Squaring the circle, packing your bags

In Britain, there are 28.89 million employed - 72.5% of the "people of working age"; median earnings approach £25,000.

In China, the average urban wage in 2006 was 1750 yuan per month, or (at today's exchange rate) slightly less than £2,000 per year.

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In Britain, there are 3 million homes where no-one works, with an average household benefit payment level of over £4,000 p.a. This doesn't factor in the cost of other benefits provided by the State, such as health and education. For example, State schooling costs something like £6,000 yearly per child.

In China, the official urban unemployment rate at the end of 2008 was 4.2%, or nearly 9 million people. This statistic does not include unemployed not eligible for benefits, or migrant workers - about 20 million out of 130 million migrants have no job. In industrialized Guangdong Province, for those who qualify, unemployment benefit for the first 24 months is 688 yuan per month, or £757 per year.

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In Britain, the 27.5% of the "people of working age" that might be employed but are not, number approximately 10.96 million.

In China, estimates Eric Janszen of iTulip, there are 20 million officially unemployed and the real tally should be 40 - 50 million.

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China has over 1 billion people and is desperate for land, and natural resources such as wood, water and arable soil. Despite restrictions on family size, her population continues to increase, largely because her people are getting to live longer (and will one day incur the high additional costs of growing old). She has industrialized at high speed and has built a massive skill base. She is continuing to acquire technological and scientific know-how, and is sucking in the world's steel and a panoply of key African and Australian minerals and rare earths. She sits on vast reserves of coal. The ruling Communist elite have not spent a long lifetime climbing the exceptionally dangerous slippery pole in their country, to see their beloved nation sink into chaos and their equalitarian beliefs defeated.

You are a British (or American) politician. You know all the above - or your handlers will tell you just before you go on "Question Time" or some other grill-the-pol show. (1) What will you say to your voters? (2) What private plans will you make for yourself, your family and your friends?

Back where we started

As concern grows for the future of the dollar, we should reinterpret stock movements to take account of currency exchange fluctuations. The above chart shows the Dow since the start of the year (red line) and adjusted for relative value of the US dollar against the Euro (green line).

If you have any suggestions as to what other currency to use instead, I'd be glad to read them. I fear that future weakening of the British pound and the US dollar may well undermine apparent future recoveries on their stock exchanges.

Euro and EU doomed?

Justice Litle thinks so.

Beg to differ on one point:

If the Brown government fails, Britain will be left rudderless in the midst of the worst fiscal storm in decades. In a worst-case scenario where bad events lead to worse decisions, opines Stephens, the domino chain could even lead to a British exit from the EU.

"Worst-case"? Au contraire, the sooner the better, and for the reasons he has given in his exploration of Europe's problems.

Desperate diseases call for desperate remedies

Mervyn King at the Bank of England refers to "unconventional unconventional measures". One seems to be to stop publishing what he's doing; what else can he have in mind?

Brad Setser thinks the pound sterling may crash through the floorboards.

"If you cannot bring good news, then don't bring any."

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.

China starts dumping the dollar

Perhaps this is just a little jerk on the chain, to remind us who's on the collar end now.

That sinking feeling

It is now 100 days since July 6, our starting point for measuring the Dow's fall. Against gold, the decline is substantial.

What about currency risk? According to O&A historical figures (using interbank rates), the US dollar has declined against the British pound by only 0.8%; and against the Chinese yuan, only 1.2%. But in the same period, the dollar has lost over 4% against the Euro, and 4.3% against the Japanese yen. Annualised, that's a drop of about 15% per year in yen terms. (Which currency has Warren Buffett bought this year?)

Gold? Acording to the World Gold Council (WGC), in the twelve months to 26 September, the Eurozone has sold 475.75 tonnes. (This zone includes Sweden and Switzerland; the latter has disposed of 113 tonnes out of that total, or nearly 9% of its stock. How strong is the Swiss franc? Is sound money a bad idea?)

The WGC September account reports that the US still holds 8,133.5 tonnes of gold, exactly the same amount as reported for Q1 2005, two and a half years ago. Allegedly: never forget that "credit" is Latin for "he believes it."

But maybe that's so; maybe Uncle Sam has, er, requested that other countries reduce their bullion stock in order to, um, maintain price stability. After all, the dollar has fallen 13.4% against gold already.

The competitive struggle to lose currency value continues.

Inflation, here we come

Jordan Roy-Byrne's article featured in Financial Sense last week examines various types of inflation and gives graphs, facts and his thoughts on future trends. He concludes:

It is my belief that the Fed's recent cut is the wake up call that will finally stimulate rising inflation expectations. Moreover, the public awakening towards inflation is coming at a time when monetary inflation, commodity inflation, currency inflation and wage inflation, already at significant highs, are set to rise even further.

He predicts a sharp acceleration when gold breaches $1,020 per ounce - itself a price level about 38% higher than today.

Although his remarks have most relevance for an American audience, it is worth remembering the recent Telegraph article (5th October) that forecast sterling dropping even faster than the dollar. Our determination to be as financially reckless as our Transatlantic cousins may result in our facing similar problems.

The good news? Our enormous holding of US Treasury stock may turn out to have been a reasonable investment, in sterling terms. The bad news? Perhaps we should have put that money into bonds denominated in a stronger currency. The Euro, maybe?

Which will fall faster: the pound or the dollar?

An article in the Telegraph (referred to by today's Daily Reckoning) says that the pound sterling could drop about 14% against the dollar by 2009.

Which one is the basket case economy?

Risk avoidance leads to stronger dollar

That's the analysis of Kathy Lien at DailyFX.com yesterday:

These days, cash is a valuable commodity since a liquidity crisis means a lack of cash. The sharpness of recent moves and the lack of liquidity have probably pushed more traders to liquidate positions than to add funds. Flight to safety continues to send the dollar higher against every major currency with the exception of the Japanese Yen as more victims of the subprime and liquidity crisis surface.

There's a possibility of an interest rate reduction:

...the biggest question on everyone’s mind is when the Federal Reserve will cut interest rates. The market is current pricing 75bp of easing by the end of the year. There has also been speculation of an intermeeting rate cut.

But:

Like many central banks around the world, the Fed has been reluctant to lower rates because they feel that the markets need to be punished for their excessive risk appetite. Furthermore, they have said that they need to see market volatility have a “real impact” on the economy.

This, she thinks, is becoming apparent:

With major losses and bankruptcies reported throughout the financial sector, we expect companies to layoff staff left and right. [...] For the people in the “real economy,” their 401ks have taken a harsh beating while their mortgage interest payments are on the rise. It is only a matter of time when we see economics reflect that. The bad news is already pouring in with housing starts hitting a 10 year low and manufacturing activity in the Philadelphia region stagnating. Since the beginning of the year, the weak dollar has provided a big boom to the manufacturing sector. Now that the dollar has strengthened significantly, activity in the manufacturing sector should also begin to slow.

Buffett on trade imbalances

Warren Buffett's 28 February 2007 letter to shareholders is available online, and makes educational and entertaining reading. Here's a pithy extract:

As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. I fervently believe in real trade – the more the better for both us and the world. We had about $1.44 trillion of this honest-to-God trade in 2006. But the U.S. also had $.76 trillion of pseudo-trade last year – imports for which we exchanged no goods or services. (Ponder, for a moment, how commentators would describe the situation if our imports were $.76 trillion – a full 6% of GDP – and we had no exports.) Making these purchases that weren’t reciprocated by sales, the U.S. necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy but self-indulgent family, we peeled off a bit of what we owned in order to consume more than we produced.

The U.S. can do a lot of this because we are an extraordinarily rich country that has behaved responsibly in the past. The world is therefore willing to accept our bonds, real estate, stocks and businesses. And we have a vast store of these to hand over.

These transfers will have consequences, however. Already the prediction I made last year about one fall-out from our spending binge has come true: The “investment income” account of our country – positive in every previous year since 1915 – turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience “reverse compounding” as we pay ever-increasing amounts of interest on interest.

I want to emphasize that even though our course is unwise, Americans will live better ten or twenty years from now than they do today. Per-capita wealth will increase. But our citizens will also be forced every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S. workers and voters will find this annual “tribute” so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict – but to expect a “soft landing” seems like wishful thinking.

It's reassuring that Buffett thinks per-capita wealth will increase; this is an antidote to the most extreme doomsters. But it begs the question of how equitably that wealth will be distributed. The transfer abroad of industrial jobs leaves most of their former holders in less well-paid employment, while boosting the profits of large multinational companies (such as Wal-Mart, in which Berkshire Hathaway has close to a billion-dollar stake). From James Kynge's China book, it seems that the gap between America's rich and poor is widening, and the middle class is shrinking. Save and invest while you can.

Buffett is also enlightening on the future of newspapers in the electronic age, and the occasional bargains to be had in insurance. His firm has made money out of carefully-considered reinsurance (including for Lloyds of London) and derivatives. Berkshire Hathaway has gradually moved from being a "growth" to a "value" business, delivering returns increasingly from income earned, and insurance business helps. BH has made a profit from "super-cat" insurance in the past year, but Buffett warns that Hurricane Katrina wasn't the last nor the worst possible.

Note also the warning in the extract about the dollar. Recent falls aren't the end of the necessary decline - see to the Levy report referred to in my previous post.

A note of caution about the Gold Standard, and the Euro

Until I looked it up (isn't the internet wonderful?) I had thought that the "Geddes Axe" (which slashed UK public expenditure) was a response to the Depression. Far from it: some would say it was a major cause. It turns out that after the First World War, our politicians wanted Britain to be great again, and thought that meant getting the pound back up to its former exchange rate against the dollar - just as I dream about getting into my old teen jeans.

They managed to do it for a while, but the result was a deflation that failed to take into account Britain's postwar economic weakness, and the 1925 restoration of the gold standard at this fatally high level prolonged the suffering. Then the zip bust.

More recently, some felt that lacing the pound into the Euro would stiffen our backs. Or perhaps this idea owed more to fuzzy notions of European brotherhood, modernity etc - we in Britain have had ten years of being led by a fuzzy thinker.

But not all agreed that the time was right - see the 2002 Cairncross lecture by Ed Balls. This lecture, by the new Prime Minister's former economic adviser (see Wikipedia bio), sets the historical context for the "five tests" that he formulated with Gordon Brown in a New York taxi in 1997. The tests were designed to determine the timing of the UK's entry into the Euro - for details, see this Scotsman article of 2003, which also reviews progress. Perhaps the timing will never be right.

Some hope that's the case -because it's not just about economics. Can Europe ever be a country? What will happen to our mode of government, civil liberties and economic prosperity in this herd-rush towards an "ever-closer union" commanded by a remote, opaque elite?

Is currency stability generally desirable? Sure; but another return to fixed exchange rates would certainly need extremely careful management, especially in fundamentally unstable conditions. I don't think Western trade deficits are purely due to monetary inflation; China's rapid rise from poverty seems just as challenging to our budgets as the Great War that drove us off the gold standard.

More on Marc Faber

I missed this article from May 23 about Faber's recent recommendations - some on currency, but also some on commodities, e.g. gold versus oil.

Planning for the dollar drop

The bear view continues to spread. Greg Peel at Australian financial news site FN Arena today rehashes the article by Mr Venkatesh I covered yesterday.

The IHT article from March 28 last year was significant in that the Asian Development Bank was then urging countries to appreciate their currencies in concert when the dollar falls, so as to minimise the additional disruptive effect of national economic rivalry in the region. I guess that contingency plans are indeed being formulated.

The point of my own coverage is not to add to the gloom-and-doom, but so that readers may make their own plans to survive and thrive in the coming changes. Some will do well. What is your strategy?

Dollar's rise only temporary

Chris Gaffney in Friday's Daily Pfennig comments on the recent rise in the dollar and puts it down to a sell-off in emerging market equities and some selling of gold to settle cash calls. He says the money is only "parked" in the dollar and will be off again soon:

The dollar will continue to trend down versus the currencies of economies that are better off.
As investors move away from riskier assets, the countries with strong balance sheets will begin to trade at a premium.

This refocusing on fundamentals suggests a return to sanity is on its way - initially not pleasant.

US dollar needs to fall; intellectual property needs protection

An interesting report from China Daily yesterday. The American Chamber of Commerce there is asking for less pressure to revalue the renminbi and more for structural reforms in China.

The value of the renminbi is not the answer to everything. If the Chinese yuan rises against the dollar, then Chinese imports will cost more, and America might well cut back; but US industrial exports could be slow to grow because of eroded manufacturing capacity. And a weaker dollar would mean foreigners could bid more for US products (including foodstuffs), so creating price inflation in the US while production lags behind demand.

And there is also the question of just how much the dollar would have to drop to make US products globally competitive anyway. What you could see is Chinese light industrial manufacturers suffer a contraction, losing business to countries that have even lower wage costs, such as Vietnam. When the dust has settled, America's balance of trade crisis could simply have widened from US-China to US-Far East.

So it's not so much the renminbi that has to rise, but the dollar to fall.

Also interesting to see intellectual property rights come to the fore. As America sees her economic strength sapped, she must worry about the scruples of her competitors. If "might makes right", patents and copyright may not be the pension she was hoping for. I did discuss this a while ago (May 23), and think it's an issue to follow.

US-China "Strategic Economic Dialogue" resumes

We're waiting to hear much from the Western side on the talks, but see here for a Chinese-angled general background to the series. However, this one from China View is more frank about the differences between the two sides.

Pakistan's Daily Times gives useful detail on the economic issues: US manufacturers are calling for further appreciation of the Yuan against the dollar, but "an international think tank, Oxford Economics, estimated that even a 25 percent revaluation of the yuan against the US dollar would decrease the total deficit by only 20 billion dollars after two years."

For the American side, it must be like an uncomfortable meeting with your bank manager.

What is Alan Greenspan doing?

Recently, ex-Federal Reserve Chairman Alan Greenspan has been sounding warnings about the US economy and is now aware that his back-seat driver comments may affect the market (see end of this article). It must be irritating for Ben Bernanke to deal with a boat-rocker whom some blame for creating the problems that Ben now faces.

And what is Mr Greenspan now doing? One of his new roles is as an adviser to investment managers PIMCO - see here for their latest US report. The style of the report is an uncomfortable combination of stuffy and jazzy, but the substance is interesting. Here's a few extracted phrases:

Currently there's a "virtuous circle favoring capital at the expense of labor", which only "a global financial bubble popping of sorts, an accelerated decline of U.S. housing in the short run, or a U.S.-led trade policy reversal that could precipitate counter-attacks from Asian exporters" could stop;

there are "inflationary pressures" in the US and an "asset bubble";
if a housing slump hits the American consumer economy, "anti-trade [i.e. protectionist] legislation may or may not become a reality";

"The emphasis on emerging market currencies rather obviously suggests relative weakness of the U.S. dollar. We continue to believe that U.S. growth will descend towards the lower quartile of countries within a broad global composite. Such U.S. growth, despite relatively favorable demographic labor force trends spiked by immigration, will suffer due to reduced U.S. consumption and the need for higher savings. Even in the face of resistance by Chinese authorities vis-à-vis the Yuan and the Japanese via artificially low interest rates, this lower growth speaks to a weaker dollar and lower relative asset price appreciation in comparison to the rest of the world. PIMCO portfolios will therefore likely feature increasing international diversification in foreign currency terms.";

PIMCO thinks that "sustainable global growth with perhaps an early cyclical slowdown appears to be the likeliest outcome. Those who “own” this growth as opposed to those who lend to it will benefit."

Not hard to boil this down. But potentially rewarding for an alert and adventurous investor. And Mr Greenspan the poacher will act as your gamekeeper, if you go with PIMCO.