Dollar rising strongly - what does it mean?

[Iroquois]

You don't need to hold dollars as long as there is a strong flow of them. But, if a nation is facing a severe crisis, their access to that flow may be limited or, if the crisis is global in scope, the flow itself may be limited.

I believe this explanation for the surge in the dollar falls under 5).

Dollar Surges Amid Hustle For Supplies Overseas
Oct. 7, 2008 (WSJ)

The dollar is in demand because many foreign banks engaged in short-term borrowing in dollars to fund various activities in recent years. Now, one normal channel for getting those funds or rolling over such debt -- borrowing from U.S.-based banks -- is gummed up, as banks are leery of lending to one another.

At the same time, banks world-wide are also looking to reduce their overall borrowing as part of a race to clean up their balance sheets. Where that borrowing was in dollars, they need dollars in order to repay it.

"There is a pyramid of leverage" in the financial system built up over years, says Mark Astley, CEO of Millennium Global Investments, a U.K. currency manager with $15 billion in assets. "This isn't going to be over in a couple of weeks."

The global demand for dollars pushed the U.S. Federal Reserve to announce a major expansion of its "swap" lines with other central banks, which allow them to provide liquidity in dollars to their local commercial banks. The Fed now has arrangements with nine other central banks, which together provide access to a total of $620 billion.

Still, that hasn't been enough to ease the squeeze. Some of the demand for dollars has spilled over into the currency markets. There, participants can buy dollars outright, or use derivatives known as currency swaps to exchange one currency for another at two different points in time.

Some investors say the appetite for dollars is akin to the demand for the yen. The yen surged against the dollar and the euro Monday; late in New York one dollar bought 101.61 yen, down sharply from 105.14 Friday.

The yen's ability to thrive stems from the fact that in better times, investors borrow in yen to take advantage of Japan's ultralow interest rates. But when volatility rises or investors need to cover losses elsewhere, they undo these maneuvers -- known as carry trades -- and buy back yen, boosting Japan's currency.

Meanwhile, by borrowing so much in dollars, foreign banks may have created "the biggest carry trade of all time," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London.

What will happen when this temporary dollar carry trade reverses? When?

The dollar will weaken rapidly. When? The de-leveraging of the "pyramid of leverage" will take from two to six months but not likely more than that.

...

http://www.itulip.com/forums/showthread ... #post52818

[JackRiddler]

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Thanks for very interesting link from early in the month of Oct. 08, one should read the whole thing. Readers, note that the last two lines Iroquois quotes are not from WSJ but commentary on the WSJ article, but they follow logically.

http://www.itulip.com/forums/showthread ... #post52818

It occurs to me that paying down debt could be deflationary (reduces money supply) but only insofar as the paydown comes from production and not additional debt creation. The bailout could have worked that way if it weren't itself borrowed money. All it does is shift some part of the nominal debt to the taxpayer - actually a small amount compared to overall liabilities, another reason it can't work.

Anyway, the link makes the case that players need dollars right now to pay off dollar debt, and after all this unwinds, the dollar falls again.

The chart above shows money flows through the economy. Consumers borrow new money into existence when they purchase cars, homes, and other items on credit through the banking system, resulting in Mb cash balances for households. Businesses and government also borrow money into existence. On one side of the balance sheet (the lenders') lending money into existence (dotted lines) results in an asset. On the other side of the balance sheet (the borrowers') borrowing (dashed line) creates a liability. Once created, the money flows through the economy. The banks fund the new debt through the Credit market. The Monetary agency (Fed) funds the Credit market and government via short term lending. When the Credit markets seize up, as they have recently, the Fed steps up its short term lending to the credit markets. In a drastic measure, it buys securities directly, acting as "buyer of last resort" in order to keep maintain money creation.

The Fed is responding to the seizing up of credit markets with heroic reflation measures, such as outright purchases of commercial paper today. Once liquidity is restored, the money created for that purpose will remain in the economy, potentially producing massive inflation. The Fed will later attempt to withdraw the money by targeting the price of money, that is, interest rates: the Fed will raise rates rapidly.

This part is fascinating, on the mechanics of how the market inevitably passes liability on to the most vulnerable (if I've understood well enough to put simply: Those behind in a game need to gamble to make up position, are likelier to bet on the junk, as a class end up holding the most junk at the end).

A very large domino is still to fall: credit default swaps.

Four trillion in OTC credit default swap gross market replacement value (the notional value is just silly) of credit debt default insurance that can never be paid has been taken out against trillions in mortgage and corporate debt that can never be repaid. The CDS are thousands of hand written contracts sans clearing house, settlement based on novation, the weakest form of contract settlement. A huge disaster waiting to happen. It's been waiting to happen for at least nine years:

Derivatives markets guarantee a winner for every loser, but they will over time concentrate the losses in vulnerable sectors. Nature obeys Mayer’s Third Law, which holds that risk-shifting instruments will tend to shift risks onto those less able to bear them, because them as got want to keep and hedge while them as ain’t got want to get and speculate. The logic behind margin requirements in stock markets and capital requirements in banking also holds in the derivatives markets. Permitting highly leveraged institutions to hold private parties behind closed doors is the political version of selling volatility: the predictable likely gains will one day be overwhelmed by an equally predictable disastrous loss. - Martin Mayer, Somebody Please Turn on the Lights, Derivatives Strategy, 1999

Buying gold on the short term dollar bounce is probably a sound move, if you buy into our general thesis that a new global currency regime is needed that does not have the dollar at its center; a smaller role for the dollar in the global economy is not dollar positive.

iTulip Select: The Investment Thesis for the Next Cycle™

[Iroquois]

Readers, note that the last two lines Iroquois quotes are not from WSJ but commentary on the WSJ article...

I apologize for that. A part of my brain suggested I make that more clear, but it was out voted by the parts requesting caffeine.

[JackRiddler]

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Hey, no offense imputed.

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[whipstitch]

[url=http://www.rgemonitor.com/blog/roubini/254148/the_coming_global_stag-deflation_stagnationrecession_plus_deflation]The Coming Global Stag-Deflation (Stagnation/Recession plus Deflation)
[/url]
Nouriel Roubini | Oct 25, 2008

Last January – at a time when the consensus was starting to worry about rising global inflation - I wrote a piece titled Will the U.S. Recession be Associated with Deflation or Inflation (i.e. Stagflation)? On the Risks of “Stag-deflation” rather than “Stagflation” where I argued that the US and other economies would soon have to worry about price deflation rather than price inflation.

As I put it at that time last January:

the S-word (stagflation that implies growth recession cum high and rising inflation) has recently returned in the markets and analysts’ debate as inflation has been rising in many advanced and emerging markets economies. This rise in inflation together with the now unavoidable US recession, the risk of a recession in a number of other economies (especially in Europe) and the likelihood of a sharp global economic slowdown has lead to concerns that the risks of stagflation may be rising.

Should we thus worry about US and global stagflation? This note will argue that such worries are not warranted as a US hard landing followed by a global economic slowdown represents a negative global demand shock that will lead to lower global growth and lower global inflation. To get stagflation one needs a large negative global supply-side shock that, as argued below, is not likely to occur in the near future. Thus the coming US recession and global economic slowdown will be accompanied by a reduction – rather than an increase – in inflationary pressures. As in 2001-2003 inflation may become the last of the worries of the Fed and one may actually start hearing again concerns about global deflation rather than inflation.

Let me elaborate next why…

…unlike a true negative supply side shock – that reduces growth while increasing inflation - a US recession followed by a global economic slowdown is a negative demand shock that has the effect of reducing US and global growth while at the same time reducing US and global inflationary pressures. Specifically such a negative demand shock will reduce inflation and across the world because of a variety of channels.

First, a US hard landing will lead to a reduction in aggregate demand relative to the aggregate supply as a glut of housing, consumer durables, autos and, soon enough, other goods and service takes places. Such reduction in aggregate demand tends to reduce inflationary pressures as firms lose pricing power and then to cut prices to stave off the fall in demand and the rising stock of inventories of unsold goods. These deflationary pressures are already clear in housing where prices as falling and in the auto sector where the glut of automobiles is leading to price discounts and other price incentives. Obviously, inflation tends to fall in recession led by a fall in aggregate demand.

Second, during US recessions you observe a significant slack in labor markets: job losses and the rise in the unemployment rate lead to a slowdown in nominal wage growth that reduces labor costs and unit labor cost, thus reducing wage and price inflationary pressured in the economy.

Third, the same slack of aggregate demand and slack in labor markets will occur around the world as long as the negative US demand shock is transmitted – through trade, financial, exchange rate and confidence channels – to other countries leading to a slowdown in growth in other countries (the recoupling rather than decoupling phenomenon). The reduction in global aggregate demand – relative to the global supply of goods and service – will lead to a reduction in inflationary pressures.

Fourth, during any US hard landing and global economic slowdown driven by a negative demand shock the US and global demand for oil, gas, energy and other commodities tends to fall leading to a sharp fall in the price of all commodities. A US hard landing followed by a European, Chinese and Asian slowdown will lead to a much lower demand for commodities pushing down their price. The fall in prices tends to be sharp because – in the short run – the supply of commodities tends to be inelastic; thus any fall in demand leads to a greater fall in price – given an inelastic supply curve – to clear the commodity prices. And indeed in recent weeks the rising probability of a US hard landing has already lead to a fall in such prices: for example oil prices that had flirted with a $100 a barrel level are now down to a price closer to $90; or the Baltic Dry Freight index – that measures the cost of shipping dry commodities across the globe and that had spike for most of 2007 given the high demand and the limited supply of such ships – is now sharply down by over 20% relative to its peak in the fall of 2007. Similar downward pressure in prices is now starting to show up in other commodities.

Note that a cyclical drop in commodity prices – led by a US hard landing and global economic slowdown - does not mean that commodity prices will remained depressed over the middle term once this global growth slowdown is past. If in the medium term the supply response to high prices is modest while the medium-long term demand for commodities remains high once the US and global economy return to their potential growth rates commodity prices could indeed resume their upward trend. But in a cyclical horizon of 12 to 18 months a US hard landing and global economic slowdown would lead to a sharp fall in commodity prices. Note that even in the case of oil that is the commodity with the weakest supply response to prices – as the investments in new production in a bunch of unstable petro-states (Nigeria, Venezuela, Iran, Iraq and even Russia) are limited - a cyclical global slowdown could lead to a very sharp fall in oil prices. Indeed while oil today is closer to the $90-100 range in the last 12 months oil prices drifted downward at some point close to a $50-60 range even before a US hard landing and global slowdown had occurred. Thus, one cannot rule out that in such a hard landing scenario oil prices could drift to a price close to $60.

The four factors discussed above suggest that – conditional on the negative global demand shock (US hard landing and global economic slowdown) materializing even the risks of stagflation-lite are exaggerated; rather US and global inflationary force would sharply diminish in this scenario and, if anything, concerns about deflation may reemerge again.

This is not a far fetched scenario as one looks back at what happened in the 2000-2003 cycle. Until 2000 the Fed was worried about the economy overheating and rising inflation risk. But once the economy spinned into a recession in 2001 US and global inflationary pressures diminished and by 2002 the great scare became one of US and global deflation rather than inflation. Indeed the Fed aggressively cut the Fed Funds rate all the way to 1% and Ben Bernanke – then only a Fed governor – wrote speeches about using heterodox policy instruments to fight the risk of deflation once and if the Fed Funds rate were to reach its nominal floor of zero percent.

Today, following a US hard landing and a global economic slowdown, the risks of outright deflation would be lower than in the 2001-2003 episode because of various factors: US inflation starts higher than in 2001; the Fed needs to worry about a disorderly fall of the US dollar that may increase inflationary pressures; the rise and persistence of growth rates in Chindia and other emerging market economies implies that – even if such economies likely recouple to the US hard landing – a global growth slowdown will not turn into an outright global recession that would be truly deflationary. Still, while the scenario outlined here – US recession and global slowdown – may not lead to outright deflationary pressures it would certainly lead to a slowdown of US and global inflation.

The fact that the most likely scenario in the global economy in 2008 is one of a negative global demand shock is the one that is priced by bond markets: if investors were really worried about a rise in US and global inflation – or about true stagflationary shocks – the yield on long term government bonds would have not fallen as sharply as it has since last summer. With US 10 year Treasury yield now well below 4% and sharply falling in the last few weeks it is hard to see a bond market that is worried about global inflation or global stagflation. And while until recently commodity prices pointed to the other directions, recent weakness in oil prices, the cost of shipping commodities and the price of some other commodities also signals that commodity markets are now pricing the risk of a US recession and the risk that – with a lag – a US recession will lead to a broader global economic slowdown.

So in conclusion “stag-deflation” (i.e. low growth or recession with falling inflation rates and possible deflationary pressures) is more likely than “stagflation” (low growth or recession with rising inflation rates) if a US hard landing materializes and leads – as likely – to a slowdown in global demand and growth.

So last January I argued that four major forces would lead to a risk of deflation (or stag-deflation where a recession would be associated with deflationary forces) rather than the inflation risk that at that time – and for most of 2008 – mainstream analysts worried about: slack in goods markets, re-coupling of the rest of the world with the US recession, slack in labor markets, and a sharp fall in commodity price following such US and global contraction would reduce inflationary forces and lead to deflationary forces in the global economy.

How have such predictions fared over time? And will the US and global economy soon face sharp deflationary pressures? The answer deflation and stag-deflation will in six months become the main concern of policy authorities. Let me now explain in more detail why…

[Nordic]

Nordic: I think you mean 5 from the OP?

Uh .... yes.

DOH!

What is interesting to me about this whole mess (in this regard) is that the dollar should be dropping, but the euro is dropping faster.

It's like the law of relativity applied to currencies.

If the dollar does "crash", what does it crash relative to? Some other currency? Or does everything just get really expensive, i.e. worldwide inflation?

Right now the prices of everything are plummeting it seems ....

Man, they don't know shit, and neither do we! That's for damn sure. Nothing seems to be making any sense right now. It's like sailing into some mythic storm where there are whirlpools and serpents and rain falling upwards and ball lighting scaring the shit out of everybody.

Just .... epic in its collosal, violent unpredictable turbulence. We just don't know if we're going to be plunged over a waterfall, sucked into a whirlpool and slammed into the ocean's bottom, lifted into the air like the house in the Wizard of Oz, or suddenly becalmed.

[JackRiddler]

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Roubini knows a lot more than I do, and he lays out a clearheaded and pretty much incontrovertible case for why inflationary pressures due to demand are about to drop in the US and around the world - The Depression - but I can't help notice that in all that, he only mentions in passing the main concern of our own present discussion:

the Fed needs to worry about a disorderly fall of the US dollar that may increase inflationary pressures;

Yes, well. Is that all he has to say about it?

I also wonder about his expectation that the world's "recoupling" to the US is quasi-automatic. The rest of the world now seems to be looking forward to the potentials for decoupling, once the dollar-denominated ponzi scheme has unwound.

Obviously he's right, if the dollar avoids a disorderly fall. Otherwise he's not accounting for that possibility at all in the long summary quoted above.

Credit makes money. Paying off credit reduces money supply again and clears the way for more credit. Defaults on a massive scale - i.e., the direct mechanics of the present crisis - leave that money circulating in the economy, and have a depressing effect on long-term confidence in both the country's fundamentals and its currency, both of which exert pressure to devalue that currency. So demand can fall even as the dollar loses in value, with US domestic inflationary pressures from the dollar decline great enough to trump all the deflationary action he's talking about for purposes of cost of living (albeit not for assets, which obviously still have a long way to go down, since after all they were subject to hyperinflation already in the last 10 years).

Again, that's if we're basically right here in this thread about why the dollar is suddenly so strong: because everyone with dollar obligations is selling anything not nailed down in an effort to meet those overwhelming debt obligations, however, in advance of a default tsunami in the next six months that will leave the dollar weak and unstable, after the debt has unwound.

Again, assuming there is even anywhere outside the dollar to go after that as a reserve currency. Roubini seems to be thinking there isn't. But it's going to be EU-Japan-Russia-China and the rest who will decide if that's really the case, and whether "recoupling" is as sure a bet as Roubini implies.

Has this prophet of doom succumbed to denial after all, or is he not just smarter about economics but also a better prognosticator than I am in the above?

A god's eye view of the numbers might tell, but I don't think anyone actually has that yet, regardless of mathematical talent since so many books remain to be cracked open, so many announcements have yet to be made. In hindsight, they will.

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[ninakat]

A god's eye view of the numbers might tell, but I don't think anyone actually has that yet, regardless of mathematical talent since so many books remain to be cracked open, so many announcements have yet to be made. In hindsight, they will.

And that was exactly the point that Mandelbrot and Taleb made in their interview on PBS the other night -- that they don't have the numbers. In fact, from what I understand, nobody has the numbers on the derivatives and all these other unregulated devices that became the fad (thanks to Greenspan et al) over the last decade or so.

Top Theorists Examine Rippling Economic Turbulence
http://www.pbs.org/newshour/bb/business ... 10-21.html

PAUL SOLMAN: What is the doomsday scenario? I mean, what actually happens tomorrow, next week?

NASSIM NICHOLAS TALEB: I mean, I am convinced -- there's been a package recently of $700 billion. It's pocket money, because you don't understand -- they don't understand the ripple effect that hedge funds have, OK, that the banks not lending to hedge funds will force hedge funds to liquidate positions.

PAUL SOLMAN: Sell off?

NASSIM NICHOLAS TALEB: Sell off positions. These positions, sold off by hedge funds, will impact other entities.

PAUL SOLMAN: Driving down the price.

NASSIM NICHOLAS TALEB: Driving down the price. Driving down some prices. That a supermarket, OK, needing funding, will not be able to find a bank solvent enough to lend them money against inventory to make payroll, OK?

You may have chain reactions we've never imagined before. And these come from the intricate relationships in the system we don't understand.

PAUL SOLMAN: You've been around a lot longer than we have. That's possible. Is it likely?

BENOIT MANDELBROT: Well, we don't know the probability. We don't have enough knowledge. We don't have enough information. We don't have enough reliable information on data which are not published. I mean, I sleep better, perhaps, than Nassim, but I don't sleep very well.

[ninakat]

Peter Schiff's recent viewpoint -- video -- god I hate all the yelling, and the moderator guy looks and sounds drunk to me, but Schiff makes some valid points, IMO:

Peter Schiff - Why is the Dollar Rising?
http://www.youtube.com/watch?v=AaUkpDddPDM

[whipstitch]

Has this prophet of doom succumbed to denial after all, or is he not just smarter about economics but also a better prognosticator than I am in the above?

My impressions of his predictions (based on an admittedly small sample size) is that he talks about the future based on what is happening now - ie where the current trend will lead. He doesn't go into "if then" senarios much. I think that's what makes his predictions clear and forceful, where they might otherwise lead to a confused morass of possible future senarios. As the current trend shifts, I think we will hear from him about it.

[JackRiddler]

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SURPRISE! COUNTERARGUMENT ALERT!

AVENGERS ASSEMBLE! BATTLE TIME!

Since it's international markets that determine dollar value and that value can only be defined against other currencies, the dollar will survive within the range of exchange rates it has occupied in recent years, for the simple reason that this Monopoly money stopped being the American currency long ago. Thirty years of humonguous trade deficits and insane daily capital flows have put gazillions of these babies in the hands of Japan, China, EU, Britain, the oil states, et al., and since they don't have anywhere big enough to stick all that, they don't want to burn it overnight. They'll hang on to their reserves and do business with each other - in dollars. Long as the crazy American government doesn't try any more oversize stunts like Iraq, why burn their own reserves? They may also hesitate to give the crazy nuke-brandishing Americans cause to blame the rest of the world for a dollar meltdown and the loss of all their goodies at once. Besides, they'll shortly be able to buy up everything in the States for like, nothing. (New bubbles to follow. Get in on the ground floor!)

Contest.

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[Fat Lady Singing]

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Credit makes money. Paying off credit reduces money supply again and clears the way for more credit.

Hi again, JackRiddler: I'm trying once again to understand the situation in my own homely way...

So, the ideal way for the economy to function/flourish is for people to be in debt but paying it off then acquiring more debt to repeat it all again. In other words, perpetual debt equals prosperity. We power the system by running around in our hamster wheels of consumerism. We owe our souls to the company store.

Yikes! I think maybe this is what Vigilant was getting at in his many posts that I could never quite follow, myself, but maybe it's sinking in anyway.

[vigilant]

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Credit makes money. Paying off credit reduces money supply again and clears the way for more credit.

Hi again, JackRiddler: I'm trying once again to understand the situation in my own homely way...

So, the ideal way for the economy to function/flourish is for people to be in debt but paying it off then acquiring more debt to repeat it all again. In other words, perpetual debt equals prosperity. We power the system by running around in our hamster wheels of consumerism. We owe our souls to the company store.

Yikes! I think maybe this is what Vigilant was getting at in his many posts that I could never quite follow, myself, but maybe it's sinking in anyway.

Yes that is pretty much exactly what I have been saying, but with exceptions.

"Ideal" way? "Prosperity"? It is exactly the ideal way for the elite as it is incredibly prosperous for them. Money is like a river and it flows like one. He who has the most water under his boat can float the biggest boat. Steering the course of the "flow" through your hands is the key to winning the game. Hoarding it up isn't nearly as important as directing the flow through your hands. Most of the elite have trust funds so that they don't technically own anything. They steer the flow of dollars through the trusts and manage the trusts.

We are the hamsters on the paddle wheel that churn the money down the river. We also pay for the flow with most of our own food rations that we must buy from the country store. See the law of Moses. See Leviticus...see Jubilee....believing is seeing....not seeing is believing....be careful what you "choose" to believe.

[vanlose kid]

[deleted

[Fat Lady Singing]

So, the ideal way for the economy to function/flourish is for people to be in debt but paying it off then acquiring more debt to repeat it all again. In other words, perpetual debt equals prosperity. We power the system by running around in our hamster wheels of consumerism. We owe our souls to the company store.

Yikes! I think maybe this is what Vigilant was getting at in his many posts that I could never quite follow, myself, but maybe it's sinking in anyway.

Yes that is pretty much exactly what I have been saying, but with exceptions.

"Ideal" way? "Prosperity"? It is exactly the ideal way for the elite as it is incredibly prosperous for them.

That's what I meant -- wish I'd had a sarcasm emoticon! Thanks for the confirmation, V.