Does Socialism Make Smarter Capitalists?

I think that to understand the present crisis - I mean even to wrap your mind around it - you have to have been schooled in Marxism for at least some time. I really do. It's not that Marxism itself is so informative here, although highly selected and re-interpreted portions can be. It's that to understand what is happening now, you have to have learned - at some time - to look at the capitalist system from outside of it. You have to have wondered "what's next?" and tried to come up with something positive, rather than just catastrophe.

And it really helps if you have had the experience of rejecting doctrinaire Marxism and thus developing a deeper appreciation for capitalism. I theorize that this is why Jim Cramer has had such good instincts about this crisis. He was a red for a while back in his college days, I understand. And of course George Soros - another devout capitalist schooled, if unwillingly, in Marxism - has done really, really well.

Meanwhile his old partner Jim Rogers is floundering. High-powered investment bankers - like Henry Paulson - are confused. America's greatest living expert on deflationary crises - Ben Bernanke - has been slow to react after making an entire academic career around the observation that people in government - in his very position - were too slow to react in the 1930's. But European leaders - schooled in socialism, whether right wing or left - are acting with increasing clarity. Meanwhile high-powered people who have gotten so many things right - like Brad Setser, Nouriel Roubini and even Warren Buffett - seem increasingly baffled.

What they seem almost unable to really understand is simply this:



...and why it's happening.

That is a chart of the Dollar Index - a measure of the value of the U.S. dollar against major currencies. During this period, the U.S. government and now other governments have been pouring an supply of dollars and dollar credit onto the market that is not just unprecedented, but previously unimaginable. And these governments are doing nothing but announcing plans to keep on providing dollars as fast as they can for the foreseeable future. And during this period, the value of the dollar is going up - fast.

The law of supply and demand seems broken when it comes to the U.S. dollar. They supply and the world just keeps demanding.

I think the misunderstanding is based on some fundamental misconceptions, but who am I to explain things to the smart set? Let them figure it out for themselves, the big show-offs. I'm just going to predict that it's going to keep happening for a while and that is going to be really scary and bad. At the same time, the dynamic is forcing us to re-think the structure of our financial system and put some solid government backing behind it, which is a good thing. I think most of the major traded commodities and currencies are probably going to fall versus the dollar for quite a little while. Maybe even the renminbi will fall, although that is a currency highly subject to government intervention. Maybe even the yen will fall, although that is the currency of arguably the most-productive nation - person for person - in the history of the world. And, yes, maybe even gold will fall, although panic-buying gives gold the potential for incredible volatility, as we've seen. If you're not looking at the system from outside the system - questioning some of the common assumptions - I just don't think you could even be expected to see this coming.

Brad Setser has a wonderfully informative article about the "End Of Bretton Woods 2." on his blog. It's very good, although I'm not sure it explains why we've seen the reverse of some of his most important predictions. But in economics the same dynamic can have effects that seem the opposite of each other, particularly if they involve foreign exchange. He did get the timing of his crisis call very right. Nouriel Roubini did also and Roubini doesn't really need to get mechanisms quite right. He observes so many things about the world that he's incredibly informative and flexible. And Warren Buffett? I dunno, maybe his call on stocks isn't so bad, although I'm not sure his predictions of record profits in 5 years for some American corporations is necessarily all that meaningful if the majority are in the soup. Certainly unprecedented volatility looks like something we're going to have to get used to and people don't usually like having so much of their principal at risk.The point is that even people who saw a lot of risk in the American economy have consistently misidentified the likely results or come to make predictions that seem to ignore obvious risk.

To me, what looks clear about the world looks very clear and it's a strange experience. Every morning I wake up expecting everything to reverse course, but it doesn't. I'm usually terrible at making specific calls on markets and now even my call on gold doesn't seem so bad. Even the yen looks like it might be turning. That's pretty wild.

I hope I'm not right. I hope I'm really not seeing something important. Although the future does ultimately look bright to me, it's going to be pretty scary and people will be hurt. What can you do, other than...

...live in interesting times

The Face of a New Monetarism???

I was talking on the phone with a Republican friend of mine - we've been arguing for about 20 years, often every day - and he suddenly stopped me and said:

"Pal, a tear just came to my eye."

"Huh?" I said, "What the hell are you talking about?"

"I just realized it.....you're an inflation hawk. I've never been so proud."

I denied it of course because, well, he's a Republican. That's not my friend, there, at right, that's Indian Central Bank Governor Duvvuri Subbarao. But he looks like a nice fellow.

But, you know, I am an inflation hawk - of a sort. And you know what else? This is even worse, but the IMF was kinda right - well at least half-right. Developing economies really do have to focus on currency stability. And some of them have, but maybe not in the way people think. That's not me, at left, that's my Republican friend.

Okay, it's Karl Marx. But something old Karl would take note of these days is the growth in global dollar reserves - by which I mean the insanely large amount of dollars and dollar-denominated credit flowing from the U.S. to the rest of the world. It's immense. This guy Brad Setser from the Council on Foreign Relations wrote an important paper on it - got him onto CNBC. He seems like a nice fellow, too.




Woops! Sorry, that was rockabilly guitar genius Brian Setzer, not Geo-Economics Genius Brad Setser. Brad Setser's video may be have a smaller picture, but it has a hot woman and hotter economics in it. See below.


Foreign Funds

The video is an interesting debate. I find it a well-traveled path, but I would travel any path with her... Anyway...the point is that the numbers are enormous. Here is a nice highlight from Setser's paper that's getting him such press(.pdf):

"As Figure 7 demonstrates, the financing that emerging economy
governments have provided to the United States dwarfs the emergency
financing that the IMF provided to the emerging world in the
1990s.

Indeed, in 2007 alone, the estimated increase in the dollar reserves
of emerging economies was roughly thirty times larger than the financing
that the IMF provided to the emerging world in 1997–98.14
Table 1 illustrates this astonishing imbalance in a slightly different
way: The $30 billion in new capital that U.S. banks and broker-dealers
raised from sovereign funds in China, Singapore, and the Gulf states in
December 2007 and January 2008 is equal to the largest loan the IMF
extended to any emerging economy."

It's excellent, readable and informative stuff and I recommend it highly

Still this is the Internet, and here we quibble. It's just what we do. Note the implicit assumption of "outgunned". The idea is that not only have emerging markets done without IMF financing (net), but that these much-poorer countries have actually financed the United States to the tune of 30 times such financing. I'll spare you the table and give you the highlight that the emerging economies put more money into the Citigroup refinancing alone ($17.5 billion) than the nation of Turkey got from the IMF in the three years of its inflationary/financial crisis 1999-2001

So here's the question to Mr. Setser and to all of you: Does it really make sense that the emerging economies can spare 30x the the financing the IMF offers? Could these fast-growing, but poor, countries possibly afford to, in effect, give the United States of America more than $1.6 TRILLION dollars in financing out of the goodness of their hearts?

I believe their hearts are good, but India alone has accumulated over $300 billion in dollar reserves. Indians are generous people and some are quite ascetic and frugal, but that is just a lotta money.

Or did India - and these other countries - get something in return for their apparent largesse? From Reuters India:

India cbank sold $9.9 bln in currency market in July

Fri Sep 12, 2008 6:19pm IST

MUMBAI, Sept 12 (Reuters India) - India's central bank sold a gross $9.9 billion in currency market intervention in July, the highest on record, in a volatile month when the rupee hit a 15-month low but then later rose 1.1 percent on the dollar.

The central bank's monthly bulletin showed on Friday the monetary authority sold $6.32 billion on a net basis in July, trimming its net dollar purchases in 2008 to $13.24 billion.

The $9.9 billion gross is the most sold in a month by the Reserve Bank of India (RBI) since it began publishing its currency intervention figures in April 1995. It surpasses record dollar sales of almost $7 billion gross in June.

The rupee fell 7.4 percent in the first seven months of 2008, ending July at 42.57/58 per dollar , in a reversal of its fortunes in 2007 when strong foreign investment inflows drove it to 39.16, its highest in nearly a decade.

This year's fall accelerated sharply in July as crude touched a record above $147 a barrel, the trade deficit widened, and investment outflows weighed.

Traders say that in recent months and days the central bank has continued to support the rupee, which is now at its lowest in two years, has shed nearly 4 percent this month alone and lost 13.9 percent this year.

(Reporting by Anurag Joshi; Editing by Charlotte Cooper)

What this suggests about the relationship between the dollar and the rupee (or any emerging-markets currency) is not Gresham's Law: "bad coin drives out good" or the reverse (as is perhaps more often observed) but a situation where the "good coin" of the dollar and...if you'll excuse me...the "bad coin" of the rupee are made to be one in the same. With a positive flow of dollars behind it, the rupees is as good a coin as any. Everyone wants to be part of that unique dollar situation if they can be. Everyone wants the liquidity that comes from adding that unquestionable "goodness" to their currency.

Do government's decide this consciously? I don't think so. It's simply an evolutionary process. The world needs a standard of credit which is "risk free" and in buying what they perceive to be the closest thing to the thing they want, they make it so.

A virtuous cycle, but as we see with India, the dollars are now flowing out - quickly - and Gresham's Law may be reasserting itself to the disadvantage of the people of India. The learned at Harvard and The Economist proposed all sorts of wonderful solutions Indian inflation in April and I'm sure the large amount of empirical wrongness contained in their proposals will not dissuade them from making them again. But India needs better answers.

We may yet have to dig up Mr. Gresham and get him sorted.

May you live in interesting times

It Begins.

In July of 2003, Didier Sornette wrote this:

A very interesting additional information point is provided by the behavior of the main currencies against the US dollar. We have found unmistakable LPPL signatures of a speculative bubble which is presently developing on the Euro. Specifically, Specifically, the Euro in US$ exhibits a typical accelerating LPPL bubble pattern, which is suggestive of a speculative herding buying of Euros using US$. Similarly, the Euro in Yen also exhibits a typical accelerating LPPL bubble pattern, leading to a similar conclusion. In contrast, the Yen in US$ does not have any acceleration (nor has the US$ in Yen), even if a marginally significant log-periodicity may be observed. These three analyses provide a remarkable message: the depreciation of the US$ is not just the undirected flight-for- safety of a herd fleeing from a looming catastrophe; it seems to be associated with a speculative bubble directed to what is felt (at least on the short- and medium-term) to be the new haven currency, the Euro.

Here's the bubble he's talking about, which is the Euro versus the dollar:

And here's the reverse of that bubble, that I've been talking about, which is the Dollar versus everything:

The euro is a part of that "everything" but there are other big parts - like the Japanse yen and thereupon hangs a tale. This gets a little tricky, but follow me here, because the most-fascinating thing about an LPPL bubble is that you can actually watch people's thinking change as they go through the phases of the bubble.

So back in March, you can see that the dollar was about to make a turnaround. Of wise and prescient Japanese, the Financial Times wrote this:

Japanese savers convert yen into dollars

By Lindsay Whipp in Tokyo

Published: March 18 2008 20:13 | Last updated: March 18 2008 20:13

Not everybody is shunning the dollar, it seems. Since the US currency started its descent against the yen last summer, some Japanese people have been trying to gauge when the currency is cheap enough to start buying back.

During the past few months Japanese banks have seen an increase in the value of deposits in dollars in foreign currency deposit accounts.

At some banks an increasing number of customers have opened such accounts in anticipation of buying dollars at what they consider to be the right time

Wow, were those Japanese ever right on the money!...here's the yen versus the dollar:

By June, the huge bubble of dollars (more dollars = lower price, so it's sort of a "down bubble") had popped. The price of the greenback was roaring back to life, so the Financial Times wrote this:

Risk-hungry investors shun a weakening yen

By Peter Garnham in London and Andrew Wood in Hong Kong

Published: June 16 2008 18:37 | Last updated: June 16 2008 18:37

The yen has weakened 10 per cent to the dollar in the past three months as improving risk appetite and a widening yield disadvantage have led investors to abandon the Japanese currency.

The yen appreciated rapidly in the first quarter of the year as the US Federal Reserve slashed interest rates and the financial crisis intensified.

Here's that Yen again:

Once again, the yen - although it went up really fast - was not *in* a bubble itself when it made that big spike on the left of the chart. But it was *part of* the bubble of everything versus the dollar. Therefore that slope down you see on the right was not an anti-bubble in the yen, but it represents the yen being caught up as a large element of an anti-bubble.

One of the amazing things about anti-bubbles is the predictable, roller-coaster oscillations they go through. We're starting to go through an oscillation in the price of the dollar, and it's starting with the yen. So now - referring to that little upwards hook on the far right of the chart - the Financial Times writes this:

Reversal of carry trade makes a star of the yen

Published: September 12 2008 17:19 | Last updated: September 12 2008 17:19

The yen has been the star performer on the currency markets over the past month as investors have sought refuge from the recent upheaval.

Japan’s economic fundamentals have not changed. Indeed, the authorities are warning of a recession and there is little prospect of the Bank of Japan raising interest rates, which currently stand at just 0.5 per cent.

However, it was the low-yielding yen’s part in feeding the rise in asset prices – which have reversed so dramatically recently – that has boosted the currency.

Carry trade investors sold the yen heavily to fund the purchase of riskier, higher-yielding assets elsewhere.

Now those positions are being reversed as investments are liquidated across a range of asset classes and regions across the globe.

This article represents something so interesting: the kind of argument traders will use to justify their bubble/anti-bubble psychology in "truth" and "objectivity". It's not that these things may not be true, it's just that they don't matter right now. What matters is the psychology of the traders. Right now, the trade of buying the dollar and selling everything else has become too easy. The market was moving too fast. Suddenly the conviction is gone. We have that moment of rest in the roller-coaster the train goes up. There's a break from fear and you can catch your breath. People like this break from fear so the "dollar-down, everything-else-up" psychology will get stronger. Remember, the traders are people who only months ago believed that the dollar would go down forever. The yen will be one of the "explanations" for things "getting back to normal". You can also see it starting in the euro. I don't know what the "explanation" for strength in the euro will be yet, but it doesn't matter. The important thing is that it's coming.

The bewildered panic will reverse for a while. Oil, gold, everything will eventually go up at least a little and the dollar will go down. Everyone will feel comfortable for a moment......

..... and just when they do: whoosh, hands up in the air and everybody yell!

May you live in interesting times