar and the trade deficit?

[Spartacus]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

just a note of caution - a question I ask about my own "investments"

how can you ascertain whether you are or are not one of Nassim Taleb's 10,000 traders that flip a coin, and you're one of the 1,000 left standing after 3 flips?

I'm happy to report that I am up nearly 3x since 2001 on idle speculation in 2001 of dollar depreciation. The process that drove the dollar down this far is about as mysterious as rainfall. Everyone now knows how it works, everyone now knows that the Fed is stuck in its role defending dollar depreciation policies due to the politics that created this state of affairs, and now–six years later–I can't find a fund manager on the other side of the trade. It's all about non-dollar investment and commodities.

[GRG55]

Re: I don't know if Mish is specificially responding to this

but here's his take

He has a chart showing the deficit bobbing up and down as the dollar is mostly going nowhere.

his reliance on the charts is "interesting" to say the least - has anyone actually claimed there is a statistical correlation between the dollar and the trade deficit?

For many years now Stephen Roach at Morgan Stanley (used to be their Chief Economist, but I think he is now MD for Asia based out of Hong Kong or Shanghai) has written that a depreciation of the US$ is a necessary, but not sufficient, condition to correct the gargantuan US trade and current account deficits. Well so far he's been dead right - the $ has depreciated but it hasn't been sufficient...

[GRG55]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

OK. Hands up everyone who thinks this will help Paulson's "strong dollar" when the Asian currency markets open shortly...

ECB May Have to Raise Rates to Contain Inflation, Weber Says

By Gabi Thesing and Michael Wudonig
Oct. 21 (Bloomberg) -- European Central Bank governing council member Axel Weber said the bank may have to raise interest rates further to quell inflation and that the euro-region's economy does not need support from borrowing costs.

``I don't believe that interest rates have to support the economy, which is currently growing at 2.5 percent,'' Weber said in an interview in Washington D.C. yesterday. ``Inflation risks have increased recently,'' and the bank will ``have to counter these risks should they materialize.''

Weber said there's a ``reasonable probability that inflation may end up above 2 percent in 2008 and possibly in 2009,'' and ``that is reason enough to examine closely if there is a need to adjust'' interest rates. The bank aims to keep inflation just below 2 percent...

Link to article:
http://www.bloomberg.com/apps/news?p...&refer=economy

[lobodelmar]

Re: What's Ailing the Dollar? Part I: Current Account Deficit

I searched the forums to see if this article by Paul Krugman was ever mentioned, and since I didn't see it anywhere figured some of you might be interested in reading it if you hadn't seen it yet.

Will there be a dollar crisis? -from Economic Policy July 2007, Krugman, Paul