Pulling
out the rug
The Daily Reckoning
PRESENTS: In the wake of last Friday's jobs report, can anyone
yet claim that the U.S. "recovery" is self-sustaining?
On the contrary, Dr. Richebächer sees a "variety of
accidents" in store for the market...and chief among them,
a dollar rout.
By Kurt Richebächer
The Daily
Reckoning
March 12, 2004
Apparently,
the consensus economists are still convinced that the growth
acceleration in the second half of 2003, and above all a sharp
rise in profits, have laid the foundation for sustainable growth.
In particular, sustainable growth with sufficient creation of
employment.
We disagree.
But we must
admit that our own assessment is prejudiced by the postulate
of the Austrian school, that "the thing which is needed
to secure healthy economic growth is the most speedy and complete
return both of demand and production to its sustainable long-term
pattern, as determined by voluntary consumer saving and spending."
Friedrich Hayek
said in 1931: "If the proportion as determined by the
voluntary decisions of individuals is distorted by the creation
of artificial demand, it must mean that part of the available
resources is again led into the wrong direction and a definite
and lasting adjustment is again postponed. And even if the absorption
of the unemployed resources were to be quickened in this way,
it would only mean that the seed would already be sown for new
disturbances and new crises."
We think this
precisely describes what has been happening and continues to
happen in the United States. The Greenspan Fed has discovered
a new, amazingly easy and quick way to create higher consumer
spending virtually from thin air - by way of so-called wealth
creation through asset bubbles. It began with the stock market
bubble, to be followed by bubbles in bonds, house prices and
mortgage refinancing.
Measured by
real GDP growth, it seems a successful policy. But measured by
employment and income growth, it is an outright disaster. The
so-called "wealth effects" are not for real, neither
for the economy as a whole nor for the individual asset owners.
The reality in the long run is only the horrendous mountain of
debts that consumers, corporations and financial institutions
have piled up.
Given the general
euphoria about the U.S. economy and its recovery, there appears
to be a general apprehension in the markets that the Federal
Reserve will be forced to raise interest rates in the foreseeable
future. The Fed is clearly anxious to dispel any such fears -
and this, in our view, is for a compelling reason. U.S. economic
and financial stability have become inexorably dependent on the
existence of a steep yield curve allowing and fostering unlimited
carry trade in long-term bonds. Any major rise at its short or
long end would shatter this artificial stability and send the
economy and financial system crashing.
Considering
all the imbalances impairing U.S. economic growth, we are unable
to see the sustained, strong recovery. A closer look at the recent
economic data [and last Friday's jobs report] confirms this skepticism.
Possibly, if not probably, economic growth has already peaked.
For us, the question rather is when general disappointment will
gain the upper hand.
That, of course,
is sure to soothe the bond market, allowing moreover the Fed
to maintain low interest rates. But it will conjure up another,
even greater risk at the currency front. It will pull the rug
out from under the dollar.
In our view,
the U.S. trade deficit is big enough to cause a true tailspin
of the dollar against all currencies. So far, two things have
prevented this threatening dollar collapse: the gargantuan dollar
purchases by Asian central banks and the still rather positive
perception around the world of the U.S. economy. In our view,
few people realize its true weakness and vulnerability.
There is widespread
hope that the falling dollar will go a long way to lower the
U.S. trade deficit. It takes a lot of wishful thinking to believe
that. Its persistent growth has various reasons. One of them
is that the gap between exports and imports has simply become
too big to be reversible. Last year, exports amounted to $1,018.6
billion and imports to $1,507.9 billion. Just to prevent a further
rise of the deficit, exports would have to rise 50% faster than
imports.
Principally,
the trade flows of a country are exposed to three major influences:
first, relative prices and the exchange rate; second,
relative demand conditions; and third, relative supply
conditions.
Empirical experience
suggests that exchange rate changes by themselves have very little
effect on trade flows. One obvious reason is that Asian as well
as European exporters readily adjust their prices to maintain
their market shares.
For years,
the United States has been top in the world with its domestic
demand growth propelled by the loosest monetary policy in the
world. For sure, lacking demand growth in the rest of the world
has played a role in boosting the U.S. trade deficit. Yet what
matters most for the trade balance is not U.S. growth in relation
to other countries, but U.S. demand growth in relation to U.S.
capacity and capital-stock growth. In essence, such a deficit
indicates an equivalent excess of domestic spending over domestic
output.
More precisely,
the U.S. trade deficit reflects gross overspending on consumption
on the demand side and a grossly unbalanced investment structure
on the supply side. There was gross underinvestment in manufacturing
versus gross overinvestment in retail, finance and high-tech.
Our assumption
is that there is no intention or will on the American side to
correct any of these maladjustments. Given their enormous size,
it is a Herculean task, too Herculean, in fact, to be seriously
addressed.
Principally,
American policymakers and economists take only two economic problems
seriously: high rates of inflation; and, in particular, slow
growth and rising unemployment. They could not care less about
the dollar. The low inflation rate is the excuse for more of
the same extreme monetary looseness.
There is quite
a variety of accidents waiting to happen in the markets, but
the most predictable and biggest risk is a dollar crisis. In
addition to the gargantuan trade deficit, looming in the background
are existing foreign holdings of dollar assets in the amount
of $9 trillion.
As explained,
the tremendous vulnerability of the U.S. bond market due to its
underlying heavy leveraging prohibits any defense of the dollar
through tightening.
Instead, the
plunging dollar will pull the rug out from under the bond and
the stock markets.
Regards,
Kurt Richebächer
for The
Daily Reckoning
As the good doctor notes above,
not only is a continued dollar decline inevitable...it is indefensible
by the U.S. powers that be. If you haven't already hedged your
portfolio against the dollar's devaluation, you should do so
today:
Seven Ways To Sell The Dollar
321gold Inc
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