Oil, geopolitics, those pesky Russians, irrational Bay Area exuberance, the drums of war, Sir Alan's folly, the cheeky Chinese, the conceit of monetarism, or, that inept circus known as the Bush Administration? We all know the dollar is collapsing, but what we don't know is (a) why, and (b) where to? JPM sent news last month of the latest RBS brief that says, in brief, to hell in a handbasket:
The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.
"A very nasty period is soon to be upon us - be prepared," said Bob Janjuah, the bank's credit strategist.
A report by the bank's research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets.
Heady stuff! The essential problem is that the US economy, and/or the government, and/or the Americans, has overspent.
The old story is the inflation one: too many dollars washing around causes too much investment, and then a little inflation, and a little more and a little more and a lot more ... until the government decides to put the brakes on because the lenders want more than can be returned. But the brakes take a few years to change the pace, and a few more years of pain and a few more years of rebuilding. By the time all the damage is repaired, we have forgotten where it came from, so nobody really believes this stuff anyway, and we're ready to live the good times again! It's our turn! Hysteresis being a wonderful thing, we enter what is quaintly called the Austrian Business Cycle, and the economy bounces around like a yoyo from generation to generation.
Except: supposedly with the death of Keynes and the rise of the Austrians and the new enlightened central banking age, we were supposed to be passed all that. What went wrong? That is what is flumoxing the fundamentalists amongst us. What we know is that we've never been here before, and like other complicated stories, there are *many factors*. Here's my attempt at listing the forces:
1. The 1990s Internet/tech boom caused a massive jolt to business, in effect a "productivity shock" albeit upwards. Productivity was kicked upwards in those areas effected. This released additional value into other areas, which had the effect of releasing additional investment into other areas. In a sense, the overall effect was inflationary, because the existing money stock was being used more effectively.
2. Because of the climb in productivity, the economy grew rapidly. This meant an increased demand for money, which central banks were happy to accomodate. However, because of the release of value, this also had the effect of increasing the supply of money. More inflation.
3. Around 2000, when most households in the USA had acquired their obligatory new-age accessory, the PC, the wheels came off the Internet boom. Which should have been expected to put an end to the general boom in the economy. Predictably, Alan Greenspan boosted up money creation to soften the blow.
4. In comes Bush: "Cry Havoc! and let slip the dogs of war!" Which unleashed the wildcats of spending. Well, maybe..., opinions might be divided on what the causes where, but the fact remains that this President has doubled the national debt of USA from 2001 to now, and that's one big achievement that we can all be proud of.
5. Which, as war talk inevitably does, leads to the observation that certain countries were targetted, and nobody has any clue what the metric was. If you know, please write in, with evidence if possible. Which, more importantly, resulted in an explosion of that old disease: Fear, Uncertainty and Doubt. In this case, monetary FUD meant that those who *might* be targetted worried about their over-dependency on that ultimate class of financial oil: the dollar.
|Gold went up . . . .|
5.b Sometime around 2002-2003, countries started shifting out of the dollar. Slowly. Gently. Pretending not to. Refer to cartel and game theory to understand the theatre here. Either way, the shine was off, especially for those at the nexus of confusion: Islamic, oil-exporting, non-USA trade partners such as Libya, Iran, Iraq.
6. Which was extraordinarily lucky for Europe, as just around the right time, the Euro burst into life, giving a currency of impeccable (Bundesbank) anti-inflation credentials. The Bundesbank was located in Frankfurt. The ECB is located in Frankfurt, too. This is no accident. So, countries found it relatively easy to justify shifting a large part of their reserves to Euros. Slowly, Gently, Pretending Everything But.
7. Which meant all this dollar surplus went washing back to the US, at around the same time as the Bush administration was borrowing more, spending more, warring more. It may never be officially confirmed, but the Fed was on the case by 2003, and managing the process of absorbing a more than normal homeward bound flow of dollars. Not a happy picture. Monetarily speaking, although the tech boom was over, the money boom carried on, and there wasn't a darn thing the Fed could do about it, because those darn foreigners insisted on buying real assets in paper dollars. Hello, housing boom.
8. The dollar went down. Consistently, from around 2001. Which would have been fine, all things being equal, as this just means we buy less Airbuses, more Boeings, etc, until it all balances out.
9. However, as the dollar was the trading currency of the world, things were decidedly not equal. By fiat of Bretton Woods, as it were. Monetary policy has never really considered wholesale redemptions by the world's customers, so it was an open question as to what would happen. In this case, those wiley Europeans, those cunning Chinese, those devilish Japanese, and even the happy go lucky Aussies ... all decided to *help the Fed*. And, help in this case, turned out to be letting their currencies go down as well. Which means, they issued more money, and inflated under the umbrella, while the Fed was swallowing more, while the Bush administration was borrowing more. In essence, this meant the real corrections were delayed and hidden, because the currency markets were more or less in balance.
10. Not so real assets: Gold went up. Housing boomed. Dollars went down, and the other nationals went downish, enjoying the chance, because they won profit by their favour to the Fed. And, what happens when everyone inflates at the same time?
11. Commodities first, but then foodstuffs, and finally ordinary stuff went up in price. Tech stuff still continued going down because the tech machine was still rolling, if not booming. Stuff that was made in the new wunderfabrik of China went down in price, as that vast empire of cheap labour opened up. In sum, nobody noticed that the central banks, all of them, were stealing the bounty of the lowering dollar, the tech productivity shock, and the China export trade. So much for the vaunted anti-inflation reputations.
12. Hence, in short summary, the military expenditures took over from the tech bubble. The dogs-of-war chased dollar-holders who went scurrying across to the Euro, creating a dollar bubble which underwrote the housing bubble. All hard assets boomed around the western world. Everything boomed in the US, except fiscal balance.
13. Which all came to a close when the oil shock hit. The shock was triggered by the boys-own adventures of Bush and his chums in the great game (a euphemism for interference and manipulation in the Middle East). However, be careful: we have to factor in around 50 years of manipulation of the oil supply industry, which caused an imbalance waiting to collapse. This supply-side manipulation can be seen in new oil fields like Alaska, there is so much oil washing around there that some say that if it were fed to the US market, the prices would drop to around zero and Kissinger's fabled contracts with the sheikhs would collapse. Which would collapse the dollar. Apparently, if there's anything that Washington fears more than an open market in Middle Eastern democracy, it is an open market in oil.
14. Never minding the source of the shock, it was the straw that broke the camel's back: Cash that was previously washing around from other sources was sucked up by the new demands on oil (which feeds into practically every other sector of the physical goods economy) and this caused the investment, housing and other booms to break. Then, the fundamentalists (those traders who believe in long term trends and numbers) started to take a good hard look at the real numbers, and people got scared. "Withdraw from everything!" ...
Fundamentalists knew the USA economy was out of balance in around 2000, when the tech bubble burst ... something should have happened then, but to our surprise, nothing much happened (unless you had a tech job, that was pretty dire). What caught us out is how many other factors were involved, how deep the USA trap was, and how long it took for these huge, massive imbalances to come home to roost. If it is any comfort, this is going to be as well studied as the Great Recession, for the same reasons: the monetary authorities and the governments got it all wrong.
Here we are, staring at recession. It's hard to recommend what to do, but it should be to reduce dependency on the US dollar, anyway you can. Whatever you have in mind, do it quickly.Posted by iang at July 15, 2008 08:03 AM | TrackBack