Dollar will get no help from the Fed
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Pity the poor American tourist in London. You can see him schlepping across town in his white shoes and shorts; he dares not take a cab for fear it will bankrupt him. Coming out of a restaurant he is white with shock… or food poisoning. He expected to be charged for a meal, not for the national debt. And taking leave of the city, he is on the phone to his lender before he gets out of the hotel lobby – refinancing his house to pay his bar tab. Fortune magazine calls it the “Greatest Economic Boom Ever.” And it is great. But it is great like the Great Depression or the Great War – what makes it especially great is also what makes it particularly dangerous and disagreeable.
The dollar has sunk for the last five weeks straight. Today, it trades at record lows against most major currencies – and record lows against forms of wealth that don’t come from trees. On Wednesday, it took more than 2.05 dollars to buy a single pound, making this the most expensive time in 26 years for American tourists in London. As to the euro, the dollar dropped to its lowest level since the Esperanto currency was launched in January 1999. The Loony – Canada’s own dollar – and the New Zealand currency are at multi-year highs too. Measured against oil, meanwhile, the dollar has scarcely ever been lower; it now takes 75 dollars to buy a single barrel of oil. And against gold, too, the dollar stands near a 27-year low.
There are few things one can forecast with confidence. No matter what you think, Mr. Market has a way of making a fool of you. Many dollar bears lost money during the dollar’s spring rally. On the other hand, few dollar bulls have made money in the long run. Because, one of the surest bets in finance, over the very long run, is that the dollar will fall. The when and how are unknowns; the countertrends treacherous. But the direction and final destination of the buck are almost certain: it will go down until it disappears. In economic theory, as well as in practice, the price of a thing and its quantity vary inversely. This applies to money too. As you grow the supply of dollars, each represents a little fewer goods and services. It takes time, investment, skill and luck to raise production. But it barely takes anything at all to raise the quantity of paper money. Over time, the quantity of paper money tends to exceed the quantity of oil, gold and real wealth it is measured against. Prices of everything go up, except the price of money itself.
There is no mystery to this. Given the temptation to create money ‘out of thin air’, the money-tenders usually yield to it. They give in sheepishly at first; then wolfishly. By March 2006, the big, furry ears and the long, sharp teeth were becoming such an embarrassment that the US government thought it prudent to cover up. The Treasury stopped publishing data on the growth in M3 – the broadest measure of the US “money supply”. But independent analysts keep watching, and they report that the rate of monetary inflation is running at one of its highest levels ever – about 12% a year, or four times the GDP growth rate.
The financial industry has rejoiced in spreading the new, ersatz money around. Fund managers, merger and acquisitions pros and structured financiers have made fortunes lending, securitising, and derivatising it. Central bankers all over the world have run their own printing presses night and day trying to keep up. The resulting worldwide “liquidity” is the greasy bilge upon which today’s prices float. It is what makes this boom so great. But it is also what threatens to soak people when the system springs a leak. Last week, all three rating agencies – Standard and Poor’s, Moody’s, and Fitch – announced downgrades of subprime-linked debt. And this week, Bloomberg says, Bear Stearns told investors in one of its hedge funds that bought CDOs on a leveraged basis that they would get none of their money back. Zero. The fund had bought Triple-A rated bonds, but was wiped out anyway, said Bear’s letter. Just how subprime CDOs, suspicious by-products of a disreputable industry, came to be rated AAA is a story worth telling in itself, but today we will stick to the news. Bear went on to say that investors in the other fund could relax – they had only lost 91% of their money.
As this news hit the street, the indices measuring confidence in collateralised debt dropped. “All but one of the 15 ABX indexes fell to a record low,” says Bloomberg. In the words of one trader, offers for CDOs are going “no bid”. Ben Bernanke might like to boost rates to support the dollar and help US tourists, but faced with a liquidity crisis in the $500trn derivatives market, he’ll have to think thrice before raising rates.
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