Nice ClownBuck critique in Prudent Bear today:
prudentbear.com
On Borrowed Time
by Dr. Kurt Richebacher
August 15, 2000
What is really sustaining bullish sentiment about the U.S. stock
market and, propping up the dollar? When asked, everybody
pulls the same trump card: Faith in the economy’s superior
qualities, and faith in the unique wisdom of Mr. Greenspan. No
further explanation is needed. His name stands for two tacit
presumptions: first, that any signs of undesired economic
weakness will prompt the Fed to instant rate cuts; and second,
that the U.S. economy and the financial markets will just as
promptly respond to any monetary easing.
Okay, let’s assume that the U.S. economy shows more
sluggishness than Mr. Greenspan and investors (domestic and
foreign) like. The difference between desired and undesired
economic weakening, by the way, may be no more than a hair’s
breadth. Smelling lower interest rates, the stock market may even
be pleased, at first. However, there is another market of crucial
importance to the well-being of the U.S. economy and its financial
system where such prospects are liable to cause a shock, and
that’s the currency market. Slower economic growth and lower
U.S. interest rates are unambiguously bad news for the dollar.
And what’s bad for the dollar is bad for the needed capital
inflows, and what’s bad for capital inflows is bad for the financial
markets.
It is reported that measured bullish sentiment on the dollar is at
an absolute peak, as against an extreme low in bullishness on
the Euro. Considering the present attractiveness of the U.S.
financial markets on the one hand, and the excessive and
dangerous dependence of the dollar on uninterrupted, huge
capital inflows to finance the yawning current-account deficit on
the other, the U.S. currency’s resilience is certainly most
astonishing, if not enigmatic. Back to the question of what Mr.
Greenspan will do when the U.S. economy’s growth starts to
disappoint. There is no doubt in the markets that he will instantly
fight any threat of recession by immediately cutting rates and
loosening his credit reins. In reality, he will face the catch-22
situation of his life. Prompt monetary easing may help the
slowing economy and even launch a rally in the stock market, but
he would take an incalculable risk on the grossly overvalued
dollar. Some downward adjustment may be desirable. But with
the monstrous current-account deficit looming in the
background and only a minimal interest rate advantage against
the Euro, the U.S. currency is vulnerable to any slight shift in
market perception and psychology as never before.
The experience of 1985-88 suggest that once the dollar begins to
fall, a self-accelerating bandwagon easily develops. At the time,
the dollar’s earlier steep rise turned abruptly into an equally steep
plunge that erased its prior gain by about 100% within less than
three years. Apparently a major factor behind the dollar’s sudden,
sharp reversal was a drastic shift in economic growth between
American and Europe. While slowing in the United States in real
terms from 6.8% in 1984 to 3.4% in 1985 and 2.7% in 1986, in
Europe it accelerated from 1.4% to 2.8% and 3.9% during the
same year.
Traditionally, American monetary policy has been strictly geared
toward domestic requirements. Fending off a threatening
recession has always had absolute priority, regardless of what
happened to the dollar. Given the relatively small share of foreign
merchandise trade in the economy, it seemed an appropriate
principle. In short, the tail should never wag the dog. In this light,
it seems a foregone conclusion that Mr. Greenspan, too, will act
accordingly, once the economy weakens more than desired.
CHANGE IN THE RULES OF THE GAME
As already noted, a catch-22 dilemma is waiting for him. Quite
possibly, the link between the falling dollar and domestic price
level may still not bother him. But over the last few years, another
linkage has grown to crucial, overriding importance, and that is
the linkage between the dollar, capital inflows and the stability of
the financial system. The problem is that the stability of both the
dollar and the financial system over the last years has become
singularly fated on the persistence of huge credit and capital
inflows that have to finance not only the gargantuan
current-account deficit, running now at an annual rate of more
than $400 billion, but also very substantial capital outflows on the
part of U.S. corporations and investors.
In fact, there is far more at stake than merely the financing of
current outflows. An even bigger threat to the dollar looms in the
existing, vast foreign holdings of dollar assets that have in
particular accumulated in the last few years and are now soaring
faster than ever. According to the latest official calculations,
these amounted to almost $2,700 billion on December 31, 1999, of
which $1,837 billion was on private account and $833 billion on
account of central banks.
What few seem to realize is that this unprecedented dependence
of the dollar and the U.S. financial system on uninterrupted, huge
capital and credit inflows has thoroughly changed the rules of
the game for U.S. monetary policy. It has created conditions
under which the dollar tail could indeed – would most probably
would-wag the big economic and financial U.S. dog. Once lasting
dollar strength begins to be questioned in earnest and people’s
willingness to increase their exposure to the dollar dries up, the
full force of both the current-account deficit and the horrendous,
existing foreign dollar holdings will, finally, impact the currency
and the financial markets.
In order to get some idea of the looming risks, it is necessary to
also visualize the market dynamics that are sure to come into
operation once the dollar starts its definite decline. An important
point to keep in mind is that any slowdown in investment and
credit inflows relative to the current-account deficit and U.S.
capital outflows instantly weakens the dollar. Yet, pondering
potential, dangerous market dynamics, we see the incalculable,
greatest hazards in the linkage between existing dollar trillions in
foreign hands and the futures and derivatives markets.
Their owners may be slow in unwinding their positions by selling
their dollar assets outright and converting the proceeds into euro
or yen. Many of them, however, will be inclined to play at least
temporarily for safety and lock in the dollar value by selling the
U.S. currency forward through the futures and derivatives
markets. As heavy, one-way selling of this kind develops, the
institutions making these markets are, in turn, compelled to
hedge their forward purchases of dollar entirety by selling
correspondence amounts in the spot market.
In this way, the forward sales will immediately translate into
correspondingly large spot sales of dollars. It is this reflection in
particular that frightens us of a possible, it not probable sudden
bandwagon effect against the dollar, once the confidence in its
stability begins to wear off. There is no precedent in history
where the economy of the world’s major currency vehicle has
been so preposterously out of balance.
A sliding dollar will, in turn, promptly close the spigot of capital
inflows – with dramatic effects on the U.S. financial markets,
showing up in plunging stock and bond prices, that is, in rising
market interest rates. The resulting crunch in the financial
markets is the link through which the plunging dollar will rapidly
spread recession. The hard landing has arrived.
What will and can Mr. Greenspan do under these circumstances?
Slash interest rates? Before long, it will dawn on him and the
markets that his freedom to pilot the economy away from the
threatening recession through easier money is less than zero. As
this alarming realization spreads, it is sure to precipitate the
dollar’s slide into a free fall. Hoping to prevent a bottomless dollar
crash with inflationary implications, the Fed will probably feel
compelled to raise its interest rate and tighten its monetary reins
which, by the way, has always been normal policy for normal
countries. The important point is that a responsible and prudent
central banker will never allow such stupendous internal and
external imbalances to develop.
Dr. Kurt Richebacher is editor of The Richebacher Letter, published by The Fleet
Street Group. Subscription inquries call (888) 737-9358. |
