Central Perk: Mish's Global Economic Trend Analysis

luni, 28 februarie 2011

Mish's Global Economic Trend Analysis

US Dollar About to Lose Reserve Currency Status - Fact or Fantasy?
Clinton Tells Qaddafi "Surrender Now"; More Protests in Yemen, Bahrain, Oman
Clinton Tells to Qaddafi "Surrender Now"; More Protests in Yemen, Bahrain, Oman
Timing the China Property Crash

US Dollar About to Lose Reserve Currency Status - Fact or Fantasy?

Posted: 28 Feb 2011 04:50 PM PST

A number of sites are commenting on a Bloomberg video in which El-Erian, PIMCO Co-CEO says "Dollar could lose its reserve currency status".

Bloomberg: "Mohammad what does a weak dollar signal to you, a dollar that can't jump up here on a day like we've seen today?"

El-Erian: "It is a warning shot to America that we cannot simply assume flight to quality, flight to safety. That people are starting to worry about the fiscal situation in the U.S. They are starting to worry about the level of debt. They are starting to worry about what they hear about states and municipalities. So, I would take this as a warning shot that we cannot assume that we will maintain the standing of the reserve currency as we have in the past."

Reserve Currency Definition

Before we can debate whether or not the US will lose reserve currency standing, we must first define what it means.

Investopedia defines Reserve Currency as follows.

"A foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate."

I accept that definition. Unfortunately Investopedia rambles on with nonsense about the implications: "A large percentage of commodities, such as gold and oil, are usually priced in the reserve currency, causing other countries to hold this currency to pay for these goods."

That sentence is a widely believed fallacy. The reality is no country is obligated to hold dollars to buy goods denominated in dollars.

Currencies are Fungible

Currencies other that illiquid currencies with low or no trading volume (think of Yap Island stones or the Cuban Peso) are fungible. It is a trivial process to switch from one currency to another.

You can buy gold or silver in any country, and I assure you those transactions do not all take place in dollars. Thus, just because a commodity is widely priced in dollars does not mean it only trades in dollars.

That holds true for oil as well.

I keep pointing this out, unfortunately to no avail, that oil trades in Euros right now. There is no selling of Euros to buy dollars on the front causing the oil producers to trade dollars for euros on the back end. The oil states simply sell oil for a price in Euros and then hold Euros in their Forex reserves.

Fact and Fantasy

The first part of what El-Erian said is factual. Here it is again for convenience. "People are starting to worry about the fiscal situation in the U.S. They are starting to worry about the level of debt. They are starting to worry about what they hear about states and municipalities."

Those are true statements. Unfortunately, his "warning shot" regarding reserve currency status is fallacious.

To understand why, let's return to the definition of reserve currency: "A foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate."

Foreign Currency Reserve Factors

Trade Volumes
Trade Deficits
Currency Manipulation
Hot Money

Trade Volumes and Trade Deficit

The US happens to be at or near the top of nearly every country's trading partners. The US runs a trade deficit with most of them. Those trading partners accumulate dollars as a simple function of math. We run a deficit, someone else runs a surplus.

Some wonder why the surplus countries do not buy oil or commodities with their accumulated dollars. OK, what does Saudi Arabia, Iran, or Venezuela do with the dollars then?

Does Iran or Venezuela even hold dollars now? Think of the implications of that answer in light of the widely viewed fallacy that one needs dollars to buy oil.

Regardless, of where the dollars end up, those US dollars will eventually return home. Recall that Dubai tried to buy a US port and China tried to buy Unocal. Both were rejected for security reasons. However, those dollars will return home, with China, Japan, and the oil states buying various US assets.

Currency Manipulation

Most US trading partners do not want their currencies to rise, especially China and Japan.

Consider the Yuan which does not float. To suppress the value of the Yuan, China takes US dollars and exchanges them for Yuan at a pegged rate. China does this hoping to create job and boost exports.

The US calls this currency manipulation and it is. However, it is no more manipulative than Bernanke flooding the markets with US dollars hoping to weaken the US dollar and stimulate growth.

Hot Money

Hedge funds and other speculators have moved money to China banking on currency appreciation.

China needs to maintain currency reserves to allow for the repatriation of those US dollars. Michael Pettis at China Financial Markets points out that most of the hot money inflows into China are done by Chinese businesses that understand how to get around rules and regulations regarding currency inflows.

That argument make perfect sense, but the math remains the same regardless of where the hot money comes from.

Global Beggar-Thy-Neighbor Policies

It is pretty pale to suggest the end of the US dollar as a reserve currency when countries hold dollars as a function of math, then hold still more dollars to suppress their currencies, hoping to keep their exports up to "stimulate growth".

Mathematical Impossibility

Another mathematical relationship says the dollar, the pound, the Yen, and the Yuan cannot all be weak at the same time (relative to each other). Yet that is precisely what every country wants. It's mathematically impossible.

You can see the effect in rising commodity prices.

If commodity prices were a function of the US dollar alone, then they would be rising in US dollar terms alone. Instead there is upward pressure on commodities in all currencies.

At some point the desirability to hoard commodities will peak.

Zero Hedge Comments

Zero Hedge commented on reserve currency status about a week ago.

Regarding El-Erian's statement: "I would take this as a warning shot that we cannot assume that we will maintain the standing of the reserve currency as we have in the past"

Zero Hedge quipped:

That's a given - the question however remains, which fiat currency, if any, is willing and ready to step in and replace the USD? With all eyes continuing to be look at the CNY, how long before China finally takes the plunge to find out just who is the real reserve currency in the world?

Will Another Fiat Currency Replace the Dollar?

For starters, Zero Hedge ignored the essential trade deficit math. The US runs a trade deficit, someone else must run a trade surplus.

Second, Canadian dollar and the Swiss Franc do not have enough trading volume. More importantly, there are not enough Canadian Dollars or Swiss Francs to go around. Look at what happened to Iceland when too many plunged into the Icelandic króna.

The Canadian and Swiss economies are simply not big enough for them to be global reserve currencies. In regards to the Euro, is Europe in a better fundamental situation than the US? Would it matter even if it was? To answer the second question, please remember trade deficit math.

As for the Yuan, it is complete silliness to suggest the currency of a command-economy dictator-led country that will not even float its currency will be some sort of major reserve currency.

To the extent that China trades with Russia, South Korea, etc., local reserves in varying currencies can happen (and are happening already), but the global significance of it is wildly overstated. The amounts in question are tiny, as a simple function of math.

Will the dollar remain the global reserve currency forever? Of course not. However, it is highly unlikely any of the presumed leading Fiat candidates including the Yuan and the Keynesian wet-dream IMF SDRs (Special Drawing Rights), will take the dollar's place. SDRs are essentially a basket of currencies.

The concept of trading in baskets of currencies backed by nothing is even more ridiculous than the existing setup. People do not buy goods and services in baskets of currencies.

What can replace the dollar?

Gold, or a mechanism like gold that would impose a hard restrictions on perpetual deficits is what its takes to restore sanity. However, we may not see a significant move towards gold until there is a massive currency crisis or revolt against fiat currencies in general, not just the US dollar.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Clinton Tells Qaddafi "Surrender Now"; More Protests in Yemen, Bahrain, Oman

Posted: 28 Feb 2011 10:33 AM PST

Libyan rebels now hold about 80% of the country. France is sending an airlift of medical supplies, including doctors and nurses to aid the rebels. Think anything else might be in those planes?

Regardless, Qaddafi is holed up in Tripoli with options growing smaller by the day. The only country that might take him is Venezuela. Why anyone would take him is beyond me.

US Secretary of State Hillary Clinton has stepped up the rhetoric as International Pressure on Qaddafi Intensifies.

An international campaign to force Col. Muammar el-Qaddafi out of office gathered pace on Monday as the European Union adopted an arms embargo and other sanctions, as Secretary of State Hillary Rodham Clinton bluntly told the Libyan leader to surrender power "now, without further violence or delay."

Germany proposed a 60-day ban on financial transactions, and a spokeswoman for Catherine Ashton, the European Union's foreign policy chief, said that contacts were being established with the opposition.

Italy's foreign minister on Sunday suspended a nonaggression treaty with Libya on the grounds that the Libyan state "no longer exists," while Mrs. Clinton said the United States was reaching out to the rebels to "offer any kind of assistance."

France said it was sending medical aid. Prime Minister François Fillon said planes loaded with doctors, nurses and supplies were heading to the rebel-controlled eastern city of Benghazi, calling the airlift "the beginning of a massive operation of humanitarian support for the populations of liberated territories."

Across the region, the tumult that has been threatening one autocratic government after another since the turn of the year continued unabated. In Yemen, protests drove President Ali Abdullah Saleh to make a bid for a unity government, but the political opposition rapidly refused. An opposition leader, Mohamed al-Sabry, said in a statement that the president's proposal was a "desperate attempt" to counter major protests planned for Tuesday.

In Bahrain, protesters blocked access to Parliament, according to news agencies. In Oman, whose first major protests were reported over the weekend, demonstrations turned violent in the port city of Sohar, and spread for the first time to the capital, Muscat.

Third Night of Protests in Oman

Bloomberg reports Youth Protests Enter Third Night as Sultan Promises to Create Jobs

Hundreds of Omani protesters gathered in the city of Sohar for a third night, demanding that the government open talks on their demands for more jobs, higher pay and more representative political institutions.

Khaled Maqbuli, a leader of the protest, called on the demonstrators at a roundabout in the center of Sohar, north of the capital, Muscat, to stay peaceful and avoid confrontation with the army and the police. Two people were killed, several wounded and a supermarket set on fire over the past two days.

"We are peaceful, we have demands, we are not saboteurs," Maqbuli, 26, said through a loudspeaker. "We want the government to send civilian people to discuss our demands; we have nothing to say to the military."

Sultan Qaboos Bin Said, the country's ruler since 1970, "has received the demands of the citizens in all the provinces and is giving them his attention," state television reported.

If governments could easily create jobs they would. Look no further than the US for proof. Only private enterprise can create jobs, at least lasting ones.

Governments can only take wealth from one place and distribute it elsewhere, by taxation, by force, or by the hidden tax of inflation that comes from printing money. When the stimulus ends, so do the jobs, except the bureaucratic ones, where massive pension problems and needless bureaucrats remain.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Clinton Tells to Qaddafi "Surrender Now"; More Protests in Yemen, Bahrain, Oman

Posted: 28 Feb 2011 10:33 AM PST

An international campaign to force Col. Muammar el-Qaddafi out of office gathered pace on Monday as the European Union adopted an arms embargo and other sanctions, as Secretary of State Hillary Rodham Clinton bluntly told the Libyan leader to surrender power "now, without further violence or delay."

Germany proposed a 60-day ban on financial transactions, and a spokeswoman for Catherine Ashton, the European Union's foreign policy chief, said that contacts were being established with the opposition.

Italy's foreign minister on Sunday suspended a nonaggression treaty with Libya on the grounds that the Libyan state "no longer exists," while Mrs. Clinton said the United States was reaching out to the rebels to "offer any kind of assistance."

France said it was sending medical aid. Prime Minister François Fillon said planes loaded with doctors, nurses and supplies were heading to the rebel-controlled eastern city of Benghazi, calling the airlift "the beginning of a massive operation of humanitarian support for the populations of liberated territories."

Across the region, the tumult that has been threatening one autocratic government after another since the turn of the year continued unabated. In Yemen, protests drove President Ali Abdullah Saleh to make a bid for a unity government, but the political opposition rapidly refused. An opposition leader, Mohamed al-Sabry, said in a statement that the president's proposal was a "desperate attempt" to counter major protests planned for Tuesday.

In Bahrain, protesters blocked access to Parliament, according to news agencies. In Oman, whose first major protests were reported over the weekend, demonstrations turned violent in the port city of Sohar, and spread for the first time to the capital, Muscat.

Third Night of Protests in Oman

Bloomberg reports Youth Protests Enter Third Night as Sultan Promises to Create Jobs

Hundreds of Omani protesters gathered in the city of Sohar for a third night, demanding that the government open talks on their demands for more jobs, higher pay and more representative political institutions.

Khaled Maqbuli, a leader of the protest, called on the demonstrators at a roundabout in the center of Sohar, north of the capital, Muscat, to stay peaceful and avoid confrontation with the army and the police. Two people were killed, several wounded and a supermarket set on fire over the past two days.

"We are peaceful, we have demands, we are not saboteurs," Maqbuli, 26, said through a loudspeaker. "We want the government to send civilian people to discuss our demands; we have nothing to say to the military."

Sultan Qaboos Bin Said, the country's ruler since 1970, "has received the demands of the citizens in all the provinces and is giving them his attention," state television reported.

Timing the China Property Crash

Posted: 28 Feb 2011 02:40 AM PST

Inquiring minds are investigating Analysis of the Chinese Property Bubble by Huw McKay, Senior International Economist, for Westpac Bank.

China: strong for now but imbalances loom

The strength in China's January trade data was absolutely remarkable. Going back to 2000, the level of unadjusted exports or imports in a January month has never exceeded the level in the immediately prior December: until now. There are deep-seated seasonal reasons why this just shouldn't happen - and history had never offered an exception to the rule. So, clearly, seasonally adjusted month-on-month growth was huge - around 12% for exports and 16% for imports. Iron ore import volumes were a monthly record by almost 7%. Sure, global manufacturing had a strong end to the year and business surveys had a respectable January, but this sort of implied demand is bordering on ridiculous. While three consecutive months of triple digit growth in imports to the special economic zones through Q4 argue the export numbers should not be a total surprise (at least on the supply side, never mind who the customers are), we remain astonished by the import surge.

Yes, commodity prices rose and some public and private discretionary inventory building ahead of the lunar new year was likely underway, but neither factor goes all that far in explaining the level of apparent demand. Getting away from levels and getting back to growth, at 51%yr imports are as strong as they were in the first half of 2004, when the authorities saw fit to clamp down on out of control heavy industrial investment, overall fixed investment began the year up 53% and 24 of 31 provinces experienced power shortages as an overloaded grid strained under the pressure. Is that a good description of the current climate? No, not really, but to say that the economy has good momentum opening the year would be an egregious understatement.

So, the Chinese economy is expanding at a rapid pace – for now. However, the imbalances that have emerged in the policy induced recovery phase have not disappeared. In fact, they have been inflamed. When real estate policy began to be tightened in the first half of 2010, the volume of sales moved broadly sideways (with regional variation), but the volume of new starts continued to rise .

The implications of this are many. One, bringing these projects to completion will generate very significant demand for raw and intermediate materials. This should keep commodity markets well supported in coming months - even if a pull-back from extraordinary January import levels must be assumed, and the fact that base metals prices are extremely elevated already. But the stronger implication is that once these starts do reach completion it seems extremely unlikely that the level of sales will be high enough to comfortably absorb the new supply. That implies that the developer industry will run into some trouble later this year and into early 2012 – and that will impact on activity levels in the construction sector, with predictable flow-on effects for upstream industries inside China and out.

Estimating a precise lead time between starts and completions is not easy. The private construction cycle is young enough that it has yet to establish firm "rules of thumb" for forecasters to adopt. Chinese housing ownership reforms date back to just 1998 and the explosion in private sector housing activity dates to only 2003. We have a single national downturn to ponder (late 2008) in addition to the Shanghai experiment of 2004/05. While the cycle does appear to be settling into more of an established groove, we are not at a point where we can be confident about the leads and lags. Our best efforts suggest that a lead period of between 1½ and 2 years is a reasonable if imprecise guide. As the surge in starts dates back to the middle of 2009, the first "cluster" of completions should be hitting the market in physical form later this year, and in "off-theplan" form somewhat earlier. But the post-April rise in starts is a story for early-mid 2012. Where will sales demand be at this time against a backdrop of monetary tightening? Not high enough.

It should be emphasized that we are talking about new supply coming to market. Secondary stock is to be added to the amount of housing available for sale. When the volume of sales fell below completions in late 2008 (Chart 2) developers were forced to discount aggressively to offload their properties. In the absence of a supportive policy shift as part of the second stimulus package, realised prices could have fallen by 20-30%, essentially consuming the entire margin rumoured to be enjoyed by the luxury development sector. The policy response should events play out as expected is a vitally important question. On the one hand, history argues that the "Wen put" (an analogue of the legendary "Greenspan put") will again be exercised, thereby sparking another wave of subsidised housing speculation and downstream demand for the heavy industrial sector. On the other, the administration's oft-stated and pragmatic desire to tackle housing affordability concerns, and their desire to ignite the latent consumption impulse, might argue for a very public sacrifice of the developers. Taken together with the current focus on inflationary risks – both immediate and medium term – and a disinflationary trend emanating from residential real estate doesn't appear to be wildly inconsistent with the broader aims of policy. Whatever balance the policymakers strike, the implications will resonate far afield.