Thursday, July 26, 2007

The U.S. Dollar is not the lifeboat you want to be sitting in.

The market may have taken it on the chin 2 days ago, but it got its head handed to it today. The knee jerk reaction was “a flight to quality” – U.S. Treasuries. Now, who in their right mind thinks U.S Treasuries have any quality left? Only those Americans who do not possess a passport and have never converted currencies (do big money manager’s really lack a passport? No, I just like insulting them).

The $ is on the ropes; the U.S. housing and debt markets (excluding for the moment Treasuries) are on the ropes. If the Fed lowers rates to help housing, mortgages, and the CDO market, the $ will go down like a rock in a pond. If the Fed holds rates steady, or heaven forbid, tries to control food and energy prices by raising rates (insanity), they stem the bleeding in the $ temporarily and kill the U.S. economy. As my friend Fireangel from likes to say: Bernake must be the dumbest man on the planet, because that designation is defined as willingly taking over the job of the former Fed Chairman, Alan Greenspan. Why? Because there is no way out of THIS “conundrum”, and although he had nothing to do with the circumstances, the blame for the train wreck will fall entirely on Bernake (and maybe the next President).

Perhaps you think I am being alarmist, after all the Dow hit a record 14,000 and has doubled since 2002… but that measures the value of the market against the $; if you compare the market against gold since 2002, the market is down; if you measure it against silver, the market is down far more than versus gold; if you measure the market against crude oil, the market is an unmitigated disaster. In fact, you would have done better if you held milk (no real way of doing so) instead of stocks for the past 5 years.

If milk, corn, wheat, gasoline, and healthcare continue their price appreciation (inflation) and must be purchased using real dollars, why would you measure the market in nominal dollars? Doesn’t make a lot of sense, does it?

But I digress...

In the short run, the various central banks can get together to support the dollar. My contention is that the central banks might want to, but their politicos might not. Some might not even want to, and we (Congress) may not want them to… The following was front page on Bloomberg news today:

“Some U.S. lawmakers deem the yuan's ascent -- about 9 percent since the Chinese government ended a link to the dollar -- insufficient to narrow the trade gap. The Senate Finance Committee is set to consider legislation aimed at pushing China and other countries to raise the value of their currencies.”

Now how can the Fed be successful in defending the value of the dollar in a political environment in which our elected officials want “China and other countries to raise the value of their currencies” (the mirror image of which is a decline in the U.S. dollar)?

This brings us back to The Problem. Energy - and oil in particular. The U.S. is borrowing over $1.2 billion every business day to finance its oil purchases. That piles up into a heap of money in a hurry. That pile devalues the dollar as it increases, leading us to borrow more money to buy the oil… see where this is going? So why is it so hard for the guys running the train set? (Next year those prima donna baby boomers that elect to “go ugly early” are going to start drawing on Social Security, Medicare, and “the drug benefit”. If you think the dollar is cheap now, just wait for the collision of the baby boomer’s entitlement drain and significantly declining U.S. oil imports.)

Oil, at this moment, is priced in U.S. dollars, and the price of oil is set by the incremental imported barrel of oil. The value of the dollar is declining, while at the same time the supply of oil in the export markets is declining. If this continues, the U.S. will increasingly find itself being priced out of the international Oil market ($100, $150, $200 per barrel) it created and once controlled. And that, my friends, for better or worse, is going to change the world.

Yours for a better world,

Mentatt (at)

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