I had some interesting phone conversations today with local mfgrs who import a lot - they are keenly aware of the dollar. Most haven't seen a large swing yet because almost all the stuff they get is from Asia (so a weighted average of RMB & Yen makes more sense than that a weighted index per se)...

This is going to have an effect... its a lot like Plaza with the Accord... We'll see it in both domestic activity and also inflation. We'll know its kicking in without looking at statistics... our wallets will tell us. My guess is the want ads will also tells (more welder openings and fewer mortgage bankers). That's what happened after Plaza.

This is going to have an effect... its a lot like Plaza with the Accord

Typo alert... should read:

This is going to have an effect... its a lot like Plaza WITHOUT the Accord.

So far the dollar's decline has been orderly. The decline may accelerate as the fed cuts rates but the ECB will end up cutting rates in the not too distant future as well.

European nations will have a similar drag on their economies when their housing bubbles begin to deflate. European politicians in general are more concerned about labor and will act to keep a strengthening currency from harming European manufacturing exports.

I expect a European recession to lag a US recession as happened during the 1990s. European recessions tend to be less severe but longer. See The CEPR Business Cycle Dating Committee for some charts on the synchronization of Euro zone v. US recessions.

I'll keep holding my foreign stocks until the US recession is realized and priced into the market then move the money back home, hopefully before the economies across the pond go down the tubes.

Something "more rapid" could be painful. Since Americans have financed their prosperity with borrowed money, reversing that habit means a period of living less opulently.

What? That's the heresy! That would imply we're living in an illusion of prosperity.

Here's yet another thing to consider: Gasoline vs. Treasuries.

Here's yet another thing to consider: Gasoline vs. Treasuries.

Mark,

I really think the key question here is whether this is genuine inflation or just a commodity bubble.

I think it is some combination of increasing demand, dollar devaluation, and a "commodity bubble".

But I think it's mostly the latter. The fact that prices are increasing far faster than production costs seems to me to support that conclusion.

But I don't know that much about commodities - I've just read claims about the futures not reflecting production costs. Still, I feel like I know gearing  when I see it.

Bao,

So the USD will stay ahead of the Chinese and Indian currencies? And behind, what, everything else? Great.

Here is another chart that might show what is really going on.

Trade Deficit, Part 4

The extrapolator in me would chart Chinese wages out to a point where they have more jobs than we do, since that's where "our" wage growth is occuring as we send them more of our money.

Mark, I define inflation as the money supply increasing more rapidly than real wealth.

In that regard, Chinese wages really have little to do with inflation, per se.

First of all, if Chinese wages are rising at the same rate as wealth is in that country, then that is not inflation (as I define it).

Secondly, Chinese wages are paid in Yuan, not dollars. Since China can't print US dollars, I don't see how they can affect our monetary supply relative to domestic wealth.

That said, I do think there was a great deal of inflation in the past that could show up now if these dollars are suddenly dumped on the market, but until I see the actual money supply in the US growing rapidly (not credit) I can't buy into the inflation argument.

Again, I would not be surprised to see import prices rise, but if wages don't increase domestically, that will necessarily be met with a decline in demand (assuming we don't have another borrowing spree).

In the 70s we saw wages rising rapidly. This why I keep insisting the situation now is fundamentally different - no wage/price spiral.

As I define it, at least, this is not inflation.

That said I don't think real inflation is out of the question. I believe a hyperinflationary response to deflation is at least a possibility.

Ultimately the real problem with inflation seems to be that the term is unclear - everybody defines it differently.

ac,

I think it is some combination of increasing demand, dollar devaluation, and a "commodity bubble".

Yeah, I'd agree with that.

I'd argue that what we have now is what would happen if the Great Depression met up with the 1970s.

We have two opposite forces and the Fed is trying to play them off against one another. However, two wrongs don't make a right.

--
"If the trade deficit has peaked, the dollar is probably much closer to the bottom than the top."

I agree. Dollar has huge purchasing power. Just try to purchase the same goods and services in any other developed economy and you will find out in a short order. The lower dollar may force some of the exporters to export less. But that would be mostly European countries. What will settle the problem is sharp decline in the aggregate demand in the US and it is coming.

Exchange rates are not the problem as far as the US economy is concerned. US economy's problems are all with irresponsible Americans and their crooked leaders. It was fascinating to listen and watch so many crooks in one day. Where are the lightening strikes when we need 'em.

Jas

How can you believe anything will be "gradual" in a financial market dominated by highly leveraged hedge funds?

The volatility spikes keeping closer together and deeper.

Throw the charts away. We've never been here before. Hedge funds are heading for a huge blow-up and unwind. Soon.

ac,

Ultimately the real problem with inflation seems to be that the term is unclear - everybody defines it differently.

That is true. I'm more of a hands on kind of guy myself. Do I stock up on canned goods or do I not? Lately, I have chosen to stock up (not that it will make any difference in the long-term).

Jas,

Exchange rates are not the problem as far as the US economy is concerned.

I agree. We can't solve a rebalancing of the world's labor force with smoke and mirrors. Others will be better off. We'll be worse off. That's how rebalancing works. The only question is how we go about it.

It seems we've opted for the denial approach to dealing with it, which isn't known for its gradual and smooth transitions.

ac,

We saw a similar pheonomenon in Japan during the 80s. The inflation turned to deflation when the bubble burst.

Just a couple of points on that, although I mostly agree.

• Japan did not have the world's reserve currency.
• Japan runs trade surpluses.
• Japan was not at war.
• Trade deficits as high as ours might be better compared to banana republics, and banana republics are not known for their deflation.

--

"Euro related housing bubbles are in UK, Ireland, Spain(related to the bubble in Eire & UK), Germany has been flat for a decade+, Italy & France has been sluggish."

Germans and the Swiss will come out on top after the coming worldwide US-led depression. Germans will get what they had wanted before 1913 -- end the domination of the British despotic power and play the leading role in European economy. Sometimes the history has to wait. English Speaking countries, including India, will suffer the most during the depression.

Jas

Thanks CR,

The Dollar crash thesis is about as silly as the mid-cycle slowdown thesis. The Dollar is likely to fall further, but a number of factors will offset -

Lower Dollar / higher yields WILL attract capital
American repatriation of earnings and investment
Lower imports / higher exports
Foreign asset purchases

One other important factor to remember - We're not the only ones with a bubble.

It's the fiscal deficit we need to worry about. It's going to explode.

Stagflationary Mark is correct. This has the hallmarks of the worst of the 1970s combined with some of the 1930s. Wanna talk about why there is no wage inflation? Now we just slash and outsource at the first hint of mulish employees.

The unions definitely were responsible for part of the wage/price cycle. The government spending in the 70s was a big component to.

But I think it's imperative to differentiate between "wage/price spiral inflation" and "binge borrowing inflation" because I believe they tend toward dramatically different outcomes:

Rising prices fundamentally related to rising wages and earnings tend toward hyperinflation (as in the 70s and China today).

Rising prices fundamentally related to excessive borrowing tend toward disinflation or outright deflation (as in the Great Depression and Japan today).

This is just a personal theory, one that may be wrong, but I don't get much specific feedback when I bring it up.

Also, these outcomes are in no way inevitable depending on the responses in monetary policy, etc.

BTW, Marc Faber I believe has made similar arguments - that we would have hyperinflation but this would be a response to a deflationary asset bust.

Here's some food for thought. Assume that a weaker dollar will help manufacturing. We can argue about how much more the dollar is going to fall, but unless it recovers dramatically it is safe to say that exporters in this country are going to be happy and importers aren't, for quite some time.

Now manufacturing isn't what it used to be in the US, for sure, and more importantly, it is concentrated in regions that were largely left behind economically in the past two decades (think Buffalo, Cleveland, etc.)

Wouldn't it be ironic to see these areas experience a renaissance while other areas (California, Arizona, Florida) get a taste of depression.

ac,

You bring up another good point.

When discussing inflation vs. deflation we also should be talking short-term vs. long-term.

For what it is worth, I lean towards deflation in the short-term followed by inflation in the long-term (at least as it relates to the price of canned goods).

CR, I'm sure you're aware of this, but Menzie Chinn posted "Divining the Dollar" covering an overview of this on the Econobrowser site, citing your vicious cycle post.

One of the points he had that I thought was of interest was that an dollar decline will most likely overshoot, particularly if the CB's depeg or diversify reserves.

Econbrowser: Divining the Dollar
. . .
"Postscript: Note that one has to be careful about interpteting the magnitude of the drop in the dollar's value. If prices are sticky, then according to the Dornbusch monetary model of exchange rates [1], the dollar will overshoot on the way down its long run value."
. . .

It would also be interesting to get Paul Krugman's take on this, given his monetary crisis experience, or at least an update on his thoughts of the Wile E. Coyote article.

re: currency attack

To get this you need an imbalance between the government's known and committed stance and the economic realities. The most famous recent attack was against the UK pound :
Black Wednesday - Wikipedia, the free encyclopedia

Britain's commitment to the ERM committed it to keep the rate against the US$ within a certain range that was unsustainable in terms of the import/export balance. The speculators ( no value judgment implied) then had a fixed target to attack and attack they did and won.

To get a similar coup going, IMO, we need the Treasury not just mouthing that they want a "Strong dollar" but some precise statement of this low and no further and laid out policy statements of what they will do to keep it there.

There may be other ways to do a currency attack of course - I'm only a bystander - I don't even trade currency futures, just non-US stock that does business only domestically, non-$hedged bonds and old-fashioned non US$ currency CDs.

-K

-K

ShortCourage, your point on China and Saudi Arabia swallowing inflation is well put. That was supposedly one of the reasons for the Saudi's not following the Fed's interest rate drop. China's economy is showing increasing inflation strains also, they just instituted selective price freezes.

BBC NEWS | Business | Beijing to launch price freezes

"The Chinese government has ordered some prices to be frozen as it battles to contain the country's inflation surge.

The demand came after China's rate of consumer price inflation hit 6.5% in the year to August, from July's 5.6%.

The items to have their prices frozen will be those whose cost is already set by Beijing - though the government did not specify which would be affected.

About one third of prices in China are set by the government - including coal, cooking oil, sugar, petrol and tobacco."

TCW CDOs Dump $3.2 Billion of Mortgage Securities (Update3)

By Jody Shenn

Sept. 20 (Bloomberg) -- TCW Asset Management, the money manager owned by France's Societe Generale SA, is selling $3.2 billion of mortgage securities backing collateralized debt obligations after the value of the bonds fell.

A decline in the price of securities in the market-value CDO, called Westways Funding X, managed by TCW triggered a clause that demands assets be sold so holders of the highest-rated pieces don't incur losses, TCW said today in an e-mailed statement. TCW was unable to amend the clause, according to Moody's Investors Service, which cut the credit ratings on six classes of the Westways CDO.

[snip]

re:

The dollar may not be as weak as you think. Check out How Strong Is (Was) the Dollar?. Figure 2 shows that the dollar has only fallen slightly from its peak.

Peter Schaeffer

That conclusion, in that link, was about the dollar at the beginning of 2005. The US $ index was around 88 at the beginning of 2005. Its at 78.5 today. Source:
US Dollar Index

The chart and calculation need to be updated.

-K

ac,
They are not destroyed. Show me where the amount of debt issued by the US Treasury has been falling. You can't, because it isn't happening. In fact, since 2001 the supply of tbonds has DOUBLED. The Tbond is the basis of the currency. Period. Monetized or not, it is the currency of the USA.

I'm not talking about treasury debt.

Here's an example of the process I'm describing as I understand it (again, I may not understand it properly):

1) I go to my investment banker to borrow $100,000 on margin to buy stocks.
2) The investment banker can loan me money it does not have due to the nature of the fractional reserve system. It loans me $100,000 dollars which are created by monetizing the debt I owe. $100,000 has been added to the money supply now.
3) I buy stocks with the money. Other people do the same thing and the stock price doubles.
4) I now borrow another $100,000 against the appreciation. So an additional $100,000 has been added to the money supply.
5) The stock crashes, and I am forced to pay off all $200,000 of my margin debt at once. $200,000 have now been removed from the money supply. The debt is effectively "demonitized" and the money is "destroyed".

If this is an accurate description of our monetary system, imagine the inflationary effect the first 4 steps would have if huge numbers of people were doing this all at the same time for several years.

Now what happens if there is a market crash and this money is all "destroyed" in the space of a few months as these debts are paid off.

Again, I'm no expert - this is just my current understanding based on some superficial reading.

Is there a generally agreed dollar amount that each basis point cut provides in taxpayer subsidy to private borrowers?

This may be the ULTIMATE in contrarian indicators, but I absolutely give up! I basically agree with the excellent and thorough analysis on this blog, but let me go over a few points:
1. Gold Over $740
2. Dollar at ALL TIME LOW
3. Plans to allow 2 GSE's (fannie, freddie) that cannot even produce financial filings (and would be delisted if not for government backing) to jump in and buy crap paper
4. REAL inflation in food, gas, health insurance etc running by low estimates 5-8%
5. Massive pumping of liquidity daily into the money supply

I could go on, but my point is this, nothing is happening! No problems, no massive repercussions, no pain, not even a slight "WTF" from the average fool walking around the street. I give up. I am loading up on banks, homebuilders, credit companies and shorting gold, oil, and reason if there is an ETF for it. I think most of us are just plain wrong and I cant figure out why I am so dumb!
Have a nice day!

"if you want to see an excited Bernanke listening to Ron Paul,"

Ron Paul tells it like it is and was probably the only one in that whole damn room that gives a rats ass about the average citizens of this country.

"and reason if there is an ETF for it"

Bet Wall Street can hook you up.

Dept, Allen, is simply the flip side of money.

I think most of us are just plain wrong ....

Jerry | 09.20.07 - 7:10 pm | #

Told you so....and most in this board are still fighting their own shadows, while the real world moves along nicely after a small hiccup.

Remember how you felt cheated somehow if you got change that included a Canadian Penny or Dime....

Not Anymore

"Someday this war's gonna end..."

Now, would you please stop that? It was cute in the beginning, but starts to get real annoying after a while. Your time will be better invested in learning about inflation, deflation and price change than coming with silly slogans.

Why is this statement Flawed?

I have read that it is no longer profitable if the yen is below 115. The yen is 113 and heading lower. Forcing traders to sell dollar-based assets and repatriate the funds into yen

charles hugh smith-The Big One Just Hit

Jerry wins best damn quote of the year:

going short .... and reason if there is an ETF for it.

A reason ETF. LOL.

Bernanke: ... and we will certainly make sure that doesn't happen.

Even if it means more changes to CPI.

Regarding the video, Benanke has put himself directly in the line of fire to take the responsibility directly for "domestic inflation" which is nice to see.

What is the probability that so many people come up with the same wrong answer at the same time? In regular life, it is very small, but it is puzzling that the probability is very high, when economic matters are concerned. That is the principle that supports contrary investments.

Well, there is that book wisdom of crowds (which should be called the accuracy of crowds, big difference in my opinion). You know, enough people guessing how many jelly beans are in a jar or how fat that cow is... But it turns out the accuracy completely goes away if people are attempting to estimate something they are clueless about (number of atoms in a jelly bean, read Infotopia). Since the number of variables in the economy is extremely large and complex systems are known to be difficult to predict, it is not at all puzzling that so many people can be wrong on economic predictions. I think the principle behind contrary investing is that the majority of the people are not independent thinkers, probably a manifestation of herding instinct. Which evolutionarily works great until a bunch of Native Americans herd you off a cliff.

Just keep running for that yield off in the distance! Come on, you can make it!

A lot of our most vibrant industries are still going strong because the logistics don't lend themselves to exports.

That is correct. Yesterday I drove past a place that does tear-down and rebuilds on railroad locomotives. They were adding a new/larger shed to handle what appears to be an increased work load. That is a type of work I don't expect to see being exported.

I don't know Sebastian. Perhaps the people here are the people who have been right?

Losses from sub-prime mortgages have far exceeded "even the most pessimistic estimates", US Federal Reserve chairman Ben Bernanke has said

Or maybe you're right and all this is just a small hiccup.

Got Gold?

Hell yes and silver too, long and strong since 2003 that stuff going higher.

Assuming you read at average speed, by the time you get to the bottom of this column, the war in Iraq will have cost the United States another $760,000. More than $4 million of U.S. taxpayers' money ebbed away in the 18 minutes it took George W. Bush to explain to his country and the world last week why the war he ordered would last well beyond his presidency.

The $3,850 per second war and its victims: Bernd Debusmann
| Reuters

Someday this war's gonna end... when the foreigners stop financing this foolishness.

In Fiscal Year 2006, the U. S. Government spent $406 Billion of your money on interest payments* to the holders of the National Debt.

Federal Budget Spending and the National Debt 

Falcor 8:33, when a bank hauls a wheelbarrow full of CDO's or boat loans or whatever to the discount window, and the Fed loans cash to that bank, money is being created. Now, if the Fed had taken the money in from some source of revenue, then no money is created, but that's in some fantasy world. The Fed has no money except what it creates, if I understand correctly.

Now, let us say that after two weeks the bank returns the money and takes back the collateral. Then what does the Fed do with the money? If it zeros it out, then okay, it has demonetized and we are back at the original M3. But I doubt that is what the Fed does. I imagine that money stays in existence somewhere.

But more importantly, the Fed can create money to buy Treasury debt. That is monetizing the debt, and by using that mechanism the Fed can pump up M3 beyond anyone's imagination, which was Bernanke's point when he talked about helicopter-dropping.

That is why we will have hyperinflation. If it comes down to it, the gov't will simply send every poor family in the country ration coupons, paying for them by issuing more T-bills, with the Fed creating money to buy those T-bills if no foreign country will touch them.

CR,

This is a really great chart. I remember in 2000 when we had the glut in supply capacity in Techland, I was trying to figure out under what senario the bulls could regain momentum. I just couldn't see anything in the immediate future. I recognized that there were a lot of places around the globe where the market was barely touched, let alone saturated, but from what I could see, these places could not afford the trinkets we were making. Go figure, the solution was to drop the value of our currency so that in relation the purchasing power of many of these places would rise and make our products more affordable. It seems to have worked pretty good so far. I wonder if its possible for our currency to fall far enough to reinvigorate the manufacturing base here in the USA, i.e., outsourcing reversed?

dryfly -
no offense but every time you mention PPP i chuckle.

as far as i can divine, that PPP is a quaint notion.

why else would there be a big mac index?

dc1K - I can hardly wait for the next BMI from the economist... wooohooo supersize me!