By Ambrose Evans-Pritchard | 8 November 2007
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The witches' brew of 1987 is back again. We forget now, but the triple backdrop to the Wall Street crash in October 1987 was a tumbling dollar, record oil prices, and an inflation mini-scare across the world.
Double, double toil and trouble
This witches’ brew is coming to the boil again with some violence. The dollar has crashed through historic support levels to an all-time low of 75.61 on the global index, and oil is flirting with $100 a barrel. Take a glance at these two dollar charts.
The Greenback has slumped to 91 cents against the Canadian Loonie, the lowest since Canada’s currency was floated in 1950.
It has fallen for three years against the Brazilian real, the Mexican peso, the Russian ruble, et al— the first time it has ever lost ground in this fashion against a mix of emerging market currencies. And, of course, the euro has risen 70pc in six years to $1.47.
Why is the dollar crumbling? Is it just because the Federal Reserve has begun to cut interest rates, while other central banks are still tightening?
Or have we reached the moment when the United States is downgraded as an economic, political, and military power by the rest of the world— permanently— reflecting its new status as a super-debtor with $3 trillion in external liabilities?
What we know is that Asian and Mid-East central banks are cutting their holdings of US Treasuries at a brisk clip. Qatar has cut the dollar share of its $50bn sovereign wealth fund from 98pc to 40pc.
The effect was disguised as long as the credit bubble continued to lure huge sums of foreign "hot money" into America’s $2.2 trillion commercial paper market. But this market is half-frozen. Loans have contracted by $300bn in twelve weeks. The risk this winter is that a hot money exodus will follow the glacial exodus of Chinese, Japanese, Taiwanese, Korean, Saudi, Emirati, and Norwegian cold money— if it has not begun already.
Nor is that the only risk. Stephen Jen, chief currency strategist at Morgan Stanley, says we may face a full-fledged crisis in short order if hedge funds armed with huge leverage come off the sidelines and begin to pummel the dollar as well.
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And then there is the yen "carry trade", that $1,200bn flow of Japanese money (often borrowed at near-zero rates in Tokyo) that has juiced global asset markets through the boom.
"The most dangerous threat is that the yen will snap back and destroy the carry trade," he said. This is exactly what happened in 1998, setting off a chain of falling dominoes.
While we are talking about Morgan Stanley, let me quote the latest thoughts of their credit strategist Gregory Peters— which were e-mailed to me today:
“In my mind, the critical importance of the securitization process (ie packaging mortgages into CDO bonds, etc) has not been fully appreciated. It is crucial for the overall economy. The virtuous circle of cheap financing helped prop up consumption. Today, [that] machine appears to be broken, turning the virtuous circle into a vicious one. “Subprime problems are [only] the canary in the coal mine. They have led to the shuttering of much of the securitization market, which is thus restricting capital. The longer we see dislocation, the more troubled I will be regarding financials, the consumer, and the economy,” he said. |
Quite.
As for the inflation part of our witches' brew, a note today from Capital Economics warned that headline CPI inflation in the US is likely to reach 4.5pc in November, and could reach 5pc by the end of the year— largely due to the [already built-in] effects of oil doubling [earlier] this year.
The futures markets seem to be disregarding this. They have priced in a likely half point cut in rates by January. Well, the best of luck to them. But do they imagine that Fed hawks from Dallas, Richmond, St Louis, among others, will countenance two more cuts with inflation running at this level?
Not even the Washington doves are thinking along these lines. Ben Bernanke told Congress today that "the upside risks to inflation and the downside risk to growth" are roughly balanced. Rightly or wrongly, the Fed is now neutral.
The Fed is caught between the Scylla of screaming CPI inflation and the Charybdis of a housing crash. Call this stagflation [[Or, a foreshadowing of TEOTWAWKI: normxxx]], if you want.
Perhaps the Fed should have thought about this danger when it held rates at 1pc in 2003 and 2004, and kept them at recklessly low levels in 2005 in one of the greatest policy blunders of the post-war era.
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As the Bank of Japan noted in its latest minutes, the "excessive financial behaviour" of the credit bubble has been the direct result of the Fed’s loose monetary policy. The boutique investment banks that trafficked subprime CDOs were merely responding to the distorted incentives created by the US government itself when it fixed the price of credit too low [[the world (including a lot of innocent bystanders) will have paid a very high price for Alan Greenspan's last days in office— and this administration's desperate attempts to 'goose' the economy): normxxx]].
Nor can there be much help from the rest of the world on the inflation front. The disinflation era of the 1990s is no longer on offer. The cost of Chinese and other Far Eastern manufacturing is shooting up.
Here is a sampling of global inflation rates.
Eurozone 2.6%, (highest since the launch of the euro).
China 6.2%
Russia 9.0%
Vietnam 14.0%
United Arab Emirates 9.3%
Saudi Arabia 4.9%
Latvia 13.0%
Romania 6.0%
Chile 6.5%
Kazakhstan 8.6%
Most of these levels are the highest in a decade, whether caused by commodity booms, dollar pegs or euro pegs, or a mix.
We are reaching the point when governments across the world will have to do something before inflation spirals out of control. Such moments are never happy in the lives of stock markets. Wall Street’s S&P 500 has just broken down through its 200-day moving average, the line closely watched by funds.
There will be trouble unless it moves back above this line very soon.
Normxxx
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