Ass-Backward Economics - II
Jim Willie CB | |  |
d) The USDollar's recent decline in value has adequately addressed the imbalances in world trade, affording our corporations the opportunity to compete on a more level field. No way, not even close, the USDollar correction has not yet begun.
The facts support quite a different story, if bothered to be read at all. Again, the level of analysis is shallow. The lion's share of the US trade gap favors the Asian continent. Together, Japan and China weigh in at $200 billion in trade surpluses versus the USA alone. Other Asian nations command additional outsized surpluses. The remainder of the surplus benefits the Middle East oil producers and Mexico, our new outpost of assembly plants. The surplus with the European Union is tiny. Trade imbalance is corrected by currency adjustments, a natural process. Where have we seen more than minimal shifts in Asian currencies in dollar terms? Nowhere. Over a year ago, I predicted that the dollar would fall markedly and the euro would rise substantially, resulting in no change whatsoever in the US balance of trade. I cited our Northern European roots, trust in financial "paper," and Arab PetroDollars diverting to Europe, where the bulk of Middle Eastern commerce takes place. That is precisely what happened, as the monthly gap has ranged $41-43 billion. Mindless media parrots chirped about our trade gap coming down in a recent month, all the way down to $41B. That is not progress!! The May gross current account imbalance (trade plus investment) jumped to $48B, despite the widely reported USDollar "adjustment."
As the Fed shifts to a higher gear in monetization, our debt continues its growth, and our trade gap maintains its worrisome rift. The yen has risen less than 10% versus the dollar in the past three years. Asian imports are not changing in price, as producers are eating the exchange shift within their profit margins in order to retain market share and continued distributor relationships. America continues to bleed capital heavily, with the trade gap clear evidence that the great USDollar correction has yet to get underway. When it happens, it will be painful and drastic in its medicine. The arrival of a true USDollar correction will be headline news.
Since autumn 2001, the euro has appreciated 30% versus the USDollar, only relaxing in recent weeks a few percent. The press & media have made great fanfare of this enormous shift. I regard it as a "hot potato" evasion of, and distraction to the problem, and in no way a correction. It is evidence of failure to deal with the heart of the problem. The euro appreciation fails to address the current mammoth trade imbalance between the United States and a host of Asian exporting nations. The imbalance threatens the entire world economy. A casual observer might indeed note that the white Europeans have tossed the hot potato from New York City and Chicago to Brussels and Bonn (but not London), from the USDollar to the euro. The dollar and euro have not merely traded places, but rather, Americans have allowed the Europeans to share in the pain from an over-valued currency. In doing so, nothing has been solved. Even greater problems have sprung up. The Chinese in the last 18 months have benefited from a 25-30% competitive price advantage over their European rivals in the EU marketplace. Even in Canada, a 15% change in price has favored Chinese imports. Their pricing advantage in the USA is constant from the yuan's pegged exchange rate to the USDollar, the recent source of political conflict. The Eurozone must next contend (as the USA did) with sharply cheaper Asian imports, stubbornly rising trade gaps, and eventually increased debt. Such is life for economic ships in the sea of floating currencies since abandonment of the Bretton Woods anchor to gold. Shifts in currencies act much like giant invisible tsunamis, crashing onto commercial shores. Most of the capital undergoing movement originates from the USA, originating as govt debt and extended credit to finance federal deficits and trade gaps. Our nation has matured into an inflation monstrosity.
The popular widely reported dollar index (DXY) is very misleading and misrepresentative, having over 50% weighted component in the euro. Authorities claim it to be a narrow trade-weighted index. What trade are they referring to? Perhaps trade in the 1950 decade. Both the index and its futures contract are an artifact of the past. True, the DXY dollar index has fallen significantly. It has careened from its high two years ago at 121 to the 95-97 interval now. Some call this 20-25% decline a necessary and sufficient correction. However, it has accomplished nothing. Now Europe has a similar problem with an overvalued currency, which will wreak havoc among its industrial producers, and cause a recession. They will not be able to compete against the Asians any more successfully than the US has for years. The Chinese could peg their currency against the euro at a later date, in a devious maneuver, to ensure a continued advantage.
The Federal Reserve maintains what they call "the Broad Fed Dollar index" which is more appropriately weighted against actual trade in recent years. It is heavily tilted toward the Asian currencies, in particular the fixed Chinese yuan. It properly reflects the burgeoning trade with China, completely unaddressed in the DXY. The broad index is a well-kept secret. So far, the Broad Fed Dollar index has budged a mere 4-6% since the dollar's peak. We have witnessed a mere smidgeon of progress in the USDollar correction. A brief essay (see [10]) in the FOREX News provides complete details on the component makeup of the two indexes, and status of the absent correction. One index serves the white Europeans who play games among themselves with a blazing hot potato. The other serves a trade imbalance reality which has yet to be addressed. Focus upon the DXY index has furthered the deception.
When a genuine correction finally does take place for the USDollar, the change will indeed be noticed. It will usher in painful price increases of Asian imports, quickly measured even within the fantasy CPI index. Imagine Nissan cars, Sony televisions, Hitachi computer storage devices, JVC stereos, Nikon cameras, even engines for Detroit's cars all costing 10-20% more. When China adjusts its peg to the USDollar, who knows how much of an increase will be permitted by their infinitely patient leaders? It should be large, but it will in all certainty be minimal so as to defuse political pressures and keep their domestic employment brisk. The USA just registered the largest bilateral trade deficit between nations in history, with China. Wal-Mart alone bought so many finished products that it would be ranked China's 8th largest trading partner, ahead of Britain and Russia, if it were a sovereign nation. Imagine the wide assortment of Chinese products from lamps to desks to shirts to furniture, even bobble-head dolls, all costing more. Next on loading docks will be auto parts from China, sure to attract attention as well as public uproar. Will longshoremen cooperate with teamsters and auto workers to cast the net of a union strike on these docks? Protective tariffs and other actions are right around the corner for this nation. Furthermore, India is now draining the service sector within our economy, slowly but surely, and in a very big way. Recent announcements by General Electric, Oracle, and IBM all confirm a step-up in the trend. India offers customers in our economy a 70-80% cost advantage that is hard to pass up. Even the state of New Jersey was tempted for certain call centers.
For 30 years, the gold standard has been substituted by an unstable fragile floating triangle with corners upheld by the USDollar, Japanese yen, and the Deutschemark (now euro). These three currencies dominate the world foreign exchange. So far, the euro and dollar have experienced a shift which now shares the abnormality vis à vis Asia. These three currencies have tremendous liquidity, enough to absorb large changes in capital flow. The European Central Bank initially may have relished the healthier respect, if not prestige, with the rise in euro valuation after over ten years of shameful disrespect. Arab diversion of petro-dollars was initially welcomed, perhaps to inflict a measure of embarrassment to the United States. However, the euro's rise augurs a negative systemic effect to the EU economy.
Next up on the FOREX dance floor is for the Japanese yen, sporting a face lift in the eyes of many, but suffering from a heavy handed father at the Bank of Japan. Its annual $90 billion trade surplus versus the US Economy creates a capital flow too large to overcome. In a matter of weeks or months, a rise in the yen relative to the USDollar is inevitable. Three weeks ago, a momentous event occurred in the market for Japanese Govt Bonds, forcing the largest decline in bond principal in a single day for many years. An auction was seriously undersubscribed. Ripples from the shock wave were felt in Europe and the USA within hours. Japan apparently has begun to sell large blocks of USTBonds in order to cover losses in their govt bonds. Events prompted the American Plunge Protection Team to act quickly. They seized the moment to push up the USDollar over 1% overnight, held firm the 10-yr Trez Notes, and poured money into S&P futures contracts. The Federal Reserve may have allowed a backup in longterm interest rates to ensure stability in the USDollar. Recall that the dollar and treasury bond are two faces on the same security. So far the maneuver has taken root in a sizeable bounce in the dollar. Lost confidence in the integrity of free markets has acted to erode trust in US financial securities generally. The lesson from July has been that something must give: either the dollar or the bond.
The bond event in Tokyo came just two weeks after an unexpectedly poor response to the Fed's latest 25-basis point rate cut. The event earmarked a "hat trick day" as stocks, bonds, and the USDollar all fell in unison. Yields on the Trez Note are now a full 120 bpts higher than the last FOMC meeting. Credit market response constitutes an unmitigated disaster for the Fed, which blatantly misled the bond market into expecting direct purchase of longer maturity bonds. Now the Fed has announced that will not happen. They cite an exaggerated renewed strength in the US Economy as justification for the betrayal. Many regard the Fed move to a target 1.0% rate as marking the top for the manipulated govt debt market, with the reversal of longterm rates the recent confirmation. Fed Open Mouth Committee tactics have been shouted down. Mortgage rates have backed up almost a full percent, having a stall effect on the housing sector. The domino effect falls one step farther onto the consumer economy, since refi's have dropped a reported 30% from springtime levels. At the same time geopolitical pressures are being exerted to call into question the honesty and devotion to truth in US presidential leadership. The entire Iraqi war justification is on shaky ground, to say the least. The international pressure valve could very well become the USDollar and its flip side, the USTreasurys.
The Japanese Nikkei stock index has moved strongly upward, breaking a longterm downtrend. First their bonds fall, then their stocks rise, next their currency rises. Note the clear longterm "head & shoulders" bullish pattern in the yen currency, a very reliable pattern in its weekly chart (see [11]). Note also the nearterm "ascending triangle" bullish pattern in the same chart, which appears to be in a tough struggle for resolution. The Bank of Japan is in the fight of its life. They desperately seek to emerge from the tight grip of the multi-year Liquidity Trap. They have coerced money out of the $11 trillion pool of individual savings. In doing so, they have also encouraged capital frozen in their moribund govt bond market to exit. The beneficiary so far has been their stock market. In its wake will follow their yen currency. Forces could easily become too great for the BoJ to withstand and resist a damaging yen appreciation. Sea changes are coming to the American shores, a potential tsunami from Japan.
If China follows suit in a rising currency, the effect will be tremendous. They may allow the rise so as to minimize Asian regional damage with respect to Japan. In finding new life, the Japanese economy must sooner or later withstand rising prices among export markets. Without a yuan peg increase, China will enjoy a widening relative price advantage over Japanese imports. Political pressures are inevitable to urge the Chinese to rejigger their yuan currency higher, to allow it eventually to trade on the FOREX. Chinese leaders think in terms of decades, while we westerners tend to think in terms of months. Days of reckoning lie ahead. America will be weakened in the remedy phase with imported inflation in the form of rising imported product prices, a long overdue reversal of a trend that has endured for almost 20 years. We have printed money, issued debt, extended credit, and sent the money abroad to pay our bills. In effect, we have exported our inflation, if not our counterfeit operation. Next is the reverse. It will be ugly.
Problems are only beginning on the competitive currency front. Within a few years, the Chinese yuan is likely to become gold-convertible. They are accumulating gold on the quiet. Full scaled repercussions would be enormous, easily resulting in their new currency becoming the most pursued and fastest rising in the world. For that reason, their leaders will be slow to guarantee convertibility. For American markets the development would lead to widespread import price increases and reduced demand. The impact would be vast. Perhaps by that time, China will have the yuan pegged versus the euro in order to regulate the capital drain from the European Union. The entire depletion process from the USA and EU will combine to build a massive world power, complete with a navy. I fully expect the USA to design and construct that Chinese Navy, paid by USTBonds stored in surplus.
The much more immediate concern is the US Govt fiscal distress, which now borders on a panicky extreme. The public consensus regards the extraordinary federal deficits as "no big deal," typical for investing in a stimulus, to finance unemployment, and to nurse the economy into a recovery. This round is far more different and dangerous. We are financing $1 billion per week in a guerrilla war of attrition in Iraq, crossing our fingers that chaos does not result. Federal bills are mounting, even as tax revenue fails to grow. Richard Russell expects those bills to be paid with printed money, whose monetization is sure to add pressure on the weakening USDollar. I expect the Medicare prescription drug bill to be the real coup de grace to the federal budget over the next several years, sure to bankrupt the budget process entirely. If the Federal Reserve and Dept of Treasury decide to monetize large portions of the US Govt budget bill paying, we will accelerate to the downside on the USDollar decline by another 10-15% easily. From start in early 2001 to finish in 2005-2006, I expect at least a 50% decline in the USDollar. Those who believe the dollar correction has reached conclusion are as foolhardy and mindless as a child who observes a sunny Boston 40-degree day in December, on the backside of a 4-inch snowstorm two weeks before, and proclaims winter is over.
e) We must encourage continued consumer spending, by whatever means, in order to sustain the economy at a healthy growth level. Sure, if toxic debt and lethal trade hemorrhages are worth continuing. We are deep into a game with no happy ending. The US Economic activity consists of somewhere in the neighborhood of 80% consumption. That figure in itself represents a severe distress signal. An imbalance exists characterized by consumption far in excess of production across our nation. What financial products we sell, we deceive ourselves into believing they are legitimate form of production, resulting in real wealth. Instead, they represent speculative vehicles and packaged debt instruments nourished by rampant printing press output. The result is a potentially disastrous trade gap, with our nation's govt liability and capital asset base gradually forfeited to Asia and the Middle East. Where is the wisdom in attempting to sustain such a steady capital loss?
Further aggravation comes from our income levels, insufficient to keep pace with consumption. Absent lunatic adjustments, in actuality we have negative savings to boot. For the last 20 to 30 years, our standard of living (regarded as an entitlement of the "good life") has increased in cost. Our health and energy costs, coupled with taxes and insurance, have steadily increased the general cost of living of households and the financial burden of corporations. As a result, household debt has risen to near crippling levels. To exhort strapped households to step up and keep the engine running seems ridiculous, since additional debt extensions are clearly required. Our corporations can no longer compete, especially with our overvalued currency. Hence, we import our consumer goods. The engine not only runs of fumes, but it pulls foreign economies, drawing our own deeper into debt. Not a good plan. The beneficiary nations to our trade gap will over time assume more prominent positions on the world stage. Their claims on our asset base have grown to a staggering level.
The recent federal stimulus package seeks to remedy the tax burden for households, but it falls short in depth or timeliness. Stretching the benefits of reduced taxation will serve to weaken those who need benefits. While targeting the middle class for benefits only furthers the wrong-minded consumption model, such directed targets are essential but constitute a welfare package. Corporations require at least the same tax relief. US corporations bear the greatest tax burden among the 17 industrialized nations. High taxes, high labor costs, high debt loads, and a high dollar all work against our nation's businesses.
I object to the spirit of the stimulus package, which states an intention to sustain consumption regarded as essential to the economy. The design is flawed. Our national economy is distorted to the extreme in its dependence upon consumption as opposed to restraint. We as a nation desperately require savings and investment, and an end to foreign dependence upon imported products, imported capital, and a stem to debt's accelerated growth, both household and governmental. Carried to an extreme, our national pursuit of consumption can be shown to be patently absurd. We strive to maintain retail sales, even at the point of the gun known as debt. Employing such ideals, our investment society would hold in higher esteem a household couch potato who downs a pizza, a six-pack of beer, while ordering unneeded video games on extended credit than we would a man who joins his wife on that same couch for a snuggle, a favorite show, and an early lights out to prepare for the next day of work, eagerly awaiting the vacation they save for. Everything nowadays is backwards.
f) During the monetization process, Federal Reserve open market operations result in the creation of new assets in the form of US Treasury Bonds, Notes, and Bills, thus strengthening the foundation of the banking system. Wave the wand, debt becomes an asset during the grand counterfeit process, and nobody is the wiser. An entire generation has bought into this charade, not just in the USA, but worldwide. The American public urges, cheers on, and applauds the illicit alchemy perpetrated in the Fed's basement. Now our modern alchemists have pulled finally it off in equivalent form. Print currency, dry it with hot air in ample supply, bless it as real money, and call it "paper gold." The finishing process involves new debt issuance. In the accounting sham of disputable bookkeeping, these debt securities are listed under the asset column. Congress, industry, and over 100 million households sanction the fraud. Our federal govt and its banking accomplices have colluded to dupe the world. Their example has been followed by Enron and far too many publicly owned and traded corporations. How can the USGovt prosecute Enron when more grand fraud occurs every week?
And then there is the gold story. As debt securities are labeled as assets, and their paper dollars as gold, where the hell is the real gold? Good question. The Dept of Treasury is chartered to manage our national gold treasure, fully entrusted to ensure that our currency is adequately collateralized. The Fed is an accomplice to the gold disappearance. They toss around alibis founded upon national security, national interest to maintain stable currency values, all manner of excuses. The fact is that the Fed defies Congress and will not admit how much gold bullion it has dishorded on the commodity markets to fortify the no longer defensible USDollar. It may have also dumped our treasure on behalf of European interests after the 1999 Washington Accord, when the Germans and other continental bankers refused to play the insane game any longer. What a travesty, to date our gold supply not disclosed!!!
The integrity of our financial markets is at risk from actions taken by the Exchange Stabilization Fund, which has used money produced boastfully at a cost of three cents per any denominated dollar bill. Nothing in the financial world is permitted at virtually free cost without violent consequence. Nobody seems to call into question the "visible hand" at work in our markets. Could that hand be in any more contrary alignment to Adam Smith's righteous "invisible hand"? The absence of loud criticism of the heightened level of govt and regulatory intervention and market interference by the New York Times, the London Times, the Wall Street Journal, Barrons, and other notable publications highlights the moral hazard which corrodes all things financial. These prestigious journals are deadly silent about sanctioned alchemy, nondisclosure of gold reserves, and market interference. Free market response might be violent.
When actual federal bills are paid with this alchemic output, and longer maturity govt bonds are purchased by the same output, attention will be very negative on the entire corrupted process. Faith in US paper might be eroding right now. The combination of declaring newly created debts as assets and paying for real bills with unreal money makes for an reckless, dangerous, and highly risk-laden environment for maintaining international confidence in our economy, our currency, and our leadership. When lost, confidence is difficult to restore. Yet, economists cheer the charade. Everything nowadays is backwards.
g) Rising prices for commodities and imported products serve as evidence that the Fed has succeeded in its mission to reflate the economy, and is "on the job." Wrong, all inflation is not created equal, we are seeing the horrible side of price inflation's homecoming on the cost side of production and household expenses. Most commodities are produced outside our shores, and thus are subject to price increases as our currency falls in value. Closer to home, high employee health costs and corporate taxes already factor into higher production costs. If material costs rise on top of that, if shipping costs rise on top of that, if imported component supplies rise in cost on top of that, then we have significant increases in production costs. Profit margins will be under additional strain, at a time when price competition from Chinese imports is acute. Pricing power is totally nonexistent, especially with Chinese competitors omnipresent. The early signs of reflation are more like extreme warnings that production costs are rising, the worst kind of inflation for our businesses, which will further inhibit profit margins.
Compounding the matter is the rise in energy costs, almost across the board. The declining USDollar has resulted in higher energy costs, just when a shortage of natural gas is evident. Spikes in natural gas prices have become an annual event. Businesses consume more energy than households, in production processes, in maintenance of building operations, in shipping end products, in travel for meetings. Electricity bills, gas heating bills, and car fuel bills for gasoline are all rising. The strain will crimp consumer budgets and spending. We are not seeing reflation of the economy. We are instead seeing rising production costs and rising energy costs, without the benefit of improved pricing power anywhere. The Fed is not "on the job" in this case. Its easy money policies have aided speculators in the stock and bond markets (hence real estate), and to some extent in the currency and energy markets. In no way has increased money supply from an open monetary spigot increased capital equipment demand, improved balance sheets, or alleviated pricing power problems. We are witnessing the early stages of the Perform Storm cited by Jim Puplava of the Financial Sense. Its earmarks are price inflation of necessities and supplies, against the unfortunate erosion of pricing power (i.e. price deflation).
One might be led to believe that an amendment to the Constitution was recently passed by Congress, declaring that all inflation is created equal, with equal protection under the law for due process to liquefy. The level of understanding for all things relating to "inflation" is utterly abysmal. The public has granted the Fed and Greenspasm carte blanche in attacking the misdiagnosed deflation problem. He is prescribing heavy doses of more inflation, while we observe the deflationary aftermath following years of unchecked inflation. Greenspasm is clearly a menace, a "serial bubble engineer." A bigger bubble chases each previous bubble, fed by an even greater urgent supply of inflationary green matter. The public is misinterpreting the result of the Fed's handiwork, incapable of negotiating through the inflationary maze. We are seeing the worst possible type of price inflation, which will likely do further damage to corporate profit margins, and inhibit consumer spending.
Part II of this article will address the final three incorrect premises, and several remarks in summation. Look for the conclusion to this article soon :
- Global trade has been beneficial to the US Economy, opening new markets
- The US Economy will gain strength to offset rising interest rates along a normal cycle
- The US Economy is growing again, led by profits, productivity, improved balance sheets
- Summary Remarks :
- Folly & Metamorphosis, Austrians & Gresham, Roach's latest, the Fed calls its own Bluff, Inner Circle & Outer Vision, Dangerous Signals, Massive Bubbles Threaten
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PERSONAL ASIDE: It is my sincere curiosity how many readers are willing to make the commitment to pay a nominal $8-10 per month charge for regularly timed clarification on economic matters, to debunk conventional claims, and to provide guidance through the minefields in today's confusing financial world. Something very ugly this way comes, on the tail end of the dissipating bond market bubble and real estate decline that has begun. The long treacherous ride ahead requires a guide.
Professional crossroads lie ahead in my life. For months now, my efforts in the economy, gold, and currency front have been given away. I am excited by the prospect of performing a labor of love in a new opportunity. An informal survey would be helpful for my personal planning. If interested in a monthly paid subscription to a website newsletter with primary focus on economical policy and principles, with direct implications on currencies and gold, please let me know. If you wish, shoot a quick email to me at : JW@goldenjackass.com
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REFERENCES (including those from part II) :
[1] "A Statistician's Indictment of Economists" by Jim Willie CB (Dec 2002)
[2] essay archives by Stephen Roach (July 2003)
[3] "Govt Statistics: Lessons in Cooking and Spinning" by Richard Benson (June 2003)
[4] "Statistical Revisionism and Wizardry" by Michael Hodges (June 2002)
[5] partial editorial list by Kurt Richebacher (2000 to 2003)
[6] "Wall Street Great Says the Market is Broken" by Bill Fleckenstein (July 2003)
[7] "Vicious Circles and US Credit" by Jim Willie CB (May 2003)
[8] "Looming Mortgage Crisis" by David Chapman (June 2003)
[9] "Housing Cover Clause" by Rodney Cook (June 2003)
[10] "The Crumbling Strong Dollar Policy" by Ashraf Laidi (May 2003)
[11] weekly Japanese yen chart by Stockcharts.com
[12] "Japan, Argentina, Weimar, or Muddle?" by Jim Willie CB (April 2003)
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Jim Willie CB
August 6, 2003
Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 22 years. He aspires to one day join the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.
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