regarding the dollar decline (CITS Debt Watch supplement)

Dear debt-interested folk,

I have written, extensively, about how yet more
borrowing (now by all sectors) is a true 
promise of a day of reckoning.

The FRB did not want extensive debts, as of 2002,
to be their undoing, so, they committed what
I would call an unpardonable sin -- they so greatly
lowered the interest rate as to provide the wrong
signal to borrowers.

We must understand.  Most borrowers are simply 
trying to live "the American dream."

They have one or two paychecks; they buy houses
that are often too large for their actual needs;
they buy vehicles that are often too large for
their actual needs; and they lavish Christmas
presents that are often too expensive for their
means.

Who's to blame?  We must squarely say, lenders
and borrowers are both, equally to blame.  Lenders
have learned a pattern.  They will lend to all, but,
they will require higher interest rates for those
with "lesser credit histories."

And, this is fine -- in what we might call "in steady
state."

In steady state, a system behaves as expected.  Small
perturbations are readily corrected for, life goes
on "as normal."

Only by stepping back can we wonder how precarious
this "steady state" is.

Simply go back thirty years.  Or go back 85 years.

Imagine you are in a chat with any one of many
lenders of those times.  You tell the lender that they
will not only lend at the "full market price" of a house,
but they will do so, with barely any adjustment in the
interest.  To some, you say "you'll lend at 135% of the
home's price."

The lender would ask, "why would I, with any sanity,
do that?"

You would say that there are many reasons.  First, many
of the high risk borrowers are guaranteed via FHA, etc.
(but is the federal government the "infinite sink" for
moral hazard?)

You would say that, "we must not stand in the way of
the American dream, that all shall own houses."

You would say, real estate prices have been climbing
at propitious rates, and that the result is there is
"little risk."

To the credit card lender you would say that your
usurious rates ensure that those who default, are
not a threat to earnings.

To the U.S. government you would say, "current expenditure
needs are pressing, we will deal with the deficit later."

To the large population of Americans soon to enter
retirement, you would say, "someone else will figure
out how to keep S.S. and medicare solvent."

To States and municipalities you would say, "oh, there
is always deadwood to be trimmed in the schools and
in public services."

So is our current status.

***

That the Euro, the price of gold, and the price of
silver says there is something wrong -- "so what?"
We price things in "American dollars" -- and "in
God we Trust."

So is our current status.

***

Levis just announced that the last blue jean factory
will close in the US.

Such is NAFTA and free trade.

We are reminded that the "service sector" "fills
the gap" -- but -- wages are about half.

We are told that federal tax reductions will unleash
more production and more jobs -- only to find that
only 20 jobs per state were added in the last quarter.

So is our current status.

***

We hear that about 1/3rd of all species will die off
in the next few decades, because of our insatiable
thirst for energy.

The good news is, much of the increased demand for oil
is in China; the bad news is, they are "eating our lunch."

So is our current status.

***

If things are this convuluted, then, by all means, lets
not just send a few folk to Mars -- let's colonize
the place.  It won't be that much more of a hardship  :)

***

So, let me understand.  The dollar has dropped with
regard to the Euro by 20-25% in the last few months.
The price of gold is 37% higher than a year ago.
The price of silver is up 50% from a year ago, and
I can tell you it is not due to increased usage for
photography.

Why this flight to more stable forms of money if
this economy is so promising?

A letter in the Boston Globe explained, with respect
to Europe, our stock market has rised a tiny 3% in
the last half year.  So, the current boom is no longer
a belief shared elsewhere.

And, because folk in Bejing still think their economy
is "too fragile" -- the Chinese yuan remains pegged
to the dollar, making Chinese goods still flood our
markets when a "dropping dollar" should be correcting
for that.

Yes, European cars (made in Europe) are more expensive,
but, not the ones made here.  Besides, the Chinese are
introducing their own automobiles to a pegged market.

***

Could someone, please, explain to me how, even the
service economy will pay our workers when service
jobs are now being heavily exported to Canada, India,
and elsewhere?

Also, those counting the "unemployment rate" are again missing
countless people who are no longer looking.

As for the fall in the dollar, here is one of
many stories:

["fair use," "teachable moment," "archival," Section 107(a), 1976
Copyright Act and 1998 Digital Millennium Act]

Copyright 2004 U.S. News & World Report U.S. News & World Report

January 26, 2004

SECTION: MONEY & BUSINESS; Vol. 136 , No. 3; Pg. 40

LENGTH: 1603 words

HEADLINE: The Curious Shrinking Dollar

BYLINE: By Jodie T. Allen; Paul J. Lim

HIGHLIGHT: For now, a cheaper buck is mostly good news

BODY: First question: Why has the dollar been falling--now? Second
question: Has it hit bottom?

"I don't think anybody knows the answer to the 'why now' question,"
says former Treasury Secretary Robert Rubin. After all, as Alice
Rivlin, a former Federal Reserve vice chairman, observes, "the mystery
is why the dollar didn't go down sooner."

Since 1982, the United States has run an ever growing current account
deficit--the gap between what we buy and reap from investments abroad
and what foreigners sell to us and garner in returns on their U.S.
investments. That should have led foreigners to dump excess dollar
holdings on exchange markets, driving down the greenback and making
imports more expensive for Americans and U.S. exports more
competitive. This, in turn, should have corrected the U.S. trade
imbalance long before the United States ran up more than $ 3 trillion
in net debts owed to foreign governments and investors. But it didn't.
And now, with inflation minimal and the U.S. economy, corporate
profits, and consumer spirits rebounding strongly, it seems a strange
time for the dollar to be heading south. Yet, since February 2002, the
dollar has lost about a quarter of its value relative to other major
currencies. 

Why should we care? Certainly there hasn't been much reason to so far.
As Fed Chairman Alan Greenspan noted in a speech in Germany last week,
partly because of vast excess in global production capability,
"inflation, the typical symptom of a weak currency, appears
quiescent." Moreover, he noted, the now flexible international
financial system has proved able to absorb vast quantities of U.S.
debt "without measurable disruption." His remarks reinforced those of
Fed governor Ben Bernanke, who noted earlier that the Fed has the
"luxury of being patient" when it comes to raising interest rates.

A boost. Last week's report that the November trade deficit narrowed
unexpectedly, though due in large part to transitory factors, gave
hope that the weaker dollar was finally doing its job of reducing the
U.S. trade deficit. That boosted the dollar, which, by week's end, had
regained its losses since December 22. And certainly, the cheaper
dollar has improved the fortunes of firms with sizable foreign
markets: Technology and energy companies in the S&P 500 posted
earnings gains of about 88 percent and 59 percent respectively last
year. Still, says Rubin, now a top Citigroup executive, "If you walk
around Wall Street, there is enormous concern."

One worry, says economist Catherine Mann of the Institute for
International Economics, is that the dollar's painless decline has
depended heavily on foreign central banks. A big reason that a cheaper
dollar hasn't translated into a damaging rise in consumer prices, she
says, is that "Asian policy authorities have put competitiveness
first." By pegging its currency to the dollar--and buying up huge lots
of U.S. treasury securities--China has forced its Asian competitors to
follow suit. Sooner or later, the strain on its economy could force
the Chinese government to repeg the yuan, perhaps by 15 percent. This,
says Mann, will "breach the dike holding back the appreciation of
other Asian currencies. We won't have a crash, but we could have a big
step down."

Which means higher prices on those consumer imports. "There's no doubt
that the falling dollar is inflationary," says Keith Karlawish, chief
investment officer for BB&T Asset Management. Already some prices have
been rising. Last week's consumer price reading was still tame, but
the wholesale price index jumped in December to register a 4 percent
gain for 2003, its fastest rise in 13 years. On Tuesday, oil briefly
hit a post-Iraq-invasion high. Since oil is priced in U.S. dollars
globally, a further fall in the greenback could cause producers to
keep prices above OPEC's target range of $ 22 to $ 28 per barrel,
notes Morgan Stanley's Richard Berner. That could dampen the global
economic rebound.

Fed watch. Other commodities, driven by rising demand from China, have
taken far bigger leaps. Last year, for example, prices on raw
materials used in manufacturing skyrocketed 18.5 percent. Lester
Brown, president of the Earth Policy Institute, expects more pressure
on the food front. "With world grain stocks at the lowest level in 30
years and China soon to start importing grain big time, the upward
pressure on grain prices comes as no surprise," he says.

But Gregory Mankiw, who chairs the Bush administration's Council of
Economic Advisers, sees no cause for alarm. "Inflation is primarily a
monetary problem," says Mankiw, "and as long as we have a central bank
as competent as ours, I don't think inflation will be a problem."

Still, even a hint of inflation can spook the bond market, since
rising prices erode the value of fixed-income returns. That could
drive up long-term interest rates regardless of what the Fed does and
well before inflation becomes an obvious problem. Marilyn Cohen,
president of Envision Capital Management, notes that the bond market
typically starts to anticipate inflation by three to six months.
Already, the spread between the yield on 10-year Treasury
Inflation-Protected Securities and regular treasuries has widened, a
sign that the market is indeed worried about inflation down the road.

Wall Street has been banking that the dollar will weaken well into
next year. A December Merrill Lynch survey found a third of fund
managers worldwide think the dollar is still overvalued. And Standard
& Poor's Investment Policy Committee predicts the euro, which
currently trades around $ 1.24, could hit $ 1.40 sometime in 2005.
Partly this reflects confidence in an economic rebound abroad. But it
also reflects worry about imbalances in the U.S. economy. Few
economists expect an abrupt retreat from the dollar, but fear of a
hard landing lurks. The real threat is not "that the U.S. can't pay
off its debts, like Korea," says Mann. Rather it's that "investors
wake up, look at their portfolios, see that U.S. assets aren't
offering as good a return anymore and say, 'I already own a lot of
them, so I'm going to diversify.' "

A move by foreign investors to repatriate their investments would
magnify pressure on the Fed to abandon its low-interest-rate policy.
In the third quarter of 2003, foreign private investors cut purchases
of U.S. stocks and bonds other than treasuries from $ 86 billion in
the prior quarter to $ 9.6 billion--though data released last week
show a healthy influx in November. Still, notes Joseph Quinlan, chief
market strategist for Banc of America Capital Management, while
three-month money market rates here are about 1 percent, "it's double
that in the eurozone, 5.5 percent in Australia, around 4 percent in
Britain, and 2.5 percent in Canada." To be sure, U.S. equities bounced
back last year, with the tech sector scoring 50 percent gains. But
Latin American stocks soared 61 percent, emerging-market equities
jumped 55 percent, and Asian stocks 52 percent. "If you're a private
investor, why hold dollars when you get a higher rate of return
elsewhere?" asks Quinlan.

More troubling for foreign investors is that, facing huge public and
private debts, America will ultimately resort to the debtor's final
recourse: deliberately cheapening its currency and hence the value of
its obligations. Rubin and Rivlin--along with many others including,
recently, the International Monetary Fund and Goldman Sachs--fear that
the mammoth federal deficit is a red flag for foreign investors. They
project that even with steady economic growth, current policies will
push U.S. treasury debt, already at $ 7 trillion, up by another $ 5
trillion over the next decade. Add to that rising consumer debt--which
topped $ 2 trillion for the first time in November--and it seems
likely that America will be ever more dependent on the kindness of
strangers to maintain its buy-now, pay-later style.

Not so, says Mankiw. "The president has said many times that he is
committed to cutting the deficit in half." Mankiw says the State of
the Union message that Bush will deliver this week, and the budget to
be unveiled soon thereafter, will lay out spending cuts to achieve
those savings. Nor are many Americans worried about U.S. dependence.
"The fact that we are borrowing 5 percent a year of our GDP [from
foreigners] hasn't sunk in," says Lael Brainard, a senior fellow at
the Brookings Institution. But her colleague Ron Haskins, a former
senior Republican House staffer, argues that the fact that "our
financial future depends on foreigners" could resonate with the U.S.
public, especially since "we are leaving the problem to our children
and grandchildren."

For the moment, those concerns are hypothetical, says Benjamin Pace,
managing director for Deutsche Bank Private Wealth Management. Many on
Wall Street think U.S. policymakers may win this game of chicken and
not have to raise interest rates sooner than expected. After all, a
cheaper dollar also means that U.S. stocks and bonds are more
affordable overseas. And if Japan and other Asian central banks
continue to prop up the dollar and if European central
bankers--worried that their exporters will struggle if the dollar
falls farther--lower their interest rates, that could put more wind at
U.S. investors' backs. "By pushing the dollar down, the U.S. is in
effect putting pressure on other governments to stimulate their own
economies," says Francois Sicart, chairman of Tocqueville Asset
Management. And that could mean another soft landing for the dollar,
if not a permanent one.

GRAPHIC: Picture, no caption (PHOTO ILLUSTRATION BY ROB CADY--USN&WR
WITH PHOTOGRAPH BY JEFFREY MACMILLAN FOR USN&WR); Picture, TAME.
Inflation is lying low, says Fed Chairman Alan Greenspan. (DAVID Y.
LEE FOR USN&WR)

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