Why The Dollar Is Rising

By | March 14, 2015

Contra Corner is not about investment advice, but its unstinting critique of the current malignant monetary regime does not merely imply that the Wall Street casino is a dangerous place for your money. No, it screams get out of harms’ way. Now!

Yet I am constantly braced with questions about the US dollar and its impending demise. The reasoning seems to be that if America is a debt addicted dystopia—-and it surely is—- won’t the US dollar sooner or later go down in flames as the day of reckoning materializes? Won’t you make money shorting the doomed dollar?

Heavens no!  At least not any time soon. The reason is simply that the other three big economies of the world—Japan, China and Europe—are in even more disastrous condition. Worse still, their governments and central banks are actually more clueless than Washington, and are conducting policies that are flat out lunatic—–meaning that their faltering economies will be facing even more destructive punishment from policy makers in the days ahead.

Indeed, Draghi, Kuroda and the commissars of red capitalism in Beijing make Janet Yellen and Stanley Fischer (Fed Vice-Chairman) appear to be slightly sober. So as trite as it sounds, the US dollar is the cleanest dirty shirt in the laundry. And on a relative basis, its is going to look even cleaner as two decades of monetary madness around the world finally hit the shoals.

You have to start with a stark assessment of the other three major economies.To hear the Wall Street analysts and economists tell it, Japan, China and Europe are just variants of the US economy with different mixes of pluses and minuses, experiencing somewhat different stages of the economic cycle and obviously shaped by their own diverse brands of domestic politics and economic governance. Yet despite these surface difference, the non-US big three economies are held to be just part of a global economic convoy heading for continued economic growth, rising living standards and higher stock market prices.

Actually, not so. Japan is a bankrupt old age colony. China is the most monumental credit and construction Ponzi in human history. Europe is a terminal victim of socialist welfare and statist dirigisme. All three are attempting to defer the day of reckoning via resorting to a final spasm of money printing and central bank manipulation that is so desperate and crazy that it can only end in disaster.

So there is no global convoy of inexorable economic growth and progress. Instead, we are entering a new era of spectacular financial disorder and credit fueled booms turning into unprecedented deflationary busts. And it is the three big economies outside the US which will hit the wall first, causing the US dollar to thrive on a relative basis.

Consider the absolute monetary madness in Japan—-where the current policy of the BOJ is to expand its balance sheet each month by what would amount to one-quarter trillion dollars on a US scale GDP. Yet this madcap money printing cannot possibly help the Japanese economy because it already has essentially zero interest rates and has had them for nearly two decades. So Kuroda can’t possibly induce Japanese households and business to borrow more money and stimulate growth because they have long been at “peak debt” and couldn’t borrow more if you paid them.

At the same time, the BOJ’s massive bond buying campaign is sucking up 100% of the supply of new government debt—–and Japan’s fiscal deficit is still massive—-and actually eating into the existing float. As a result, the Japanese government bond market is dead as a doornail; the only “bid” comes from the BOJ.

Here’s the thing. The Japanese government is hands-down the largest debtor in the world, with its gross public debt currently at 240% of GDP. Accordingly, it needs a healthy public debt market more than anything else, but its monetary policy has actually killed what remained of it on the eve of Abenomics.

The consequences for fiscal policy and Japan’s ability to finance its immense public debt as its collective old age home steadily fills up is simply mind-boggling. If it continues to monetize the public debt at current rates, it will destroy the yen—sending into free-fall from today’s 121/ dollar to 200, 300 or even worse.

By contrast, if it sends the madmen who are currently running the BOJ packing, installs new central bankers and allows interest rates to normalize, debt service on Japan’s public debt will skyrocket.  As it is, more than 40% of Japan’s current tax receipts go to interest on the public debt and that’s with the 10-year bond yield at 0.4%. Under normal rates, debt service would absorb all of Japan’s current tax revenues, causing welfare and retirement spending to be slashed on upwards of 40% of its population, which will soon  be retired, while raising tax burdens on its shrinking labor force to truly brutal levels.

So Japan’s fiscal equation is calamitous and terminal. Its governments will resort to increasingly dangerous and destructive expedients as they wrestle with its impossible nature. Indeed, the built-in financial, fiscal, demographic and economic trends are so powerful that there is virtually no set of policy measures that could reverse Japan’s headlong tumble into old age bankruptcy.

As shown below, its debt to GDP ratio and the size of the BOJ balance sheet have been exploding for decades. Yet these maneuvers have only made matters worse. As also shown below, Japan’s nominal GDP in dollar terms is no higher today than in was in 1996:

Historical Data Chart

Historical Data Chart

Historical Data Chart

Notwithstanding the perennial bullish expectations of Wall Street Keynesians, the BOJ’s mad money printing campaign has accomplished nothing. In fact, after the downward revision to Q4 GDP it is absolutely evident that its economy is still sputtering. Real GDP is barely higher than it was in December 2012 before Abenomics launched its truly monstrous money printing spree

Yet, the Abe government and BOJ does not hesitate to threaten even more monetary carnage—even as the abysmal failures of current policies are reported month after month. So the yen is heading down, down, down.  Not because the dollar is inherently strong, but because it is currently being traded against a slow-motion trainwreck.

Historical Data Chart

In China the scene is even more tortured. As McKinsey’s charts so dramatically document, the overseers of red capitalism in Beijing have driven China into a monumental debt trap.

Its massive spree of construction and fixed asset investment has created an utterly deformed economy that will literally implode unless its keeps building empty luxury apartments, phantom cities, silent shopping malls and hideously redundant roads, bridges, subways and airports. Yet whenever the short-term indicators stumble, the government finds some new, convoluted way to release more credit into the system.

This too is reaching the farcical stage. During the six-short years since the financial crisis, China has boosted it credit market debt outstanding by the staggering sum of $20 trillion or by 4X the growth of GDP during the same period. How in the world could any one believe that China’s tottering house of cards can be rescued by piling on even more debt financed construction and fixed asset acquisition?

Source: McKinseyThe rate at which the China Ponzi is falling apart is now accelerating. In a nearby post this morning, Mish Shedlock provided a devastating survey of the excess capacity which looms in nearly every industry and the massive overbuilding of public infrastructure and housing based on debt that cannot be serviced and customers and users who are non- existent.But now things are heading into the theatre of the economic absurd. Government officials are forcing the restart of idle steel and aluminum plants so that the can produce unwanted supplies to dump on the world market in order to generate enough cash to pay interest.In a similar vein, the whole phony bullish thesis about the growth wonders to come from China’s highly touted “urbanization” campaigns are being revealed for what they are—-a monumental Ponzi of borrowing from Peter to pay Paul.Millions of peasants have had their land taken over by local governments which borrowed huge sums to pay inflated compensation for the land—-so the displaced farmers could buy newly built high-rise apartments, also built with borrowed money.  That was called “urbanization”, but what it means is that former peasants have been stranded literally high and dry without incomes and without farms, while the local development agencies which borrowed all this money have no possible way to repay it.Needless to say, as China veers ever closer to a crash landing, the China-dependent EM economies are rapidly faltering. It now appears that Brazil will suffer back-to-back years of GDP decline for the first time since 1930-1931.  Indeed, the China-led global commodities and industrial production boom is cooling so fast that global CapEx in mining and energy, materials processing, manufacturing and shipping is on the verge of a huge downward correction. And that will hit the high end machinery and engineering exporters like Germany and the US, creating a further negative loop in the gathering deflationary crisis.And these ricocheting impacts from the China implosion will drive the dollar higher as well. That’s because Chinese companies have borrowed something like $1.5 trillion in external dollar markets, and the EM economies which boomed from the China trade also borrowed trillions in dollar markets—– owing to the cheap dollar interest rates manufactured by the Fed, and the global scramble for “yield”  by dollar based money managers.

While it lasted, the tsunami of cheap dollar based capital which flowed into China and the EM appeared to fuel economic miracles. The socialists of Brazil, the crooks of Indonesia and corrupt crony capitalist of Turkey all feasted on the capital markets deformations emanating from the Eccles Building.

But now the financial boomerang is flying back at them at devastating speed.  As China and the EM struggle against global deflation, their economies are faltering and exchange rates are sinking. Accordingly, they are desperately trying to hedge their immense dollar exposures—a process which drives the greenback steadily higher.

Finally, the madness in Europe speaks for itself. The ECB is now literally destroying the Euro in a disastrous quest to restart economic growth by monetizing $1.2 trillion of mostly European government debt. But Europe’s stagnation is not due to  insufficient private sector borrowing or interest rates that discourage it.

The problem is a state sector that has reached nearly 50% of GDP and is thereby smothering entrepreneurs and investment everywhere on the continent. And it also  means a public debt burden so high that prohibitive levels of taxation are unavoidable.

Stated different, Europe’s economic growth problem is structural and was the result of statist policies over many decades.  The only thing Draghi will accomplish with his massive bond buying campaign is to drive the Euro to par and below; and enable Europe’s government —–all of which can now borrow long-term money at 1% or less—-to kick the can down the road, thereby insuring that Europe’s eventual day of fiscal reckoning will be cataclysmic.

Euro Area Government Debt As % of GDP

quick view chart

Historical Data Chart

So there is a reason why the dollar is soaring. The other shirts in the laundry are not just dirtier. They are actually disintegrating.

Reprinted with permission from David Stockman’s Corner.


Category: Liberty

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