Naked Capitalism’s Yves Smith pointed to an Oct 10 2010 article written by Tim Duy as a “must read.” Coming as it was from Yves, I made it a point to read it first thing. Here is the link:
http://economistsview.typepad.com/timduy/2010/10/the-final-end-of-bretton-woods-2.html
Tim Duy’s argument contends that “an excessively high dollar is the explanation for the simultaneous existence of a sizable current account deficit and excessive unemployment.” I hadn’t thought of that before but it intuitively makes sense. He then goes on to claim that “foreign central [banks] repeatedly acted to limit dollar depreciation.” Yes, Most notably with Mexico 1994, Asian tigers 1997 and Russia 1998.
Duy states all of these observations with the dollar now below 80 cents. The only time the dollar has ever been below 80 cents was in the the first half of 2008, the 2nd half of 2009 and 2H 2010. 80 cents is the level at which the dollar repeatedly found support in the 1990s (1991,1992,1995) following the 1985 G-5 Plaza Accord and once again in 2004. The strengthening of the dollar in 2005 came about roughly 9-12 months after jobs began to be created in the US. A dollar devaluation may be the best hope for the US to create jobs again. It certainly was a contributing factor to job growth in 2004.
The dollar had to persistently decline from 2001 through 2004 before jobs began to be created following the last recession.
Duy continues:
“Currency depreciation – of substantial magnitude – is a mechanism by which economies recover from financial crisis. But we shouldn’t underestimate that challenges that accompany such an adjustment. If it happens to quickly – a sudden stop of capital – the most likely short run outcome is that the current account deficit will be resolved with import compression via a sharp drop in demand. This would be painful, to say the least.
Neither, though, is the current path – a painstakingly slow Dollar depreciation. The result so far is persistently high US unemployment, with no relief in sight.” QE2 is coming with a vengeance on Nov 3. Notes Duy, taht is the date the Fed is positioning “to declare war on Bretton Woods 2.” QE2, Duy asserts, will be a de facto “attack on the strong dollar policy.”
That attack (war) is already well underway. It began when the Fed announced its QE2 intentions on Aug 10 2010. The announcement was akin to broadcasting to the rest of the world that you had a bazooka in your pocket and were preparing to launch a few rounds from it. They telegraphed their intentions and are giving mkt participants about 3 months to get positioned for it (assuming Nov 3 is when QE2 gets underway).
I myself have been underestimating the impact and aim of QE2. I dismissed it as just another QE1. But I probably underestimated the aim of QE1 to drive the dollar down as well. The aim of QE1 to drive the dollar down you see, was disrupted by the series of potential sovereign default crises in Dubai and throughout Europe at the end of 2009 and the first half of 2010.
Fact of the matter is this: QE1 was announced on March 18 2009. The dollar decline from March 2009 to Nov 2009 (dubai world interrupted the dollar decline)was not quite disorderly but it was the most rapid decline I have ever seen and was worse than the dollar decline following the 1985 G5 Plaza Accord.
The dollar destruction that got underway in March 2009 resumed in June 2010. And guess what? The dollar decline following the June 2010 high has had an even more rapid than the dollar decline following the March 2009 high. The dollar decline off the June 2010 can not yet be characterized as disorderly either. However, we can observe that the potential for a disorderly decline in the dollar is greater than anytime since the Smithsonian Agreement of 1971.
From Wiki:
“On December 17 and 18, 1971, the Group of Ten, meeting in the Smithsonian Institution in Washington, created the Smithsonian Agreement, which devalued the dollar to $38/ounce, with 2.25% trading bands, and attempted to balance the world financial system using SDRs alone. It was criticized at the time, and was by design a “temporary” agreement. It failed to impose discipline on the U.S. government, and with no other credibility mechanism in place, the pressure against the dollar in gold continued.
This resulted in gold becoming a floating asset, and in 1971 it reached $44.20/ounce, in 1972 $70.30/ounce and still climbing. By 1972, currencies began abandoning even this devalued peg against the dollar, though it took a decade for all of the industrialized nations to do so. In February 1973 the Bretton Woods currency exchange markets closed, after a last-gasp devaluation of the dollar to $44/ounce, and reopened in March in a floating currency regime.”
Duy continues:
“Bad things happen when you fight the Fed. You find yourself on the wrong side of a whole bunch of trades. In this case, I suspect it means that Bretton Woods 2 finally collapses in a disorderly mess. There may really be no other way for it to end, because its end yields clear winners and losers. And the losers, in this case largely emerging markets, and not prepared to accept their fate.”
Bad things you might say are already underway, and is already threatening to become disorderly. Recent spikes in commodity prices and foreign currencies are an indication. The Swiss and the Aussie dollar set record highs last week, the Yen is positioned to set record highs itself in the weeks ahead despite BOJ interventions.
Gold has been making record new highs almost on a daily basis since finding a floor on July 29 2010. Other commodities have begun to take flight as well. Grains and cotton were limit up on Friday, in response to the USDA supply demand report. Corn, beans and cotton were roughly limit up on Sunday night as well. Corn has risen 15% in less than 2 sessions and Soybeans 10%.
Funny thing about that limit up day in soybeans on Friday however, The USDA confirmed soybeans would achieve a record harvest (albeit 2% below last months record harvest forecast). Think about that for a moment. Why would soybeans go limit up on confirmatory news of a record harvest? Might something be afoul and distorting the soybean and other commodity mkts? Yves Smith and many other mkt participants raised this very question two years ago in the following posts:
http://www.nakedcapitalism.com/2010/10/summer-rerun-is-the-commodities-boom-driven-by-speculation.html
http://www.nakedcapitalism.com/2008/04/commodity-volatility-creates-problems.html
These articles attribute much of the increased volatility in the commodity mkts to the recent securitization of the commodity mkts, made possible by the commodity modernization act of 2000 to circumvent the regulatory framework, limits and oversight of the CFTC.
Some quoteworthy highlights from these Naked Capitalism articles:
Rising prices and a widespread bull market in commodities should indicate that there is a growing scarcity of hard assets. However, traditional forces of supply and demand cannot fully account for recent prices.
To be precise, the normal price-inventory relationship has been altered. This is the assertion of an expanding list of bona fide hedgers, commodity professionals and economists. Specifically, dynamics have changed because securitized commodity-linked instruments are now considered an investment rather than risk management tools. Of late, this has been causing a self-perpetuating feedback loop of ever higher prices.
That means a bubble. Back to Frankfurter:
In a statement to the CFTC, Tom Buis, president of National Farmers Union, testified, “If [farmers] can’t market their crops at these higher prices, we’ve got a train wreck coming that’s going to be greater than anything we’ve ever seen in agriculture.” Billy Dunavant, head of cotton merchant Dunavant Enterprises, was more blunt, “The market is broken, it’s out of whack-someone has to step in and give some relief.”
“The system is really beginning to break down,” Mr. Grieder said. “When you see elevators start pulling their bids for your crop, that tells me we’ve got a real problem.”
“I can’t honestly sit here and tell you who is determining the price of grain,” said Christopher Hausman, a farmer in Pesotum, Ill. “I’ve lost confidence in the Chicago Board of Trade.”
David D. Lehman, director of commodity research and product development for the C.B.O.T.’s owner, the CME Group, said: “We know that the current global environment is creating challenges for many of the traditional users of our markets, and we are very concerned. But there are a lot of things that are changing and there is no silver bullet, in terms of a solution.”
Mr. Fletcher does not blame the big institutional investors stampeding into the market. “But they have contributed to the problem by making these markets so much larger – so large that they have outgrown their delivery system,” he said. “And that has detached the futures market from the cash market.”
Unfortunately, this thinking is a self-fulfilling prophecy which ultimately may feed into a negative economic cycle where legitimate commercials are squeezed out of business thereby reducing supply, protectionism gains traction, trade breaks down, hoarding ensues, riots occur and wars erupt over access.
This may sound alarmist, but industry insiders are not buying into the one-size fits all answer that emerging economies are the primary factor driving up prices from the demand side, reinforced by supply-side shocks and peak production fears. In a slowing global economy hit by a major credit crisis and reeling from a falling dollar, it is likely that money flows seeking safe haven in hard assets is the key driver of recent volatility…..
Read that last sentence over. “In a slowing global economy…reeling from a falling dollar, it is likely that money flows seeking safe haven in hard assets is the key driver of recent volatility.”
This means the world at large began adopting an “anything but dollars” policy back in 2008, and that same policy is reemerging with a vengeance in 2010 as QE2 gets underway. Tim Duy’s suspicions appear to be spot on, this is beginning to feel like the beginning of a disorderly mess. From Duy again:
“The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US.”
More on this topic is addressed by Marshall Auerbach:
