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.

US economy over-dependent on housing sector

The Daily Reckoning Australia summarises Dr Kurt Richebacher's analysis: the US economy depends on the housing sector to a dangerous degree, so even a stall in housing will have a big effect.

"...property bubbles have historically been the regular main causes of major financial crises. During its bubble years in the late 1980s, Japan had rampant bubbles in both stocks and property. While the focus is always on the more spectacular equity bubble, hindsight leaves no doubt that the following economic disaster was mainly rooted in the property bubble. Both bubbles burst in the end, but the property deflation has continued for 13 years now, with calamitous effects on the banking system."

I suspect we have a similar problem here in the UK.

Here is tomorrow's news

An online newspaper from the Northern Marianas (south-east from Japan), dated Friday, gives some quotes from Peter Schiff, including this startling (and measurable) one:

"People call us the biggest economy in the world but it’s false, we’ll be lucky to be in the top 20 in two years’ time."

According to the World Bank and ranked by 2006 GDP, the 20th country is Switzerland; by purchasing power parity, it's Iran; by Gross National Income (Atlas method) it's Turkey. Doesn't look likely, so far.

But by gross national income per capita, on a purchasing power parity method, the 20th country is Belgium; and by GNP per capita (Atlas method), it's Germany. Maybe we're getting somewhere now.

In this list of countries by external debt, the USA comes top (over $10 trillion), with the UK in second place (over 8 trillion), and I'm sure we'd rather swap places here with Greece in 20th position ($301.9 billion); but that doesn't take into account the relative sizes of our economies. I'm still searching for a list of countries by net external debt, related to GDP. Help would be appreciated!

On a list of public debt to GDP, the USA is in 32nd place (64.7%), and the UK is in 61st place (42.2%). The Lebanon (209%) and Japan (175.5%) are the top two on this sinner's list.

As they say, comparisons are odious.

More on Dow stock valuation

Further to the assertion that stocks are reasonably valued, and Marc Faber's answer that we have an "earnings bubble" that is skewing p/e (share price compared to earnings, i.e. dividends) calculations, here is an essay by David Leonhardt in the International Herald Tribune (14 August) on historical p/e ratios.

A couple of extracts:

...the stocks in the Standard & Poor's 500 have an average P/E ratio of about 16.8, which by historical standards is normal. Since World War II, the average ratio has been 16.1. During the bubbles of the 1920s and the 1990s, the ratio shot above 30...

Graham and Dodd argued that P/E ratios should compare stock prices to "not less than five years, preferably seven or ten years" of profits...

Based on average profits over the past 10 years, the P/E ratio has been hovering around 27 recently. That's higher than it has been at any other point during the past 130 years, except for the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off...

In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street's soothing words suggest.

A drop from a p/e ratio of 27 down to 16.8 would imply a share price drop of 37%.

Thanks to Michael Panzner for spotting this and putting it onto his Financial Armageddon site.

Weakness of UK M3 relative to gold

Relating total national money and credit to gold holdings, we've seen that the USA would price gold at around $45,000 an ounce, Germany at maybe $14,000 an ounce.

World Gold Council June 2007 figures say the UK has 310.3 tonnes of official gold, and Mike Hewitt's table shows UK M3 at $3,532.1 billion. Using the same gold value per kilo as with the other two countries, if the UK's M3 were entirely gold-related, this would imply a price of about $35,4046 per ounce.

From this perspective, although Britain's economy is much smaller than America's, its currency weakness is much closer to America's than to Germany's.

Dow and FTSE lows

The Dow had its lowest close yesterday since 19 April 2007; the FTSE is currently below 5,950 - the most recent lower closing figure was on 3 October 2006. Why we're suffering more, I have no idea.

More on gold and the money supply

At last, I've found something to help me see currencies in the context of official gold reserves - a brilliantly useful essay by Mike Hewitt in The Market Oracle (July 31).

The above chart (one of several in his exposition) shows that the Euro zone has a better ratio than the USA of gold to currency, and as I tried to demonstrate yesterday, within Europe Germany is particularly strong. And Europe's economy is also of a size to make it a possible reserve-currency contender.

As a footnote, my fellow Brits must be dismayed at the UK's pathetic weakness.