February 04, 2004

Self Immolating Currencies

So much hinges on the dollar now. This isn't clear to most investors. It's not perceived as a threat, and probably won't be until it's too late. But the twin deficits are grinding the currency into a mush pulp. Check out the dive-bombing dollar below. The dollar matters a lot more to stock prices now than any single factor. That's why I'm spending so much time trying to make it clear that sometime this year, you're going to hear the dollar break, and it's going to start costing Americans in ways they can't imagine. Here's a quote from a Dallas Fed report on the risks to the economy in 2004. You can find the whole report at http://www.dallasfed.org/research/indepth/2004/id0401.html . The big risk is that the weak dollar leads to a sell-off in U.S. financial assets AND a powerful surge in inflation. Which means you'll wake up one day and find that your latte is 40% more expensive. "...a disorderly decline in the dollar could boost inflation fears and bond yields, thereby undoing some of the financial stimulus to housing, consumption, and investment. Currently, foreigners are lending an extra $1.5 billion a day to the U.S., much of which is in the form of central bank purchases of U.S. Treasuries." It's not just a fall in stock prices that a weak dollar prompts...but a rise wholesale and consumer prices. The study continues: The dollar could plunge if private investment sentiment shifted suddenly against investing in U.S. assets or if some foreign central banks buy less Treasury debt to keep their currencies from rising against the dollar. The dollar matters partly because a sudden decline could push up non-oil import prices (shown by the red line in Figure 12), which have an influence on core wholesale prices at the intermediate level (the blue line). The Fed report says the stage is set for a robust recovery, but that there are some remaining "headwinds." The dollar is the biggest one. What's interesting is how important business investing is to the tone of the report. And within business investing, the report mentions exactly the same subject I looked at yesterday, IT and software spending. "Looking within manufacturing, virtually all the increase in output has occurred in the high-tech sector, depicted by the blue line in Figure 5, with recent signs that output excluding high tech; the red line;has begun increasing. The revival in high tech reflects the combination of a rebound in business equipment investment and increased high-tech sales to consumers." Manufacturing output because business investment in IT is up. So shows the chart below. But it hasn't yet led to higher employment. And as I contended yesterday, it might not at all. Changes in the labor market don't take place within just the U.S. economy any more. They take place in a globalized workforce, where the division of labor is global. There's no guarantee that lost jobs in one domestic field will lead to new jobs in a new domestic field. My colleague James Boric summed up--with a lot more efficiency--the argument he saw me making: "What you are saying is...Sure, US companies may continue to invest in new equipmentnt. And in fact they might keep on coming up with the best new inventions -- that revolutionize the world. And yes, those will create new opportunitieses for workers. But it isn't likely that those jobs will be filled in the US. It would be cheaper for Intel, Microsoft and Cicso to farm out their work to Mexican or Chinese workers -- who will do the same job but for 40% less. As we become more and more technologically advanced, our machines will actually replace the need for manpower -- just like mechanized farming equipment did in the 1900s." Jamedisagreesss with me and sides with the chairman that the key issue is flexibility...and that even though we can't know what the next big thing will be that creates new jobs, there's always been one...from the railroads, to cars, to computers. Maybe. But maybe it's not a bad time to prepare yourself for a world in which all but the very best jobs migrate outside America to places where they can be done more cheaply. It's another great migration. But this time it's not to America, or even within America. It's the great migration of the world economy from the West to East...the services production capital of the world in India and the goods production capital of the world China. It's a great economic contest. And America does have some economic advantages, technology being one of them. But it's also a contest for basic natural resources. As a reviewer for a book I'm reading on China put it, "Can the Earth sustain yet another industrialized and consumption-based economy in a country with a population nearly four times that of the U.S.? Are Americans and other Westernized countries willing to relinquish some of the standard of living increases made in the past few decades to meet the growing resource demands of such international development?" You don't have to relinquish a high standard of living. You just have to prepare for the events coming. One way of doing that is to realize the gravity of the threat. Just doing that will make you much more realistic about what you have to do as an investor. And after that...you can pursue the path I've laid out in SI...profiting on the delcine of the financial economy (sometimes with leverage if you can afford the risk). Owning the assets of countries on the periphery of the Asian boom through exchange traded funds. And of course, in an age of self-immolating paper currencies, own gold.


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