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Shock & awe? Or shockingly flawed?

Saturday, September 22, 2007 | 10:30 AM

in Currency | Federal Reserve | Inflation

Since we have been discussing the Dollar all week, let's go to Alan Abelson's Barron's column this week, Debasing Bernanke.

With a wordsmith's gift for clever wordplay, he opened the column "BEN BLINKED. Or was it a wink? Was he only funning the folks with all that malarkey about acting judiciously lest he encourage reckless financial behavior among the great unwashed -- moral hazard, as the cognoscenti like to put it?"

We had titled our post-FOMC post on Tuesday "Bernanke Blinks." Whether its surname or proper name, past tense or present, the similarities make us smile just a little on the inside. Anytime a scribe whose prose we admire or whose perspective is noteworthy or influential or just plain fun uses similar language to our own, we know that we are at least heading down the right path towards scribbling enlightment.

Anyway, back to the subject at hand, which is the ever shrinking purchasing power of the US greenback. Here is the relevant Ubiq-cerpt:™

"NO GOOD DEED, OF COURSE, goes unpunished. And wouldn't you know, Mr. Bernanke's muscular move that touched off a blistering rally in stocks also, it grieves us to report, had less salutary, if equally predictable, consequences in other trading arenas. Turmoil in the credit markets, which presumably was among the Fed's primary concerns prompting the rate slash, though hardly erased, nonetheless was suddenly overshadowed by turmoil in the foreign-exchange market and ominous disturbances in key commodities.

Our own beloved currency turned garishly green around the gills, nicely matching the traditional color of its back. A euro fetched a record price in U.S. dollars and the Canadian dollar -- the loonie -- achieved parity with our battered buck for the first time in over three decades (who's crazy now?). Virtually every currency known to man appreciated against our beleaguered greenback, which did hold its own, we're happy to say, against the Zimbabwean dollar (inflation in that ruined nation is running an estimated 15,000% a year and seems determinedly headed for six figures).

Moreover, the latest dizzying descent in the buck can only make our foreign creditors, those generous folk whose forbearance, encouraged by our insatiable appetite for their goods, has enabled us to live the good life on borrowed money, all the more antsy. They had already shown growing disquiet over the steady erosion of their huge hoards of our IOUs, by edging their reserves into more stable currencies.

The incidental devaluation of the U.S. dollar sent the price of crude, which is denominated in dollars, barreling to an all-time high above $84 a barrel before it paused to take a breath. And the fresh debasement of our coin, coupled with prospects of a surge in inflation, powered a spurt in gold to nearly $745 an ounce, the highest price since January 1980, when it hit $850 as bungling Bunker Hunt tried to corner the market for the yellow metal.

The moral imperative that inspired Mr. Bernanke to take down interest rates half a point instead of a quarter was to ease the pressure off the reeling housing market. In the event, though, he managed to steepen the Treasury yield curve, which means that the longer-term obligations, which effectively determine the level of mortgage rates, went up. Not, we suspect, the ideal medicine for what ails homebuilding.

Indeed, it's doubtful that any of the palliatives being proposed to dull the pain of mortgage holders who can't meet their payments or improvident lenders in the soup are likely to prove very effective. The latest data certainly provide little comfort. The news from the builders is uniformly bleak. And, as the aforementioned Minter and Weiner note, foreclosures on subprime loans alone could result in cumulative losses of -- gulp! -- $164 billion. It's also reckoned, they say, that a 15% decline in house prices -- not exactly outside the realm of possibility -- could wipe out $3 trillion of household net worth.

It's ease to see what got us into this bloody bind: a breathtaking binge of mindless borrowing accommodated by legions of lenders uninhibited by scruple of any sort, mightily aided and abetted by Wall Street's ingenuity in discovering new ways to create and peddle leverage. And, of course, by snoozing watchdogs, like the Fed.

How to get out of the very sticky mess is a bit more difficult to envision. Except cutting rates and going the way of Zimbabwe probably isn't it."

A shrinking dollar means reduced purchasing power, which is in and of itself the equivalent of a particularly pernicious form of inflation.

But not to worry, the solons and spinmeisters have assured us that the dollar will raly upon the news!

Shock & awe? Or shockingly flawed?

Source:
Debasing Bernanke
ALAN ABELSON
Barron's September 24, 2007
UP AND DOWN WALL STREET
http://online.barrons.com/article/SB119041472248335791.html

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Comments

Welcome to the new and brave world of elitism. Yes the cuts will cause high inflation for the huddled masses in everything, but thank God we saved the elites from themselves.

The dollar, small d from now on, is toast. How exactly will we sell Treasuries, Agency and MBS Paper to our patsy, I mean partners in trade? They ain't buying like they used to. I wonder why?

Posted by: SPECTRE of Deflation | Sep 22, 2007 10:43:20 AM

Goodbye U.S. dollar, hello global currency
says Benn Steil, Director of international economics at the Council on Foreign Relations

"The dollar's privileged status as today's global money is not heaven-bestowed. The dollar is ultimately just another money supported only by faith that others will willingly accept it in the future in return for the same sort of valuable things it bought in the past.

In other words, if the institutions of the U.S. government fail to validate that faith, the dollar, too, merits being abandoned".

No wonder why the rest of the world is sick and tired of U.S. dollar standard because America is careless in its monetary and fiscal policies e.g. the bullshit US housing market, the Iraq war racket to line the pockets of Bushco corporate cronies, the almost $1B/yr trade deficit, and so on.

Posted by: km4km4 | Sep 22, 2007 10:52:26 AM

Is it just me, or does anyone else have this deja vu feeling that it's the 70's all over again.

I was particularly struck by the statistic that the last time the Canadian Dollar had parity with the US$ was 1976.

I also recall the housing boom here in California in the early 70's that preceded the raging inflation, energy crisis, and general 'malaise' that ensued at the end of the decade.

But there is one difference between then and now; then we at least had Paul Volker...

Posted by: Pool Shark | Sep 22, 2007 11:03:59 AM

Now that an elementary understanding of the difference between higher prices and inflation is starting to catch on in circles where it should have been common knowledge before this, let's discuss the basic theory of exchange rates ... sometimes called the balance of payments in text books. (long sentence, huh?)

When one or more countries hold an excess of the currency on another nation, the value of the currency falls. Three things may increase the value of the currency ...

1) Higher interest rates in the country with the falling currency and/or

2) Rising exports from the country with the falling currency due to the now cheaper currency and/or

3) Capital investment from foreigners in the country with the falling currency.

Each of these reactions causes the currency to be repatriated. Less currency in other parts of the world raises the value ... and thus flows the great currency cycle.

Of course, aberrations can sometimes occur but these are rare and are usually preceded by huge inflationary bubbles like Japan in the 1980s and Asia in the late 1990s.

The natural currency cycle will take care of itself and re-balance providing no meddlers try to prevent currency repatriation. Exports are good. Investment from foreigners is good. High interest rates are bad at this time since they have a crushing effect on liquidity when confidence is low and inflation does not exist.

Low taxes are good (deficit financing is not good) if they encourage investment that will ultimately create jobs, improve the infrastructure, or raise productivity.

Everyone benefits.

Got it?

With respect to China .....

China has pegged it's currency to the US dollar at a, basically, fixed rate. When the dollar falls, the value of Chinese currency falls. China must set a new peg rate or let their currency float to offset this decline in value.

If China lets their currency rise, import prices mitigate but their export products become more expensive to the rest of the world. Chinese exports will decline as a result, causing business problems and unrest in China.

This will be good for any other country with a labor advantage over China and for exporters such as the US, Japan and Europe who will all appear to be more competitive with China at the low end.

China is not going belly-up. It is just joining the world business community on a more even footing. And there should be a decent stock market shock and buying opportunity when it does. Maybe next year?

In fact, China is in a sort of squeeze play right now ... It can do nothing and see Chinese inflation root and sprout -or- raise the exchange rate and lower Chinese import prices, causing Chinese export prices to rise. This is a hot box situation and China is in the middle of it.

Posted by: cinefoz | Sep 22, 2007 11:23:25 AM

I stopped reading at this point:

"the highest price since January 1980, when it hit $850 as bungling Bunker Hunt tried to corner the market for the yellow metal."

Bunker Hunt tried to corner the market in SILVER not gold. If the facts are bad how can I believe the analysis?

Posted by: Jason | Sep 22, 2007 11:53:27 AM

My recollection is that prior to the run on Silver the Hunt Brothers made a run on Gold.

I'll find a link.

~~~

Nope. Can't find anything. Maybe it was a gold mine, not gold . . . they were originally Oil men. . .

Posted by: Barry Ritholtz | Sep 22, 2007 12:15:14 PM

Goodbye U.S. dollar, hello global currency
says Benn Steil, Director of international economics at the Council on Foreign Relations
_____________________

Global Currency - thats likely the destination, but first the relentlessly patient CB's, will travel the direction of the continental currency. The first leg in the trip having been already completed with the EU and its Euro, stage 2 and well on its way to implementation is the NAU with the Amero. Most "top tier " candidates have specific affiliation to, CFR, SPP, etc. Is this conspiracy, possably, but only untill enough sound bites reach the ears of the public to garner recognition then the sales pitch, with finally acceptance.

"If you've retired you don't have anything to worry about, thats the third time I've said that. I'll probably say it three more times, see, in my line of work you've got to keep repeating things over and over and over again, for the truth to sink in. You've gotta catapult the propaganda."

George Bush

The following quotation of David Rockefeller, then Chairman of Chase Manhattan bank, speaking at the June, 1991 Bilderberger meeting in Baden Baden, Germany (a meeting attended by then-Governor Bill Clinton) is illustrative of the media control mentioned above:

We are grateful to the Washington Post, the New York Times, Time Magazine and other great publications whose directors have attended our meetings and respected their promises of discretion for almost forty years. He went on to explain: It would have been impossible for us to develop our plan for the world if we had been subjected to the lights of publicity during those years. But, the world is more sophisticated and prepared to march towards a world government. The supernational sovereignty of an intellectual elite and world bankers is surely preferable to the national autodetermination practiced in past centuries.

Still wondering why the banks are being salvaged at the risk of the Dollar? The Dollar has been a tool, that tool has out lived its usefullness, I don't know when but it will be replaced. After all these are the individuals that brought us the dollar (FRN's), as Bernanke demonstrated it is Their Dollar not ours, every dollar issued is issued at a cost. In today's globalized market place subject to an advanced world wide communications network, the public scrutiny of a single Soveriegn nation appointing controllers of the world's reserve currency will become too restrictive. As this unfolds it will become neccessary to have a unit of exchange completely independent of the Will of the Public.

Posted by: stormrunner | Sep 22, 2007 12:17:27 PM

No, the Hunts went after silver. They manipulated the market until the price rose to about $50 per ounce. Then they went bust. What a pair of dumb asses.

Posted by: cinefoz | Sep 22, 2007 12:31:02 PM

Cinefoz is right. All those other nations that have so greedily bought up anything in dollars, will have some thinking to do. No one forced them to. They did so for their own reasons. Their alternatives going forward are not great from their point of view and they will find themselves in a worse position than us.

Posted by: Lord | Sep 22, 2007 12:36:32 PM

Lord, thank you. (I bet people have fun with your name).

Posted by: cinefoz | Sep 22, 2007 12:39:27 PM

The Hunt Brothers attempted to corner the silver market. I have no recollection of them being in Gold.

Posted by: SPECTRE of Deflation | Sep 22, 2007 12:47:58 PM

Rates were cut drastically because the Fed fears the consequences of debt default more than inflation.

The underlying pressures fueling debt default are only going to increase from here.

Pretty clear where this is going.

Posted by: stuart | Sep 22, 2007 12:49:01 PM

Hunt Brothers only went after the silver market. The comex then changed the rules and snookered them.

Posted by: stuart | Sep 22, 2007 12:51:03 PM

When one or more countries hold an excess of the currency on another nation, the value of the currency falls. Three things may increase the value of the currency ...

1) Higher interest rates in the country with the falling currency and/or

2) Rising exports from the country with the falling currency due to the now cheaper currency and/or

3) Capital investment from foreigners in the country with the falling currency.

Each of these reactions causes the currency to be repatriated. Less currency in other parts of the world raises the value ... and thus flows the great currency cycle.

Of course, aberrations can sometimes occur but these are rare and are usually preceded by huge inflationary bubbles like Japan in the 1980s and Asia in the late 1990s.

Low taxes are good (deficit financing is not good) if they encourage investment that will ultimately create jobs, improve the infrastructure, or raise productivity.

Everyone benefits.

Got it?

No I don't. You can't extrapolate prior history into this scenario. The variables ha
ve changed to a degree that makes easy answers impossible. Ever hear of exponential growth? Our debt has doubled in 7 years. It took 220 years to get to the level of the year 2000 debt. In 7 short years we doubles it. With M3 growing at better than 14% we will again double the national debt in 5.25 years.

We have systemic problems that make prior problems a walk in the park. Our trade partners, what a joke that is, are not buying our paper causing net outflows which aren't going to get better with a dollar that is a form of fancy ass wipes.

Got it?

Posted by: SPECTRE of Deflation | Sep 22, 2007 12:56:54 PM

SPECTRE of Deflation,

Most people suffer from not understanding the problem solving technique of 'problem decomposition'. To put it simply, within each big problem are a lot of little problems trying to get out. This is also your problem. Most people look at problem like one big lump. None are, except the smallest ones.

Posted by: cinefoz | Sep 22, 2007 1:04:34 PM

Abelson is as senile as he is a poor writer.
Hunts were in silver. And if you take the adjectives and alliteration out of his windy prose his padded column would be half as long, which would be twice as good. Still not perfect because he should give up that space to someone with a brain. Sorry to speak ill of the braindead, but back when I read Barron's he wrote about 2 or 3 good columns a year, and, unfortunately, it is a weekly gig. IMHO. Barry, don't model your style on that windbag, please.

Posted by: lurker | Sep 22, 2007 1:30:58 PM

http://www.wallstraits.com/main/viewarticle.php?id=1298

It was a concerted effort of the futures exchange and the Federal Reserve to break the Hunt's silver hoarding episode.

Posted by: Eclectic | Sep 22, 2007 2:02:04 PM

Abelson and blogger talk about how 'the sky is falling' just makes me laugh.

Its in the US interest to break the Asian dollar peg.

oh ... and what was that? I thought I just heard Airbus squeal ...

Let's play on ...

Posted by: jimo | Sep 22, 2007 2:10:44 PM

lurker - I pretty much agree with you.
All of the nonsense about 'woe is me' re the $ has many complicated reasons.
AND
I think all the whiners are about to be surprised over the next 6 months.
geeze louise

Posted by: Diva | Sep 22, 2007 2:15:36 PM

PS
My sister worked directly for/with one of the Hunt Bros. It was a silver deal that went 'bad'.
Anyone who doesn't know that has 'limited' understanding of the 'real world'.
PPS
She was in KY, not TX.

Posted by: Diva | Sep 22, 2007 2:20:47 PM

I'm having a bit of trouble comprehending the us vs them mentality. Maybe someone can clue me in.

As an outsider, no real ties to the financial community, I see two ideologies. In one, The US, EU, BoE, Private for Profit banks control the issuance of the currency and retain all interest charges levied upon issuance. On the opposing front China, ??, the currency is state issued and interest is levied by the state for the benefit of the state, largely, public self appointed citizens. This in effect means the government is run using taxation and inflation. Have the Chinese ever had to borrow to build their military and infrastructure?? Honestly I don't know.
In the former, Private Model, the government is run on credit, taxation merely pays interest on the national debt to private Global Interests. To some extent this is merit based. In other words industrialists built their companies and employed the people that generated the wealth leading to the acquisition of this power, it is the retention of this power though the industrialist creation of a banking cartel which issues and manipulates the currency I object to. I also have trouble envisioning a peaceful coexistence of these two opposing models. In the end I see this as the catalyst leading to Global confrontation more so than any religious ideology. It may be sold to the public as a "Holy War" but in the end it will boil down to the Industrialists and Banking Elite, wanting their cut.

JMHO, a merging of the two systems would be of the most benefit to the public at large. One is which the state controls the issuance of the currency and the state is appointed by the public where business is allowed to be conducted as it always has profiting by way of service and production enhancement as opposed to currency manipulation.

What does this have to do with the dollar? I think everything as we shall soon see especially if animosity builds against the FED. The Ron Paul Revolution is just one example though still muted, of possable back lashes. Even Greenspan projected recently public condemnation of the FED in the not to distant future.

Posted by: stormrunner | Sep 22, 2007 2:26:10 PM

Stormrunner,

Currency is state issued in the west. Credit is bank issued in the west. Although obviously related, currency and credit aren't the same thing.

In China, credit is essentially state issued, though this appears to be changing (slowly).

Posted by: Estragon | Sep 22, 2007 2:34:43 PM

Strangely enough, the Hunt's silver hoarding came to a crashing end when, after speculating and building a large inventory of a commodity thought to always be ultra-liquid, it was suddenly not negotiable with anyone because the Fed encouraged member banks to refrain from lending to other speculators who wanted to buy the metal.

Industrial users (capable of cash buying) didn't need enough of the metal to help the Hunts cover margin requirements, and with no more speculators to fuel the climb, and with the exchanges not permitting the Hunts to buy up more positions and effectively complete the "corner," the Hunts were in a special kind of no-man's land specially designed for them.

Sound refreshingly similar to anything rounding the bases right now?... Let’s see… an asset thought fully negotiable at all times becomes no longer salable?...Hmmm?… Could that be, uh, dare I say… MBS and ABCP?… the special type carrying Will-o'-the-wispish consequences were it to be whipped down to mark-to-markie value?

http://en.wikipedia.org/wiki/Will_o'_the_wisp

Funny, but, THE PEOPLE are who finally halted this latest fiasco (unfortunately with their frantic, if unknowing, financial system-threatening balking in markets, and their sidewalkian line-dancing actions at a Californicating bank as well as an across-the-pond variety, that they wouldn't take it any more!), not the FOMC that has the responsibility to recognize hyperbole and do something about it before it harms the financial system.

I’ve always thought that the very moment, the exact instant in time, in which WorldCom began to unravel was when its merger/acquisition of Sprint fell apart… Why?… Because until that very moment, WorldCom was able to con its internal and external auditors into sucking up to the illusion of an endless stream of hocus-pocus pro-forma EBITDA accountancy. Busting the merger finally broke the endless chain of meet-or-beatsmanship and forced the uncovering of their off-the-book slime.

Posted by: Eclectic | Sep 22, 2007 2:56:00 PM

Estragon said
"Currency is state issued in the west."

http://en.wikipedia.org/wiki/Federal_Reserve

The Federal Reserve System is a quasi-governmental/quasi-private banking system composed of (1) the presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C.; (2) the Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and (5) various advisory councils.
********************

Item 4, Private US member banks which hold stock, this is where the profit in issuing currency exists. The FFR on released FRN's goes to these member banks to private stock holders and is a credit to the public's books, thus the deficit. This taken into consideration with the fractional reserve lending methodology where these high powered funds are loaned out 10X again at interest, the credit you refer to, it is easy to see the wealth being accumulated by the banking system. Somehow this does not infer state issuance.

If there is something abjectly false in this deduction, someone please enlighten me.

Posted by: stormrunner | Sep 22, 2007 3:35:29 PM

Stormrunner,

The FFR is the rate targeted by the fed for overnight lending between private banks. The fed adds/removes currency by buying/selling treasury securities from/to private banks to/from fed holdings.

AFAIK, the net earnings (interest received on treasury securities holdings, fees, etc.) of the federal reserve system are returned to the US treasury, not the private banks.

Posted by: Estragon | Sep 22, 2007 4:06:05 PM