Impending Destruction of the US Economy

[Rajiv]

Impending Destruction of the US Economy - Paul Craig Roberts

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the US economy. If the subprime mortgage meltdown is half as bad as predicted, low US interest rates will be required in order to contain the crisis. But if the dollar’s plight is half as bad as predicted, high US interest rates will be required if foreigners are to continue to hold dollars and to finance US budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and over-extended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington’s ability to borrow abroad. Without the ability to borrow abroad, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

A few years ago the euro was worth 85 cents. Today it is worth $1.48. This is an enormous decline in the exchange value of the US dollar. Foreigners who finance the US budget and trade deficits have experienced a huge drop in the value of their dollar holdings. The interest rate on US Treasury bonds does not come close to compensating foreigners for the decline in the value of the dollar against other traded currencies. Investment returns from real estate and equities do not offset the losses from the decline in the dollar’s value.

China holds over one trillion dollars, and Japan almost one trillion, in dollar-denominated assets. Other countries have lesser but still substantial amounts. As the US dollar is the reserve currency, the entire world’s investment portfolio is over-weighted in dollars.

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The US dollar has lost 60% of its value during the current administration. Obviously, countries are not locked into accumulating dollars.

The reason the dollar has not completely collapsed is that there is no clear alternative as reserve currency. The euro is a currency without a country. It is the monetary unit of the European Union, but the countries of Europe have not surrendered their sovereignty to the EU. Moreover, the UK, a member of the EU, retains the British pound. The fact that a currency as politically exposed as the euro can rise in value so rapidly against the US dollar is powerful evidence of the weakness of the US dollar.
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[Tulpen]

Re: Impending Destruction of the US Economy

"The US dollar has lost 60% of its value during the current administration. "

Amazing actually!
Looks like the Democrats can have a new sticker ;)

[grapejelly]

Re: Impending Destruction of the US Economy

Ty Andros in his Fingers of Instability series has made the argument that we are in for a crack-up boom, a la Mises, because these dollar holdings will be repatriated quite rapidly at some point leading to runaway asset prices for a short while.

The Euro, of course, is no stronger and may be worse than the US$.

But Euros aren't stored in the trillions by US trading partners to my knowledge.

It is the argument for precious metals -- these US dollars will have to be invested somewhere. But it is also an argument for US equities, isn't it?

[santafe2]

Re: Impending Destruction of the US Economy

"The US dollar has lost 60% of its value during the current administration. "

While still not a great outcome, it's more accurate to say the US$ has lost 1/3 of it's value during the current administration. When the administration took over the US$ was ~112 against a basket of currencies and today it's ~75.

[Guest]

Re: Impending Destruction of the US Economy

Craig Roberts concludes the "inevitable" choice for the Government will be to defend the dollar, but USD and the US economy are tightly intertwined. Where does he therefore gain such assurance that "faced with defending the dollar or housing, the Fed and Govt. will have to choose the dollar?

If by "defending the dollar" this means raise interest rates, only to see housing tank like a piece of lead and drag the dollar down with it regardless, they've obtained the worst outcome - dollar tanks anyway, and housing tips the US into Great Depression #2.

Maybe instead, when push comes to shove they have to prevent the internal collapse at all costs - (and then maybe we'll get GD-2 anyway) ...

I agree with Grapejelly on his skepticism that currencies and treasuries (let alone bonds) may have what it takes to safeguard people's serious money when TSHTF - which seems to me eminent common sense. GRG55 thinks certain commodities will keep a bid, due to some very long cycle fundamentals (underinvestment, demographics). A nice little farm in Iowa (or someplace), and a pot'o'gold buried there for a rainy day, begins to look like a real refuge as things are apparently getting hairier by the day.

[BiscayneSunrise]

Re: Impending Destruction of the US Economy

But it is also an argument for US equities, isn't it?[/QUOTE]

Most definitely, yes.

The past few years was the time to invest in the rising tide of commodities prices and metals and to hedge against the dollar. Commodity prices have adjusted to the new global demands and are high enough to allow new production to come on line thereby softening future price increases. That play is over.

iTulip calls for the next bubble to be infrastructure & alternative energy related. I'm not so sure about the alt. energy bit but anything related to global growth and the buildout of the developing world, whether it is hard industrials, tech or supply chain should be the place to be now. Namely, mid to mega cap companies with a global footprint.

I tend to believe it is always a bad idea to bet against the US economy. Whether you believe that or not, I think you might have to agree the opportunity in the equities market now lies in the global growth story.

[Guest]

Re: Impending Destruction of the US Economy

Biscayne -

There is a contradiction there - you can't have a global infrustructure boom without firm commodities. GRG55 thinks the impending "death of commodities" has been much exaggerated. I agree. Also, the "alt-energy bubble" may well not be a bubble at all. It looks to me to have all the fundamental drivers in place to be a good old-fashioned boom, with solid fundamentals going right out to the mid-century.

[BiscayneSunrise]

Re: Impending Destruction of the US Economy

Agreed.

I didn't mean to say that commodities will crash but they have leveled off to a sustainable level, a new normal. And from a standpoint of an equities investor, the play is now elsewhere.

Also agreed that alt. energy, infrastructure build out and global growth are real stories with long term secular growth and probably the better place for
equity investors now.

[santafe2]

Re: Impending Destruction of the US Economy

The past few years was the time to invest in the rising tide of commodities prices and metals and to hedge against the dollar. Commodity prices have adjusted to the new global demands and are high enough to allow new production to come on line thereby softening future price increases. That play is over.

Going forward the upward movement may not be as strong for large cap commodity producers but well run small cap / micro cap, exploration stage producers will do very well. Almost all of these companies are beaten down now as risk is out of favor and most base metals have been moving down for some time.

[Guest]

Re: Impending Destruction of the US Economy

Biscayne -

I have a confession to make. Holding any kind of stocks these days gives me the serious willies!

[BiscayneSunrise]

Re: Impending Destruction of the US Economy

True enough. The fundamentals still look good for miners, I was just speaking to investor psychology. It seems the momentum has shifted.

Additionally, more and more analysts are saying that market sentiment has shifted to favor the mega cap companies in whatever industry.

PS: I'm leaving town today for a week and will not have constant internet access so it may seem I went dark over the next week.

[Tulpen]

Re: Impending Destruction of the US Economy

It is the argument for precious metals -- these US dollars will have to be invested somewhere. But it is also an argument for US equities, isn't it?

I think only for global US companies with a unique position in their industry, e.g. Microsoft, Intel, Cisco, GE etc.

But I do not think it is an argument for for mid- and smallcap corporations.

[rj1]

Re: Impending Destruction of the US Economy

Jim Jubak of Money Central (MSN) has a good article about the published European inflation rate of 3.3%, well above the target for the European Central Bank, and how he expects the ECB this coming Thursday to raise their interest rate.

http://articles.moneycentral.msn.com...bak.aspx?msn=1

That puts the U.S. Federal Reserve, which holds its own Open Market Committee meeting on short-term rates just a few days later, on Dec. 11, in a quandary. If the Fed cuts interest rates as Wall Street expects -- right now the odds of a rate cut are about 90%, according to the federal funds futures market -- and the European Central Bank raises rates, that will eliminate the interest-rate gap between the United States and the European Union. Short-term rates in both markets would stand at 4.25%. If the Fed eases to 4.25% and the European Central Bank stands pat, the gap will shrink from the current half-point to a meager quarter-point.


And the euro, which has been climbing steadily against the U.S. dollar for most of 2007, will climb even more. Shrinking or closing the interest-rate gap between the two currencies will eliminate one more reason for the world to hold dollars.

[Guest]

Re: Impending Destruction of the US Economy

RJ1 -

Odds are for rate cuts in the US and UK, and "unclear" in the EU, although I read there are many very emphatic calls in the EU for rate cuts too. I find it utterly inconceivable the US FED will have the nerve to raise rates in the next six months. The UK sounds even worse a prospect if you go by the article below. Wherever Goldman Sachs is deriving a "short gold in 2008", I sure as hell don't get what they are on about.

_____________

Pleas for rate cut as interbank loans dive

By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 2:04am GMT 04/12/2007


The sterling interbank market has collapsed at the fastest rate in modern history, prompting pleas for immediate rate cuts from a chorus of top British economists.

Office for National Statistics data sourced to the Bank of England shows the volume of market loans in the banking system plunged from £640bn at the onset of the credit crunch in August to £249bn by the end of September, suggesting British lenders have been hit even harder than US banks in relative terms. Total sterling assets dropped from £3,244bn to £2,876bn.

This is one hell of a shock to the financial system," said Professor Tim Congdon, a leading monetarist at the London School of Economics.

"A market that has taken 30 years to build has completely imploded in a matter of months. Lenders have been squeezed savagely. We've moved into a different era," he said.

Mr Congdon called for a half-point cut to the interest rate to 5.25pc when the Monetary Policy Committee meets this week, warning that the M4 money supply is slowing fast and might contract over the next six months.

Patrick Minford, a professor at Cardiff University, called for a three-quarter point cut, accusing the MPC of "standing idly by" as three-month Libor spreads rocketed by 75 basis points - a severe tightening of credit.

"I regard the Bank's behaviour as highly irresponsible, neglecting a century of monetary teaching from Bagehot on. It is time for some sense to prevail. The Bank look like fools," he said.

The hard-hitting comments were contained in the minutes of the Shadow MPC (SMPC), a group of economists who take the pulse of the economy prior to each MPC vote under the aegis of the Institute of Economic Affairs. SMPC member Peter Warburton, from Economic Perspectives, called for a half-point cut, with further easing in the New Year.

"A profoundly deflationary credit downturn has taken hold," he said. "Recent weeks' dramatic events have infected urgency into the situation."

David Smith, a professor at Derby University and chair of the SMPC, defended the Bank's wait-and-see approach. "The MPC is walking along a narrow and dangerous Alpine ridge in a blinding blizzard. They can't see anything," he said. "People assume that the risk is a credit implosion leading to a second Depression, but there is also a serious risk on the other side of the ridge in terms of inflation.

"The British economy was red hot in the third quarter. RPIX inflation is at 3.1pc. If you look at oil prices, commodities or gold, there are many signs this is like the early 1970s," he said.

"Has the economy suddenly and totally fallen out of bed? We don't know yet, and it would be dangerous at this stage to bet it has. There is a risk rates will have to go up next year, not down," he said.

Most City economists expect the nine-strong MPC to hold rates steady when it meets on Thursday. Sir John Gieve, the Bank's Deputy Governor, and David Blanchflower voted for a quarter-point cut in November, fearing that the property market was starting to buckle.

Credit conditions have tightened abruptly since then, driving Libor back to crisis levels of 6.60pc. The Nationwide house price index dropped 0.8pc in November, the steepest fall in 12 years.

[GRG55]

Re: Impending Destruction of the US Economy

I think only for global US companies with a unique position in their industry, e.g. Microsoft, Intel, Cisco, GE etc.

But I do not think it is an argument for for mid- and smallcap corporations.

Microsoft, Intel and Cisco are part of a group (tech) that peaked in 2000 and won't be coming back any time soon.

GE, despite they hype, is a financial company in drag. Note that despite its AAA credit rating, insurance rates for GE bonds are blowing out. Yesterday the infantile equity market seems to have figured this out as it clocked GE with a 3.5% loss.