Sell Everything

[bart]

Re: Sell Everything

As another famous bart once said, "eat my shorts".

If you insist: ;)
http://www.nowandfutures.com/grins/eat_short.mp3

What do you mean by "global purchasing power"? I dare you. Just try ... try and short "global purchasing power". Or for that matter, go long the same. In the world of investing, we are stuck with a limited menu. If we buy stock on margin, we are shorting USD and going long stock. If we short stock, we are shorting stock and going long USD. Whether you admit to being a relativist or not, you can't escape the fact that every trade that involves shorting something also involves going long something else, and that you are implicitly taking a position on the relative merits of two assets.

So if you short a stock, you can just as properly say you are making a bet that cash (the dollar) will outperform the stock as you are that the stock will underperform cash. And if you are advocating shorting a bunch of stuff - as you suggested above - that you are expressing a view that cash will outperform a bunch of stuff.

Consequently, you are a dollar bull.

Q.E.D., ipso facto, and all that jazz.

Far be it from me to once again look askance, and without even the normal quantity of baited breath, at your non relative relativistic shortcomings.

There's never been much question about your power (and I leave the "what" to more worthy folk than I to judge), and purchasing is something that I assume you do yourself rather than leave it up to other Manor denizens... and that only leaves global as the possible fly in the ointment. Perhaps you're further out than has so far been recognized and acknowledged?

I'll leave it up to the student and the necessary homework to figure out how to short (or go long for that matter) global purchasing power...

I do agree on the bull part of your statement though... and consequently I do have an investment in mind for you. I hear they're beginning to work on version 2 of the movie.





;)

[Finster]

Re: Sell Everything

If you insist: ;)
http://www.nowandfutures.com/grins/eat_short.mp3

Far be it from me to once again look askance, and without even the normal quantity of baited breath, at your non relative relativistic shortcomings.

There's never been much question about your power (and I leave the "what" to more worthy folk than I to judge), and purchasing is something that I assume you do yourself rather than leave it up to other Manor denizens... and that only leaves global as the possible fly in the ointment. Perhaps you're further out than has so far been recognized and acknowledged?

I'll leave it up to the student and the necessary homework to figure out how to short (or go long for that matter) global purchasing power...

I do agree on the bull part of your statement though... and consequently I do have an investment in mind for you. I hear they're beginning to work on version 2 of the movie.

...

;)

;)

Being that you are such a dollar bull, I'll just pop over to the "Too Many Dollar Bears" thread, where your services will provide a much needed balance ...

;)

[Finster]

Re: Sell Everything

For clarification, by "deflation" he means, and I mean, a debt deflation.

Whose debt? Everyone's, including the US government's. But it is the form of the deflation of the US government's debt that bears upon the question of the value of the dollar, "money," and "cash."

One of the potential avenues for a US government debt deflation is default, the other is currency depreciation. The iTulip take for quite a few years (e.g., our mock 2001 US bankrupcy filing -- Ha-ha!) is that the US is far more likely to choose debt deflation via the latter method than the former, as the latter is painful yet recoverable (see Can the US Have a Peso Problem?) while the former tends to lead to mass unemployment, and severe self-reinforcing economic and political crisis. The "Poom" event versus a "Poom" event is no mere post crash reflation but a one time write-off of US government debt via dollar depreciation.

We'll try to interview Grantham directly, but I have spoken with enough professional money managers over the years to conclude that none of them have debt deflation via currency depreciation on the radar. Jim Rogers has discussed it with me, but he's not a money manager. The most extreme financial markets condition that can be expressed in the context of a professional money manager's letter to clients is the kind of post-bubble panic and rush to liquidity that Grantham is talking about in his April letter. You won't see the potential for a US currency crisis discussed even in the Twin Focus client letters, and non-traditional crisis events are part of their model. (We picked them as a sponsor for a reason.)

The traditional crisis model is the standard script: risky emerging market assets sell off first, then less risky exotic domestic assets, cascading all the way down the risk ladder to US bonds, the "safest" of all. A lot of rarefied paper gets dumped for good old red, white, and blue bonds.

A scenario that includes a rush to non-US bonds and hard assets–capital fight from the US–does not fit the standard crisis model, and you will not hear Grantham talk about gold. The reason is simple: it's not that professional money managers cannot imagine it happening, but if it does happen it may not be the end of the world, but at least for a time it will be the end of their world. So why propose it? Under what conditions is that scenario relevant in the context of that client relationship? Think about it. Grantham is telling his portfolio manager clients that the most rational thing they can do is go to cash–but they can't do that. Such an event will be a boon for the hard assets crowd, however.

Think about it this way. Most professional money managers kept their clients in the stock market in 2000, and many lost a bundle. Guess where they are keeping their clients today? To Grantham's credit, he is talking them out of risky assets, now in fashion, and into relatively safe ones. But how will they be regarded if the US defaults on its foreign debt via depreciation? January 1999 we called for a 87% decline in the NASDAQ. In 2001 years we predicted a 50% decline in the dollar. The former turned out to be optimistic if you count all the companies that went out of business. The latter prediction may also turn out to be optimistic. If you believe that, do you want to hold a lot of long term US bonds? TIPS if you trust the house to index the resulting inflation accurately, T-bills otherwise.

Grantham's letter analyzed in detail over on the Select forums next week.

Thanks for the illumination, EJ. Maybe if you do talk to Grantham, you could get some further clarification. When he says "all asset classes" will decline, it's not clear in exactly what terms he means. They will decline in dollar terms? Euros? Ounces of gold?

These are "asset classes", too, aren't they? And if he means they will decline, that still leaves the question of relative to what they will do so. It's no trivial point, either, since whatever it is they would declining against would appear to be those things one should have one's assets in! And if everything does indeed decline, then that implies that there is nothing the investor can do. Doesn't matter what he does, because cash, stocks, bonds, gold, commodities and real estate ... whatever ... all will go down.

I take it from your comments about debt deflation via currency depreciation that cash (USD) would be one of those depreciating assets. This, in turn implies that some other form of money, whether foreign currency or gold, would rise in dollar terms. On the other hand, Grantham in his missive cites "the probable exception of high-grade bonds" (in addition to some other of his long time favorites such as managed timber). So it sounds like he is saying that such bonds would appreciate in dollar terms. Is this an area of disagreement? Or are we still missing something?

[bart]

Re: Sell Everything

;)

Being that you are such a dollar bull, I'll just pop over to the "Too Many Dollar Bears" thread, where your services will provide a much needed balance ...

;)

It's much more fun to wait a few days so that you can see for yourself the error of your (short term) ways... ;)

[EJ]

Re: Sell Everything

Thanks for the illumination, EJ. Maybe if you do talk to Grantham, you could get some further clarification. When he says "all asset classes" will decline, it's not clear in exactly what terms he means. They will decline in dollar terms? Euros? Ounces of gold?

These are "asset classes", too, aren't they? And if he means they will decline, that still leaves the question of relative to what they will do so. It's no trivial point, either, since whatever it is they would declining against would appear to be those things one should have one's assets in! And if everything does indeed decline, then that implies that there is nothing the investor can do. Doesn't matter what he does, because cash, stocks, bonds, gold, commodities and real estate ... whatever ... all will go down.

I take it from your comments about debt deflation via currency depreciation that cash (USD) would be one of those depreciating assets. This, in turn implies that some other form of money, whether foreign currency or gold, would rise in dollar terms. On the other hand, Grantham in his missive cites "the probable exception of high-grade bonds" (in addition to some other of his long time favorites such as managed timber). So it sounds like he is saying that such bonds would appreciate in dollar terms. Is this an area of disagreement? Or are we still missing something?

Keep in mind, iTulip has been chronicling the imminent death of the dollar since 1998. Here are a few stories from 1997 - 2001.

What I try to get across to readers is the concept of very slow, discontinuous processes, with plenty of surprise turns–which can last for a decade.

In 2000, the jury was very much out on the euro. Recall it plummeted for the first few years. Not until the post stock bubble depreciation of the dollar did the euro get its shot. But the euro has its problems. We know it works well when all is well. Let's see how well the euro does in the next global economic and financial crisis. At some point Spain will need emergency 1% rates to cope with the aftermath of their extreme bubble created over the past decade as it become the special home for Russian money that's been stripped out of everything from oil refineries to Russian pensioners (a book will be written about that some day, a Russian friend tells me), while other countries will be suffering inflation. In the US, the Fed happily allows Michigan to go into a depression while Massachusetts booms. To heck with Michigan, says the Fed. The equivalent, allowing Spain to go into recession while Germany gooms, is politically impractical in Europe. Either the euro takes a credibility hit to save Spain, or Spain–if things get bad enough–splits off. Neither event will be good for the euro.

Ka-Poom Theory has, since 1999, theorized that the end of the cycle of bubbles will occur as a one time write-off of US domestic and foreign debt via currency depreciation. The mechanism of that depreciation is US creditors repatriating dollars already floating outside the US, either out of desperation because domestic political demands in a severe recession are more pressing than the geopolitical demands of the US, or due to some other forcing function, such as war. So far, that has not happened. Will it eventually? Still seems more likely than a debt deflation. Will it be sudden and dramatic? Perhaps at some stages. Can we die a death of 1,000 cuts? You bet.

I grow more convinced by the day, though, that we are in for at least one more great asset bubble after this one ends, that the process is by no means over.

Energy and Infrastructure.

Listen to the Republican presidential debate tonight? Watch the memes sprout like crocus in spring: "We need zero taxes on alternative energy to support long term investment to end our dependence on foreign oil and stop global warming!"

Who's going to argue with that program? How about taxing oil, too, to create extra demand for alternative energy and use the tax $$$ to fund Medicare and SS?

Hank Paulson was talking the game, using almost the same language, in an interview on Charlie Rose two weeks ago.

Hear that? That's the sound of the next bubble rising over the hill.

But, to your question, I will try to talk to Grantham to get clarification on which sovereign debt and whose cash.

[flow5]

Re: Sell Everything

WHITHER THE DOLLAR?
A nation has a TRADE DEFICIT when the cost of merchandise imports exceeds the receipts from merchandise exports. The CURRENT ACCOUNT balance encompasses merchandise, service items, commodities, and “current” financial transactions; while the BALANCE OF PAYMENTS includes the entire above plus capital flow items; all transactions involving foreign exchange.


The foreign exchange value of any currency is determined by the supply of and the demand for that particular currency. In international financial analysis supply and demand take on an unique role; for what is demand form our point of view is supply from the standpoint of foreigners – and vice versa.

All transactions that require the conversion of foreign currencies into dollars constitute a demand for dollars. These include exports, payments received for serves rendered to foreigners, interest and dividends collected from foreigners, etc. An increase in the volume of any one of these things will increase the demand for dollars and, ceteris paribus, the foreign exchange value of the dollar.

The opposite types of transactions, imports, etc., which involve payments to foreigners increase the supply of dollars and thereby reduce the foreign exchange value of the dollar.There is no “flow” of money internationally, only offsetting debits and credits on the books of the financial institutions involved in financing trade or other transactions. A slight modification of this statement is necessary to take account of the movement of paper and coin currencies. Their contribution to surpluses or deficits is extremely minor and short run, when not actually offsetting.In foreign exchange supply always equals demand at the current rates of exchange.

International debits equal international credits. The balance of payments always balances since there can be no credit transfer of funds.When the balance of payments is balanced by foreigners acquiring net holdings of our equities, bonds, and real estate, and capital outflows (interest, dividends, rentals, etc.) exceed inflows, we are either decreasing our net creditor position in the world, or increasing our net debtor position.

Beginning 1985 it has been the latter. The trade deficits, plus the unilateral transfers of funds by the Federal Government to foreigners, transformed this country from this world’s largest creditor to the world’s largest debtor – for the first time since 1917. Since 1985 we now have a net debtor position exceeding 5.7 trillion dollars, but the principle villain (since 1973) has been our dependence on foreign oil.

Trade deficits at any particular time for any given country can be beneficial or harmful; can represent economic strength or weakness. In the period before Worlds War I the By the end of World War I the U.S. had mostly trade deficits. We were a debtor country – and we thrived. Foreign investments accelerated our economic development and our standard of living rose faster as a consequence.

U.S. was a creditor nation, but we refused to act like one. We opted for tariffs and other restrictions on imports, rather than free trade. Capped by the sky-high Hawley-Smoot tariff of 1931, U.S. trade policy was an important contributor to the world wide depression of the 1930’s.

By 1933 there was not a single major nation on the gold standard except the U.S.The situation was further exacerbated when Roosevelt and his Treasury Secretary, Morgenthau, exercising the crisis powers delegated to the executive branch by Congress, took the U.S. off the gold standard in April, 1933 by making the dollar inconvertible into gold at a fixed price. And to make matters worse they periodically kept raising the price of gold from $20.67 per ounce to a final price in Dec. 1933 of $35. This had the effect of depreciating the exchange value of the dollar. All of this was done by a creditor nation operating with a chronic surplus in its balance of payments.

The Bretton Woods Agreement of 1944 established, amount other things, the International Monetary Fund and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreign and confirmed the previous international status of the dollar, that an ounce of gold was equal to $35 and that all dollars were to be freely convertible into gold bullion at that price to foreigners but not to U.S. nationals.In 1949, the U.S. dollar was not only as “good as gold”, but it was also preferred over gold. There were not enough dollars to finance the legitimate needs of the world economy. So, the chronic balance of payments deficits which began in 1950 were for a number of years beneficial to the world economy and to the U.S.

Because of our large and chronic balance of payments surpluses after World War II, foreigners were unable to accumulate sufficient dollar balances to efficiently finance world trade. These balances were desperately needed because of the total dominance of the dollar as the reserve custodian, standard of value and transactions currency of the world.

The Korean Conflict (1950-1953) temporarily solved the problem but, the longer term solution consisted in implementing our “containment policy” against the U.S.S.R. This involved the establishment of approximately 700 military bases, not only around the perimeter of the Soviet Union but throughout the world. We have paid hundreds of billions of dollars to foreigners to acquire the bases and to maintain a garrison of more than 400,000 military personnel abroad.

With diminishing merchandise surpluses this policy proved to be financial overkill.By the mid 1960’s foreigners found themselves in possession of excessive dollar balances, excessive in terms of the needs of trade. Some of these excess dollars came to be used as “prudential” reserves in the formation and growth of the Euro-dollar banking system.

Since 1970, the “western” world has functioned within a system of essentially free exchanges. Before 1973, exchange rates were in terms of a “fixed target”. Now the dollar is a “moving target”.

The Korean War, which began in June, 1950, initiated the chronic balance of payments deficits that persist to this time and which will probably continue as long as foreigners are willing to increase their net investments in this country.The U.S. has had a net liquidity deficit in every year since 1950 (with the exception of 1957), Up to 1976 (when the private sector contributed its first trade deficit ) these deficits were entirely the consequence of excessive U.S. government unilateral transfers to foreigners (re: foreign policy – solely our far flung military bases and personnel). During all this time the private sector was running a surplus in all accounts: merchandise, services and financial.

The Vietnam Ten-year War administered the coup d’etat to our gold bullion standard. By 1968, in an effort to keep the dollar at the $35 par, we had exhausted nearly two thirds of our monetary gold stocks, or approximately 700 million ounces to about 260 million ounces.Although the dollar ceased to be freely convertible in March, 1968, institutional (central bank practices) and attitudinal lags were sufficient to offset, until late 1970, the excessive expansion in the supply of dollars. In August 1971, all convertibility was ended. This further accelerated the decline in the exchange value of the dollar.

All fluctuations in exchange rates prior to this time were the result of other currencies changing in value relative to the dollar.During the early seventies of the Nixon administration the dollar was twice devalued, raising the fictional price of gold to c. $41-43. These were non-events. When the dollar was no longer on a gold standard (after March, 1968), the dollar price of gold was determined by the open market. In response to the devaluations, the Federal Reserve Banks marked up the balance sheet values of their holdings of gold certificates. These were also nonevents; since the capacity of the Reserve banks to create credit (acquire Treasury Bills, etc. by creating Interbank Demand Deposits) was unaffected; nor did the devaluations alter the capacity of the fed to pay out Federal Reserve Notes in exchange for these IBDDs.

From late 1970 to 1978, the dollar depreciated relative to other major currencies.After the “Marshall Plan”, which did not produce a balance-of-payments deficit, most of this aid was in the form of various types of military assistance, or to maintain our numerous foreign stations and bases, and to finance approximately 400,000 military personnel abroad; except for the Korean and Vietnam wars, which more than doubled that figure. The policy that engendered the outlay of trillions of dollars for these purposes was called dollars for these purposes was called “containment”, i.e., containment of the U.S.S.R.By the end of the cold war in 1990, the United States had 395 major military bases and hundreds of smaller installations around the world. Most of the bases are part of military alliances formed to contain communism. By 1990, 435,000 American troops, 168,000 Defense Department civilians and 400,000 family dependents were living on foreign bases. Another 47,000 sailors and Marines were stationed aboard ships in foreign waters. A million Americans abroad were on the Defense Department payroll.

Even if we eliminated the trade deficit and ran a surplus sufficient to service our foreign debt, the dollar would still decline because of the war/containment/terrorist deficit. Since actions sufficient to eliminate these deficits are highly improbable, the dollar will eventually decline to a level which will eliminate them. At that level our standard of living, for this and other reasons including financing the federal debt, will be much lower than at present, and the capacity of the Pentagon to project conventional military power abroad will be severely circumscribed.

We have observed, given the situation of this country in the 19^th century, (its people government and undeveloped resources) that it was advantageous both to lenders and borrowers for the U.S. to run a trade deficit.Conversely it is also economically advantageous for creditor nations, and for the world economy, if creditor nations operate with trade deficits: deficits proportionate to their creditor status. This is, the deficits should be large enough to enable the nationals of debtor nations to acquire a sufficient amount of foreign exchange to enable them to service their international debts.

Since the U.S. is no longer an economically undeveloped nation, but is increasingly an international debtor, what evaluation should be places on our huge trade and current account deficits? For the very short run these deficits keep prices and interest rates lower than they otherwise would be and they subsidize our standard of living. But the deficits also are inexorably forcing the dollar down in terms of its foreign exchange value—and no consortium of central bankers, treasury secretaries, et al. can stop the process.

With a chronically depreciating dollar foreigners will be much less inclined to invest in the U.S. on a creditor ship basis, thus pushing up interest rates. The rising cost and diminishing volume of imports will contribute to an increase in inflation, and the expectation of further inflation will also push up interest rates. This spells stagflation.

Under pressure from this country, the Pacific Rim, Oil Exporting, etc., central bankers try to support the dollar. They do not try to arrest the long-term downtrend of the dollar, but seek to erase some of the unnecessary short-term and destabilizing fluctuations. This is a correct statement of what the function of the central bank should be where the objective is to influence rates of exchange.

The net accounting effect of the Chinese buying U.S. dollars is 1) the importer pays in his own country’s currency, 2) the exporter receives payment in his country’s currency, 3) for very debit there is a credit, 4) there is no net transfer of funds, and 5) money is not flowing in or out of the respective countries. This is proved by using “T” accounts. The balance of payments always balances even though the statistics on payment balances never do. To correct this deficiency, the commerce Department inserts an item called “Errors and Omissions”. Thus, the triumph of theory over “facts”.

The Chinese loss of income and probable exchange rate losses, when the reverse of these operations is consummated at a later date, are, of course, compensated by the Federal Reserve. The adverse effects on the Chinese economy receive no such compensation.

For all of this reason, the policy of the U.S. Treasury and the Federal Reserve is to minimize overt intervention in the foreign exchange markets.Although the lags are sometimes unusually long between exchange rate changes and the changes in volume and value of trade, the present situation cannot be explained by these lags.Trade restrictions have some effect, but the U.S. is not immune from subsidizing exports and using numerous devious devices by the Customs Service to restrict imports.

A weak currency is not a cause; rather it is a symptom of a weak, noncompetitive economy. In time, of course, a declining dollar will eliminate the deficit in our balance-of-trade. But the price exacted will be a sharp decline in imports, principally oil, and the purchase of foreign services, reflecting our relative poverty and inability to compete in the international economy. The fact that we are the world’s number one producer of smart bombs will not arrest that trend.T

The real culprit seems to be the cost of our products relative to their quality. Inferior quality is not a good buy at any price. We are even getting a reputation for inferior products.

For the people of limited foresight, which apparently includes a substantial majority, debt expansion can be very exhilarating. One’s standard of living can take a quantum leap forward. Taxpayers are currently being subsidized, in terms of taxes not paid, more than 248 billion annually. It is called the federal deficit. Consumers are being subsidized by approximately 875 billion annually, of which, 494 billion is for oil. It is called the foreign trade deficit. In the longer term the problem of servicing all this debt, consumer, corporate, and federal poses daunting problems. And that is a gross understatement. These circumstances, as we know, are of our own making. The country has not been invaded, nor have our productive resources have not been destroyed, or even impaired, by national calamities.

It is also important to note that imports decrease the money supply of the importing country while exports increase the money supply, and the potential money supply, of the exporting country. Purchasing the deficit countries currency will reduce its supply but sooner or later the central banks will have to reverse their positions and the foreign exchange dealers know this.The trade-off of reducing the pressure on the global dollar by temporarily decreasing the volume of the dollars requiring conversion into yaun is the cost of foisting an inflationary policy on China. Obviously, and for good reason, the Chinese have reason to resist this kind of assistance.

While the U.S. will have a temporary gain, as will foreign enterprises engaged in foreign trade who are momentarily freed from excessive fluctuations in the exchange rate, the overall financial effects are a loss to the Chinese and to the Chinese economy.

No country has become and remained a world power if it is a world debtor and has a weak currency. From these unwanted events we can expect a vicious level of stagflation that will become an enduring feature of our economic landscape. And the United States will be forced into a high degree of economic isolation and perhaps into an increasingly totalitarian mold

[flow5]

Re: Sell Everything

ADOPTION OF A GOLD STANDARD
There are increasing numbers of advocates for the adoption of some form of gold standard. Gold standards of whatever type, gold coin, bullion or some modification of the gold bullion standard, all require that the unit of account be defined in terms of gold of a certain fineness, e.g., one dollar equals 25 grains, 9/10 fine, thus establishing the mint price. The other sine-qua-non requires the government, acting directly or through the agency of a central bank, to stand ready at all times to buy or sell gold at the mint price.

An operating old standard creates, or is associated with, many advantages: 1) stable foreign exchange rates; 2) free multilateral clearing of currencies among nations; 3) the maximization of multilateral foreign trade; and, 4) relatively stable price levels e.g., no chronic inflation. All that is required to achieve this economic utopia is a 1) world free of major wars, depressions and cartels (OPECs); 2) markets with downward price flexibility, that is , true price competition; 3) creditor nations which impose no significant restraints on imports; 4) monetary authorities who abide by the “rules of the game”, i.e., the central banks expand credit (create commercial bank legal reserves) when gold stocks expand, and vice versa; 5) monetary authorities who restrict the expansion an d contraction of central bank credit within a very narrow range, thus preventing the commercial banks from creating an unsupportable volume of credit money (demand deposits); and, finally, 6) a world where the reserve currency countries (those countries whose currency serves as a store and standard of value as well as a transactions currency) never operate with chronic deficits in their balance of payments.Note: deficits or surpluses refer to changes in a country’s gold stocks and net short-term claims (demand deposits, CDs, commercial paper, etc. – the “balancing items” in the balance of payments.) deficits result from gold exports and/or a decrease in short-term claims against foreigners relative to the short-term claims held by foreigners. The reverse is true for surpluses.

From 1816-1914 there conditions were achieved under the aegis of the Bank of England to an extent sufficient to provide international trade, and the British domestic economy, with all the advantages of a free gold standard. This period marked the heyday of the gold standard. The British pound sterling was the reserve and transactions currency of the world. International transactions were financed largely by transfers on the books of the “big five” World War I ended all this. Attempts to restore the gold standard in the 1920’s were swallowed up in the Great Depression. For most of the period from the end of World War I to 1968, the world was on a U.S. dollar standard, but never a free gold standard.

World War I transformed the London banks, thus minimizing the necessity to transport gold. So great was the faith in the convertibility of the pound sterling, that the Bank of England could, and did, operate with relatively small gold reserves. A change in the central bank’s discount rate, or a small change in the buying price of gold (not a devaluation or a revaluation, but simply a change in the price sufficient to offset implicit interest and shipping costs) usually was enough to prevent significant or unnecessary outflows of gold.
*
U.S. into a creditor nation, left our industrial capacity expanded and intact, and set in motion forces which made our economy the safest haven for foreign capital seeking escape from foreign nationalization. World War II and the Great Depression accentuated these trends. But the U.S. tended to ignore its responsibilities as the world’s principal creditor nation and reserve currency custodian. We severely restricted imports through sky-high tariffs (Hawley-Smoot, 1931, for example), customs red tape, commodity classifications and other devices. The volume of Federal Reserve Bank credit was determined more by domestic considerations than by gold flows.

In April, 1933 we nationalized gold, made the dollar inconvertible and by administrative fiat capriciously raised the dollar price of gold in a series of steps from $20.67 to $35 per ounce. All of this was done even though were a creditor nation and had a chronic surplus in our b balance of payments. In January, 1934 the Congress codified these administrative actions into law. Under this modified gold b bullion standard, the dollar was convertible on foreign, but not domestic account at $35 per ounce.

Before we commit ourselves to the naïve proposition that a successful gold standard requires only an Act of Congress, we should examine the reasons for the abandonment of gold convertibility in March, 1968. That was the month and year the U.S. Treasury ceased to sell gold on the open market. No longer could foreigners buy gold and the London or any other exchange at $35 per once.

The U.S. Treasury held approximately two thirds of the world’s monetary fold stocks in 1949. They resulted from years of surpluses in our balance of trade and “flights” from foreign currencies. In 1949, the U.S. dollar was not only as “good as gold”, but it was also preferred over gold. There were not enough dollars to finance the legitimate needs of the world economy.

With the outbreak of the Korean War in 1950 surpluses turned to deficits. With the sole exception of 1957, these deficits (usually of increasing magnitude) have characterized our balance of payments in every year since. For the first few years, the deficits were beneficial. But a good thing can be over done and we did it. In our efforts to police the world, we overcommitted ourselves. This zealotry finally leg to the escalation of the Vietnam War in 1965 and the subsequent demise of the dollar as the reserve currency of the world.Note: Until 1971, the private sector always operated with a surplus. These surpluses were more than offset by the excessive unilateral foreign transfers by the Federal Government. Since 1971, the Federal Government can share the blame. U.S. industry has become less competitive, but the principal villain (since 1973) has been OPEC.

By the mid 1960’s foreigners found themselves in possession of excessive dollar balances, excessive in terms of the n needs of trade. Some of these excess dollars come to be used as “prudential” reserves in the formation and growth of the Euro-dollar banking system. Other excess dollars were used to buy our under priced gold (under priced as a consequence of chronic inflation). Our gold stocks, which were about 700 million ounces in 1949, had fallen to about 260 million ounces by March, 1968. Had the Treasury not abandoned its effects to maintain the equality of the market price with the mint price, our entire monetary gold stocks probably would have been depleted by the end of 1968.

Paradoxically, the Euro-dollar System, (now a foreign-dollar prudential reserve banking system) which was established both because the dollar was in excess supply and the reserve currency of the world, is now one of the principal factors militating against any attempt to reestablish the convertibility of the dollar into gold’s at a fixed price. We are not even willing to give the Fed the degree of control over our own domestic money creating institutions.

Regardless of whether or not our objective is establishing a gold standard, the situation requires measures be taken which well reverse the deterioration of the dollar’s integrity. What is required is no less than an end to the chronic liquidity deficits in our balance of payments, and a halt to the excessive creation of U.S. and Euro-credit dollars. But the alternative is, at some point in time, a flight from the U.S. dollar and, therefore, the Euro-dollar. This will generate hyperinflation in terms of U.S. and Euro/Yen/Yaun/Petro/-dollars, etc., and an international financial crisis of unprecedented proportions

[flow5]

Re: Sell Everything

FOREIGN-DOLLAR MARKET
A common misconception is that Euro-dollars (E-Ds) are U.S. dollars that have somehow contrived to leave this country, whereas in fact all E-Ds are created abroad. The foreign commercial banks, and foreign branches of U.S. banks, which create this money, operate on the premise that they will always be able to convert E-Ds into U.S. dollars on demand on a one-to-one basis.

This exchange equivalence privilege may suggest to the E-D borrower that there is no meaningful difference between E-Ds and U.S. dollars. But in terms of our national and the international economy this is an illusion. In both an economic and legal sense the E-D is no more a part of the lawful money supply of the U.S. than is the Canadian dollar, or any other national currency.

Two principal factors were responsible for the origin of the E-D banking system; (1) the possession by foreign commercial banks of an excess volume of short-term claims against the U.S. dollar, and (2) the preeminence (at that time) of the U.S. dollar as the reserve, standard-of-value, and transactions currency of the world.

Beginning in 1950 the U.S. incurred the first of a chronic series of net liquidity deficits in its balance of payments. These deficits have grown in magnitude and continued uninterrupted ever since 1950 with the exception of 1957. By the mid sixties foreign banks had acquired more dollar balances than were required to cover their own international transaction needs – so they started lending their excess U.S. dollar balances: (described by Bernanke as part of the global savings glut; Greenspan’s so-called interest rate conundrum, i.e., artificially low, short-term and long-term interest rates).

E-D banking originated in the City of London and London based banks still dominate the E-D banking system. As the number of banks participating in the E-D transactions increased (G7), the E-D bankers discovered that the E-D deposits they created for borrowers often did not result in any diminution of their U.S. dollar balances – the System was merely shifting balances within itself. That is, drafts drawn on E-D banks increasingly were deposited in other E-D banks.

Thus was laid the economic basis of an international system of “prudential” reserve banking – the discovery that the amount of actual U.S. dollar reserves required to support the E-D loans made – and E-D deposits (money) created.

The prudential reserves of the E-D banks consist of various U.S. dollar-denominated liquid assets (U.S. Treasury bills, U.S. commercial bank CDs, etc.) and interbank demand deposits held in U.S. banks. The volume of prudential reserves held by each E-D bank presumably is dictated by “prudence” – not by any legal requirement administered by a monetary authority.


All prudential reserve banking systems have heretofore “come a cropper”. Money creation by private profit institutions is not self-regulatory- the “unseen hand” simply does not function in this area. Invariably the systems created too much money, speculation became rampant, inflation distorted and destroyed economic relationships, confidence that the banks could meet their convertibility obligations eroded, “runs” on the banks caused mass banking failures, and entire economies were left in ruin.

With this historical record to draw from the pertinent question is: Why did the various governments and monetary authorities allow E-D banking to grow on an unregulated, prudential reserve basis? The situation obviously required that the E-D banks be constrained in their money creating activities through the standard devices of legal reserves and reserve ratios, the volume and level of which are controllable by the monetary authorities. There is no assurance, of course, that the monetary authorities having such powers will use them to prevent and excessive creation of money.

Until the early sixties there was a chronic shortage of U.S., dollars available to finance international transactions. But the E-D system came about precisely because the U.S. banks. The volume of prudential reserves held by each E-D bank presumably is dictated by “prudence” – not by any legal requirement administered by a monetary authority.
*
U.S. balance of payments deficits had finally supplied a more than adequate volume of international liquidity (fed continuously by U.S. trade deficits). The E-D has been a superfluous and harmful addition to the world’s monetary stocks and E-D bankers have increased their earnings assets by approximately this ? addition.. This figure is many times the U.S. means-of-payment money supply.As of April 2006, China holds the largest foreign exchange reserves, much of which are denominated in US currency.

Such deposits are now available in many countries worldwide, but they continue to be referred to as "Eurodollars" regardless of the location. E-Ds, Yuan, Yen, Rupee, Rial, Ruble, Naira, Rupiah, Bolivar; (U.S. trading partners and Petro-dollars), etc.. are now contributing to this excess.This vast addition to the world’s money supply has substantially contributed to the high rates of inflation that have prevailed since 1965 with U.S. trading partners. Nor can the E-D be defended as being in any way superior to the U.S. dollar as an international reserve and transactions currency since the acceptability of the E-D is totally dependent on the acceptability of the U.S. dollar.

If the E-D system is not to repeat the tragic record of all previous prudential reserve banking systems two thins are necessary: (1) the U.S. dollar must remain acceptable as the world’s transactions currency (This requires that the chronic deficits in the U.S. balance of payments cease), and (2) the E-D system must be subjected to the restraints of controllable legal reserves and reserve ratios.But this is only the beginning. After the legal structure has been put in place we will still need monetary authorities who understand the economics of money creation, the consequences of excessive money creation – and are willing to force on the governments and business communities of their respective countries the discipline of a properly regulated money supply. The latter problem will be with us whether control is vested in the central bankers, or the International Monetary Fund is made a world central bank and control of the E-D is vested in it.

If history is a guide it is obvious these requisite conditions will not be achieved.

[Sapiens]

Re: Sell Everything

Flow5,

Are you quoting someone's writings or is this your original work?

-Sapiens

[flow5]

Re: Sell Everything

They are my writings though not my propositions or principles. I was schooled by a friend. Most people thought he was obsolete or worse. He was a self-described rates-of-change / flow-of-funds economist. However, papers in the early 50's called him a monetarist. He's unique. He alone understands money & central banking.

He stopped researching and publishing in the early 60's. He became sort of an arm chair theorist. I believed every word he said. So I keep tinkering until I discovered the "holy grail", i.e., "considering the distortions in the def of M1A and the rapid increase in the currency componet, the correlation of the time series is remarkable", i.e., monetary flows (MVt) 28 years ago.

Dr. Leland James Pritchard (Feb 20 1908 – Nov 15 1991) had a political science degree from Syracuse Unviersity and taught political science while getting his masters in statistics, and received a Ph.D. from the yracuse, he taught political economy courses at Syracuse University Univestiy Maxwell School of Public Administration. He taughtUniversity of Chicago in 1933, where he was elected Phi Beta Kappa. Dr. Pritchard served with the Federal Emergency Relief Administration, The Works Projects Administration, and The War Labor Board. He served both as the Chairman of the Economics Department from 1955 to 1962 and Dean of the School of Business from 1955 to 1962. He was a Fulbright lecturer and President 1963-1964 of the Midwest Economics Association. His extensive research and publication record display a broad knowledge of both Finance and Economic Statistics. His Money and Banking Texts (1958, 1964) were widely used and are perhaps the most literate of all recent American texts in economics. He became professor emeritus in 1976 but continued to serve the university. He left an economic scholarship fund. The only thing he bought on time in his life was his house. He owned a credit union and died a multi-millionaire. He passed of pancreatic cancer in 1992.

While he was in Chicago, Milton Friedman was there getting his masters. But unlike Leland, Milton Friedman is retarded.

If you want, I have his publication list.

[Sapiens]

Re: Sell Everything

The prudential reserves of the E-D banks consist of various U.S. dollar-denominated liquid assets (U.S. Treasury bills, U.S. commercial bank CDs, etc.) and interbank demand deposits held in ffice:smarttags" All prudential reserve banking systems have heretofore “come a cropper”. Money creation by private profit institutions is not self-regulatory- the “unseen hand” simply does not function in this area. Invariably the systems created too much money, speculation became rampant, inflation distorted and destroyed economic relationships, confidence that the banks could meet their convertibility obligations eroded, “runs” on the banks caused mass banking failures, and entire economies were left in ruin.

Can you please clean and clear this up?

Where are the demand deposits held?

Also, when did it happen, where?

-Sapiens

[jk]

Re: Sell Everything

At some point Spain will need emergency 1% rates to cope with the aftermath of their extreme bubble created over the past decade as it become the special home for Russian money that's been stripped out of everything from oil refineries to Russian pensioners (a book will be written about that some day, a Russian friend tells me), while other countries will be suffering inflation. In the US, the Fed happily allows Michigan to go into a depression while Massachusetts booms. To heck with Michigan, says the Fed. The equivalent, allowing Spain to go into recession while Germany gooms, is politically impractical in Europe. Either the euro takes a credibility hit to save Spain, or Spain–if things get bad enough–splits off. Neither event will be good for the euro.

the gavekal folks think italy is the weak link. prior to the euro, italy did fine while continuously devaluing the lira. stuck with euro, the italian economy is having hard times. if the eurozone economy slows materially, expect more calls for italy to withdraw. [there were a bunch of such statements last year.] gavekal's new book, the end is not nigh, contains a lengthy discussion of the issues involved, including the relevent international law and the legal issues re: italy's euro denominated bonds should they indeed withdraw.

Ka-Poom Theory has, since 1999, theorized that the end of the cycle of bubbles will occur as a one time write-off of US domestic and foreign debt via currency depreciation. The mechanism of that depreciation is US creditors repatriating dollars already floating outside the US, either out of desperation because domestic political demands in a severe recession are more pressing than the geopolitical demands of the US, or due to some other forcing function, such as war.

ej, have you addressed the question of what assets are purchased in the course of this repatriation? buying bond doesn't really get the purchaser out of dollars. that leaves the other major asset classes: real estate and equity. so is poom accompanied by a stock market moonshot? [making the poom differ in this way from what happened in the inflationary '70's.]

[Finster]

Re: Sell Everything

Keep in mind, iTulip has been chronicling the imminent death of the dollar since 1998. Here are a few stories from 1997 - 2001.

What I try to get across to readers is the concept of very slow, discontinuous processes, with plenty of surprise turns–which can last for a decade.

In 2000, the jury was very much out on the euro. Recall it plummeted for the first few years. Not until the post stock bubble depreciation of the dollar did the euro get its shot. But the euro has its problems. We know it works well when all is well. Let's see how well the euro does in the next global economic and financial crisis. At some point Spain will need emergency 1% rates to cope with the aftermath of their extreme bubble created over the past decade as it become the special home for Russian money that's been stripped out of everything from oil refineries to Russian pensioners (a book will be written about that some day, a Russian friend tells me), while other countries will be suffering inflation. In the US, the Fed happily allows Michigan to go into a depression while Massachusetts booms. To heck with Michigan, says the Fed. The equivalent, allowing Spain to go into recession while Germany gooms, is politically impractical in Europe. Either the euro takes a credibility hit to save Spain, or Spain–if things get bad enough–splits off. Neither event will be good for the euro.

Ka-Poom Theory has, since 1999, theorized that the end of the cycle of bubbles will occur as a one time write-off of US domestic and foreign debt via currency depreciation. The mechanism of that depreciation is US creditors repatriating dollars already floating outside the US, either out of desperation because domestic political demands in a severe recession are more pressing than the geopolitical demands of the US, or due to some other forcing function, such as war. So far, that has not happened. Will it eventually? Still seems more likely than a debt deflation. Will it be sudden and dramatic? Perhaps at some stages. Can we die a death of 1,000 cuts? You bet.

I grow more convinced by the day, though, that we are in for at least one more great asset bubble after this one ends, that the process is by no means over.

Energy and Infrastructure.

Listen to the Republican presidential debate tonight? Watch the memes sprout like crocus in spring: "We need zero taxes on alternative energy to support long term investment to end our dependence on foreign oil and stop global warming!"

Who's going to argue with that program? How about taxing oil, too, to create extra demand for alternative energy and use the tax $$$ to fund Medicare and SS?

Hank Paulson was talking the game, using almost the same language, in an interview on Charlie Rose two weeks ago.

Hear that? That's the sound of the next bubble rising over the hill.

But, to your question, I will try to talk to Grantham to get clarification on which sovereign debt and whose cash.

Thanks again!

What we've been hearing from both the Dem and Rep candidates gives me no cause for optimism. They are seemingly willing to do anything but let the free market work. The pattern is the government interferes in the market place with its overreaching programs and money creation, makes a mess of things, and then presents itself as the doctor who will cure the disease of its own creation. This in turn creates another mess, which naturally then requires another cure, which creates another disease ... :mad:

[EJ]

Re: Sell Everything

the gavekal folks think italy is the weak link. prior to the euro, italy did fine while continuously devaluing the lira. stuck with euro, the italian economy is having hard times. if the eurozone economy slows materially, expect more calls for italy to withdraw. [there were a bunch of such statements last year.] gavekal's new book, the end is not nigh, contains a lengthy discussion of the issues involved, including the relevent international law and the legal issues re: italy's euro denominated bonds should they indeed withdraw.

ej, have you addressed the question of what assets are purchased in the course of this repatriation? buying bond doesn't really get the purchaser out of dollars. that leaves the other major asset classes: real estate and equity. so is poom accompanied by a stock market moonshot? [making the poom differ in this way from what happened in the inflationary '70's.]

Several things are going on during the self-reinforcing dollar repatriation process, which some I've talked to recently believe has already begun. Different things happen at different stages of the process.

In the early stages, there is a shift from more to less risky securities within a class–from less to more blue chip within the stock market, from junk bonds to munis and treasuries within the bond market. Rather than chasing yield as in a "bubble in everything" market, investors seek liquidity and wealth preservation.

If there is a sense of panic in the market and the process becomes disorderly, then the rush to liquidity, to cash, can become intense. If you are in Europe and are worried that your US treasury bonds or agency paper is going to lose purchasing power suddenly, you sell them and get dollars in return. You then need to exchange those dollars for local currency in order to purchase safe domestic bonds, or simply hold the cash in a local money market account. Multiply this by a few million transactions and its clear how you wind up with a lot of dollar sellers and few dollar buyers, thus causing the depreciation that the bond holders fear–that's the self-reinforcing aspect of "Poom".

We're working up an anaysis to try to anticipate the process. There are a wide range of potential scenarios. For example, there is the possibility of a 1997-1998 Asian currency crisis in reverse, where instead of capital fleeing to the US, pumping up stocks and bonds, the opposite occurs.

Then you have to consider policy responses, which is unknowable, such as capital controls.

Our survey of professionals in the precious metals business tells a tale of two markets. Joe and Jane sixpack have been sellers for years. Squeezed by inflation and less access to home ATM refi money, they are selling PMs (and jewelry and coin collections) to raise cash. At the same time, people with money are buyers to hedge dollar depreciation risk. On balance, there is more $$$ coming from the latter than the former, so PMs continue to rise. Hard to see why in a "Poom" process that trend will not accelerate.

By the end of the process, the most liquid assets denominated in the most stable currencies will hold the greatest value.

[grapejelly]

Re: Sell Everything

EJ, where do the sovereign (Asia et al) US$ investment funds play into things? Shouldn't the investment of, say US$300 billion shore up US stock prices and forestall a rush to liquidity?