The Dollar is Being Devalued

This chart is from an excellent blog called Sudden Debt. We read it regularly, and suggest you do as well.

Someone sent us this chart and asked: What do you make of this? and by inference: What does it mean, what does it imply?

We make a lot of it, because it has been a recurrent theme at this blog since the first: The Die is Cast for the US Dollar, Is the Fed Monetizing Bad Debt, Is the Fed Accountable? and The Odyssey of Ben Bernanke.

It has also been a recurrent theme at The Crossroads Cafe, postings at various places around the web, and a primary investment strategy in our personal portfolios since about 1999. Let's put it up as a headline, and in one nice simple sentence.

The Fed is being forced to devalue the US Dollar.

At one time the dollar was backed solely by US sovereign debt: AAA Treasuries and a few fully guaranteed agencies like Ginnie Mae. Now it is backed at least in good part by collateralized debt obligations for which there is no market at stated values.

The devaluation of the dollar has been gaining steam relative to the other fiat currencies around the world like the euro and the yen under the Bush Administration. The strong dollar under the Clinton administration was effectively an accounting illusion. Commodities are a real problem because so many of them are controlled by non-G8 countries.

A lot of breath has been wasted debating the Hegelian dialectic between inflation and deflation. In a purely fiat regime it is a policy decision, nothing more.

Japan made their decision for their own reasons and got a protracted deflation, probably because they had a huge national savings at hand, an industrial policy of net exports, and a complex kereitsu controlled economy in cooperation with the bureaucrats at Ministry of International Trade and Industry 通商産業省 or MITI.

The US is making its decisions its way and is getting inflation, probably because it has a huge national deficit and no savings. Debtors do not willingly choose deflation. Without external standards its a policy decision. But the debate masks the real issue, that we are falling into a centralized command economy, and moving away from free market discipline. The further they go, the more the Fed will have to control directly. Some say that dollars can only be created if banks make loans, as if it is some law of physics. Oh really? Who says this? Where and by whom is it written? When will the decisive moment come when this is put to the test.

Its all about moving to a common and interlinked fiat system, not necessarily one currency. Its an arranged system similar to Bretton Woods with a renewed dollar hegemony, except the fix might be more flexible and less explicit. Its does not have its basis in evil. Its fault is hubris, the fatal flaw of all central command economies and those who would rule them.

Its a neo-liberal Keynesian dream in which the country is managed as a command economy by a small group of elites, and the rest of the world accepts their designated place in the grand scheme of things.

An important milestone along the way will be when the Fed runs out of Treasuries to back the dollar currency in circulation. Will people care that the dollar is now backed by questionable Wall Street debt? Will the Treasury find a graceful way to give them unlimited supplies? Will the rest of the world keep providing us with key commodities and manufactured goods? Its an awkward bridge that must be crossed in which appearance slips and the crowd gets a brief glimpse of reality. But its not the last obstacle, and perhaps not the biggest.

Will it succeed? We surely do not know. As the president said, it would be easier to make things happen if we had a dictatorship. We like the idea of hedging against a possible failure.

Until 1971 the US dollar was backed by gold. The Dollar is no longer the reserve currency of the world. Until last month it was backed by the sovereign debt of the United States government. One can presume that it is still backed by the full faith and credit of the federal government, no matter what. Although the nature and character of its backing is clearly changing, the final outcome of what it will become exactly is yet to be decided.

The die is cast

Someone just sent me this April 8 interview with Jim Rogers in which he says similar things. Its worth reading. Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve

The Big Lie: the Fed is Blameless On the Housing Bubble

"The question is whether you were lying then or are you lying now... or whether in fact you are a chronic and habitual LIAR!..."

"My Lord, may I also remind my learned friend that his witness, by her own admission, has already violated so many oaths that I am surprised the Testament did not LEAP FROM HER HAND when she was sworn here today! I doubt if anything is to be gained by questioning you any further!

Sir Wilfrid played by Charles Laughton, Witness for the Prosection

USA TODAY February 23, 2004

"Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said. "Overall, the household sector seems to be in good shape."

Alan Greenspan, April 8,2005 Washington, D.C.

"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants...

With these advances in technology, lenders have taken advantage of credit scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers...

Where once more marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending... fostering constructive innovation that is both responsive to market demand and beneficial to consumers."

The Fed is blameless on the property bubbleBy Alan Greenspan
Financial Times - Commentary

Published: April 6 2008 22:03

I am puzzled why the remarkably similar housing bubbles that emerged in more than two dozen countries between 2001 and 2006 are not seen to have a common cause. The dramatic fall in real long-term interest rates statistically explains, and is the most likely major cause of, real estate capitalisation rates (rent as a percentage of a property’s value) that declined and converged across the globe. By 2006, long-term interest rates for all developed and main developing economies declined to single digits, I believe for the first time ever.

Doubtless each individual housing bubble has its own idiosyncratic characteristics and some point to Federal Reserve monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence that monetary policy added to the bubble is statistically very fragile. Paul De Grauwe, writing in the Financial Times’ Economists’ Forum, depends on John Taylor’s counterfactual model simulations to conclude that the low funds rate was the source of the US housing bubble. Mr Taylor (with whom I rarely disagree) and others derive their simulations from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the basis for policy.

Mr De Grauwe asserts that “signs of recovery” (I assume he means sustainable recovery) were evident before 2004 and hence the Fed should have started to tighten earlier. With inflation falling to quite low levels, that was not the way the pre-2004 period was experienced at the time. As late as June 2003, the Fed reported that “conditions remained sluggish in most districts”. Moreover, low rates did not trigger “a massive credit ... expansion”. Both the monetary base and the M2 indicator rose less than 5 per cent in the subsequent year, scarcely tinder for a massive credit expansion.

Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators. Regulators, to be effective, have to be forward-looking to anticipate the next financial malfunction. This has not proved feasible. Regulators confronting real-time uncertainty have rarely, if ever, been able to achieve the level of future clarity required to act pre-emptively. Most regulatory activity focuses on activities that precipitated previous crises.

Aside from far greater efforts to ferret out fraud (a long-time concern of mine), would a material tightening of regulation improve financial performance? I doubt it. The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent. How can we otherwise explain how the UK’s Financial Services Authority, whose effectiveness is held in such high regard, fumbled Northern Rock? Or in the US, our best examiners have repeatedly failed over the years. These are not aberrations.

The core of the subprime problem lies with the misjudgments of the investment community. Subprime securitisation exploded because subprime mortgage-backed securities were seemingly underpriced (high-yielding) at original issuance. Subprime delinquencies and foreclosures were modest at the time, creating the illusion of great profit opportunities. Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality. Even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle.

Martin Wolf argues in the FT that central banks “can surely lean against the wind” even if they cannot eliminate bubbles. I know of no instance in which such a policy has been successful. For reasons I have outlined elsewhere (American Economic Association, January 2004), I doubt that it is possible. If it turns out to be feasible, I would become a strong supporter of “leaning against the wind”.

As far as US monetary policy being (in Mr Wolf’s words) “dangerously asymmetrical”, I point out that over the past half-century the US economy has been in recession only one-seventh of the time. Yet the unemployment rate exhibits no trend. Hence the average rate of rise of unemployment has been far greater than its average pace of decline. Monetary policy in response has been more active during recessions than during periods of expansion, but scarcely “dangerous”.

Much of the commentary critical of my FT article (Comment, March 17) is directed less at its substance and more, as Mr Wolf describes it, at “the ideology I display”. Ideology defines that set of ideas that we each believe explains how the world works and how we need to act to achieve our goals. Some of our views of causative forces are rational, some otherwise. Much of what we confront in reality is uncertain, some of it frighteningly so. Yet people have no choice but to make judgments on the nature of the tenuous ties of causation or they are immobilised.

I do have an ideology. So does each member of the forum. I trust our views are subject to the same standards of evidence that apply to all rational discourse. My view of how the efficiency of global capitalism has evolved over the decades as new evidence has appeared contradicts some earlier judgments and confirms others. I have been surprised by the fierceness of investors in retrenching from risk since August. My view of the range of dispersion of outcomes has been shaken but not my judgment that free competitive markets are the unrivalled way to organise economies. We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?

The writer is former chairman of the US Federal Reserve. A longer version of this article is on the FT’s Economists’ Forum at www.ft.com/wolfforum

US Corporate Earnings Estimates Decline Further

We start the first quarter earnings reports this afternoon with Alcoa.

Earnings prospects continue to decline for US companies not involved in the energy sector. Especially hard hit will be the financials.

The biggest events this week may be currency related with interest rate decisions from the ECB and BOE, and the US Trade deficit and IM/EX prices at the last part of the week.

Be careful with trading this information since much has already been discounted in the current stock market prices, and volumes on the NYSE are the lowest of the year.

Be even more careful about listening to the usual Wall Street siren song about now being the time to buy. Its traditional to try and lure the non-US and small investor into the market to help cushion the next leg down, which looks like at some point within the next month or so. A 'trigger event' could take this market down sharply despite the best efforts of the President's Working Group on Markets and the Federal Reserve trying to overlay the cracks with the plaster of monetary inflation.

P.S. @ 5:25 PM - After the closing bell today Alcoa missed estimates, and Advanced Micro Devices (AMD) warned.


Wall St sees sharper drop in Q1 earnings

NEW YORK: April 7, 2008 (Reuters) Wall Street analysts have cut their first-quarter earnings forecasts for US companies even further, according to figures from media estimates on Monday.

Earnings for Standard & Poor's 500 companies are now expected to decline 11.8 per cent, compared with the 8.1 per cent drop projected last week. When the quarter began on January 1, analysts had forecast earnings to grow 4.7 per cent in the period.

The revised forecast comes as a deep global credit crisis has dented the profit outlook for many US companies, particularly those in the financial sector. Financial companies are expected to be affected the most, with earnings projected to fall 61 percent. Consumer companies follow, with earnings expected to drop 11 per cent as US shoppers faced with higher food and energy prices and declining home values spend carefully.

The energy and technology sectors are expected to show the best gains for the quarter, up 33 per cent and 10 per cent respectively, according to Reuters Estimates.

The overall projected rate combines actual figures for companies that have reported with estimates for companies that have not.

The turbulent environment has prompted most companies to issue negative outlooks for the upcoming quarter. There are 242 negative outlooks, and 169 positive, according to Reuters Estimates.

The Die is Cast for the US Dollar

The Rubicon is a river that marked the boundary between the Roman province of Gallia Cisalpina to the north and Italy proper to the south. Roman law prohibited its returning generals from crossing into Italy with their army, protecting the civilian basis of the Roman Republic: Senatus Populusque Romani. SPQR: the Senate and the People of Rome. (A modern equivalent is the US law of posse comitatus.)

When the Roman general Gaius Julius Caesar crossed the Rubicon with his army in 49 BC with the intention of going to Rome, he challenged the independence of the Roman political system and made a war to resolve the outcome of the change inevitable. Hence the phrase, "crossing the Rubicon" to mean an action that precipitates major change and inevitable consequences.

The Republic was replaced by an autocracy as Caesar assumed the title dictator perpetuus, dictator for life.

As Julius Caesar crossed the Rubicon, the historian Suetonius reports that he uttered the phrase alea iacta est, "the die is cast".

Until 1971 the US dollar was backed by gold. The Dollar is no longer the reserve currency of the world. Until last month it was backed by the sovereign debt of the United States government. One can presume that it is still backed by the full faith and credit of the federal government, no matter what. Although the nature and character of its backing is clearly changing, the final outcome of what it will become exactly is yet to be decided.

And so the die is cast.

Bearing Down on the Fed's Balance Sheet
By Randall W. Forsyth
Barron's

Congress turned its sites this week on the rescue -- don't call it a bailout! -- of Bear Stearns by the Federal Reserve and JPMorgan Chase.

All the principals involved, from Treasury to the Fed to the banks, insisted the deal staved off a certain bankruptcy of Bear on St. Patrick's Day, which would have set off a chain reaction that might have threatened a meltdown of the global financial system.

They're probably right; the risk of letting Bear go bust was too great to take. And since then, financial markets have begun to rebound. Stocks have bounced, but more importantly from the standpoint of the economy, the capital markets have improved materially.

Starting with Lehman Brothers' $4 billion convertible preferred offering earlier this week, the capital markets have become much more receptive, allowing banks and other financial firms to rebuild capital that was hit by writedowns of sub-prime-related assets.

While balance sheets in the private sector are being rebuilt, the opposite is happening to the balance sheet of the nation's central bank. Specifically, the Fed's holdings of U.S. Treasury securities are plummeting. In their place, the Fed's various new-fangled lending facilities to banks and the rest of the financial system are burgeoning.

Since Dec. 6, just before the Fed instituted its Term Auction Facility to auction loans to banks, its holdings of Treasury securities plummeted from $780 billion to an average of $589 billion in the week ended Wednesday.

As MacroMavens' Stephanie Pomboy points out, at this rate the Fed will be out of Treasuries before Labor Day, or Aug. 14 to be exact.

Meantime, TAF lending has climbed to $100 billion. And the Primary Dealer Credit Facility -- representing the opening up of the discount to non-banks -- averaged $38.1 billion in the week ended Wednesday. JPMorgan Chase chief executive Jamie Dimond told Congress that Bear Stearns is borrowing about $25 billion via this facility.

That is apart from the controversial $29 billion that will be provided by the Fed to JPMorgan Chase and backed by Bear Stearns collateral -- which won't happen until the merger closes.

In addition, the Fed lent an average of $64.3 billion a day in Treasuries under its Term Securities Lending Facility in the week to Wednesday, in addition to the $21.3 billion a day in Treasuries lent under its overnight lending scheme. Lending Treasuries in exchange for other, lower-quality and less-liquid securities doesn't expand overall liquidity. But it does give dealers securities that are as good as cash in exchange from securities that, in essence, aren't.

But, wait, there's more. In the week ended Wednesday, so-called Other Fed Assets leapt by $21.4 billion a day, to an average of $64.9 billion. In that category resides foreign assets, such as currency swaps with foreign central banks such as the Swiss National Bank and the European Central Banks.

The latest bank-statement week took in the turn of the quarter, when money markets tighten, especially in skittish times such as these. So, European banks likely turned to their friendly, local central bankers for dollar liquidity, which the central banks apparently obtained by drawing on swap lines to the Fed. And those loans were an asset on the Fed's balance sheet, requiring it to shed Treasuries as an offset.

It's enough to make anybody's head spin. But the key point is that all these new and novel loans are displacing Treasuries on the Fed's balance sheet. That means, in effect, the Fed is taking on far greater credit risk in support of the banking system. (and it is the Fed's Balance Sheet Assets that provide the backing for the Federal Reserve Notes - US currency - in circulation - Jesse)

Indeed, says Robert Rodriguez, chief executive of First Capital Advisors, we have "crossed the Rubicon."

"In our opinion, a new financial system is in process of being created," he writes in a report to shareholders. "Some may refer to it as Pre-Bear Stearns and Post-Bear Stearns."

As it becomes the protector of the financial system, Rodriguez continues, the Fed's focus may be distorted by the credit risks that now reside on its balance sheet. Having these risky assets might influence the Fed to follow a less stringent anti-inflation policy as when it just held Treasuries.

For now, Job 1 for the Fed is to keep the financial system functioning -- even if it compromises its other objectives. Hobson, here's your choice.