Saturday, November 25, 2006

The DR is in

Dr. Kurt Richebächer

On the surface, it seems that there are diametrically different views at work in the markets. While the rising bond prices and the falling commodity prices apparently suggest underlying distinct economic bearishness, the sudden surge in stock prices and persistent record-low credit spreads appear to reflect very optimistic expectations about the economy.
The turn in the bond market started in June with yields of 10-year Treasury notes at 5.25%. A decline to 4.7% generated a 5% return for investors within just three months. Annualized, this comes to a return of 20%. Take further into account that there is generally heavy leverage involved, multiplying this return between 10-20 times.
Considering further that this rate of decline of long-term rates has occurred against the backdrop of a firmly inverted yield curve, implying that expenses of carry trade exceed current yields, the strength of this move seems a bit surprising. The quick capital gains, though, have richly offset these interest expenses - for the time being. But to maintain these highly leveraged positions, it will need at least one of two things: either a further sharp fall in long-term rates providing new capital gains or rate cuts by the Fed reducing the costs of carry trade.
More surprising is the new bull run of the stock market in the face of an economic slowdown. Approaching recessions have always tended to depress stock markets in expectation of falling profits. Well, there is a tremendous difference between past and present experience.
Past recessions were all triggered by true monetary tightening, hitting both the economy and the markets. The current economic downturn is unfolding against the backdrop of unmitigated monetary looseness. While the Fed has raised credit costs from unusually low levels, it has done nothing to tighten credit. Its expansion has kept accelerating.
Credit demand has been running wild for consumption, housing and financial speculation. There is just one striking and ominous exception: Corporate credit demand for fixed investment remains zero. Corporations, too, have been borrowing heavily, but for mergers, acquisitions and stock buybacks, not for productive investment.
In 2005, nonfinancial corporations spent $136.8 billion less than their cash flow from retained profits and depreciations on capital expenditures. Simultaneously, they spent $363.6 billion on mergers, acquisitions and stock buybacks. Given their moderate cash surplus, one has to assume that the stock purchases were generally financed with borrowed money.
It is certainly reasonable to regard the strong trend of corporate stock purchases as an early negative indicator of investment intentions. Principally, there are two different ways for corporations to expand and to raise profits. One is the old-fashioned way of organic growth through creating new plant and equipment. The other is to purchase economic growth and higher earnings through mergers and acquisitions by going more deeply into debt.
What, then, has been happening more lately to mergers and acquisitions? In short, they have gone crazy. During the first quarter of 2006, they hit an amount of $558 billion at annual rate, and in the second quarter another $554.8 billion.
This compares with continuously weak capital investment. In the first quarter, it was $2.7 billion below cash flow, and in the second quarter, $43.2 billion above cash flow. There is an interesting comparison with the year 2000. Then, capital expenditures of nonfinancial corporations exceeded their cash flow by $310.8 billion, compared with net stock purchases of $118.2 billion.
We would say that these figures indicate a continuous, rather dramatic change in corporate policies of expansion away from new capital investment and toward "purchasing" growth and earnings. It started in the 1980s. It strongly intensified during the 1990s, and during the last few years has gone to extremes.
Stating this, we primarily have the long-term development in mind. But in the same vein, we are pondering what is going to happen to business investment in the short run, when consumer spending slows, or even slumps, in the wake of the bursting housing bubble. The generally highly optimistic expectations and forecasts about investment spending taking over from consumption as the driver of the economy greatly puzzle us.
To stress one important point, which appears to be generally overlooked: Some rise in capital spending is not enough. Given its much smaller share of GDP than consumer spending, it needs a very strong rise to offset even a minor decline in consumer spending.
While the markets seem to reflect highly conflicting views about the U.S. economy's outlook, we nevertheless presume one underlying common view, and that is the perception of very little risk of a possible recession because the Fed would, in any case, swiftly act to head off any gathering weakness. What matters from this perspective both in the bond and stock markets are impending rate cuts.
In essence, this is in line with the conventional thinking that the U.S. Great Depression of the 1930s, as well as Japan's prolonged malaise since the early 1990s, could have been avoided by prompter monetary easing. Whoever believes in this is entitled to be bullish both on stocks and bonds.
U.S. stock prices received their lift since June/July mainly from lower oil prices and lower long-term interest rates. To keep heading higher, it will now need sufficient earnings growth. After an unusually steep rise in profits during 2005, analysts are predicting more of the same. Our focus is on aggregate profits, as calculated and reported by the Bureau of Economic Analysis within the National Income and Product Accounts (NIPA).
The customary way of making forecasts of economic developments is to extrapolate the recent past. Profit growth in the United States during the last two years has been at its best for the whole postwar period. Profits of the nonfinancial sector in 2005 have jumped to $900.1 billion, from $584 billion in 2004 and $411.8 billion in 2003. These figures compare with a profit peak of $508.4 billion for the sector in 1997 and a profit low of $322.0 billion in 2001.
If you look at the profit development of U.S. corporations over the last 10 years, you will see that it is an awkward picture. Profits fared very poorly during the "New Paradigm" years of the late 1990s, presumably a time of excellent economic performance. No less astounding is their sudden steep rise in the course of 2005, from $624.2 billion in the fourth quarter of 2004 to $1,027.7 billion in the first quarter of 2006, happening while the economy distinctly slowed.
The irony is that after a strong rise during the first half of the 1990s, profits abruptly turned down during the "New Paradigm" years of the late 1990s. For six years, from the recession year 1991-97, the nonfinancial sector's profits had soared from $227.3 billion to $508.4 billion. As a percentage of GDP, these profits had risen from 3.8% to 4.9%.
While "New Paradigm" ballyhoo and stock prices flourished after 1997, business profits, as officially measured, suddenly slumped. As a percentage of GDP, they were a little higher at the height of the dot-com bubble than in the recession year 1991.
Coming to the recent recovery years, we must point to some irritating observations. On the surface, it looks like a fabulous profit development. From recession year 2001 to 2005, profits of businesses in the nonfinancial sector have more than tripled, from $322 billion to almost $1,100 billion. It was the best profit performance of all time.
However, this good-looking total consisted of two extremely different parts. It was in the first quarter of 2004 that profits exceeded their peak of 1997 for the first time. From there, they shot up almost vertically. Typically, it has been inverse that the very first years of recovery were best for profits.
21 November 2006
Dr Kurt Richebächerfor The Daily
Editor's Note: Dr. Richebächer has found the best investments to protect your portfolio, no matter what lies ahead for us in 2007. See his full report here:

Friday, November 17, 2006


Home builders slam on the brakes

Housing starts hit six-year low while permits, a key sign of builder confidence, slide to the lowest since 1997.
By Chris Isidore, senior writer

November 17 2006: 1:04 PM EST
NEW YORK ( -- New housing starts sank to the lowest level in more than six years in October and a key measure of builders' confidence in the market hit a nine-year low, a government report showed Friday.
Both housing starts and applications for new building permits tumbled well below Wall Street forecasts - a sign that the slumping housing market has not yet hit bottom.
"Today's figures clearly reveal that a quick turnaround in this sector is not just around the corner," said Anthony Chan, chief economist for JPMorgan Chase Private Client Services. "Any real turnaround may not be forthcoming until the central bank reverses course and begins to lower short-term rates again."
Housing starts plunged nearly 15 percent to a seasonally adjusted annual rate of 1.49 million in October from a revised 1.74 million in September, according to the Census Bureau report. That was the lowest reading since July 2000.
The pace of single family housing starts in October was down nearly 32 percent from the year-ago period when the home building boom was still roaring forward.
Building permits, seen as a measure of builder confidence in the real estate market, fell to the their lowest pace since December 1997, coming in at 1.54 million, down from 1.64 million in September. Permits for single family homes are also off 32 percent from the year-ago levels.
Economists surveyed by forecast that starts would fall to an annual rate of 1.68 million and permits to 1.625 million.
"Housing starts reported this morning was a shocker," said Phillip Neuhart, an economist with Wachovia. "The South -- the strongest home building region during the recent housing boom -- had by far the weakest month of any."
In some ways the slowdown in starts and permits is a positive for the housing market, since it will reduce the inventory of homes on the market, which as been depressing prices for both new and existing homes. But Neuhart said as inventory-induced slowdown is likely to depress the gross domestic product, the broad measure of the nation's economic activity, throughout all of 2007.
"We do not see healthy inventory levels being reached until at least the second quarter of next year," he said.
Another sign of weakness in the housing market came when a realty tracking firm reported Friday that home foreclosures rose once again in October, climbing 42 percent from year-earlier levels.
Still, before Friday's report, there had been hopes from other recent real estate reports that perhaps the slump in home sales and home building had bottomed out.
The National Association of Home Builders' survey of builder confidence for November posted a modest increase for the second month, even though far more builders still saw the market as poor rather than good. And housing starts rose in September, although permits fell.
In addition, mortgage rates fell sharply this week, with the average 30-year fixed rate mortgage dropping to 6.24 percent from 6.33 percent a week earlier, according to mortgage financier Freddie Mac. Mortgage applications climbed to their highest level since January in the most recent weekly reading from the Mortgage Bankers Association.
But other reports have showed weakness in prices for both new and existing homes, as inventories of both types of homes available for sale climbed to record levels. And home builders have reported having to offer attractive deals to move homes they have completed.
Major home builders have been reporting lower earnings and cutting forecasts for future results due to the downturn in new home sales.
Pulte Home (Charts), the nation's largest home builder, became the latest to report a stepper-than expected drop in earnings earlier this week, and cut its outlook.
"You can count us among the companies that would like to see this be the beginning of a more stable operating environment," said Pulte CEO Richard Dugas, after he cited some of the hopeful signs of improvement in the housing market during his call with investors following Pulte's earnings report. "But for now we will wait for the trends to continue and to broaden before we conclude that the bottom is being reached."
He said that it was important that Pulte and other builders cut back on housing starts, especially so called "spec homes" that are begun without a sales contract in hand.
"There is no need for us to aggravate existing market difficulties by throwing unnecessary supply into the market," he said.
Other home buildings reporting problems reduced earnings and or sales outlooks include Centex (Charts), D.R. Horton (Charts), Lennar (Charts), K.B. Home (Charts) and Toll Brothers (Charts).
Builders to buyers: Take this house, please!
October foreclosures jump 42 percent

Tuesday, November 14, 2006


Until the BEars stop trying to call the TOP, and IMHO until the CPC (put call ratio) takes a hard dive this rally can feed off the newbie dopes who might keep getting in front of it as it has feasted on the ones already run over.

When ALL have given into its hypnotic cry of riches and any stock can rise, obviously this is not the Titanic yet, it seems topsy, it seems unreal, it seems like it needs a breather, it keeps going up. The animal is loose when the techs lead the way, we might be in that phase now.

PPI shows almost deflationary drop, maybe market loved that, FED will soon cut? Can they? The YIELD CURVE says they MUST! 10 yr near 4.5% but 90 day money is near 5% ??!!! woweeee the shits upside down and being ignored.

ENERGY TRUSTS have been GORED by tax fears, even if not taking effect until 2011 !!!!

I am licking my chops to nibble, but it is always toughest when something is getting blown up, right ow maybe too hot to handle, I am charting the secrot now, but if OIL does not hold this area and falls below recent low range, they could be whollapped again.

Consumer spending falls for second straight month.

Housing stocks rumbled today? what happened to the bubble?? saying low rates here we come!

Well if bonds are soaring money not coming out of there, money also in stocks, liquidity floats all boats.

I could say when this party is over, the market of 2001-2003 will look tame, but I wont.

I am NOT short any more, even though my charts tell me a comeupins is NEAR, I mean what I see has held true last 5 years on my indidcators......but only once did the market NOT bottom in OCT, in last 10 years!!! well make that 2 now in over 10 tricked us and bottomed in JUly.

I see where the NAZ has declined most years in Jan quarter, but these days, I dont know if I want to bet on it.

One lesson all must learn for sure, you can find ALL the fundamental reasons, and charts that say this ish ow IT SHOULD BE, but shoulda coulda dont make you money, not fighting the trend does.

Specialist short position just SKYROCKETED, I thought I'd throw that in. It doesnt have to lead to a huge retrace, but it normally is good NOT to bet against these guys while they are at an extreme.

Money managers MUST run after performance, evryone is running to and running from. I am concerned with this chart.

So have fun while the fun lasts, I have a sip, but I sure as hell am not staying long enough to get drunk. For I am at least of memory of 2001-2003 and know that NO BEAR MARKET has ended with the SPX PE ratio and DIVIDEND yields where they were in 2003 bottom.

We are in the stratosphere of performance historically, and sooner or later you revert to the mean.

I get the feeling at some point next year this might be visable, but then no year after MIdterms has evern been a disaster, and most quite good, more history for you....not a guarantee.

If Dem's go after BUsh, all bets are off and tax cuts, but we dont know just yet what 2007 holds, for all of us I hope promise, and no worse than muddle thru.

Trillions in mortages are set to go much higher in 2007, and could greatly effect consumer spending. Savings rate still negative.

Saturday, November 11, 2006

Doug Noland from Prudent Bear

The explosion of Credit derivatives and top-rated corporate securities issuance is a Monetary Development of historic proportions. I have written about the “Moneyness of Credit” issue over the past few years, but never did I imagine it would come to this. Marketplace perceptions of safety and liquidity are today being grossly distorted on a scale – multi-trillions of securities from one corner of the world to another - that so overshadow the technology Bubble – that overshadow anything previously experienced in the history of finance.

Following in the footsteps of the technology derivatives Bubble, the mania in Credit “insurance” ensures a collapse. It today feeds a self-reinforcing boom, but when this cycle inevitably reverses, the scope of Credit losses will quickly overwhelm the thinly capitalized speculators that have been more than happy to book premiums directly to profits. Undoubtedly, an unfolding bust will find this “insurance” market in complete disarray. Much of the marketplace today expects that they will - when things begin to turn sour - either obtain Credit “insurance” or hedge/”reinsure” protection already written. But when much of the marketplace moves to offload Credit risk there will simply be no one to take the other side of the trade. As losses mount, the market will then face the harsh reality that minimal “insurance” reserves are actually available to make good on all the protection written. This will have a profoundly negative impact on both Credit Availability and marketplace liquidity – ruining the plans of many expecting – and requiring – that “money” always flow so freely.

A major problem with the current monetary boom – the “Moneyness of Credit Bubble” – is the enormous and widening gulf between the market's perception of safety and liquidity and the acute vulnerability of the actual underlying Credits. Runaway booms invariably destroy the “money” – in whatever form it takes – whose inflationary expansion was responsible for fueling the Bubble. This lesson should have been learned from the late-twenties experience, or various other fiascos as far back as John Law. When current perceptions change – when $ trillions of Credit instruments are reclassified and revalued as risky instruments as opposed to today’s coveted “money” – Dr. Bernanke will learn why a central bank’s monetary focus must be in restraining “money” and Credit excesses during the boom. And the longer this destabilizing period of transforming risky Credits into perceived “money” is allowed to run unchecked, the more impotent his little “mop-up” operations will appear in the face of widespread financial and economic dislocation – on a global scale.


Briefly, a mild pullback seems in order, but high beta NAZ issues are holding strong, but I do see multiple bearish divergences, at some point should come into play.

High volume selloff was not followed though Friday. Options expiration is Fri and MAX PAIN has Q's at $42 Area just above current price has been resistance, if broken price could run.

Commodities after brief pullback could be good place to be. Same for OIL.

LArge caps still outperforming, some newsletters calling for rally into 2007, top making data near non existant. Opinions dont matter, market action does.

Sometimes you need to be watching when good stuff gets battered AKA EBAY at $22 or YHOO at $23. HOT stock HANS been gored. Dem's in charge has some selling in big pharma.

I think a top of mega years in duration appears early 2007, but year after mid term elections decisively bullish, if still so, maybe the market holds together even longer than now expected. One thing is will consumers with Bush spanking and Dem's in charge have a giddy rise in Consumer Sentiment?



A Time For Accounting
Joseph L. Galloway
November 10, 2006
Joseph L. Galloway is former senior military correspondent for Knight Ridder newspapers, columnist for McClatchy Newspapers, and co-author of the national best-seller We Were Soldiers Once ... and Young. Readers may write to him at: P.O. Box 399, Bayside, Texas 78340; e-mail:
Better late than never.
Secretary of Defense Donald H. Rumsfeld is gone, but there's little time for celebration, even for those of us who long ago began calling for his removal. The damage that men do lives after them, and it's time at last for an accounting. The nation’s voters have spoken, and it's reasonable to expect that the Congress finally will begin to exercise some oversight of the wars in Iraq and Afghanistan after five years of serving as rubber stamp and doormats.
Can you spell "subpoena?"
For the Democrats who will soon take charge of the House of Representatives and perhaps the Senate, too, here's a preliminary laundry list of some of the things that need doing:
A comprehensive investigation of the pre-war intelligence on Iraq and how it was perverted, how the mine was salted, and by whom.
A thorough investigation of what pre-war advice was offered by senior American military commanders on troop strength, equipment requirements and strategy and tactics. Did even one general ignore the bullying from on high and ask for more troops, and how did Defense Secretary Donald H. Rumsfeld respond?
Why did the Pentagon send American troops into battle without enough armored vests, armored vehicles, rifles, ammunition, food and water? Who's responsible for that debacle which cost so much in blood and money?
Where did our money go? Billions of dollars of taxpayer money disappeared down various rat holes in Iraq, forked over to contractors without even so much as a handwritten receipt. Who got the money? What did they do for it? This is a fertile field that can be drilled for years, with a steady stream of indictments, trials and prison sentences.
What about those no-bid Defense Department contracts that were parceled out to the Halliburtons and KBRs and Blackwaters in Iraq and Afghanistan, and other more costly weapons and equipment contracts that went to big defense industry conglomerates accustomed to writing very generous checks to the Republicans?
Why did an administration that was hell-bent on going to war, with the inevitable and terrible human casualties among our troops, consistently underfund the Veterans Administration, which is charged with caring for our wounded and disabled?
What's been the effect of the grotesque politicization of the selection and promotion system for senior military commanders by the office of the Secretary of Defense? What failures have resulted from that ill-conceived action? What responsibility do those generals and admirals chosen by Donald H. Rumsfeld bear for the failure to prepare for and conduct effective action against an inevitable Iraqi insurgency?
Who at the top bears responsibility for the torture and mistreatment of prisoners and detainees at Abu Ghraib prison and the Guantanamo detention camp? A score of Pentagon investigations got to the bottom of the chain of command but declared that the top, in Rumsfeld’s office and the White House, was innocent.
Who's responsible for breaking our understrength Army and Marine Corps with endless combat duty tours in Iraq and Afghanistan? Who refused all suggestions that the force was too small for the mission, and that 50,000 or 100,000 more men and women were needed in uniform? Who stubbornly refused even to consider the inevitable consequences of an Army so tied down trying to man these wars that it no longer could react to an emergency anywhere else in a dangerous world?
Simply put, the jig is up. President George W. Bush, Vice President Dick Cheney and Rumsfeld have come to the end of their free ride. No longer can they act without thought or ignore the boundaries of the Constitution, the law and common sense.
Did they really think they could get away with all of this without ever being called to answer to history and the American people?
They all deserve what's about to descend on their heads. They deserve every subpoena. They deserve every indictment. Most of all, they deserve a reserved place atop the ash heap of history.

Thursday, November 09, 2006


NYSE traded close to 3 billion shares today on DECLINE, when a move is made on increasing volume it is to be taken seriously. Selling pressure picked up today that is for sure, why it did is for speculation.

I have reasoned that IF the Repub's and their inside cronies goosed the market by buying futures togive the party a lift, now seeing it was for naught, might sustain new buying as the reason to do so is no longer there.

The Q's were held right at their previous 52 wk high leaving a double top in place, it is very interesting how stocks and indexes act at important levels be they previous support now resistance or other way around. Its full meaning is for now unclear, but what is sure, is a pause was necessary.

Will this lead to a meaningful correction? SHOW ME I say, but if high volume continues on declines, be very cautious.


Saturday, November 04, 2006




Bush is stumping on his Economic record and sending fears of tax hikes if Dem's gain control as only reason to vote R.

President Bush said Saturday his tax-cutting policies have created jobs and promoted growth, economic progress he contended is jeopardized by the prospect of Democratic victories on Election Day.

"Americans are finding jobs and they're taking home more pay. The main reason for our growing economy is that we cut taxes and left more money in the hands of families and workers and small business owners," the president said in his weekly radio address, delivered live from Mile High Coffee in suburban Denver.
Campaigning on the final weekend before Tuesday's vote, Bush told reporters just before the broadcast that he "feels good. It's quite a campaign coming down the stretch."
On the radio, he said Democrats consistently have opposed his tax cuts and they predicted the tax would not create jobs or increase wages and "would cause the federal deficit to explode."
"American workers and entrepreneurs have proved all those predictions wrong. But Democrats are still determined to raise taxes. And if they gain control of the Congress, they can do so without lifting a finger," said Bush, seated at table in the shop as patrons sipped coffee and snacked.

Bush's main tax cut was a cut in dividend tax rates in which the avg American gained very little, however the insiders and already rich in the higher tax brackets with much larger stock portfolio's have gained mightily.

Bush's policies have widened the gulf between the have's and the have not's. The avg American is falling deeper and deeper into debt.

ALL we have gotten from Bush policies is asset inflation and dollars fleeing this country to Asia. China now holds a record $1 trillion dollar of US debt, even more than Japan.

It takes 250,000 jobs a month just to keep up with those coming into work force. Yet last 2 months we have averaged less than 100,000 and unemployment rate drops dramatically?

Only once has the market rallied in OCT, now make it twice in 10 years. just a coincidence?

I think the short term health of the stock market will be determined by the outcome of the Tues election, if the Repulican's lose their grip I think the market will react badly, but you never know the Republican's might pull it off again, and then we see a SWIFT rise.

The markets recent mild pullback is telling us it doesn't know for sure how it will all come out, I do not expect much until we get Wednesdays reaction.

If you like the way things are going, if you support the war in Iraq, and don't mind losing some of your constitutional rights, vote R. If you think a STRONG message needs to be sent to the Republican majority and BUSH we don't agree with his policies and ignoring criminally the know what to do


Wednesday, November 01, 2006

The Brilliant Hans Sennholz "An Unstable Dollar Standard"

An Unstable Dollar Standard
We live in a period of world-wide economic expansion and prosperity. The world economy is said to grow this year at some five percent, which will be the third year above the historic average. Even if, in the coming year, the growth rate should decline a little, the global economy looks bright and prosperous. Led by some Asiatic countries, especially China and Japan, more countries than ever before are reporting rapid economic expansion.
But no matter how bright the economic outlook may be, the international prosperity is exposed to a looming risk, which has even grown in recent months. The war in Iraq and the skirmishes in Afghanistan are an ever-present danger that may destabilize the Middle East and spread the conflict to more countries. The Islamic republic of Iran, which does not hesitate to confront American interests and concerns, may upend the peace at any time. But the greatest concern of many economists is the global economic imbalance which is clearly visible in the huge balance-of-payments deficits of the United States and in the corresponding surpluses of the creditor countries. Americans are said to consume some 70 percent of the world’s savings while Japan, China, and other developing countries are financing the deficits and accumulating American IOUs. Many economists are convinced that such disproportions and imbalances are unsustainable in the long run.
Surely, American foreign debt has increased significantly, but so has individual income and wealth. Total domestic debt has risen visibly over the last decade, but so have productivity and income. This economic harmony nevertheless is burdened by considerable risk of global imbalances that may cause disruption and upheaval in the future. The debt-and-credit differences of the large national economies continue to grow, the balance-of-payment deficits of the United States surpass all national surpluses. In 2005 the deficits amounted to some $790 billion, which, in relation to gross national product, exceeded six percent. So far this year, it may exceed $800 billion, or 6.5 percent of GDP. Moreover, the federal government continues to suffer huge budget deficits which enlarge the national debt and add weight to the international concern.
The American mountain of debt is matched by large balance-of-payment surpluses in developing Asian countries, as well as by most oil-exporting countries. Many creditors welcome the surpluses. They keep the exchange rates of their currencies low which, in turn, boosts their exports and gives employment to millions of workers who, with American assistance and technology, are learning to produce for the world market. Chinese banks now hold nearly $1 trillion, which is the highest reserve position in the world, having passed Japan this year with some $865 billion. Without such dollar purchases, their currencies would rise immediately, which would boost all export prices, curb exports, and depress economic production and employment.
A few critics believe that the U.S. trade deficits may be the greatest threat to the economic order. Yet the deficits have neither impaired the U.S. dollar nor undermined the position of the United States as the primary economic engine and power. Many observers, therefore, question and disclaim the dangers of American balance-of-payments deficits. They not only cast doubt on official statistics that may exaggerate the case, but also point to the stable rates of exchange which all participants maintain voluntarily. Stability, after all, benefits everyone.
This economist, nevertheless, is convinced that a correction is unavoidable. All markets function to adjust and readjust any maladjustment. They are burdened and strained by the growing mountain of debt which raises the question of American ability to meet its obligations. If there ever should be any doubt about the stability of the American economy, the world-wide demand for U.S. dollars would decline, which would cause the dollar exchange rate to plummet. American imports would decline, dampening the surge of consumption and slowing the very growth engines of export countries such as Japan, China, and many others. The whole world would feel the American instability. A weaker dollar and rising import prices also would accelerate the inflation rate which would pressure the Federal Reserve to raise interest rates. Higher rates would slow the American economy and boost the rate of unemployment.
Despite such international imbalances, the U.S. dollar has not weakened significantly in recent months, and the world economy has not fallen into a global recession. At first, Asian central banks, and then also the oil-exporting countries, financed the huge deficits. It is in the economic interest of the Asian developing countries to keep their exchange rates low in order to keep export prices low and thus keep the export motor running. Massive purchases of federal obligations support the exchange rate of the dollar and increase Asian currency reserves.
It is in the interest of the United States, as well as the Asian countries, that the U.S. dollar maintain its high exchange value. Some American economists like to speak of a “Bretton Woods II” arrangement, which would resemble the international system in effect between the Second World War and 1973. Participating countries supported each other’s currencies and thus sustained stable exchange rates.In Bretton Woods I, the member countries supported each other’s currencies – in Bretton Woods II, they eagerly support the dollar. The European Central Bank, which actively pursues employment policies, manages to avoid the influx of U.S. dollars by keeping interest rates very low and liquidity plentiful. According to some estimates, the quantity of money in euro countries, since 2000, has increased some 25 percent faster than the gross product. In the United States, it has grown some 10 percent, and in Japan by 15 percent. The European Central Bank even surpassed the Bank of Japan, which is inflating its currency in order to counter powerful deflationary forces. In short, euro liquidity is plentiful and interest rates, seen historically, are exceptionally low.
As the U.S.-Asian imbalances continue to mount, the forces of readjustment are gaining strength. There are indications that the imbalances are correcting slowly and in an orderly fashion. Most governments agree that greater flexibility of the exchange rates, especially of the Asian currencies, is an orderly step toward the correction of the global imbalances. But most governments cling to their old policies. The interest rate differences are closing slowly, which causes more and more investors to shun the dollar risk. Moreover, the American real estate market has cooled off significantly without dramatic crashes. The boom, according to Fed Chairman Ben Bernanke, has given way in an orderly and moderate fashion. But there cannot be any doubt that the decline in the housing market will be felt throughout the economy in months to come.
Some Americans will have to curtail their spending which is bound to slow down the economy. Will it drag the world economy with it? The rate of expansion in many Asian countries undoubtedly will decline, but by less than pessimists predict. Most economic expansion in China, India, and other developing countries in recent years has been driven by domestic demand and supply. Yet we must not underestimate the weighty and consequential role played by the United States in world financial markets. A huge debt casts a shadow on any market; the rapidly growing international debt of the United States is clouding the world economy. It cannot grow perpetually; it will be settled sooner or later either in an orderly and upright fashion or in financial crisis and economic recession.
The finale of the scenario may be played by the Federal Reserve System. It may seek to reassure and pacify numerous Asian creditors by maintaining high market rates of interest or at least approximate them, or cater to the notions and wishes of most legislators and their constituents who usually favor monetary stimulation. Sooner or later Federal Reserve governors will have to choose between economic consideration or political preference. Their choice will determine the future of the U. S. dollar.
Hans F.