How Much Farther Will the US Dollar Decline?

The short answer is that the dollar will continue to decline in relation to the currencies of its trading partners until it starts generating a trade surplus. As the dollar loses its status as the reserve currency of the world this process will accelerate.

This decline will not be uniform. The Euro may have already achieved much of its appreciation, with the Asian currencies and those of resource exporting countries lagging significantly.

The process will be slower to the extent that the world is willing to subsidize US consumption by treating the dollar as a reserve currency with inherent value greater than their own currencies. This is how the trade surplus was allowed to remain negative for so many years.

The price of imported natural resources such as oil will provide a significant lever in the dollar's decline.

Note that there is no discussion of domestic money supply growth or contraction per se, only the flow of currencies between and among countries. The issue of money supply becomes relevant through its effect on the interest rates, and the interest rate differentials.

This is not a metaphysical debate; this is math. Unless the rest of the world wishes to allow the US to be its sovereign lord and master, the dollar has a significant distance to travel on its long day's journey into night.


What is the Dollar’s Sustainable Value?
By Martin Feldstein
July 31, 2008

How much further will the dollar fall? Or has it already fallen so far that it will now start to move back to a higher level?

For travelers to the United States from Europe or Asia, US prices are dramatically lower than at home. A hotel room or dinner in New York seems a bargain when compared to prices in London, Paris, or Tokyo. And shoppers from abroad are loading up on a wide range of products before heading home.

But, despite this very tangible evidence, it would be wrong to conclude that US goods are now so cheap at the existing exchange rate that the dollar must rise from its current level. Although the goods and services that travelers buy may cost less in the US than abroad, the overall price of American products is still too high to erase the enormous trade imbalance between the US and the rest of the world.

To be sure, the falling dollar over the past few years has made American products more competitive and has caused the real value of US exports to rise sharply – by more than 25% over the past three years. But the trade deficit in 2007 nevertheless remained at more than $700 billion, or 5% of GDP.

The large trade deficit and equally large current account deficit (which includes net investment income) implies that foreign investors must add $700 billion of US securities to their portfolios. It is their unwillingness to do so at the existing exchange rate that causes the dollar to fall relative to other currencies. In falling, the dollar lowers the value of the dollar securities in foreign portfolios when valued in euros or other home currencies, shrinking the share of dollars in investors’ portfolios. The weaker dollar also reduces the risk of future dollar decline, because it means that the dollar has to fall less in the future to shift the trade balance to a sustainable level.

But what is that sustainable level of the trade balance and of the dollar? While experts try to work this out in terms of portfolio balances, a more fundamental starting point is the fact that a US trade deficit means that Americans receive more goods and services from the rest of the world than they send back – $700 billion more last year. The difference was financed by transferring stocks and bonds worth $700 billion. The interest and dividends on those securities will be paid by sending more “pieces of paper”. And when those securities mature, they will be refinanced with new stocks and bonds.

It is unthinkable that the global economic system will continue indefinitely to allow the US to import more goods and services than it exports. At some point, the US will need to start repaying the enormous amount that it has received from the rest of the world. To do so, the US will need a trade surplus.

So the key determinant of the dollar’s long-term value is that it must decline enough to shift the US trade balance from today’s deficit to a surplus. That won’t happen anytime soon, but it is the direction in which the trade balance must continue to move. And that means further depreciation of the dollar.

An important factor in this process will be the future price of oil and the extent of US dependence on oil imports. In each of the past four years, the US imported 3.6 billion barrels of oil. At the current price of more than $140 a barrel, that implies an import cost of more than $500 billion. The higher the cost of oil, the lower the dollar has to be to achieve any given reduction in the size of the trade deficit. So a rising oil price as measured in euros or yen implies a greater dollar fall, and therefore an even higher oil price when stated in dollars.

There is one further important consideration in thinking about the future value of the dollar: relative inflation rates in the US and abroad. The US trade deficit depends on the real value of the dollar – that is, the value of the dollar adjusted for differences in price levels in the US and abroad. If the US experiences higher inflation than our trading partners, the dollar’s nominal value must fall even further just to maintain the same real value.

The inflation differential between the dollar and the euro is now relatively small – only about one percentage point a year – but is greater relative to the yen and lower relative to the renminbi and other high-inflation currencies. Over the longer run, however, inflation differentials could be a more significant force in determining the dollar’s path.

Martin Feldstein, a professor of economics at Harvard, was formerly Chairman of President Ronald Reagan’s Council of Economic Advisors and President of the National Bureau for Economic Research.

Have Fed Policy Errors Pushed Us Into a Stagflationary Depression?

As we noted at the end of 2007, there is little doubt we entered a recession in 2007. The only question was how long and how well the Fed might conceal it, and mask its effects on the financial markets and banking system which is their first priority no matter what else they might say, for a variety of reasons.

Depending on how one wishes to define it, and how one wishes to measure our monetary inflation, we have probably been in a technical recession starting early in 2007 and perhaps late 2006.

The recession is growing stronger and deeper because of the Fed and Treasury policy errors, squandering valuable national capital on a financial sector that requires reform, not welfare support.

Their errors are so large and so misguided that they may have condemned the US to a stagflationary depression. The equally misguided efforts of several national central banks may drag a good part of the developed world down with us for several years.

This study is a significant focus of our inquiries at this time, our intellectual raison d'être now that the question of recession is settled. Its no longer a question of 'how long and how deep' but the evlving nature of this downturn, the actions of the Fed and Treasury in reaction and the manner in which they prolong and mutate it. We may be watching something truly exceptional, and are seeking to understand it.

It will probably be the employment numbers that eventually make the difference in definition, although as we have previously shown that the government is actively revising those numbers many years back on a regular basis.

The major stock markets deflated by an appropriate contra-dollar measure also are consistent with the view that we are entering the recessionary aftermath of a market crash that occurred in 2000-3. We have never legitimately recovered. The Fed has been engaged in a protracted monetary experiment. We await the outcome of their gamble with keen interest, as the stakes of the wage are severe.

A significant challenge is the lack of transparency and reliable government and private statistics, and the willing complacency of most economists.

This may be an historic event. It is entirely consistent with what occurred in 1929-31 that it is happening largely unnoticed by a complacent public until they are swept away by it, with revelation after revelation that they have been deceived and misled.

What about the theory that if we pretend there is no recession or inflation then we won't have one? If we pretend that reality doesn't matter we will simply and slowly go collectively insane. There is some precedent for countries that do this.

So what ought one to do? Get in there and short the financial markets? That is like running down on the beach to sell flotation devices for an incoming tsunami.

When the tsunami is coming, get off the beach. The 'beaches' in this case are dollar denominated financial assets and financial assets dependent on the US economy.

We hope that the vectors of our data analysis are not correct. May God have mercy if they are.


U.S. Recession May Have Begun in Last Quarter of 2007
By Timothy R. Homan

July 31 (Bloomberg) -- The U.S. economy may have slipped into a recession in the last three months of 2007 as consumer spending slowed more than previously estimated and the housing slump worsened, revised government figures indicated.

The world's largest economy contracted at a 0.2 percent annual pace in the fourth quarter of last year compared with a previously reported 0.6 percent gain, the Commerce Department said today in Washington. Growth for the period from 2005 through 2007 was also trimmed.

The revisions now reinforce measures such as employment and production that already signaled the economy was shrinking. The National Bureau of Economic Research, the Cambridge, Massachusetts-based arbiter of economic cycles, defines a recession as a ``significant'' decrease in activity over a sustained period of time. The declines would be visible in GDP, payrolls, production, sales and incomes.

``We're in a recession,'' Allen Sinai, chief economist at Decision Economics Inc. in New York, said in a Bloomberg Television interview. ``It's going to widen, it's going to deepen.''

The government also said incomes grew less than previously thought, raising the risk that consumer spending will again stumble after getting a temporary boost from the tax rebates last quarter....


Today's GDP Number Will Be Revised Lower - April 28

Why the US Has Really Gone Broke - April 28

Jobs Numbers Revised Back to 2003: Confirm Recession - April 4

The Potemkin Economy Just Fell Over - March 7

SP 500 Tops in Recessions

ISM Numbers As Indicators of Recession - February 6

Are We In A Recession? - February 4

Fed Policy Actions in Anticipation of a Recession - January 7

Recession, Straight Up with a Twist - December 8

Dow Jones Industrial Average Since 1999



Dow Jones Industrial Average Since 1999 Deflated by Gold



Shadow Government Statistics Estimates of Real GDP



Shadow Government Statistics Estimates of Consumer Inflation

Of Government Intervention and Why I Write This Blog

A brief treatise in which Jesse questions the reason for this blog among other things

Most people will read only the subject title of this essay and then immediately begin composing their own off-the-cuff thoughts which they will rush to either email to us or slap on some chatboard or blog somewhere. Or they might even scan it for a daytrade and then discard it. But one or two will read it and think about it, and become links in a chain, and the spirit of knowledge will grow, little by little.

The government is intervening in the various markets. There is little or no question about it, if you allow that actively changing, with intent, the rules, money supply, short term liquidity, interest rates, methods by which key statistics are tallied, spin and other information that might impolitely be called 'propaganda' is manipulating the markets. And it often is.

They admit it. The evidence is there. If you don't know about it you have not been keeping up with current events. So it becomes a question of when, where, and why.

On the other hand, there are those who think every market move is active government intervention. This just is not the case. In the short term markets are more like rugby scrums than chess or even a well-managed game of limit poker, and the bigger players spend a great deal of time putting up bluffs and bullying the smaller player using their better access to information and bigger stacks of chips, especially when government regulation is lax and inefficient, with society ruled by narcissism and greed, as it is today.

The action of the past two days in the US stock markets is a almost classic end-of-month paint job by the fund managers and other-people's-money crowd, who are able to influence the grade on their own reports cards by buying the market and driving certain prices up after selling their losers three days before the end of the month. Their motive is their bonus, and the lax regulation with light penalties, and their general lack of compunction against cheating which they have likely done in school, in sports, in relationships, in most of their lives.

It is very hard to look at a specific market at a specific time and say with certainty "Aha, this is explicit government intervention" as opposed to something else. Governments work through third parties and hide their tracks, except when it suits them to be blatant. Often big third parties are just flush with hot money from the Feds and looking to shove some market for the short term trade.

But they do it, both directly and indirectly. If you are a momentum player it doesn't really matter, and if you are an investor you will see it only in sustained efforts that last some time, and usually involve a multi-faceted approach. We call these 'reflations' and try to point them out as we think they are occurring.

Speculating about when, specific markets on specific days, and the why, their long term motivations, is fun because its like gossip. It also can have some value if it causes us to look at things more deeply and examine the evidence, which may be easily dismissed by the public. Spotting effort to suppress or inflate markets can be exceptionally rewarding, since they often fail and sometimes spectacularly so. And motive is a key companion to opportunity, means, and any other circumstantial evidence.

But more often in questioning long term motivations we are asking a question that cannot be answered objectively except after a very very long time, even if then. Its like arguing about whether or not God exists, or aliens are visiting us, or what is the best beer, or who all shot Kennedy, or which is the greatest football team. Sometimes these discussions are fruitful and scandals are uncovered. They do exist. But often they degenerate into recreational discussion and faux expertise.

What makes it fun is that you can just yell about it endlessly, and believe what you want, because what cannot be proved cannot be disproved.

It is a way to pass the time relatively effortlessly, like griping and bitching at work. It can be a trap because anytime you are wrong you can retreat into the rationale of external forces. How can you be responsible for your actions if 'they' are doing it to you. Sometimes it can be a crutch. But so many things are.

As a general rule an objective person doesn't take credit for being right unless they know why they were right and can explain it. Otherwise they might just have been lucky, and it not only does not add to our knowledge but may reduce it.

If the Fed is indeed making policy errors, then we will take one path versus another. Then one should do one thing versus another. Those things can be examined, can be dissected, can be studied, but they take work and effort, and one can be right or wrong. But they add to a body of knowledge. And often this work is dismissed by those doing the behind the scenes work as recreational gossip. They seek to raise the bar so high that no possible proof can be provided without subpoenas and wiretaps.

Speculation based on evidence is the heart on the scientific method. Yesterday's radical theory scoffed at and discouraged by the established view is tomorrow's generally accepted truth. The difference is free discussion and evidence, above all, strong comprehensible evidence.

The value we get from even pointless disagreements is that it causes us to think and define thoughts which otherwise are all too easily just parked in our minds, and never really given any vigor or life.

Besides the relentless impulse of humanism, this is a major reason for this blog. We used to look for valuable feedback and discussion on the specifics, but that's beyond hope.

Those who are in-the-know are in denial and hiding, trying to line their pockets and curry favor with whomever they think will be in power next.

Those who don't know are running around waving their hands, shouting slogans and hearing only their own voices, or just ignoring it all getting loaded on whatever happens to be handy.

All in all, a nice microcosm. Life imitates high school so often in our experience, and one's best recourse is essere umano, to be human throughout it, and perhaps give the bastards a swift kick just to let them know you're still out there.

In the meanwhile there are important and interesting questions to investigate as best one can. Its not clear yet exactly which way this thing goes, and the variables interact with one another, and are many more than can listed here:

A. Will our government become a better democratic Republic, Fascist, or Socialist, and the related broader question of the Individual vs. the State which tends to modify all the general types.

B. When and how the dollar will be further devalued and how fiat currencies can be sustained without being destroyed by inflation? (By the way in all history none have succeeded}.

C. How will the world's reserve currency evolve? Can a greater centralization of power and control be avoided gracefully? Can freedoms be maintained if it cannot?

D. How deep and protracted will the recession be and will it cross a threshold into a depression through Fed policy errors and how and when will we know it?

E. Will there be a 'moment of clarity' when the failure becomes evident and things move with alarming speed, or will this be a damp fizzling decline into an ignoble whimper.

We will continue to explore all these areas with what we hope is a bias to objective analysis and pertinent data, laced heavily with humour, satire, charts, and pictures.

Little by little, there is progress, and the body of knowledge grows, and life is renewed, and creation is made more orderly, and liberty and the spirit is restored.

The Future of Financials

Here is a video well worth watching.

The Future of Financials - Meredith Whitney

Meredith, in a polite and somewhat understated way, makes some excellent points as an independent analyst, but probably of necessity treads lightly around some serious issues and deeper economic problems.

The real economy must pay a significant 'tax' to support the financial sector as it is now, and an incredibly large tax to restore it to its former excesses. Don't forget this, especially when the government tries to argue that there is no money for human services, and health, and basic infrastructure.

It is a matter of our priorities. We can choose to pay that tax, and let our children pay it, or we can try to restrain the banks again and bring the economy back into balance. A healthy economy requires a finacial sector that functions as a capital accumulation and allocation system with price discovery in an open, honest and transparent system of transactions, with the minimum 'friction' of overhead and corruption.

We will have no sustained recovery overall until we move much further towards a balanced system as set forth in our Constitution, and establish rational, peaceful, and equitable policies for our nation.

So we must roll up our sleeves, let go of our fears, gather ourselves together, and move forward.