Thursday, December 06, 2007

When the stopped clock is both correct AND right

A full-blown dollar collapse would be disastrous. Thankfully, it need not happen - Economist

The old trading adage - a trend is ending when it makes the cover of Newsweek, came to mind when I saw the cover of the Economist magazine. But that wasn't the first thought that popped into my head. My first thought was, "How did Jim Sinclair get his cartoon on the cover of the Economist?"

After enjoying a chuckle I got back to serious thinking (the reading of which, after all, is why I assume you spend your precious time seeing if I've gotten around to updating my blog).

For the past few years I haven't paid much attention to contrary indicators, not because they don't produce tradable moves, but rather because I find it more relaxing to trade from a long term perspective. As speculation is my only income source these days, comfort in trading is key for me.

Yet, I remembered quite a few times during my career when the US$'s obituary was published in the financial media only to beg Mark Twain's response - rumours of my demise have been greatly exaggerated
. One of the Economist's essays noted this: The dollar's place as a reserve currency always seems to be questioned when it falls. Weakness in 1977-79, 1985-88 and 1993-95 was each time met with predictions that governments were about to switch their reserves into another currency. A burst of high inflation, which undermined the dollar in the late 1970s, made that slide as serious as today's scare is. Between 1978 and 1980 the Treasury sold $6.4 billion of “Carter bonds”, mostly denominated in Deutschmarks, to raise funds to defend the dollar. In January 1980 the gold price reached a record $835 (around $2,250 in today's prices) as investors sought an alternative store of value. And when the dollar fell to ¥81 in 1995, many—including this newspaper—saw it as the beginning of the end of its reserve-currency status.

I wondered if this was to be yet another instance when the US$ is doomed crowd was to be seen, in hindsight, as the stopped clock that was momentarily correct, but not right. Interestingly, the Economist took that view, which seems, to the contrarian in me, more a sign to sell than buy. Perhaps they are gun-shy after forecasting a loss of reserve status for the US$ in 1995.

Drifting further down this stream of thought I began to wonder about the "stopped clock" designation. Should one who only forecasts the inevitable on an issue be seen as a "stopped clock?" I'm sure those who made a habit of fleeing Pompeii every time Vesuvius rumbled were seen as "stopped clocks"- and when the inevitable did occur, these "stopped clocks" were the only ones left to be seen.

Alternatively, I'm sure there were many similarly single minded folk who worried about the levees breaking in New Orleans each time a hurricane came near. Eventually, they too were correct- and, it seems to me worth noting, right as well.

The levee as US$ support metaphor seems particularly apt in that the timing of the too-strong storm was always in doubt until the event, but THAT such storms did manifest in that region from time to time was not. Like the next big quake in California or the next eruption of Anak Karakatau (the "child" of Krakatoa) when is unknown but that it will happen is pretty certain. Equally, given that every other fiat currency man has ever tried has eventually, as Voltaire noted, traded at its intrinsic value of zero, the eventually fate of our fiat currency seems sure, even if the timing is not.

And this storm seems big enough to me. Unlike previous storms, which occurred either before the US' current account became chronically negative, such as in the early 80s, or when potential rivals, like Russia and China were weak, such as in 1995, this storm is hitting the US$ after many years of chronic, large and growing current account deficits and when our rivals are on the ascendancy. Meanwhile, such as was the case during the last great US$ bloodletting, the US is bogged down in another expensive war. Additionally, and importantly, efforts to tighten monetary conditions keep getting unwound once real pain is felt. If interest rates cannot rise, inflation will continue.

This time, it seems to me, the "stopped clock" that says the US$'s days as global reserve currency are over is correct and right. Betting on the inevitable will always, it seems, require a few premature wagers- but that just makes the payday that much sweeter. s obituary was published in the financial media only to beg the response of Mark Twain- rumours of my demise have been greatly exaggerated. One of the Economist's essays noted this: The dollar's place as a reserve currency always seems to be questioned when it falls. Weakness in 1977-79, 1985-88 and 1993-95 was each time met with predictions that governments were about to switch their reserves into another currency. A burst of high inflation, which undermined the dollar in the late 1970s, made that slide as serious as today's scare is. Between 1978 and 1980 the Treasury sold $6.4 billion of “Carter bonds”, mostly denominated in Deutschmarks, to raise funds to defend the dollar. In January 1980 the gold price reached a record $835 (around $2,250 in today's prices) as investors sought an alternative store of value. And when the dollar fell to ¥81 in 1995, many—including this newspaper—saw it as the beginning of the end of its reserve-currency status.

I wondered if this was to be yet another instance when the US$ is doomed crowd was to be seen, in hindsight, as the stopped clock that was momentarily correct, but not right. Interestingly, the Economist took that view, which seems, to the contrarian in me, more a sign to sell than buy. Perhaps they are gun-shy after forecasting a loss of reserve status for the US$ in 1995.

Drifting further down this stream of thought I began to wonder about the "stopped clock" designation. Should one who only forecasts the inevitable on an issue be seen as a "stopped clock?" I'm sure those who made a habit of fleeing Pompeii every time Vesuvius rumbled were seen as "stopped clocks"- and when the inevitable did occur, these "stopped clocks" were the only ones left to be seen.

Alternatively, I'm sure there were many similarly single minded folk who worried about the levees breaking in New Orleans each time a hurricane came near. Eventually, they too were correct- and, it seems to me worth noting, right as well.

The levee as US$ support metaphor seems particularly apt in that the timing of the too-strong storm was always in doubt until the event, but THAT such storms did manifest in that region from time to time was not. Like the next big quake in California or the next eruption of Anak Karakatau (the "child" of Krakatoa) when is unknown but that it will happen is pretty certain. Equally, given that every other fiat currency man has ever tried has eventually, as Voltaire noted, traded at its intrinsic value of zero, the eventually fate of our fiat currency seems sure, even if the timing is not.

And this storm seems big enough to me. Unlike previous storms, which occurred either before the US' current account became chronically negative, such as in the early 80s, or when potential rivals, like Russia and China were weak, such as in 1995, this storm is hitting the US$ after many years of chronic, large and growing current account deficits and when our rivals are on the ascendancy. Meanwhile, such as was the case during the last great US$ bloodletting, the US is bogged down in another expensive war.

This time, it seems to me, the "stopped clock" that says the US$'s days as global reserve currency are over is correct and right. Betting on the inevitable will always, it seems, require a few premature wagers- but that just makes the payday that much sweeter.

Perhaps "George Elliot" captured the sense I'm trying to convey in this passage from her novel Silas Marner: The sense of security more frequently springs from habit than from conviction, and for this reason it often subsists after such a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened, is, in this logic of habit, constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent. A man will tell you that he has worked in a mine for forty years unhurt by an accident as a reason why he should apprehend no danger, though the roof is beginning to sink; and it is often observable, that the older a man gets, the more difficult it is to him to retain a believing conception of his own death.

3 comments:

zeno said...

I'm beginning to feel the same way about the medium term implications for the $'s reserve status. This especially following the new subrime-rate freeze drawn up by Paulson. This is essentially a US government-mandated private party default which opens up a whole new ball game - ala Argentina style. Supportes of the plan might say that it's a better idea than allowing defaults which would hurt everyone including the creditors. But that is not the point. Today they change the rules for subprime borrowers. Tomorrow they may change the rules for other debtors including possibly the US Treasury itself. They are laying open a very dangerous door by doing this when they owe the rest of the world over $3T and when they need to borrow $800B each year. Hopefully, the reaction to this will play out over the medium term. There may even be a short-term $ bounce on technicals (and perhaps behind-the-scene intervention). But I'm afraid the dye is cast and the US is crossing the point of no return.

Dude said...

I think we passed the point of no return years ago.....all that remains now is for the "penny to drop" as the Brits put it.

jeff said...

there is no other currency big enough to serve as reserve. neither the euro, nor the yen, nor the pound, nor [insert your favorite currency here], nor certainly gold is big enough to replace the buck. to me, this implies that the dollar will retain a lame reserve status, ever weaker and more uncertain, while dollar holders scramble to find other stores of value.