Deficit damns dollar: the new normal (bulls vs bears pt 3)
If you’ve been following this series on bulls vs bears, you won’t be surprised to learn that I believe that we have a front-row seat on a bear market rally. I can give you a long list of reasons why: both prime and subprime mortgage defaults are still growing; commercial real estate is about to rattle banks; debt-laden consumer are busy repaying credit cards, not jump-starting the economy; corporate profits are likely to come from shaving overhead not expansion. That’s not exactly a recipe for a rousing bull market — even if the temporary help market is signaling that the worst is likely behind us . And then there’s this little detail: The last time the market rallied 50% within 24 weeks was during the Great Depression. Back then, the rally pushed the beaten down price/earnings ratio of the market to 5.6. By comparison, after the March-September rally, the S&P 500 looks grotesquely robust with a p/e of 13.4 (click on graph, above, to enlarge).
One year after the economy suffered a stroke I am stunned at how readily everyone expects the patient to jump out of bed as if nothing had ever happened. No limp. No walker. Just an intravenous dose of good ole’ liquidity, and presto! no tell-tale sign of a near-death experience. Early last spring, I launched this blog as The New Wall Street — clearly an act of optimism. New, shmew. For the most part, Wall Street and the regulators are looking like hopeless recidivists. Or ostriches.
Pacific Investment Co. chief Bill Gross wrote not too long ago about a “new normal” in the marketplace. And it’s not a warm and fuzzy new normal that promises a return to the prosperity we have come to expect as a birthright. Baby boomers have been trained to ‘buy on the dip.’ Boomers also subscribed to newspapers that landed on their doorsteps and considered the Walkman a great advancement in civilization — alongside the fax. Buy on the dip? Would it were so simple. The damage to the economy is structural and neither the President nor Congress nor the regulators have shown the will to do what it takes to set things right. No one has shown the imagination to create incentives to help us heal ourselves.
So all this talk brings me to the question of the Big D — the dollar — and that other Big D — the deficit.
The feds raced to revive the economy after the Lehman bankruptcy with pint after pint of dollars, the lifeblood of the moribund credit markets. Congress passes the $787 billion stimulus bill. One year later, the central bank continues to print money and Congress continues to spend as if the events of the past year were a mere hiccup in time. At the Bureau of Printing and Engraving in Washington, DC, ground zero for money-printing, hangs a sign: “We make money the old-fashioned way. We print it.” Someone should have told the feds that it was a joke. Not too long ago, California got into the money-printing business as well, only the Golden State called its scrip IOUs. Fiat money(‘Let there be dollars — and there were dollars!’) is beginning to look like a bad habit.
Wall Street is a confidence game. And so is money. Whoever can command the most respect gets to be the leader of the money pack; and with that comes all kinds of privileges — like issuing the cheapest debt in the world. In the past, the US commanded this respect because it was a leader in matters economic and military. Unfortunately, the US has lost its footing. It’s financial products (where it leads) are about as healthy as the cars coming out of Detroit. Gregor Macdonald gives a withering exposition on the demise of our economy:
The internal composition of the US economic and financial system when it hit 2007/8 was very different than in previous recessions, even the severe recession of 1980/82. It’s this internal composition that’s now determinative, to the outcome. The sawdust of debt, and the monetization of assets rather than the production of goods, continually came to define the internal composition of the system. The economy cannot, therefore, express the same kind of resilience it has done so often, since WW2.
… By the time the US reached the 21st century, our primary manufactured product was debt, and dollars. Is it any wonder that once that system collapsed, that we quickly gave up 100% of the phantom job growth that had been sitting on top of the debt bubble? The current level of employment in the United States has now returned to the levels of June 2000. Enough said.
Investors have taken note of those changes, to say the least. Earlier this year, Chinese investors warned: Get your fiscal house in order, or else. Who wants to invest in Treasury securities that the Fed can simply inflate away (that is, sell today’s debt at 100 cents on the dollar and buy it back at the equivalent rate of 60 cents). That’s one way to make sure the rising mountain of debt remains affordable. Naturally, the budgeteers in Washington assert the burgeoning deficits are not structural but temporary: No need to inflate; the US will earn its way out of this mess. Wall Street has learned its lesson and will behave more responsibly. My kids will never again deposit their socks on the living room floor.
In my view, it is only a matter of time before the dollar loses its status as the global reserve currency. And that is a game-changing event — just as the Internet was a game-changing event for the media. But there is a big difference: The old media is passing but something new and exciting and explosive is replacing it — a cacophony of voices and ideas. The likely demise of the dollar brings no such excitement, at least not to those of us who consider the greenback a source of pride and strength. It is a quiet, wonkish event, a whimper. It’s the backdrop for everything that feels different about the way we live and see ourselves.
Currency expert Ashraf Laidi suggests the dramatic drop in the dollar this year may well be part of a secular change for the dollar. For now, most analysts have argued that the decline in the dollar — a new low for the year vs the Euro — says more about renewed appetite for risk than faith in Uncle Sam per se. Why invest in the dollar when there are all these green shoots sprouting up all over the world? Why not go for the so-called riskier markets with higher returns? But Laidi notes that the Japanese yen is appreciating; the yen usually falls with the dollar when risk players emerge. The disconnect between dollar and yen could be a signal that something new is afoot.
One year after the demise of Lehman and the scariest market plunge since the Great Depression, the dollar remains unchanged. But it’s not unchallenged. This bear market will end in the next year or so; but what emerges, I suspect, will be nothing like the bons temps we have savored in the past. The market breakdown and our response to us has shown the weakness of our system; our competitors and those who do not wish us well have tasted blood and will not go away so easily.
- Is the Euro strong because risk is back in vogue?
Euro graphs from MSN Money Central