(an email)

>   On Sun, Apr 13, 2008 at 11:41 PM, Craig wrote:
>   Ok. So then it seems to me that it’d be a big change
>   for foreigners to panic on USD assets. Not saying it
>   couldn’t happen, but it’d need a big catalyst. In the
>   mean time, I suppose foreigners will peck away,
>   the dollar will do what it does and purchasing power
>   parity will provide some elastic limits on downside.
>   True?
>   Craig

Ironically, the ‘fundamentals’ of the $ are pretty good – purchasing power parity is good, the govt deficit is relatively small, and the relatively difficulty of getting $US credit helps as well.

But the technicals remain extremely negative (we’ve cut off the traditional buyers) CBs, monetary authorities, and chunks of our own pension funds.

So it’s not so much as concern about ‘foreigners’ in general, but specifically CBs and monetary authorities no longer accumulating perhaps $50 billion a month, and no one else stepping in to replace them, so instead the $ goes to a level where the trade gap goes away.

And that level of the $ can be anywhere, as while the correction process is ‘using’ the level of the $ to get the trade gap to 0, the trade gap is not that strong/precise a function of the level of the dollar.

It’s an example of a ‘cold turkey’ adjustment (the sudden cut off of all the $ accumulators at once) with no prior thought to the subsequent adjustment process, apart from the limited understanding that it would somehow drive exports, and the mistaken notion that exports are a ‘good thing.’

I do think the rest of the G7 thinks the ‘answer’ for the G7 is to convince the Fed to stop cutting rates.

As I mentioned a while back, the Fed has become an international ‘outlaw’ seemingly prodding the world to follow it in an international race to the bottom regarding inflation. It started the game ‘who inflates the most wins’ with their ‘beggar they neighbor’/mercantilist weak/$ policy to ‘steal’ (or maybe in the way the Fed sees it ‘reclaim’) world agg demand and support US gdp with US exports at the expense of foreign gdp.

Now it seems this policy is backfiring. The weak $ has seemingly raised food/energy prices for the US consumer, weakening the financial sector as less income is available for debt service as well as other consumption, and while exports have helped it’s only been enough to muddle through. And US inflation is sprinting ahead as well.

So the Fed rate cuts have not been seen to have helped the financial sector, the consumer, nor the US economy in general.

The Fed is being seen as destabilizing the world’s economy, weakening the US financial sector, depressing US consumer demand, depressing foreign domestic demand, and driving US to dangerous levels.

Once again it seems it’s being demonstrated that weakening your currency and inflating your way out of debt is not a road to prosperity.

And world markets are pricing in further US rate cuts.

Good morning!


2 Responses

  1. Warren,

    Isn’t it also true that the US export boom is less a result of the weaker dollar, so much as it is the cause? Foreigners using the trade surplus dollars they were previously content to save, are now spending them, and the shopping list is sizeable. In this sense, all the dollars we have been exporting for years are coming home to roost, and that explains a good chunck of the inflation we are seeing.

    Ed Rombach

  2. I agree the cause is foreigners switching as a sector from wanting to accumulate $ to not wanting to accumulate them, and therefore spending them.

    However, I see the market forces working differently.

    The first desire is ‘not to save’ which drives the $ down either until the $ is somehow low enough where they want to save it again, which doesn’t make sense to me, or until the $ is low enough for them to spend them here, which makes a bit more sense to me.

    And the other force is the decreased desire to export to us which is evidenced by higher import prices.

    Last, this is all inflationary, and inflation is the other channel for getting rid of a trade gap.

    For an extreme example, if there is sufficient inflation for the minimum wage to go to $60 billion per hour, the real trade gap is suddenly down to only an hour of labor, though still nominally at 60 billion.

    The combination of rising net exports, falling imports, and inflation are all working together right now to digest the sudden shift from cb’s and monetary authorities away from buying $US financial assets.

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