Agora Financial’s Rude Awakening

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Ouzilly, France

• The fall continues…markets plummet across Asia and the Middle East,
• The dramatis personae of the great dollar destruction,
• U.S. sneezes and global meltdowns, the tale of Mr. Anytown China and
  more…

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Joel Bowman, from the Arabian Gulf…

Global markets again capitulated to the wobbly outlook from the U.S. today.
As we write to you from the City of Gold this afternoon, the Dubai Index is
down almost 4 per cent, the Nikkei 225 lost about the same and China’s Hang
Seng scraped more than a thousand points off the year’s run to shed four and
a quarter per cent.

So much for the great “decoupling.” It seems that when the U.S. sneezes, the
world still contracts some kind of infection.

So far this month, concerns over the U.S. meltdown has pushed the MSCI
Emerging Market Index down 12% relative to profit. Two-thirds of the world’s
equity indexes have now donned their official bear market caps.

Analysts were so excited to pronounce their economies independent of the U.S.
that they forgot all about the drivers of the world’s economy…the U.S.
consumer. His strength, or weakness, determines to a large extent how much
oil is consumed, how many computers are bought and how many donuts are eaten.

If Mr. Anytown U.S.A. wants a new pair of socks, the economy of Anytown Asia
becomes one pair of socks (minus tax and Wal-Mart markup) richer. As long as
Mrs. Anytown U.S.A. needs a new hair dryer/straightener/crimper/removal kit,
the global hair care assembly line remains intact.

When the U.S.A. decides it is “driving season” or “central heating season” or
“air conditioning season,” producers of energy in Russia, Nigeria, Venezuela,
and the Middle East expect a fat paycheck for their natural resources.

But the U.S. consumer can’t keep pulling the credit lever forever…and
neither can his central bank. As some point, the credit on which all these
luxury items were bought must be replaced with hard cash. His banker won’t
stand for soft credit extensions forever…

…neither will Anytown Asia.

With every dollar the Federal Reserve churns out, the value of the foreign
dollar reserves held by creditor nations around the world diminishes. As you
might well imagine, nations toiling in the oil fields and manning the hair
crimper assembly lines around the world are not particularly thrilled about
this.

Here in the Gulf, inflation is already at record levels thanks to a vast
shortage of housing and the Gulf Cooperation Council’s (GCC) peg to the
eroding U.S. dollar. In a report issued yesterday, Merrill Lynch warned that
inflation could hit 12% in the Gulf – a twenty year high – if governments
here did not work to free their currencies from the beleaguered
greenback…or at least revalue them.

But GCC states (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United
Arab Emirates) do not only import a glut of withering U.S. promissory notes.
With the exception of Kuwait, which depegged its dinar back in May of ‘07,
they also import frivolous monetary policy. When Bernanke swooped to the
rescue if irresponsible investors last week, Gulf states were obliged to
followed suit to maintain their peg.

In a desperate attempt to avoid inflationary erosion of their petrodollar
wealth, sovereign funds have sought value in embattled financial
institutions. Luckily for them, with the calamity up and down Wall Street,
the pickin’s are plenty. So now, when Mr. and Mrs. Anytown China or Middle
East want to add a beleaguered lending outfit to their shopping cart, it’s
American bankers who line up to fill the order.

How did it all come to this, we wonder. How did the dollar become so
worthless that even emerging markets are scared to hold them?

For some thoughts on the matter, we turn to Bill Bonner, reporting from
Ouzilly, France. In the following column, Bill gives us the highlights and
lowlights of the great dollar destruction. Enjoy…

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Against the Gods
By Bill Bonner

What makes the blow up so astonishing is that it is astonishing at all…

An emergency meeting of the U.S. President’s “Plunge Protection Team” must
have been called Monday night. Any other group of chief executives, colluding
to rig prices, would have drawn, say, 5 to 10 with time off for good
behavior. But the fix was in. And the Fed announced the new price of credit
and waited to see how the rubes would react. In the event…reactions were
mixed. Asian stocks rebounded. The Dow ended the day down. Then, the
following day…it looked like the fixers might have rearranged the whole
deck; rumors of a deal to save Wall Street further losses sent the Dow up
more than 300 points. 

Thus the long-running spectacle continues. Today, for the benefit of those
who haven’t been paying attention, we clarify the plot.

The dramatis personae are many. But they fit into two camps. In one is a
whole line of Promethean protagonists — prominent economists and
politicians, beginning with Fed chairman Arthur Burns …followed by the epic
hero Alan Greenspan. Currently, the lead is being played by Ben Bernanke,
supported by George W. Bush in the White house and colleagues Mervyn King in
England and Jean-Claude Trichet at the European Central Bank. In the other
camp are, well, the gods.

It’s an antique story but the current action began in 1971, when Richard
Milhous Nixon snuck in and stole the gods’ golden fire. Not surprisingly, the
gods were cheesed off. They had put the metal in the ground themselves. And
gold’s record for maintaining steady prices was second to none. An ounce of
gold would buy about as much in 1950 as it would have in 1800…or 1700, when
Isaac Newton was Master of the Mint. But modern political economists turned
their backs on number 79 on the periodic table. They wanted a different kind
of price stability…a stability they could mess with. Henceforth, the Nixon
team announced, the world financial system would dispense with gold entirely. 
They would control the value of money themselves. They no longer needed gold
backing them up.

As to this proposition, David Ricardo spoke for the gods:

“Experience shows that neither a State nor a Bank ever had the unrestricted
power of issuing paper money, without abusing that power: in all States,
therefore, the issue of paper money ought to be under some check and control,
none seems so proper for that purpose, as that of subjecting the issues of
paper money to the obligation of paying their notes, either in gold coin or
bullion.”

And thus were the lines drawn. Who would prevail?  The gods or The Man?  It
would be a first for mankind. But in the 190 years since Ricardo wrote, had
man evolved into a more perfect being? Given a once-in-a-lifetime opportunity
to stiff foreign creditors by printing up dollars at will, would a nation of
angels be able to resist? 

You may guess the answer, dear reader. But what is extraordinary about this
tale is that the telling has taken so long. And then, when it inevitably goes
the way it always goes, people are astonished by it! 

It looked as though the question would be settled quickly when prices ran
wild in the ’70s. Inflation in July of ‘71 was almost the same as it is today
– about 4.4%. But then, Richard Nixon judged it such a threat to the nation
that he imposed price controls. Still, without gold anchoring the dollar,
prices rose. Ten years later, CPI was running over 10%…and gold had soared
over $800. The gods were having their fun.

But then, into the Fed stepped a colossus of a man; “Tall Paul” Volcker moved
quickly to rescue man’s paper money. He tightened lending and pushed up 30-
year Treasury yields over 15%. The dollar advanced and the gods retreated. 
Man was proud again. The drama seemed to be over. The fellows with their feet
on the ground had triumphed.

For the next 20 years, crises came and crises went. Each one was dealt with
by softening up man’s money with more cash and credit. And each one seemed
like such a success; man’s confidence grew. Consumer price inflation remained
low and gold fell. By ‘99, gold coins were practically the only thing you
leave on the seats of your car in Baltimore…confident that no one would
bother stealing them. And as recently as this past November, William Poole,
president of the Federal Reserve Bank of St. Louis, speaking for the whole
race and sounding like Scipio after the destruction of Carthage, announced:

“Macroeconomists today do not believe that policies to stabilize the price
level and aggregate economic activity create a hazard… Investors and
entrepreneurs have as much incentive as they ever had to manage risk
appropriately. What they do not have to deal with it macroeconomic risk of
the magnitude experienced all too often in the past.”

But this week, the macro-economic risk seemed as great as ever before. What
had gone wrong? The gods had set a trap. Between the Nixon and the Bush II
administrations, low rates of consumer price inflation caused our heroes to
err. With the quality of their money in no apparent danger, they allowed
themselves to print more and more of it. Money was available to anyone who
asked for it. For 25 years, the cost of credit fell…leading Americans to
borrow and spend …until they had borrowed and spent too much. And after the
limp recession of 2001-2002, the quantity of paper money increased even
faster – three or four times faster than GDP. Fancy new instruments – ARMs,
SIVs, CDOs, Swaps and MBSs – gave him even more rope.  And then, the gods
roared with laughter.

Gold shot up to three times its price in 1999. Oil reached $100 a barrel. 
Housing markets wobbled…credit markets crunched…and then stocks fell. 

And now Mr. Bernanke has panicked. He offers even more money and credit to a
world that already has too much. Of course, we don’t know how the contest
will turn out, but we bet on the gods.

[Joel's Note: Eager to avoid the panic? Don’t want to get caught in the
crossfire? Rather sit back and have a laugh at the whole ludicrous process?
We just started re-reading Bill Bonner’s Mobs, Messiahs and Markets:
Surviving the Public Spectacle in Finance and Politics. If you’re keen for a
fresh insight laced with trademark Bonner wit, it’s a must read. If you’ve
not done so already, grab yourself a copy here.

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——————————————————–

[Rude Endnote: Regular guest essayist, Dan Amoss, has just completed beta
testing of his newest service, the Strategic Short Report. Not surprisingly,
the results were pretty outstanding, up about 102%. Positions on Dan’s
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at the numbers and you believe all’s rosy in the world of finance, this one’s
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Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening