Last night I saw an image of a wounded bull, bleeding between the shoulder blades, and taunted by a matador with a sword...
Then, instead of doing what he was expected to do (stare his executioner in the eye and die), the bull charged into the crowd, scattering the blood-thirsty spectators.
Of course, the bull died anyway. But not without a fight.
That’s what the US Dollar charts tell me about 2007. The buck is going to rally. The alternative is its immediate destruction as the world’s reserve currency. But the Dollar is too important to global liquidity right now to simply disappear overnight.
The US Dollar may experience a reprieve, in fact, if only because so many people own it and do not want to see their Dollars devalued. Developing countries, while gaining exposure to the strong euro, still prefer the Dollar. And then there’s China.
With one trillion Dollars in foreign currency reserves (most of them US greenbacks) the Chinese have about a trillion reasons to fear inflation in the Dollar. This erodes their purchasing power. But maybe 2007 is setting up quite nicely for the Chinese, after all.
If the Dollar rallies, this will lead to falling or at least more stable commodity prices. The Chinese can then carefully go on a global resource shopping spree (as they have for the last three years) trading stronger paper Dollars for temporarily weak real assets – oil, gas, minerals, factories, capital...
At least that’s how we’d play it if were running China’s economy. We’re not. But it makes sense to us. Make sense to you?
It will take not only a lot of creeping inflation before the Dollar falls. It will also need the bursting of the derivatives bubble. Every New Era needs a new set of laws or commandments that can be proclaimed before the world. Moore’s law...love one another as I have loved you...and in the ear of "New Monetarism"...anything can become an asset as longer as there is an investor willing to buy it.
The New Monetarism is a theory of Independent Strategy in London. Their research shows what they believe to be the cause of the continued demand for Dollars in global asset markets...and why the economic imbalances that grab ink (American fiscal and federal deficits, trade deficits, current account deficits) don’t seem to fundamentally alter the demand for Dollars.
That’s because the volume of Dollar-denominated transactions in the asset markets – a volume which only the Dollar, with help from the Euro and the Yen, can accommodate – dwarfs the Dollar volume of economic imbalances in the real global economy.
This clarifies just what is going on with Dollar demand and shows both that it can last a lot longer and that when it ultimately fails, the failure will be greater. It’s all here in this chart...
Globally, derivatives now account for 75% of liquidity...some 802% of global GDP. Next comes scrutinized debt at 13% of liquidity and 142% of world GDP. Then broad money supply, at 11% and 122%, and finally central bank money at 10% of global GDP and just 1% of liquidity.
That doesn’t mean the central banks have totally lost control. They could raise the cost of capital above the natural rate of interest...and kill off the speculation that’s led to an explosion in speculation. But as pseudo-public officials with questionable independence from elected officials, how willing will central bankers be to raise interest rates on millions of deeply indebted borrowers (home-owners)? Not very, we predict.
What’s behind this demand for ‘asset money’? We think it’s the Baby Boomers who need inflating asset prices to increase their net worth before retirement. Thus, the creation of new asset classes is a function of automatic liquidity into the stock market from Asian savers (and institutional money from pension funds, insurance companies etc.) looking for a home in new assets that can make everyone rich.
Or in simple supply/demand terms, demographics has created a demand for financial assets. Asian savings and cheap credit have created the supply of liquidity. Wall Street, the hedge funds, and private equity have rented a room in which the whole affair can be consummated, for a $23 billion clip of the ticket.
Because the demand for ‘asset money’ is so high, says Australia's Financial Review, “almost everything today can become an asset class, whether a freeway, an aircraft lease, or royalties from David Bowie’s back catalogue. All that’s needed is for someone to work out the rocket science of how to construct a security and convince investors to buy it. Recent history shows investors will buy almost anything.”
How long can this party go on? Well, a lot longer. Governments are showing an increasing interest in adopting Australia’s superannuation model which directs private savings directly into the stock market. It’s mandatory, it supports liquidity in the stock market, in inflates pension values, and it keeps everyone in the money shuffling industry happy.
Something like this could soon happen in the US now the new Congress has met in Washington. The United Kingdom already has an official report advising mandatory investment in the stock market by employees, made straight from their pay packets – just like PAYE, and with the same accounting burden thrown onto employers.
The idea of making everyone a millionaire through inflating asset values in the stock market is, of course, absurd. But that doesn’t mean it won’t be tried. And that’s why the demand for Dollar-denominated assets could support the US Dollar for a lot longer.
What’s more, it may not be long before Europe’s central banks (led by a Frenchman) begin to sell Euros to weaken that currency and strengthen the continent’s exports.
A Dollar bull goring spectators at the bullring? Don't count against it.