Monday’s WSJ brought a front page article that made me LOL at the hypocrisy. The sub-headline was all it took. The article in question is “China’s Blunt Talk for Obama” and the humorous sub-headline “Regulator Says U.S. Policy Puts Global Recovery At Risk as President Arrives in Beijing”. What specifically is so funny? Let me quote:

“Liu Mingkang, chairman of the China Banking Regulatory Commission, said that a weak U.S. dollar and low U.S. interest rates had led to “massive speculation” that was inflating asset bubbles around the world.”

Wow. Really? I suppose what really amazes me is that anyone can speak such hypocrisy with a straight face. Just today, a Bloomberg article, discussed what the Organization for Economic Cooperation and Development (better known as the “OECD”) had to say about China itself:

“Credit conditions may need to be tightened to prevent the emergence of inflationary pressures and asset bubbles.” – OECD

The truth is so powerful, I won’t even bother adding my usual emphasis to the quotes below. Quoting from the Bloomberg article:

“China is among the emerging markets facing risks of property and commodity market bubbles, central bank adviser Fan Gang said yesterday, joining officials from the region in expressing concern about surging asset prices.

Asian economies from Hong Kong to Singapore are fighting rising property values, which threaten to mimic the U.S. mortgage bubble that roiled the world economy.”

Also:

“Rising residential prices are “abnormal,” Dong Zuoji, director of land planning at China’s land ministry, said last week.”

And:

“China’s decision to fix its yuan to the dollar since July 2008 may increase inflationary pressures” the OECD said.

Yet, as President Obama visits China, the Chinese ignore all these facts and proclaim that the U.S. response to the crisis is the problem despite its own actions including a $586 billion (that’s dollars) stimulus program and a $1.3 trillion (again dollars!) credit program. Now, if that ain’t propaganda, I don’t know what is.

Would someone please explain the security procedures that banks and other financial institutions implement? I happen to run into a “verification process” quite frequently. This normally entails answering a series of questions. You know, questions like “what city did you get married in?” or “what is the first name of your paternal grandfather?” There seems to be about 15 standard questions used by financial institutions, not all of which are used by each. My problem with these has to do with a lack of understanding exactly how they are supposed to protect me.

When I call a financial institution, my favorite is the old “would you please verify your home address for me?” As if a criminal wouldn’t have the easiest piece of personal data to find at their fingertips. Puhleaze! That one is so simple and fast it requires no forethought- just a Google search in real time. Now consider the typical “what high school did you attend” question. This isn’t secret or private information by any means. A bit of googling or facebooking and you have the answer. Similarly, it doesn’t require much of a fishing (phishing?) expedition to uncover a maiden name or child’s name. So what’s the point? The standard answer I’ve been given is that it makes it “more difficult” for the crooks. Sure, but they are crooks. It’s like putting an extra wrapper on the box of candy to keep the fat guy from being tempted- it takes an extra second, but he’s still going to eat the candy. They are intentionally stealing identities and one more informational hurdle isn’t going to stop them. After all, they managed to track down a sufficient amount of the victim’s info such as social security numbers and birthdates anyway. This is sort of like saying if we just had more checkpoints at the border, it would stop drug use.

There are some questions, such as the “name of your first pet” which I admit are more difficult to find. However, once you start providing this information to institutions, it becomes part of each company’s profile of you. If they get it from one institution, it works at the others too. The more places that ask for this info, the easier it is to be stolen and the more likely it is to be used. Pretend one of your financial institutions, XYZ Credit Union, loses data. The criminals can take the name of your first pet and use it on your American Express account too. Seems like an enormously weak link to me.

Any customer service agent can get such data as can hackers and criminals actively seeking it.  What is to stop a customer service agent from scribbling down this info during your routine call inquiring about an unknown fee for example? I’d like to think it is a brainless, secure computer safekeeping my personal answers, but in reality any customer service agent can see it when you call. Writing it down is a low tech theft for sure, but every time one of these individuals help me, they see my “secret” answers.

Equally unnerving is when I recently opened a new account online at a financial institution I’ve never worked with before. In order to verify I was who I claimed to be, it asked me “which of the following vehicles have you owned recently?” On the list was a vehicle I owned three years ago for which I paid cash. There was no loan on record that could have possibly been pulled into my profile. Where did this data come from? Old motor vehicle registrations? In other words, if a completely unrelated record could be pulled by the financial institution to verify me (with no right or legitimate related business use of that data), what is to stop a criminal from pulling data to impersonate me?

All this work to annoy people in the name of security. Yet to my eyes, it does little if anything to bolster security. In my view it actually weakens security since one key fits multiple locks. Alas, I am certainly not a data security expert. So tell me, what am I missing? Am I wrong or is this an absurd waste of time in the name of a false sense of security?

A few months back The Long Run blog’s founder Brett Spurr was in Vegas and observed an interesting economic phenomenon: while hotel room prices were at all-time lows, food was now pricier. So a hotel room at a major hotel might run you $50 a night but the Coke machine on your floor is now charging double. The old “if you can’t make it in popcorn, make it in peanuts” strategy.

Brett cautioned his observations were purely anecdotal. I thought I’d follow up on Brett’s intriguing observation by wrangling my connection¹ with Vegas local Michael Goudeau (former co-host of the Penn Jillette Radio Show and an occasional panelist for the yearly The Amazing Meeting) and get his observations about how the down economy is affecting what is surely one of the most interesting local economies on earth.

Karl: Let’s start with Brett’s observation. Being a Vegas local have you noticed food in the touristy areas getting pricier?

Michael: I haven’t noticed that. If I’m in that little room near a Coke machine in the hallway of a hotel it’s because I’m hiding from security.

Actually, when I came to Vegas in 1983 there were a million super cheap dining options. Steak and lobster was a buck and most of the buffets were incredibly inexpensive BUT you couldn’t easily get great food here. The food sucked. Super sucked. Now Vegas has almost all of the big names in the chef industry here with their own restaurants. Even the buffets at many hotels are now great. The food is now incredibly good but expensive.

The tickets prices for shows have also gone way up.

The original intent was that a show or inexpensive food would draw people into your hotel and they would gamble. It wasn’t important to the hotel that Sinatra cover his costs. He drew people into the casino, they gambled while there, and, since this is the land of bad math, they lost. Those losses were the reason tickets and food used to be inexpensive. Hotels don’t seem to operate that way any longer. The food and the shows must make more than the costs to run them and so prices reflect that. I don’t know if that’s a better way to run things or not but it is how things are currently done.

Karl: Your day job is working as a staff juggler for a magician at a major casino?

Michael: Actually, it’s a night job. I’m the featured act in the Lance Burton, Master Magician show. We have shows Tuesday through Saturday night at 7 PM at the Monte Carlo Hotel.

Karl: Gambling, of course, is what Vegas is known for and I guess the town will always have its core constituents: people trying to save the family business at the roulette table. But it strikes me that the big shows like Lance Burton, Penn & Teller, Mac King, and Carrot Top are shows that depend on tourists leaving the slots and being a bit more free with their money. How have crowds been since the downturn last year?

Michael: There has been a definite slowdown in ticket sales. Vegas has busy and slow seasons. During the busy season, because the show regularly sells out, things are still pretty close to normal. During the slow times there is a noticeable drop in show attendance. This week it seems a little busier, but since we’ve done only one show so far this week that is incredibly optimistic. By 8:30 PM tonight my financial prediction may be crushed beyond recognition.

Karl: You don’t have to name names, but you circulate with some of the richest show people in Vegas. You made a funny observation once that your children’s friends all have parents who have their images on big billboards that line the road to the airport. Have you noticed the down economy affecting them (the rich parents, not the little kids) at all?

Michael: Many of the “big” acts make a reasonable part of their money performing for corporate functions. Everyone takes off and performs for annual “We Are Giants, Inc.” business meetings. Those meetings, because of stupid comments made by many sources, have been scaled back and that affects everyone who performs at those shows.

I should explain my “stupid comments” stupid comment; we need people to spend money to have an economy. Someone said the rich should stop flying jets and having parties because it looks bad. That idea is INCREDIBLY stupid. That means that everyone in the jet, party, hotel, restaurant, entertainment, and every other industry that supports those things, and everywhere the people who work those things spend money get screwed. If the people who have money to spend are made to feel embarrassed about spending, then they don’t. Who the hell does that help?

Karl: Several years ago when you were co-host of the Penn Radio Show, you and Penn noted an interesting disparity between jugglers and comedians. Stand-up comedy for most comedians is low pay and it’s hard to get a regular job. But if you make it, top comedians are among the richest entertainers in the world. Jugglers on the other hand can usually find gainful employment but there are no rich jugglers. Is that an accurate assessment of your line of work?

Michael: That’s pretty accurate financially. If you were to star on a sit-com you might make great money for a year or two but then, well, does anyone know what Balki is making these days? Many jugglers make a pretty good salary every year. I don’t know how the math works out in the end. It seems like it might be a push.

Comedy juggling is a really fun job. Many jugglers make a comfortable living AND they do it doing something they love. I make a good salary and I have very short actual required work hours. I say “actual required” because juggling practice or writing are things that I can do anytime I feel like it. If I want to spend the day playing with my kids instead of practicing I can usually do that. I have a great deal of freedom to spend my day how I want. Right now my kids are on a “track break” at their school and they’re off for a month. I’m going to spend a lot time every day doing things with them. I have projects I could and should work on but none of them are time restricted. I hope none of the people waiting on me read this.

Karl: Lately you’ve taken to helping train a new generation of jugglers at UNLV. What’s the deal there?

Michael: I met a juggler/magician/college student (Jacob Jax) at a skeptic convention here in Vegas and he was just starting at UNLV. He asked if there were a juggling meeting in town. Jugglers often practice together to share tricks and hang out. My wife takes classes at UNLV so we decided to set up a juggling group. Now, every Tuesday at 10 AM (The time and day are for this semester. It will probably change next semester) a bunch of jugglers meet outside the student union and juggle for an hour and a half. I’m teaching them to pass clubs. Before a hang glider injury forced me into a solo act I was part of a juggling “team.” I’m a pretty lousy solo juggler but a very good club passer. I’m having a blast juggling with other people.

Karl: You’ve been with the Lance Burton show for more than a decade and in the middle of the worst economic downturn since the Great Depression, it was looking like Lance might retire. You quipped at one point that you’d be back in the job market for the first time in a decade. Was that a frightening prospect?

Michael: Before I was in Lance’s show unemployment meant a vacation until someone called me and asked if I’d work again. I would get in a van and go on a rock climbing expedition to Yosemite or to an island in Caribbean and live like a monkey until I had to go back to work. Since Lance hired me I’ve had gainful employment for 18 years. I’ve been lulled into the sense that juggling is a regular job. I forgot that comedy jugglers are an ethereal, non-essential part of everyone’s life. Now I have kids, and a wife, and a house. I now fear unemployment. My family doesn’t see the appeal of living out of the back of a van or hunting and gathering on a hot and humid island.

Since there was a chance the show would close, suddenly I needed a good web site with videos and photos of myself. I might even have needed an agent. I haven’t had those things in 18 years. I’ve been booked solid so I didn’t need them. I’ve got them now. (Except the agent. Anyone know a good agent? For those of you unfamiliar with agents, insert your favorite lawyer joke and replace the word “lawyer” with agent.)

Under the best circumstances I’d get jobs on cruise ships and at comedy clubs and state fairs. That meant that rather than this cushy life of watching kids on track break I’d be on the road. I honestly love working cruise ships and comedy clubs and state fairs but I don’t love being away from my family. I was really scared that I’d miss my kids growing up. Fortunately Lance signed a contract extension. It looks like I’ll get at least a couple more years of enjoying my family life. Once again I’m free to take any of those jobs as a temporary break from my routine and see them as positively delightful experiences.

Karl: You didn’t plan to be a juggler, you actually went to university to be a forest ranger. When was the last time you worked what many would consider a “regular” job?

Michael: I think the answer is never. I started doing shows on the street in San Francisco and at Renaissance Fairs when I was 16. I’ve done shows continually since then. For a short time I did run a movie theater. I was 18, but even then it was a family owned movie theater and there was no one else there. I sold tickets, made popcorn and sold candy, then ran upstairs to start the projector. It was old carbon arc projectors so I had to run up and change projectors every 20 minutes. It was the closest I’ve come to a “regular” job. I quit because I needed to be free to book juggling gigs whenever they came up.

Karl: Besides juggling for Lance, you do a really wide range of things. You’re head writer for Penn & Teller’s Bullshit! Showtime series. Sometimes you’re in Europe juggling on French TV. Sometimes you’re on a Japanese cruise ship performing your act in actual spoken Japanese. What else do you do? And why do you do it?

Michael: Part of the joy of a steady juggling job is that I’ve got the time to do crazy things. I’ve been stupid lucky to hook up with Penn and Teller. They’ve allowed me to write for them on a TV show that really means something to me.

I do a reasonable number of trade show gigs. I juggle on a trade show floor and talk about someone’s product or software. If you’ve got an “unsexy” product like a new protective metal box or something complex like nutritional analysis software you can hire me to juggle at your booth. I do a show and explain the product while keeping people laughing and entertained.

I perform at corporate events when a meeting needs something to wake people up or just to get them laughing.

I sometimes do shows like the Japanese cruise you mentioned when it sounds like something fun to do. Like most people I love to break the regular pattern of my life temporarily. I often do shows that are more work and don’t pay as well as my “regular” job just because they sound like fun. I think part of what makes me a successful comedian is my very serious commitment to fun.

I’ve done shows in Japanese, Spanish, French and Hungarian because it seemed like a fun challenge. I’ve stood on stage and tried to seem casual as I read lines in other languages that I’ve written on my arm with a Sharpie.

As long as we’re talking about the crazy stuff I do, somehow I also write speeches for people who want something more exciting than the usual. Thanks to a friend’s recommendation I am now the speech writer of choice for transplant surgeons. I do other professions too but for whatever reason the transplant surgeons have been my most regular customers. I think they’re busy saving lives so writing speeches is something they’d rather pawn of on a monkey. I am that monkey. I have always been a cheerleader for science and so I am SO excited to get to do something that makes me feel like I’m on “The Team.”

– Karl Mamer
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¹Disclosure: I develop Michael’s web site.

A couple of noteworthy items made their way to my attention this week and unfortunately both are sad. Let’s start with our official paper of record, The Wall Street Journal. Yesterday, the WSJ featured a 6-column article on the top of page 2 about the Fed’s “Path to Higher Interest Rates”. The article goes to great lengths speculating about how the Fed will raise rates when it ultimately decides to do so. Not only did I waste a few moments of my life reading this useless piece, but my only response was, well, “duh!” More precisely, many many “duhs”.

Why so harsh on this article? Well, Hilsenrath (the author) begins describing that the Fed will “eventually” have to raise interest rates. Duh #1. Then comes the premise of the whole piece in paragraph two: “What will a Fed tightening cycle look like? When will it begin?” And the answer in the very next sentence “Fed officials don’t have answers to either question yet”. Gee, thanks for the insight. Duh #2.

Hilsenrath goes on to say the economy isn’t strong enough to raise rates yet (duh #3) and that this tightening cycle won’t look like the last one (5 duhs for that). He spends a great deal of time expounding on how hard it will be to communicate intent, how little we know, how the market’s reaction may be important and then that it won’t be important. By two thirds of the way through and fifty “duhs” later, I was feeling like Homer Simpson in one of his painful “doh” chain reaction moments. For the creme de la creme of duhs, the chart in the center of the article displays the last tightening cycle with the caption (emphasis mine) “When the Fed starts raising its federal-funds target rate, it may not follow the same pattern as the last time it tightened monetary policy.” Well, thank you Captain Obvious.

———————————-

What put me in a mood critical and irritated enough to write nasty things about WSJ articles (from authors I usually like) was The Truth Twister alluded to in the post’s title. The AP reported what former GOP presidential candidate Mitt Romney had to say about Obama’s economic stimulus plan. Since Romney isn’t a name I’ve seen or heard much in the past twelve months, let’s recall that Mitt worked for a prestigious management consulting company before running a private equity group. These credentials were supposed to enable Mitt to lead like a CEO or businessperson instead of a politician. Clearly, Mitt was a credible, financially literate soul who could be trusted to tell it like it is and make decisions based on economic merit rather than political goals.

Such lofty expectations is why I award him the Truth Twister of the Week award. What did Mitt twist the truth about? Well, according to the AP article, Mitt says it is time to stop the stimulus program because the plan “didn’t work”. As evidence of his twisting, I submit to you the latest GDP report from the BEA (Commerce Department).

If you recall, each quarter’s GDP report comes in three reports, an “advanced” report, a “preliminary” report and the final report. You may have already guessed correctly that as the data comes in, more accurate calculations are made and the report is revised. Last Thursday’s report was the “advanced” or first, raw, estimate.

Moving along, what did the report tell us? Well, GDP grew at an annual pace of 3.5% from the second quarter to the third which was above the consensus estimate of 3.2%. That should be good news right? The stock market didn’t like it much and here is why: it doesn’t look as though this performance was possible without the stimulus. Let’s take a closer look. Of the 3.5%,

• 1.7% came from motor vehicle output, courtesy of “cash for clunkers” (which spurred 700,000 unit sales)
• 0.5% from residential construction (breaking a 14 quarter losing streak), courtesy of the 1st time homebuyer tax credit universally acknowledged as sparking buying at the low end of the housing market.
• 0.6% from increased Federal government spending

These add to 2.8% of the 3.5% or fully 80% of the increase in GDP due in some way to the stimulus. (The rest came from a small inventory build, most likely as a result of simply low stocks, seasonality and some multiplier effect from the auto build). As a gut check, consider that $173 billion has been reportedly spend so far. Let’s say $125B was in the 3rd quarter. On a $14.1 trillion economy, that works out to a 3.6% annual rate. Net imports subtracted 0.5% this quarter, which calculates to about 3.1% growth. Pretty close huh?

All of this means, that sans stimulus economic “growth” was anemic at best. The silver lining might be “stabilization”, not growth, for the private sector. As for Mitt, he certainly isn’t above twisting the truth to make a political statement. It would be naive to expect differently I suppose.

The first two parts of this series dealt with the reasons the dollar is not about to collapse, but could the dollar weaken anyway? The short answer is a resounding ‘yes’. The dollar’s value will fluctuate and it may even decline fairly significantly in value as a result of all the recent monetary policy. However, hyperinflation is not in the cards, nor is an outright dollar crisis.

Take a look at the Real Trade Weighted Dollar index. This index maintained by the Fed weights the various exchange rates by the amount of trade conducted in each country. Thus, it is a good representation of the supply and demand for dollars as priced in a basket of currencies. I am specifically choosing the real index as opposed to the nominal index because when inflation various between countries, the effect on the index can be one of massive distortion. Fortunately the Fed has made the appropriate adjustments in the real index presented below. (If you’d like to see the nominal index, you can here. It can either be interpreted as a massive bubble in the dollar popping or as a fairly meaningless chart. I submit it is the latter because the value of the dollar actually fell quite a bit when Nixon closed the gold window ending the Brenton Woods paradigm of fixing the dollar to gold. That devaluation is not reflected in the nominal index at all).

As you can see from the chart above, the dollar has recently gone through two mini-bubbles. The first was in the 1980s. As then Fed chair Volcker raised rates and broke the inflationary spiral, real interest rates remained unusually high (a “real” rate is the interest rate in excess of inflation). High real rates make a currency attractive and the dollar entered a bit of a boom.

Beginning in the early 1990’s, the dollar entered its second mini-bubble. As American conspicuous consumption ramped up along with the tech bubble and demand for US tech stocks, the dollar gained considerable strength. At the time, it wasn’t viewed as an overvaluation in part because Clinton’s Treasury Secretary, Robert Rubin, proclaimed a “strong dollar policy” as desirable while China and Japan began keeping the dollar artificially strong in earnest.

It is the slide down from that height that appears so dramatic. However, as you can plainly see from the chart, the current value is not in any way new territory. The dollar has been here before, for considerable stretches of time, without unraveling the world.

Consider that when the dollar weakens, it forces other countries to stop depending so much on the American consumer buying their exports. A more balanced, healthier and growing global economy should result. A weak dollar is part of the solution and it is being reflected accordingly.

How low can it go? That’s hard to say. It could certainly get weaker, particularly since the nominal exchange rate value is still quite high. And it may stay down for some time. The major adjustment so far has been against the Euro, when the bulk of our trade deficit is with Asia, which leads me to believe the index won’t bottom until China (and other significant Asian exporters) allows the currency to trade more freely, something Chinese leaders are loathe to do.

Another very bad outcome for the dollar may happen if Congress starts dismantling the Fed’s independence and/or doesn’t reign in long-term deficit spending. (The Fed is technically independent of both the President and Congress; a few years of large deficits are ok, but watch out if Congress can’t get control of it). Be wary of any politician that thinks the Fed is the problem.

However, an Icelandic experience (the country went bankrupt and even McDonalds closed their stores there) or Weimar Republic style inflation is so unlikely that I’d call it nuts. (Don’t hold me to that in 50 or 100 years though, I’m talking about in the next decade).

So what happens if the Chinese stop buying our debt? Let’s start with a some perspective: China currently owns about 11% of all the outstanding U.S. Treasury notes and agency debt (Fannie, Freddie, etc). While this is a large, significant and growing proportion, it is hardly enough to consider the Chinese our economic masters. Consider that the UK, Cayman Islands, Luxembourg, Belgium and Canada collectively own twice as much as the Chinese. Indeed, Japan alone is still our largest creditor holding a little more than the Chinese.

Perhaps even more important than the relative size of the Chinese or Japanese or whichever creditor’s position is why they have lent us so much and why that isn’t likely to change overnight. When a country imports a lot more than it exports, the importing country’s currency should fall. For example, when we buy something made in China, we pay in dollars. The Chinese seller doesn’t want dollars, so they must trade the dollars for Yuan. If China is accumulating dollars because we are buying more than we export, then the Chinese will have lots of dollars to sell. All that selling will cause the dollar to weaken and fall. As the dollar falls it can buy less and consequently we can’t buy as much from China as before. Now, China’s number one goal is to grow fast and employ as many peasants as possible. In order to keep growing, the Chinese central bank manipulates the exchange rate (by buying our debt) so the Yuan doesn’t rise too much relative to the dollar. This keeps the dollar artificially strong and Americans buying cheap Chinese goods.

Given that the U.S. consumer is the ultimate destination for most of China’s exports, the Chinese are dependent on our buying. The last thing the Chinese want is for the dollar to weaken so much that we stop buying from the Chinese. This is precisely why China has recycled all those dollars into our debt- it is a safe place to park those dollars while supporting the exchange rate so they can continue to grow. Japan and other countries have also followed a similar strategy. (Now, there is another issue not addressed here, which who is going to buy all the debt to be issued in the next few years. We’ll address this next time as it does not relate to China specifically.)

Can the dollar lose its reserve currency status?

For the sake of discussion, let’s assume something goes awry and the world decides it wants another reserve currency in lieu of the dollar (which will happen someday). Replacing the dollar as the world’s reserve currency is not as simple as a central bank committee making a choice between this or that currency. A “reserve currency” is a currency that is held in significant quantities by governments and central banks to help stabilize their own currency. For example, in most systems currency is an obligation of the central bank. Here in the US, our bills say “Federal Reserve Note” on them. The note has value because we trust that the Fed has the authority and assets to keep those bills valuable. People aren’t so trusting of smaller countries and their money however. A country like Brazil or South Korea will occasionally have to “defend” their currency. They are able to “prove” it has value by showing that the bills are backed up by more than just a promise; rather those bills are backed up by a giant vault of cash from another country. The value of the foreign money can’t be tinkered with and so it “backs up” the home country’s currency.

64% of the world’s official reserves are currently in U.S. dollars. If you are a Brazilian, South Korean, Yemeni or Indian central banker for instance, what currency are you going to hoard in order to protect your own country’s money? You’d look for a currency with a giant, liquid market so it can always be traded. Since that reserve currency needs to be secure, the country must be able to defend itself and its interests regardless of what happens. No one holds the Ukrainian Grivna as a reserve currency, because who knows if they will be around in a few years? Or if Russia decides to cut off their natural gas, what can the Ukraine do to protect its economy? A reserve currency must also hold its value because the country issuing it is an economic powerhouse. Despite bumps and potholes in the road, does the country have the stability, natural resources, economic system and culture that will enable it to be and remain prosperous in the long run?

The answers to all these questions point only to the United States. Is a central bank going to trust the Chinese, who are command and control communists that regularly manipulate their currency? Or the Yen, when the Japanese debt is double the amount of ours, the population is shrinking and they can’t defend themselves? The Russians who play energy politics? Maybe the Euro is the alternative- and indeed it is- the Euro is roughly 27% of the world’s reserves. However, the Euro is really just an experiment, not a currency. It is not supported by one country or government; its member states have wildly different agendas; the European Central bank was more or less powerless to help European banks during this crisis; and let’s not forget that the Europeans have never gotten along with each other for more than a half century or so. In sum, reserve currencies are born, not agreed upon. The U.S. dollar is the only currency that can currently serve this role and its position has actually increased since the crisis began.

Next up: Part III: Can the Dollar weaken anyway?

We hear many prognosticators talk negatively about the dollar (I call them “dollar bears”). Some predict the dollar will get so weak it will crush the economy, cease to be the world’s reserve currency, and drive interest rates to double-digits. Some even talk about Zimbabwe or Weimar Republic style hyperinflation due to the all the money the Federal Reserve is “printing”.  These fears are overblown and unrealistic in my opinion and I’d like to take a moment to explain why this is not something we should fear. Since this is an extensive topic, I will break it into several parts.
The “falling” or “weak” dollar hypothesis is based on several items in particular. Reasons include that the Chinese will stop buying our debt; that the Fed is “printing” money which will result in hyperinflation; and how massive government deficits will scare lenders and cause higher interest rates. Let’s examine these in more detail.

The government is just “printing” money
This was discussed in a recent post. Aside from the Fed creating large reserves which aren’t being translated into the money supply, they are also engaging in “quantitative easing”. One way to increase the number of currency units (dollars) in circulation or “get more dollars out there” is to actually “print” bills like $20s or $100s. In eras gone by, governments actually used to run the printing presses and create money. You may remember pictures of Germans in the 1920s carrying wheelbarrows full of money just to buy bread.

Today, money is “printed” by the Fed simply by buying bonds and other assets from banks. When they buy a treasury note, they credit cash to the bank. The bank then has excess reserves which it can lend out and increase the amount of dollars in the world. This process is sometimes referred to as “quantitative easing”. Currently, quantitative easing is NOT increasing the money supply.

What about other countries also printing money?
The UK, China, Japan and even Switzerland are also printing money (with others like Canada, Sweden seriously considering it soon). If everyone grows their money supply at the same time, we might get some inflation, but the relative value between currencies ought to remain about the same. If there are 1,000 dollars and 500 pounds in a hypothetical world, we have an exchange rate of $2 per £1. If both countries print 50% more currency, we have $1,500 and £750 which is still $2 per £1. A dollar might be worth less, but it will still buy the same amount of foreign stuff. As someone said recently (and my apologies to the witty originator of this) “the dollar is the worst currency, except for all the rest”.

What about all the printing plus all the debt our country is borrowing?
The Fed has expanded its balance sheet about $1.3 trillion and the Treasury is borrowing another $1.8 trillion this year. So the country is trying to expand its spending by about $3 trillion. In 2008, the stock market lost some $6 trillion and housing has another $6 trillion since 2007. That is $12 trillion in wealth destroyed compared to a hoped for creation of just $3 trillion. We’re still left with much less money than before. Yes, budget deficits can be problematic for the dollar but aren’t sufficient to cause its decline on their own.

Next up: Part II, the Chinese and the Dollar

Many commentators still seem to be screaming that hyper-inflation is around the corner. The crux of their argument is that the Fed has pumped hundreds of billions into bank reserves. There is a chart circulating, which you may have seen, illustrating this explosion of credit. After all, reserves normally translate directly into fresh lending. I have reproduced the chart for you here:

It is a scary chart, I admit. The inflation fear-mongers forget several things though. First and foremost, reserves don’t become part of the money supply until loans are actually made from those reserves. So how are we doing on that front? Well, the Fed reported consumer credit yesterday and it was dismal despite “cash for clunkers”. Total consumer credit fell, again, and has contracted some 4.6% since its peak. For the record, it hasn’t declined more than 1.8% from any peak since WWII. Take a look:

Might those reserves be lent to businesses instead? Well, here is a chart of total loans and investments at commercial banks- in other words, this is lending to businesses:

No loan growth there either. This makes perfect sense when you stop to think about it. All banks care about (or should care about) is how likely they are to have their loans repaid. Aside from credit bubbles when banks act like drunken sailors, that is all they need to figure out. In an economy this bad, the most credit worthy borrowers don’t want more debt, nor do they need it. The less credit worthy are too risky, so less lending takes place. On the business side, what business is eagerly borrowing to finance expansion? When consumers are clearly retrenching, global trade is slowing and massive uncertainty about growth prospects remain, who is going to borrow in order to expand? Companies are in survival mode and are using cash flow to maintain their business or even shrink it. Without demand for loans from credit worthy borrowers, lots of new loans are not going to be made.

This scenario is what a develeraging cycle is all about. It is by its very nature deflationary. As I have written about before, deflation is your worst enemy. Those screaming about inflation seem to ignore this dynamic. It is also this very deleveraging cycle which helps cause velocity to fall. For everyone’s sake, you better hope the Fed can create some inflation before serious deflation takes hold.

“Cadbury shareholders stand to lose out massively” is the language a shareholder has used in suing Cadbury to reconsider the Kraft offer. More specifically, according to a Reuters story today:

“Cadbury shareholders stand to lose out massively if the Cadbury board continues to refuse to negotiate a transaction with Kraft,” the lawsuit said. “But Cadbury’s board stands to lose its lavish compensation and positions of power if Cadbury is sold.”

And there you have it. Either this shareholder reads TLRB or more likely came to the conclusion that I hypothesized: management has a lot to lose when the company gets sold, while shareholders have a lot to gain. The agency dilemma is alive and well. I for one have my popcorn and comfy chair ready to watch as the Kraft-Cadbury saga gets even more interesting (to me at least).

Brett is probably too shy to toot his own, but I interviewed him about China, money, the gold standard, and trade on my podcast The Conspiracy Skeptic. Not much conspiracy talk, just some econ 101 stuff:

http://www.yrad.com/cs/
http://www.yrad.com/cs/feed.xml

Anyway, enjoy. I think I know why he’s successful as a fund manager. He’s got a very calming voice.