Brad DeLong's Semi-Daily Journal: A Weblog

What's frightening is that no one will talk about this outside of financial papers.

Btad Delong has accurately described a problem here. The sky may not be falling right now, but fall indeed it will.

Unfortunately he has not prescribed a solution. So this information, while true, is useless.

Presumeably we should not be fools and rush it, but if we do not rush in, to where - instead - should we proceed.

Doutlessly many posters on this list believe that Kerry, Rubin, or somebody has a poltical / policy type solution - but I personally doubt that they can or will solve this problem.

Rather, I'd like to know what steps I - individually - can take in response to this: Buy gold? Move to Montana and purchase on of the submachine guns that now are available? Convert to Zoarastrianism? Play the lottery and cross my fingers? What?

Noah - Here's Brad's relatively recent (7/12/04) thoughts on investment:
http://www.j-bradford-delong.net/movable_type/2004_archives/001180.html

If (since) the dollar is headed for a fall, I think I should to start buying stuff manufactured overseas , invest in learning a foreign language (Mandarin, Hindi, anyone?) or maybe buy some foreign real estate. Of course, if Bush gets elected, I may have to accelerate my timeframe. Moved to Australia when Nixon got elected - can do it again.

What should I, as a civilian, do to protect myself from a dollar crash? I have low debt, a fixed rate mortgage, and I pay off my credit cards every month. Will a dollar crash lead to hyper inflation?

"The counterweight is that the United States and its main trading partners have a vested interest in the status quo."...

This is Ms. Mann's theory?

crisis, not end of the world.

asset diversification, including Europe and AP.

So the question is, is bay area real-estate in Stage 2 or Stage 3?

Seriously, a sub-median house is nearly-unaffordable with a $100k/year+ household income,

Likewise the cost of JUST tax-ajusted interest, property tax, and homeowners insurance (not even including HOA fees of a couple hundred a month) for a condo equivelent to my apartment I'm renting would be about $100+/month more!

"Doutlessly many posters on this list believe that Kerry, Rubin, or somebody has a poltical / policy type solution - but I personally doubt that they can or will solve this problem."

Well, the prescription would be, I think, of the same type as the bitter medecine the IMF has developing countries swallow when they're headed the same way: reduce that budget deficit! That in turn should help with the current account deficit. Where, in my mind, the analysis becomes more complicated is with monetary policy prescriptions. Orthodoxy would dictate tightening money supply and raising the interest rate. That would be a lot easier to do at this stage, if this Administration's taxes had been effective in stimulating demand. So, besides reducing the deficit, one would want to elect a candidate likely to shift tax cuts away from the super-wealthy and towards higher bang-for-your-buck income brakets. One could do a lot by cancelling the existing tax cuts and offering a more modest set of tax cuts towards the poor and the middle-class cum emergency cash for states. When that starts to work, then it may well be wise to consider raising the interest rate back towards some historical norm... But that's just my opinion, obviously.

I put a very large chunk of change into a simple savings account in Australia. It pays 5% and I'll participate directly in any dollar rebalancing. I also bought more Berkshire Hathaway, because I bet you anything Warren Buffett's seeing what's going on right now and has some tricks up his sleeve. He's already done silver and 1/3 of his cash into foreign currency. He had to reveal that due to regulatory requirements I believe. And if we're about to go through some very crazy financial times, I'd much rather he be in charge of my money than me!

Gold and silver seem a good bet to hedge against the dollar as well as to play the speculation panic that may ensue once people figure out they really do have a problem.

Also, does anyone else think shorting Google at 140 times earnings might not be a bad idea?

I don't follow the real estate recommendation Brad makes at these prices. Seems to me more sensible to hold cash and pick up cheap real estate after unsensible homeowners who've borrowed beyond their capacity get slammed.

This happend in Boston in the early 90s, and as crazy as it seems now, you could get properties for a song (I did get two in fact) because the banks were desperately trying to get the defaulted-on homes off their books.

>this episode of the U.S. dollar cycle has
>officially reached stage (2).

{stage three}
>Fortified by these theories, yet more investors and speculators chasing short-term returns flood into the market, causing the anomaly to last for *much* *much* longer than economists had originally expected.

{raises hand} Taking the economy as a WHOLE however, aren't we well into stage three?

Given that the rough stock market valuation (~85% of all capitalization) is around 150% of GDP? As opposed to the 200% valuation of early 2000?

Or is there a stretched-out stage two involved? And don't these faults tend to cascade?

ash
['Welcome to Annexia!']

To DeLong it may be an issue, but it's been a longtime matter of survival for the Japanese. They're addicted to U.S. debt. Buying dollars to keep their exports affordable isn't healthy for the Japanese, either. And, like any addiction, it will continue until the disease is more painful than the cure.

In short, the dollar won't crash until the damage is guaranteed to be catastrophic. That could take some decades, though, so I wouldn't panic just yet.

"U.S. dollar cycle has officially reached stage (2)" - plenty of time to *buy* some more USD then!

It's the weak demand that's wading into the equation here, no? If we just had another house we could draw equity from for those nifty foreign gadgets. Or if they bought our Orgazmatrons instead of TBills, maybe they could juice up their demand for our exports.
I'm not sure who I like better, Mann throwing the towel in on Roach's indefatiguable "unsustainable" or Brad throwing the Dornbusch rag at Mann.
As sustained as the dollar is by the China peg and the Japanese interest arbitrage, I think Mann threw the towel a little early and I'd be surprised if the dollar were able to endure the 3 yr that Setser gives it. Australia is approaching Argentina status according to poster General Glut with a slightly higher deficit/GDP ratio. Not a senior currency of course but it may still be interesting to watch as a leading example in the same way that Britain may be a leading example for a housing market adjustment.

Besides buying Berkshire Hathaway stock, how does an ordinary investor go about protecting against a decline in the relative value of the dollar? Do you buy Swiss bonds? Euro bonds? Do you open a Canadian bank account? Australian bank account? Do you buy the Europe Stock Index? What is realistic? Vanguard does not offer an international bond fund, though there are international stock indexes and managed international stock funds.

There is some agreement that an economy with global impact, such as the US, can't continue to overspend. The question is not so much how long this binge can last, but what can realistically be done to stop the overspend.

Bearing in mind that the rest of the world depends on the overspending.

A Bretton Woods Mark2 on the Internet?

Indeed, how does an ordinary investor protect herself against a decline in the dollar whether the decline is expected to be suddenly severe or quite gradual? Trying to time declines in the dollar is not viable, unless you are a professional speculator. Precious metals funds have been terrible long term investments. Pacific stock markets have been mediocre to terrible investments since 1990. Can the Europe Stock Index be a proper long term hedge? I was taught that international bond funds entail too much risk to possible reward.

It's a tricky business trying to find alternatives that won't tumble along with the dollar. Any foriegn equity markets will be dramatically effected by a crash in US demand. The best you can hope for is the conversion back to dollars can make up for equity losses. I find that pretty unlikely. Precious metals to the retail investor or a rip and are extremely speculative. My guess is a straight currency play might be the best bet. However, which one? Asia and Europe would be under political pressure to keep thier currencies low to stimulate demand.
Counter intuitively, borrow. Payback those worthless green backs. What to do with borrowed money...still don't know.

Still on the question: how could an ordinary investor protect herself against the inevitable decline in the dollar? National politics seems to be the root of the problem.

If this is unacceptable to international investors, the dollar could be converted into a new international currency. The new currency would be tightly controlled by an international central bank; the printing of extra money would be approved by the board. Perhaps the IMF could play a role here - after all, the reform of the UN system is officially being considered at present.

I think investing now depends on whether you believe there'll be a short-term adjustment/rebalancing or a long-term slowdown. Will people wake up and panic when they figure out that, sooner or later, debt does matter? Or are we actually simultaneously deflationary due to a lethargic economy and overburdened consumer as well as inflationary with a Fed printing money like crazy and commodities prices rising?

My own personal view, probably completely wrong, is that we're in a calm now waiting for the US elections. If Bush wins, one would anticipate interest rate and dollar pressure since the deficit/debt problem is already off-the-charts dangerous and he seems not just incompetent but oblivious. I don't think investors are willing to risk their money on 4 more years of this nonsense. It seems there are only two ways out: default or the Bernanke way: print money. Which of course means inflation and big interest rate rises. If Kerry wins, I think there'll be a stock selloff as the assessment is made that corporate giveaways are over. But more than anything, one has to anticipate a slowing of the American consumer, who is simply running out of sources money. That could finally pop the housing bubble, bring down the odd bank, impose bailout pressure on the federal govt and yet more debt. Add to that the drop in corporate profits as demand slows (how can corporate America compete when there's such a high dollar?) and demand for equities looks unattractive, especially given where multiples are now.

That's all before coming to grips with entitlement and pension funding needs over the next decade or so.

And in a larger sense, what's the dollar for but to buy US goods, services and assets? There's no need to buy our goods or services if Asia can provide them at 1/5 the price. And there seems to be no great thrust to come up with the industry(ies) that the world will pay Americans the wages they're used to. So starting a business here is not obvious. There's no need, especially at these prices, to buy American commercial property or a residential property if you can't compete laborwise, or if there's nowhere to work and if your president is intentionally destroying middle class prosperity and opportunity and social services like schools and the environment.

China and Japan can continue to support the dollar to drive demand, but demand is slowing, and barring a big new source of American consumer money, demand must slow or stop or even go backwards as debt-laden Americans finally come to grips with the burdens of their debt-service. Add to that the inflation created by a government printing money to pay its debts, and the poor American consumer would seem to be in big trouble.

The last straw on the dollar would be China and Japan deciding not to support the dollar. Isn't it likely they might do this if they saw no big benefit from supporting the drowned and weakened American consumer, no decent assets to go after, and the substantial risk of a devaluation of their dollar investments as the Fed prints money to avoid default?

Can someone tell me what I'm missing?

Mann was wrong about all the IT jobs to be created here due to "cheap IT overseas" by offshoring our jobs so it would be no surprise that she is wrong again.

PaulO makes sense to me.( He might be missing the way in which Japan is exporting deflation to us and the real cost of those Chinese bargains.) Likewise poster me declining Mann's view because she made a mistake once, IS in this case the right choice (even if the reasons for that choice seem a tad this). May I plug that 'comrad' Faber link again?:
http://quote.bloomberg.com/apps/news?pid=10000039&cid=mukherjee&sid=a.7B2SsYPdIM

I hate to parade in all this rain, but in spite of the growing US current account deficit America is NOT becoming more indebted.

Since 1986 America's Net Factor Payments account (interest, dividends, profits, royaltees etc) is in SURPLUS and has been stable at +0.5% of GDP since 1986. The sine qua non of a country with an unsustainable current account expansion is that there is a growing Net Factor Payments deficit.

America's NFP surplus is due to US investors and firms earning a persistently higher return on foreign assets than foreigners earn on their US assets. E.g. Japan bought Rockefeller Center at the top of a cycle, as did Germany when it bought Chrysler.

Buying US assets at stupid prices is not the main story of course. The real return on business capital located the US is persistently higher than business capital located elsewhere, and it has been through the past 2 decades. This is the real story behind the US foreign income surplus

A link in an earlier post mentions a research paper out this month. The paper apparently argues that the colossal spending of the US overseas won't be reduced until Asia ups its exchange rates enough; both to make Asian imports more expensive and US goods much cheaper.

But surely the %age increase needed would be astronomical to achieve a substantial reduction in the US current account.

Back to IMF reform?

Peter

"The real return on business capital located the US is persistently higher than business capital located elsewhere, and it has been through the past 2 decades. This is the real story behind the US foreign income surplus."

Hmmm... Friends of mine from Hong Kong and Japan are consistently interested in buying American assets and have done so thinking our assets provide a stable value core that balances more speculative holdings in Asia. We do attract international capital.

A number of major European currencies were allowed to float within a narrow range through 1992. At that time, currency speculators began to to after several of the currencies. There were balance of payments problems, and it was clear currencies like the Pound were artificially overvalued. When the British and French currencies were forced beyond the set ranges, the currencies were allowed to devalue. The result was a sharp drop in value of about 18%, but there was no economic crisis. The economies were helped by the fall in value of the currencies, and sharp stock market declines were quickly made up. Possibly we worry too much about the value of the dollar.

I think anne makes sense. The currency drop per se isn't a net negative. On the contrary, it's exactly what the US needs to be able to compete globally again.

Peter -

I don't see why the past two decades should have much if any bearing on the coming two, which we enter with two billion new eager laborers willing to do our jobs for 1/10 the cost, which hits our companies' demand side very hard, and with an aggregate indebtedness not seen since depression days, which shunts off domestic spending and investment power. Finally we have the incredible burden of the entitlement programs and underfunded pensions to pay for coming up, which no one - right or left - seems to be able to offer serious direction in solving.

None of these three conditions, nor anything remotely close, existed in the past two decades.

Interesting comments PaulO.

In response to the question of what average investors can do:

I myself bought shares in BEGBX, American Century International Bond. It's mainly a Euro government bond fund.

The distinguishing feature (at least when I bought) is that it's one of the few international bond funds that doesn't hedge back into dollars. Presumably those which do won't offer you protection if the dollar falls.

I have no connection to the fund other than having invested in it. And of course, this advice comes with a disclaimer that I'm not an investment adviser and am not liable for any losses...

Peter vM wrote, "America's NFP surplus is due to US investors and firms earning a persistently higher return on foreign assets than foreigners earn on their US assets. E.g. Japan bought Rockefeller Center at the top of a cycle, as did Germany when it bought Chrysler."

That's true. But that still doesn't mean that the current deficit (5% GDP) can continue forever.

I don't understand the combination of economic activities. Promote job export, wring hands over inevitable current account deficit, repeat process until....

Peter's
"I hate to parade in all this rain, but in spite of the growing US current account deficit America is NOT becoming more indebted.

Since 1986 America's Net Factor Payments account (interest, dividends, profits, royaltees etc) is in SURPLUS and has been stable at +0.5% of GDP since 1986."

fails to placate me.
Does the 5.7% ( that is > 10 times this NFP number) of GDP trade deficit not put a few holes in your umbrella?
If this doesn't then I imagine the similar current accounts deficit would not have any impact either.
What would it take to make you reconsider the claim that " America is NOT becoming more indebted."

America is becoming more indebted no matter how you measure it.

Several folks have asked about how to protect the ordinary investor. Start with buying the physical metals, gold and silver. Purchase what you think is the right amont for you. Build a position here then get into the paper.

About the PM funds being bad long-term investments, it's true if you bought in 1983 and held until 1999. Look at the charts and decide for yourself. From 2001 on it's been a darn good place to have money. Get a trial subscription to lemetropolecafe.

Go into the commodities funds like PCRIX, or any other commodity fund that doesn't charge a load that follows the CRB, Rogers Raw Material Index, Goldman index, or DJAIG. Park some of your USD into debt-free natural gas companies. How about timber via a timber REIT? What about the royalty trusts that are paying 10% dividend. There are options.

An international income fund that is kind of interesting is the prubear.

Most of all, get into things and out of the dollar. Ignore the bubblevision. If people call you pessimistic, tell them it's a paradigm shift and they don't get it yet. Sheeple.

calmo wrote, "Does the 5.7% ( that is > 10 times this NFP number) of GDP trade deficit not put a few holes in your umbrella?"

Right, this was the point I was making, made more precisely.

Thanks for your support liberal. Sometimes I do wonder about some of the posts here.
What do you make of phil's REIT reccommendation? a tad late?.
But the paradigm shift I think is correct.
The details and especially the timing may be important to your portfolio, but not compared to the changes in that other world.

calmo wrote, "What do you make of phil's REIT reccommendation? a tad late?."

Not sure. He's referring to "timber REITs", which I don't know anything about. I have owned plain old REITs through the Vanguard REIT index, but it's moved up so much that I dumped most of it. Also my understanding of that sector isn't all that great.