Monetary

You can put a fork in us down the road....

The U.S. currency dropped against 12 of its 16 major counterparts as the International Monetary Fund said traders are probably using the dollar to fund so-called carry trades around the world and it may still be overvalued.

I hope everyone here in The United States takes a moment to understand what this means.  Let me lay it out for you:

• When the global economy truly recovers oil will skyrocket up to or beyond the $150 where it was in late 2008.  If the dollar is indeed still "overvalued" and going to 40 as many technicians predict, oil will likely reach $300 a barrel.  This will in turn drive gasoline prices north of $6, heating oil will reach $7-8/gallon, and diesel will be commensurate with heating oil.
  
  
• This will in turn decimate the trucking industry.  Now you know why Buffett bought BNI.  Many things he may be, but dumb isn't one of them.  Trucks will of course remain for terminal-to-door deliveries but for long-haul they will simply be uneconomic.  Those who currently are employed in this business will lose their jobs.  All of them.
  
  
• The middle class will be decimated.  Those who live in suburbia, who are primarily middle-class Americans, will find themselves faced with commute costs that are double or more what they pay now.  Those in the middle class who live in the Northeast where heating oil is the primary fuel for winter, where natural gas infrastructure does not exist to replace heating oil, will find themselves choosing between heat and food in large numbers.

What's far worse is that all carry trades eventually unwind and in the history of the markets I have never seen it happen in an "orderly" fashion.  Japan witnessed the destruction of the Yen Carry last year and it was horrific.  We will see it in the future - exactly when cannot be predicted with certainty, but that it will happen in an uncontrolled fashion will be.  While this "unwind" will bring relief from sky-high commodity prices it will do so at the expense of asset prices, which will collapse.

Our government has, quite simply, refused to take the steps necessary to stem this ridiculous and self-destructive course of action.  Part of the problem does indeed lie with the yuan and China's mercantilist policies, but this is similar to blaming the drug dealer in the entirety for one's addiction.  Without the user the dealer has no customer and makes no money.  We have become addicted to cheap Chinese crap, even when it is poisonous (e.g. lead-painted toys or adulterated toothpaste) while refusing to address our own debt imbalances by either government or private interests. 

The rest of the issue is ours, and ours alone - Bernanke could end this tomorrow by draining the liquidity necessary to cause short term interest rates to rise to 2% - still a very "accommodative" rate, yet one that would make carry trades unprofitable.  He and the rest of the FOMC have refused, even though they're aware of the extreme distortions this creates in the foreign exchange markets and the draining of productive capital from the "funding" currency source nation that always accompanies carry trades.

The only remaining question is whether these "carry trades" and the dollar depreciation that they cause will continue to levitate the equity markets.  Friday morning there was a stunning correlation between the moves in the dollar and the S&P 500 - but then suddenly about 11:00 AM Central time, it broke down.  Many equity and index futures traders have been essentially using the dollar as their "roadmap" for the last several months - but this is a correlation that only works so long as the decline is both orderly and perceived to continue to be so.  If and when that perception changes the correlation will break with extremely violent results.

We certainly do and will live in interesting times, but thus much I am certain of - the Average Joe will neither understand why oil skyrockets the next time it does, nor will he properly place the blame where it belongs: squarely on Ben Bernanke, President Obama and our Congress.

I have been on a potential dollar dislocation - or collapse - for more than two years.  Indeed, back in the fall of 2007, it was one of the themes of petitions to Congress and letters I sent under personal cover to all 535 members.

The debt liquidation cycle of 2008/early-09 appeared to stop the deterioration.  Unfortunately that cycle was interrupted - intentionally - by enabling a continuing pattern of lies and fraud within our government.

This has reversed all of the gains that the dollar had made last fall and winter, despite the stock market and other asset prices being materially lower - by a lot - than when those warnings were issued.

Treasury is always "for a strong dollar" in word, but their view when it comes to deeds is another matter.  This is most unfortunate, as this, like Treasury's and The Fed's view when it comes to sweeping trouble under the rug and lying about asset quality has been proved wrong through time not only here in America but worldwide.

Japan is a prime example.  They adopted the same sort of "programs" we did when they ran into debt-based trouble in their economy two decades ago.  Instead of forcing those who had made bad loans and by doing so blown asset bubbles to eat them - even if it blew them up - they instead played extend and pretend - that the loans were good, that the asset quality was fine, that the banks had plenty of reserves.

The Japanese economy never recovered.  Instead it scraped along a deflationary bottom for a literal two decades, sustained only by the Yen Carry Trade.

But carry trades don't deploy the borrowed funds in the "host", or "funding" nation.  Indeed, the entire point is to borrow there cheaply and then "invest" (or trade) somewhere that has a higher return.  This drains the host just as does any parasite, and drain it did - for more than a decade, Japan's capital flows were turned inside-out.

Now it's our turn; the dollar has turned into the funding currency of choice, cutting off the last bit of Japan's bond appetite.  The government is now threatening to issue as much as $50 trillion Yen of bonds in the next year of "new issue" in an attempt to keep the game going, flooding the market.  This could in turn provoke a currency dislocation and drive the Yen/Dollar swap to 200, according to some observers.

There is a lesson there that is not lost on others; out of Australia we now have this:

In unusually pessimistic comments for a senior political figure, Senator Joyce said the US Government was running such large deficits and building up so much debt that it was in a similar position to Iceland or Germany before World War II.

In a Senate estimates hearing on Wednesday night, he asked Treasury secretary Ken Henry what would be the implications of an American debt default for the Australian economy.

....

''Far from turning around the [George] Bush legacy of deficits and debt, [US president Barack] Obama has made it worse. It has got all the hallmarks of a financial collapse about to happen in America.''

Senator Joyce said investor concerns about the American Government's ability to fund its deficits were already undermining the role of the US dollar in the international trading and financial system.

''The US dollar is almost becoming like junk bonds,'' he said.

Uhhhhhhh.... yeah. 

Unfortunately.

America had a justified hubris for decades coming out of WWII in terms of our manufacturing base and intellectual capital, both of which led to the dollar's strength and a fully-reasonable view that the dollar was indeed the global currency - whether others liked it or not.

But today this has changed.  The view that "deficits don't matter" and that The Dollar can be debased by outrageously ridiculous spending patterns in the Congress has undermined the foundation on which the dollar relies for that reserve status.  Political promises have put into place a budgetary structure in our government that defines more than half of all the money spent every year as "mandatory", going to either Social Security and Medicare or debt interest, and another 1/4 being spent on defense.  Of those four categories only two - interest and the military - are defined as enumerated and proper powers in The Constitution, yet the demographic and political realities turn the other two into "mandatory" categories that are impossible to challenge or modify.  Those who have tried to do anything other than enlarge either have been swiftly booted from office.

Mathematics, however, trump politics.  The mathematical reality is that you can only sustain deficit spending policies (whether by government or private debt acquisition) if GDP grows faster than debt and that growth has to come from the private sector, not government transfer payments, or the deficit percentage and impact will grow faster than GDP.  This is, again, mathematics and cannot be avoided, since the government is only a fraction of the entire economy (and even in a command economy can't be more than 100% of it!)

Again I present the graph that I have shown before on what happens if you don't obey the realities of mathematics:

This isn't conjecture.  It isn't politics.  It is mathematical reality.

There has been NO - underline that - NO - recognition of the mathematical realities that underlie debt and GDP growth within our government, including Congress and regulators.

None.

This is precisely the same road that Japan went down after the Nikkei topped and then crashed when their debt bubble blew up. 

A raw refusal to recognize the mathematical realities has led The Fed and Treasury to instead make legitimate outright fraudulent accounting, enabling banks and others to arbitrarily defer recognition of losses based on nothing more than a hope that through currency debasement popped bubbles can be re-inflated.

History tells us that such strategies never succeed, especially in an import-based economy, which we are, as input costs are tied directly to currency debasement and worse, those foreign interests that hold necessary imports also tend to hold significant currency reserves.  As those reserves are debased the holders of these resources will raise prices and/or constrain supply so as to recover not only the current debasement but also the debasement of their reserves. 

Congress may not like the facts, but that doesn't change them.  Fraud never pays in the end, and despite all of the crooning and intentional diversion by people such as Bernanke, Summers and Geithner the above chart is a simple reflection of mathematical realities of compound growth - a reality that cannot be changed with "magic wand" waving or burying bad assets under a mountain of fraudulent accounting manipulation.

When Bloomberg runs articles like this, you have to wonder....

Oct. 12 (Bloomberg) -- Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two-quarter rout in almost two decades.

Flush with printed reserves, I might add.

World leaders are acting on threats to dump the dollar while the Obama administration shows a willingness to tolerate a weaker currency in an effort to boost exports and the economy as long as it doesn’t drive away the nation’s creditors.

Tolerate?  I'd argue that this is a formal policy of the administration (and the last one too), not a matter of "tolerance." 

That Congress allows this is a raw dereliction of their duty as set forth in The Constitution; they seem to be entirely blind to the willful destruction of currency value that is taking place.

This is not the first time, I might add.  Go look at what happened in the 80s with regard to our currency....

America’s currency has been under siege as the Treasury sells a record amount of debt to finance a budget deficit that totaled $1.4 trillion in fiscal 2009 ended Sept. 30.

Oh wait - maybe it is Congress.  Hmmm.... who is it that passes revenue bills again?  That would be Congress.  Who passed the budget?  That would be Congress.  Who has control of the debt ceiling?

That would be Congress.

Oops.

This is just another example of "kick the can"; instead of facing our medicine and swallowing, instead of forcing those financial institutions who made bad bets to eat them, we are instead devaluing our currency as a means of trying to "print" our way out of this.

But that has never worked throughout history.  Japan tried this in the 1990s and all they did was cause capital to flee; the capital that "came in" was all consumed in carry trades!  They're not the first either; devaluations of this sort in other nations have all failed.

Bernanke, Geithner, Paulson and both administrations seem to believe that because The Dollar is the world's reserve and trading currency that they can ignore these lessons of history and get away with it.

I'm skeptical, for the simple reason that if you look at the issue in terms of what people are doing, as opposed to saying, they are all moving out of dollars and into other things.  The dollar's reserve currency status isn't a function of The US "military might" (until and unless The US is willing to start flinging nuclear warheads around, which I more than somewhat doubt) it is a function of the US maintaining sustainable monetary and fiscal policies.

Again, for the mathematically-challenged, consider the following story.

Many years ago there lived a monarch in India who ruled that all of the people must store their 90% of their rice harvests with him for safekeeping, so in the event of famine there would be enough rice to eat.

One year a famine hit but he refused to release the stored rice, fearing that he would run out and starve himself.

After a couple of months a clever girl came to the monarch and asked for one grain of rice, and for the next month to double it each day.

The Raja agreed, and shortly discovered the magic of exponents, much to his chagrin.

On the first day, he gave 1 grain of rice.
On the second, two.
On the third, four.
On the fourth, eight.
On the fifth, sixteen.
On the sixth, thirty-two.
On the seventh, sixty-four.
On the eight, 128.
On the ninth, 256.
On the 10th, 512.
On the 11th, 1024.
On the 12th, 2048.
On the 13th, 4096 (it was now taking a while to count!)
On the 14th, 8192
On the 15th, 16,384 (The Raja now knew he was in trouble)
On the 16th, 32,768
On the 17th, 65,536
On the 18th, 131,072
On the 19th, 262,144
On the 20th, 524,288
On the 21st, 1,048,576
On the 22nd, 2,097,152
On the 23rd, 4,194,304
On the 24th, 8,388,608
On the 25th, 16,777,216
On the 26th, 33,554,432
On the 27th, 67,108,864
On the 28th, 134,217,728
On the 29th, 268,435,456
And on the 30th, 536,870,912

Needless to say before the 30th day the village was quite-well fed and the Raja was the one who went hungry.

But I want you to pay special attention to the above table, which is why I reproduced it all - most renditions of this story do not.

Notice that on the 29th day the girl was due more rice than had been paid to her in all of the previous 28 days.  This is also true for each day in the series - a fact that you need to think about for however long it takes to sink in.

This is the fundamental truth of all exponential (or "power") functions.  It is a mathematical truth, not a theory or possibility.

Now let's add another fact - if you take the growth rate of anything and divide 70 by it, you get the doubling - or halving - time.  (Yes, I know this imprecise - but it's close enough to do with a paper and pencil or in your head, which is what counts here.)

So let's take the so-called "average" 3.5% inflation rate over the last couple of decades.  If you're saving money, this is a problem.  Why?  Well, divide 70 by 3.5 and you get 20, which means that money stuffed in your safe loses half its purchasing power in 20 years.  In another 20 it loses another half, and is now worth 25% of what it was in terms of what it will buy.

Now let's look at the debt growth percentage from 1990 onward.  On an average annualized basis, it is 7.90% (this is from the Fed's Z1 table, by the way - go argue with them if you disagree. As an aside from 1953 to the present debt has grown at an annualized rate of 8.77%, and since 2000 onward at 8.495%, so I'm being nice here by using the 1990 forward numbers.)

This means that the total debt doubles every 8.86 years (or around 8-1/4 years if you use either of the other rates.)

Now go back to the above table again.

Notice that this table shows the unfortunate reality - every 8.86 years there is more NEW debt taken on than has been taken on in the entire history in The United States up to that point.

This cannot continue forever.  The politicians do not want to talk about this, nor do the economists and central bankers, but it is a mathematical fact, and if we continue to ignore it we will suffer the loss of our currency and, in all probability, our form of government.

This, by the way, is why credit-led recessions cannot be "printed" or "eased" out of.  Credit-led recessions occur because debt service cannot be met by the population any longer, and as a consequence they begin to go bankrupt, forcing credit contraction instead of expansion.  Yet all modern monetary systems are debt-based, and as a consequence as this contraction occurs it begets more contraction.

Lowering the cost of borrowing money (making money/credit more available) is nothing more than an attempt to allow "one more doubling" to take place in avoidance of reality.  But as you can see, had the Raja above not made a "forward promise" of allowing thirty doublings, he could have stopped before he was bankrupted.

Everyone in America wants "a pony" - the magical alchemy that will turn lead into gold, or return their stock market portfolio to its previous purchasing power.

It won't happen so long as our government and citizens spend more than they make.

There is one and only one way to make that happen: You must grow output faster than debt.  When there is a credit overhang this means you must get rid of the debt at a faster rate than GDP declines.

There is only one way to achieve the necessary outcome - what is called "creative destruction", where those who made bad bets (both as lenders AND borrowers) go bankrupt, clearing the path for new lenders to spring up and take their place.  Attempting to prop up GDP with government spending is exactly backward and in fact insanely destructive since to do so you must expand debt issued by the government dollar-for-dollar and due to inefficiency (which is very high in the government!) the debt taken on for each point in GDP created is ridiculous.

In the last quarter, for example, government handouts and spending added about four points to GDP.  That works out to about $130 billion dollars (the math is ~$13 trillion X 4% / 4 quarters = $130 billion).  But to generate that $130 billion government took on $435 billion in new debt (Source: Treasury Direct "debt to the penny"), or roughly $3.35 for each dollar of GDP boost. 

There is no durable recovery that can come so long as debt expands faster than GDP does.  The math simply does not permit it.

In 1930 there was a tremendous stock market bounce, and everyone and their brother thought that The Depression had been avoided as a consequence of looser money and recovery of asset values.  Indeed, I am hearing echoes of President Hoover and James Davis in my head these days..... 

May 1, 1930
“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States – that is, prosperity.” – President Hoover

June 29, 1930
“The worst is over without a doubt.” – James J. Davis, Secretary of Labor.

June 9, 1931
“The depression has ended.” – Dr. Julius Klein, Assistant Secretary of Commerce.

Uh huh.  The government tried to shield borrowers and lenders from having to take their medicine in 1930 too.

The result was a Depression that lasted until we entered WWII in 1941.  The Depression was not exited despite more than a decade of attempts from our government as the government never forced those who had gone bust to take their medicine and thus allow creative destruction to run its course - instead they interfered at every turn (even to the point of burning fields and shooting cattle!) and as a consequence until we were faced with a war that killed a large percentage of the workforce and destroyed massive amounts of material, thereby forcing full employment and realignment of industry, our economy languished.

If The Government comes to recognize the sixth-grade math and implements policy that comports with the immutable mathematical facts the dollar would strengthen significantly and, if maintained, such a policy would guarantee the preservation of reserve status.

However, such a set of policy actions would also prohibit the hiding of losses and force their recognition, thereby forcing the oligarchs and thieves out of business on Wall Street who are currently hiding defaulted paper in the hope that devaluation will allow them to abscond with all of their ill-gotten gains.

The choice is quite simply between economic and policy stability and the banksters on Wall Street along with their handmaidens in Congress.

That's the debate folks when it comes to the dollar and indeed the future of our nation, and the sooner we recognize it the sooner we can exit from this mess.

Until then the claims of "arriving dawn" are in fact incoming ordnance.

Gee, it took this long for someone over on the other side of the pond to figure it out?

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

You're the one who's mad.

The problem isn't lending capacity.  Lord knows with a doubling of base bank reserves at The Fed there is plenty of "money" (credit or debt) available to be lent out.

The problem is that there are no qualified borrowers.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

It is unclear why the US Federal Reserve has allowed this to occur.

Bernanke has no choice.

He would (certainly) prefer this not occur.  What would you call a zero percent Fed Funds rate and printing new bank reserves like a madman?

But just as occurred in the 1930s, Bernanke cannot change the dynamic because there are no willing and able borrowers left.

THAT is the dynamic that sets off deflation and makes it pervasive.  This is the condition that Bernanke has ignored and claimed does not exist, but the fact remains that it does.

It is the dynamic that I identified more than two years ago in April of 2007 when I showed analysis right here on The Market Ticker talking about the "terminal shift" of consumer borrowing onto credit cards in a desperate attempt to keep the game going.

Bernanke, Geithner, Paulson, Bush, Obama.

All have gotten this mess dead flat wrong.

The debt collapse necessary to clear the system once you have hit the wall on borrowing capacity given your free cash flow cannot be avoided.

It can only be made worse - much worse - by trying to tamper with what is an essential corrective process that clears the system of unsupportable debt that must be defaulted.

We have spent two years trying to avoid the truth.

Trying to avoid taking the inevitable pain.

Trying to avoid the inevitable economic contraction.

We have only made the problem worse.

What sort of worse?  Well, you could start here:

The running joke in Singapore, Hong Kong, Bangkok, and Kuala Lumpur is that the U.S. is the place where even your pet could get a credit card or a home mortgage.

So to Asians, the crisis we’re going through is our own fault. And although it was also caused by blunders in Western Europe and other regions, truth be told, they are mostly right.

The message is clear: We need to immediately stop living beyond our means.

That's not funny.

It is, however, true - and an exact copy of the path that I have been preaching since The Market Ticker began publication.

We have blown several trillion dollars in a futile attempt to stave off the contraction in debt outstanding and GDP that must come.

The contraction is still coming, but the several trillion we wasted in an ill-advised attempt to prevent the inevitable is all gone.

Make sure you thank Bernanke, Geithner, Obama, and of course Paulson and Bush.

While I disagree with pretty much everything Jim Willie writes when it comes to metals and such, every squirrel finds a nut once in a while:

You can read the original article at the above link, or I'll just point out the important parts: foreigners are rejecting virtually all forms of US debt, most specifically corporate and agency (mortgages.)

The only place foreigners are "still buying" is in the Treasury market, and one wonders: for how much longer, and how much of that is really foreign buying?

Not that it matters.  This debt is being rejected because foreigners have no faith in the future of its value.  It is not just the risk of default any more - it is also the risk of currency translation going "the wrong way" to an extreme degree, potentially destroying the buyer's purchasing power even if a formal default does not occur.

This is the wall that I have written about for more than two years, and the risk of Bernanke's so-called "smarts" when it comes to "quantitative easing", otherwise known as "monetization" (which Bernanke said, under oath, he wouldn't do - but both was and is.)

Here's the issue, in a nutshell: Bernanke surmises that he wants long-term (and short-term) interest rates low to "spur borrowing" and thus attempt to kick the economy back into growth.  This in turn "mandates" an extraordinarily loose monetary policy.

The math says this is idiotic: We are in this mess because of too loose a monetary policy for too long, which in turn engendered too much debt in the system for the economy's productive output.  The economy got drunk on too much credit; you can't fix it with a bottle of whiskey.

In turn the market believes this policy is dangerous on two accounts: The debt itself needs to yield more as a consequence of actual default risk and the dollar has a risk of rapid, disorderly decline due to money printing which is exactly the same from a foreigner's point of view of purchasing power as a default.

The fallacy Bernanke (and other policy-makers, including Congressfolk) have is that "they're in control."  In fact the market is in control; you can offer all the bonds you want, but you can't force anyone to buy them.  What we're now seeing is outright rejection - it began slowly, but as it has become clear that The Fed was hellbent and determined to go to the wall, consequences be damned, that trickle of rejection has turned into a veritable flood.

There is no "solution" for this problem that maintains what Bernanke (and other policy-makers) want: rates must and will rise; we are now only left with the ability to choose the method by which they do.

Bernanke must withdraw the "loose money" policy now and allow lending rates to find their market equilibrium before the water flowing through the cracks of the dam washes away too much of its foundation and it collapses in an outright revulsion toward all dollar-denominated credit instruments.

That equilibrium, which will be reached one way or another, will be higher than today's rates, perhaps significantly so.

This may in turn force the bankruptcy of firms that have been artificially supported by these insanely low rates, as their borrowing costs will rise.

It will force the US Government to cut back its spending to a level it can actually afford.

It will keep the consumer from spending beyond his or her means not only now (as is already happening) but going forward as well.

If we do not withdraw the extraordinary actions and that revulsion breaks through we could easily see a technically-driven disorderly collapse in the dollar's value along with mass-selling of dollar-denominated securities.

If that occurs last fall will look like a Girl Scout picnic.

Let's not.