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Thursday October 8, 2009 - 16:08:03 GMT
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Forex Blog - Oh No Mr. Bill

Oh No Mr. Bill


As in Saturday Night Live in the late 70’s and as in dollar bill…get the imagery Mr. Bill redux?  Oh no Mr. ($) Bill is falling…


Well I have read Malpass (WSJ op-ed), UK Independent on pricing oil away from USD, FT’s Guha (pressure on Obama on weak dollar), Palin, debated Steve Forbes (on CNBC) and (watched) Glenn Beck and CNBC’s Santelli.  What is all the fuss about? Most of these dollar hand wringers are more inclined to neoclassical economics and the Austrian school - governments always get it wrong.  Yet much of their argument rests on government jumping into the FX market.  Malpass blamed the weak dollar from Monday on a weak G7 communiqué which simply repeated language from the prior G7 communiqués.  The implied preferred approach is for G7 to circle the wagons around the USD and start buying the greenback in the open market (intervention) and jawboning the dollar higher with a “strong” communiqué.  Not very Austrian I am afraid to say.  And as if the dollar is not freely floating and reflecting underlying fundamentals?  Scratch below the surface and many in this camp advocate a gold standard.  Is there anything more representative of a large government footprint than a currency tied to the price of gold?  And the money supply tied to the price of gold?  This assumes all other major currencies continue to float (against gold).  Heck, a hedge fund can put $20 on gold in a few minutes.  Be careful what you wish for.  China could corner a big piece of the market with its near $3trln in reserves.  Talk about a path to disparity.


If the view of this crowd on the USD is more akin to Mr. Bill’s predicament, then its view on inflation is more akin to Chicken Little...the sky is falling.  Deficit spending and Fed monetization is inflation in spades.  Never mind that what money has been created is a drop in the bucket of wealth that was destroyed by the crisis. Nor that banks are more comfortable earning zero holding reserves t the Fed rather than lending them to business…large ones, much less small ones.  And households don’t want any more debt. They want to pay it down – just look at the huge decline in consumer credit in the last 7 months.  Supply and demand curves for credit have both shifted inward.   Do the Rick Santelli’s of the world think the Fed is relishing in the fact that it has expanded its balance sheet by a factor of 2 by adding zeros to its balance?  Or are Fed officials masters of deception and really don’t mean it when they say the balance sheet will contract and liquidity provisions reversed once the private sector is on a sustainable path (basis for a dollar recovery)?  But illogic seems to run thick in the policy discourse…gold is up because of inflation expectations are elevated in one of the least liquid markets and bond yields are low not because inflation expectations and monetization are an issue but because of manipulation in the most liquid asset market (FX excluded). 


Zoellick, Geithner, Bernanke and any reasonable observer agrees that the current policy mix is unsustainable and over time and will leave the USD a second rate (non-reserve status) currency in the long-run unless deficits (long-term liabilities) and Fed balance sheet expansion are first contained and then reversed.  This is a particularly difficult problem if you believe the crisis has changed US consumer behavior permanently…with the aging boomers and among them I think it has…growth as a ticket out of accommodative policy reversal is going to have to come from some other non-governmental source like exports or a major new technology revolution (energy, digital, medical…) not now foreseen (wealth creation machine).  But these are long-run stories and what matters now is the next 12 months.  Positive fat tail outcomes are no way to plan the long-run and in the medium-run US authorities are going to have to do what they have been unable to to date…convince markets they can downsize (in either political party).   


And oil priced in euros or yen or yuan?  UK Independent report has been denied by every state mentioned…no secret meeting, no clandestine effort to end the pricing of oil in USD unless we count Iran and Venezuela


China won’t stand for a weaker dollar we are told by the Mr. Bills of the capital markets.  What BS.  China is so into the USD that there is no way out.  For China to say don’t let the USD weaken or else after amassing $3trln in reserves is laughable.  Where is the gun pointed at China making it buy dollars to peg the yuan for the last decade?  China was free to choose.  They could have bought other currencies or none at all and helped prevent the build-up in global imbalances that allowed cheap credit to dope markets and regulators into excessive complacency (stupidity).  China holds up half the sky of this gigantic problem (bad policy here and there).  And in another irony the neo-Austrian set mostly is infatuated with China…the only other seriously planned economy since the collapse of the Soviet Union…reminds me of the hero worshipping of Japan in the 1980’s…let’s not confuse mercantilism with free market economics.


So raise the Mr. ($) Bill alarm on the USD loudly and often and the vocal minority can hijack public discourse and policy to reverse the USD fortune.  Malpass said all Geithner needs to do is say US wants a stronger dollar rather than a strong dollar and Mr. Bill will live another day.   But what about the fact that the market is pricing the USD (a floating currency) and based on fundamentals?  The USD is back to where it was before the crisis…weakening as markets normalize and world’s investment and trading classes rush from risk to risk free is no longer part of the mindset.   If the RBA is the spark to a prairie fire of rate hikes across G20 in the next 6 months, I will eat my didgeridoo. Frankly the RBA will be hard pressed to continue raising rates alone short of taking its currency to levels that may make China (pegged to USD) look elsewhere for Aussie minerals.  The market has priced 150bps tightening through June 2010.  My guess is we will be lucky to see half that and the RBA may end up like the BOE (in 2007) with hikers remorse.


Lastly, a weak dollar is what the doctor ordered.  If you believe in the vastly liquid market of US Tsys is a better indicator of inflation expectations than the rarified air of the gold market, low inflation is on the horizon indefinitely and Fed inflation credentials are fully intact. Why would any reasonable central banker or finance minister want to oppose the only escape hatch for private growth by engineering (assuming it is possible) a USD rally?  Printing money with a low multiplier is not inflationary outside of asset prices.  Ahead the c bankers may have to lean into asset prices some to prevent new bubbles from forming while keeping traditional and non-traditional policy accommodative as the real economy crawls back to life.  But right now is not the time to rush to the defense of the USD and I would go with the IMF’s WEO conclusion on exchange rates…the USD is not significantly undervalued or overvalued.  Asia is where the misalignments are in FX and to a lesser extent Latin America…pre-emerging-market currency crisis norms should be permitted.  Inflation risks are real in Asia much sooner than they are in the US, Europe or Japan and these economies scream out for currency revals.


I think the IMF, BIS and G20 need to look at limits on government foreign reserve accumulation.  A sizeable chunk of the world’s savings is in foreign reserves held by central banks who actively manage their currencies (mostly emerging markets and Japan pre-2004).  In light of the need for risk capital in the world to fill massive withdrawal of private risk capital, having all these global savings (FX reserves) in cash and government paper is hugely inefficient on top of being distortionary.  Maybe it is time for regulatory reform for the regulators.


Rule of thumb is be careful of analysts and economists who raise politics to a principle and then start with economic analysis.  No I am not throwing stones in a glass house.  This is kind of like asking a trader long several yards of AUD against USD to explain what might make the USD recover in the near-term.


David Gilmore


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