4. Financial Crisis Continues
• US GDP grew $400 billion to $14.5 trillion in 2010
– US debt is at about the same number, 100% of GDP
– Deficit spending grew to $1.5 trillion per year
– So the improvement was largely faked by massive
influx of borrowed or printed capital
• Stock market back up (money had to go
somewhere)
– Housing and employment still in the doldrums
9. Euro: Danger of Disintegrating?
• Vulnerable to debt defaults by member nations
• Spiking interest rates on weakest member
country debt
– Troubled economies can barely service their debt
– Forced austerity programs leading to much unrest
• New debt restructurings, loans and losses are
inevitable.
10.
11.
12. EFSF contributions
Germany 119,000,000,000
France 90,000,000,000
Italy 78,700,000,000
Spain 53,500,000,000
Netherlands 25,140,000,000
Belgium 15,000,000,000
Greece 12,300,000,000
Austria 12,240,000,000
Portugal 11,000,000,000
Finland 7,900,000,000
Ireland 7,000,000,000
.. Total 440,000,000,000
20. Conclusions
• The crisis is still very much with us
• US dollar and economy is in deep trouble
– But likely no other currency will replace it in next few years
– May rise is short term but expect much more trouble
starting in the fall.
• Eurozone is in trouble principally due to troubles of
members it is sworn to support
• Japan, already in major debt is likely to lose its positive
balance of trade while rebuilding
• China is severally overextended in money supply and
facing its own large housing bubble crisis
Notes de l'éditeur
Wars and increasing numbers of retiring boomers will seriously implode US debts. Who is buying all that debt? China, Saudi Arabia and other countries are buying much lessProjecting forward with even optimistic buying outside the country it is clear that the FED banks will attempt to sop up much of it. even though the Federal Reserve says it will stop creating new money to buy Treasuries by the end of this month, it will have to return to the Treasury market as the lender of last resort in the foreseeable future.Should interest rates rise to only 5%, a certainty, the interest on the debt will increase to one trillion dollars per year. As an important point of reference, the federal government collected only about $2.5 trillion in taxes in 2010. If the interest rate on the debt rose to 12%, which is entirely within the range of possibility, interest costs would completely absorb all taxes – though the financial system would collapse before it got to that point. Even though the Fed and federal government claim to be working to avoid such an outcome, this is the trend currently in motion.
Simply stated, continuing to spend on the military at anywhere near current levels ensures that annual U.S. deficits will persist at elevated levels well into the future. When official military budget, all wars and semi-wars and estimated black op budgets are combined it comes to over $1 trillion. So 5% interest rates (historically modest) for $1 trillion in interest plus military expenses at this level would almost tank tax revenues by themselves.
In other words, the government, in conjunction with the accommodating Fed, purchased a modest recovery – and boosted the stock market – but at a very steep cost.By such extreme measures even more massive misallocation of resources and trillions in new debt has occurred.the huge debt of U.S. banks, much of it bad mortgage debt, is still on their books.Banks foreclosing will find the loans are not supported by the house price, and if all the pools of mortgage debt were marked to market, banks would be facing a trillion dollars of bad loans. This is not a problem that will slip quietly into the night.
The chart shows the percentage of our workforce in manufacturing dropping from 15% to 5% since 1970. This is a structural change, and these jobs are not going to return.The result is that we will not see the kind of job recovery that so many politicians promise. The middle class is in decline, so housing won’t be supported.Those are just a few of the challenges facing the American economy. Viewed in isolation, these problems point to continued deficit spending by vote-pandering politicians – clearly indicating further declines in the dollar. The view is not quite so clear, however, when you compare the U.S. dollar to the currencies it competes with on foreign exchange markets. Which brings us to the three most prominent competing currencies: the euro, the yen, and the renminbi.
The euro, the Japanese yen and, in the longer term, the renminbi, are the only currencies big enough to become serious competitors for the dollar.The chart here shows the dollar’s relative strength – with a down-trending line indicating strengthening in the competitive currency against the dollar. The trade-weighted index of major currencies is also included as a combined measure.Currencies can be viewed either as the foreign currency ratio to the dollar as in the first chart, or the reverse. Here is the other view of dollars per foreign currency:
a look at the relative strengths and weaknesses of each of the three potential competitive currencies..
the euro is vulnerable from the PIIGS (Portugal, Ireland, Italy, Greece and Spain), weak members whose debt is too big to serviceSpiking interest rates for debt issued by those countries confirm a loss of confidence that these countries will be able to pay back their debt in full. the higher rates make it nearly impossible for these governments to service their debts, and so are something of a self-fulfilling prophecythe big eurozone bailout programs, and announcements of austerity measures, have not calmed the markets.
The chartcompares the Current Account Balances of advanced economies. The same weak PIIGS are obvious in the negative trade balance that dominates the Current AccountThe U.S. is not yet under attack, but with a large deficit, it is clearly on the wrong side of the equation.The single Euro currency partially exacerbates the problem. the weaker countries cannot let their currency drop, and this makes the problems worse as the debts stay fully valued. It is not unlikely that some of these countries will seek to leave the Euro pact.At the least more defaults are baked in.
Total less Greece, Iceland, Austria, Slovakia: 403,000,000,000Total less Portugal, Italy, Spain : 260,000,000,000Given 100 billion euro bailouts of Greece, how well do you think a much larger bailout of say, Spain, would be handled?the foreign debts of Greece, Portugal, Ireland and Spain are roughly €1.2 trillion.With only a 30% write-down, the funds of the EFSF would be exhausted. At 50%, back-up sources from the IMF and ECB would also be beyond their commitments.If Italy joined the demand for handouts, the system would certainly collapseThe sorts of social unrest we have seen in Greece, and recently in Spain, could very well spread, leading to open discussions of the weaker countries leaving the euro.
Typically, the IMF is brought in as a last resort for countries in a crisis. Their mode is to impose austerity to make the debts repayable.In the environment of public outcry at bailing out foreign banks, the usual austerity patterns may become unacceptable to the populace. In short, structural weaknesses in the euro make it unlikely to appreciate significantly against the dollar, despite the latter’s many problems.
Japan’s deficit will continue to worsen due to the extraordinary costs associated with reconstruction following the recent tsunami. Early estimate: $300 billionAgriculture and fishing are seriously damaged, and exports are slowed by electricity shortages, while imports will increase for construction materials.As a consequence, Japan’s traditional trade surplus will turn to deficit, and that will further hurt the yen. If the yen falls, Japan’s extremely low interest rates are likely to rise, no small matter given the scale of the government’s debt.Underscoring the many deep problems Japan is facing, prime minister Kan just announced he will step down.
China was able to quickly unleash extreme stimulus following the collapse of 2008 – expanding the country’s money supply by 58% in two years.Unfortunately this created a real estate bubble that is even bigger than the one that blew up in Japan in 1990 – and that is saying something.Chasing jobs at all cost, the Chinese have built empty cities and expensive high-rise condominiums, despite a shortage of available tenants who can afford the relatively high purchase price.The situation is almost certainly not sustainable, and recent economic statistics show high vacancy rates in housing and a decline in real estate prices.Also the country is experiencing the worst drought in 50 years, affecting its agriculture output. This has also significantly decreased hydroelectric power leading to more brownouts.A decline in Chinese manufacturing has also begun to materialize.Faced with rising inflation, the Chinese have begun raising reserve requirements and interest rates have risen, potentially setting the stage for a decline in their rate of growth. The real estate bubble and manufacturing overcapacity cloud their short-term future.China is a strong nation with a strong export business, which helps keep its renminbi currency highly valued. But the government's stimulus and printing programs mean that the currency has weak underpinnings. As an important aside, an issue that rightfully worries holders of dollar-denominated assets is whether China will continue to purchase U.S. government debt (Treasuries).They have been backing away from treasuries and buying up hard assets for some years.
So what are the implications for the US dollar? By printing new money to buy Treasury securities, the Fed was successful at driving short-term rates to zero in 2008, and at keeping them there to this day.The key point is that the Fed balance sheet grew abruptly, starting with emergency loans, then moving to QE1 and the purchase of $1.5 trillion of mortgage-backed securities, and finally QE2, when they purchased at least $600 billion of Treasuries starting in November 2010. earlier this year the Fed announced a policy change – that it will conclude QE2 this month, June 2011. The importance of this policy shift can be understood by focusing on the money created by the Fed for QE2 – the wedge at the top right of the chart.That money was used to buy Treasuries and therefore fund the deficits of the government. That wedge was big enough to completely absorb all the newly issued Treasuries since November, keeping interest rates low. Which brings us to the question of what effect the Fed’s action has had on the exchange rate of the dollar?The green line on the chart is the trade-weighted exchange rate of the dollar against major currencies. Stepping back a bit, you can see that the announcements of the large QE1 and QE2 programs sent the U.S. dollar on a steep downward slideThat is logical in that the printing up of trillions of new dollars by the Fed – classic monetary inflation – dilutes the existing stock of currency. The dollar hit new lows around the time that the Fed announced it was changing course and would be concluding the QE2 program in June, suggesting that dollar weakness was a factor in the Fed’s decision to stop its big Treasury purchases, although it doesn’t admit it. The US dollar may rally a bit here – before the next program to print more and have the FED by debt – which is pretty much inevitable.
Hitting its self-imposed debt limit isn’t anything new for the U.S. government – it happened previously in 1996, 2002, 2003, 2005 and 2006. The latest official debt limit has already been hit, in mid-May. So what are the “extraordinary measures” Treasury Secretary Geithner says will keep the government operating until August as expanding the debt limit is once again debated? The quick answer is that the government will rob other slush funds available to it, including the following:State and Local Government Securities (SLGS)Government Securities Investment Fund (G-Fund)Exchange Stabilization Fund (ESF)Civil Service Retirement and Disability Fund (CSRDF)Federal Financing Bank (FFB) swap transactionsThis is likely partially in response to end of QE2 but the Treasury as stated that it will not be incurring new treasury debt until sometime this fall at least.Without QE2 it could not do so anyway so it will likely raid other sources for shortfalls. The big question is, what happens after the debt limit is raised, as it certainly will be? At that point, on top of the aggressive demands for normal government funding, the slush funds will need to be replenished, pointing to large new Treasury auctions in which the Fed will not be present as a back stop.
Given that currencies are used to buy commodities, a good way to define the value of a currency is by the quantity of commodities it can buy.Thus there is an obvious inverse relationship between commodities and the exchange rate of a currency. Simply, when a currency weakens against a basket of more stable currencies, it is logical to expect that the price of the commodities in that currency will rise. This relationship is shown in the chart with the scale for the dollar currency exchange rate inverted to make the lines move in the similar pattern.If the dollar strengthens against other currencies, due to the ending of QE2, will the prices of commodities in dollars fall – or at least not rise so rapidly? The pattern in the chart above hides that the fluctuations in commodity prices are much bigger than the fluctuation in the exchange rate.
That’s because all of the fiat currencies are on a downward trend, so the exchange rate is not as much changed. This is why commodities are a better anchor to use in measuring real wealth. The next chart confirms that point, showing that the prices of specific commodities move much more than the exchange rate. A conclusion here is that a modest rise in the exchange rate for the dollar may not trigger an overly large down move for commodities in dollar terms.
