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Wednesday August 31, 2005 - 11:09:30 GMT
Black Swan Capital -

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Linkage back to the buck


“Capital markets have always been volatile, because they trade in nothing more than bets on the future, which is full of surprises.”

Peter L. Bernstein

FX Trading

From the Financial Times [our emphasis]: “Stephen Jen, currency economist at Morgan Stanley, warned that other Asian currencies could also now come under pressure [as a result of the problems in Indonesia].

“’The bottom line is headwinds - rising oil prices and rising US interest rates - are mounting against the Asian economies,’ he said. ‘Indonesia is the first to crack, due mainly to its fragile institutional framework and a general lack of credibility.’

“’But we should start to consider the possibility where what is happening in Indonesia may not be an isolated event in Asia.’”

This system we call a global economy is probably linked more tightly that we care to know. Thinking about linkage this morning…

Japanese industrial production numbers disappointed. The Indonesian currency is in big trouble, saved for now thanks to a $6 billion standby loan from Japan and South Korea. And we forgot to share this chart prepared by Mr. Frank Veneroso, the global strategist we referred to on Monday, the one expecting a hard-landing in China:

Chart: China credit growth

Source: Veneroso Associates, Welling @ Weeden

And from Mr. Greenspan at Jackson Hole recently [our emphasis]:

“The surprisingly high correlation between increases in home equity extraction and the current account deficit suggests that an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit.”

Think of the linkage of a decline in exports triggered by rising Fed Funds to cool housing at a time when Asian economies might be hitting a soft patch? Back to that in a jiff…first some comments on the cause…

From Andy Xie, of Morgan Stanley yesterday, in an excellent piece entitled, Bubbles All Around Us [our emphasis]:

“The major central banks mistakenly released too much money in the past decade, justifying it with the low inflation relative to the recent past. The monetary excesses have led to the rapid expansion of asset valuation relative to income. The global economy has become dependent on the demand spillover from asset inflation.”

“The fundamental changes [technology driven productivity enhancement and three billion people unleashed into the job market] in the 1990s severed the short-term relationship between money supply and inflation. Indeed, the monetarist explanation for inflation championed by Milton Freidman was discarded in the 1990s as inflation rates failed to respond to surging money supplies.”

If the relationship between money supply and inflation has been severed, then buy bonds. Because when the liquidity one day, and maybe soon, starts to ebb, a slow growth world sure ain’t going to hurt bonds. Conundrum solved?

The asset bubble has magnified the linkages in the global economy. It has led to increased leverage—and we know leverage is a sharp double-edged sword that cuts even faster on the way down.

Bringing this back to the currency front. The key question; “If Mr. Greenspan and company are serious about taking some air out of these bubbles, is it good for the US dollar? Our short answer: YES!

“Asia could be the trigger for a global adjustment. If the hot money in Asia (over US$700 billion) is scared of something like 1998, it could rush out of Asia and into the US. The dollar would strengthen and the US bond yield would decline. The combination could prop up the US property market and the US economy. The world would look like it did in 1998,” writes Mr. Xie.

Yikes! This is linkage on linkage.


1) Money flow back to the US driving the dollar
2) Rising US savings rate reduces the current account canard fears for long-term dollar bears

Maybe this is enough to make the big-time bears, and we know who you are, Bill and Warren, to finally capitulate. (Sorry, our obsession with see that Bill and Warren are proven wrong betting against the buck is, well, an obsession.) That would lead to the leg up in the buck we have been waiting for.

And just think, with all the big names out there, the trigger could for this could be Indonesia. Now that would be a surprise.

Jack Crooks
Black Swan Capital


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