Everything up against the dollar. Even Bernanke.

While I wait for dinner to finish, and before doing some actual work. Following on from this morning’s post, and why I thought the US would face the ForEx exposure problem first.

The euro hit an all-time high against the dollar Wednesday, rising above $1.39 amid speculation that the Federal Reserve will soon cut key interest rates as much as half a percentage point.

The 13-nation euro rose as high as $1.3914 in trading in New York — breaking through its previous record $1.3852, reached on July 24. That compared with the $1.3832 a euro bought in New York late Tuesday.

In fact:






Expansionary Monetary Policy

That report strengthened speculation that the Fed will lower its target for a key interest rate at its Sept. 18 meeting. A cut from the current rate, 5.25%, would be the first reduction in four years.

The new dollar low came as “traders continue to second-guess how (Fed Chairman Ben) Bernanke and his team will act” next week, said James Hughes, a market analyst at CMC Markets.

Lower interest rates, used to stimulate the economy, can weaken a currency by giving investors lower returns on investments denominated in the currency.

Bernanke offered no hints during a speech in Germany on Tuesday.

“The fact no mention of monetary policy was made in yesterday’s speech in Berlin has done little to placate the market, and we’re also seeing growing speculation that the Fed may elect to cut rates by a half a point as they try to steer the economy away from recession,” Hughes said.

Two problems. First, Monetary policy is a slow-moving kind of deal, but it seems like this recession we’ll have to have is quite near. I don’t see rates getting us out of it, unless the Federal government is going to buy up all the dodgy loans and never foreclose on people. Then, maybe. There is always Fiscal policy – I wonder why that isn’t discussed (rhetorical. Sit tight for that one).

Secondly, the problem isn’t an ordinary slowdown, it’s a fundamental cock-up in the financial market, which the Fed will only reward and worsen, if it lowers rates. The problem was caused by the people who’ll benefit first from the rate cuts, while the people who need the help will be unlikely to do more than be sold a deeper hole into which to dig themselves (as they surely will).

Bernanke will never give a hint, and I don’t know why ‘the media’ persist in pretending we should expect him to. Macroeconomic policy, particularly Monetary policy, works best when we don’t know it’s coming. Daylight itself couldn’t get between us seeing Bernanke heading a certain direction, and rushing there ourselves to beat him to it and make a bundle of money. Personally, in this instance, with these problems, he should however just state, very forcefully, that bailing out one-way-Wall-Street-ers is not his job, and that he is the Federal Reserve Chairman: he can make his own decisions. The principle of Central Bank Independence applies to financial wankers, too.

Now, about those exchange rates.

Interest Rates and the Exposure to Foreign Capital

Why can’t expansionary Fiscal policy be applied to this problem? It would work faster, and incomes in the US have gone almost nowhere in several years, now. It seems sensible to push them up. A little inflationary pressure won’t hurt, if it came to that. Petrol and food are going up, but it seems housing costs are about to slide a little.

So, about Fiscal policy. The US budget deficit, even with its false ‘drop’, still doesn’t much have the slack required for much expansionary policy, nor does Congress seem to have any sort of taste for it (war funding appropriations seem not to count).

The shortfall in US current accounts needs to be met by foreign capital inflows (i.e. borrowing, or sales of US assets to foreign entities):


That’s over a couple of billion dollars a day of capital inflow, and the US keeps that with high dollars and competitive interest rates, assuring lenders a good return on investment in the US debt. Only, that dollar is sliding admirably, meaning if you lend the US money now, chances are it will be worth less in a year, because the USD value of US debt will be worth less. As we speak, the world is shedding their holdings of US debt.

The days of the dollar as the world’s “reserve currency” may be drawing to a close. In August, foreign central banks and governments dumped a whopping 3.8% of their holdings of US debt. Rising unemployment and the ongoing housing slump have triggered fears of a recession sending wary foreign investors running for the exits. China, Japan and Taiwan have been leading the sell-off which has caused the steepest decline since 1992.

o some extent, the losses have been concealed by the up-tick in Treasuries sales to US investors who’ve been fleeing the money markets in droves. Investors have been trying to avoid the fallout from money funds that have been contaminated by mortgage-backed assets. Naturally, they bought US government bonds which are considered a safe bet. But that doesn’t change the fact that the dollar’s foundation is steadily eroding and that foreign support for the dollar is vanishing. US bonds are no longer regarded as a “safe haven”.

What is needed, to keep US debt attractive? Higher interest rates. Hence Bernanke’s problem, and one I’m terribly glad is not mine. His economy needs low interest rates, but his economy also needs high interest rates. As his economy slows, the dollar depreciates – and both of those needs become greater.

Not to mention, of course, his Chinese problem: speculators. He is not in charge of only a domestic economy. That would be much too easy. Foreign capital can fly in and out more and faster than ever before, and he can’t help what trillions of dollars floating the globe, looking for a place to land, might do. Directly or indirectly.

Bernanke will, may, eventually, soon, face the crunch: an insistence by both foreign capital and domestic that he will align Fed policy with them. And he can’t do so for both. If he’s tempted to try, I hope he has a friend nearby to smack him over the head with an article about Chancellor Norman Lamont.

The Pound Sterling once crashed out if its trading market, and there’s really no reason why the US dollar can’t, too.

Bernanke is in fact probably taking his best bet: stalling, keeping both sides from reacting too negatively too quickly, hoping for a quick recession and a quick re-interest in investing in US debt, and hopefully with the US dollar still the world’s choice for ready cash.


  1. The US dollar is down while foreign economies are doing well. The combination of exchange rate differentials and GDP differentials means that US exporters should fare quite well, giving the US economy some boosting, as it goes (remember: AD = C + I + G + NX).
  2. With debt in US dollars, as the dollar slides so does the debt. Possibly tempting the escalation of debt and budget deficits – practically a catastrophe – but currently helping out a little.
  3. The interest in Federal securities in the US. We’d prefer investment in US firms, but it seems those don’t exist anymore – there’s just a Freak-Field Of Credit Instrument Bundles to buy. One of the reasons the debt under Reagan wasn’t as bad as the debt under this Bush is that it was sold to Americans – so it was American assets, and American savings, so American wealth. Foreign-owned debt is simply a drag on the economy, so any extra domestic ownership should help.

As Goes Private Equity, So Goes The Bottom Of The Dow

Finally (I’ve finished dinner while typing, but I really need to Get To Work): the interest rate problem, the credit crunch, call it what you will. Evidence abounds of a serious problem with the Ordinary Private Equity Machine. The existence of this machine, lurking, waiting to pounce on declining stocks of Rescuable Companies, has played a big part in keeping Wall Street up, by keeping stocks from truly failing the old-fashioned way. Almost no industry stock could even decline for long, without pre-buy-out speculation pushing the price back up.

Stocks that were of little practical worth, potentially, were as popular as stocks of companies that were still, you know, good.


Private Equity’s buy-outs were leveraged buy-outs, and they’re having more and more trouble raising debt to pay their average 14.7 times earnings (2002 average: 3.8 times). Meaning sliding stocks slide. And the Dow with it, and Wall Street with that. This is the natural order of the stock market. Indices advance, then they retreat, then advance again, always moving onwards, roughly with inflation but a bit faster, increasing wealth. We were so enamoured of our own wealth and genius that we forgot you can’t beat that one. Gravity always wins, just like the song says.

It isn’t a fucking cash machine in the lobby of Goldman Sachs that never dries up, but we were so sure that we beat inflation during the Clinton years that we forgot about that part. We forgot about taking our lumps and taking long views, because we were so busy buying and selling CDOs, pushing them onto idiot pension funds and chasing ever higher yields, while nobody with any sense stood in our way.

A fabulous city of Xurbs unfolded, and all we needed was cheap credit and cheap oil. Well, a funny thing happened on the way to the car, this morning…

So that’s my big picture, however incomplete. Like I said, I’m just glad the problem isn’t mine to try to solve. This blog will need an inflation tag, soon. Possibly a recession one, too. I hope not. We can, still, skate very close to it and survive. Speculators are always the ones who always end up Tilting, the bastards.

Final solution (no, not that one). China is, whatever her other problems, growing ever more wealthy. Find out what they want, find out what, of that, we have a comparative advantage in, and start producing it as quickly as we can. Even a small share of such a market could carry an economy. Just a thought.


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