Sept 21, 2011


Last week I shared some of my favorite excerpts from this past year’s My Take articles—please enjoy the following selections as well...


Toward A New Dollar Policy

April 8, 2011


The recent fall in the dollar, which was somewhat predictable--and necessary--is for the first time not being met with other nations devaluing their currencies against the dollar. Competitive devaluations typical of years past have become more difficult as interest rates in competitor countries have increased while US rates remain low and unchanged. Our competitors have little choice but to raise interest rates and fight inflation. And where that choice has not been made by governments, the market has made it for them. That choice has not yet been thrust on the United States.


For the first time in a very long time other currencies around the world have been going up while the dollar falls to historic lows against them. The dollar is in the position of encouraging exports and discouraging imports, while other nations are forced to tolerate a rise in their currencies. This has turned the international trading system on its head…


There are a lot of accusations that the Fed is intentionally depreciating the dollar to stimulate growth, and that this is somehow their “grand plan.” I disagree. The Fed's province is not the value of the dollar, internationally. The Fed is charged with providing stability of prices domestically, back-stopping the financial system, and applying monetary policies that further non-inflationary growth. It is the Treasury that is in charge of the dollar internationally. The Fed can influence the dollar's value on international markets through its monetary and interest rate policy, but the Treasury can sterilize the affects if it chooses to through buying dollars or buying and selling other currencies to offset Fed policy.


While the Fed is responsible for the domestic price index, it is the Treasury that is responsible for the international value of the dollar. To this end the Treasury is supposed to work closely with the Fed to coordinate policy. Both Greenspan and Bernanke have unfairly been accused of pursuing a cheap dollar policy that caused the dollar to fall. But the rate of inflation has fallen over the years to one of the lowest rates in history under both Fed regimes. It has fallen from almost 14% in the early eighties to .8% last year. It is the value of the dollar vis-à-vis other currencies that has fallen in recent years. This is a matter for the Treasury—not the Fed.


It is time for a change in monetary policy, away from dollar neglect towards a policy of dollar stability. Such a change, if it comes, will have a profound effect on the investment landscape we have grown accustomed to.

(Since the writing of this article the dollar has remained in a tight trading range, basis the dollar index. April, the month this article was posted marked the low of the dollar on international markets.)


The Next Big Thing


April 19, 20011


A little less than six months ago this country assumed the Bush tax rates would expire and with it would come a dramatic increase in taxes, across the board. But tax rates were extended "as is" and other taxes actually fell. We were also prepared to accept a freeze of all discretionary spending at all time highs. Instead we have pared that spending by 38 billion, with even more cuts to come.

By choosing to cut government spending more than we ever have as a nation, we are taking our first step toward facing reality. The national debate has changed from what government should spend more on, to how government can spend less. I cannot overstate what a dramatic philosophic change of direction this is. We are no longer talking about growing government, as much as reducing it.

Still before us is the vote on raising the national debt, and under scrutiny is the real cost of allowing such an act of irresponsibility. Expect a fight over the entitlements Paul Ryan wants to cut, revamp, and dismantle to the tune of some 6 trillion dollars over the next ten years. I am content to let the Tea Party freshmen fight those battles, which I delineated almost a year ago and will continue to support.

It is now time to move on to our next big step we need to take as a nation to ensure our return to prosperity and stability—tax reform. Cuts alone will be insufficient to get our house in order. Real tax reform will be needed to go the rest of the way. We need to end all corporate welfare, subsidies, and loop holes in exchange for a lower tax rate for everyone. Because corporate profits are at all-time highs and corporate cash is at record levels, this should be an easy sell. Tax reform with a stress on ending corporate welfare is something I think can be passed with this Congress and this President. The result would be what every politician wants today—increased revenue. Anyone who disputes this need only look at the history of every country who has taken this step in the past 50 years…

By 2013 this nation needs to be moving toward cuts in entitlements, a decrease in the size and scope of government, a new simpler tax code, stable and sound money domestically and internationally, real healthcare reform, regulatory reform based on private property and the protection of individual rights, and an energy policy free to produce without government help or hindrance.

It can be done.


The Death of the Euro

June 25, 2011

While most have been predicting the death of the dollar, I have been predicting the possible death of the Euro. It is too early to know exactly how the Euro crisis will play out, but the odds are high that the Euro will not survive in its present form.

The most likely scenario for Europe, I think, could look something like this:

Over time, Greece will be forced to break from the Euro Zone and return to the Drachma as its national currency. It will then allow its currency to float and seek its true market level, which would result in a major devaluation and a de facto default on creditors. All those with loans outstanding to Greece will be forced to write down these loans, and the losses could be huge. French, banks hold a lot of Greek debt and would come under heavy attack from speculators. The fall in French bank stocks would then create a liquidity squeeze, much like what happened with Lehman Bros. The world financial community would try to rally around the banking system in an effort to save it; but at a tremendous cost. (This week European bank stocks are falling dramatically. The Bank of Scotland, one of the world’s largest banks fell 11%. The European stock markets are down eight weeks in a row, and Italy’s debt has reached 100% of GDP.)

Greece would no longer be able to borrow after defaulting, and the country would be forced to live on tax receipts alone. The result would be the same kind of austerity measures they’ve been trying to avoid--only two to three times worse. Meanwhile creditors would be licking their wounds after having taken a beating on Greek bonds. Money would again become tight in Europe as creditors pulled in their risk lending and an inevitable economic contraction set in.

As governments and creditors assessed the damage, the market would likely turn to the next weakest link, and begin to attack its banking system causing fast and furious selling off of financial stocks there. That country would also be forced to part from the Euro and reestablish its own currency at substantially devalued levels. The next potential candidates to be run are Ireland, Portugal, and even perhaps Italy and Spain.

If this is the outcome, after the smoke cleared, the Euro would be represented by only the strongest, most solvent nations. Europe would be split in two, divided into a group of strong nations (the haves), and a recession torn group of financially weak nations who would then make up Europe’s have not’s.



News & Views

July 9, 2011

For some time now I have been sounding the alarm about my concern that China is worse off than people think. Three things confirm this for me. First, you cannot believe the official numbers of the Chinese government. Second, it is a command economy that controls, regulates, and dictates everything concerned with the economy and money, and plans the economy over a five year period. That is just not possible. Ask the Russians about the five year plans they carried out for almost a century.

Yet for some reason it is taken as "gospel" that China will continue to grow vigorously under this system. And third, we hear that the State has been building entire ghost towns. In other words the Chinese are erecting office complexes and apartment buildings to create construction jobs despite having no one to occupy them...

Watch out for China! Any surprise slow down there will affect world growth. And any financial shock there will be felt around the world.



QE2 Analyzed

July 22, 2011


Most believed that quantitative easing was going to bring on raging inflation as the Fed pushed first 1.3 trillion dollars, then another 600 billion dollars into the economy. The dollar was supposed to fall out of bed and it was expected that interest rates would either rise or fall substantially. My readers know that after both QE1 and QE2, I said that beyond a small increase in inflation, it would prove to be neutral.

What do the stats say now that QE2 has ended?

TBT, the ETF which tracks long term interest rates, was 32 at the start of QE2 in November. It traded at 32 this week. The USD was 75 at that time and is about 75 now. Inflation rose from .08% to 3.6% as expected. In the same period the GDP fell from 3.5% to 1.8%, while home prices declined, and stocks rose.

The purpose of QE2 was to head off a possible deflationary trend. That it did. Inflation had declined quickly from around 3 to 4% down to only .8% before the Fed stepped in. The downside to QE2 is that as planned, inflation is back at 3.6%. The possible upside being the prevention of a Japanese style deflationary recession, but that’s impossible to know for sure.

Whatever your views of the Fed's actions, I want to focus on one aspect of it. Most commentators and economists stated openly, and often, that the Fed was buying up 70% of the Treasury’s paper at the weekly auctions in an attempt to lower interest rates. This was most loudly voiced by Bill Gross and his colleagues at PIMCO.

PIMCO, the largest bond buyer in the world (after the Fed), sold their position of Treasury bills. Why? They feared the end of Fed purchasing would lead to higher interest rates. Since that time the ten year bond rate has fallen from 3.5% to 2.9%. Now I ask you, how is it possible that rates have fallen dramatically when the two largest buyers of bonds are absent as bidders? There is only one possible answer. PIMCO, and all others that espoused this view, were dead wrong. The fact is that the Fed is prevented by law from buying any paper auctioned by the Treasury. They never participated in the auctions in the first place—the Fed bought only in the secondary market—not at the Treasury auctions. That is why the Fed’s ceasing to buy had no effect on interest rates whatsoever…

QE2 will eventually be remembered by economic historians for what it really was; an anti-deflationary policy designed to avoid the kinds of mistakes made going into the Great Depression here in the US, and by Japan during its real estate boom which led to 30 years of de-leveraging and deflation. If inflation is low a year from now, I think the nation owes Mr. Bernanke and the Fed members of the Board of Governors an apology – and a debt of gratitude.



The Deficit Crisis

July 31, 2011

The Deficit talks have come a long way. Let's review the bidding: the President wanted a clean debt ceiling bill with no spending cuts. That's not going to happen. President Obama called for tax increases on the rich. That also looks unlikely. What is being talked about is a 2-3 trillion dollar cut in the increase in spending over ten years which would result in about a 6-7 trillion dollar increase in the national debt over that period. That’s not enough, but it is the first time this country is requiring spending cuts equal to the amount the debt ceiling is raised.

It's a move. Not a large one, but a move. It at least reduces government spending, and more important; it puts tax reform on the table. A committee could recommend reduced tax rates in exchange for limiting or eliminating deductions, subsidies, and corporate welfare. And even better (if it is true) is the rumor of a “trigger” that would cut government spending across the board if these objectives are not met. This is the scuttlebutt coming out of Washington at this hour…

This year—and next—the government will increase spending, regardless of income, to the highest amount any nation has ever spent in history. Yet the politicians are unable to curtail this new spending in more than a token way. This has threatened the US bond rating. So much so, that there is talk of US government bonds being downgraded by rating agencies, even with an agreement to raise the debt ceiling.

The downgrade would have an immediate negative market effect, but I think it will be limited. The reason is two-fold:

First, the market rates bonds minute to minute. Rating agencies are inferior to the market, and their ratings serve only as academic ratings. Agencies can downgrade US bonds, but would that prevent people from buying them? It's like the dollar. People all over the world use dollars as their currency of choice. Citizens of the world may someday shun the dollar and use other currencies, yet the dollar at this minute is the one piece of paper that everyone recognizes and accepts around the world. Second to the dollar is the Euro, but that is not a people’s currency. It is a government’s currency.


The same holds true for US bonds. They are the most acceptable investment in the world. Everyone knows the financial problems of the US government. A rating agency's downgrade will simply confirm what everyone already knows. So other than a temporary negative reaction, nothing will have changed. The market rating is what to watch, not some rating agency that always lags the market.


The second reason that a downgrade is no big deal? It has happened many times before. When Japan was downgraded from AAA to AA, nothing happened. Japan's markets, currency, and interest rates were never affected. Its currency has risen since despite a debt burden soaring to twice that of the US. And Japan’s interest rates have remained near zero.

I expect a downgrade. I do not see it as a threat, but a trading opportunity. I’ll gladly take whatever the market offers. We must never lose sight of the fact that the US government is on a different planet than the private sector. It is a story of “two different worlds,” the government who struggles to pay its bills and is technically broke, and the private sector which is making more money than any other nation on earth—by far!

Apple Inc. has more cash on hand at this moment than the US Government. Its income is larger per year than the GDP of most nations. And that is just one company. While the GDP in this country averaged less than 1% the first half of the year, US profits rose about 15% higher than expectations. Companies like Boeing, Caterpillar, and Netscape, just to name a few, are making more money than most governments could ever dream of.

California, one of the worse fiscal nightmares in the country, is where 90% of the world’s innovation comes from. Never take your eye off the ball, and remember there are two different worlds out there; the public sector and the private sector. The US makes its money off the private sector. The government is simply a drag on us all. It can create havoc, like it has, but even in a 1% economy; look at what this nation’s companies are capable of.

That is why I am concerned about the amount of regulation about to descend on American business. Yes I’m concerned about the slowing growth rates around the world, but the dollar is not crashing, nor are US Bonds. The demand for US bonds is 2-3 times the supply of them. And that is in these times. With everything going on today, the price of gold (in real terms) is still lower than it was in 1980. This all may seem like a giant contradiction, but again it is testimony to the strength of the private sector, and America as a country.


The Extra Mile

August 13, 2011

Beyond mere budget cutting we need to do something about the heap of regulations descending on the economy. A regulatory moratorium is in order. Once additional regulations stop, business can make plans again. Only then will they feel free to reinvest the huge mountains of cash they are sitting on.

Obamacare needs to be either repealed or reformed, although the Supreme Court may eventually do that by striking down the individual mandate. And Dodd-Frank needs a lot more reforms and a lot fewer regulations. There is much to be done: pass the free trade bills in Congress, address tort reform, extend the payroll tax cut, reform the tax system so that it is flat, fair, and less encumbered by deductions, loopholes, subsidies, and corporate welfare. In fact, immediate tax reform plans need to be drafted. A bill to allow businesses to repatriate the two trillion in cash they are sitting on abroad would be a good start.

Perhaps the biggest thing we can do to spur economic activity and job creation is to get government off the back of the energy industry. Free companies to drill for oil and gas and we will see an economic boom in this country. Imagine what a million new jobs in the private sector paired with increased tax revenue and lower gas prices would do for our economy! Liberals say this is impossible due to EPA standards. My answer? Get rid of the EPA. We would save additional billions and the bureaucrats who claim to know so much about energy can find private jobs helping to explore for it, pumping it out of the ground, or refining it.

There is much work ahead, but we must go that extra mile if we agree our goal is a smaller, less expensive, and less intrusive government. A larger more productive economy would be the result, and no matter what is actually accomplished from the above list, it is important that these issues are the ones that are aired, and that we push this kind of agenda between now and the election. The table must be set for a debate which will rouse voters to act if we are to see any lasting change. It is a referendum that is needed in November of 2012 – and it will be then that the real progress can begin.



And the intellectual battle continues…

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--Paul Nathan