Worth less, not worthless
I am glad Mr. Buffet clarified that. Project out last weeks trends for very long and there might be a bit of doubt.
Mr. Soros wasn’t as kind.
""The dollar is a terribly flawed currency"
Nor, for that matter, was Robert Lynch of HSBC:
"the dollar is basically being re-rated … in much the same way many U.S. credit derivative securities have been re-rated."
Ouch.
Joanna Slater and Craig Karmin are a bit kinder. They compare the dollar to Windows. Unloved, but impossible to avoid.
"for all of the gloom, the world is unready to let go of America’s unloved dollar. Akin to the way Microsoft’s often-criticized Windows operating system remains indispensable to the majority of computer users, the dollar remains the common language of finance, the medium of exchange in everything from sugar to wheat to oil."
I have no particular insights into the causes of the dollar’s big fall last week.
At the same time, I don’t think its weakness since last August should be a mystery. Robert Lynch wasn’t far off the mark: the dollar’s weakness fundamentally reflects the collapse in demand for securitized US credit.
For much of this decade, financial engineering was to the US what automotive engineering was to Germany. Mortgage-backed securities were the United States leading export — by a large margin. Those securities no longer command a premium in the global market. Indeed, they can only find buyers if they carry an Agency guarantee.
That has consequences.
1/ The collapse in demand for complex securities has reduced overall foreign demand for US financial assets. There was a time when serious observers - including observers at places like the IMF — argued that the United States comparative advantage at creating complex financial "products" would assure demand for US dollars and the financing of the US current account. That forecast hasn’t been born out. Foreign demand for US equities has emerged, but that demand hinges on getting those assets at a sale price.
2/ Sharp falls in the market price of a range of complex securities have seriously dented the capital base of the US banking system. It turned out that not all — and perhaps not even a majority — of subprime debt has been shipped abroad. A lot remained on the books of the banks and broker-dealers. The large resulting losses forced the large banks and broker-dealers to turn to the Gulf, Singapore and China (and to a lesser degree Korea and New Jersey) for new capital. Real estate losses could lead some smaller banks to fail. The big banks — even after getting a few petrodollars — are now unwilling to commit their now scarce capital to backstop something like the auction rate security market.
3/ Capital constraints and a closed market for most forms of securitized housing credit — at least housing credit that lack an Agency guarantee — seem to have slowed the US economy. The combination of a slowing economy and a weak banking sector which would benefit from a upward sloping yield curve makes it hard for the Fed not to cut interest rates. And lower rates don’t help the dollar — particularly against the yen.
4/ Lower US rates though imply even looser monetary conditions than is already the case in high-growth, high-inflation countries that currently still peg to the dollar. Real rates in the Gulf and China are now quite negative. That fuels their growth — and their demand for commodities. Decoupling isn’t good for the dollar; investors generally prefer to finance rapid growth rather than a slowdown. And right now the rapid growth in the dollar zone isn’t found in the US.
5/ The combination of a slowdown and rising prices (notably commodity prices) has forced the Fed into a difficult position. See Dr. Hamilton or Dr. Duy. Opting to focus on limiting the risk that US output will fall too sharply rather than the risk that inflation will remain high is the right choice (in my view), but it nonetheless has consequences. America’s foreign creditors are seeing the US purchasing power of their dollar holdings fall along with the global purchasing power of their dollar holdings.
Central banks though are the one group of American creditors who do not seem to have lost their appetite for dollar-denominated securities. They are a tolerant group. The Fed’s custodial holdings continue to rise.
Dollar reserve growth almost certainly set a record in 2007. And - barring a big shift to sovereign wealth funds — I would bet 2008 will be similar.
Just as the market for housing finance has been "effectively nationalized," so too has the financing of the US current account deficit. The Agencies are now big buyers of US mortgages. Central banks are big buyers of Agency securities. Treasuries too.
As a result of this intervention, the dollar isn’t uniformly weak. It unremains fairly strong against many emerging currencies. Something of a rebalancing which left the emerging world with stronger currencies, less inflation and more external purchasing power and Europe with a somewhat less appreciated exchange rate likely would be better than the world we now have. The emerging world would have less inflation, Europe would have better prospects for growth and the US trade deficit might start to come down against the fastest growing parts of the world economy — not just Europe and Canada.
“For much of this decade, financial engineering was to the US what automotive engineering was to Germany. Mortgage-backed securities were the United States’ leading export - by a large margin.”
Brad, where might I find the numbers to substantiate this claim? I can’t even find a breakdown of total US exports which specifically includes MBSs.
I’m curious to hear an elaboration on why you believe the policy response to date has been the correct one.
In particular, how do we attract capital and savings without having a fairly high real interest rate without depending on the continued largesse of central banks?
Does median real income really rise as a result of this, given the impact of dramatic increases in the price of oil and other commodities that are ubiquitous in economic activity?
Does our net income and balance of payments position improve? What does the debt-for-equity swap look like in a world with lower profits and more turbulence and risk premium? How’s our J-curve shaped?
It’s getting spectacular, to be sure, and I know rate cutting and devaluation of the currency are the theoretically correct approach. I just want to know that someone has run the numbers to show that it really does work out in the end. I’d sleep a lot better.
Not what I thought would happen, even if it suits me personally as I’m being paid in Yen right now.
“They are a tolerant group”
Looking at the situation from, for instance, China’s point of view.
There is a lot of sell pressure on the dollar, it is a bit weak.
China has a heap of dollar reserves and they are losing value.
It wants it’s revaluation program to be gradual.
If they keep buying dollars, they can help protect the value of these reserves and also minimize the risk of a large or sudden dollar movement.
Middle East countries may also take this view.
Who says there are no friends in business?
http://www.atimes.com/atimes/Global_Economy/JC04Dj07.html
A tragedy of inflation and global recession as this may all well end up to be, there is the funny side. The world’s chosen reserve currency, the one constant in a changing financial landscape for the past 30 years, is now officially relegated to second-class status thanks not so much to its champions in the US government, but because of buyer behavior - that is the buyers that are constantly passing the parcel of damaged goods that the US dollar has now become.
The US government is now forcing the IMF to sell its gold holdings, as it attempts to puncture the value of the precious metal and hopefully jolt some current holders to buy US dollar-denominated assets instead. Presumably, the idea for the IMF is to sell its gold and buy some US financial assets, in what constitutes an eerie turn to fact from satire at least from this columnist’s perspective.
As all the central banks that bought into the myth of US financial companies have realized of late, this course of action will simply lead to more losses for the IMF and leave the institution at a new nadir of relevance as far as the emerging financial order is concerned.
The question then becomes what can replace the US dollar and an obvious contender is the euro. The more sensible policies of the European Central Bank have in contrast to the Fed allowed the euro to gain much ground and it is now worth 50% more against the US dollar than the bottom that was reached not over five years ago, in the days before the “war on terror”.
“…Ulyukayev retracted his earlier statement that the bank was suffering losses on the investments in bonds of Fannie Mae and Freddie Mac… Ulyukayev has been reported making several controversial statements this year, including suggestions for giving priority to liquidity over inflation…” http://www.moscowtimes.ru/stories/2008/03/03/043.html
Warren Buffett says the US Economy is in recession now, Paulson and Bernanke say we are not even headed towards a recession, but strong economic growth. Who do you believe?
Buffett: US Essentially in Recession
http://biz.yahoo.com/ap/080303/buffett_economy.html
OMAHA, Neb. (AP) — Billionaire Warren Buffett said Monday that the U.S. economy is essentially in a recession.
Buffett said in an interview with cable network CNBC the reports he gets from the retail businesses his holding company owns show a significant slowdown in purchases.
Mitchell Porter — for real time data, look at the TIC numbers. Corporate debt includes MBS/ ABS and CDOS composed of leveraged loans (so long as the loans are packaged onshore). For more details, look at the Fed flow of funds, which gives stocks of various kinds of securities and a breakdown between foreign and domestic holdings. And finally, look at the change in foreign holdings between the june 2005 and june 2006 surveys of foreign portfolio investment in the US (available on the treasury/ TIC data web page). it has an ABS/ MBS breakdown for corp debt and a Agency MBS v pure Agency breakdown for agencies.
NDK — I don’t think central bank intervention will go away, so the financinging the US needs will be there. And absent a government policy response, i think there is a real risk us demand would fall off a cliff — with demand collapsing faster than exports could rise, leading to a simple loss of output.
taxpayer — China can only avoid taking losses now (by letting the RMB move) by adding to its future losses; buying more dollars doesn’t protect the value of its reserves so much as delay their loss of value, at the cost of adding to the size of the ultimate loss.
Well if you go around selling damaged, defective goods people tend to stop buying. That is what has happened to the US. The erosion of the dollar will continue since the US isn’t doing a thing to stop it. BTW, Brad, would you be willing to suggest what stopping the war in Iraq might do for our balance of payments? Nothing? Not much? Lots?
To be honest, that’s scant solace, because it will continue to send distorted economic signals to private investors and American citizens who will probably continue to fail to save. I guess it’s a lot better than falling off a cliff and more reliable than a horde of speculators, but it feels like yet deeper trouble in the medium term. Thanks a lot for the response.
guest - directionally, it would help. it alone wouldn’t be enough tho.
how do you segregate ‘new jersey’?
if you can find one quote from a large bank or broker-dealer stating they were “forced” to turn to the Gulf, Singapore and China… as any of the quotes i’ve seen have indicated that was not entirely the case
Charles Dallara (of the IIF) indicated at the US-China commission hearing that it would have been impossible for the banks and broker dealers to raise the funds they wanted to be able to announce they had in hand at the time they announced their large losses in late q4 without SWFs. No one else could provide as much money as fast. Were there other choices — i.e. operating with less capital/ shrinking balance sheets and the like/ smaller bonuses — yes. If you want to argue then the banks were not forced to turn to Gulf and other SWFs, fair enough. but if they wanted capital, they had no other real choice from what Mr. Dallara said.
And here i would note that neither Goldman nor BoA — both of which have large profits on their investment in China’s state banks — have opted to seek SWF capital. It seems correlated with the absence of other attractive options.
I am happy to listen to a rebuttal, but it needs to be grounded on a realistic assessment of the available alternatives. Dallara presumably knows what he is talking about here.
bsetser: For much of this decade, financial engineering was to the US what automotive engineering was to Germany. Mortgage-backed securities were the United States leading export — by a large margin.
Most mortgage-backed securities don’t involve very sophisticated financial engineering. They are straight through securitizations, and have been around since the 1970’s.
bsetser: Those securities no longer command a premium in the global market. Indeed, they can only find buyers if they carry an Agency guarantee.
This is somewhat misleading in that the vast majority of mortgage backed securities have always been MBS’s sold through Fannie Mae or Freddie Mac.
How about alittle more doom and gloom for monday? Alittle more pessimistic than even doomster Nouriel Roubini, the article foresee collapse of real US economy. - DC
“International experts foresee collapse of U.S. economy”
http://www.intelligencer.ca/ArticleDisplay.aspx?e=918803
“Global Europe Anticipation Bulletin (GEAB), think-tank writes:
“The end of the third quarter of 2008 will be marked by a new tipping point in the unfolding of the global systemic crisis.
At that time indeed, the cumulated impact of the various sequences of the crisis will reach its maximum strength and affect decisively the very heart of the systems concerned, on the front line of which (is) the United States, epicentre of the current crisis.
In the United States, this new tipping point will translate into a collapse of the real economy, (the) final socio-economic stage of the serial bursting of the housing and financial bubbles and of the pursuance of the U.S. dollar fall. The collapse of U.S. real economy means the virtual freeze of the American economic machinery: private and public bankruptcies in large numbers, companies and public services closing down.
The report goes on to say that we are entering a period for which there is no historic precedent. Any comparisons with previous situations in our modern economy are invalid…a true turning point affecting the entire planet and questioning the very foundations of the international system upon which the world was organized in the last decades.”
We are not experiencing a “remake” of the 1929 crisis nor a repetition of the 1970s oil crises or 1987 stock market crisis.
What we will have, instead, is truly a global momentous threat - a true turning point affecting the entire planet and questioning the very foundations of the international system upon which the world was organized in the last decades.
The report emphasizes that it is, first and foremost, in the United States where this historic happening is taking an unprecedented shape (the authors call it “Very Great U.S. Depression”).
if it could be said that certain dollar peggers “are seeing the US purchasing power of their dollar holdings fall along with the global purchasing power of their dollar holdings” and are therefore ‘forced’ to ‘invest’ in select u.s. financial institutions, as influenced by their client relationships.
bsetser: I am happy to listen to a rebuttal, but it needs to be grounded on a realistic assessment of the available alternatives. Dallara presumably knows what he is talking about here.
The capital infusions that the banks got were in the $5 to $10 billion range and are not very high in financial terms. If they wanted to, Bear-Sterns and Morgan Stanley could have gone to Warren Buffett, Kirk Kerkorian, or Bill Gates, each of whom have that sort of cash lying around, or to a private equity firm or big pension fund.
They probably got a much better deal from the SWF’s then they would have gotten from Buffett in an odd way. In particular, had they gotten the money from a private holder, the private holder would have absolutely insisted on management control. I can see Warren Buffett buying a piece of Citigroup, I can’t see him doing this without demanding veto over the new CEO and a seat on the board. Same is true for any domestic purchaser.
However, the SWF’s weren’t in a position to insist on management control since that would have raised all sorts of Congressional opposition, so the “no strings attached” nature of the money that they got from the SWF’s is what made this attractive.
I’m actually quite surprised that no one has mentioned that the New Jersey purchase of Citigroup was at least partly helped by the fact that the Governor of New Jersey (Jon Corzine) and the acting head of Citigroup (Robert Rubin) both worked at Goldman-Sachs at the same time.
There’s nothing wrong with that, and these sorts of deals happen all of the time, and are generally a good thing. What I think that this does kill is the argument that American based funds are supposedly apolitical ones in which personal relationships don’t matter.
Just as an example of the law of unintended consequences, laws and politics that make it difficult for SWF’s to exercise control over companies, actually have the effect of making SWF money *more* attractive to companies in need of cash. Without the ability to exercise control, SWF’s are limited to the degree to which they can second guess management, and by having several large investors with shares that cannot be used for a hostile takeover, this greatly limits the ability of third-parties to exercise influence over management.
the supposedly sophisticated bit was the technology for repackaing MBS into CDOs, and then repackaging the lower tranches of those CDOs into another round of CDOs. not sure how much of the more sophisticated stuff was “exported” tho.
“…”The [election] process was far from ideal, but Medvedev, out of the field of people that was suggested as a potential successor for Putin, is the most consistent with the wishes of the international business community,” said Alan Rousso, chief political adviser at the European Bank for Reconstruction and Development…” http://www.moscowtimes.ru/stories/2008/03/04/041.html
Brad,
It seems we have a vicous cycle playing out and I wonder when the market takes control of the yirled curve which has been heretofore monopolized by the Treasury/Fed. As farber said today, the bond market is the biggest bubble going - Treasuries that is. I am somewhat shocked that long bonds are not 6+% given everything the market knows. Hence we come back to the SWF/Surplus countries that are buying the debtr. It seems to me that the foreign buyers are doing themselves a massive disservice by buying the debt. A short term buyers stricke would drive yields up rapidly and given the inlfation awareness/announcmeent by fed yields would likely be sticky. I understand the short end of the curve but buy for negative real returns isnout and out stupid. This can not last. Yet another free lunch rapidly coming to an end. If yields blow out could easily offset the benefit of halting war.
Twofish’s credibility (or credulity) is shot; last year he was vigorously defending CDO structures and insisting that subprime losses weren’t going to be a big deal — I believe he said he wasn’t worried about any event less than half a trillion, well…
“Financial firms are likely to face at least $600 billion of losses as the crisis triggered by the collapse of subprime mortgages batters banks, brokers and insurers…” http://www.bloomberg.com/apps/news?pid=20601103&sid=auI8qPM3t6uc
Stop it you’re scaring off the creditors…
“The U.S. said that China’s reluctance to share details about its military buildup poses a risk to stability in Asia. The Pentagon report highlights Beijing’s space program.” http://online.wsj.com/documents/ChinaMilitaryReport.pdf
“The dollar is vulnerable.” http://www.morganstanley.com/views/gef/archive/2008/20080303-Mon.html
Brad, thanks for the detailed response, despite my naivete in looking for securities in the trade data! Back to National Accounting 101 for me.
Carlos Abadi - Financial Engineer
“…In 1991, Carlos Abadi established Abadi & Co. Throughout the now legendary “Tequila” and Russian crises of the 1990’s, Abadi & Co. remained a consistent and steady force in the emerging markets debt class. Over the past two decades, he has advised emerging market governments, banks, and private sector companies on liability management, debt-to-equity conversions, debt buybacks, debt restructurings and debt monetization programs… Today Mr. Abadi continues as an active Board member of the Refco Litigation Trust…” http://www.carlosabadi.org/carlos-abadi-career.html
“Carlos Abadi, RGE and Abadi & Co. has been featured on various international media publications…” http://www.carlosabadi.org/carlos-abadi-resources.html
“…Over time, as sophisticated risk management techniques migrate down the customer food chain, that will change. For example, credit default swaps will probably become exchange-traded, clearing house-settled instruments. If Mr Abadi and others like him succeed in bringing prime brokerage services to the masses with only $20m-$30m to their names, it could significantly add to the breadth of more exotic markets and put welcome pressure on the fees charged by portfolio managers.” http://www.ft.com/cms/s/2/19197600-103d-11db-8f6f-0000779e2340.html
Question for Brad, if he is willing to answer:
If the Chinese investment authority puts, say 5 billion, into a US financial firm, would it be reasonable to expect that it would continue to do so if necessary to avoid bankruptcy of the firm? In other words, would a Chinese investment of that size suggest to you a commitment to keep the firm afloat?
@ bsetser “…delay their loss of value, at the cost of adding to the size of the ultimate loss.”
That’s true.
They have a real dilemma.
My guess there is also a counter trade out of dollars by “non official” individuals and entities in China.
Officially, they must support the dollar.
This is from a few weeks ago,
“BEIJING, Feb. 26 (Xinhua) — The sound development of the U.S. economy and a steady U.S. dollar benefits the United States and the world, said Chinese Premier Wen Jiabao here on Tuesday.
Wen, at a meeting with visiting U.S. Secretary of State Condoleezza Rice, said that China was ready to make concerted efforts with the United States to promote world economic growth and maintain the stability of the world financial markets.
Wen said that Sino-U.S. economic and trade relations were mutually beneficial and it was inevitable for problems to occur during rapid development.”
http://news.xinhuanet.com/english/2008-02/26/content_7674163.htm
Thanks again for your great blog.
Do you have any thoughts on the carbon tax idea discussed at wolfforum,
http://blogs.ft.com/wolfforum/2008/02/we-must-curb-international-flows-of-capital/
“I too dream of a global energy tax, but in its own right, not one that is a response to a capital flow problem….”
I don’t support the carbon tax idea.
It causes all sorts of strange effects like the current conversion of woodland to pasture in New Zealand because doing so after tax startup day will result in, by some estimates, a charge of NZ$14000/Ha in carbon tax.
One more thing, I have held dollar denominated equities for about 12 years, so I know how the Chinese might be feeling.
My FX loss is about 30% so far and it looks like I’m about to take another haircut.
Gents, today I took what might some people here call a foolish step, but I converted all my Euros into USD. Time will tell if I am a fool.
It is interesting that, while Warren Buffett is widely revered in the US for his astute and successful investment, less notice is taken of his analysis of the US economic situation:
“So far, at least, a plunging dollar has not done much to bring our trade activity into balance. There’s been much talk recently of sovereign wealth funds and how they are buying large pieces of American businesses. This is our doing, not some nefarious plot by foreign governments. Our trade equation guarantees massive foreign investment in the U.S. When we force-feed $2 billion daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds? Our country’s weakening currency is not the fault of OPEC, China, etc. Other developed countries rely on imported oil and compete against Chinese imports just as we do.”
eurovoice — a bold move, but not necessarily a foolish one. the euro is very strong right now. the real misalignments (undervaluations v the $) are clearly found in the gulf and asia, not europe. asia europe loosk way out of whack.
guest — you are raising the too chinese too fail point. basically, if you have $5b from the CIC, the CIC won’t let you sink. the problem with that argument is that a bigger capital injection from the CIC would raise issues of control, and I am not sure the US is willing to have the Chinese government own a major US financial institution.
Australia Increases Benchmark Rate to 12-Year High
Australia’s central bank increased its benchmark interest rate for the second time in four weeks and said there are signs the highest borrowing costs in 12 years are prompting consumers and businesses to temper spending.
Governor Glenn Stevens and his board raised the overnight cash rate target by a quarter point to 7.25 percent in Sydney today, following adjustments in February, November and August to stem the fastest inflation since 1991.
Dubai Firm Says Citi Needs Cash
Citigroup will require more investment from sources like oil-rich Mideast sovereign wealth funds amid further write-downs related to U.S. subprime mortgages, the head of a $13 billion Dubai-owned investment firm said.
Whitney on Citi
‘Central banks though are the one group of American creditors who do not seem to have lost their appetite for dollar-denominated securities. They are a tolerant group.’
‘Just as the market for housing finance has been “effectively nationalized,” so too has the financing of the US current account deficit.’
These phrases seem to me to imply a strange view of the current account deficit. When foreign central banks buy U.S. dollar-denominated assets, they are effectively lending to U.S. borrowers. Unless the effect of their actions is undone by private international capital flows, they CAUSE the U.S. current account deficit. That is, the net effect on international capital flows, official plus private, is exactly equal to the effect on the current acount deficit. This conclusion is a simple result of the balance-of-payments identity. The foreign central banks do this primarily to promote local demand, not to invest in U.S. assets.
So, the statements in quotes are not incorrect, but they could more accurately be phrased as saying “despite the growing U.S. international indebtedness, and despite slowing U.S. demand, some foreign governments continue to pursue policies to take U.S. demand away from U.S. products and steer it towards their own.”
don,
Foreign central banks can only “cause” a US current account deficit in conjunction with the US. Having received the capital inflow, the US government could choose to on-lend it, possibly keeping some spread reflecting its “exorbitant privilege”, by building its own reserves or SWF. The US foreign currency reserves are abysmally low for such a large economy.
a bigger capital injection from the CIC would raise issues of control, and I am not sure the US is willing to have the Chinese government own a major US financial institution
I guess what I really would like to know is whether the US would prefer that a major US financial institution go down the tubes or let the Chinese government own it (or most of it).
Brad - thanks for the response. Yeah, Korea has more foreign reserves than we do. The question I would have is why we need any foreign reserves at all. To prevent unstabilizing currency speculation against the dollar? The size of our currency markets should protect against that, as well as ensuring that any attempt at intervention would be useless. Intervention in exchange markets mostly means currency manipulation.
I agree that either public or private capital flows could offset the effects of foriegn central bank reserve policies. However, I wonder how much offsetting has been done by private capital flows. Clearly, the Treasury/Fed have not done any. (It would be interesting to see the Treasury instruct the Fed to buy Chinese Yuan or Japanese Yen in the amount of their CB purchases of U.S. dollar assets - “if you try to lend to us, we will lend right back!”) So far, our response has been to ask them to stop. Japan listened after 2004 (maybe - we’ll see what happens if the U.S. slowdown really crimps their economy, or if the unwinding of carry trades puts their exports at risk), but China has not.
Are you aware of any studies that determine how much foreign CB buying of U.S. assets has contributed to the U.S. CA deficits? Some of your posts come close to doing this, it seems to me, but not directly.