Tuesday, September 28, 2010

Beggar Thy Neighbor

At your leisure, please read this article from the Financial Times

When a country that makes its way in the world by exporting wishes to protect or increase its market share, it will lower the value of its currency. That has the effect of making its imports cheaper in the countries which are its main customers. The way it works is simple. I will use two hypothetical currencies to demonstrate: The dollar and the Reale.

If a product sold is sold for, say, 100 Reales per ton, and a dollar was worth 100 Reales, then one dollar would by one ton of the product. But if the currency were devalued to an exchange rate of 200 Reales to the dollar, but the price of the product was kept at 100 Reales per ton, then it would only take 50 cents to buy a ton. Obviously that gives you a competitive advantage over other countries who are trying to sell the same product to the same customer. If these other countries want to remain competitive they will have to slash the value of their currency.

This behavior also tends to protect domestic industries in the country which devalues its currency because it makes imports more expensive. For instance, my uncle lived in Chile in the 1980's. He said that American made razor blades by Gillette were very expensive in terms of the Chilean currency while the equivalent Chilean brand were quite cheap. The Chilean blade was the better option when simply comparing prices, so Gillette sold relatively few razor blades in Chile.

As an additional means of protecting domestic industries (and thus domestic jobs) a country can slap a tax or import duty on any imports, making those products more expensive and thus protecting the domestic industry from competition. This almost always leads to retaliatory practices by other countries. You end up in an economic slugfest of competitive devaluations, tariffs, and import duties.

Well, that's exactly what's happening right now. There's a quiet currency war going on. 25 countries have recently intervened in the world currency markets to devalue their currencies. This is unprecedented behavior. Ben Davies, CEO of Hinde Capital said,

“Within a single week 25 nations have deliberately slashed the values of their currencies. Nothing quite comparable with this has ever happened before in the history of the world.”

This is exactly what happened in the world commodity markets in the 1930's. The means of production is very efficient, supplies of almost any given commodity are easier to produce than ever, so there is a great glut of capacity to supply. But demand is collapsing. In order to try and move the supplies the prices are being cut via currency manipulation.

This is yet another piece of evidence for the deflationary case.

Friday, September 17, 2010

Fiat Money Has Nowhere to Go but Gold- Greenspan

Greenspan's Warning on Gold

Editorial of The New York Sun | September 15, 2010


Alan Greenspan spoke at the Council on Foreign Relations earlier today, and what was his advice? That central bankers should be doing what these columns, among others, have been rattling on about, namely that they should be paying attention to gold. “Fiat money has no place to go but gold,” the former Fed chairman said at the Council, according to economist David Malpass, who quotes Mr. Greenspan in one of Mr. Malpass’ emails on the political economy. Mr. Malpass writes that the former chairman of the Federal Reserve’s board of governors was responding to a question in respect of why gold was hitting new highs.

Mr. Greenspan replied that he’d thought a lot about gold prices over the years and decided the supply and demand explanations treating gold like other commodities “simply don’t pan out,” as Mr. Malpass characterized Mr. Greenspan. “He’d concluded that gold is simply different,” Mr. Malpass wrote. At one point Mr. Greenspan spoke of how, during World War II, the Allies going into North Africa found gold was insisted on in the payment of bribes.* Said the former Fed chairman: “If all currencies are moving up or down together, the question is: relative to what? Gold is the canary in the coal mine. It signals problems with respect to currency markets. Central banks should pay attention to it.”

To which, forgive us, one can only say, “Now he tells us.” The fact is that if Mr. Greenspan governed the Fed with an eye on gold, it wasn’t a particularly steady eye. He might argue that when he left the chairmanship of the Fed, in January 2006, he left a dollar worth a 400th of an ounce of gold, slightly more valuable than the 461st of an ounce of gold that it was worth when he came in nearly 20 years before. But in the first five years of the 21stcentury, when he was in the last quarter of his years as chairman, the value of the dollar started its long collapse, plunging from the 282nd of an ounce of gold that it was worth on January 4, 2000. In the years since, it has cratered to record lows once imagined only by such sages as Ron Paul.

Mr. Greenspan’s remarks at the council were not the first time he gave us a glimpse of his views on gold. He discusses gold on several pages of his memoir, “The Age of Turulence,” reminding that he once told a Congressional committee that “monetary policy should make even a fiat money economy behave ‘as though anchored by gold.’” He wrote that he had “always harbored a nostalgia for the gold standard’s inherent price stability.” But he confesses that he’s “long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate functions of government — in particular the need for government to provide a social safety net.”

The American people, he asserted in his book, have for the most part “tolerated the inflation bias as an acceptable cost of the modern welfare state.” And he claimed, “There is no support for the gold standard today, and I see no likelihood of its return.” We’ll hazard a guess that the statement makes him a man more of the past than of the future. But at least some politicians are hearkening to his advice about the price of gold. They’re people like Congressman Ron Paul and his son, Rand, who may yet be a senator, and Governor Palin, who was one of the first to warn about the gold price, and Congressman Paul Ryan, who asked Mr. Greenspan’s successor, Ben Bernanke about gold.

And, by the way, a few journalists, like Glenn Beck, who are students of history and just can’t believe their eyes that the dollar has plunged to the level it has with so few people raising an alarm. We are in a period when gold is more than a canary — to cite Mr. Greenspan’s bird of choice — it’s a full-throated rooster, cock-a-doodling at the top of its lungs. It was nice to see Mr. Greenspan mark the point at the Council. Would that he’d taken more of his own advice. And nice to see Mr. Malpass mark the Greenspan comments so prominently in his letter to his economic clients. He is more for a gold price rule in monetary policy than a gold standard, but we hope he makes another run for high office at the first chance, and presses the principle for all its worth. It’s what we need in the national debate, and none too soon.


* Not just in World War II did the special role of gold come into focus. Covering the fall of free Saigon for the Wall Street Journal in April 1975, your editor witnessed a bank run in which panicked Vietnamese citizens, in the streets outside the financial institutions, bought, when they could, gold that had been pressed into sheets the size and approximate thickness of cigarette paper.

Wednesday, September 15, 2010

Friedman Mostly Nails It

We’re No. 1(1)!

I want to share a couple of articles I recently came across that, I believe, speak to the core of what ails America today but is too little discussed. The first was in Newsweek under the ironic headline “We’re No. 11!” The piece, by Michael Hirsh, went on to say: “Has the United States lost its oomph as a superpower? Even President Obama isn’t immune from the gloom. ‘Americans won’t settle for No. 2!’ Obama shouted at one political rally in early August. How about No. 11? That’s where the U.S.A. ranks in Newsweek’s list of the 100 best countries in the world, not even in the top 10.”

The second piece, which could have been called “Why We’re No. 11,” was by the Washington Post economics columnist Robert Samuelson. Why, he asked, have we spent so much money on school reform in America and have so little to show for it in terms of scalable solutions that produce better student test scores? Maybe, he answered, it is not just because of bad teachers, weak principals or selfish unions.

“The larger cause of failure is almost unmentionable: shrunken student motivation,” wrote Samuelson. “Students, after all, have to do the work. If they aren’t motivated, even capable teachers may fail. Motivation comes from many sources: curiosity and ambition; parental expectations; the desire to get into a ‘good’ college; inspiring or intimidating teachers; peer pressure. The unstated assumption of much school ‘reform’ is that if students aren’t motivated, it’s mainly the fault of schools and teachers.” Wrong, he said. “Motivation is weak because more students (of all races and economic classes, let it be added) don’t like school, don’t work hard and don’t do well. In a 2008 survey of public high school teachers, 21 percent judged student absenteeism a serious problem; 29 percent cited ‘student apathy.’ ”

There is a lot to Samuelson’s point — and it is a microcosm of a larger problem we have not faced honestly as we have dug out of this recession: We had a values breakdown — a national epidemic of get-rich-quickism and something-for-nothingism. Wall Street may have been dealing the dope, but our lawmakers encouraged it. And far too many of us were happy to buy the dot-com and subprime crack for quick prosperity highs.

Ask yourself: What made our Greatest Generation great? First, the problems they faced were huge, merciless and inescapable: the Depression, Nazism and Soviet Communism. Second, the Greatest Generation’s leaders were never afraid to ask Americans to sacrifice. Third, that generation was ready to sacrifice, and pull together, for the good of the country. And fourth, because they were ready to do hard things, they earned global leadership the only way you can, by saying: “Follow me.”

Contrast that with the Baby Boomer Generation. Our big problems are unfolding incrementally — the decline in U.S. education, competitiveness and infrastructure, as well as oil addiction and climate change. Our generation’s leaders never dare utter the word “sacrifice.” All solutions must be painless. Which drug would you like? A stimulus from Democrats or a tax cut from Republicans? A national energy policy? Too hard. For a decade we sent our best minds not to make computer chips in Silicon Valley but to make poker chips on Wall Street, while telling ourselves we could have the American dream — a home — without saving and investing, for nothing down and nothing to pay for two years. Our leadership message to the world (except for our brave soldiers): “After you.”

So much of today’s debate between the two parties, notes David Rothkopf, a Carnegie Endowment visiting scholar, “is about assigning blame rather than assuming responsibility. It’s a contest to see who can give away more at precisely the time they should be asking more of the American people.”

Rothkopf and I agreed that we would get excited about U.S. politics when our national debate is between Democrats and Republicans who start by acknowledging that we can’t cut deficits without both tax increases and spending cuts — and then debate which ones and when — who acknowledge that we can’t compete unless we demand more of our students — and then debate longer school days versus school years — who acknowledge that bad parents who don’t read to their kids and do indulge them with video games are as responsible for poor test scores as bad teachers — and debate what to do about that.

Who will tell the people? China and India have been catching up to America not only via cheap labor and currencies. They are catching us because they now have free markets like we do, education like we do, access to capital and technology like we do, but, most importantly, values like our Greatest Generation had. That is, a willingness to postpone gratification, invest for the future, work harder than the next guy and hold their kids to the highest expectations.

In a flat world where everyone has access to everything, values matter more than ever. Right now the Hindus and Confucians have more Protestant ethics than we do, and as long as that is the case we’ll be No. 11!

Friday, September 10, 2010

Zimmer on CNBC: We're tracking 1930

Zimmer gives his take on the big decline he forsees this Fall. It's about the scenario I predicted before. At least a retest of the 2009 lows.

Friday, September 3, 2010

Remember Those Muni Bonds I Warned You About?

Awhile back I did a couple of posts warning readers to stay away from Muni bonds. Brokers (salesmen) were calling clients trying to peddle these things at really high interest rates (like 7% in the current environment.) But there is no reason for a muni to ever return that kind of interest rate unless there was a lot of dodgy debt in it.

Here is a good article on today's big story. Harrisburg, PA has defaulted on its muni bond debt. It's only the "second biggest default this year." Normally we have about $1 billion in defaults per year. This year so far we've had $1.7 billion, and we've still got 3 months to do. The whole sector is struggling. Property tax and sales tax receipts are down and municipal entities are struggling to make their debt payments.

Stay tuned. As the Depression unfolds we'll have a lot more of this sort of thing.