Monday, June 13, 2005

Signs of the Economic Apocalypse 6-13-05

From Signs of the Times 6-13-05:

The euro closed last week at 1.2106 dollars, down 1.1% from 1.2236 the prior week. That would put the dollar at 0.8261 euros compared to 0.8173 the previous Friday. In the U.S. stock market the Dow closed at 10,512.63, up 0.5% from the previous week's close of 10,460.97. The NASDAQ closed at 2,063.00 on Friday, down 0.4% from 2,071.43 the week before. The yield on the ten-year U.S. Tresury Bond closed at 4.04% up from 3.98% the previous Friday. Oil closed at $53.23 a barrel, down 4.1% from last week's $55.40. In terms of the euro, oil would be 43.97 euros a barrel down 3.0% from 45.28 on the previous Friday. Gold closed at $426.40 an ounce, up 0.07% from the previous Friday's close of $426.10. On Friday and ounce of gold would buy 8.01 barrels of oil compared to 7.69 (up 4.2%) a week earlier.

The past few weeks have seen two remarkable rebellions against globalization and the neoliberal project. That of the EU and that of Bolivia. If anyone is looking for a definition of neoliberalism, this one's good:

Building on simulations of traditional precepts of liberal democracy, neoliberalism has forged a new synthesis or hybrid that effectively rationalizes, celebrates, and promotes the globalization process and the increasing globality of industrial production, commercial trade, financial integration, and information flow. It has brought to the fore a new global class of economic and political entrepreneurs who operate not only transnationally but also at the national, regional, metropolitan, and local scales to foster those conditions that facilitate the freedoms of global capitalism: increasing privatization of the public sphere, deregulation in every economic sector, the breakdown of all barriers to trade and the free flow of capital, attacks on the welfare state and labor unions… And it is carried forward in a series of familiar spin-doctoring slogans having to do with the magic of the market, the ineffectiveness of Big Government, the triumph of capitalism, the emergence of a borderless world, and a whole slew of "end-ofs" - of history and geography, of socialism and the welfare state, of ideology itself. (from Edward W. Soja, Postmetropolis: Critical Studies of Cities and Regions, Malden, MA: Blackwell Publising, 2000, p. 216)

In Bolivia, the government was brought down by massive protests calling for the nationalization of that impoverished country's natural gas reserves. According to Tom Lewis:

Ordinary working Bolivians are fighting to get rid of the stranglehold that transnational corporations have on Bolivia's economy. They are also fighting to strip power away from a political elite who they view as in bed with the transnationals--as vendepatrias (corrupt officials willing to sell off Bolivia's patrimony on the cheap).

Ever since the popular victory achieved during Cochabamba's Water War in April 2000--when mass struggle defeated a plan to privatize the city's water system--the struggle of the Bolivian people has focused mainly on reclaiming workers' and citizens' control of Bolivia's natural resources. The experience of throwing U.S.-based Bechtel out of Cochabamba--and of then turning the city's water service over to the elected representatives of a citizens' and workers' self-management team--inspired the confidence and determination of Bolivia's disenfranchised majority.
Here's Bill Van Auken:

There is hardly any need for an outside spark to ignite the social powder keg existing in Bolivia, South America's most impoverished country. According to Bolivia's National Institute of Statistics, 64 percent of the urban population lives in poverty, while in the countryside conditions are even worse, with 80 percent in poverty. More than one-third of the country lives on less than two dollars a day, while the infant mortality rate - 95 for every 1,000 births - is worse than much of Africa.

The conception that the country's wealth should be utilized to benefit its people rather than fatten the profits of foreign oil conglomerates has gripped the masses. This is not - to use the words of George W. Bush at his speech at the OAS this week - the product of a "false ideology," but rather a conclusion drawn from intensely bitter experience with free-market policies and wholesale privatization.

The conception that the struggles that have shaken Bolivia in recent weeks are the product of "outside agitation" by Chávez is an echo of the longstanding US view that every movement against social oppression and every challenge to the interests of US-based multinationals represents a "communist conspiracy." This police-state ideology guided a US policy of support for military dictatorships and savage repression in Latin America for over 50 years. Noriega's comment is a warning that the Bush administration is prepared to resort to these methods once again.

In Europe, the populist revolt against the reforming (neoliberal) Brussels bureaucrats was both a blow for democracy and a blow against the neoliberal project. In the words of a neoliberal sympathizer, Marshall Auerback:

Jean Luc Dehaene, a former Belgian PM, exhibited comparable contempt for popular opinion: In a BBC interview last Monday, Mr Dehaene made the extraordinary remark that the results in France were meaningless because the electorate was not voting against the constitution, but against the French government. Common
sense suggests that on the contrary, they were voting precisely against the constitution, a project of politicians such as Dehaene who are determined to pursue an unpopular agenda with or without popular consent. This notion also appears to be confirmed by the British newsmagazine, The Economist, which noted that five of the top 10 best-selling non-fiction books in France were about the Constitution. Millions of people watched television shows discussing it. A huge percentage of respondents in public opinion polls were familiar with its content. There was huge voter turnout (70 per cent) and people had a very good idea of what the issues were.

This obliviousness to public opinion has been the flaw at the heart of the whole "European Project" right from the start. It is scarcely remembered now that France only barely ratified the introduction of the euro in a vote so tight that its adoption by a few tenths of a percentage point gives lie to the word, "democracy" that lifts so carelessly off the lips of the most undemocratic of politicians.

The dirty little secret of European Monetary Union is that there has never been a proper debate on the pros and cons of the single currency union within the member states. Like so much else in regard to the EU, it was imposed from above. Yet this is a debate that must occur because the European Monetary Union and its attendant institutions, such as the European Central Bank, ultimately cannot succeed in the absence of open, public discussion and acceptance, in lieu of bureaucratic imposition.

It is said that politicians in particular and the democratic process in general cannot be trusted with economic policy formulation because they lead to decisions that have stimulating short-term effects (for example, reducing unemployment via higher government spending) but are detrimental in the longer term (a notable example is a rise in inflation). But comprehensive rejection of the constitution has proved to be an outlet for discontent extending well beyond this particular issue; French and Dutch voters have now shown us the limits of pure technocratic economic management in an environment divorced from political reality.

On the other hand, to debate the appropriateness of a single currency union at this juncture may engender unintended results. It is extraordinary to consider, for example, that the German people never had the opportunity to express their views in a referendum as to whether they ought to abandon one of the most successful post-war monetary regimes in favour of an untried and untested currency. Even if one makes allowances for Germany's traditional post-war phobia of being perceived as "bad Europeans", it is almost certain that most would have voted to retain the D-mark, had they been given the opportunity to express themselves in a proper democratic forum.

Already, there are stirrings of euro discontent emerging at the margins in Germany as well as Italy. The referendum results in France and the Netherlands appear to have lit a match on a tinder box of huge continent-wide disenchantment. Consider what is happening to the now discredited EU constitution in the wake of the French and Dutch referendum results: Four separate polls in Denmark and a survey in the Czech Republic indicated the two countries could both vote No in referendums on the constitution. Bild, a leading German tabloid, showed overwhelming hostility in Germany to the constitution. Of the 390,694 readers who responded, 96.9% said they would vote no if a referendum were held there.

In the United States, the elite, led by U.S. Federal Reserve Board Chairman Alan Greenspan, are trying to present an optimistic view of the United States and the world economy. They are able to do this thanks in part to the recent rise in the value of the dollar compared to the euro. There are a couple of questions to ask, however. First, is the dollar rising or is the euro falling? Second, if the dollar is rising, is the rise the beginning of a new trend or just an interruption of an existing one?

Taking the second question first, here is Stephen Roach, lead analyst of Morgan Stanley:

The interest rate conundrum is challenging enough. But now the dollar is springing back to life in the face of America's record current account deficit. In my view, this defies both the history and the analytics of the classic current account adjustment. Is this just another example of a world turned inside out, or is it a head-fake likely to be reversed?

Despite rebounding nearly 3% from its low this January, the broad dollar index is still down about 13% from peak levels hit in early 2002. The dollar's descent is a logical outgrowth of America's massive current account deficit. The only problem is that it hasn't fallen nearly enough to make a dent in the US external imbalance. A comparison with trends in the late 1980s underscores this conclusion: During that earlier period, America's current account deficit peaked out at 3.4% of GDP and the broad dollar index fell nearly 30% over the three-year period, 1985-88. With our estimates placing the US current account deficit at about 6.5% in 1Q05, it is hardly a stretch of the imagination to see the external shortfall rise into the 7-7.5% range over the next year. In other words, today's current account problem is easily twice as bad as it was back in the 1980s but the US currency has fallen by less than half as much as it did back then. On that simple basis, alone, the dollar has plenty more to go on the downside.

I have long maintained that the dollar can't do the job alone in correcting America's current account imbalance. Two reasons come to mind -- the first being that the impact of currency fluctuations on real trade flows and inflation seems to have diminished over the past decade. Trends over the past three years underscore this observation: The US trade deficit has continued to widen fully three years into what had been a 15% dollar depreciation, whereas inflation has remained generally subdued over this same period. By this time in the dollar's downtrend of the late 1980s, both trade and inflationary impacts were evident. I suspect that the diminished impact of currency swings in the current climate stems importantly from the increasingly powerful forces of globalization, as low-cost offshore price setters (i.e., China) constrain domestic pricing leverage -- even in the face of currency swings and concomitant fluctuations in import prices. That suggests, of course, the impacts of currency fluctuations could show up more in corporate profit margins than in generalized inflation.

But the second and far more important reason that the dollar can'tsolve America's trade and current account problem is that it doesn't get directly at the most critical ingredient of the imbalance -- excess imports, which are, in turn, an outgrowth of excess US domestic demand. One number says it all:

In March 2005, US imports were fully 54% larger than exports. In my view, there is no conceivable dollar adjustment -- or should I say no politically acceptable dollar adjustment -- that would eliminate America's excess import problem. The only effective way to temper an import overhang of this magnitude lies in a real interest rate adjustment that would squeeze excess consumption --and its import content -- out of the system. At a minimum, this would entail a normalization of real US interest rates -- both short and long. Specifically, I believe that would require the term structure of real rates to move upward by about two percentage points from present rock-bottom levels. Not only would that hit the interest-sensitive components of domestic demand -- consumer durables, capital spending, and residential construction -- but it would also cool off frothy asset markets and the wealth-dependent consumption (and imports) such market excesses are fostering.

In this context, America's current account adjust requires a combination of currency and real interest rate adjustments -- both a weaker dollar and a normalization of real interest rates. This underscores an important tradeoff: To the extent that one of the ingredients in this external adjustment equation doesn't deliver its fair share, the burden of rebalancing should then be transferred to the other part of the equation. Therein lies the case for a significant further weakening in the US dollar. In my recently revised view of US interest rate prospects, America's long overdue normalization of real rates is likely to be aborted (see my 30 May dispatch, "Rethinking Bonds"). In the face of the coming China-led slowdown in global growth and its collateral impacts on reduced inflationary expectations, a decidedly pro-growth and market-friendly Fed is unlikely to have much of an appetite for additional monetary tightening. Moreover, the combined impacts of a global growth shortfall and further declines in commodity prices point to a likely compression in the inflationary premium embedded at the long end of the yield curve. As I now see it, given the urgency of a US current account adjustment, further dollar depreciation is a logical outgrowth of such a benign climate in the bond market.

Of course, precisely the opposite is now happening. After an orderly three-year descent of about 5% per year, the broad dollar index has been edging higher over the past four months. This momentum has accelerated in the days immediately after the French and Dutch rejection of the EU constitution. Market participants have taken this political verdict as negative feedback on the future of European integration and the reforms and efficiency enhancement such convergence was long thought to deliver… However, given my concerns over the US current account deficit and my reassessment of the US interest rate prognosis, I do not agree with Stephen that the dollar's structural decline is over. By my count, this is the fourth trading rally in the dollar's recent 39-month downtrend. Like the first three, I believe this one will also fade as the power of the US current account adjustment regains its prominence as the dominant macro theme shaping foreign exchange markets. In the absence of an upward adjustment to US real interest rates, I believe this possibility is even more compelling than might have otherwise been the case.

The next downleg of the dollar should be very different from the first one. The euro has borne the brunt of the dollar's decline over the three years ending January 2005. Most Asian currencies -- especially the yen and renminbi -- were completely unscathed. If the dollar resumes its downward descent, as I suspect, that will have to change. Not only do I look for a politically driven change in Chinese currency policy that would allow for an RMB revaluation, but I also suspect that the yen-dollar cross-rate could move into the mid-90s. The Japanese currency has been virtually unchanged on a broad trade-weighted basis over the entire span of the dollar's adjustment. If the Japanese recovery is finally for real, as official Japan seems to be signaling, then yen appreciation should be a natural outgrowth of that healing. If the Chinese and Japanese currencies strengthen, most other Asian currencies should follow suit -- with the possible exception of the Korean won, which has already moved a lot. I've said it from the start: Global rebalancing is a shared responsibility. It is high time that Asia participate in the adjustment process.

…Of course, currency markets are also highly sensitive to swings in investor sentiment. And with the benefit of hindsight, we should have known that the dollar was about to surprise on the upside. …Nevertheless, I think this counter-trend rally will be short-lived. The imperatives of global rebalancing -- underscored by America's massive current account deficit in conjunction with an aborted adjustment in US real interest rates -- points to nothing less. If I'm wrong and the dollar continues to defy
gravity in a low interest rate climate, you can forget about global rebalancing. In that case, global imbalances will continue to mount and asset markets could become all the frothier. Sadly, the endgame would then be ever more treacherous.

Addressing the first question (Is what we are seeing a strengthening of the dollar or just a weakening of the euro?), there does seem to be a piling on of attacks against the whole concept of the euro after a couple of years of euro-enthusiasm (which I confess I have shared). Now people are looking at the EU and the Euro on their own terms, not in comparison to the United States, and, in the aftermath of the defeat of the proposed EU constitution in France and the Netherlands, many of the assumptions behind the EU and the euro have proven questionable.

The roots of euro-enthusiasm lay both in the hope of the gains to be had in harnessing and coordinating the advanced economies of western Europe with the cheaper labor and more flexible work arrangements in eastern Europe and in the hope for a political counterweight to the American Empire (as well as in plain old pessimism about the prospects for the dollar given the suicidal policies of the Bush administration). The problem is that for the fulfillment of the economic promise of the EU depended on the member countries adopting the neoliberal agenda: cuts in social benefits, increases in work hours, offshoring of jobs to the periphery, etc., all of which would understandably not be supported by the public in the advanced economies of Europe. On the other hand, the fulfillment of the political promise of the EU depended on it following its own path, distinct from the neoliberalism of the United States.

Marshall Auerback concludes that the rise of the dollar recently can be attributed to the fall of the euro bull-market sentiment. More importantly, though, he concludes that all paper currencies are vulnerable. So far, the price of gold has risen ony in terms of the dollar, not so much in terms of euros. According to Auerback, this could change:

In the past we have described the problems of the US economy ad nauseum. We have also highlighted the problems of the yen and the structural problems inherent in the existing European Monetary Union. Although the euro zone as a whole suffers
less from the debt disease prevalent in both the US and Japan, it has largely "earned" its spurs on the foreign exchange markets as a consequence of being the least bad major paper currency alternative. Its acceptance has, until recently, continued unabated, largely by virtue of not being the dollar, as opposed to any intrinsic merits.

Generally speaking, most currency choices faced by market practitioners today are comparable to Keynes's notion of market speculation: to paraphrase Keynes, one is not seeking to adjudge the most beautiful currency in absolute terms, but merely seeking to guess what the market's will judge to have the best relative merits . In other words, paper currencies are only "relatively" attractive vis a vis each other and not genuinely attractive as ultimate stores of value. The current problems of the euro (as well as the longstanding problems of the dollar) illustrate that phenomenon.

This points the way toward a potential major paradigm shift in relation to gold, long viewed simply as another variant of the "anti-dollar" theme. Symptomatic of this shift in thinking is the Financial Times, a publication which has usually been viscerally hostile to gold as a legitimate reserve currency asset. In an editorial last April, however, the FT came to a fairly stunning conclusion:

"In truth, there are good reasons for selling all three of the world's main currencies. But could they all fall? Yes, against either gold or the Chinese renminbi. In recent years, gold has been a useful hedge against the dollar, but not against the euro or yen. Meanwhile, the U.S., Japan, and the EU would all like to see the renminbi revalue, but so far, the Chinese are not playing."

The current travails of the euro may change the perception of gold as a barbarous relic from a bygone era For the FT, which has been known asa very anti-gold publication, to come to this conclusion means that many people who have long viewed bullion as economically irrelevant are likely reassessing their viewpoint. This could well point the way forward for gold, notwithstanding the many travails its holders have experienced over the past two decades. Often, seismic shifts in thinking unfold in slow-motion, and are often masked by other "noisier" events, such as the French and Dutch referendums. The "noisier events", however, could well be catalysing a far more profound change in financial thinking. The rejection of the EU's constitution in France and the Netherlands, therefore, may well have initiated something well beyond the control of today's paper currency custodians, much to their ultimate horror no doubt.

As for our watch on the timing of the popping of the real estate bubble in the United States, there was a disturbing article published last week on MSNBC, disturbing because it is so reminiscent of articles published in the late 1990s during the peak of the dot com bubble. Only this time the article is about someone making lots of money trading real estate in Florida at home rather than a stock day-trader making lots of money trading tech stocks at home:

Buying into 'virtual realty'

Investors go online to buy into hot housing markets

By Scott Cohn, Correspondent

CNBC June 9, 2005
Location is the most important thing in real estate, they say, but if you're looking to invest in real estate, but don't want to travel to any of the hot markets, the Internet has created a "virtual realty" just in time for the housing boom.

Take Mike Bozzo, for example. He owns a successful welding business in Dayton, Ohio. But every day, when he gets to his office, the first place he goes to is Florida.

"I like to spend about an hour looking at different properties," Bozzo says, adding that he visits a number of different real estate sites every day. "This is something I'm looking to do for the future of my family."

Bozzo says his Florida Web surfing is paying off. Over the last four years, he has made well into six figures by buying and selling Florida real estate online, and almost all of it has been sight unseen.

Indeed, a condominium Bozzo bought four years ago for about $220,000 is now selling for two and a half time that amount. One he bought earlier this year for $279,000 is on the market today for $379,000.

Mike Bozzo isn't alone. With the housing market booming, 22 million people are visiting real estate Web sites every month. But before you jump on the Internet and start buying, beware - this is still a risky business, and it's made even riskier by doing it on the Internet.

Bozzo confines his surfing to Naples, Fla. Not just because housing has appreciated 93 percent there in the last five years, but also because he's been going there since he was a teenager and he knows the area.

"I'm a very detail-oriented person, and that's the way I approach it," said Bozzo. "I think that's important - that you understand the area that you're getting involved with."

And Bozzo doesn't only use the Internet to find properties through the Web sites of several local realtors. He also uses it to research tax assessments and recent sales - information that's readily available online. And he always gets a properties inspected, and has a realtor he trusts in Naples who'll check out the property in person if necessary.

Real estate expert John Reed says that's important.

"The due diligence still has to be done," said Reed of Real Estate Investor's Monthly. "And if you're going to trust somebody else to do it, you better know that person really, really well." Bozzo hopes to retire on his real estate profits, which may be another benefit to investing this way…

Articles like these are a sure sign of an impending bursting of the real estate bubble.


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