Signs of the Economic Apocalypse, 9-17-07

From Signs of the Times:

Gold closed at 717.80 dollars an ounce Friday, up 1.1% from $709.70 at the close of the previous week. The dollar closed at 0.7206 euros Friday, down 0.8% from 0.7263 at the close of the previous Friday. That put the euro at 1.3877 dollars compared to 1.3768 the Friday before. Gold in euros would be 517.26 euros an ounce, up 0.3% from 515.47 for the week. Oil closed at 79.10 dollars a barrel Friday, up 3.1% from $76.70 at the close of the week before. Oil in euros would be 57.00 euros a barrel, up 2.3% from 55.71 for the week. The gold/oil ratio closed at 9.07, down 2.0% from 9.25 at the end of the week before. In U.S. stocks, the Dow closed at 13,442.52 Friday, up 2.6% from 13,100.70 for the week. The NASDAQ closed at 2,602.18 Friday, up 1.6% from 2,560.21 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.46%, up nine basis points from 4.37 for the week.

In his new book, former Federal Reserve Chair Alan Greenspan is calling for an economic depression. He didn’t put it quite that way, of course, but that’s what he did when he called for the Fed to raise interest rates through the roof .

Greenspan predicts double-digit rates

Barbara Hagenbaugh, USA TODAY

WASHINGTON — A day before the Federal Reserve is expected to cut interest rates, former Fed chairman Alan Greenspan predicts in a new book out Monday that the Fed will have to raise rates to double-digit levels in coming years to thwart inflation.

Greenspan's prediction comes a day before Fed officials are widely expected to cut interest rates for the first time in more than four years following turmoil in mortgage markets that has rippled through the entire financial sector, leading to concerns about a credit crunch and a slowdown in the overall economy.

Fed Chairman Ben Bernanke and his colleagues have kept their target for short-term interest rates, which influence borrowing costs economywide, at 5.25% for more than a year.

Greenspan, 81, says in his book The Age of Turbulence that the inflation-damping effect of globalization, which has led to lower wage pressures, inflation and interest rates worldwide, will recede.

At some point, the flow of people into the workforce in developing countries such as China, which has seen a movement of workers from farms into factories, will slow, leading to stronger wage pressures and prices, he says. The impact will be global.

And the shift "may be upon us sooner rather than later," he says. Evidence: Prices of Chinese imports coming into the USA started rising earlier this year. That suggests that in the "next few years," inflation will build unless action is taken.

Greenspan can’t really be serious about higher pay in China, India and elsewhere causing inflation. He knows as well as anyone that they can always find ravaged countries for cheap labor (Haiti, Africa, etc.). What he most likely is worried about is a collapse of the dollar if interest rates are lowered. The steady fall in the dollar’s value in recent weeks combined with a slowing of the U.S. economy raises the risk of a complete collapse, since a slowing economy normally would call for lower interest rates. But for foreign investors and central banks, the lower the interest rate on the dollar the less value it will have.

Dollar's retreat raises fear of collapse

Carter Dougherty, International Herald Tribune

Septermber 13, 2007

(Frankfurt) Finance ministers and central bankers have long fretted that at some point, the rest of the world would lose its willingness to finance the United States' proclivity to consume far more than it produces - and that a potentially disastrous free-fall in the dollar's value would result.

But for longer than most economists would have been willing to predict a decade ago, the world has been a willing partner in American excess - until a new and home-grown financial crisis this summer rattled confidence in the country, the world's largest economy.

On Thursday, the dollar briefly fell to another low against the euro of $1.3927, as a slow decline that has been under way for months picked up steam this past week.

"This is all pointing to a greatly increased risk of a fast unwinding of the U.S. current account deficit and a serious decline of the dollar," said Kenneth Rogoff, a former chief economist at the International Monetary Fund and an expert on exchange rates. "We could finally see the big kahuna hit."

In addition to increased nervousness about the pace of the dollar's decline, many currency analysts now also are willing to make an argument they would have avoided as recently as a few years ago: that the euro should bear the brunt of the dollar's decline.

The euro, shared by 13 countries, once looked like a daring experiment. But it has gained credibility and euro-denominated financial assets are as good as their U.S. counterparts. With a slow economic overhaul under way in European capitals, and a fundamentally sound corporate structure, a weaker dollar justifiably means a stronger euro.

"The euro has earned what it has gotten," said Stephen Jen, global head of currency research at Morgan Stanley in London. "It is not simply rallying by default."

So long as Americans buy more than they earn from exports - and they did, creating a current account deficit of $850 billion last year - the rest of the world financed the binge by bringing dollars into the United States for investment in stocks, bonds, real estate or other assets, thereby preserving demand for the dollar.

The continued appetite for U.S. investments stemmed from a track record of strong economic growth and a financial system that has been remarkably resistant to shocks.

But the latest turmoil in mortgage markets has, in a single stroke, shaken faith in the resilience of American finance to a greater degree than even the bursting of the technology bubble in 2000 or the terror attacks of Sept. 11, 2001, analysts said. It has also raised prospect of a recession in the wider economy.

While most economists just a few months ago would have dismissed the prospect of a dollar collapse outright, they now are debating the possibility that something on par with the dollar debacle of the 1970s might just happen again.

When a currency collapses, the central bank can push up interest rates to attract needed investment, but strangle the economy in the process. Alternatively, it can let the currency fall and watch prices of imports - and eventually competing domestic goods - rise sharply.

Double-digit inflation resulted in the 1970s and only a global recession brought it to an end.

Today, the dollar's current weakness is being driven by uncertainty over how central banks will react to the turmoil in financial markets, unleashed by the collapse of the U.S. market for subprime mortgages given to borrowers with shaky credit histories.

The European Central Bank put off an interest rate increase it had planned for September, but is still inclined to tighten credit at least one more time by the end of this year. By contrast, the U.S. Federal Reserve has hinted at a rate cut at its meeting next Tuesday - a step that would diminish the appeal of dollar-denominated assets, almost certainly sending the dollar lower.

But across a horizon of 18 months to two years, investors are pondering how quickly the dollar will fall, a question to which there are no easy answers.

After a run of strong growth, the U.S. economy has lurched into a phase of slower expansion, and last Friday the most serious warning sign appeared - an outright deterioration in employment growth.

The data has coincided with profit warnings from major U.S. retailers like Wal-Mart Stores and Home Depot, suggesting that consumer spending, the backbone of the American economy for years, was ebbing. This step would logically follow the rapidly cooling housing market, since Americans have spent heavily with money borrowed against rising home values.

A drop in consumer spending by Americans means fewer imports. The current account deficit peaked at 6.8 percent of gross domestic product in late 2005 and is now running at about 5.5 percent, with figures for the second quarter of 2007 due out on Friday.

A lower deficit means less capital needs to flow into the United States, and is consistent with a steady decline in the dollar. Since the middle of last year, the dollar, weighted for trade flows, has fallen steadily against a broad range of currencies, according to data collected by the Fed.

All this suggests that, in spite of headline-grabbing news about the latest low, the dollar could be adjusting gradually as the U.S. economy becomes driven less by lending on the back of rising home price.

The problem, as every economist knows, is that the current account deficit - about $770 billion - is still colossal in absolute terms.

And foreigners are being asked to provide those dollars at a time when the subprime turmoil is threatening to spill over into the broader economy.

Put another way, at a time when the psychology of crisis has gripped financial markets, intangible attitudes toward the dollar have become all the more important. And with growth strong elsewhere in the world, there are appealing places to go besides the dollar.

"The problem is that the deficit is still very, very large," Jen said. "And there are plenty of other investment opportunities outside the United States."

Pressed to make an educated guess, most economists opt for calm, believing the dollar is unlikely to go into a tailspin even as they mark up the odds of one.

The major holders of dollars - notably the Chinese, with their $1.3 trillion in currency reserves - have little incentive to see the dollar weaken, and their support provides the dollar with a bulwark of strength. And since investors need to stay diversified, and U.S. markets are deep and liquid, abandoning the dollar wholesale is hardly a realistic option.

"Rather than a precipitous decline, we are probably be looking at a move steadily lower," said Simon Derrick, chief currency strategist at Bank of New York in London.

Of course most economists “opt for calm” in predicting a dollar crash. Given their track record in predicting the housing crash, no one should believe their optimistic statements:

Forecast says: Chances of recession growing

Andrew Leonard, Salon

Confirmed pessimists on the economy can be excused for reacting with a big fat "I told you so" to the news today from the Wall Street Journal that its latest survey of economists had raised the chances of a U.S. recession occurring in the next 12 months to 36 percent.

Too bad the survey is essentially worthless. The monthly roundups are called "forecasts" but all they really tell us is the conventional wisdom prevailing in the moment, and for reasons not particularly clear, that wisdom almost always appears skewed toward the don't-worry-be-happy end of the spectrum.

Just for fun, let's review. One popular question posed by the Journal over the last year has been to ask whether or not "the worst of the housing bust is behind us."

In November 2006, 65 percent of the economists surveyed agreed: The worst is over.

Wrong.

In December 2006, 57 percent said the tide had turned.

Wrong.

In March 2007, an amazing 80 percent told us the worst was in our rearview mirrors!

Really, really wrong.

In April 2007, 71 percent said we'd seen the worst.

Still wrong!

In May, the Journal did not ask the question. But in June, 74 percent said the baddest of the bad stuff was bye-bye.

Nope.

In August, 64 percent were whistling a happy tune.

Strangely, in September, the Journal again did not ask the question.

The evidence that we've yet to hit bottom on the housing bust can be seen in mounting foreclosures, falling home prices, accelerating construction job losses, and a flood of red ink for homebuilders. But for the most convincing proof that a chill wind is getting more blustery, one need only review the latest prediction from the National Association of Realtors, an organization renowned for its steadfast cheerfulness in the face of all real estate data to the contrary. On Tuesday, the NAR revised its estimate for existing home sales in 2007 downward, for the seventh month in a row, to an 8.6 percent drop. New home sales, it declared, would plummet by 24 percent.

Maybe that's why the Journal didn't ask the question this month. It would have been too embarrassing.