Turning point; hiatus

Reading around in the wisdom of others, I predicted Dow 9,000 here, here and here. Now it's happened. Good for you day-traders, but a fraidy-cat like me is staying away.

Since Marc Faber and others have been saying for some considerable time that they can't see anything worth getting into, and now the dollar is getting closer to having the carpet yanked out from under its feet, and the British pound may follow suit thanks to the miserable state of the British economy, and China is busy blowing an inflationary bubble to maintain its vampire trading relationship with the West, and the gold-bugs are chirruping ever louder (though the US Government might not only seize gold as it did in 1933, but for those smarties who invest in overseas gold stores the bad news may be that Uncle Sam will also seize US citizens' title to those stores), the question is... where to hide your stash?

For the private investor, maybe part of the answer is to look at the currency market, for a country that isn't over-dependent on international trade, has enough natural resources to survive if the world system goes down, and is reasonably stable by second or third world standards. Sadly, I have even less expertise here than elsewhere, but any thoughts on e.g. the Thai baht?

HIATUS

We're going on holiday now, to a place where cellphones don't work (and it's in the UK) and our place has no broadband. Best wishes to you all, hope to be back in touch soon.

Locking the doors

The dethroning of the US dollar as the international trading currency is under way. New bonds issued by the International Monetary Fund in the form of "Special Drawing Rights" are related to a basket of currencies, thus diluting the dollar element and reducing America's opportunity to cheat the world by devaluation.

The same article describes a Chinese proposal to start issuing bonds denominated in renminbi, so that if the dollar does drop against the Chinese currency, all that will happen is that the dollar cost of the capital debt will increase.

It occurs to me that such extra security for lenders may help interest rates to remain lower than they otherwise would be. So the threat to borrowers is not that interest rates will increase, but that debt outstanding will continue to feel heavy, since inflation won't lighten the burden. In fact, the burden of foreign debt could get worse, if the dollar weakens in this new foreign-currency-mortgage era.

Another factor, which may be a deliberate strategy with an eye to the above, is China's own expansion of credit. If monetary inflation goes global - including in the East - then there's less hope that Western businesses could use relative currency devaluation to increase the demand for their goods and services. Manufacturers here will still be unable to compete and debt will grow. Our creditors will own us - we'll "owe our soul to the company store".

It's time to grasp the nettle - bust the banks who got us into this, have a tremendous clearout of debt from the system, reset wages and prices at lower (more internationally competitive) levels, get the people back to work and shrink the dead weight of government and its dependants.

That, or see what's left of our wealth leak away, and then suffer all the above as well - at even lower levels of per capita assets and income.

Doubtless the politically-favoured option is the latter - "Let it all happen on someone else's watch, after we've made ourselves into the New European Aristocracy and gone to our country estates." This would be a mistake. The palace of Versailles didn't protect Louis XVI, nor Waldsiedlung the East German communist elite.

Signs and portents

Over at Financial Sense University, Jim Willie paints a frightening picture. He claims that the US Federal Reserve has been secretly giving dollars to foreigners to buy US Treasury Certificates, so (temporarily) supporting US bonds and the dollar. Meanwhile, big banks are waiting for smaller banks to suffers losses on commercial loans, at which point they will gobble up their smaller competitors. But the big banks are insolvent, so rather than a healing juncture, it'll be a vampire puncture.

Studying the US Dollar Index, Willie uses a measure that Karl Denninger has previously cited, namely, a comparison of two trends: the 20-week moving average with the 50-week moving average. When the first crosses the second, the second will eventually follow - in this case, downwards.

In my previous post, I referred to signs and portents. This is because when big things are happening, the fog of lies thickens, so we have to look for betraying details and use our intuitions. Art is often the canary in the mine - you hear the coming conflict in the discords of Stravinsky's 1910 "the Rite of Spring". The disturbed children that I teach have recently been exploring zombies. Some also play computer games at home, that involve stabbing opponents in the eyes or genitals. One child's graffiti tag is JABZ.

Doodling, they draw pistols, rifles, knives, swords; but still read Postman Pat and Spongebob Squarepants. Gossiping, they talk of their mother's vibrator, their father's merkin, but (at age 11) don't quite understand and are looking forward to learning the facts about sex next week, which our curriculum now requires me to deliver. They come in shadow-eyed from gaming, but also from (in one case) accompanying their father late at night as he hunts down and savagely beats people who tied up and soaked with petrol an uncle suspected of stealing a motorbike. Where are the police? you may ask; the father is an ex-policeman. The Monarch's writ does not run where our underclass have to live; to have normal social inhibitions would be dangerous in such an environment.

Some may accuse me of moral panic; but I didn't grow up with the currently prevailing sense of moral ambiguity, despair and social collapse. Are we breeding a nation of future child guerrilla-band soldiers? And how tragic, how culpable, that the entertainment industry is playing its part in this; and that the Government hopes to shore up its vote by perpetuating the financial dependence of its claimants.

But it won't happen to us, will it? "Wat geht dat mik an?" as the mediaeval Germans would say: "What's it got to do with me?" Years ago, my Prussian grandmother described Der Flucht, the flight from the Red Army in 1945. They would come to a farm and be very grudgingly permitted to sleep in the haybarn; two days later, the owners would be on the road themselves.

We are in this together; but I cannot see how the present political arrangement can tackle the challenges. There are too many ways for our leadership to be distracted, to be suborned and to escape consequences personally.

When the music stops, a dollar collapse?

Brad Setser's analysis is that Americans have been repatriating their dollars even faster than foreigners have been getting rid of theirs:

"Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets."

At some point, the balance of these cross-currents will change, and then? Maybe the turning point will come when Americans are forced to sell financial assets to meet living expenses and medical costs.

Meanwhile, Tim Iacono comments on a proposal to substitute the dollar as the world's reserve currency, with drawing rights from the IMF, i.e. a mixed bag of currencies. China's central bank seems terribly keen.

I have a sense of something being held up, but not for ever.

Hold dollars?

Karl Denninger argues that the failed stimulus will lead to accelerating deflation in the US. His prediction is that demand for the dollar will soar and other currencies will collapse instead. He thinks this will hit US exports and the economy will be crippled, so Americans need to hold in-the-hand folding money - lots of it, maybe a year or two's basic expenses! - away from the bank.

He may be on the wrong medication - the current state of the world's finances is a great impetus towards paranoia and depression; but if he's even half right, we need to start making those quiet, regular cashpoint withdrawals and (for non-Americans) visiting the bureau de change. And not living in the city.

Is now a good time to invest?

I've just been asked by a client whether he should switch from cash to equities. Here's my view, and it may explain why I haven't earned much from investments over the last few years:

It is not possible to predict the market with any accuracy, but I think I have done well in foretelling the current state of affairs as early as the late 1990s. The market has dropped to half its 1999 peak (again, as it did in 2003), but that is not to say we are now at the bottom. Some (and I am moderately persuaded to this view) think that there may be a "bear market rally" soon-ish - maybe a rise that recovers perhaps 50% of the losses so far - but it is perfectly possible that the underlying trend is still downwards, so there may then be a horrid lurch towards - what? Maybe, ultimately, 4,000 on the Dow and 2,000 on the FTSE.

We are in the middle of an exciting ride and I fear that entering the market at this stage may still be for the adventurous and nimble. Yes, had one invested in mid-2003 and got out, say, late 2007, it would have turned a nice profit; but much depends on the entry and exit points. So as ever, attitude to risk and corresponding watchfulness are key factors.

There is also the question of what asset class to choose. I think domestic and commercial property are still overvalued, relative to income; because of fears regarding other assets, and also because of central bank investment ("quantitative easing" etc) government bonds are very highly priced, which is why the yields are so low (and if interest rates rise, bond values could then drop sharply); equities are depressed, but as dividends decline in very testing economic conditions, they may ultimately be depressed still further. Commodities (e.g. gold, silver, oil) are the subject of some speculation, but owing to shortage of borrowed money to invest with, not quite so much institutional speculation as formerly; even so, gold (for instance) is a bit above its long-term inflation-adjusted average, as far as I can tell - though if inflation takes off, the price could indeed escalate.

And then there is the question of currencies. The pound has lost heavily against the dollar; but some say the dollar may catch us up again. The Euro may also not stay as strong as it is now - several countries within the Eurozone are suffering economic problems and are hampered by the common currency; I have even read speculation that the Euro system may fall apart within a decade, or some states may secede from it.

In short, I still urge caution, and if you do decide to get in, be prepared to move quickly if the market should turn. Meantime, there are relatively safe options such as National Savings Certificates, including the index-linked ones that will at least keep the value of your savings roughly in line with RPI...

Denninger: deflation

Belatedly, I refer you to Karl Denninger's end-year review and forecast. He sees continuing deflation, and makes a number of other plausible and worrisome predictions - scroll to the end of his post for the horrid gallery of prognostications.

In short:

...rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance, get stingy and prudent. Your personal financial survival could well depend on it.

So instead of staring at the low interest on your cash balance, think of the real capital appreciation of your money as measured by what big-ticket items it will buy. And for once, the government can't easily tax your capital gain.

You may also want to hold more cash away from a bank ("Round #2 of severe bank instability gets served up on us in the second half of 2009").

And maybe diversify your currency holdings:

The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are... The rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example... I see the potential for the pound and euro to both reach par with the dollar.

I think Denninger on the one hand, and Faber/Janszen on the other, may both be correct. It's a matter of timing - deflation now, debasement of the currency later. Because nominal debt gets relatively bigger as assets and incomes decline in value, something will have to give.

You've had your warning

Lord Myners has been criticised for telling the truth too early, i.e. 3 months after the general public could have done anything to save themselves. On October 10, "major depositors" in the USA and Japan were preparing to withdraw their money, and were willing to paying any attached penalty to do so.

For the rest of us, the corralito: "The Mail on Sunday has been told that the Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals."

Even if they had caught wind of it, would we have learned anything of this from the mainstream media? (Scornful laughs) But what were MPs doing with their own money? Perhaps they'd have abandoned us to our fate, like Lord Jim. (I have often thought that the main reason for getting into politics is the opportunity to trade - in all sorts of ways - on inside information and networking).

Do you think the banks have been saved? Mish doesn't think so. Is the pound safe? Jim Rogers doesn't think so (though this business associate of the sterling-busting George Soros may be playing a nasty little game of market manipulation - which is, scarcely credibly, not an incarcerable crime but merely a civil offence.)

Within the past 12 months, the pound has gone from USD $2.12 to $1.43 and Euros 1.40 to 1.06; to put it another way, imports now cost 48% more from the States , and 32% more from Europe. (O&A typical cash rates)

At least you can still get your hands on your money; but for how much longer? It may be that the crisis is over; but it may be that we are in the eye of the storm. Personally, after settling debts I intend (a) to draw extra cash, keep the slip to prove it's been legally obtained, and store it safely away from a bank; (b) to keep at least some of my money in foreign currencies - perhaps the Yen* and Euro*; (c) to look for a variety of non-cash stores of value - and not all of them with Government guarantees, either.

My trust in banks, politicians and journalists is broken. My faith in them is gone, because they did not keep faith with me.

*Though The Big Picture thinks Japan will move to weaken the yen and the Euro-zone is struggling to hold its members together. So, US dollars?

Abolish the Federal Reserve

On The Big Picture, a rude but concise video by Neal Fox about the Federal Reserve. As his catchy song points out, its existence defies the Constitution - the same Constitution that made President Obama say his Presidential Oath again.

Yet again, I say economic issues resolve into democratic ones. The Constitution is very clear that the power to create money (using gold and silver) must remain with Congress; yet in 1913 that power was given away to a newly-invented quango, run by people whose names and organisations are not permitted to be publicly known (which secrecy gives rise to some very paranoid theories!)

Why wait until its centenary to abolish it? No "four more years", please.

And while I'm on, let's have a massive cull of quangos in the UK, too.

Europe is keeping China (and America) going

A very interesting piece by Brad Setser, where he shows that the EU's currency strength and growing imports from China have offset the levelling in demand from America. His bottom line is that China's making money from us and lending it to the US.

Should sterling now decline against the US dollar?

Mish thinks so, now we've decided to borrow our way out of a recession.

Also interesting to hear the discussion on Radio 4's Any Questions, where the assertion that Gordon had stuck to the EU's "40% of GDP" borrowing guideline wasn't challenged by anyone, despite the massive off-book PFI financing.

Will the UK/US trade balance influence the dollar value of sterling?

Here's some trade stats for UK/USA. Last year, we imported $6.6 billion more from the US than we exported to them. Last night, the exchange rate for the pound rose above US$2.00. For some time, we seem to have been shadowing the dollar, but do we have an incentive to allow the dollar to fall further against the pound?

Or will we be more influenced by the desire not to devalue the amount we have loaned to the US via Treasury bonds? And then there is the possible extra unemployment that could result from UK goods becoming more expensive in dollar terms.

Any forex experts care to give a view?

UPDATE: Here's the answer, it seems:

Weak jobs data knocks pound vs dollar and euro (Reuters)

UPUPDATE: ...And here's a different answer:

Sterling up versus dollar, banks support (Reuters)

Wouldn't roulette be more honest, somehow? "Manque! Pair! Impair! Passe! Noir! Rouge! Numero 17!"

Emerging markets inflation could break the current system

... says Nouriel Roubini, and there's already a fund to speculate on consequential revaluation of developing world currencies, according to this.

Help required: economic modelling

Following reported opinion from Marc Faber and others that we may expect sell-offs in commodities, bonds, equities and real estate, and given concerns about the quality of our currencies, the question arises, where should we hold our cash?

It seem that in the USA and UK, we are holding down interest rates to avoid crippling homeowners, the home-loan-based economy, and what's left of our industries, and also in the hope that we can repay our debts to foreigners with devalued cash. On the other side, countries like China and Japan seem to be trying to prevent their currencies from appreciating, so as to preserve their trading advantage.

So one party is letting their currencies sink, and the other is trying to stop theirs rising. To this amateur, the world's foreign exchange system looks like a bunch of corks tied to an unchained anchor and flung into the sea. Will the string on the corks hold, or break under the strain, or be abruptly cut?

Is there any computer- or board-game-based model of the world economic system, that might make it clear to me how this wretched thing works?

And how is the ordinary person to save money and preserve its value in real terms, without having to be super-sophisticated? I know something about American TIPS and British NS&I Index-Linked Savings Certifcates, but I'm leery of handing the government what little money they haven't already extracted from me in taxes. And I don't trust them to define inflation fairly.

Does anybody know how this boneshaker of a contraption actually operates, so we can make sensible decisions?

Nationalism and internationalism

"James Higham" joins his voice to those who detect a revival of the nationalist spirit.

I don't think nationalism will be confined to losers in the game, or rejected by those who claim to love all mankind. Once there was Bukharin/Stalin's "Socialism in one country"; soon it'll be "China first". I can't blame the latter - they have worked so hard for what they've got, and won't understand why we think we can whinge it all back from them.

Speaking as the man in the street, my perception is that we have had a long period in which global businesses and a carpetbagging international managerial class developed and made fortunes. The liberal economists say this system is great for all of us, and should stay that way; perhaps so, if we had honest money and sound national budgets, so the correction mechanisms could steer the course of international trade more steadily.

But thanks to criminal negligence, incompetence and greed by those who could have maintained the integrity of the economic system, I think the aspirant working class and lower middle class in the developed world are paying heavily, and will pay more heavily. As they give up on their aspirations, we shall see a ballooning underclass, increasing the drag on national economic performance; but the situation may prove impossible to change for electoral reasons in a sort-of-democracy. The gap between rich and poor in our countries has widened, but will widen further: "Devil take the hindmost."

At the same time, on both sides of the Atlantic, people suspect a sell-out by the political class, which is intertwined (professionally and often maritally, or extra-maritally) with the business, media and public relations people. I have often said that I think we are seeing the reconstruction of the aristocracy in Europe. Many Americans also fear that their society is moving away from its historic and constitutional foundations.

The implications for democracy, social cohesion and international relations are worrying.

Cure, effect, cause

A paper from the Levy Economics Institute is arguing (at least theoretically) for an extra US fiscal stimulus of 4% of GDP. That's $600 billion.

The authors say that the effect would be better if this reflation came in the form of additional direct government spending, though they acknowledge that it still wouldn't immediately halt the economic decline:

It is somewhat discouraging to see that even a relatively large stimulus plan will fail to prevent a substantial loss of output. But over the medium term, as the devaluation of the dollar and reduced spending begin to exert a moderating effect on the current account deficit, foreign trade will boost output and employment, providing the impetus for renewed growth.

Karl Denninger begs to differ (though in his case, he's still talking about transfers of money, rather than direct government expenditure):

But now we have reached the point where we need $5 in debt to create $1 worth of GDP. As debt levels rise this ratio goes parabolic and ultimately becomes impossible to sustain. That we have reached a 5:1 ratio means that the game is basically up, and the rapidly rising rate of defaults across all areas of consumer debt mean that this "engine" to fuel "growth" simply can't find any more fuel, despite the desires of the bankers and merchants to "make it so."

The Levy paper has echoes of FDR's 30s rescue, but Denninger is more concerned to compare the present mortgage bubble with the one that led to the Crash of '29:

...we've done this before... We saw, in fact, nearly the exact same pattern of practice, fraud and theft that were featured in the housing bubble during the years just before The Depression, and those "standards" in fact were a primary causative factor OF The Depression!

So maybe both parties are correct.




It's also possible that the Uk has got it wrong even worse than Uncle Sam. $600 bn is about £300 bn sterling, but adjusted for relative population size that's only equivalent to £60 bn pumped into the UK economy. We're already talking about a possible £100 bn-worth of mortgage garbage being swapped by HMG for government bonds - and our current fussing over Gordon Brown's crumbling reputation suggests that Prudence wouldn't dare try to reflate with even more direct government spending.

Besides, we are starting with a higher debt-to-GDP ratio than the USA, a State that consumes a bigger proportion of the economy, and a populace that suffers a significantly lower level of personal income on a Purchasing Power Parity basis.

Maybe that's why the pound is matching the dollar in its downward trajectory, and may even overtake it.

I've been wondering recently whether the ordinary investor of the future will be more interested to play in the foreign exchange markets, rather than stocks whose value is lied about, manipulated by rumour and sovereign wealth funds, and nibbled half to death by fees, commissions, taxes and inflation.

UPDATE - Karl Denninger is emphatic that it can't work:

Sack, no.

You can't spend $600 billion in deficits without it coming back SOMEWHERE.

Government spending is not a net positive. You can't only get to a net positive via growth in GDP.

Debt-initiated spending only returns $1 for every $5 taken on in debt.

Lessons from Japan

Krassimir Petrov looks at the Japanese experience of deflation - 17 years and counting. A monetarist view would require the following steps to end it:

• Condition 1. Bad loans made during the boom years must be written off as losses during the bust. This cleanses the banking system from the toxins of the boom.

• Condition 2. Weak businesses should be liquidated during the bust, rather than propped up by the government or the banks. These bankruptcies and liquidations shift scarce resources to more productive uses

• Condition 3. Finally, Interest rates must rise sufficiently to restore proper valuations in the capital markets, and therefore allow stocks and bonds to fall in value relative to consumer goods. This realigns properly the price ratio of capital goods to consumer goods.

Now, I suppose, it's our turn.

Money has poured out of Japan over the years, looking for better yields elsewhere, but Petrov is not at all sure that when the "carry trade" reverses, the Japanese market will rise. He thinks a more interesting bet is on the rise of the Yen in the foreign exchange market. And that's a poker game I don't have the confidence to join.

A pound to a penny

Adrian Ash points out that against gold, the British pound is now less than 1% of its value in 1931.

Beyond gold

This blog by Thomas H. Greco looks interesting. The author, an American, has taken the trouble to address a convention in Malaysia on currency issues,and you'll recall that they're trialling the gold dinar in the province of Kelantan.

Greco thinks that modern technology may let us keep accounts of exchanges without having to resort to traditional forms of currency. I suppose this could be similar to Local Exchange Trading Systems. It's also interesting that he's featured and commented on Ron Paul's proposal that currency systems should be allowed to compete. Greco even looks at Air Miles as one candidate!

Flat Broke and Berserk

Stagflation? Who can say?

Paul Kasriel says no to seventies-style stagflation, for two reasons: oil supplies aren't being choked off, and unions are weak. He may be right.

But I understand that the Saudis are keeping oil production at an unsustainably high level, even though this is damaging the quality of the remaining underground reserves. In French wine-growing terms, this is known as "faire pisser les vignes". And given the Peak Oil issue, we're going to find that countries like Russia and Iran may use their energy supplies to further their own agendas.

As to union wage demands, yes, the brothers are no longer so united; but the voters may yet get together behind a politician who promises to maintain living standards. I predict this will be achieved by writing checks/cheques on the future, i.e. inflation. That's after the current bout of monetary deflation, of course.

Which brings us to currencies. It's a good week for readers of Julian Phillips: here he discusses how in rural India, the rupee is on a flexible gold standard to avoid the depredations of taxation and bribery; and here he looks at possible plans by G7 nations to place your money under house arrest, to prevent it fleeing the country.

Is this back to the 70s, or the 60s? As Wikipedia reminds us, "In the summer of 1966, with the value of the pound falling in the currency markets, exchange controls were tightened by the Wilson government. Among the measures, tourists were banned from taking more than £50 out of the country, until the restriction was lifted in 1979. "

Pursuing my "sell up and get a (possibly horse-drawn) caravan" theme, I note it's a tradition of the Romanies to collect large pieces of Royal Crown Derby pottery - beautiful, thickly patinated with gold, easily identifiable in the event of theft, and impossible to melt down. Soon it'll be time to join the raggle taggle gypsies, O.

Until then, I have to have a replacement car (they tell me Fiat stands for "Fix It Again Tomorrow"), so I'm off to a second-hand auto supermarket today. Let's see if there is any real sign of recession hitting big-ticket items.