Page 2 of 2 Dollar doing the right thing
By Julian Delasantellis
Starting around 1997, international observers were amazed at a remarkable
six-year experiment that Japanese economic officials were able to get away with
- the 0% real short-term interest rate. Recovering from the bursting of the
1980s stock and real-estate bubbles, while simultaneously dealing with bouts of
incompetent stop-and-go Japanese government fiscal policy, interest rates were
brought right down to their absolute nadir, and there they stayed, right until
late 2003.
By this time, the liberalization of the international capital markets, their
freedom from most forms of government, any government control, had created a
new definition of money. This essentially meant that all monies, be they marks,
pounds, francs, yen or US
dollars, were, since they could be near-costlessly converted from one
denomination to another, basically the same.
The back page of The Economist might be quoting British pound sterling interest
rates at say, 6%, and yen interest rates at 0%, but those who borrowed yen at
0%, converted them into sterling and then deposited them in a eurosterling
interest-bearing account had British pounds created out of thin air, but still
paying a very real 6%.
This strategy, called the "carry trade", became wildly popular during the boom
times in the middle of the decade. It was almost as if the private sector had
discovered its very own liquidity creation machine, one that, unlike
traditional monetary policy, did not have to share the throttle with the
government. Many observers (including this one) believe that it is was industry
generated facilities such as the "carry trade", along with the incredible
amounts of leverage applied to mortgage and other asset-backed securities, that
generated the liquidity that rolled and amplified the boom times right into the
current catastrophe.
The only drawback of the carry trade was if the funding currency, in this case
the yen, rose in value against the currency of whatever you were investing the
yen converted funds in before the trade was closed. If the funding currency
rose far enough and fast enough, easy profits could turn into humongous losses
very quickly. This was why, on days when somebody in the markets would float a
rumor that Japan was about to raise short-term interest rates, one frequently
saw sharp, violent selloffs in world stock markets, and concomitant rises in
the VIX.
Japanese interest rates are still very low, but now they're not alone. For 11
months now, US short-term interest rates have essentially been at zero; the US
dollar is now replacing the yen as the great carry trade funding currency.
On October 28, the Financial Times reported that Lou Jiwei, chairman of the
China Invest Corporation, China's sovereign wealth fund, warned that what he
called "small bubbles" were developing in various world asset markets.
This is the new dynamic of post-immediate crisis world capital flows, as the
now US dollar carry trade transmits liquidity generated from the zero US
short-term interest rates to the rest of the world. The flow hasn't reached
everywhere yet; for instance, it's not providing much relief to beleaguered
financial systems in Latvia or Iceland, nor is it helping much with the grubby
paws of tight-fisted bankers still withholding vital operating capital from
small businesses in Heartland, USA.
But it is unquestionably acting to reflate asset markets worldwide, just the
same way it did during the boom. During the long-ago presidential campaign,
Barack Obama was cheered when he called for a new type of economic growth and
jobs more centered on real economic production rather than financial
legerdemain; these days, with the stock market rally the only good card he has
to play among a seeming whole deck full of deuces, he'll undoubtedly take, and
take credit for, all the help he can get.
This is why a policy that aims at reversing the dollar's slide would be so
counter-productive to this newly developed system. Many observers have noted
that it is not at all uncommon lately for world stock markets and the dollar to
move in opposite directions, in that stock markets rise when the dollar falls,
and vice versa.
The above analysis provides the reason: on days when the dollar falls, the
dollar carry trade is even more potentially profitable, so more do it and then
use the proceeds to buy more global stocks. But should the dollar rise, the
carry trade will shut down (as it did during the dollar rally that accompanied
the worst of the equity market meltdown up to last March) and, once again, the
world's markets will be lefty high, dry - and broke.
It should also be noted that, even independent of these financial market
innovations, the dollar, the currency of a country in deep economic distress
but still running trade deficits of over $30 billion a month, with zero
interest rates, should be falling; that's what the rules of the floating
exchange rate regime adopted from 1971-73 dictate.
In the old days of the global gold standard, trade accounts would be settled
with the deficit country paying the surplus country the amount of its
profligacy every month in gold. At present rates of exchange, that would have
about 800 tonnes of gold steaming away from America to the Old World every
month.
But for Rupert and his media researchers, for the Republican pollsters such as
Frank Luntz and Alex Castellanos practicing the black art of the focus group,
the economic arguments against dollar fearmongering matter little.
Like veritable Hannibal Lechters of the American political brain, they've cut
through all the outer layers of protective fluff and defensive balderdash to a
core fear of the Middle American psyche, that a strong dollar, just as much as
a strong army or navy, is in reality just another protective fortification
defending the nation against smelly foreigners with cheap phrase books whose
kids want to use your establishment's restrooms so as to leave behind the most
unimaginably fierce and uncivilized fecal microorganisms; also, against the
howling hatreds and incivilities of a world that, for reasons that America
still can't understand, frequently just seems to hate it.
"Sure," the country thinks. "We may bomb and pollute and change the trade rules
when and how we please, but why do they have to take it so personally?"
So, if in the near future you find yourself in possession of a publication like
that found by Ricardo, my advice would be to conquer your fears and turn to the
pictures. Better to risk your soul tomorrow than your wallet today.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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