More On Lies – Strong Dollar
Courtesy of Karl Denninger at The Market Ticker
10 handles came off the S&P 500 in less than 30 minutes (a 1% move) when the dollar strengthened by about two tenths of 1%.
What would be the impact of the dollar moving higher by 10%?
This is the problem with the carry trade. The leverage that gets deployed, once it gets going, is typically in the range of 5:1, 10:1 or even more compared to the equity markets. (Absolute leverage in the FX markets is frequently 100:1 – in fact, even retail traders can run 100:1 leverage at most FX brokers!)
Just remember folks, ZIRP and it’s pals are always exploited by the politicians to issue debt "free" into the markets. But once issued that debt has to be rolled over (since governments almost never run an actual surplus allowing them to pay down that debt), which means that the issue is not whether you can make the interest payments today, it is whether you can make them tomorrow given the possible changes in interest rates.
If interest expense ever exceeds income, you’re finished, just as was the "buyer" who took out an OptionARM and then had his payment reset to more than his income. Instant Boom.
The same thing happens to nations.
The problem is that nobody knows exactly where the line is, because that debt must be rolled, and it is the future cost of that rollover, not today’s interest rates, that determine where the wall is.
Have we reached the wall? Probably not yet. But if we keep issuing debt into artificially-suppressed interest rates, we will hit it with certainty, and the carry traders are betting (successfully so far) that government will not stop issuing debt (spending more than they make) and Bernanke will not pull enough liquidity to cause short rates to rise by even 1 or 2%.
Better hope all those "ands" and "buts" hold up folks.
(PS, if you think they will: Sold to you.)
Strong Dollar Lies
"His lips are moving."
"I believe deeply that it’s very important for the U.S. and the economic health of the U.S. that we maintain a strong dollar," he said at a roundtable discussion with Japanese reporters. "We bear special responsibility for trying to make sure that we are implementing policy in the U.S. that will sustain confidence not just among American investors and .. savers but investors around the world" that the U.S. will fix its budgetary problems as its economy improves.
Baloney. Geithner, Bernanke, and Obama all have intentionally promoted and created policies have that destroyed the value of the dollar, driving it lower since March of this year from 89.6 to 74.8, a decline of almost 20%.
Why? Because it has produced this:
That’s the dollar and S&P 500. The correlation showed up on a consistent basis (dollar down, equities up) late in 2008, and in March of 2009 the correlation strengthened. In July it became nearly-perfect, and has remained so since, with many days being nearly-perfect even intraday, as I documented yesterday.
What happened in late 2008? The Fed set rates to zero on December 16th. This, along with repeated assertions that began in early 2009 that rates would remain at or near zero for "an extended period of time" caused the establishment of the dollar carry trade – the cause of the inverse correlation.
This was not an accident.
Bernanke and Geithner both watched Japan do the same thing by making the same interest rate move and commitment to "extended period" zero rates, with the same result.
Asian leaders are apparently unhappy with this:
At the Asia-Pacific Economic Cooperation forum summit, leaders will tell the U.S. that "we want a stronger dollar" and a more stable dollar, said the delegate, a senior official of an APEC government. "Nobody in Asia, and only some in Europe, will speak publicly about their worries, but they are worried," the delegate said. "The world — not only APEC, but the world — needs direction and the only country that can provide this direction is the United States. This can only be achieved through a stable U.S. currency."
Asian leaders better wake the hell up. The collapsing dollar is a policy. It is the means by which the stock market has been propped up in an insane attempt to "instill confidence" in "economic recovery" that, on balance, is clearly not occurring. As a consumption-based economy we cannot recover until and unless employment recovers and we replace debt-based consumption with earnings-based consumption.
A weaker dollar makes this impossible, as it destroys earnings power in real purchasing terms, since such a policy will inevitably flow through to the largest inputs we do and must import: energy. Since we cannot fix this at any time in the near future it is impossible for us to create sustainable economic growth in The United States except by strengthening the dollar and forcing (through various policy measures) higher-income jobs back here to the United States.
Instead our politicians are engaged in a puerile confidence game, trying to convince ordinary Americans that "things are getting better" when the Dow goes up 200 points.
But the market rising on the back of skyrocketing energy prices (oil has doubled since spring and gasoline is now back to $3 or higher in many parts of the country) doesn’t create a single job, and in fact ramping energy prices destroy consumer purchasing power, just as if taxes were raised. At the same time "health reform" is threatening to impose a 20% "excise tax" on wage-earners making $100,000 a year, and a 10% "excise tax" on those making $40,000 a year (gross.) This will drive marginal rates for middle-class earners from the 25% range to as high as 40%, decimating end-user purchasing power.
Many Asian central banks have intervened repeatedly in the currency markets in recent months to prop up the dollar and curb their own currencies to bolster their export-reliant economies. But the APEC delegate said such intervention was only a short-term solution and "cannot go on forever."
To those Asian Central Banks: If you really mean what you say dump your dollar-denominated assets, particularly US Treasury Bonds.
Not as a means of "sending a message", but because our government is lying to you, the proof is right in front of your face, and as I have repeatedly chronicled in The Ticker over the last two and a half years our government simply doesn’t give a damn about our balance of payments or for that matter the rule of law.
They will not stop this destructive cycle and thus the Asian Nations must act to protect themselves, the US be damned.
Even an increase of short-term rates to 2% would stop the carry and restore balance. But the longer the "zero rate" policy goes on the harder it gets to do it, and the more-severe the damage. If The Fed waits too long it will become literally impossible to raise interest rates and withdraw liquidity given the outstanding amount of Federal Debt without causing an immediate failure of The Federal Government.
Bernanke and Geithner know this. They also know that if they withdraw the liquidity and put a stop to the carry equity markets will come off their insane P/E of over 130 – perhaps by as much as half.
History says they will not act, unless forced, until backed into a corner, until it is too late and Federal Debt becomes impossible to finance in a proper liquidity and rate environment. At this point we will choose between economic destruction and monetary destruction as the immovable object meets the irresistible force. Who knows which path we will take at that point – both suck.
Look at history – recent history:
Our central bank will buy assets that black letter law says it cannot.
Our regulators and politicians have ignored banks that are clearly underwater to the point that the FDIC loses as much as 50% of a bank’s alleged asset base, even though Prompt Corrective Action, black-letter law, should prevent any such loss from ever occurring. Let me be clear: Such losses can only happen due to massive, outrageous and intentional blindness to willful and intentional mis-marking of assets – that is, accounting fraud.
This very same willful blindness is how we got in this mess in the first place. Intentionally making loans that the banks and others involved knew could never be repaid on the original terms is an outrageous act of asset-stripping of ordinary Americans – the "seed corn" necessary for economic growth.
Our Congress puts forward 1,100 page bills to "fix" problems instead of demanding prosecution and prison time for those who committed fraud, leaving them free to do so again in the future. Our banksters peddled their crap far and wide – including to your very same central banks and investors – that they knew was worthless, as evidenced by the fact that some of them were shorting the very same instruments while selling them to you!
Finally, look again at the above graph. Japan’s carry trade ultimately proved unable to prop up the Nikkei stock market, even though originally it looked real good. We are now seeing the same thing – if you look closely at the right side of that chart you will see that while the S&P 500’s gains on a percentage basis have slowed, the dollar’s losses have accelerated. This is simply due to how compound changes work – a drop from 90 to 80 inflicts less damage (as a percentage) than a drop from 80 to 70.
We are in danger of reaching a "knee point" where the carry becomes self-reinforcing but fails to create asset (stock price) inflation, as the side effects of the percentage move necessary to do so in the dollar will outweigh the "benefits" to the equity markets.
These sorts of distortions almost always go on longer than anyone thinks they can, but as Japan discovered when they unwind the damage to the global economy is severe. In our case if we do not put a stop to this destructive pattern the damage to our economy and monetary system will not be severe, it will be critical – and perhaps irreversible.
